Wargaming a western freeze of China’s foreign reserves
The Russian invasion of Ukraine prompted comprehensive and harsh sanctions from the United States, Europe and other allied countries against Russian banks, companies and people. A remarkable measure, unprecedented for a major country, is the Western blockade of foreign exchange reserves by Russia’s central bank – the Bank of Russia (BOR) – tying up more than half of its $630 billion international reserves placed in Western financial institutions. In addition, the BOR was prohibited from trading in the US dollar, euro and British pound. I increased the geopolitical and sovereign risk of central bank reserve holdings. They have also sparked talk of the possibility of similar sanctions being imposed on China in the event of a military invasion of Taiwan. The consequences of such sanctions will be greater than the measures against Russia. The Chinese economy is ten times larger than that of Russia; it carries much more weight and is more integrated into the global economy and financial system. As a result, China has more means to retaliate against Western sanctions. This article outlines a possible scenario of Western sanctions against China and its countermeasures to illustrate the extent of possible damage on both sides.
Currently, the People’s Bank of China (PBOC) has $3.2 trillion in international reserves, the exact currency composition of which is kept secret. However, in a 2018 report, China’s State Administration of Foreign Exchange (SAFE) indicated that the USD share of its assets fell from 79% in 2005 to 58% in 2014, which is likely to have declined further since. during. Nonetheless, it is reasonable to assume that most of the PBOC’s international reserves are denominated in major currencies such as USD, Euro, Yen and British Pound, including $1.1 holdings of securities US Treasury, $217 billion in asset-backed securities (ABS) and $273 billion. billion shares. In addition, Chinese companies have made about $145 billion in foreign direct investment (FDI) in the United States and about $83 billion in the European Union. Many of these companies are state-owned or may be linked to the Chinese government, as in the case of Huawei, and may be subject to US and EU sanctions.
In response to a freeze on its foreign exchange reserves and possibly other external private sector assets, China decided to nationalize much of China’s FDI stock, worth $1.9 trillion. dollars, focusing on investments from the United States, Europe and other China-sanctioning countries. China can also freeze more than $1.2 trillion in domestic Chinese stocks and bonds held by foreign investors. Additionally, Chinese entities have taken on approximately $2.7 trillion in external debt, mostly in US dollars and euros, including a few Chinese sovereign international bonds. China can stop repaying some of these debts, using the same argument as Russia – that it is willing and able to pay, but is prevented from doing so by the actions of the US government. China can even invoke the force majeure clause if such a clause is contained in one of the foreign debt contracts. The clause allows parties to a contract to suspend performance of contractual obligations due to unforeseen government actions at the time of signing the contract. servicing China’s external debt w inflicting substantial losses on Western investors, mainly investment funds and pension funds.
As a result, in terms of on-balance sheet exposures, China holds approximately $3.4 trillion in identifiable international assets that may be subject to potential sanctions and up to $5.8 trillion in liabilities or assets. in China from international investors and companies largely from Western countries. China therefore has a wide margin of maneuver to take retaliatory measures. A war game of sanctions and counter-sanctions suggests that the losses are comparatively severe for both sides.
In addition, such a situation will significantly disrupt economic exchanges, mainly exchanges between the two parties. Given that exports represent 18.5%, a relatively large share of China’s GDP, of which about a third goes to the United States and the European Union, their disruptions could lead to a substantial drop in Chinese economic activity. . On the other hand, China accounts for 18.6% of US imports – and 22.4% of EU imports – particularly in manufactured goods and several essential products, such as pharmaceuticals and chemicals to manufacture pharmaceuticals. Therefore, disruptions to Chinese imports would lead to significant shortages, higher prices and discomfort for consumers and some producers in importing countries. The macroeconomic impact for the United States could be less severe than for China, the lower would mean that the social and political fallout from an all-out economic war with China could be greater in the United States. The economic impact on Europe would also be greater as the EU exports more, including to China, at 17.6% of GDP compared to 11.7% for the United States.
In short, in a scenario of Western sanctions coupled with Chinese countermeasures, both sides will suffer substantial damage. This could lead to a situation of economic MAD – mutual assured destruction reinforcing the more catastrophic nuclear MAD. These considerations would define the parameters of the geopolitical rivalry and the conflict between China and the West is likely to escalate in the foreseeable future to encompass all areas of relations between the two sides, but will hopefully end before the economic or military wars!
Hung Tran is a Nonresident Senior Fellow at the Atlantic Council, former Executive Director General of the International Institute of Finance and former Deputy Director of the International Monetary Fund.
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