The dollar: China's Achilles heel
How Washington has an edge over Beijing
The second phase of the US dispute against China has been severely derailed by the Covid-19 crisis. Issues have become more contentious, and tensions have become more acute.
The US is determined to build an international coalition to isolate China. These efforts, however, will likely be frustrated, and the power struggle will likely remain a bipolar one for many years to come.
The US might have more success if it focused on financial sanctions rather than its playbook approach of trade sanctions. China is significantly more vulnerable to the former than the latter.
China's economy, unlike thse USSR half a century ago, is deeply intertwined with the rest of the world. Many regions run a substantial current account surplus against China.
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This means other countries perceive the economic gains from remaining amicable to China as exceeding those from aligning solely with the US.
This is clearest in the case of Europe and much of Asia. Thus, regardless of many commonly shared concerns, such as intellectual property, technology and geopolitical reach, the rest of the world will likely prefer to 'sit on the fence' for as long as possible.
The US, on the other hand, has a far greater stake in these contentious issues. And on trade, the balance between the US and China has been very much lopsided: the US has accounted for $3.4trn of the $4.8trn trade surplus that China has accumulated against the world since it joined the World Trade Organisation.
In this global power play, China has a lot of leverage when it comes to negotiating trade disputes, given how integrated its economy is with the rest of the world. Where it does not have leverage and is remarkably vulnerable, however, is in international finance.
China has kept a tightly closed capital account throughout its development. But it has until recently relied on a consistent and plentiful external surplus that has provided it with vast sums of dollars.
As a result, while China's financial system is very insular, its economy is highly dependent on dollar funding.
This is China's Achilles heel.
Dollar financing has been crucial not only to fund domestic operations, but also for China to expand its portfolio of international assets, and to advance its global influence. Just 85% of China's Belt and Road loans are denominated in dollars.
Corporate dollar-denominated debt has ballooned, from about $20bn in 2010 to $590bn today. Many of these borrowers have little or no foreign income.
Furthermore, Chinese companies have been aggressively raising capital in the US market. China's total equity market cap in the US exceeds $1trn.
Meanwhile, crucially, China's vast external surplus, in former years accounting for 10% of GDP, has dwindled, and could soon turn negative.
As a result, China's FX reserves, while still large, have declined significantly as a share of China's economy and hard currency liabilities.
In short, China no longer has ample supply of dollars to support its expansion.
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