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China’s Economic Arsenal: Yuan Internationalization as a Defense against Future Conflicts

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As global tensions rise and the threat of economic sanctions looms, China has taken significant steps to reduce its reliance on the US dollar and insulate its economy. The desire to safeguard against potential conflicts, such as the situation with Taiwan, has amplified the urgency to decouple from the dollar.

The unintended consequence of Western sanctions on Russia has been the bolstering of the Chinese yuan. With the restriction of transactions in US dollars, Russia turned to the yuan for international trade, leading to a surge in the share of Russian imports paid for in yuan. In fact, the yuan even surpassed the dollar as the most traded currency on the Moscow exchange for the first time in history.

China’s efforts to boost the internationalization of its currency began before the Ukraine crisis, but the conflict acted as a catalyst. The yuan’s share of the trade finance market, which underpins 80% of global trade, more than doubled between March 2021 and March 2023. Encouraging other countries to adopt the yuan for international transactions, China has reached agreements with countries like Argentina and Brazil to pay for Chinese imports in yuan instead of dollars.

China’s determination to protect its economy from potential sanctions is evident in its energy sector. In a landmark move, a Chinese company used yuan to purchase liquefied natural gas (LNG) from a French multinational, marking the first international LNG transaction conducted in yuan. By diversifying away from the dollar for essential imports like energy, China aims to secure its energy supply and reduce vulnerability.

To support the internationalization of the yuan, China has developed alternatives to traditional systems like Swift, along with the introduction of its own digital currency, the e-CNY. These technological advancements, although significant, are secondary to the political motivations behind the yuan’s global appeal. China seeks to position its currency as an attractive alternative to the dollar.

However, the campaign to decouple from the dollar also faces challenges tied to China’s domestic financial market and the party’s control over capital flows. Achieving true internationalization would require loosening the government’s grip on the currency’s valuation, which the party is reluctant to do. Balancing the yuan’s international prominence with domestic financial stability is essential to ensure the party’s economic control and political power.

China’s economic interdependence with the West makes it challenging for the West to impose severe economic punishments without harming themselves. Nevertheless, China remains committed to reducing its vulnerability and securing its economic interests. By leveraging the yuan strategically, China aims to create a financial buffer against potential sanctions and assert itself as a global power not reliant on the dollar.

While the specter of conflict and sanctions casts a shadow on international relations, China’s proactive approach to fortifying its economy through currency diversification underscores its determination to navigate an increasingly complex geopolitical landscape.

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