SHANGHAI: A sharp escalation of tensions with the United States has caused fears in China of a deepening economic war that could lead to its shutdown from the global dollar system: a devastating outlook that was once considered far-reaching but now not impossible.
Chinese officials and economists have been unusually public in recent months discussing worst-case scenarios in which China is blocked from dollar bills, or Washington freezes or confiscates some of China’s huge US debt holdings.
These concerns have galvanized some in Beijing to revive talks to strengthen the yuan̵
Some economists even float the idea of regulating the export of China-made COVID-19 vaccines in yuan, and seem to circumvent the dollar settlement with a digital version of the currency.
READ: Why China’s Yuan Goes Digital?
“Yuan internationalization was a good thing to have. It is now a must,” said Shuang Ding, director of Greater China Economic Research at Standard Chartered and a former economist at the People’s Bank of China (PBOC).
The threat of Sino-US financial “decoupling” is becoming “clear and present,” Ding said.
Although a complete separation of the world’s two largest economies is unlikely, the Trump administration has pushed for a partial decoupling in key areas related to trade, technology and financial activity.
Washington has released a barrage of measures punishing China, including proposals to exclude US lists of Chinese companies that do not meet US accounting standards and a ban on Chinese-owned TikTok and WeChat apps. Further tensions are expected in the run-up to the US presidential election on November 3.
“A broad economic war has already begun … the deadliest tactics have not yet been used,” Yu Yongding, an economist at the state-run Chinese Academy of Social Sciences who previously advised the PBOC, told Reuters.
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Yu said the ultimate sanction would mean US seizures of China’s US assets – Beijing holds over $ 1 trillion in US government debt – which would be difficult to implement and a self-inflicted wound for Washington.
But to call US leaders “extremists”, Yu said that decoupling is not impossible, so China should make preparations.
The stakes are high. Any deal by Washington to shield China from the dollar system or retaliation from Beijing for selling a large portion of US debt could break financial markets and hurt the global economy, analysts say.
Fang Xinghai, a senior securities regulator, said China was vulnerable to US sanctions and should make “early” and “proper” preparations. “Such things have already happened to many Russian companies and financial institutions,” Fang told a June forum organized by Chinese media company Caixin.
Guan Tao, former head of the international payments department for China’s government development and now head of global economics at BOC International (China), also said that Beijing should prepare for relaxation.
“We need to prepare mentally for the United States to be able to oust China from the dollar settlement system,” he told Reuters.
In a report he wrote last month, Guan called for increased use of China’s yuan data system, a cross-border interbank payment system, in global trade. Most of China’s cross-border transactions are settled in dollars via the SWIFT system, which some say leaves it vulnerable.
After a five-year period, Beijing is reviving its pressure to globalize the yuan.
The PBOC’s headquarters in Shanghai last month called on financial institutions to expand yuan trading and prioritize the use of local currency in direct investment.
Governor Yi Gang said in remarks published on Sunday that yuan internationalization is doing well, with cross-border settlements growing 36.7 percent in the first half of 2020 from a year earlier.
The internationalization of China’s own strict capital controls is still hampered. It may also face opposition from countries that have criticized China on issues ranging from the coronavirus to its breakdown of Hong Kong.
The yuan’s share of global foreign exchange reserves exceeded 2 percent in the first quarter, Yi said. It also beat the Swiss franc in June for being the fifth most widely used currency for international payments, with a share of 1.76 percent, according to SWIFT.
One way to speed up cross-border settlements would be to price a certain export in yuan, such as a possible vaccine against coronavirus, suggested Tommy Xie, head of Greater China’s research at OCBC Bank in Singapore.
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Another is to use a proposed digital yuan in cross-border transactions on the back of currency swaps between central banks and circumvent systems such as SWIFT, said Ding Jianping, a professor of finance at Shanghai University of Finance and Economics.
China has fast-track plans to develop a superb digital currency, while the PBOC has been busy signing currency swap agreements with foreign counterparts.
Shuang Ding of Standard Chartered said Beijing had no choice but to prepare for Washington’s “nuclear option” to push China out of the dollar system.
“Beijing cannot afford to be thrown into disarray when sanctions really outweigh China,” he said.