Author: Barry Eichengreen, UC Berkeley
What will be the demonstration effect of Western sanctions on Russia? And what will be the reaction of China and of other countries worried about similarly being on the outs with the United States? Will they shift their foreign exchange reserves away from US treasury bonds? Will they reduce their reliance on the dollar and US banks? Will they curtail their commercial and technological dependence on the United States, cutting supply chains and reshoring production? Will the global economy be reconfigured into rival blocs?
The answer to these questions is no. Although we have seen some movement in these directions, this has not been a result of Russian sanctions. Prior to Putin’s attack on Ukraine, the United States and China, along with other countries in their orbits, had moved some way in the direction of decoupling. The United States and China slapped tariffs on one another’s exports, and a change in US administration has brought no sign of these being reversed.
The United States has also prohibited sales to China of high-tech gear potentially useful for surveillance. In 2021, President Biden issued an executive order denying 59 Chinese defence and surveillance firms access to US investment finance.
All this is occurring against the backdrop of declining dollar dominance. The share of the dollar in foreign exchange reserves has fallen from around 70 per cent of the global total at the turn of the century to less than 60 per cent today. Most of this movement has been toward the currencies of small, open economies with strong policies, such as the Canadian and Australian dollars, South Korean won and the Swedish krone.
There is no particular reason to think that sanctions against Russia will accelerate these trends. Russia has been sanctioned not just by the United States, but by a coalition of Western countries, including Japan and Australia. Collectively, these countries are the source of 95 per cent of identified global foreign exchange reserves. This means that Russia and other countries contemplating a scenario in which they find themselves in the same position cannot hedge against sanctions risk by shifting from the dollar into other Western currencies.
Countries which face sanctions may attempt to shift to gold, as Russia has done, but gold is in limited supply. They may shift towards the Chinese renminbi, but this currency comprises less than 3 per cent of allocated foreign exchange reserves and is not a form in which China can hold foreign assets. While isolated countries, such as Russia, can shift their reserves and monetary relations in these directions, these options are not available on a large scale to the rest of the world.
It is not just US banks and clearing houses that have been prohibited from doing business with Russian institutions. Governments worried about Western countries weaponising their currencies may seek to make more payments via the renminbi. They will clear those payments using the Cross-Border Interbank Payment System (CIPS), China’s equivalent of the US Clearing House Interbank Payment System (CHIPS) or the United Kingdom’s Clearing House Automated Payments System (CHAPS).
But CIPS is still a small fish in a sea of whales. CHIPS processes 40 times as many transactions for 10 times as many participating banks worldwide — including several Chinese banks. CIPS also depends on SWIFT, the Belgium-based Society for Worldwide Interbank Telecommunications, for most cross-border messaging.
Recent events may encourage additional banks to make cross-border payments through CIPS. But it is revealing that although China has been building CIPS for seven years, its transactions and membership remain far behind those of Western clearing houses.
If sanctions on Russia will not break the world economy into Western and Eastern blocs, a Chinese incursion into Taiwan most certainly would. At a minimum, China will be subject to the same range of sanctions. Its foreign exchange reserves will be frozen and it will be barred from SWIFT. China could insist that foreign counterparties make payment exclusively in renminbi and route their payments through CIPS, but its business with the West would be decimated.
This would be an economic catastrophe for China and the world economy. And Chinese officials know it. Taiwan can derive at least some comfort from the fact that President Xi Jinping evidently cares more about the health of his economy than does President Putin.
Two windows on China’s intentions will be its use of dollars and its reliance on SWIFT. If China trims its dollar reserves, this might be an indication that it is preparing for sanctions. If China insists that foreign banks with which it does business install digital translators to convert CIPS’s Chinese language messages into their local language, this may be an indication that it anticipates being barred from SWIFT.
On the other hand, China’s moves could be innocent. Its reserve managers may simply be seeking to reap the benefits of diversification — a better combination of risk and return. Or they may only be trying to further develop the capacity of their home grown payments system. Either way, it is important to keep a watchful eye.
Barry Eichengreen is George C Pardee and Helen N Pardee Professor of Economics and Political Science at the University of California, Berkeley.