Financial Interdependence, Digitalization and Technological Rivalries: Perspectives on Future Cooperation and Integration in Sino-American Financial Systems 9783031278440, 3031278445

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Financial Interdependence, Digitalization and Technological Rivalries Perspectives on Future Cooperation and Integration in Sino-American Financial Systems René W.H. van der Linden Piotr Łasak

Financial Interdependence, Digitalization and Technological Rivalries

René W.H. van der Linden · Piotr Łasak

Financial Interdependence, Digitalization and Technological Rivalries Perspectives on Future Cooperation and Integration in Sino-American Financial Systems

René W.H. van der Linden International Business The Hague University of Applied Sciences The Hague, The Netherlands

Piotr Łasak Institute of Economics, Finance and Management Faculty of Management and Social Communication Jagiellonian University Kraków, Poland

ISBN 978-3-031-27844-0 ISBN 978-3-031-27845-7 (eBook) https://doi.org/10.1007/978-3-031-27845-7 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Cover illustration: © Melisa Hasan This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Contents

1

Introduction

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A Comparative Analysis of the Chinese and the US Financial System and Its Regulatory Environment

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China’s Deepening Integration into Global Financial Markets: Lessons Learned from Its US Counterpart

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Pre- and Post-pandemic Sino-US Inbound and Outbound Investments

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The Rise and Decline of China’s Shadow Banking Subject to a Deleveraging Policy

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Current Trends in the Digitalization Process and Related Fintech-Based Businesses of the Sino-US Financial Markets

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The Digitalization of Cross-Border Payment Systems and the Introduction of the CBDC

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The Ongoing Sino-US Trade War and Subsequent Tech War

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The Sino-US Technological Decoupling and Ways to Address It

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CONTENTS

The Future Sino-US Financial Coupling or Decoupling Accompanied by Their Fierce Rivalry with Different National Approaches

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The Current Intensifying Sino-US Rivalry and Its Impact on the Possible Future Scenarios About the International Economic Order

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Conclusions and Recommendations

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References

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Index

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List of Figures

Fig. 3.1 Fig. 3.2

Fig. 3.3

Fig. 3.4

Fig. 3.5

Fig. 4.1

Structure of China’s financial system (Source Tobin and Volz [2018]) Investments, savings, and current account surplus in China in the period 2000–2021 (as a percent of GDP) (Source Own elaboration on the basis of IMF database) Portfolio investment liabilities in China in the period 2000–2021 (millions of US dollars) (Source Own elaboration on the basis of IMF database) Foreign onshore portfolio investment in China (in trillions RMB) (Source Reprinted by permission “Rising foreign investment in China’s onshore stocks and bonds shows accelerating financial integration” by Nicholas R. Lardy and Tianlei Huang, originally published by the Peterson Institute for International Economics, January 4, 2021. (https://www.piie.com/research/piie-charts/rising-for eign-investment-chinas-onshore-stocks-and-bonds-showsaccelerating) The value of funds raised by new listings and number of IPOs in 2022 in selected countries (in billion USD) (Source Own elaboration on the basis of PWC data and other sources) Value of US FDI transactions in China, 2000–2020 (USD million) (Source Rhodium Group and National Committee on U.S.-China Relations [2021, May])

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LIST OF FIGURES

Fig. 4.2

Fig. 4.3

Fig. 5.1

Fig. 6.1

Fig. 6.2 Fig. 7.1 Fig. 7.2

Value of China’s FDI transactions in the US, 2000–2020 (Source Rhodium Group and National Committee on U.S.-China Relations [2021, May]) Annual Value of FDI Transactions between the US and China, 1990–2019 (billion USD) (Source Rhodium Group and National Committee on U.S.-China Relations [2021, May]) Shadow financing in China in the period of 2006–2020 (as a percent of GDP) (Source Own elaboration on the basis of: A. Apostolou, A. Al-Haschimi and M. Ricci, Financial risks in China’s corporate sector: real estate and beyond. In: ECB Economic Bulletin Issue 2/2022, ECB) The areas on the US financial market where banks cooperate with Fintech startups (US bank-backed deals to Fintech startups, the period of 2010–2020) (Source Here’s Where Goldman Sachs, Morgan Stanley, And Other Top Banks Are Investing In Fintech—And Why—CB Insights Research) Fintech population (December 2020) (Source Carbó-Valverde et al. [2021]) China’s cross-border RMB trade settlement (Source CEIC database; People’s Bank of China, 2021) The CBDC issuance mechanism in China (Source Own elaboration)

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66 68 81 89

List of Tables

Table 2.1 Table 2.2 Table 3.1 Table 5.1

Table 7.1 Table 7.2 Table 7.3 Table 9.1

A comparison between Sino-US financial systems between the mid-1980s and 2007 Comparison between the Chinese and US financial regulatory environment before and after the GFC The 10 largest stock exchanges in the world The comparison between shadow banking in China and in Western countries—the original and the current situation Benefits and risks of an international currency Roles of international currency The current models of cross-border RMB settlement and the planned model within e-RMB Comparison of the share in the global market of selected Chinese and US industries and products in selected years

13 16 27

52 78 79 85 106

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CHAPTER 1

Introduction

Abstract Since the 1980s China and the United States (US) became more interconnected in economic terms. However, the process of economic coupling between these two countries did not immediately result in greater interconnectedness between the financial markets of these countries. Only since the global financial crisis (GFC) of 2008–2009, the Chinese financial system has gradually changed from a traditional bank-based to a more market-oriented financial system. It triggered a massive expansion and opening of China’s capital markets to the outside world, and these financial markets are gradually broadening and deepening more in line with those in the West. At the same time, China has become increasingly important for international financial markets, especially due to its weight in international trade, but also because certain cross-border capital flows are increasing. The Chinese financial market is accompanied by the digitalization of this market and an increasing application of financial technologies. As a result, both US and China have become the world’s largest financial centers based on financial technology. Currently, the fierce competition between both countries in the global economy is primarily fuelled by their technology sectors, including world-class research expertise, deep capital pools, data abundance, and highly competitive innovation ecosystems. The US–China trade dispute has gradually turned into a tech war that increasingly reflects the change in the technology landscape between the two countries. Strong economic © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_1

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competition between China and the US in recent years has ultimately led to an economic and partial technological decoupling. However, the Sino-US financial ties are different and are more characterized by financial coupling even though this Sino-US financial interdependency has recently come under increasing pressure due to geopolitical tensions between the two countries. Keywords Bank-based financial system · Market-oriented financial system · Chinese financial system · Economic decoupling · Technological decoupling · ‘Linking strategy’ · ‘Cryptoization’ · Deleveraging · ‘Made in China 2025’ policy

Since the 1980s the US took the lead in globalizing financial markets. The US leadership, together with the rise of China’s “open door” policy since 1978, led to rapid, large-scale Sino-US financial exchange resulting in more global supply chains of mainly manufactured products. Although before the GFC of 2008–2009 the financial systems of the two countries still differed greatly, after the GFC the Chinese financial system has gradually changed from a traditional bank-based to a more marketoriented, but still strongly influenced by commercial state-owned banks driven financial system. The controlled market-oriented approach to the financial system by Chinese authorities is of two minds and can largely be understood as an attempt to reduce the threats posed by risk assets to overall financial stability while preserving sufficient bank credit to stimulate economic growth. This dual approach has been accompanied by relatively strong growth of the unregulated, but in China still strong and increasingly declining in importance bank-driven shadow banking system. This system especially gave the opportunity to finance the businesses of the strongly growing small- and medium-sized enterprises (SMEs) and to be less dependent on funding from the largest state-owned commercial banks or the so-called “Big-5”.1 However, since 2017, with an interruption due to the Covid-19 pandemic, the authorities launched a massive

1 The Industrial & Commercial Bank of China (ICBC), China Construction Bank (CCB), Agricultural Bank of China (ABC), the Bank of China (BoC), and the Bank of Communications.

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deleveraging campaign aimed at not only controlling the country’s debtto-gross domestic product (GDP) ratio, but also declining and changing the nature of China’s shadow banking and associated systemic risks. Although China has underdeveloped its capital markets for decades, since the GFC, there has been a massive expansion and opening of China’s capital markets to the outside world, and these financial markets are gradually broadening and deepening more in line with those in the West. In contrast to China’s strong fiscal and monetary stimulus response to the GFC, this response to the Covid-19 pandemic has been relatively moderate. However, the Covid-19 epidemic in China was tackled by firm lockdowns in 2022 and despite the drastic relaxations at the end of that year, the lockdowns have strongly disrupted the global value chains. As a result of the war in Ukraine, global financial conditions have changed significantly since February 2022 and downside risks to the economic outlook have significantly increased. While no global financial-systematic stability risks have been identified so far, the sharp rise in commodity prices, which has exacerbated pre-existing inflationary pressures has challenging trade-offs for central banks implementing quantitative tightening measures after more than a decade of expansionary monetary policies. The effects of the war in Ukraine will continue to reverberate worldwide and will also test the resilience of the Sino-US financial systems through various channels. Market disturbances including in commodity markets and increased counterparty risk; the emergence of “cryptoization” in emerging markets and possible cyber-related events could threaten the financial stability (IMF, 2022). As financial vulnerabilities in China remain elevated amid ongoing stress in the real estate development sector and the new possible Covid-19 outbreaks, there is still a strong focus on deleveraging and risk avoidance policies in the financial system. In the past few years, deeper reforms have improved the stability and efficiency of the Chinese financial system and transformed it into a more market-oriented global financial system. Combined with more long-term sustainability targets, this has been accompanied by an inevitable lower growth path. At the same time, China has become increasingly important for international financial markets, especially due to the weight in international trade, but also because certain cross-border capital flows are increasing. Similarly to the US, the development of the Chinese financial market is accompanied by the digitalization of this market and an increasing application of financial technologies. As a result, both US and

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China have become the world’s largest financial centers based on financial technology. Amidst this technological development, in conjunction with the economic importance of these economies, the gap in the overall economic power of both countries relative to every other country in the world has widened dramatically. At the same time, the fierce competition of both countries in the global economy is primarily fuelled by their technology sectors, including world-class research expertise, deep capital pools, data abundance, and highly competitive innovative ecosystems. As of 2019, the US–China trade dispute has gradually turned into a tech war that increasingly reflects the change in the technology landscape between the two countries. Strong economic competition between China and the US in recent years has ultimately led to an economic and partial technological decoupling ,2 the latter of which is mainly focused on digitally oriented technologies where there is a distinctive selection of business between those two largest trading nations of the world. The Chinese authorities, meanwhile, have tried to stun US businesses with their “Made in China 2025” policy,3 embracing independence and self-reliance as the main credo. As Beijing has increasingly become an economic competitor and strategic rival to Washington, national security concerns and discussion of technological decoupling arose in the US because of the benefits of economic engagement between them. Although the economic decoupling or disengagement has received considerable public attention and can be perceived as a rather self-defeating conflict, this has by no means diminished Sino-US interdependence, especially in the financial sector.

2 This pivot makes a distinction between economic and financial decoupling in the recent development that occurs between the two countries. It assumes that the economic decoupling started with the US–China trade war in 2018 that eventually turned more and more into a dispute over a forced technology transfer, limited market access, intellectual property theft, and subsidies to state-owned enterprises. Unlike the Sino-US financial decoupling and recent financial recoupling trend, their competitive economic decoupling is associated with trade or technological decoupling. 3 The “Made in China 2025” plan is a strategy by the Chinese government to transform the country into a global high-tech powerhouse across several high-tech key sectors. It seeks innovation-driven development, apply smart technologies, strengthen foundations, pursue green development, and redouble the efforts to upgrade the global manufacturing structure from low-end to high-end production. The ultimate goal is to enable more self-sufficient Chinese companies to gain more leverage over the high-tech global value chain using state support. Therefore, from a US perspective, this plan is controversial and is associated with Xi Jinping’s slogan “socialism with Chinese characteristics” creating an unfair playing field in the Chinese market.

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Through China’s “linking strategy” to make the Chinese financial system as accessible as possible to foreign, mainly US investors, the Sino-US financial ties are more characterized by financial coupling even though this Sino-US financial interdependency has recently come under increasing pressure due to geopolitical tensions between the two countries. The next phase of development of the Chinese financial markets, therefore, requires a further inflow of foreign high-quality capital, and US companies are among the pioneers of financial innovation and networking, while conversely, the presence of Chinese high-tech companies in the US is also increasing. Since the end of 2019, the Chinese government has lifted limits on foreign ownership of asset managers, securities firms, and life insurers. MasterCard and PayPal have also been admitted to the payments sector and foreign rating agencies have been allowed to rate more Chinese companies. There are sufficient incentives for the authorities to open the financial system on a larger scale. While the current account surplus has increased due to the pandemic, it has steadily declined over the past decade as a share of GDP, putting more pressure on raising capital through the financial account. As increasing competition from abroad stimulated China to develop an impressive reputation as the “world’s factory” over the last three decades, this development is now set to take place in the financial sector, whose reforms started much later than those of the manufacturing sector. The Chinese government, therefore, wants companies to attract more financing by issuing bonds and shares, to reduce dependence on bank loans. This means that the financial intermediation or channeling of funds will increasingly take place directly through the financial markets rather than indirectly through financial intermediaries or state-owned commercial banks. In short, this is a gradual transition from the Chinese to the US kind of market-oriented financial system. However, for the time being, the SinoUS financial integration is rather uneven. While inbound investments are increasingly released, China remains relatively tight with controls over its outbound investments. US efforts to reverse the trend of deeper financial integration by threatening to cut Chinese companies traded in US markets and banning US investment in Chinese companies linked to the Chinese military seem to be symbolic considering their increasing financial interdependence (Lardy et al., 2020). China has long strived to add the renminbi (RMB) the ranks of major international reserve currencies. In addition, it still has the largest stock of foreign exchange reserves denominated in US dollar (USD). Also, China is still heavily dependent on the

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US monetary system, which could cause serious harm to Chinese banks if they are excluded from it. The aim of this book is to describe the Chinese financial sector and to identify the processes leading to a change from a controlled indirect bank-based to a more direct market-oriented financial system. While the state-led “Made in China 2025” plan focuses on global high-tech manufacturing, there is a greater need to develop a consumer, innovation, and environment-driven financial system that can push forward sustainable economic growth. As a result of China’s financial reforms over the past decade, it has become increasingly attractive to foreign investors who can benefit from positive relatively high interest rates which were significantly reduced by mid-2022, relatively high GDP growth figures and a strengthening of the credibility of the RMB against the USD and the euro. As it builds a modern financial system to support its high-quality economic development over the next five years and beyond, the Chinese authorities can learn lessons from events in the US in the wake of the global financial and Covid-19 crisis. The authors of this book also investigate to what extent the Sino-US financial systems are becoming increasingly interdependent despite the focus on recent economic–technological decoupling developments. The rapid development of new technologies and their potential for economic and social changes require international standards to minimize such effects. Amid the current Sino-US technological rivalry with opposing national interests, the authors ultimately analyze the possibilities for further Sino-US financial cooperation and regulation. There is no doubt that the next phase of cooperation or competition between these two financial systems will embrace financial technology and hence a more significant role for Fintech companies. The very recent strong growth of China’s Fintech industry is the result of massive advances in information technology, growing consumer needs for more efficient financial services that are underserved by the regular banks, and the priorities now set by regulatory bodies to design the peer-to-peer lending mechanisms for poverty reduction and financial inclusion. China’s Fintech development is mainly stimulated by a shortage of supply on the formal financial market, the strong government support for promoting financial inclusion through digital technology, and a more “indulgent” regulatory environment in this regard. Since initially the SMEs were dependent on the riskier shadow banking for their funding, recently through Fintech companies and the promotion of financial inclusion a greater number of these SMEs and low-income households have access to

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financial services. While the world continues to depend on China’s manufacturing infrastructure, China’s emphasis is increasingly on developing more consumption-driven domestic markets, becoming more advanced technologically and having stronger participation in exchanging foreign financial technology. China’s amended policy to stimulate the advent of global financial companies, the anticipated expansion of the digitalization of financial services in the current decade, and the planned digitalization of the RMB internationalization including the implementation of a central bank’s digital currency (CBDC) will also open a new dimension in the financial relations between the two countries. Recently, it has become increasingly apparent that global challenges, from the pandemic to climate collapse, increasingly require greater cooperation between the two nations, not only in economic terms but also financially. As Chinese banks play an increasingly international role, it has become more important to better coordinate Sino-US financial regulation, considering different national circumstances. Among other topics, this book will provide more insight into the following key research questions: . To what extent are the Sino-US financial systems comparable? . Why are the Sino-US financial systems becoming increasingly interdependent? . What are the processes leading to a change in the Chinese financial system from a controlled indirect bank-based to a more direct market-oriented financial system? . What is the role of financial technology in the digitalization process of the Sino-US financial systems? . How did the Sino-US trade war turn into a tech and chip war in an increasingly tense geopolitical environment? . What are the main features of the current Sino-US financial coupling and economic and technological decoupling? . What is the influence of the current intensification of the Sino-US rivalry on possible future scenarios about the international economic order? All these questions are addressed in this conceptual descriptive pivot, which is structured as follows. Chapter 2 describes the Chinese and US financial systems and their regulatory environment before and after the

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GFC. It provides a comparative analysis of the Chinese and US financial system over the past decade from the indirect traditional to the direct more market-oriented Chinese financial system. Chapter 3 focuses on China’s deepening integration into global financial markets and the lessons drawn from the US counterpart. Chapter 4 gives an overview of the pre- and post-pandemic Sino-US inbound and outbound investment developments since the millennium. Chapter 5 explains the rise and decline of China’s shadow banking subject to a deleveraging policy. Chapter 6 describes the current trends in the digitalization process of the Sino-US financial markets and the development of China’s Fintech industry and its economic and social consequences. Chapter 7 deals with the digitization of cross-border payment systems and the introduction of the Central Bank Digital Currency (CBDC). Chapter 8 gives an overview of the ongoing Sino-US trade war and subsequent tech war. Chapter 9 elaborates on the Sino-US technological decoupling and ways to address it, while Chapter 10 describes the future Sino-US financial coupling or decoupling accompanied by fierce rivalry with different national approaches. Chapter 11 briefly describes the intensifying Sino-US rivalry and its impact on the possible future scenarios about the international economic order. Finally, the authors discuss some concluding remarks with possible future developments.

Reference IMF. (2022, April). Global shockwaves from the war in Ukraine test system’s resilience. The Financial Stability Report. https://www.imf.org/en/Publicati ons/GFSR/Issues/2022/04/19/global-financial-stability-report-april-2022 Lardy, N. R., & Huang, T. (2020). Policy brief 20–17: China’s financial opening accelerates. 12.

CHAPTER 2

A Comparative Analysis of the Chinese and the US Financial System and Its Regulatory Environment

Abstract The Chinese and the US financial markets represented totally different models of financial systems until the early twenty-first century. While the US financial market was deregulated, market-oriented, and developed, the Chinese market was more regulated, bank-based, underdeveloped, and subject of a strict state control. After the GFC the Chinese financial market is undergoing a major transformation and has gradually changed from indirect to direct financial intermediation of the real economy. The transformation takes place in the context of coupling between the Sino-US financial systems and the competitive economic decoupling of these economies. The financial markets’ development is a derivative of the regulatory environment. While the US market was subject to deregulation in the decades prior to the GFC, the Chinese financial market remained rather traditional with the sole purpose to support the development of the Chinese economy. After the crisis, the US financial markets are subject to many regulatory reforms aimed at providing more safety for the US and the global financial system. At the same time, the Chinese financial market is subject to a greater state control, aimed at further economic stimulus and achieving goals such as poverty alleviation and financial inclusion.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_2

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Keywords Economic decoupling · Financial coupling · Financial system · Financial regulation · Sino-US economic relations

Before the GFC, both the US market-oriented and the Chinese bankbased financial systems have undergone very different developments and regulations. However, recently it is observed that the financial interdependence has increased with a shift from indirect to more direct financial intermediation of the real economy in China. Although the Sino-US competitive economic decoupling has continued between 2018 and 2022, it is much less so when it comes to financial transactions between China and the US. It concerns the securities markets, cross-border payments, and capital flows, but also the performance of the international monetary system (Wang, 2020). The coupling of the Sino-US financial systems has especially increased during the period of competitive economic decoupling with a tense relationship regarding the exchange of mutual trade of goods and technology. As Chinese banks play an increasingly international role, it has become more important to better coordinate Sino-US financial regulation, considering different national circumstances. To properly understand the recent financial coupling, it is important to compare the Sino-US financial systems both before and after the GFC. The deregulation of financial markets, liberalization of capital flows and improvements in information and communication technology (ICT) that enabled an emerging trend of globalization during the 1980s, has made the US financial system the epicenter of the GFC. On the other hand, China’s regulated and less developed financial markets with sometimes more and other times less strict capital constraints have experienced weaker direct effects from the GFC, although the indirect effects were significant in the form of a huge drop in foreign demand for its products. This contrast led to divergent reactions, but financial regulation would have varied anyway, given the vast differences in the structure and conditions of the financial sector in the two countries. In the US, commercial and investment banks were separated by the Glass–Steagall Act (GSA) of 1933, but actions by the Fed weakened its provisions, and the legislation was repealed in 1999 with the establishment of the Gramm–Leach–Bliley Act which eliminated the GSA restrictions against affiliations between commercial and investment banks. Furthermore, this act allows banking

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institutions to provide a broader range of services, including underwriting and other dealing activities, thus establishing the possibility of universal banking activities for US banks. After the enactment of the US Gramm–Leach–Bliley Act of 1999 and similar amended banking legislation in other Western countries including the implementation of the EU’s Second Banking Directive in 1992, the so-called universal banking model was introduced. This increased both traditional commercial on-balancesheet banking activities focused on net interest margins as the main source of income, and the riskier investment off-balance-sheet banking activities focused on commission fees as the main source of income. With the advent of large financial conglomerates from the 1990s onward, the commercial and investment banking activities gradually became more and more interwoven. At the same time, the increasing financial globalization has been accompanied by rapid progress in the development of communication technology with falling costs making it practical to operate in geographically diversified financial markets. Technological developments have facilitated the growth in the range of financial services and as such stimulated universal banking resulting in a more internationally competitive environment. While traditional banking in the Western advanced economies has increasingly shifted from a supply- to demand-driven customer focus on meeting the needs of a more diverse and financially sophisticated customer base, this development has hardly taken place in the Chinese financial sector before the GFC and thus has remained rather traditional. Also, in the transition from traditional to modern banking in the West, the change of strategic focus toward creating more shareholder value reflected in its overall market capitalization instead of more asset growth reflected in the balance sheet total has hardly affected the Chinese financial system before the GFC (Casu et al., 2015). The Chinese financial market, since its creation, functioned in a significantly different way than its Western-dominated liberal capitalist counterparts. The model can be described as a “state-capitalist financial market”. For a long time, foreign financial institutions were restricted from operating in China and the domestic participants were obliged to direct market outcomes toward specific state policy. Such policy, oriented toward active contribution to the development of China’s state capitalism, was confirmed by President Xi Jinping, who in 2017 noted that the tasks of China’s financial sector were “to better serve the real economy, containing financial risks and deepening financial reforms”. The main

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features of this model, which are opposed to those of the neoliberal capital markets are discouragement of speculation, the existence of extensive regulatory oversight, the dominant role of state institutions and institutional logic-oriented toward state control, and direction of the market(s) that facilitate state policies (Petry, 2020).1 Despite these features, after the GFC of 2008, the Chinese market began its integration into global markets. The last, and strongest wave of integration began in 2017 when financial liberalization started, and Chinese financial regulators eased many of their former restrictions. The GFC can be treated as the turning point for all financial markets. One of the crucial triggers of the crisis was asset securitization. Before and during the GFC, the US financial system was characterized by a highly sophisticated and interrelated system of banks with non-banks in which credit unions (i.e., non-profit member-owned financial cooperatives) and mutual funds (i.e., companies that pool money from many investors and invest the money in securities such as stocks, bonds, and short-term debt) played a very important role. This more fragmented US financial system2 was responsible for more than half of the country’s lending and other financial services. This system took advantage of complicated instruments and markets that had developed over decades, including extensive use of derivatives and the development of securitization. As early as the 1970s, the first forms of securitization took place in the US whereby a bank transforms illiquid assets (traditionally held until maturity) into marketable asset-backed securities. Until 2007 and often seen as a major driver of the GFC, secondary marketing and hence securitization markets grew very strongly in almost all Western economies, but especially in the US markets. Although the Chinese asset-backed securitization market3 1 In contrast, the neoliberal capital markets were featured by: encourages for speculation, limited regulatory oversight, dominance of private finance capital, and institutional logic oriented on struggles for “efficiency” through creation of private profit and separation of state and market. 2 Although there are various definitions of “fragmentation” in the literature, in this book fragmentation is used to refer to how financial markets are configured. This definition is especially often used in securities markets. Trading in a securities market can be “concentrated”, i.e., when most trading is conducted at one or two trading centers or it can be “fragmented”, i.e., when orders are sent to numerous trading venues that compete with each other (Claessens, 2019). 3 China’s securitization market is regulated and influenced by multiple government authorities in addition to the People’s Bank of China. In recent years, its development

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Table 2.1 A comparison between Sino-US financial systems between the mid1980s and 2007 Chinese financial system

US financial system

Regulated underdeveloped financial markets with capital restrictions whose reins are sometimes released a bit

Deregulated developed financial markets with free cross-border capital movements that are sometimes slightly limited for inflows for too risky capital Universal banking: both commercial and investment (on- and off-balance sheet activities) Fragmented highly sophisticated and interrelated system of banks with non-banks in which credit unions and mutual funds play an important role

Traditional banking: mainly state-owned commercial (on-balance sheet) banking activities Concentrated monolithic banking system with the People’s Bank of China (PBC) as the main entity authorized to conduct operations in the country. In the early 1980s, the government opened up the banking system and allowed five state-owned regular specialized banks to accept deposits and conduct banking business Customer focus is supply-driven Strategic focus is asset size and growth Chinese government ownership of commercial banks

Bank-based financial system: relatively simple on-balance sheet financial instruments (initially hardly any securitization, but that has changed drastically since 2005)

Customer focus is demand-driven Strategic focus is returns to shareholders, creating shareholder value Investment banks play an important role as intermediary in IPOs when a company decides to go public and seeks equity funding Market-oriented financial system with complicated risky financial instruments (the largest securitization market in the world since the 1970s and significant financial derivatives markets)

Source Own elaboration based on the literature including Casu et al. (2015)

initially did not play a significant role and is still in its nascent stage, from 2005 onward this market has developed into the second largest in the world after that of the US (see Table 2.1). The US financial authorities after the GFC have enacted a broad set of regulations and laws aimed at solving the specific problems and creating a “macro-prudential” oversight mechanism to monitor future financial systemic risks. In addition, the Obama administration has made major

was driven by the need and ambition of China’s overall economic development, such as the financial market reforms led by NDRC and the Belt and Road Initiative (Phua, 2020).

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legislated changes to the financial sector through the implementation of the Dodd–Frank Act of 2010.4 It was the new, post-crisis regulation in the US oriented toward reforming the US financial market and providing protection for consumers. The scope of the regulation was very broad, from establishment of new regulatory and supervisory institutions, up to the detailed micro-, and macro-prudential regulations, oriented toward providing stability for the US financial system. The regulations addressed such risks as the problem of “too big to fail” institutions, risks coming from proprietary trading, and exchange of risky derivatives (North & Buckley, 2011). In contrast, China largely viewed the GFC as an external Western event with major internal consequences that did not reflect flaws in China’s own financial system. Despite massive government stimulus measures in late 2008, it is inevitable that over the last decade the economy gradually entered a noticeably lower growth path. This is also emphasized in the 13th (2015–2020) and 14th (2021–2025) Five Year Plan (FYP),5 where the emphasis is no longer on high quantitative, but increasingly on lower qualitative balanced sustainable economic growth. China had a significantly less sophisticated and complicated financial system and made much less use of derivatives and other complex instruments. At the time of the crisis, the bulk of credit in China was provided by banks through traditional loans. Furthermore, Chinese government entities owned the vast

4 The Dodd–Frank Wall Street Reform Act of 2010, or simply "Dodd–Frank", is the most comprehensive piece of financial reform since the Glass–Steagall Act of 1933. Glass–Steagall regulated banks after the 1929 stock market crash until it was repealed by the Gramm–Leach–Bliley Act in 1999. This regulation covered a wide range of topics, including creation of a council of US regulators, the Financial Stability Oversight Council that should identify risks that affect the entire financial industry; a mandate to apply “enhanced prudential supervision” to systemically important financial institutions, both banks and non-banks; revised rules for dealing with troubled banks, especially when they gamble with depositors’ money; risk retention rules for mortgage securitizations; tougher mortgage underwriting standards; toughened requirements for credit-rating agencies; establishment of a new consumer financial protection bureau; limitations on the ability of the Federal Reserve to lend in a crisis; and tougher limits on credit exposure to a single counterparty. 5 The new economic strategy as part of the 14th Five Year Plan (2020–2025) is called “dual circulation” with domestic circulation as the main pillar, but domestic and foreign circulation mutually reinforce each other. In other words: foreign investments and technology remain welcome, but domestic production and consumption have the first priority.

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majority of the banks’ shares and had significant influence on their overall lending policies (Eliott, D.J., 2017). After the GFC the countries participating in the G-20 group committed to fundamental reforms, oriented toward providing safety for the global financial system. The national authorities and international bodies, like Financial Stability Board (FSB) and Basel Committee of Banking Supervision (BCBS) coordinated and closely monitored the implementation of the reforms and undertook a numerous of other initiatives (FSB, 2014). In response to the GFC, the US-led G20 countries have introduced new global standards for not only higher minimum capital adequacy requirements and tougher definitions of what counts as capital for banks, but also several quantitative banking liquidity requirements implemented by the BCBS, the so-called Basel III-accord, such as a new liquidity coverage ratio (LCR) to ensure banks could survive a liquidity crisis for 30 days; and a net stable funding ratio (NSFR) to limit the extent to which banks could borrow short term and lend long term. The G20 also established the FSB to oversee standards for all aspects of the financial systems, including coordination with the BCBS (IIF, 2011; Sironi, 2018). While the Chinese authorities have accepted and signed most of the amendments to global standards introduced by BCBS and the FSB, they have had a relatively limited impact on the Chinese financial system. China’s banking capital requirements were already very high and most of the more technical changes focused on the more complex off-balance sheet activities that have remained rather modest in China. The new liquidity requirements aimed at supporting traditional depositbased funding models have already been used by most Chinese traditional commercial state-owned banks. The tightened new Western micro-prudential approach to financial regulation from 2010 has largely failed to apply to the Chinese financial system, which simply did not use the kinds of sophisticated tools and approaches common in the West. For example, changes in derivatives regulations and oversight of credit rating agencies would have made little difference in the short term to a Chinese system that relied heavily on neither. The Chinese response to the GFC was completely different. The country has not implemented one, general regulatory act, but spread the entire process over many years, implementing numerous regulations. While a process of more financial regulation has been implemented in the

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Table 2.2 Comparison between the Chinese and US financial regulatory environment before and after the GFC China

United States

1. Creation financial regulatory framework in 1. Gramm–Leach–Bliley Act of 1999 2003 which consisted of CBRC, CIRC, and (US) CSRC 2. Dodd–Frank Act of 2010 (US) 2. Creation Financial Stability and 3. Creation Orderly Liquidation Development Committee (FDSC) in 2017 and Authority combining CBRC and CIRC into one body 4. Establishment Bureau of Consumer (CBIRC) in 2018 Financial Protection 3. Numerous micro- and macro-prudential regulations related to Chinese financial system, implemented between 2010 and 2020 4. 3-Year Fintech Development Plan issued in 2019 by the Chinese central bank is oriented toward Fintech development in the country 5. China: financial regulatory reforms as part of 14th FYP (2021–2025); revised law on the central bank in October 2020 gives green light to digital RMB; closer supervision of the corporate governance of listed companies and tougher penalties for market manipulation; PBC aims to reduce the unwanted impact of the money creation of shadow banking on the monetary policy; Qualified Foreign Institutional Investors (QFII) program launched in 2002 made access to Chinese capital markets difficult but this has gradually been relaxed; creation of Stock Connect in 2014 and Bond Connect in 2017; For the first time Chinese A-shares are included in its MSCI; all foreign investors gain access to the domestic stock futures market since November 2020 BCBS micro-prudential regulations—Basel III (capital adequacy, liquidity, leverage) (China and US) Financial Stability Board regulations related to the systemic issues: macro-prudential oversight mechanism—global dimension Source Own elaboration

US after the GFC with some interruptions under the Trump administration, the Chinese authorities have started to focus more on a somewhat more lenient financial regulation without too much government intervention (see Table 2.2). The main regulatory bodies, responsible for setting rules and standards in financial services in China, embrace People’s

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Bank of China, the China Banking and Insurance Regulatory Commission, the China Securities Regulatory Commission, and the Ministry of Finance. The current structure exists since 2018, when the Chinese central government took care of the safety of the Chinese financial system and China Banking Regulatory Commission (CBRC) and China Insurance Regulatory Commission (CIRC) were combined into one body: China Banking and Insurance Regulatory Commission (CBIRC). The aim was to strengthen the financial supervision in China (Jun, 2018; Lan, 2018). Although China, before the GFC, gradually sought to imitate the Western financial system in a controlled manner as much as possible, the credit crisis caused a sharp re-evaluation of the Western financial system. Furthermore, the Chinese government chose to use excessive bank lending as the main form of economic stimulus after the crisis, while Western regulators encouraged greater caution about default risks at a more national banking level (micro-prudential supervision). Also, more attention was paid to financial systemic risks caused by the international interconnected banking system and associated contagion risks and this should be addressed by macro-prudential supervision. There were implemented numerous regulations related to Chinese financial system, especially in the period of 2010–2020. These regulations were oriented toward banking activity (bank loss provisions, bank “wealth management products” or WMPs, interbank activities, regulatory arbitrage, and many more) (Bowman et al., 2018). When considering the regulations implemented in China, some specific stages can be distinguished. Firstly, they were oriented toward the typical financial risks (credit risk, liquidity risk, etc.), secondly, they were oriented toward the shadow banking threats, and thirdly, they focus on risks related to the processes of digitalization and application of financial technology. Chinese authorities undertook many actions aimed at managing the unregulated part of the financial system. The creation of new commercial opportunities, including shadow banking, also brought new risks, which in turn required new regulations and more agile supervision. For example, banks began to take advantage of the regulatory arbitrage afforded by the opportunity to sell WMPs that effectively took loans off-balance sheet and financed them relatively cheaply, as investors almost universally assumed that no bank should be allowed to default on the promised returns. Regulators have taken a range of measures to mitigate this regulatory arbitrage, but savvy players have found new ways to do versions of the same, such as initially switching from using bank WMPs to trust company WMPs

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and then to equivalents offered by funds managers. Borrowing over the Internet is another area that brings real opportunities as well as risks. China has seen many new initiatives by the private sector over the past decade, and it is critical that regulators keep pace with these developments (Eliott, 2017). The first regulations related to the shadow banking system in China were introduced in 2010, when incumbent banks were restricted from bundling loans off-balance sheet through trust companies into WMPs. As a result, since 2013 banks were required to separate WMP funds from their own funds. The next years brought further restrictions (e.g., related to the Internet trading). Further regulatory requirements related to shadow banking market were introduced in China mostly in 2017 and 2018 (Hsu, 2020; Sutton & Taylor, 2020). Chinese authorities realized that the shadow banking system poses a significant systemic risk, and they launched a massive deleveraging campaign aimed at reduction of the shadow banking sector (Wu & Jia, 2020). Among other regulations, the important impact was caused by implementation of new asset management rules. They are aimed at similar goals and promote reduction of riskier channels of financing, promote simplification and standardization of financial operations, and reduction of leverage. As a consequence of the rules the rapid development of shadow banking system has slowed, and a gradual decline in the value of shadow banking assets is expected. The intention of the regulators was to reduce the quantity of transactions and move into a more qualitative approach. It is aimed at reduction of funding the weaker credits and explicitly focused on the shadow banking system (Mitchell, 2021). As a result of the implemented regulations, China’s shadow finance system declined between 2016 and 2020 from 60 percent of GDP to around 40 percent as regulation was tightened and the bond and equity markets were developed as more transparent alternatives which significantly reduced the accompanying systemic risk created by the system (Sutton & Taylor, 2020). The regulatory reform in China is oriented especially toward the development of a healthier financial system in this country. The main goal is not to eliminate the alternative to bank lending channels but to make them safer and more transparent (FitchRatings 2021). Apart from the direct regulations aimed at the shadow banking system, there are many other initiatives oriented toward safer development of the unregulated or less regulated parts of the Chinese financial markets. To increase transparency, the PBC insisted on creation of a credit rating system. It also recognized

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that some credits are offered by entities without financial licenses and such institutions which are not supervised by any supervision or are subject of very limited supervision. Additional aim of the regulatory initiatives is to reduce the unwanted impact of the money creation mechanism of bank’s shadow on the monetary policy in China.6 The interconnectedness between traditional banks and the shadow banking system in China has important impact on the money supply in the economy (Łasak et al., 2019; Sun, 2019). The regulations proposed in the stage of financial technology development are oriented toward encouragement of innovations and support the development of financial services offered via the Internet, and in broader sense to provide supportive environment for Fintech development (Xiang et al., 2017; Xu & Xu, 2019). The greatest example of the impact of the regulatory regime on Fintech development in China is the peer-to-peer lending sector. This is the case how regulations enabled the adaptation of Fintech innovations in the banking sector. The Chinese government adapted the peer-to-peer lending mechanisms for its own policy designed for poverty alleviation and financial inclusion (Guild, 2017). In this case the mobile phone applications and software can match borrowers and lenders without the traditional bank as an intermediary. This opportunity enables to get access to capital for small businesses and consumers who have been excluded from the lending system. The introduction of a new regulatory framework to shape the Chinese financial system is mainly aimed at building a strong sustainable economy with a close interdependence between the real and financial sector to effectively address social problems such as poverty alleviation and financial inclusion.

References Bowman, J., Hack, M., & Waring, M. (2018, March 23). Non-bank financing in China. Bulletin, Reserve Bank of Australia. Casu, B., & Girardone, C., & Molyneux, P. (2015). Introduction to banking (2nd ed.). Pearson. 6 Bank’s shadow is defined as money creation through accounting treatments that

generate liabilities from assets. It is distinguished from traditional shadow banking which refers to credit creation that refers to non-bank financial intermediaries through money transfer. The bank’s shadow activity provides funding for enterprises, but it circumvents regulatory restrictions and formal constraints on lending and interferes into monetary policy.

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Claessens, S., Frost, J., Turner, G., & Zhu, F. (2018). Fintech credit markets around the world: Size, drivers and policy issues. BIS Quarterly Review September. Claessens, S. (2019). Fragmentation in global financial markets: Good or bad for financial stability? (BIS Working Papers No. 815 October). Elliott, D. J. (2017). Living in two worlds: Chinese and U.S. financial regulation. Centre for Strategic and International Studies. https://www.csis.org/livingtwo-worlds-chinese-and-us-financial-regulation FitchRatings. (2021, April 4). China shadow-financing reforms positive for financial stability. https://www.fitchratings.com/research/non-bank-financ ial-institutions/china-shadow-financing-reforms-positive-for-financial-stability20-04-2021 FSB. (2014, November 14). Overview of progress in the implementation of the G20 recommendations for strengthening financial stability. https://www.fsb. org/2014/11/overview-of-progress-in-the-implementation-of-the-g20-rec ommendations-for-strengthening-financial-stability-5/ Guild, J. (2017). Fintech and the future of finance. Asian Journal of Public Affairs, 17–20. Hsu, S. (2020). Government policy’s influence on shadow banking in China. https://www.peri.umass.edu/publication/item/1240-government-policy-sinfluence-on-shadow-banking-in-china IIF, S. (2011). The cumulative impact on the global economy of changes in the financial regulatory framework. Institute of International Finance. Jinghao, Z. (2022). Great power competition as the new normal of China-US relations. Palgrave Macmillan. Lan, P. (2018, July 4). Regulatory reshuffle in China’s financial governance. East Asia Forum. https://www.eastasiaforum.org/2018/07/04/regulatory-reshuf fle-in-chinas-financial-governance/ Łasak, P., & van der Linden, R. W. H. (2019). The financial implications of China’s belt and road initiative. SpringerLink. https://link.springer.com/ book/10.1007%2F978-3-030-30118-7 Mitchell, T. (2021, March 18). Chinese economy: Beijing’s war on the credit boom. https://www.ft.com/content/b99e2348-8e20-4635-b649-fffc22a9874c North, G., & Buckley, R. (2011). The Dodd-Frank Wall Street reform and Consumer Protection Act: Unresolved issues of regulatory culture and mindset. Melbourne University Law Review, 35(2), 479–522. Petry, J. (2020). Same same, but different: Varieties of capital markets, Chinese state capitalism and the global financial order. Competition & Change, 1024529420964723. https://doi.org/10.1177/1024529420964723 Phua, P. (2020). Structured finance and securitisation in China: Overview. Thomson Reuters. https://uk.practicallaw.thomsonreuters.com/1-501

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Sironi, A. (2018). The evolution of banking regulation since the financial crisis: A critical assessment (SSRN Scholarly Paper ID 3304672). Social Science Research Network. https://doi.org/10.2139/ssrn.3304672 Sun, G. (2019). China’s shadow banking: Bank’s shadow and traditional shadow banking. 47. Sutton, M., & Taylor, G. (2020). Shadow Financing in China. 13. Wang, J. (2020, September 21). Why US won’t ‘decouple’ from China in finance. China Daily. https://www.chinadaily.com.cn/a/202009/21/WS5 f67fceca31024ad0ba7aa9e.html Wu, X., & Jia, D. (2020, December 7). China’s $13tn shadow banking sector gets clearer definition. Nikkei Asia. https://asia.nikkei.com/Spotlight/Cai xin/China-s-13tn-shadow-banking-sector-gets-clearer-definition Xiang, X., Lina, Z., Yun, W., & Chengxuan, H. (2017). China’s path to FinTech development. European Economy, 2, 143–159. Xu, Z., & Xu, R. (2019). Regulating fintech for sustainable development in the People’s Republic of China.

CHAPTER 3

China’s Deepening Integration into Global Financial Markets: Lessons Learned from Its US Counterpart

Abstract China’s deeper integration into global financial markets and the lessons learned from its US counterpart includes, among others, the following developments: First, the emergence of China’s largest banking sector in the world in terms of Tier 1 capital and a more diverse financial system including insurance and non-bank financial institutions and a rapidly growing stock and bond market. Second, deeper market-oriented reforms including the reduction of implicit guarantees, interest rate, and capital account reforms to improve the stability and efficiency of the financial system and in addition an integration into the global financial system. Third, a transition from indirect bank-based to direct marketoriented financing to serve the real economy. In addition to introducing a more market-oriented, registration-based Initial Public Offering system, Chinese authorities have also fostered innovations and created an electronic trading system similar to Nasdaq’s model. This has contributed to the addition of many more technology companies to the Chinese stock market. Progress has also been made in the Chinese bond market and the financial sector has become more open. In addition, China has eased restrictions on foreign real estate in the financial sector. Fourth, the recent rapid increase in foreign holdings of onshore RMB-denominated Chinese securities has been caused, among other things, by the massive expansion and opening of the Chinese capital markets to the outside world; © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_3

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the gradual broadening and deepening of the opening of the capital markets; the inclusion of Chinese securities in global indices and investor portfolios; the liberalization that allows foreign investors greater access to hedging instruments and relatively higher interest rates on Chinese corporate and sovereign bonds. Keywords Market capitalization · “Financial dependency triangle” · Non-performing loans · “Direct financing channels” · Market-oriented · registration-based IPO system · Onshore RMB-denominated Chinese securities · Technology-focused markets · Burgeoning technology industry · Stock-, Bond- and Swap Connect · MSCI Emerging Markets Index · Qualified Foreign Institutional Investors

China’s World’s Biggest Banking Sector and Its Stock Exchanges The first notable change in the Sino-US financial system that has gradually occurred after the GFC is the importance of the largest Chinese banks relative to their US counterparts in terms of total assets and deposits (Tier 1 capital). Over the past decade, Chinese commercial banks have expanded their balance sheets at an unprecedented rate, extending massive amounts of new loans to businesses and local governments. This expansion was initially set in motion by the Chinese government’s stimulus policy at the start of the GFC, but soon gained momentum of its own. Since the GFC, China’s banking sector has more than quadrupled and has now become the largest in the world ranked by total assets. The ICBC, CCB, ABC, and the BoC are currently the four largest banks of the world by total assets and deposits.1 Before the GFC, the Bank of 1 There are more than 4,000 commercial banks, the six largest state-owned banks, i.e., ICBC, CCB, ABC, BoC, Postal Savings Bank of China, and the Bank of Communications, have 47% or USD 15.9 trillion owned all assets of commercial banks. The banking industry comprises of three wholly state-controlled policy banks, namely the Agricultural Development Bank of China, China Development Bank, and The Export–Import Bank of China. The policy banks were established in 1994 to support the government’s economic goals to finance economic and trade development, and state investment projects by issuing bonds. In addition, there are 12 joint-stock banks, which hold an additional 21% of the total assets of commercial banks. There are also many regional banking institutions with

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America, Citigroup, HSBC (UK) and JPMorgan Chase were the biggest banks of the world measured by the same standards according to the Tier 1 capital standards. However, GP Morgan Chase is still the secondlargest bank in 2023 in terms of market capitalization, after ICBC. This massive shift shows how strong China’s banking system in the world has become compared to the Western banking industry, especially in comparison to the US. For many years, China has continued to outperform its closest rival, the US, in Tier 1 capital and asset growth, despite the economic downturn due to tight and unpredictable Covid-19 policies. China expanded its total Tier 1 capital by 14.4% (versus 4.7% for the US) and total assets by 10.9% (versus 8.8% for the US) (The Banker, 2022). In addition to a strong banking sector, in the past decade, China has also developed a more diverse financial system including insurance and non-bank financial institutions and a rapidly expanding stock and bond market. A wide range of financial institutions including brokers, pawn shops, trust-, financial leasing-, micro-credit-, venture capital-, credit guarantee- and Fintech companies, and others are active in the Chinese financial markets (see Fig. 3.1). As of January 2023, the Shanghai and Shenzhen stock exchanges are the third and seventh largest in the world with a market capitalization of USD 6.87 and USD 5.24 trillion respectively, making China, after the US, the second-largest stock market in the world. However, as can be seen in Table 3.1, in size, the NYSE (USD 26.2 trillion) and the Nasdaq (USD 28.3 trillion) are significantly larger (Yap, 2023).

China’s Drawbacks of the Financial System Historically, the state has always been careful to ensure that the financial sector supports an investment- and export-led model of economic growth. This is based on three fundamental drawbacks of the Chinese financial system, deeply rooted in the former planned economy, that have recently undergone major reforms by the authorities. First, there has always been a strong bias in the allocation of credit to state-owned enterprises (SOEs) over private and/or small enterprises. This so-called “financial dependency triangle” between the state council, state-owned banks, and SOEs ultimately led to too many non-creditworthy loans varying ownership structures, including 134 urban commercial banks, approximately 1,400 rural commercial banks, and thousands of rural credit unions.

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Fig. 3.1 Structure of China’s financial system (Source Tobin and Volz [2018])

(van der Linden, 2008). Second, controls on interest rates set artificially low and stable (low borrowing rates for SOEs) helped channel high private savings into state-led investments at subsidized costs. Third, the exchange rate was controlled by the authorities with capital inflow and in particular capital outflow restrictions, preventing domestic savers from moving abroad to higher yielding assets and protecting the economy from volatility in foreign capital flows. This system had several weaknesses, such as financial vulnerabilities, inefficient investment in the state sector, excessive risk-taking in shadow financing, and the lack of significant macroeconomic shock absorbers, in the form of a more flexible exchange rate and counter-cyclical interest rate instruments. In addition, it tended to deprive the fast-growing private sectors of financing. As a result, the authorities have implemented several reforms over the past decade, including reducing implicit guarantees (from SOEs breaking the “financial dependency triangle”), increasingly use changes in interest rates to influence financial conditions and gradually opening the capital account and allowing a more flexible exchange rate. There have been some significant developments in these areas over the past years, raising questions about the future direction of the reform process (Adams et al., 2021).

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Table 3.1 The 10 largest stock exchanges in the world Stock Exchange (country) 1. New York Stock Exchange (NYSE), USA 2. National Association of Securities Dealers Automated Quotations (NASDAQ), USA 3. Shanghai Stock Exchange (SSE), China 4. European New Exchange Technology (EURONEXT), Europe 5. Hong Kong Stock Exchange (HKEX), Hong Kong 6. Tokyo Stock Exchange (TSE), Japan 7. Shenzhen Stock Exchange (SZSE), China 8. London Stock Exchange (LSE), United Kingdom 9. Toronto Stock Exchange (TSX), Canada 10. Bombay Stock Exchange (BSE), India

Market capitalization in USD trillion

Number of listed companies

26.2

2,400

28.3

3,000

6.87

>1,500

6.65

>1,300

43.6

>2,200

5.67

3,700

5.24

n.a

4.13

app. 3,000

3.1

>2,200

3.5

5,500

Source Adapted from Yap (2023)

Deeper Market-Oriented Reforms and Integration into the Global Financial System During the first two years of the pandemic, the authorities have pursued a rather moderate monetary and fiscal policy, focusing mainly on deeper market-oriented reforms including the reduction of implicit guarantees, interest rate, and capital account reforms to improve the stability and efficiency of the financial system. As a result, China’s financial system has become more accessible to foreign investments and Western investors are increasingly active in the Chinese capital markets. China has become increasingly important for the global financial system. There are three important reasons for this, namely, China’s surplus of savings over investment (or related trade surpluses), China’s increased integration with world trade and its increased integration with global capital markets and,

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related, the international use of the renminbi (RMB). All three factors have the potential to influence risk-free interest rates, exchange rates, and risk premiums worldwide. The changing influence on the global financial system is partly the result of China’s transition to a higher level of consumption which was accompanied by a smaller difference between China’s excess savings over investments from the mid-2000s which in the past resulted from the underdeveloped social safety net (see Fig. 3.2). Another development demonstrating China’s integration with the global financial system is the direct exposure to Chinese assets of nonChinese entities as capital flows have been liberalized. Figure 3.3 shows that the size of the portfolio investment liabilities in China has increased strongly over the past 15 years. The same also applies to international bank lending to China. However, the relative shares of both portfolio investment and bank loans to China (about 2% and 4% respectively) are

Fig. 3.2 Investments, savings, and current account surplus in China in the period 2000–2021 (as a percent of GDP) (Source Own elaboration on the basis of IMF database)

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Fig. 3.3 Portfolio investment liabilities in China in the period 2000–2021 (millions of US dollars) (Source Own elaboration on the basis of IMF database)

still rather modest as a percentage of cross-border loans (Adams et al., 2021). The rapid expansion of financial institutions has been accompanied by a slowdown in the real economic growth over the last decade, which has intensified during the pandemic. This mismatch between the financial and real economy reflects less efficient allocation of financial products as new sources of funding, resulting in diminishing economic returns. Over the past decade, China has accumulated an enormous, mainly corporate, debt with increasing non-performing loans (NPLs), a significant portion of which is backed by high-risk, opaque assets. The current controlled approach to the financial system by the authorities can be largely understood as an attempt to mitigate the threats from risk assets to the overall financial stability while maintaining adequate bank credit to stimulate growth. During the last few years, the attraction of the Chinese financial markets for foreign companies has increased significantly. In the past, due to various government restrictions, the share of foreign financial institutions in the Chinese financial markets has always been very small. Foreign financial institutions tended to hold less than 2% of bank assets and less than 6% of the insurance market. Over the past decade the Chinese financial institutions have also built-up strong positions in many areas of their

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own financial markets which still makes it difficult for the foreign firms to increase their market share. Given the large size of China’s domestic financial sector, it was attractive to be able to increase their shares in these markets. For decades foreign financial firms were largely limited to operating in minority-owned joint ventures, which usually meant that the Chinese partner had the ultimate control over the company. However, since 2017 the Chinese authorities have gradually eased long-standing restrictions on foreign ownership allowing China to increasingly integrate into global financial markets. For the first time it was possible that some US financial firms could achieve a majority in the property of existing joint ventures and other license companies to gain greater access to China’s financial markets. This recent liberalization has led to a significant increase in the number of majority and wholly foreign-owned financial institutions in China, including many US institutions. These developments are in line with the commitments made by China in the Phase One agreement with the US.2 In addition to the increased presence of majority or wholly foreignowned financial institutions, China’s integration into global financial markets is reflected in growing cross-border capital inflows of not only FDI but also of portfolio capital (see Fig. 3.4).

Transition from Indirect Bank-Based to Direct Market-Oriented Financing to Serve the Real Economy The Chinese authorities know that as their economy matures, it will need fully functioning financial markets that can allocate capital more efficiently. During the 13th FYP period, therefore, more liberalization of the Chinese financial system has been initiated than in the past four decades. In recent years, China has removed ownership limits, quota systems, and other barriers that had held back the development of the Chinese bond market. The Chinese authorities are also increasingly inviting foreign

2 On February 14, 2020, the Economic and Trade Agreement between the US and China: Phase One went into effect. China agreed to expand purchases of certain US goods and services by a combined USD 200 billion for the two-year period from January 1, 2020, through December 31, 2021, above the 2017 baseline levels (https://www.piie. com/research/piie-charts/us-china-phase-one-tracker-chinas-purchases-us-goods).

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Fig. 3.4 Foreign onshore portfolio investment in China (in trillions RMB) (Source Reprinted by permission “Rising foreign investment in China’s onshore stocks and bonds shows accelerating financial integration” by Nicholas R. Lardy and Tianlei Huang, originally published by the Peterson Institute for International Economics, January 4, 2021. (https://www.piie.com/research/ piie-charts/rising-foreign-investment-chinas-onshore-stocks-and-bonds-showsaccelerating)

players to participate in the new market-driven bond exchanges, ultimately making this domestic bond market an important part of the global capital markets (S&P Global Ratings, 2021). The dominance of China’s banking system in the financial system has long limited the development and growth of China’s domestic stock and bond markets. China’s equity holdings in the US as a percentage of outstanding corporate debt are significantly higher than in China and is increasing (51.8% compared to 2.9% in 2019). The Chinese bond market is strongly dominated by banks. This underdevelopment of China’s financial markets has long led small firms to seek unofficial sources of funding. This reliance on bank lending and the underdevelopment of capital markets tends to distort credit allocation in favor of large corporations, contributing to China’s high corporate debt, penalizing smaller, less politically connected companies as banks are less willing to lend to them. While China’s authorities have repeatedly called for the expansion of socalled “direct financing channels”, i.e., without a commercial bank as financial intermediary between the lender and the borrower, they remain concerned that stock market liberalization would threaten stability and have therefore taken only limited steps to address this problem. Despite

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the hesitance, China has made unprecedented progress in building a more market-oriented financial system that supports the real economy. The emphasis has increasingly shifted to direct rather than indirect financing (Bisio, 2020). According to official statistics, financial institutions have been increasingly urged in recent years to reduce their excessive leverage ratios and reduce their poor quality and risky assets. After the turbulence in 2015–2016, the Chinese stock market has witnessed breakthroughs in improving the quality of listed companies. After years of debate, China introduced a more market-oriented, registration-based IPO system in March 2020. In addition, the Chinese authorities have stimulated innovations, and created an electronic trading system like the model of the American stock exchange Nasdaq. This has contributed to many more technology companies being added to the Chinese stock market. Progress has also been made in the Chinese bond market and the financial sector has become more open. Furthermore, China eased restrictions on foreign real estate in the financial sector for the first time in 2017 and has continued to do so during the US–China trade war (2018–2023). The high-quality development by staying committed to deepening reform and opening wider to the world underscores China’s long-term determination to strike a better balance between economic growth and security or risk management in general. This requires greater emphasis on building the financial system to support the real economy. In the banking industry, the government plans to substantially enhance its efforts to contain systemic and other risks. The 14th FYP is expected to underscore this task as essential to the security of the Chinese economy and its financial sector. Finally, the reform of the financial system has momentum to unite bond markets, narrow the gap between Chinese and international financial regulations, and to promote the international role of the RMB to stimulate both inbound and outbound investments (Aglietta et al., 2021). The revised central bank law of October 2020 gives the PBC greater responsibility to ensure financial stability through the issuance of the country’s digital currency and allows the public to exchange this new type of money only against certain qualified commercial banks designated by the authorities. The first formal assessment measures on identification and management of the domestic systemically important banks will be soon effective. As a complement to the effort, the government will take various measures to improve the corporate governance of financial institutions. As the Chinese financial system develops, more extensive use of financial innovations, from derivatives to financial technology, is inevitable.

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However, the unpleasant experiences in the US with the use of innovative derivative products and their role in the GFC show that financial derivatives are a double-edged sword. Too much complexity makes them unsuitable for supporting the real economy and unmanageable for financial regulation (Yang, 2021).

The Recent Rapid Increase in Foreign Holdings of Onshore RMB-Denominated Chinese Securities The recent rapid increase in foreign holdings of onshore RMBdenominated Chinese securities has been caused, among other things, by the massive expansion and opening of the Chinese capital markets to the outside world; the gradual broadening and deepening of the opening of the capital markets; the inclusion of Chinese securities in global indices and investor portfolios; the liberalization that allows foreign investors greater access to hedging instruments and relatively higher interest rates on Chinese corporate and sovereign bonds (Lardy et al., 2020). However, since late 2021 the Fed started executing a more restrictive monetary policy, US and Chinese bond yields are increasingly converging over the course of 2022, reversing a decade-long pattern that has eroded China’s previously large yield advantage. For over a decade, government bonds in China have significantly outperformed their US counterparts, making RMB or yuan-denominated debt securities highly attractive to global investors seeking exposure to the world’s second-largest economy. The interest rate spread between Chinese and US 10-year government bonds has fallen to its narrowest point in 2022 due to the strong increase in the US 10-year government bond rate to 3.44% as of December 15, 2022 (1.44% a year ago). On the other hand, partly due to the Covid-related lockdowns, a sharp slowdown in the property sector, huge geopolitical risks about investing in China, and relatively low inflation rates, the monetary policy of the PBC has been relaxed. Yields on 10-year government bonds have been largely contained since the start of 2022, reaching a level of 2.9% at the end of this year (Feng, 2022). In less than three decades, China’s stock markets have grown to become the world’s second largest in the world after its equity market cap exceeded that of Japan in 2014. The Shanghai and Shenzhen stock markets have a combined market capitalization of approximately USD 14.4 trillion (2021) equivalent and are now comparable in size to the combined market capitalization of the London Stock Exchange and the

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Euronext exchanges. Chinese companies listed on the Hong Kong Stock Exchange add an additional USD 2.9 trillion to the total market capitalization of Chinese companies. The combined market capitalization of all publicly traded Chinese companies—companies listed domestically and on foreign exchanges—exceeds the equivalent of USD 12 trillion. This increase in market capitalization has been driven both by the listing of new companies and the expansion of existing Chinese companies into some of the largest companies in the world. Over the past decade, China has led the global IPOs as more than 2,500 Chinese companies went public, more than twice as many as in the US. During this period, IPOs of Chinese companies have raised more money than IPOs in the rest of Asia combined. China is now home to some of the world’s largest publicly traded companies and accounts for the second-largest share of the world’s top 100 companies by market capitalization, after the US. China’s largest companies include a mix of private sector tech giants such as Alibaba and Tencent, and state-owned companies such as the ICBC and CCB (Borst, 2020). While the global 2022 IPO proceeds have fallen sharply and have slowed further IPOs, partly due to the war in Ukraine, relatively high inflation rates and Western central bank interest rate hikes, this is by no means the case for China’s fund-raising for equities, which has seen a slight increase during the same period. China takes the lead in global IPOs (see Fig. 3.5) and this rush of Chinese listings can be partly explained by the desire of the Chinese authorities to achieve “technological selfreliance”, with a special focus on sectors considered essential for economic growth and competition with the West, including renewables, semiconductors, and other high-quality production. The authorities’ focus on strategic sectors has accelerated a shift in the domestic flow of Chinese IPOs. Only a limited number of new listings in 2022 went to the major markets of the Shanghai and Shenzhen stock exchanges, with nearly 80% of the funds raised in Shanghai’s science and technology-focused Star Market and Shenzhen’s technology-driven ChiNext Market. Despite the strong lockdowns in Shanghai and other Tier 1 cities in 2022, a steady flow of quotes has been possible in the city’s financial sector. Investment banks have been stationing staff at clients’ offices for months so as not to be quarantined and prevented from conducting due diligence on the spot. There is also a trend among pre-IPO private companies with some previously attempting to list offshore in Hong Kong or the US but are

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now more seriously considering finding listings in the mainland (Lockett et al., 2022). In 2022, many companies have listed on the technology-focused markets of Shanghai’s Star and Shenzhen’s ChiNext initial public offerings (IPOs). As Fig. 3.5 shows, companies raised much more money on Chinese exchanges compared to US exchanges. The vast majority of revenues have come from semiconductor manufacturers, artificial intelligence and enterprise software startups, robotics companies, and other advanced technology companies. A wave of smaller telecommunications companies flocked to the Beijing Stock Exchange, launched in November 2021 under the leadership of Xi Jinping. This development ties in well with Xi’s broader plan to match a burgeoning technology industry with bustling capital markets as part of a larger effort to make China a leader in next-generation technologies. However, state capital or “guidance capital” led by the CCP is pouring into the equity markets in this way as state entities have increasingly provided funding for IPOs. This means that policymakers are increasingly successful in directing private capital to the industries they want to prioritize. However, the increase in IPOs on Chinese capital markets is driven not only by more active government influence, but also by rising tensions between China and the US and the

Fig. 3.5 The value of funds raised by new listings and number of IPOs in 2022 in selected countries (in billion USD) (Source Own elaboration on the basis of PWC data and other sources)

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fact that several Chinese technology companies are being sanctioned by the US which has led to the situation that in 2022, financial markets in New York are almost closed to Chinese companies. Meanwhile, China’s regulatory regime has become more lenient. Not too long ago, heavy ratings were required for new listings. This led to backlogs, sometimes reaching thousands of companies, and deterred private equity investors from exiting investments. A new system, tried out in the Star and ChiNext exchanges, is currently being rolled out to other companies more in line with international standards. In addition, in line with Xi’s view on finance, retail volatility has diminished. In short, the Shanghai and Shenzhen exchanges have become arguably the top global destination for tech IPOs, but they’ve done so with remarkably little global capital. Concerns about China’s drastic and sometimes abruptly changing Covid-19 rules and faltering real estate market have caused foreign investors to leave the country. So the question remains to what extent Xi’s “big bang” turns out to be a daring experiment (The Economist, 2022). As of 2015, not only China’s stock markets have exploded with some stagnation in the Covid-19 period, but also the size of China’s domestic bond market, both government and corporate, has greatly increased and is undergoing extensive expansion and rapid liberalization. In particular, the Chinese corporate bond market is the second largest in the world, about half the size of the world’s largest US bond market. The Chinese government debt is increasingly held by central banks as foreign exchange reserves, after the RMB inclusion in the International Monetary Fund Special Drawing Rights (SDRs) basket in 2016. Although well behind the USD and the euro, global foreign exchange reserves of RMB assets now exceed USD 200 billion equivalent. Total holdings of foreign investors in Chinese RMB bonds are now worth about USD 300 billion (Borst, 2020). The current government is increasingly trying to break the “financial dependency triangle” by moving away from the once-widespread belief that it should save every ailing SOE. In 2014, the Chinese domestic bond market experienced its first default. A year later, it received its first SOE standard. This sent a clear message to market participants unfamiliar with credit risk and reliant on government backstops. Local government financing vehicles (LGFVs) had to repay their own debt as of 2014, and it wasn’t until 2018 that this message finally got through. A leap in defaults since then has underlined that this new discipline is not just a guideline, but part of the new normal policy.

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Since foreign investors only hold a small share of the Chinese corporate bond market until the end of 2020, it is likely that this share will increase. First, the increase in bond defaults in 2019–2020 includes some companies rated AAA by domestic rating agencies, presumably putting pressure on Chinese rating agencies to step up their game. Second, more and more Chinese companies are expected to request ratings from foreign agencies, presumably giving foreign investors better information. Thus, the rise in corporate bond defaults in 2019–2020 is not expected to slow the inflow of foreign investment into the Chinese bond market (Lardy et al., 2020).

Gradual Broadening and Deepening of the Opening of the Chinese Capital Markets Due to a lengthy registration process as part of the Qualified Foreign Institutional Investors (QFII) program launched in 2002, China’s capital markets have long been difficult for foreign investors to access. While the Chinese financial account of the balance of payments is still closed to many financial flows, the proliferation of channels for foreign portfolio investment to flow into China has become easier in recent years thanks to a wave of new financial account reforms including the elimination of all quota restrictions in the QFII program and simplifying procedures for transferring funds into China and repatriating investment income in 2019–2020. The creation of Stock Connect in 2014 is the most significant reform impacting China’s equity markets. Linking the Shanghai and Hong Kong stock exchanges, it offers all foreign investors, not just investors licensed under the QFII program, access to most of China’s domestic stock markets without having to register with the mainland authorities. Stock Connect still has a daily quota, but it has expanded significantly since its launch and has never been fully used despite significant adoption from foreign investors. Investing in the Chinese bond market has also become more accessible to foreign investors. As of 2015, foreign central banks, sovereign wealth funds, and institutional investors were given direct access to China’s interbank bond market, which accounts for 90% of total bond volume. Another significant bond market opening took place in 2017, with the creation of the Bond Connect program which allowed all foreign investors access to the Chinese interbank bond market. In September 2020, the regulators allowed foreign investors to directly buy and sell bonds traded

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on domestic exchanges. Like Stock Connect, foreign investors with securities accounts in Hong Kong can buy and sell mainland China bonds through a streamlined registration process. As of September 2019, more than 1,300 institutional investors had enrolled in the Bond Connect program (Borst, 2020). As China’s capital markets have expanded and become more open, the country’s weighting in global investment indices and investors’ portfolios have increased. In 2017, MSCI Emerging Markets Index (MSCI), a major global index provider which captures large and mid-cap representation across 27 emerging market countries, announced that Chinese A-shares would be included for the first time in its MSCI. This change generated headlines and was matched by actions of other index providers, including FTSE Russell and S&P Dow Jones, to include A-shares in their indices. China now accounts for 34% of the MSCI, but due to the MSCI methodology, most of China’s weighting is based on Chinese companies listed on overseas markets, such as those of Hong Kong and New York, while domestic A-shares make up only 4% of the index. However, this weighting will increase over time as China continues to reform its domestic stock markets. If China A-shares reach 100% inclusion rate (current weighting is 20%), China will account for around 43% of the index, equivalent to emerging market countries such as South Korea, Taiwan, India, Brazil, South Africa, Russia, and Mexico combined (Borst, 2020). In June 2018, QFIIs were allowed to enter the foreign exchange derivatives market to hedge their foreign exchange risk. The Chinese Securities Regulatory Commission announced in September 2020 that all foreign investors would gain access to the domestic stock futures market, allowing them to hedge their stock positions. This reform took effect on November 1, 2020. For decades, major Wall Street institutions have worked successfully on US–China financial integration and the opening of Chinese markets. The January 2020 US–China phase one deal was a highlight for US banks, which were given the opportunity to become controlling owners of Chinese financial institutions. Crucially, since 2016 there has been a significant increase in US and European investors in China’s public markets for stocks, bonds, and derivatives. Western institutional investment capital flows to China started after stock and bond index providers such as MSCI, FTSE Russell, and Bloomberg-Barclays decided to include assets from mainland China in their indices. Their decision led to the

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inflow of hundreds of billions of additional USD from the US and Europe into Chinese stocks and bonds. In the summer of 2021, Western holdings of Chinese financial assets were reported to be USD 1.1 trillion. In early July 2022, Chinese authorities announced “Swap Connect”, giving international investors access to China’s USD 3.3 trillion swap market (Hellendoorn, 2022). After the US Federal Reserve cut rates sharply in response to the Covid-19 pandemic, the positive yield differential on 10-year government bonds in China compared with the US widened to an average of more than 2 percentage points in the second half of 2020 (Lardy et al., 2020). With the strict Covid-19 lockdown measures in China during 2022 and the drastic easing at the end of that year and the ongoing war in Ukraine resulting in rising energy and food prices, it is unclear whether the interest rate differential in favor of Chinese bonds will persist. Due to high inflation in the US, the Fed has raised the US benchmark fund rate by 0.5% to a range of 4.25% to 4.50% in December 2022, the highest level in 15 years. It is likely that, like in 2022, many interest rate increases will follow in 2023. Although the economic recovery from the pandemic in China was initially quite strong, this is much less the case in the first half of 2022, which could justify a possible drop in their interest rates. On balance, it is more reasonable to expect a smaller interest rate differential between the US and China at the end of 2022.

References Adams, N., Jacobs, D., Kenny, S., Serena, R., & Sutton, M. (2021, September 16). China’s evolving financial system and its global importance: Bulletin— September quarter 2021. Reserve Bank of Australia. https://www.rba.gov.au/ publications/bulletin/2021/sep/chinas-evolving-financial-system-and-its-glo bal-importance.html. Aglietta, M., Bai, G., & Macaireet, C. (2021). The 14th five-year plan in the new era of China’s reform Asian integration, belt and road initiative and safeguarding multilateralism (CEPII—Policy Brief No 36—May 2021). Bisio, V. (2020). China’s banking sector risks and implications for the United States. U.S.-China Economic and Security Review Commission. https://www. uscc.gov/research/chinas-banking-sector-risks-and-implications-united-states Borst, N. (2020). The China investment dilemma risks for U.S. investors during a turbulent time. Seafarer. https://www.seafarerfunds.com/prevailing-winds/ the-china-investment-dilemma/chinas-financial-rise/

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Hellendoorn, E. (2022, August 3). Trading geopolitics: The US-Chinese capital markets. Atlantic Council. https://www.atlanticcouncil.org/blogs/econograp hics/trading-geopolitics-the-us-chinese-capital-markets/ Lardy, N. R., & Huang, T. (2020). Policy Brief 20–17: China’s Financial Opening Accelerates. 12. S&P Global Ratings. (2021). China’s bond market—The last great frontier. https://www.spglobal.com/ratings/en/research/articles/210415-chinas-bond-market-the-last-great-frontier-11888676 The Banker. (2022). Top 1000 world banks 2020. https://www.thebanker.com/ Top-1000-World-Banks/Top-1000-World-Banks-Tier-1-capital-hits-10-tri llion-for-first-time The Economist. (2022c, November 26), Chinese capitalism: Xi’s big bang. https://www.economist.com/finance-and-economics/2022/11/22/ xi-jinpings-big-bang-for-chinese-stockmarkets Tobin, D., & Volz, U. (2018). The development and transformation of the financial system in the People’s Republic of China. In U. Volz, P. J. Morgan, & N. Yoshino (Eds.), Routledge handbook of banking and finance in Asia (1st ed., pp. 15–38). Routledge. https://doi.org/10.4324/9781315543222-2 Van der Linden, R. W. H. (2008). China’s macro-policy and regulatory framework of the financial sector to be tested by the global economic slowdown. In New issues in financial and credit markets. Palgrave Macmillan Studies in Banking and Financial Institutions. Yang, J. (2021, January 7). China focuses on building a stronger financial system to support the real economy. Beijing Review, 1. http://www.bjreview.com/ Opinion/Voice/202101/t20210104_800231602.html Yap, R. (2023). The 10 largest stock exchanges in the world. The Smart Investor. https://thesmartinvestor.com.sg/the-10-largest-stock-exchanges-inthe-world/

CHAPTER 4

Pre- and Post-pandemic Sino-US Inbound and Outbound Investments

Abstract Chinese FDI and VC investments in the US have increased mainly since 2011, and to a lesser extent were opposite capital flows from the US to China. As a consequence of geopolitical tensions and pandemicrelated disruptions the Sino-US technology-related FDIs have declined sharply since 2017. It is also remarkable that more recently, Chinese investments in the US have declined, while US investments in China have remained relatively stable over the past decade. Chinese authorities have favored attracting foreign high-tech and knowledge-based service companies willing to serve and compete in the domestic market at the expense of the manufacturers and exporters that traditionally dominate foreign direct investment in the country. A major obstacle remains China’s restrictive foreign investment policy, driven by the authorities’ renewed focus on domestic social stability and self-sufficiency. Despite trade surpluses and significant increases in capital inflows since 2020, Beijing has not significantly eased its tight line on capital outflows from households and private companies. Most outflows are facilitated by state-owned banks, while total outward foreign direct investment has stagnated since 2017. Since 2021, China’s regulatory approach to specific sectors, such as the crackdown on domestic tech giants, has also impacted these companies’ outward investment. However, there is still scope for a resurgence of Chinese FDI in the US due to the Biden administration’s new “Build Back Better” infrastructure program with a more predictable regulatory approach. © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_4

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Keywords Foreign Direct Investments (FDIs) · Portfolio investments · Venture Capital (VC) investments · Greenfield investments · “Build Back Better” infrastructure program · Chips Act · US–China trade and tech war

The mutual Sino-US foreign investment flows have been a crucial part of the economic relations between the two countries. The bilateral inward or inbound and outward or outbound investments can be roughly divided into Foreign Direct Investments (FDIs), portfolio investments and Venture Capital (VC) investments. The most important inbound and outbound investments are the FDIs, consisting of greenfield investments and mergers and acquisitions, which give foreign investors control and long-term influence over local businesses. These transactions typically involve investments resulting in at least 10% ownership of a company’s voting shares and have a long-term character (OECD, 2008). This contrasts with portfolio investments, which involves shorter-term, financially motivated transactions that generally result in smaller ownership stakes (usually less than 10% of voting rights) and no meaningful control. While the FDIs have been the most prominent channel of Sino-US investment flows in recent decades, other types of investments have also gained momentum in recent years. One such channel is venture capital (VC) consisting of private equity referring to a type of financing that investors provide to startup companies and small businesses emerging companies with long-term growth potential and often active in advanced industries with new technologies. The Chinese VC ecosystem, spread between the three major cities Shanghai, Shenzhen, and Beijing, includes three major types of investors, namely independent domestic private investors, government and state-backed investors, as well as foreign investors. Since 2011, especially Chinese FDI and VC investments in the US, to a lesser extent the reverse, have increased. However, from 2017 onward, these investment flows have decreased sharply again. It is also remarkable that more recently, Chinese investments in the US have declined, while US investments in China have remained relatively stable over the past decade (Rhodium Group & National Committee on U.S.–China Relations, 2021, May). Another observed trend is that between 2016–2020, Sino-US technology-related foreign direct investments fell by 96 percent,

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while US spending on research and development (R&D) in China rose to record levels (Bessler, 2022).

US Direct Investments in China FDI inflows are very important for the development of the Chinese economy. Figure 4.1 shows that from 2000 US FDIs gradually gained access to the Chinese markets, modest at first, but grew to several billion USD per year during the 1990s and early 2000s. After China’s entry into the World Trade Organization (WTO) in 2001, China’s US FDIs have risen to more than USD 20 billion in 2008 with approximately the same share of acquisitions as greenfield investments. However, during the GFC, US FDIs in China fell sharply after which they gradually climbed back to around USD 15 billion a year. As was the case during the GFC, the global recession caused by the Covid-19 pandemic also led to a decline in total investment in 2020 compared to the average in previous years. In recent decades, there has also been a shift in the industrial sectors in which the US has invested in China, associated with the rapid structural

Fig. 4.1 Value of US FDI transactions in China, 2000–2020 (USD million) (Source Rhodium Group and National Committee on U.S.-China Relations [2021, May])

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change of the Chinese economy toward more high-tech consumption and innovation-driven growth. While initial investments focused on labor-intensive manufacturing, interest shifted in the 2000s and early 2010s to Chinese consumer-oriented sectors such as food (e.g., Coca Cola and Starbucks) and automobiles (e.g., Tesla). Over the past five years, US investors have increasingly focused on high-tech and advanced services sectors (RhodiumGroup, 2021). As a result, Chinese policymakers have signaled their commitment to lure high-tech foreign companies and knowledge-based services firms willing to serve, and compete in the domestic market over the manufacturers and exporters that have traditionally dominated FDI in the country. Geopolitical tensions and pandemic-related disruptions led to additional changes in the composition of US FDIs in China in 2020. ICT investments fell as technology frictions between the US and China increased and other industries, such as the auto industry, saw lower investments due to Covid-19 restrictions and temporary cuts in capital spending in response to the crisis. Overall, inbound investments to China have fallen significantly in 2022 amid geopolitical tensions, draconian measures against Covid-19, and the rebalancing of the Chinese economy to a more domestic demand-driven growth model. While the US is still the largest domestic investor, the Biden administration is also putting more pressure on companies that trade and invest in China. Among other things, the Chips Act passed in July 2022 provides incentives to semiconductor companies that manufacture in the US, provided they do not engage in the material expansion of semiconductor production capacity in China or any other foreign country of concern (Dettoni, 2022).

China’s Direct Investments in the US In 2022, the US is not only the largest recipient of inbound foreign direct investment, followed by China and Brazil, but also the largest outbound investor, followed by the Netherlands and Australia. In recent years there has been a downward trend in cross-border mergers and acquisitions in advanced economies, while greenfield projects have recently shown a slight growth, mainly driven by large investment projects announced in emerging economies in manufacturing sectors, especially in renewable energy which also could mean more US investment potential in China (OECD, 2022).

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Figure 4.2 shows that China’s FDIs in the US were modest before 2010, but annual investments accelerated rapidly thereafter, reaching nearly USD 5 billion in 2010 and USD 14 billion in 2013. Chinese investments in the US peaked at USD 45 billion in 2016 thanks to several multi-billion USD acquisitions fueled by unbridled liquidity in the Chinese market and relatively loose controls on outbound investments. In 2015, China’s outbound has surpassed its inbound investment flows changing the role of the Chinese companies from global manufacturers to global investors, although this development was reversed after the Sino-US trade war. Since then, annual investments have fallen sharply. Despite the pandemic and increasing tensions in the US–China relationship, China’s FDIs in the US rose again slightly in 2020. During the Chinese outbound investments boom in 2016–2017, Chinese FDIs in the US were concentrated in only a few sectors such as real estate and hospitality, transportation, and infrastructure. Recently, US investments have become more concentrated in less sensitive sectors such as entertainment, consumer products and services, and health and

Fig. 4.2 Value of China’s FDI transactions in the US, 2000–2020 (Source Rhodium Group and National Committee on U.S.-China Relations [2021, May])

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biotechnology. Investments in sectors subject to strict regulatory oversight, such as semiconductors, aerospace, or infrastructure, have largely disappeared. Sectors under scrutiny in China, such as real estate, have also seen a sharp decline in investments compared to the previous decade. China’s restrictive policy on outward investments, driven by a renewed focus by the Chinese authorities on domestic social stability, remains a major impediment. Despite trade surpluses and significant increases in capital inflows since 2020, Beijing has not meaningfully loosened its tight line on capital outflows from households and private companies. Most outflows are facilitated by state-owned banks, while total outward foreign direct investments have stagnated since 2017. Since 2021, China’s regulatory approach to specific sectors, such as the crackdown on domestic tech giants, has also impacted outward investments by these companies. Still, there are possibilities for a revival of Chinese FDIs in the US. First, the Biden administration’s new “Build Back Better” infrastructure program and clean energy building could provide unique investment opportunities with incentives to grow domestic supply chains in solar, wind, and other critical industries in communities on the frontlines of the energy transition. Second, as the rivalry between the US and China continues, the Biden administration is likely to adopt a more predictable regulatory approach. A continued shift toward more transparent due process and greater predictability could revitalize Chinese investment in nonsensitive areas, which had been put on ice by the previous administration’s aggressive and erratic decoupling approach. Figure 4.3 shows that the annual value of FDI transactions between China and the US have declined since the peak in 2016–2017, especially China’s FDIs in the US. There are several reasons for this, including the US–China trade and tech war, the Covid-19 pandemic, China’s stronger restrictions on outbound investments, US regulatory oversight and generally increasing geopolitical tensions between the US and China. The post-pandemic recovery could lead to a small increase in bilateral investment flows, but the effects of policy developments in Washington and Beijing have yet to be seen. Inward investments in China will depend on Beijing fulfilling its promises to level the playing field for foreign companies. The Biden administration’s trade policy, supply chain security rules, and general policy toward China will have profound implications for Chinese companies and investors when considering investment opportunities in the US (Rhodium Group, 2021).

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Fig. 4.3 Annual Value of FDI Transactions between the US and China, 1990– 2019 (billion USD) (Source Rhodium Group and National Committee on U.S.China Relations [2021, May])

References Bessler, M. (2022, November 16). Demystifying the debate on US-China decoupling. Center for Strategic & International Studies (CSIS). https://www.csis. org/blogs/new-perspectives-asia/demystifying-debate-us-china-decoupling Dettoni, J. (2022, August 25). China FDI falls to new low. FDI Intelligence. https://www.fdiintelligence.com/content/news/china-fdi-fallsto-new-low-81390 OECD. (2008). OECD benchmark definition of foreign direct investment (4th ed.). OECD. (2022). https://www.oecd.org/investment/investment-policy/FDI-inFigures-October-2022.pdf Rhodium Group and National Committee on U.S.-China Relations. (2021, May). Two-way street: 2021 update US-China investment trends. A Report by the US-China Investment Project by Hanemann, T., Rosen, D. H., Witzke, M., Bennion, S., & Smith, E. https://rhg.com/wp-content/uploads/2021/ 05/RHG_TWS-2021_Full-Report_Final.pdf

CHAPTER 5

The Rise and Decline of China’s Shadow Banking Subject to a Deleveraging Policy

Abstract Various circumstances have contributed to the development of the unregulated part of China’s banking sector since the 1980s and explain the rapid development of China’s shadow banking system after the GFC. Some examples are China’s relatively strict banking regulations, inadequate credit supply related to credit demand, lack of financial regulatory expertise and oversight, and a contraction of credit offered by the traditional financial institutions. Today’s Chinese shadow banking not only differs greatly from its origins and earlier stages of development, but is also different in nature compared to the shadow banking systems in Western countries. Chinese shadow banking is primarily oriented toward domestic financial markets and has become a central element of China’s financial transformation, which is very similar to the US, where shadow banking is an integral part of the financial system. Unlike the US shadow banking system, in the Chinese system, the non-bank financial institutions are strictly interconnected to the traditional banks, and credits provided by shadow institutions in China are more complex, more sophisticated, and riskier compared to other Chinese markets. The general nature of the Chinese shadow financing is very risky, and the risk can be easily passed on to the participating entities. In consequence, many regulatory initiatives were undertaken in China during the last decade to reduce the role of shadow banking on the Chinese economy. Despite these initiatives, the problem of risky shadow banking in China has not been resolved © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_5

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and further regulatory initiatives related to this unregulated part of the Chinese financial market are expected in the near future. Keywords Non-performing assets · Shadow banking · Wealth Management Products

The rapid expansion of Chinese financial institutions and assets since the beginning of the twenty-first century has been accompanied by the development of shadow banking system. This system especially gave the opportunity to finance the businesses of the strongly growing SMEs and to be less dependent on funding from the largest state-owned commercial banks. The development of the Chinese financial system was associated with the parallel development of the unregulated part of the shadow banking market. The creation and then development of this new financial system took place since the economic reforms were launched by Deng Xiaoping in 1978 and the financial sector was opened from the beginning of the 1990s. It was initiated by the process of financial deregulation, which had their origins in China at the beginning of the 1980s. Despite relative strict rules provided by the Chinese government for the banking business, some lending was led to other forms than traditional banking, under the cover of “joint cooperation”, “investment”, “deposit receipt”, “compensatory trade”, “Wealth Management Products”, or other factitious transactions. Such behavior can be treated as the origin of the shadow banking. The development of the shadow banking system in China covers two periods. One is the period between the 1980s up to the GFC of 2008–2009, the second concerns the period after the GFC. Unlike the early period before the GFC, the rapid development of China’s shadow banking system mainly took place after the GFC (Łasak, 2018; van der Linden, 2015). It was the consequence of the stimulus provided by the Chinese government after the crisis and the policy implemented by the People’s Bank of China since 2010. Among other determinants of the shadow banking system in China might be enumerated: inadequate credit supply related to credit demand, lack of financial regulatory expertise and oversight, and a contraction of credits offered by the traditional financial institutions after the GFC. Moreover, unregulated banking activities

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developed in China as a consequence of the growth of e-commerce and e-finance in the country (Łasak, 2018; Lindgren, 2018). The second phase of the shadow banking development continued for only a few years. Since the second half of 2020s, it became visible that the system creates serious dangers for the economy and its financial markets (Tham et al., 2017). Wealth Management Products, the main component of the Chinese shadow banking, started to be treated as products like “Ponzi schemes” (Zhang, 2013). It was highlighted that the dangers of the shadow banking threaten the regular banks in China as both systems were interconnected. Such situation creates huge danger to the whole financial system in China. There were many threats like mutual and cross guarantee system in the Chinese banking sector, high exposure of the formal and informal financial system to the booming real estate industry, high debt burden created by the local governments, and the growth of non-performing assets in the shadow banking (Chui & Upper, 2017; Yao & Hu, 2016). Moreover, the Chinese financial market is not transparent, and the lack of information is considered as an additional risk factor (Łasak & van der Linden, 2019). In consequence, many regulatory initiatives were undertaken in China during the last decade (as described in Chapter 2). All of the regulatory initiatives lead to some changes in the current nature of the Chinese shadow banking, when comparing the system to its origins and former phases of development (see Table 5.1). The system nowadays is not an additional element (by-product) of the traditional financial market, but it becomes a central element of the financial markets in China. It is especially important for retail customers and SMEs. The additional feature is that the current shadow banking in China is still submitted to many regulatory initiatives which are aimed at further reduction of unregulated part in the whole Chinese financial system. Another determinant, which triggered important pressure on the shadow banking in China during the last two years, was the Covid19 pandemic. As a consequence of slowing economic growth, the highly leveraged borrowers started to behave more safely. This situation, however, has not resolved the bank’s shadow problem and further regulatory initiatives, related to this unregulated part of the Chinese financial market, are expected in the near future (Trivedi, 2021). The deleveraging policy, together with the peoples’ behavior during the Covid-19 pandemic resulted in the declining importance of the shadow banking in China. All the negative consequences of the rapid

Source Own elaboration based on: Dang et al. (2019), Ehlers et al. (2018), Lovells (2019), Sheng et al. (2015), Sheng and Soon (2016) and Zenglein and Karnfelt (2019)

Domestic financial system Both domestic and foreign financial systems Mainly driven by commercial banks Mainly driven by non-bank financial institutions Underdeveloped secondary market Well-developed secondary market Low securitization rate High securitization rate Low leverage rate High leverage rate Purchases made by individual investors Purchases made by institutional investors Immature development phase with inherent risks More mature development phase Irregular fund-raising and lending operations More regular fund-raising and lending operations China’s shadow banking —situation from the 2015 perspective The shadow banking system became a central element of China’s financial transformation, which is very similar to the US, where shadow banking is an integral part of the financial system. Different from the US shadow banking system in the Chinese one non-bank financial institutions are strictly interconnected to the traditional banks In China, similar to Western countries the crucial stimulus for the shadow banking development is created by the process of deregulation—it is part of a “dual-track reform approach” In the Chinese shadow banking the securitization process rapidly increases—actually it is the largest ABS market in China and the second largest globally Credits provided by shadow institutions in China are more complex, more sophisticated and riskier comparing to other Chinese markets. On the other hand, the regulatory burdens imposed by the authorities reduced the investment options for households and businesses. Also, financial intermediaries face higher restrictions on some sources of funding The Chinese financial market is more open to foreign capital (cross-border capital flow), but it is done under strict regulation and control aimed to limit negative impact on the economy

Western shadow banking—original dimension

The comparison between shadow banking in China and in Western countries—the original and the current

China’s shadow banking—original dimension

Table 5.1 situation

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development of the unregulated shadow banking lead to significant problems of predatory loans that lead to dangerous levels of credit risks. The implemented regulations dedicated to shadow banking (described in Chapter 2) were able to reduce the system. As reported, the shadow banking sector in China decreased significantly in the period of 2017– 2021. During this period the value of shadow banking activities was reduced from RMB 25 trillion in 2017 to RMB 11.5 trillion in 2021. During the same period the value of non-performing assets was reduced from RMB 12 trillion to RMB 6 trillion (The State Council, 2022). Despite the significant reduction of the shadow banking in China during the last few years, the financial authorities warn about the possibility of resurgence of the system in 2022. As it is argued, the system has evolved into new forms and the Covid-19 consequences for business is leading to renewal of the system (Philips, 2022). SMEs reliance on shadow banks plays here a crucial role. Similar situation occurs in the local government sector. China’s shadow bank financing in August 2022 rose to the highest level for the last 5 years (the growth by RMB 476 billion) (Kawate, 2022). Such signs mean that in the case of China it is still too early to conclude that all problems related to shadow financing are over. Despite the last period of time, it can be concluded that as a consequence of the regulatory initiatives, currently the shadow banking system in China plays a less important role and changes its nature. It is not only a result of the regulations imposed on the sector by the China Banking and Insurance Regulatory Commission (described in Chapter 2), but also the consequence of the economic stimulus strategy, in which banks are being encouraged to increase lending to SMEs, which in the past used to borrow from the shadow banking (Wu & Jia, 2020). Among others, one of the most important developments that is increasingly affecting the Chinese financial markets is the rise of the financial technology. The Covid-19 pandemic brought back the threat coming from shadow banking system. While traditional banks are relatively safe, poorly regulated non-bank institutions are endangered (Shadow Banks Must Come out of the Shadows, 2021). In the US, the biggest problems were related to cross-border links between banks and non-bank financial institutions. The US banks were interconnected both with the UK institutions as well as with offshore financial centers, and such a situation triggered vulnerabilities in the financial sector (Aldasoro et al., 2020). Moreover, when comparing the nature of the entities functioning in the US market, it is

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Fig. 5.1 Shadow financing in China in the period of 2006–2020 (as a percent of GDP) (Source Own elaboration on the basis of: A. Apostolou, A. Al-Haschimi and M. Ricci, Financial risks in China’s corporate sector: real estate and beyond. In: ECB Economic Bulletin Issue 2/2022, ECB)

very visible that during the last years, the share of shadow banking assets exceeds the share of assets of private depository institutions (Fernández Fernández, 2022). Moreover, the threats triggered in the US financial market by the Covid-19 pandemic stem from the greater involvement of life insurers which have become a new group of institutions especially endangered by shadow banking. Foley-Fisher et al. (2021) highlight that the liabilities of life insurers with shadow banking businesses resemble the liabilities of investment banks in the years leading to the GFC. In China, the development of the shadow banking system is different from the system in the US. Shadow banking in China has developed since the GFC. The financial regulators realized the risks and began to rein in shadow financing in 2016. Despite introducing a range of measures to reduce leverage, improve transparency, and strengthen risk management in the system, the effect of these measures is rather limited and shadow financing in China has not significantly reduced (Fig. 5.1). The growth of the system comes from the fact that many traditional banks use shadow banking for regulatory arbitrage (Liu et al., 2022). At first glance, it seems that shadow banking in China plays an important role in securing traditional banking and providing financing for retail customers and SMEs during difficult times. However, such an interpretation is misleading from the long-run perspective. The nature of shadow

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financing is very risky, and the risk can be easily passed on to the participating entities (Tao et al., 2022). The Covid-19 pandemic highlighted the difficult trade-off that decision-makers face between containing longterm financial systems risks and supporting economic growth in the short term (Sutton & Taylor, 2020).

References Aldasoro, I., Huang, W., & Kemp, E. (2020). Cross-border links between banks and non-bank financial institutions. Chui, M., & Upper, C. (2017). Recent developments in Chinese shadow banking. 20, 6. Dang, T. V., Liu, L., Wang, H., & Yao, A. (2019). Shadow banking modes: The Chinese versus US system. SSRN Electronic Journal. https://doi.org/ 10.2139/ssrn.3491955 Ehlers, T., Kong, S., & Zhu, F. (2018). Mapping shadow banking in China: Structure and dynamics (No. 999; BIS Working Papers). https://www.bis. org/publ/work701.htm Fernández Fernández, J. A. (2022). Banking stability and shadow banking: “New Overview for the United States”. Australasian Accounting, Business and Finance Journal, 16(4), 131–152. Foley-Fisher, N., Heinrich, N., & Verani, S. (2021). Are US life insurers the new shadow banks? Available at SSRN 3534847. Kawate, I. (2022, September 14). China’s shadow bank lending shows biggest jump since 2017 . Nikkei Asia. https://asia.nikkei.com/Business/Finance/China-sshadow-bank-lending-shows-biggest-jump-since-2017 Łasak, P. (2018). Structure and risks of the Chinese shadow banking system: The next challenge for the global economy? In Contemporary issues in banking (pp. 409–426). Springer. Łasak, P., & van der Linden, R. W. H. (2019). The financial implications of China’s belt and road initiative. SpringerLink. https://link.springer.com/ book/10.1007%2F978-3-030-30118-7 Lindgren, M. (2018). Regulating the shadow banking system in China. Liu, A., Liu, J., & Shim, I. (2022). Shadow loans and regulatory arbitrage: Evidence from China (No. 999; BIS Working Papers). https://www.bis.org/ publ/work999.htm Lovells, H. (2019). The rising and booming Chinese securitization market—A comparison with the European securitization market. 8.

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Philips, B. (2022, May 5). Are China’s shadow banking regulations contradicting its push for common prosperity? The Diplomat. https://thediplomat.com/ 2022/05/are-chinas-shadow-banking-regulations-contradicting-its-push-forcommon-prosperity/ Shadow banks must come out of the shadows. (2021, December 7). Financial Times. Sheng, A., & Soon, N. C. (2016). Shadow banking in China: An opportunity for financial reform. Wiley. Sheng, A., Edelmann, C., Sheng, C., & Hu, J. (2015). Bringing light upon the shadow: A review of the Chinese shadow banking sector. Hong Kong: Oliver Wyman and Fung Global Institute Report. Sutton, M., & Taylor, G. (2020). Shadow financing in China. 13. Tao, S., Lu, Z., Li, H., & Liu, X. (2022). The impact of shadow banking on small and medium enterprise in China-based on trust company statistics. In 2022 7th International Conference on Financial Innovation and Economic Development (ICFIED 2022), pp. 1108–1116. Tham, E., Miller, M., & Lague, D. (2017). China’s leaders fret over debts lurking in shadow banking system. Reuters. http://www.reuters.com/investigates/spe cial-report/china-risk-shadowbanking/ The State Council. (2022). China’s shadow banking sector shrinks by 25 trillion yuan in 5 years. https://English.Scio.Gov.Cn. http://english.scio.gov.cn/pre ssroom/2022-03/03/content_78083767.htm Trivedi, A. (2021). China’s hidden bank assets are emerging from the shadows— Flipboard. https://flipboard.com/@bloomberg/china-s-hidden-bank-assetsare-emerging-from-the-shadows/a-Cn7rLmJgTW2bn2lXoRaeSQ%3Aa%3A3 195391-c3e03b6f4c%2Fbloomberg.com Van der Linden, R. W. H. (2015). China’s shadow banking system and its lurking credit crunch: Causes and policy options. In Lending, investments and the financial crisis (pp. 104–133). Springer. Wu, X., & Jia, D. (2020, December 7). China’s $13tn shadow banking sector gets clearer definition. Nikkei Asia. https://asia.nikkei.com/Spotlight/Cai xin/China-s-13tn-shadow-banking-sector-gets-clearer-definition Yao, W., & Hu, J. (2016). Inherent risks in Chinese shadow banking. In Shadow banking in China. An opportunity for financial reform (pp. 133–170). Wiley. https://doi.org/10.1002/9781119266396.ch05 Zenglein, M., & Karnfelt, M. (2019). China’s caution about loosening crossborder capital flows. Merics. https://merics.org/en/report/chinas-cautionabout-loosening-cross-border-capital-flows Zhang, J. (2013). Inside China’s shadow banking: The next subprime crisis.

CHAPTER 6

Current Trends in the Digitalization Process and Related Fintech-Based Businesses of the Sino-US Financial Markets

Abstract The past few years have witnessed unprecedented developments of financial technology (Fintech), which play a crucial role in the transformation of the bank business model. Digital technologies are external enablers that exert great influence and transform the scope of the traditional banks and banking sectors. In both China and the US, financial technology plays a crucial role in their mutual financial relationships. They offer preservation, modification, and/or creation of incumbent institutions and services, but also have a significant socioeconomic impact. In the case of China the application of Fintech not only provides financial inclusion for the unbanked and financially excluded, but it also stimulates the growth of the internal market and has important implications for financial and macroeconomic stability in the country. In the US it becomes important in both dimensions, for the society as well as for the processes of further development of financial markets. It is significant that in the past, the majority of Fintech investments took place in the US, but nowadays China is at the same level or in some areas became even the dominant player. The Chinese Fintech sector, however, differs from the US and EU in many aspects and also different are the motives for the development of the Chinese Fintech sector. In the US digital banks are also becoming more and more popular nowadays. This financial market

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_6

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of digital banking is much more developed in the US, compared with the Chinese counterpart, which influences the fact that financial technology is not only conducive to the availability of financial services to the public, but above all to provide more advanced services and processes. Keywords Big Tech companies · e-commerce · Fintech · Financial technology · Financial inclusion · Technology-based services

The past few years have witnessed unprecedented developments of financial technology (Fintech). There are two meanings of Fintech. This term means digital technologies (like artificial intelligence, blockchain, big data etc.) and related innovations focused on financial services, as well as Fintech-based businesses (Gomber et al., 2017; Puschmann, 2017). Fintech businesses usually represent an industry collaborating and competing with incumbent financial institutions, but also very often new Fintech startups are created. It is significant that currently, Fintechs play a crucial role in the transformation of the bank business model. Digital technologies are external enablers that exert great influence and transform the scope of the incumbent banks. Currently they are the significant triggers of the changes of the current banking sector. Fintech offers preservation of incumbent institutions and services (efficiency gains through time compression and resource conservation), modification of the incumbent institutions/activities, and/or creation (i.e. reconfiguration of existing activities as well as generation completely novel activities) (Łasak & Gancarczyk, 2022). Financial technologies are developing in many countries, both in the Global North and in the Global South. Whereas in the developed financial market they transform the incumbent financial institutions, in the developing countries they fill in the market gap and provide financial services to those who were financially excluded (Bhagat & Roderick, 2020; Iman, 2018). In both China and the US, financial technology plays a crucial role in their mutual financial relationships. In the case of China the application of Fintech not only provides financial inclusion for the unbanked and financially excluded, but it also stimulates the growth of internal market and has important implications for financial and macroeconomic stability in the country (Huang, 2020; Zhang-Zhang et al., 2020). In the US it becomes important in both dimensions, for the society as well as for the

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processes of further development of financial market (Hikida & Perry, 2019; Maskara et al., 2021). It is significant that in the past, the majority of Fintech investments took place in the US, but nowadays China is at the same level or in some areas became the dominant player (Palmié et al., 2020). In many ways, the Chinese Fintech sector differs from the US and EU. First, while in China the emphasis is more on mobile payments, online borrowing, and online investing, in the US and EU the Fintech industry is more focused on cryptocurrencies and cross-border payments. Second, China’s Fintech landscape is dominated by a small number of major players such as Ant Financial, Tencent, Baidu, and JD Digits, while in the US and EU, the Fintech sector is overrun by many small businesses. Third, the most distinctive feature of China’s Fintech development is the financial inclusion which improves access of households and SMEs to financial services on an unprecedented scale. Fourth, unlike many of their counterparts in developed countries, most Chinese Fintech companies often own multiple licenses for financial services and offer financial products directly to customers. In a nutshell, the development of the Chinese Fintech sector can be attributed to three main factors, namely a shortage of supply in the formal financial market, strong government support for promoting financial inclusion through digital technologies, and a relatively accommodative regulatory environment. Underutilization of SMEs and low household incomes partly explain why many informal financial activities were carried out in China. Like typical informal financial activities, many Fintech companies, at least in their early days, were not well regulated and targeting SMEs and low-income households. When the Fintech sector started offering online payment, credit, and even investment services, it was enthusiastically embraced by the market because it fills some important gaps. This also explains why, compared to the Fintech sectors in many developed countries, Chinese Fintech companies are more inclusive in nature. The second contributing factor was strong government pressure to promote financial inclusion through the rapid adoption of digital technologies, such as artificial intelligence, big data, and cloud computing use and the development of a good physical infrastructure such as telecommunications, Internet, and smart phones. In emerging economies such as China, financial consumers had few, if any, other alternatives to modern digitized financial services. Nevertheless, the Chinese government has learned from international experiences

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what digital technologies are capable of promoting inclusive economic growth and offering better financial solutions with greater efficiency and better accessibility for society as a whole. In short, with this new Fintech development, the Chinese government has again cleverly responded to the “law” of the inhibiting lead of the more technologically advanced countries. The rapid development of digital technology capabilities was the result of the joint efforts of both the government and the private sector. In China, the government has made huge investments in infrastructure, especially information and communication infrastructure across the country. Such an infrastructure enabled individuals and companies to connect to the big tech platforms from almost anywhere in the country. This one is especially valuable for people living in remote areas where formal financial services are often scarce. A third factor contributing to the rapid rise of China’s Fintech industry was the relatively accommodative regulation that for a long time was not or barely there for many Fintech companies. For example, Alipay started its business at the end of 2004, but was not officially licensed until 2011. In the end, the regulators did not adopt regulatory standards until mid-2016. There was no rush to bring Fintech companies under regulation. On the one hand, many government officials saw the value of financial inclusion in Fintech companies and therefore they were reluctant to regulate such “financial innovation”. On the other hand, China’s financial regulatory framework is the one that is segregated by industry and focuses on financial institutions. The working rule of this system is “whoever issues the license must be responsible for regulation”. In a sense, Fintech companies fell into the gap area, for which no specific supervisor was responsible (Hua et al., 2020) Chinese financial market develops rapidly, and it has increasingly shifted from indirect to direct financing. All these processes outlined above are strengthened by the dynamic development of financial technologies. The very rapid growth of Fintech is among the most important current features related to Chinese financial markets. It grows in China much faster than in the US and other countries, and nowadays the Chinese market becomes one of the world’s biggest Fintech markets (Economist, 2017). In China the technology is especially prevailing in the areas of payments, accounting, and online lending sectors. Due to the application of technology the Chinese financial markets have changed from a rather ineffective traditional financial system to the world’s most digitalized one (Arner et al., 2020). In the situation of limited access to banks by retail

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customers and the underserved demand for financial services in China, there was a natural way for development of financial technology which substituted the lacking banking services (Fungáˇcová & Weill, 2015). The same is related to business, as the scant development of capital market is not sufficient as the funding source for many enterprises, especially the SMEs (Gorjón Rivas, 2018). Such conditions create the possibilities for Fintech’s development and non-bank financial service providers. The most important fact that contributes to the fast development of Fintechs is that these entities in China satisfy peoples’ needs. When considering the financial market development in the country during the last few years, there are becoming significant such factors as financial deepening and growing customer base. The development of the financial sector in China is being accompanied by technological advances. Among the most important applications offered by Fintechs for the people are payment services, loans and microcredits, and wealth management (Chen, 2016). Apart from technology itself, there are some factors which enable the adoption of Fintechs and foster their rapid development in China. Among them might be enumerated: 1. The demographic conditions—the Chinese population creates the market on the one hand, but also provides opportunity for Fintech companies to provide financial services in these areas, which are underserved by traditional banks. 2. The space (rural areas) which is not covered by any banking networks or other infrastructure which enables the local people to access financial services. 3. The regulatory system where underregulation enables adoption and development of Fintech companies. 4. The development of network information technology which led to widespread application of information technologies. All these factors are crucial determinants which facilitate the current stage of the financial market development in China. The rapid development of Fintech services in China was possible because the country has an underdeveloped banking system which excludes large part of the population from traditional bank loans. The technology-based services are provided for China’s large rural population which has no access to the banking sector (Hau et al., 2019). During the

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last decade, China became a country with the highest number of Internet users over the world (more than 700 million users). The Internet and mobile technologies are important drivers of financial services development. The common use of mobile phones causes that it is the preferred channel of payments and access to online financial services. The strong competition in the Chinese market led to the creation of many innovations. Among such new solutions are numerous applications which enable connection between Internet network and face-to-face transactions (e.g., due to the application of QR codes, which are commonly accepted in many restaurants, shops, and other sites of retail transactions) (Economist, 2017). This is the first step to the development of financial services and the reason that the rapid development of financial technology in China is very simplified. The development of network information technology is also significant in facilitating new models of financial services such as P2P loans, crowdfunding services, and innovative Internet finance businesses (Xiang et al., 2017). The digitalization of financial services led to the improvement of their efficiency. Moreover, it reduces the information asymmetry, due to the broader access to consumer data. The important feature of the Chinese Fintech investors is that they are mainly individuals. Most of them are active especially in some areas, like Fintech lending or credit platforms. Consumers use Fintechs to refinance their existing debts or for payment transactions. Fintech credits are offered to both, individual consumers, and small enterprises with limited access to bank credits (Claessens et al., 2018). The level of Fintech development in China is very diversified. The most developed Fintech hubs are situated in cities like Beijing, Hangzhou, Shanghai, and Shenzhen (Mittal & Lloyd, 2016). Their rapid growth is fostered by huge consumer markets, advanced technology applications, and fast development of the Fintech ecosystems. Many other areas, especially remote and underdeveloped provinces, remain without access to financial services. Financial technology in China mainly focuses on banking activities such as payments and settlements, deposits and loans, and investment management. Apart from single services it creates financial market infrastructure with the fastest developing areas in Internet payments, online lending, equity crowdfunding, and investment and consultation (Chang & Hu, 2018). The payment system in China is based on Quick Response (QR) codes and is mainly implemented by two big tech firms: Alipay (running through Alibaba) and WeChat Pay (running through Tencent) (Klein, 2020). The current payment system in China is developed adequately to

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the consumers’ needs, which means that there are planned further stages of Fintech development in the payment area. In 2019 the Chinese central bank issued 3-Year Fintech Development Plan oriented toward creation of further Fintech-based services. The main aim of the plan is to make Fintech as the “new engine” for financial development in the country (Reuters, 2019). The plan promotes China as one of the world’s leading countries in financial technology. Among the main goals which are enumerated in the plan are the increase of Fintech products and services, better support of the real economy, and risk reduction. Another dimension is to foster the global competitiveness of the Chinese Fintech sector (China unveils fintech development plan—Chinadaily.com.cn, 2019). Fintech development in China significantly contributes to “financial inclusion”. The process, based on digital technology, began its growth in the country between the late 2000s and early 2010s. It was the time when the technologies and digitalization significantly progressed (Lai et al., 2020). Nowadays, the rapidly developing Chinese middle class participates in the process of financial inclusion in many areas. Among such markets might be enumerated: household transactions (salary transfers, shopping, medical services, etc.), rapidly developing services in big cities as restaurants, sport centers, cinemas, etc. Another market is created by transport services (taxis, trains, planes, etc.). One of the most important dimensions of the Chinese retail market which contributed to the process of financial inclusion is the payment market. Its development has taken place since 2004, when the Alibaba holding established Alipay, its payment solution for e-commerce customers. Several years later, in 2013 was created We Chat Pay (Arner et al., 2020). Both solutions are mobile wallets which are used by individual people and SMEs. The rapid development of the mobile payment system was able due to the introduction of the QR code. The code can be easily scanned by mobile devices (e.g., mobile phones) and then the payment is completed (Gao et al., 2018). The QR code became popular in the commerce industry in China and became a crucial payment method, especially in the retail market. The financial inclusion due to the application of financial technology has a great contribution to daily life in China. Usually, it plays very a positive role since it changed the model of shopping and is very important factor of e-commerce development. The Chinese e-commerce market became the biggest one in the world. It is estimated that China is responsible for around 60% of the retail e-commerce sales worldwide (Fulco,

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2019). The role of the Internet and its impact on the processes of remote communication, digitalization of the distribution channels, and the development of new payment methods play here a significant role (Hu, 2020). The important dimension of financial inclusion in the Chinese market is also related to foreigners. The current banking system enables foreigners in China to have access mostly to basic services. Among such services can be enumerated access to transaction account for making payments and receiving money. They do not have, however, the possibility to use more sophisticated services offered by banks like Internet banking and admittance to credit market. Such services are well provided by Fintechs like the platforms WeChat and Alipay and are limited to those who have access to these platforms (Tampuri Jnr et al., 2019). Despite the many advantages, there are also numerous examples of disadvantages of Fintech development in the Chinese economy and society. An example is the development of P2P lending platforms which are leading to the growth of risk in the lending operations (Wójcik, 2020). In such unprotected transactions, investors are exposed to numerous risks related to the unfair behavior of the initiators as well as to the market risks. The financial market in the US, similar to the Chinese market, during the last several years, becomes a tech-like business. Bank customers eagerly use the digital access to banking services. Digital banks are also becoming more and more popular in this country (Palmié et al., 2020). There are many ways how the Fintech companies have entered the banking sector in this country. Among them can be enumerated: – Entrance of new competitors coming from other sectors of the economy. – Implementation of the new technologies by incumbent institutions. – Development of new kinds of banks (digital banks). Fintech companies use innovative technologies to compete with traditional financial companies. This is of particular importance in developed countries, including the US financial market. Such companies like Apple, Samsung, and Google developed their own mobile payment systems and offer payment services for a broad range of customers (Tanda & Shena, 2019b). Another group of companies, like Venmo and Square, which are Fintech startup developers also enter the market of financial services (Bunge, 2017). They are especially present in such parts of the

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US economy, where the society has limited access to traditional banking (especially in rural communities). Fintech companies very easily enter these parts of the societies which are financially excluded. Such parts of the society do not have access to traditional banking services and the nonbank institutions have many advantages to fill in the gap. In consequence, the traditional lenders are replaced by alternative financing providers, among which are Fintech institutions. The situation also favors the development of such ecosystems as peer-to-peer (P2P) lending platforms which provide finance at lower rates to people with poor credit and those seeking small loans (Maskara et al., 2021). The financial market in the US changes rapidly, and the incumbent financial firms together with the software technology have a positive impact on the number of Fintech startups in the country (Bömer & Schwienbacher, 2018). During the last several years the banks themselves use Fintech companies (called third-party service providers) to offer bank services in a joint way. Banks in the US treat their cooperation with Fintechs as an opportunity for higher returns and to form a strategic partnership. Sometimes they are unable to enter emerging subindustries, but Fintech companies have a better opportunity to achieve this goal. It results in cooperation between banks and Fintech companies. Such cooperation enables to offer different financial services (see Fig. 6.1). Apart from the abovementioned processes of banking sector transformation, there are also radical changes in the financial sector in the US because of advanced digitalization processes. The rapid development of technological innovation gives rise to fully digital banks, often referred to as challenger banks or neobanks. Such banks seem to differentiate themselves from incumbent banks by offering novel services via a strong digital interface, often designed to appeal to specific groups of consumers. Among such institutions in the US can be included Empover, Qapital, Simple, MoneyLion, Motiv Money, and many others (Bradford, 2020). Despite this similarity to the Chinese market, in the case of the US, financial technology plays a slightly different role. This financial market is much more developed, compared with the Chinese counterpart, which influences the fact that financial technology is not only conducive to the availability of financial services to the public, but above all to provide more advanced services and processes. It means that big deals and big IPOs are important in this market. The country wants to be the biggest market of Fintech unicorns. On the other hand, the financial industry in the US is among the most developed and has been at the forefront for

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Fig. 6.1 The areas on the US financial market where banks cooperate with Fintech startups (US bank-backed deals to Fintech startups, the period of 2010– 2020) (Source Here’s Where Goldman Sachs, Morgan Stanley, And Other Top Banks Are Investing In Fintech—And Why—CB Insights Research)

many years. As a result, it may offer fewer opportunities for innovation, as disrupting the current equilibrium faces more resistance (Goldstein et al., 2019). Each new service or process that has been provided by traditional financial institutions is therefore implemented by Fintechs with much greater difficulty. It is significant that both analyzed countries are the most developed Fintech markets. While Fintech firms are born all over the world, the three geographical clusters are most significant, namely, the US, Europe, and China. It is also related to single services. For example the US, China, and the UK have been defined as the three largest Fintech credit markets (Claessens et al., 2018; Tanda & Schena, 2019b). In 2018 the US market accounted for 15.6%, the European market for 13.2%, and the Chinese market for 8.7% of the total Fintech firms. As some research shows, during the last several years both countries, China and the US exhibit the largest ratio of Fintech credit per capita (King et al., 2021). The transformations of the financial systems of China and the US from based on traditional financial institutions into systems based on financial technology are leading toward greater use of digital platforms. The cooperation between Fintech companies and financial institutions in these countries is deepening. There are some reasons for such a path of development. Firstly, the incumbent banks and Fintechs are complementary in

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their activities—banks can collect cheaper capital on money markets while Fintechs have more market experience in operating online. Banks are also constrained by regulatory requirements, while Fintechs have greater freedom in their activity. Secondly, the combination of online and offline activity (Fintechs have more advantages in online activity while banks have some advantages in offline approach) enables it to expand. Such cooperation leads to the creation of financial ecosystems (Gao, 2022). When considering financial ecosystems developed as a consequence of Fintech’s impact on traditional financial sectors, three dimensions should be taken into account. The first one is the structure of traditional financial institutions, the second one is the application of financial technologies (e.g., artificial intelligence or blockchain) and the presence of Fintech-based businesses, and the third one is the development of financial services offered due to the combination of traditional entities with the application of new technologies (Imerman & Fabozzi, 2020). The first group, the traditional financial institutions, consists of many entities, like: – large, well-established financial institutions (traditional banks); – large Big Tech companies (Facebook, Apple, Alibaba, Baidu); – established finance companies that provide infrastructure or technology to facilitate financial services transactions (e.g., Mastercard); – disruptive tech companies, often startups, that develop innovative technology or process in a specific niche or segment. All of these entities overlap and act together when offering particular financial service (Zhu, 2021). It was already highlighted that the US and Chinese markets belong to the biggest Fintech markets. In parallel to their position, there is also the greatest number of Fintech firms which provide financial services (Fintech population), which was presented in Fig. 6.2 (Carbó-Valverde et al., 2021). Despite the development of Big Tech companies (Google, Amazon, Facebook, and Apple), the typical Fintech entity in the US is a startup. China, on the contrary, is dominated by big Fintech giants. Despite these differences, in both markets, Fintech lending is mainly dedicated to individual consumers (in China, it is more than 50%, while in the US, almost 80%) (Claessens et al., 2018). The US and China belong to the biggest Fintech lending markets when considering the Fintech credit per capita.

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Fig. 6.2 Fintech population (December 2020) (Source Carbó-Valverde et al. [2021])

For the period of 2013–2019, it was USD 761 in the US and USD 745 in China (Carbó-Valverde et al., 2021). The way of expansion, however, is different in the case of both of the countries considered. The US Fintech companies are striving to achieve high specialization in a core field and to expand geographically (growing by expanding overseas). The Chinese counterparts instead focus on their domestic market and achieve high engagement in consumer platforms. Apart from Fintech lending, digital transformation stimulates the development of many other services, like crowdfunding, digital currency, or third-party payments. Their development plays a significant role in upgrading financial systems and adjusting the systems to the needs of economic development (Huang, 2020; Li, 2022). In China, Fintech credit mostly suits small firms and less affluent consumers. Very popular in this country is P2P lending. As it was highlighted before, China’s Fintech landscape is dominated by a small number of major players. A significant role is played here in these companies, which are called Big Techs, like Baidoo, Alibaba, and Tencent. Initially, these companies began their business in e-commerce, but finally, they are interested not only in the “shopping” business but offer a broad range of additional services to these customers. They also decided to enter the financial sector and offer numerous financial services to their customers. When considering such companies, the leading position belongs to the US and Chinese entities (Desjardins, 2018; Fernandez et al., 2020). Both countries are the largest markets in the world. Among the most essential companies from these countries can be pointed

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US Google, Apple, Facebook, and Amazon, and Chinese Tencent and Alibaba. They enter mostly into such services as payment, lending, and wealth management (Tanda & Shena, 2019a). Big Tech companies operating in the US also have a significant impact on some financial services. It is assessed that their contribution is so strong that they are able to redefine the financial services products to retail customers. They are especially active in payment and lending services (Tierno, 2022). The motivations of the US Big Techs’ entrance to financial services are, to some extent, similar when compared to the motivations of their Chinese counterparts. Usually, they want to diversify their revenue sources and bundle their financial activity with another activity, and in this way, facilitate another business activity. In the literature is highlighted that Big Techs have two features that distinguish their business models from other Fintech entities. First is the network effects due to the use of e-commerce platforms, messaging applications, search engines, etc. Second is the possibility to use AI, Big Data, and advanced computational techniques for achieving better results in offering financial services. Moreover, they have much better experiences related to consumers, and they were able to develop seamless consumer-centerd interfaces (Locatelli et al., 2021; Nicoletti, 2021). When considering the business models of Big Techs, they are also in a different position than other Fintech companies. Having many advantages, like a high degree of innovation and access to new technologies, strong financial position, large consumer databases, and the size and scope of their activity, they are able to offer financial services without partnering with other entities (Dziawgo, 2021). Despite the lack of traditional brick-and-mortar branches, Big Techs benefits from the knowledge of their customers, using proprietary data from online platforms and other sources, such as social media and customers’ digital footprints. This creates a big advantage for Big Techs over other Fintech businesses (Carstens, 2019). When considering the change in the financial sector, the Chinese sector is changing from a hierarchical governance structure (bank-based), to heterarchical (Fintech ecosystems), and finally to hierarchical (BigTech services) (Gancarczyk et al., 2022). Despite such changes in the governance mechanisms, Big Tech, similar to other Fintechs, play an important role as they enable access to financial services for hundreds of millions of customers. This role is also important in the case of developed countries like the US (Boissay et al., 2021). Achieving access to such a large number of customers is easy due to the application of digital

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platforms in the provision of their services (Bassens & Hendrikse, 2022; Langley & Leyshon, 2021). The development of digital platforms is related to a new and important change in financial markets, which is called the “platformisation of finance”. Both countries, China and the US, dominate in the process of emergence platform-based model of finance (Arner et al., 2021). The last phase of development of the Chinese financial system is the post-Covid-19 time. The pandemic boosted the adoption of new technologies in delivering financial services in the country. Fintech lenders are more likely to grant credit to low-income and unemployed borrowers than bank lenders (Bao & Huang, 2021). Moreover, the Fintech industry proved to be resilient for the dangers coming from the pandemic, which is difficult to say in the context of incumbent financial institutions (traditional banks) (Zhu, 2021).

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CHAPTER 7

The Digitalization of Cross-Border Payment Systems and the Introduction of the CBDC

Abstract China is the world’s second-largest economy by GDP and the largest exporter, but its currency is not yet of global significance. By promoting the RMB as a global currency for trade, investment, and foreign exchange reserves, China aims to reap some of these benefits while increasing its economic policy autonomy. There are two main goals of the RMB internationalization. The first one is to enhance the status of the Chinese currency and strengthen its role against other currencies, especially against the USD. The second goal is to support the economic developments and to strengthen the role of China in the international economy. Due to the economic Sino-US decoupling, there is currently a much greater need for China to have its own strong international currency that supports the role of its economy and the strategies for further economic development. Some economists such as H. Chey, however, assess that it is almost impossible that the RMB will achieve a status similar to that of the USD in the near future. According to them, China has not developed deep, open, and liquid domestic capital markets, so the RMB is not widely used as a medium of exchange, unit of account and store of value at both official and private levels. Another characteristic of internationally operating currencies is the open and liberalized domestic economy, which is of limited relevance to China, which still has relatively closed capital flows. Apart from the traditional developments of

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_7

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currency internationalization, there is a growing role of the internationalization via digitalization. Digitalization of the RMB is a new Chinese initiative whose pace has increased in recent years. The main goal of the idea is to replace some of the cash in circulation by central bank digital currency (CBDC or e-RMB). The PBC is one of the first central banks across the world which pays attention to the idea of the CBDC. The country also became the first major economy which decided to create an official CBDC. It is expected that at the first stage of development, the e-RMB will be a domestic currency and the international use is not the current priority. However, it is planned that in the future the eRMB will be used to navigate international transactions around payment systems and networks. The possibility to employ the CBDC in international transactions has important consequences for the process of RMB internationalization. Keywords Central bank digital currency · Dollar trap · International monetary system

Based on the GDP growth figures of recent decades, which have turned out more favorably for China than the US during the pandemic, it is expected that over the next decade China could overtake the US as the world’s largest economy. However, China’s GDP per capita is still well below that of the US. Although China is the world’s second-largest economy by GDP and the largest exporter, its currency is not yet of global significance. Compared to the USD dominance as a global trade and reserve currency, China lacks a number of advantages that the US does benefit from, such as lower borrowing costs, less currency risk, virtually no threat of a balance-of-payments crisis and the ability to accrue greater seigniorage, i.e., revenue from the issue of money. By promoting the RMB as a global currency for trade, investment, and foreign exchange reserves, China aims to reap some of these benefits while increasing its economic policy autonomy. The country has a growing role in the international trade, international flow of capital, technological advancement, and has the world’s largest stock of foreign exchange reserves denominated in USDs. Despite China’s immense trade volumes, the RMB still accounts for just 2% of global payments, is involved in approximately 4% of forex trades internationally, and makes up around 2% of foreign

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currency reserves globally. By contrast, the USD possesses a 40% share of global payments, 61% of official foreign exchange reserves, and is involved in over 88% of forex trades (iBanFirst, 2021). In a highly asymmetric international monetary system, the USD is still by far the dominant global currency when it comes to investment, invoicing and reserves. This has led to a “dollar trap” where countries and currency areas are overly dependent on the USD exchange rate, with central banks managing monetary policy in accordance with the Fed. While the PBC maintains a “managed floating” exchange rate system for the RMB against the currencies of all its trading partners, China maintains a “crawling peg” to the USD. Much of its liabilities and foreign exchange reserves are denominated in USD, while its assets are mainly denominated in RMB, with the result that a depreciation of the USD could adversely affect the Chinese economy. In addition to expanding the country’s political influence, China’s increasing international role in many financial and economic areas results in the need to more internationalize its own currency. There are two main goals of the RMB internationalization. The first one is to enhance the status of the Chinese currency and strengthen its role against other currencies, especially against the USD. The second goal is to support the economic developments and to strengthen the role of China in the international economy (Shin-hyung, 2019). Among the main arguments for the internationalization of RMB are the facts that there is a great gap between the role of the Chinese economy in the global economy and the role of RMB in the context of other currencies (Kratz et al., 2020; Zhou et al., 2020). Due to the economic Sino-US decoupling, there is currently a much greater need for China to have its own strong international currency that supports the role of its economy. Since an international currency will lower borrowing costs, reduce the foreign exchange fluctuations, and facilitate international flow of capital, it will increase the role of a home country in international trade and finance and will make it more convenient for domestic companies to conduct business abroad. There is, however, one additional significant reason for the internationalization of the Chinese currency. It is expected that with time the Chinese current account surpluses will change to a more balanced position or even into deficit. The need for higher capital income in the future requires better access of China to the global financial system. Also, China’s reemergence as the world’s fastest growing economy and its rapid recovery from the Covid-19 requires higher global adoption of RMB. It is well recognized that if a particular currency has international status it helps

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Table 7.1 Benefits and risks of an international currency

Benefits

Risks

Reduced transactions costs International seigniorage Macroeconomic flexibility Political leverage (hard power) Reputation (soft power)

Currency appreciation External constraint Policy responsibility

Source Own elaborations based on Cohen (2011)

such a country to reduce the economic risks coming from international transactions (Conti, 2020). The process of changes of the Chinese currency began in 1994 when the monetary authorities eliminated the dual exchange rate system and implemented the official central parity. During the first ten years they adjusted the official rate and kept RMB in the fixed exchange rate system in which the USD was treated as an anchor. Since 2005 the RMB abandoned its currency’s peg to the USD and became linked to a basket of most important currencies (van der Linden, 2011). Since October 1, 2016 the Chinese currency was added to the SDRs basket (the IMF’s unit of account). Due to this decision of RMB inclusion in the SDR basket the Chinese currency became more integrated with the global financial system (Harrison & Xiao, 2019). Further RMB internationalization became one of the crucial goals of the Chinese government for the last few years. The process has not progressed very far as the Chinese monetary authorities are struggling to make a good trade-off between releasing more of their own currency to the market on the one hand and giving up the government currency control that comes with it on the other. It is, however, no doubt that if the RMB is to be a global currency, it needs to be set free (The Economist, 2021a). A tool to better assess the pros and cons of an international currency is the Cohen’s Matrix (see Table 7.1). Among the advantages and disadvantages of an international currency are considered both, economic and political aspects. The economic benefits embrace reduced transaction costs (for businesses as well as for financial institutions like banks), international seigniorage (interest-free loans to the issuing central bank from non-residents), and macroeconomic flexibility (relaxation of external market discipline for the situation in the

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Table 7.2 Roles of international currency Levels of analysis

Official

Private

Medium of exchange

Intervention currency

Unit of account Store of value

Peg—exchange rate anchor Reserve currency

Vehicle currency (foreign exchange trading), trade settlement Trade invoicing Banking—investment currency

Source Own elaborations based on Cohen (2011)

balance of payments). The political benefits embrace leverage (the dependence of others on the issuer of international currency) and reputation (the international status and prestige). The economic risks embrace appreciation (as a consequence of excessive demand for the currency), external constraint (as a consequence of excessive accumulation of liquid foreign liabilities), and policy responsibility (responsibility for management international monetary structures). Regardless of the possibility of estimating the benefits and costs related to the functioning of a given currency at the international level, the decision to ruthlessly strive to achieve such status is not easy. It is due to the fact that every currency plays different roles, both, in public, and also in private dimensions. The taxonomy of these roles is presented in Table 7.2. The striving to internationalize particular currency makes the whole situation even more complicated, because the currency must provide equilibrium for all of these roles not only from the domestic economy’s point of view but also on an international level. As Cohen highlights, very often the detailed analysis of the six functions mentioned is overlooked and the prevailing idea is that the key is to obtain the status of an international currency (or reserve currency) and all the detailed functions are reduced to this one (Cohen, 2011). However, this is not the best approach, because such general approaches do not ensure full reliability of the assessment of the position of a given currency from the point of view of various economic processes. Only those currencies which can be significant in all six functions played on international level are able to be treated as a top class currencies. It means that the main success factor of currency internationalization is not the political will but the economic ability to perform the function of money achieved on many levels. Among the most important factors are indicated: economic size of

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the country, financial market development, and network externalities (the factors impacting on the length of the process) (Cui et al., 2022). The government which plans to internationalize its currency should consider in detail the potential benefits, but also costs. And the government must consider its own goals and benefits achieved as a consequence of currency internationalization. In the case of China, especially important is the situation in the balance of payments (the international currency will impact on the capital and financial account). And the last aspect is the long-term consequences of having the status of international currency. It is very significant for the process of RMB internationalization to make progress with the settlement, investment, and reserve currency functions (Ly, 2020). Some economists assess that it is almost impossible that RMB will achieve in short term a similar status like USD. Instead this currency can become an important regional currency (Chey, 2013). In this regard, it is important that the RMB is used more frequently in crossborder trade settlements, but as Fig. 7.1 shows, cross-border RMB trade settlements have not progressed in recent years. On the other hand, China has not developed deep, open, and liquid domestic capital markets, what causes that the RMB is not widely used as a medium of exchange, unit of account, and store of value for both, official and private level (McNally & Gruin, 2017). RMB is also not significant as the reserve currency. The situation and the limited role of RMB in the international economy is a consequence of too long state intervention and use of the currency as the crucial tool supporting the international trade and the managed exchange rate. Just a few years ago, it was common for the authorities to intervene directly in the foreign exchange market by buying or selling USD to get the desired exchange rate. In 2016, it reduced its foreign exchange reserves from about 4 to 3 trillion USD to support the RMB, but over the past five years its reserves have remained relatively stable. Since then, there have been no large-scale interventions and authorities have become more tolerant of allowing more fluctuations in the value of the RMB exchange rate (The Economist, 2021c). There are two reasons attributable to this new development. Firstly, the international situation of the Chinese economy plays a role here, and secondly, this development stems from the so-called Mundell-Fleming policy trilemma. The role of the Chinese economy in the international dimension is enhanced by its influence on the Belt and Road Initiative (BRI) project launched in 2013. The RMB is considered the strongest currency among

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Fig. 7.1 China’s cross-border RMB trade settlement (Source CEIC database; People’s Bank of China, 2021)

the major regions of the BRI and could therefore be used more as the settlement currency of large-scale commodity trading in the region. At the same time, the involvement of Chinese infrastructural investments could be increased in this way stimulated by more cross-border payments denominated in RMBs. Through the BRI, the RMB’s internationalization may enable China to challenge the US leadership role in the international monetary system, just as the US currency’s status was consolidated by the Marshall Plan after the Second World War. It has become increasingly evident that the cooperation between the participating countries of the BRI makes the RMB internationalization increasingly necessary, but also possible. Cooperation with trade and investment partners via the BRI is the best option as the internationalization with cooperation with the US financial institutions is limited. The US institutions are not interested in promotion of RMB internationalization. So the other option is to promote the process of RMB internationalization via the BRI (Łasak & van der Linden, 2019). It is expected that the BRI is a key area where the expansion of cross-border use of RMB is expected to make

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a breakthrough (Zhu, 2021b). Another important indicator of internationalization of currency is the level of foreign exchange reserves. In the case of China the level of foreign exchange reserves is very low, compared to the reserves denominated in other currencies. The other dimension of such currencies which are international is the open and liberalized domestic economy. The Chinese economy is still relatively closed in terms of the flow of capital (inward and outward investments). It is likely that the BRI also plays a significant role in this area (Liu et al., 2017). There are also other initiatives undertaken by the Chinese authorities to stimulate the investments in RMBs (Schwarzenberg & Sutter, 2021). Concrete actions besides the inclusion in the IMF’s SDR basket are currency swap agreements, offshore trading, RMB-denominated bonds, also known as “dim sum bonds”, liberalized foreign direct investment (FDI) through lawfully obtained offshore renminbi and beyond stimulating foreign trade, Free Trade Zones (FTZs) are used as testing grounds for wider reforms in areas like customs clearance and foreign exchange settlement (iBanFirst, 2021). The second reason which promotes the RMB internationalization and the release of the exchange rate is based on the Mundell-Fleming policy trilemma. According to this trilemma, it is impossible for a country to have control of all three of the following main aims at the same level: free capital mobility, a stable exchange rate management, and monetary autonomy. Every country should choose two out of the three (Economist, 2016; Łasak & van der Linden, 2019). The Mundell-Fleming policy trilemma indicates that with China’s independent monetary policy combined with free movement of capital, a more floating exchange rate is the only possible policy option. So if the RMB is to become a global currency, it needs to be a more liberalized The Economist (2021c). It is highlighted that the market forces are crucial for the processes of the currency’s internationalization (Zhu, 2021b). Strong international trade is an important factor which strengthens the process. One of the Chinese plans is to promote the RMB in international trade. The Chinese authorities began to create offshore RMB clearing centers and started to create bilateral currency swap agreements (Cheung, 2014; Lockett, 2016). It seems to be a natural next step of the economy’s development to enable foreign citizens to trade foreign exchange in China and Chinese retail investors to buy overseas securities and to open the Chinese derivative markets to foreign investors and to RMB-denominated commodity contracts (Bratton, 2021).

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Apart from the traditional developments of currency internationalization, there is growing role of internationalization via digitalization. Digitalization of the RMB is a new Chinese initiative whose pace has increased in recent years. The main goal of the idea is to replace some of the cash in circulation by the so-called central bank digital currency (national digital currency). The official name of the project which was launched in 2014 is the Digital Currency Electronic Payment (DCEP). The newly created digital currency is called digital RMB (electronic Chinese yuan, e-CNY). It is planned that the currency will be issued by the PBC and will be controlled by the institution (the payment clearing and settlement will be done through a centralized approach rather than distributed approach). After its formal implementation the currency will become a legal tender in China (it is planned for the Winter Olympics in Beijing which is scheduled for February 2022) (Ekberg & Ho, 2021). One of the aims is to increase the competition in the current mobile payments market and to speed up the process of cashless payments. There are many advantages of using such digital ways of payment. First, such payments are more efficient and improve the transmission of monetary policy. It will be possible for the authorities to activate the payment possibilities when some pre-defined conditions are met, which can be useful for the fiscal and monetary policies (Ekberg & Ho, 2021). Second, the digital currency enhances financial stability due to the possibility to indicate some of the illegal activities (the transactions will be disclosed to the central bank and the data records will be kept by the central bank). Third, the state currency enhances the competition in the Chinese payment system because a new player is a counterbalance for the incumbent private companies which are operating in the payment sector (companies run by Alibaba, Baidu, and Tencent). It must be highlighted that this solution is sponsored by the government not by the private sector. This nature creates additional value for the Chinese society—in contrast to the private solutions, there are no fees for the payment services. Moreover, the solutions offer offline usage (based on smartphone NFC), which creates additional challenges to the local payment service providers. Moreover, the digital currency promotes financial inclusion (Chuanwei, 2021). It is significant that at the first stage of development, the e-RMB will be a domestic currency and the international use is not the current priority of the authorities (Kharpal, 2021). Robert Greene highlights,

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however, that in the future the e-RMB will be used to navigate international transactions around payment systems and networks (Greene, 2021). Internationalization of RMB is, however, a more complicated process than its implementation in the domestic market, because such solutions must be accepted in many countries. It creates the need to elaborate such system that one country’s institutions are accepting foreign digital cash (Mukherjee, 2021). Despite the accompanying difficulties, the Chinese monetary authorities agree with the abovementioned idea and consider the implementation of the e-RMB not only into domestic transactions but also into international level. It is obvious, however, that the domestic use of e-RMB is scheduled for the short term, whereas the international application is scheduled for medium or long term. The new solution will be implemented by the commercial banking sector. Commercial banks will provide the new, digital currency to their customers. It is planned that the six largest state-owned Chinese banks (“Big-6”) will participate in the project together with the bank affiliates of Tencent and Ant Group, which are responsible for two dominant retail payment platforms in China. Regarding the technical aspects of the payment, it is expected that there will be created a special application, dedicated to such digital currency. There is a basic question how important is the digitalization of the RMB for its internationalization. Jan Knoerich argues that the crucial factor is not related to the nature of the currency (traditional or digital) but the extent to which the Chinese capital account is opened for foreign capital inflow (Knoerich, 2021). Such an approach opens a broader issue—two dimensions of RMB internationalization via the process of digitalization. One is related to retail payments and wholesale transactions connected with international trade, the other one is related to capital investments. There is no doubt that both of them are important, when considering the size of the economy and the Chinese population. Table 7.3 shows the current models of cross-border RMB settlements and the possible solutions when the e-RMB is implemented in international transactions. As it is shown, the first step of the process will be implemented in such territories as Hong Kong or Macau, which has a special status in economic cooperation with China. In the future, these mechanisms might be extended to other economic partners of China (e.g., within the BRI), and with time, also to other countries. The possibility to employ e-RMB in international transactions has important consequences for the process of RMB internationalization. For

RMB clearing bank

RMB clearing bank is essentially a special kind of agency bank with Chinese characteristics. The cross-border RMB receipt and payment is done on behalf of the overseas banks. This approach comes from the fact that in China has not yet fully realized the convertibility of capital items and from domestic payment and cross-border payment management differences

Agency bank

Offshore businesses are paid and settled through agency banks. It means that inland commercial banks open RMB interbank current accounts for foreign financial institutions, set fundamental funds and provide fundamental funds services, and sell RMB within the legal boundary at the request of foreign organizations. Commercial banks act as an RMB payment and settlement system, provide RMB liquidity to offshore markets, and realize the reflow of the RMB

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Cross-border Interbank Payment System was launched in October 2015 as an alternative to the pervasive SWIFT network. It is based on 19 commercial banks in mainland China in the first batch of direct participants and 176 indirect participants from more than 50 countries and regions all over the world (according to Reuters in 2019 there were 980 participating institutions from 96 countries). The system has adopted a method involving one connection for one bank, centralized settlement, and Real-Time Gross Settlement (RTGS). The system provides clearing and payment services for financial institutions in the cross-border RMB and offshore RMB business. Its main functions are remittances and interbank settlements for customers related to cross-border settlements (trade in goods and services, direct investment, financing, and fund transfer for individual customers, etc.)

RMB cross-border payment system (Cross-border Interbank Payment System, CIPS)

The current models of cross-border RMB settlement and the planned model within e-RMB

Current state—three models of cross-border RMB settlement

Table 7.3

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RMB clearing bank

RMB cross-border payment system (Cross-border Interbank Payment System, CIPS)

Source Own elaboration based on Auer et al. (2020), Chuanwei (2021), FACTBOX-China’s Onshore Yuan Clearing and Settlement System CIPS (2020), Institute (2016) and Zhu (2021b)

Future state—the system of using e-RMB in international transactions Retail Since 2013, China has established an offshore clearing system under the clearing bank model. Under this transactions system the Hong Kong or Macau clearing banks are directly connected to the large-value payment system of PBC, other clearing banks are connected to the large-value payment system through their head office or parent bank, and overseas banks open RMB clearing accounts at the clearing bank for joint completion. Combined with the e-RMB design plan, offshore clearing banks should be able to issue e-RMB overseas and provide exchange services between offshore RMB and e-RMB, subject to the same rules and regulatory standards as designated domestic operating institutions. For example Bank of China Hong Kong is one of the three Hong Kong dollar note-issuing banks, and it should also become a digital RMB issuing institution in the Hong Kong market in the future. The e-RMB issued in the offshore market and the e-RMB issued in China should be completely equivalent in terms of legal status and value characteristics Wholesale Wholesale central bank digital transactions are mainly issued to institutions like commercial banks and they transactions serve large-value settlement. They will use the wholesale settlement infrastructure provided by central bank. The CBDC system will be connected to existing wholesale foreign systems, including the RTGS system

Agency bank

Current state—three models of cross-border RMB settlement

Table 7.3

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example, it is feasible that the Hong Kong user can use the digital RMB wallet provided by BOC Hong Kong and exchange the digital RMB in mainland China. Conversely, the mainland citizen can also use the digital RMB wallet installed in the mainland while traveling in Hong Kong. Due to such transactions the digital RMB will become an important tool for opening up the onshore and offshore RMB markets. This feature is important in the context of cooperation via the BRI. The potential efficiency of such solution is confirmed by the fact that the Cross-border Interbank Payment System has also been implemented mainly within the BRI participating countries. It becomes obvious that the BRI contributes very much to the RMB internationalization. Participation in the Digital Currency Electronic Payment initiative can make transactions easier, faster, and cheaper (Jiang & Lucero, 2021). Currently, the central bank digital currencies (CBDCs) remain one of the most important topics among central banks across the world (The Economist, 2021b; Shen & Hou, 2021). There are many advantages connected with CBDC. Such a form of currency enables cost reduction (this includes both direct costs related to the issuance and maintenance of banknotes and coins, as well as indirect costs related to the necessity of the existence of many commercial banks, which act as intermediaries in the settlement transactions), the more efficient reaction of central banks to financial risks (CBDC reduces anonymity in transactions) and greater efficiency of monetary policy. China was always interested in the implementation and commercialization of Internet innovations, and the same was with the introduction of CBDC. The PBC was one of the first central banks across the world which pay attention to the idea of CBDC. In China, the CBDC is known as eCNY. The country also became the first major economy which decided to create an official CBDC. Its implementation means a big change in the approach because so far, usually stability, not innovation, has always been the core concern of the financial sector. On the other hand, the movement toward a cashless society later or sooner seems to be inevitable. Apart from the use of the digital RMB to reduce costs of issuing, printing, transporting, and managing paper cash and facilitate shaping the cashless society, among the main goals of the implementation of CBDC in China were: the aim to improve the monetary policy and to enhance the international position of RMB. The origins of the idea of implementing CBDC in China were in 2014 when the PBC established a research group on legal digital currency.

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In early 2016 the PBC announced a “strategic goal” of launching a CBDC, while in 2017 the project was approved by the State Council of China, and the first tests were implemented in 2020. The initial trial was launched in selected cities, namely Shenzhen, Suzhou, Chengdu, and Xiong’an. As of June 2020, the Chinese digital currency experiment has covered 20,87 (or 20.87) million individual users and 3,51 (or 3.51) million corporate users who can use e-CNY payment services in their daily transactions, such as utility bill payment, shopping and catering, and public services. In 2021 the tests were expanded to other cities (Benzmiller, 2022; Chaowei & Banggui, 2022; Cheng, 2022). Since November 2022, more cities (like Shanghai, Hainan, and Changsha) have joined the CBDC pilot project. Since January 2022, some commercial companies have included e-CNY in their services. Among them were Tencent, which has launched the currency in WeChat services, HD.com, and Didi Taxi, which has started accepting e-CNY payments in trial cities (Allen et al., 2022). Despite the implementation of the CBDC in some Chinese provinces, there is still a debate about whether the CBDC should be an instrument used for settlement only between different financial institutions acting on wholesale markets or if the currency can be applied in the whole economy and be also offered for retail customers. The second important question is how should be the settlement system organized to enable correct settlement (Allen et al., 2022). According to the mechanism that was applied in China, the current payment system will not be disturbed, and commercial banks will not be eliminated from participation in the payment system. It means that China has chosen the “two-tier operation architecture” (Fig. 7.2). Regulatory aspects, security, and customer data protection is also significant issue taken into consideration during the discussions about the DBDC in China (Chaowei & Banggui, 2022; Cheng, 2022). The positive effect of the application of e-CNY is for the monetary policy. The Chinese case shows that the implementation of e-CNY has many positive monetary aspects, e.g., it is improving the optimization of the existing payment system, enhances the possibility to control the money supply, and improves the transmission effects of the monetary policy tools (Yang & Zhou, 2022). Considering the application of CBDC in China, it must be highlighted that the currency is treated as a substitution for cash. At this moment, however, there are no plans for CBDC to replace cash rather, it should co-exist with it (Shen & Hou, 2021). The second aspect is that despite

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Fig. 7.2 The CBDC issuance mechanism in China (Source Own elaboration)

the fact that currently the e-CNY is designed mainly for domestic retail payments in the local market, it is not the only goal, and in the future, it also will be promoted by China as an international currency. Here the currency will be treated as a countermeasure for the USD and a way for the internationalization of RMB. The approach to the CBDC in the US is reflected by the motto “get it right than to be the first”. The decision-makers in the US can very easily manage the wholesale digital currencies, but the main question is how to design the “retail” digital currency for the public (The Economist, 2021b, c). Comparing China, in the US the idea of CBDC meets with skepticism. Despite the fact that the representatives of Federal Reserve mentioned about this idea, they have not decided whether to issue such currency in the US in the nearest future (Chorzempa, 2021). Meantime FED is working actively on a faster payment system, which may obviate the need of CBDC. Regarding the digital currency, the main question is whether it would prove superior to other payment methods. In such discussions are considered advantages and disadvantages of such currency. It is highlighted that the FED will take further steps on creating such currency

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when the research will indicate significant benefits for households, businesses, and the economy, and the advantages will exceed the downside risks, and they will indicate that CBDC is superior to alternative payment methods (Federal Reserve, 2022).

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Lockett, H. (2016, April 28). UK becomes second-largest offshore Rmb clearing centre. Financial Times. https://www.ft.com/content/d552173a-6030-3c83b4f7-9efc1819bb30 Ly, B. (2020). The nexus of BRI and internationalization of renminbi (RMB). Cogent Business & Management, 7 (1), 1808399. https://doi.org/10.1080/ 23311975.2020.1808399 McNally, C. A., & Gruin, J. (2017). A novel pathway to power? Contestation and adaptation in China’s internationalization of the RMB. Review of International Political Economy, 24(4), 599–628. Mukherjee, A. (2021). Paying with e-CNY? First show a digital ID. The Economic Times. https://economictimes.indiatimes.com/markets/cryptocur rency/paying-with-e-cny-first-show-a-digital-id/articleshow/83798437.cms Schwarzenberg, A. B., & Sutter, K. M. (2021). U.S.-China investment ties: Overview. 3. Shen, W., & Hou, L. (2021). China’s central bank digital currency and its impacts on monetary policy and payment competition: Game changer or regulatory toolkit? Computer Law & Security Review, 41, 105577. Sheng, A., & Soon, N. C. (2016). Shadow banking in China: An opportunity for financial reform. Wiley. Shin-hyung, L. (2019, December 19). China pushes ahead with making yuan a global currency. Asia Times. https://asiatimes.com/2019/12/yuan-globaliza tion-remains-a-long-way-off/ The Economist. (2016). Two out of three ain’t bad. The Economist. The Economist. (2021a, March 18). China’s markets are shaking off their casino reputation. The Economist. (2021b, February 16). What is the fuss over central-bank digital currencies? The Economist. (2021c, June 19 ). Why China has learned to relax about its currency. The Economist. https://www.economist.com/finance-and-econom ics/2021/03/18/chinas-markets-are-shaking-off-their-casino-reputation Van der Linden, R. W. H. (2011). The nature of China’s exchange rate regime and the potential impact on its financial system. In Bank strategy, governance and ratings (pp. 275–299). Springer. Yang, J., & Zhou, G. (2022). A study on the influence mechanism of CBDC on monetary policy: An analysis based on e-CNY. Plos One, 17 (7), e0268471. Zhou, Y., Cheng, X., & Wang, Y. (2020). Measuring the importance of RMB in the exchange rate spill-over networks: New indices of RMB internationalisation. Economic and Political Studies, 8(3), 331–354. https://doi.org/10. 1080/20954816.2020.1775374 Zhu, W. (2021b). 如何稳慎推进人民币国际化? | 朱隽: 关于推动人民币国际化 的思考. 微信公众平台. http://mp.weixin.qq.com/s?__biz=MjM5NDk0O DEwNA==&mid=2650363039&idx=1&sn=737bfaee609163e166cf15fbbb8 ccf57&chksm=bef201f8898588ee787cdf4f0caf73d810c939edb8828ee4468 46799b691867b794a9c14577c#rd

CHAPTER 8

The Ongoing Sino-US Trade War and Subsequent Tech War

Abstract The Sino-US trade war and the ensuing technological war (2018–2023) with the associated increase in all kinds of trade-restricting measures has several causes and consequences. One of the US complaints in this regard concerns the protracted US trade deficits that have been partly caused by the “currency manipulation” of an undervalued RMB against the USD that is partially tied to the value of the USD. In addition, a lower standard of living in China has led to lower wages, but this argument is less and less valid in a more prosperous Chinese economy. Also, the surge in Chinese imports to the US has led to increased unemployment in declining US manufacturing industries that have not sufficiently grown and then unable to compete on a global scale in the past two decades. One of the bigger complaints that has fueled discussions about recent US–China trade disputes for some time is US allegations that Chinese companies are stealing or misusing intellectual property rights from US companies. For the last few years, the US has increasingly accused China of not only unfair trade practices such as intellectual property theft, but also forced technology transfers, lack of market access for US companies in China, and creating an uneven playing field through state subsidies from Chinese state-owned companies. The current tech war between China and the US began as a trade dispute, but quickly turned into a battle for leadership in technological dominance in core technologies such as 5G, artificial intelligence, and semiconductors. The © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_8

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key to this is the emerging digital state-led high-tech authoritarianism with mass surveillance supported by the use of Big Data and China’s 5G technology, which is seen as a threat to the US. The US, with its long history of technological development, has been the global technology leader for decades, but that position is now being challenged by China, which has made massive efforts to catch up with the US with tens of billions in state funding. Keywords Sino-US trade war and subsequent tech war · First Phase One trade agreement · Global supply chains · Currency manipulation · State capitalism · WTO commitments · Declining industries · Comparative advantage · Intellectual property rights · Forced technology transfer · “Chip war”

The US and China have a long history of economic rivalry and for many years they have argued over their bilateral trade relations on a wide range of subjects. Since 2017, especially the Trump administration has challenged Chinese business activities and with the necessary tariff increases in 2018 and retaliatory tariffs by China, this has turned into a trade war. The protracted conflict began in 2018 when the US started its protectionist policy toward its biggest trade partner China and reached a turning point in January 2020 with the signing of the first Phase One trade agreement, but not after it weighed heavily on the global economy for 18 months as a result of additional import tariffs levied by both the US and China. As a result of these measures and the associated threats, the Chinese and US economies are at risk of economic decoupling leading to all kinds of restrictions that hamper the bilateral Sino-US business, which is a major threat to the global economic prosperity. The main impact of the trade war has been to change world trade, especially the disruptions it has had on the global supply chains. There are several reasons that led to this trade dispute that later became more and more a Sino-US trade war and was gradually supplemented by more and more disputes about technology. The following causes of the Sino-US trade war and ensuing tech war (2018–2023) with the associated increase in all kinds of traderestricting measures are often distinguished without indicating a specific chronological order in time.

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First, the US trade deficit with China since the mid-1980s. In 2017, the US launched an investigation into Chinese trade policies and, as a result, imposed tariffs on USD 250 billion worth of Chinese goods. The main area of concern was the increasing US trade deficit since a record US trade deficit of USD 375 billion was revealed in 2017. In 2018, the US imported goods worth USD 539.5 billion from China and exported goods worth USD 120.3 billion, resulting in a trade deficit of USD 419.2 billion. However, there is also another perspective from this American concern taking into account that the export-led boom of the Chinese economy in recent decades would have been impossible without the American appetite for relatively cheap imports from China. Since China began its economic reforms in 1978, China’s GDP has grown at an average rate of nine percent per year and more than 800 million Chinese citizens have been lifted out of poverty. Since 1985, trade volumes between the US and China have grown 51 times, making the US China’s largest export market and hence supporting the US dominant position in the world economy. Also, China is at the center of the world’s and US supply chains, making hundreds of billions of USD for US investors, sending the most students of any country in the world to the US, and directly employing nearly a million US citizens in US export industries (Bessler, 2022). The largest US import items from China (in 2022) consist of metals (e.g., steel and aluminum), laptops and computer monitors, cell phones, video game consoles, and toys. The demand for these products surged in response to the Covid-19 pandemic, while imports of semiconductors, some IT hardware and consumer electronics, clothing, footwear, and furniture have declined. The largest Chinese import items from the US consist of commercial aircrafts, soybeans, and automobiles. One of the reasons of the US deficit put forward by the US authorities is China’s devalued currency or “currency manipulation” due to an exchange rate that is undervalued and partially fixed to the value of the USD, but that has largely been resolved with the current market-based valuation of its currency in China. Another reason for the US deficit is China’s lower standard of living, which allows companies in China to pay lower wages to workers, although this argument is also becoming less and less valid in an increasingly prosperous Chinese economy. From the beginning of China’s economic reforms in the 1980s, when the country increasingly became a major manufacturing center for goods thanks to the availability of cheap labor, the US trade deficit with China has been widening. This

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has impacted the US manufacturing industry with a decline in job growth with relatively low wage growth. The predominant complaints now are the restrictive market access and investment opportunities to Chinese markets and numerous government controls creating an economy of “state capitalism”. An underlying issue between the US and China that has been a topic of discussion within the WTO for many years is the economic model of China with its SOEs. Especially under the current regime of Xi Jinping, the role of SOEs has increased again compared to that of the privately owned companies. The US and other Western allies are quite skeptical about the limited rule of law in China and the increased support for SOEs through subsidies that can benefit them both domestically and in their business in the global markets. The US is increasingly resented by China’s protectionist policies, which require opening global markets to its businesses, but are reluctant to open its own market to global businesses. China officially claims that it never violates its WTO commitments, strongly supports multilateralism and open economic policy, and calls for mutually beneficial global cooperation. However, it continues to renege on its WTO commitments, and its economic model, where the state controls both public and private businesses, makes it difficult to use the WTO and its dispute settlement system. Second, the surge in Chinese imports to the US has led to more unemployment in US declining industries which have not expanded in the past two decades. Since China’s entry into the WTO in 2001, no other industry has been impacted by their integration into the global economy like US manufacturing. US manufacturing capacity has stagnated for the past 20 years and as of 2000 the level of US manufacturing employment has fallen by about 30% despite a slight uptick from 2010 until the advent of the Covid-19 pandemic (Halloran, 2022). The economic dispute in the trade war with China started with cheap steel and aluminum. China had the means to produce these materials very cheaply and dumped them on the US market. US steel and aluminum producers were unable to compete with cheaper imports. Ultimately, this proved to be a major threat to the American declining industries in the steel, aluminum, shipping, and auto industries in the mid-west, which were no longer able to compete on a global scale for more than two decades. The gradual decline in US manufacturing employment as a result of diminishing comparative advantages was one reason for the

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Trump administration in 2017, as was that of the G. W. Bush administration in 2003, to protect declining industries. The human cost of sudden industrial closures can be very high. In such circumstances, a temporary protection could be justified to allow industries who have lost comparative advantage to decline more slowly. However, on the other hand, such a policy can be at the expense of consumers deprived of access to cheaper foreign imports. In addition, there are several policy measures to support workers in declining industries through retraining and special redundancy settlements which is less drastic than increasing trade restrictions (Sloman et al., 2022). A recent example is the situation with electric vehicles, with Tesla’s primary competitor Nio which does not make its own electric vehicles, instead partnering with a state-owned auto manufacturer and is being given USD 1.5 billion in subsidies. The US considers these subsidies as a threat to domestic production, as they simply can’t compete with subsidized imports. Hence, import tariffs on steel and aluminum products were the first to be raised in the hope of preserving employment in these declining industries as much as possible and perhaps also securing an election win for the Trump government. Third, claims of abuse or theft of US Intellectual Property (IP) rights by China. One of the bigger grievances that led to recent US–China trade negotiations has been US accusations of Chinese companies stealing IP from US companies. Various US organizations have accused China of stealing or misusing US intellectual property and military technology. China has also been accused of putting policies in place that puts US patent holders at a disadvantageous position in the Chinese markets. To invest or sell products in the Chinese markets, US companies need to get into joint ventures with Chinese companies, which provides illegal access to their technologies. According to US officials, such unfair trade practices of China threaten high wage jobs and high-value-added manufacturing in the US. The Commission on the Theft of American Intellectual Property states that these practices, i.e., trade in counterfeit goods, pirated software, and trade secrets in China, cost the US almost USD 600 billion annually. Moreover, these costs do not include additional costs to companies of protecting intellectual property, disincentives for investment, reduced innovation, and employment effects on the US skilled labor. In March 2019, a poll revealed that one in five US technology companies had suffered from IP theft, perpetrated by China, within the past one year (Rosenbaum, 2019).

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Fourth, a forced transfer of US technology to China. Recently, the US authorities suspect the Chinese government of a forced US technology transfer related to its new Economic Reform Agenda fueled by the hi-tech industrial policy of China as part of the so-called Made in China 2025 (MIC) strategy. The US government assumes that this will enable Chinese companies to unfairly dominate strategic industries, such as food, medicines, fuel, and semiconductors, where US companies have been global leaders so far. The MIC 2025 plan is China’s key strategy to upgrade its industrial sector by concentrating on high-value manufacturing sectors, such as aerospace, robotics, and electric vehicles. As a result of this initiative, China could surpass the US as the global leader in advanced manufacturing. Until now, China had only focused on manufacturing and exporting basic consumer goods. The US government assumes its companies are unfairly disadvantaged by the state-funded MIC 2025 plan, resulting in US tariffs being imposed to hinder China’s more advanced growth trajectory (Bown, 2022). In short, the US has accused China of unfair trade practices, including IP theft, forced technology transfer, lack of market access for US companies in China and creating an unlevel playing field through state subsidies from Chinese SOEs. China, meanwhile, assumes the US is trying to limit its emergence as a global economic power. For many years, US authorities have been pressuring China to take steps to eliminate their country’s bilateral trade surplus with the US, end “currency manipulation” and IP theft, refrain from further forced technology transfer, phasing out subsidies to state-owned companies and stopping the takeover of US companies through state-sponsored investments. A truce in the trade war occurred in January 2020 via Phase One of the US–China Economic and Trade Agreement, which consisted of Chinese commitments for USD 200 billion in US goods purchases, further financial sector opening, and intellectual property protections. The agreement put further tariff escalation on hold, but did not take on newly contentious aspects of US–China economic engagement, for example, cross-border data flows, supply chain integration, cross-border investment, and joint investment in innovation. Paradoxically, these areas of Sino-US mutual engagement were once viewed as opportunities to create positive change in China, but are now more widely viewed as potential threats to US national security and competitive advantages. These perceived threats were also exacerbated by the pandemic and associated supply chain disruptions with China playing a major role in the

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production of many critical product items (Halloran, 2022). While the main causes of the US–China trade war are still current and the Phase One agreement (2020) that strengthens protection and enforcement of IP in China has not alleviated the trade conflict, trade disputes have now increasingly been complemented by a conflict over key technologies. The current Sino-US tech war started as a trade dispute, but soon turned into a battle for leadership in core technologies like 5G, artificial intelligence (AI), and semiconductors, so has become the growing battle between China and the US for global economic and technological dominance. The current tech war is mainly triggered by the MIC 2025 plan, Beijing’s 10-year blueprint for transforming the country from a “manufacturing giant into a world manufacturing power”. Key to this is the emerging digital state-led high-tech authoritarianism with mass surveillance supported by the use of Big Data and China’s 5G technology which is seen as a threat to the US. The US, with its long history of technological development, has been the global tech leader for decades, but that position is now being challenged by China, which made huge efforts to catch up with the US with tens of billions in state funding. For many decades, the US has been able to take advantage of a competitive advantage in all kinds of high-tech production in the automotive, space technology, semiconductors, and weapons industries, but now China has overtaken it in many areas. Currently, China and the US are both technological powerhouses. A very important factor in the current technology race is the development of semiconductors which should put China at the forefront of this production as part of the MIC 2025 strategy. Up until now the three biggest players in the semiconductor space were TSMC in Taiwan, Samsung in South Korea, and Intel in the US. This meant China was reliant on importing their chips for manufacturing. The US is working hard to make sure that China doesn’t dominate the industry, with massive sanctions being placed on Chinese chip imports to protect the domestic industry. China has a strategic agenda with technological development, the aims of which are to strengthen social control, expand international influence, and enhance military capabilities and the US is threatened by these developments. From the perspective of China, the situation is largely indifferent. While they have different social objectives for technology, they also don’t want to be dominated by another superpower. TSMC, Samsung, and Intel are all US-aligned manufacturers. Taiwan and South Korea are strong allies of the US, and Intel is their domestic chip maker.

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China no longer wants to rely on other nations for their much needed semiconductors. There is an increasing need for them to fortify their domestic technological capability, in order to relieve themselves from any economic pressure from the West. After the US began blocking China’s access to core technologies controlled by the US, such as semiconductors, China redoubled its efforts to decouple its supply chains from the US as much as possible. In addition, the global pandemic contributed to tensions between the two countries, prompting the Biden administration to issue an executive order to overhaul US supply chains for core products such as chips, batteries, rare earths, and medical supplies. A series of unrelated events, including fines and sanctions imposed on Chinese telecom giant ZTE for covering up its role in selling US technology to Iran, a report by the US Trade Representative (USTR) on the alleged theft of US intellectual property by China1 and the forcing of technology transfer, and concerns about Huawei Technologies Co’s dominance in 5G technology, turned into a broader tech war (SCMP, 2021) including the so-called “chip war” as described in the book of Chris Miller published in 2022 (Miller, 2022). The concept of economic security as national security has continued with the Biden administration. This was especially effective in February 2021, when President Biden issued an “Executive Order on America’s Supply Chains”, demanding, among other things, a report within 100 days requiring key government agencies to assess vulnerabilities and consider potential improvements to supply chains in four critical industries, namely semiconductor manufacturing, high capacity batteries, rare earth elements, and medicines. China is accused of aggressively using measures “far beyond globally accepted fair trade practices” to gain global market share in critical supply chains. The US–China Economic and Security Review Commission has strongly advised the US government to take more aggressive steps to re-establish commercial ties with China, increase 1 On August 14, 2017, the President issued a Memorandum to the Trade Representative stating inter alia that: China has implemented laws, policies, and practices and has taken actions related to intellectual property, innovation, and technology that may encourage or require the transfer of American technology and intellectual property to enterprises in China or that may otherwise negatively affect American economic interests. These laws, policies, practices, and actions may inhibit US exports, deprive US citizens of fair remuneration for their innovations, divert American jobs to workers in China, contribute to our trade deficit with China, and otherwise undermine American manufacturing, services, and innovation (USTR, March 22, 2018).

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warned national security risks, reduce US investments in China, and limit investors’ ability to buy US-listed Chinese stocks (Halloran, 2022). In the decades after China joined the WTO in 2001, US and Chinese trade flows and economies became more intertwined. However, since the start of the trade war in 2018, calls for a disconnection that would reduce US reliance on China-based supply chains have been mounting. Initially, decoupling was dismissed as unrealistic because China was too big for US companies to ignore, and its economy too intertwined with the global economy to be separated. However, a limited form of decoupling has gained increasing support among the leaders of big tech companies already experiencing a large degree of “unbundling” in the Internet space, with Facebook and Google not allowed to operate their social network and search engine in China. In response came attempts under the Trump administration to ban or restrict the US presence of Chinese social media outlets such as TikTok and WeChat in the US. Although China initially imposed retaliatory tariffs, the main response was the call from the authorities for a nation to become more technologically self-sufficient amid rising unilateralism and protectionism in today’s world. After Huawei was blocked from buying US chips and Shanghai-based foundry Semiconductor Manufacturing International Corp (SMIC) was restricted from buying US technology over alleged ties to the Chinese military, a charge it denies, Beijing increased its focus on the achieving self-sufficiency in semiconductors via tax rebates to state subsidies (SCMP, 2021). Not only in the MIC 2025 strategy, but also in China’s 14th Five Year Plan (2021–2025), technology is a key focus of new digital industries, including AI, big data, blockchain, and cloud computing, along with expanding the use of 5G for more sectors such as smart transport and logistics. Following the MIC 2025 strategic plan, China officially launched the “China Standards 2035” or “Vision 2035 development” strategy in 2018, aiming to create a blueprint for the Chinese government and leading tech companies to set global standards for emerging technologies, such as 5G, Internet of Things (IoT), and artificial intelligence (AI), quantum information, and semiconductors (Wu & Jia, 2020). While the tech war has started under the Trump administration, it doesn’t appear to have diminished under the Biden administration so far. Aside from the Trump administration’s attempts to ban Chinese short video platform TikTok and social media app WeChat in the US, Biden has kept the pressure on Chinese technology high and increased in Huawei’s

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case. As far as isolating Huawei more, Biden may even seem more effective than Trump in curbing his global 5G ambitions by adopting a more friendly stance toward international partners in Europe and elsewhere. In addition to sanctions against individual Chinese tech companies, Biden has made US competition with China the main focus in a battle between democracy and autocracy. Huge investments have been made in infrastructure and science and technology in order to become less dependent on technologies (e.g., chips) that are made abroad (SCMP, 2021).

References Bessler, M. (2022, November 16). Demystifying the debate on US-China decoupling. Center for Strategic & International Studies (CSIS). https://www.csis. org/blogs/new-perspectives-asia/demystifying-debate-us-china-decoupling Bown, C. P. (2022, October 20). Four years into the trade war, are the US and China decoupling? PIIE. Peterson Institute for International Economics. https://www.piie.com/blogs/realtime-economics/fouryears-trade-war-are-us-and-china-decoupling Halloran, M. (2022). Investment implications of Sino-US economic decoupling. Investment Strategy Group Janney. Miller, C. (2022, October 4). Chip war: The fight for the world’s most critical technology. Scribner. Rosenbaum, E. (2019, March). One in five corporations say China has stolen their IP within the last year. CNBC CFO Survey. Sloman, J. et al. (2022). Economics, 11the edition, Pearson. https://www.pearson.com/en-gb/subject-catalog/p/economics/P2000000 05437/9781292405407 South China Morning Post (SCMP). (2021, April 23). US-China tech war: Everything you need to know about the US-China tech war and its impact. https://www.scmp.com/tech/tech-war/article/3130587/us-chinatech-war-everything-you-need-know-about-us-china-tech-war USTR. (2018, March 22). Findings of the investigation into China’s Acts, policies, and practices related to technology transfer, intellectual property, and innovation under section 31 of the Trade Act of 1974. https://ustr.gov/sites/default/ files/Section%20301%20FINAL.PDF Wu Xiaomeng, & Jia, D. (2020, December 7). China’s $13tn shadow banking sector gets clearer definition. Nikkei Asia. https://asia.nikkei.com/Spotlight/ Caixin/China-s-13tn-shadow-banking-sector-gets-clearer-definition.

CHAPTER 9

The Sino-US Technological Decoupling and Ways to Address It

Abstract Since 2018, the Sino-US trade war has gradually turned into a tech race that mainly stems from China’s technological ambitions reflected in the “Made in China 2025” strategy promoting China as a high-tech country in the world markets and reducing its dependence on foreign technology. More recently, there has been an increasing “titfor-tat ” game for global economic and technological dominance, while at the same time both countries are still strongly linked through the “dollar trap” of the international monetary (dollar) system. The main arguments behind the increasing technological competition are to reduce the US reliance on Chinese technology in areas that raise national security risks and to protect critical technologies from being transferred from the US to China, with technological competition mainly encompassing sectors such as 5G, artificial intelligence, and advanced semiconductors. China uses its economic power over global technology supply chains to achieve its political goals and many companies are leaders in advanced technologies relative to the US and the rest of the world in fields such as smartphones, drones, and electric vehicles. In response, the US government has placed unprecedented restrictions on technology exports to cut off Chinese companies from advanced semiconductors made anywhere in the world using US equipment or know-how. The goal is to contain China’s rise by thwarting technological development that could enhance its capabilities, especially in the military and cyber fields. In the search © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_9

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for a suitable US technological decoupling strategy regarding China, four approaches are distinguished to address it including the full technological decoupling by the separationists, the restrictive approach that assumes that the technology relationship between the US and China is a zero-sum game, a cooperative approach that views US–China technical ties as nonzero and largely beneficial to the US and the centrist approach conducted by the Biden administration that tends to focus on the advanced technology decoupling while enabling fair economic engagement with China in other fields. Keywords Economic and technological decoupling · Blacklist of technology companies · “tit-for-tat ” game · “dollar trap” · Inflation Reduction Act · Separationists · Restrictive approach · Zero-sum game · Cooperative approach · Centrist approach · Entity List · Global chip supply chain · Economic statecraft

Since 2018, the main point of conflict between China and the US is the trade war which has gradually turned into a tech war or tech race (Wu, 2020). A major cause of the tech war stems from China’s technological ambitions reflected in the MIC 2025 strategic plan, which presented the goal of reducing China’s reliance on foreign technology and the need to promote Chinese high-tech manufacturers in the global market. The Chinese practices were considered as “forced technology transfer” by the US, the EU, and Japan. In return, Trump’s administration took unilateral actions against China and created a blacklist of technology companies which should be stopped of cooperation, thereby severing the technological ties between these two countries. The US sanctions were imposed on the top Chinese technology companies (Qin, 2019; Sun, 2019). Since then, China and the US have increasingly entered a “tit-for-tat ” game as they compete for global economic and technological dominance in this decade. While both countries are currently competing with all kinds of restrictions such as export controls, divestment orders, licensing denials, visa bans, sanctions, tariffs, and the like, they are also tied via the stillexisting “dollar trap” which is a given phenomenon for both countries what the politicians can’t really avoid. Together with trade tensions, the technological relations between China and the US are leading to greater decoupling. The main argument

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behind the mounting technological competition is national security. The technological tensions between these two countries are bigger than their trade confrontation and affect other areas. Technological development has a great impact on trade relations but also on investment networks, and social separation (reducing education and R&D processes) leading to great decoupling of the two countries (Lim, 2019). The technological competition embraces especially such sectors like 5G, artificial intelligence (AI), and advanced semiconductors (Kahata, 2020). Some of the Sino–US technology rivalry is still in its early stages, with emerging areas such as quantum computing and artificial intelligence where the US still has an edge in critical sectors such as software and semiconductors. However, in sectors such as smartphones, drones, and electric vehicles, Chinese companies are gaining ground or are ahead of the curve thanks in part to a skilled and cheaper workforce, massive government subsidies that have driven out Western rivals, and, unlike many US investors, a willingness to finance expensive manufacturing sectors that sometimes yield lower profits than software companies do. The new Chinese regulations result from the current situation while the US and China are in a race to develop the newest technologies. The main argument is that China uses its economic power over global technology supply chains to achieve its political goals. Also, more and more intensive activities are being set up in China to develop the domestic capacity to produce advanced technology reflected in the rapid development of selected sectors (Kahata, 2020). Very often the Chinese companies are leading in the advanced technologies not only comparing to the US industry, but also, they are leading in the world (see Table 9.1). While Apple and Samsung are the best-known smartphone brands in the West, in many other parts of the world the Chinese brands dominate, securing the top sales rankings worldwide. US authorities have been trying to cut off supplies of semiconductors to Huawei, which has hampered the Chinese tech giant’s ability to make smartphones, but other Chinese brands have filled that gap. Partly by taking Huawei’s market share, China’s Xiaomi has overtaken Apple in 2021 to become the second smartphone worldwide, with Samsung being the first. In addition, several other Chinese brands such as vivo, OPPO, and HONOR that are even lesser known in the West have made major inroads in Africa and Asia with low-cost, high-quality handsets, making Chinese smartphones account for more than half of the top 15 brands’ sales worldwide. Over the past decade, the share of smartphone units shipped by the top 15 global

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Table 9.1 Comparison of the share in the global market of selected Chinese and US industries and products in selected years The sector of industry/product

US companies

Chinese companies

Share of smartphone units shipped by the top 15 brands worldwide Annual share of global revenue from sales of telecom network equipment Share of global photovoltaic cell shipments Domestic market share of new plug-in electric passenger cars Share of global semiconductor manufacturing Market share of US downloads among top 10 social media applications

19% (2011)

15% (2021)

11% (2011)

58% (2021)

10% (2014)

9% (2021)

28% (2014)

36% (2021)

10% (2005)

1% (2020)

4% (2005)

67% (2020)

0,8% (2015)

4% (2021)

0,9% (2015)

15% (2021)

37% (1990)

13% (2021)

N/A

16% (2021)

Facebook Messenger 18% (2009) Instagram 13% (2009) Facebook 13% (2009) Snapchat 13% (2009)

Facebook Messenger 13% (2021) Instagram 11% (2021) Facebook 15% (2021) Facebook 9% (2021)

Tik Tok 10% (2009)

Tik Tok 20% (2021)

Source Own elaboration on the basis of Whalen & Alcantara (2022) and Calhoun (2021), and others

brands has risen more than 60% for Chinese brands, while for US brands it has only increased by about 15%.

China is by far the largest supplier of the global demand for solar panels (see Table 9.1). Demand is rising sharply as countries make efforts to harness more renewable energy sources. The Chinese

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government has heavily subsidized this production with cheap land, electricity, and financing. Due to the sharp increase in Chinese production, the prices of panels worldwide fell, and many Western manufacturers had to go bankrupt. The US government has blocked imports of some solar panels on alleged forced labor use, leading some panel buyers to look for US suppliers instead.

The first Chinese technology to gain significant attention in the West is the telecommunications sector, where Huawei quickly grew into the world’s largest manufacturer of cell phone tower equipment that transmits mobile signals. In particular, Huawei became dominant in selling equipment for the latest 4G and 5G networks, which are the foundation for many future technologies involving mobile data connections for self-driving cars, automated factories, and more. Huawei’s heavy investments in equipment development and manufacturing helped the company grow, even as US companies withdrew from the business, discouraged by the heavy capital investment required, and the fragmented Western market that made it difficult for them to achieve economies of scale. As a result, almost no US companies sell telecom network equipment today and when Huawei became dominant, the US essentially banned the equipment domestically and pressured allies not to use it, claiming that China could use the devices to build networks, to spy on, or disrupt. The success of the social media app TikTok shows that China is gaining ground in software, a sector that the US has long dominated (see Table 9.1). TikTok’s user boom in the US continued even after the Trump administration tried to ban the app for threatening national security by collecting huge chunks of user data that Chinese Communist Party could tap for unspecified sinister purposes. The Biden administration reversed that ban, in part because federal courts had temporarily blocked it from proceeding, saying it appeared to be exceeding the limits of the law (Whalen & Alcantara, 2022). The US continues to dominate global sales of semiconductors and the computer chips that power most modern electronics, from airplanes and smartphones to cars and vacuum cleaners. However, many US companies design the semiconductors and outsource production to major manufacturers such as the Taiwanese TSMC. The US production of chips had fallen from over 30% three decades ago to around 10% in 2022. About

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13% of semiconductor manufacturing capacity is in the US, compared to 16% in China, 20% in Taiwan, 19% in South Korea, and 17% in Japan. When it comes to the most advanced logic chips with the smallest transistors under 10 nanometers, Taiwan produces 92% and South Korea produces the rest. Despite years of investment, China has struggled to develop and manufacture state-of-the-art semiconductors, which require intricate designs and manufacturing know-how. Still, China is investing billions in its chip companies to try to catch up. Partly out of concern over China’s increasing technological prowess, the Biden administration is urging to move some of its chip production to the US. In an effort to reverse a decades-long decline in US share of chip production, Joe Biden signed the Chips and Science Act in August 2022, which can be seen as a statement of support for a “new era of industrial policy”. This law approves an amount of USD 52 billion in subsidies and tax breaks to help jump-start the renewed production on American soil of advanced semiconductors. That same month, the president’s groundbreaking Inflation Reduction Act was passed. This law involves nearly USD 400 billion spent to boost clean energy and reduce reliance on China in key supply chains, such as in batteries and subsidies for US-made electric vehicles and the like, designed in part to bring supply chains back from China. In October 2022, Biden announced unprecedented restrictions on technology exports, including chips and chip making technology, designed to cut Chinese companies off from cutting-edge semiconductors made anywhere in the world using US equipment or know-how. The goal is to contain China’s rise by thwarting technological development that could enhance its capabilities, especially in the military and cyber fields (The Economist, 2022). Current export controls on advanced semiconductor technology to China, including semiconductor manufacturing equipment, effectively limit China’s ability to produce its own advanced devices. In addition, support for US semiconductor manufacturing is subject to additional restrictions on Chinese companies and government-affiliated entities, and unprecedented bureaucratic scrutiny of US venture capital and equity financing flows to China. In effect, the US is forcibly decoupling all advanced technology supply chains before China can insource them. In addition, as of mid-December 2022, the number of Chinese companies and research labs including forced delisting from US stock exchanges and prohibitions on investments by US fund managers on the Entity List of the Ministry of Commerce has quadrupled over the past four

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years. This means a strong restriction on exports to foreign companies identified as engaging in activities detrimental to US national security. The new tough “carrot and stick” approach of the US government is partly influenced by the recognition of the military strategy of the Chinese authorities increasingly using national efforts to improve China’s economic and technological progress achievements and then converting them into military power. Given the building block role that semiconductors around the world play in its technology spectrum from smartphones to ballistic missiles, their development is also a top priority for China to achieve Xi’s stated goal of becoming a leading manufacturing superpower by 2049. Along with quantum computing, big data, and AI, semiconductors have also become an inherently “dual-use” technology that has both military and civilian applications. It is a great challenge for the US to convince allies to join the same restrictions on China’s chip industry for their own companies. Like many US chip manufacturers or equipment makers, the European, Japanese, and South Korean companies are at least as dependent on the Chinese market for their businesses. Although the US tends to rely on unilateral and especially extraterritorial controls because it is faster and more effective in the implementation in the short term, it becomes all the more difficult to work with allies. It is essential that the Biden administration’s “carrot and stick” approach be implemented as multilaterally as possible to avoid leaving too many ways for China to undermine or circumvent controls. In the past decade, semiconductors have become central to the global economy and associated with it supply chains that are increasingly characterized by a relentless drive for efficiency and innovation, where governments use subsidies and tax incentives to gain industrial advantage. The result is a business model built on specialization and cost advantage. Taiwan, South Korea, and, most recently, China have emerged as the leading chip manufacturers. The US, Japan, and the Netherlands monopolize the semiconductor manufacturing equipment that is crucial to semiconductor innovation. The US dominates chip-design software, and along with Taiwan is on the cutting edge of designing the most advanced circuitry. China, Taiwan, and Southeast Asia handle final-stage assembly, and dozens of countries supply specialty chemicals, gases, and other inputs (Mark & Roberts, 2023).

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Unlike semiconductors, China is leading the way in lithium-ion battery production that is central to the emerging green economy that powers electric vehicles and stores solar and wind energy for later use. China has bolstered its battery and electric vehicle businesses with tens of billions of USD in state aid, including research and development funding, subsidies to manufacturers and funding for battery charging stations. It has also boosted demand by subsidizing the purchase of electric vehicles by consumers and by making buyers of petrol cars wait much longer for a license plate. In the US, the battery industry has been largely left to the free market, but thanks to federally funded universities and national labs, the US has some of the best battery research in the world (Whalen & Alcantara, 2022).

The US representatives publicly announced that it is necessary to take restrictive measures against the Chinese technology. The restrictions started during Donald Trump’s presidency, when two executive orders were signed by the US President, banning US companies and citizens from doing business with two Chinese companies, ByteDance and Tencent (Ma, 2020). Apart from such selected cases of competition, in a more general sense the US policy against Chinese technological competition embraces: 1. Reducing US reliance on Chinese technology in areas that raise national security risks. 2. Protecting critical technologies from being transferred from the US to China. These two points represent only a general line of the US policy and the goals of the long-term technology relationship with China. The real situation related to the Sino-US technological competition is much more complicated and is still unpredictable. Under the Biden administration, the US is seeking a more effective technology decoupling strategy with China. It is important that a comprehensive assessment is made of the technical ties between the US and China and the effects on each other’s national interests. In fact, this technology decoupling strategy should

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consider more than just technology-specific aspects, but it should also be rooted in a broader approach that decoupling united with other national priorities, from international trade to domestic political stability to global climate change, which can be directly or indirectly affected. In the search for a suitable US technological decoupling strategy regarding China, four approaches are distinguished to address it. First, the most extreme approach to a full technological decoupling is that of the separationists, which is often seen by populist politicians as an extreme form of economic nationalism in which China and the US split into separate blocs. Due to the recent tense geopolitical situation, especially due to the position of Taiwan, the separatists have received more attention. Because Taiwan serves as a global hub for semiconductor manufacturing, a so-called Chip War would disrupt trillions of USD in global trade, slow global electronics consumption, and take manufacturers several years to replace Taiwan’s central role in chip manufacturing (Taiwan makes nine-tenths of the world’s advanced semiconductors). However, a future without international trade between the US and China could significantly weaken both economies. The consequences of full decoupling are difficult to predict considering, among other things, the spillover effects on global supply chains and international banking. It is to be expected that as military friction between the US and China increases, the influence of the separatists will increase as well (Bessler, 2022). Second, there is a restrictive approach that assumes that the technology relationship between the US and China is a zero-sum game and tends to favor Beijing, necessitating a dramatic curtailment of bilateral technical ties. This approach fears China’s technological dominance the most and urgently wants to accelerate technological decoupling. However, unlike the separatists, the restrictionists are not seeking to completely cut the economic ties with China. Restrictionist policies that have recently gained support usually harm the US economy in some way because of the Sino-US interdependence. Hence, proponents of this policy must clearly demonstrate, due to national security concerns, that China is much more dependent on the US economy than the other way around. Third, there is a cooperative approach that views US–China technical ties as non-zero game and largely beneficial to the US, causing it to have reservations about key elements of Washington’s decoupling

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agenda. This more pro-business technocratic approach considers the benefits of continued US–China involvement as greater than the strategic risks and they fear US overreaction, inflated threat perceptions, and excessive trust in restrictive instruments. According to this approach, cooperative policies such as China’s entry into the WTO in 2001 and the US–China cyber agreement in 2015 link the two economies closer together. Fourth, there is a centrist or in-between approach that identifies the technical relationship between the US and China as complex and uncertain, with both zero-sum and non-zero-sum elements and mixed costs and benefits for both countries. Centrists want targeted, fine-tuned defenses plus major offensive investments. The centrist strategy tends to focus on the advanced technology decoupling such as microchips while enabling fair economic engagement with China in other trade flows, financial flows, obsolete technology or labor and student flows. This approach fears the American inability to strike a balance between interdependence and decoupling and is together with the cooperative approach advocating for a gradual winding down of certain aspects of China’s tech ties. Key capacity challenges include securing public–private coordination, mapping complex global supply chains and overcoming the US stalemate between the restrictive and cooperative approach. So far, it appears that the Biden administration is taking a more centrist approach coupled with more competitive trade and technology decoupling in the short term to allow for more financial-economic and perhaps technology coupling in the longer term. The current US centralist strategy is to make offensive technology investments, but because these are difficult to implement and take a long time to pay back, in the short term fast acting more defensive restraints are used to buy time. This means that the US must introduce technological controls in areas where China can gain strategically significant long-term benefits. Although the restrictive measures as part of the Sino-US tech war by themselves cannot ensure US technological preeminence over the long run, but they can frustrate the Chinese technological dominance in the short run. But ultimately, in the longer term, the less reliant China is on US-made technology, the less leverage the US will have to influence the way China pursues its interests over time. So far, the US government has been the main driver of the recent technological decoupling with China, while the

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Chinese government has been more reactive. China still seems interested in preserving many of the technological connections it has built over the decades, at least until it can position itself for greater self-reliance. Although during the Sino-US tech war the Chinese government gradually becomes more assertive, the authorities usually have cautiously and reciprocally responded to many of US technical restrictions (Bateman, 2022a). However, at the end of 2022, it looks more likely that the US restrictive or zero-sum thinkers will have the upper hand in technological decoupling than the more cautious voices among the cooperationists and centrists. This shift portends even tougher US measures to come, not only in high-end computing, but also in other sectors such as biotechnology, manufacturing, and finance that are considered strategic. The pace and details are uncertain, but the strategic purpose and political commitment are now clearer than ever. China’s technological rise will be curbed at all costs. The most important US measure among others that has restricted the flow of technology to and from China in recent years is the Entity List, which prohibits designated companies from importing US goods without a license. The number of unique Chinese companies on this list has quadrupled from 130 to 532 between 2018 and 2022. Leading Chinese chip companies, supercomputing organizations, and software and hardware vendors have all been placed on this list. Chinese company Huawei has faced a unique, supercharged version of the Entity List, an expanded form of its foreign direct product rule, a powerful regulation that gives US export controls greater extraterritorial reach. US export controls primarily apply to US-origin items, but the Foreign Direct Products rule extends its scope to non-US items made using US technology. Taking advantage of America’s central position in the global chip supply chain, the US Commerce Department’s Bureau of Industry and Security (BIS) forced semiconductor designers and manufacturers in third countries to limit sales to Huawei. The new export controls effectively bring all of China under the special rule previously reserved for Huawei. Advanced semiconductors from any country will presumably be denied to any Chinese company, even those that have no direct ties to Beijing’s military or intelligence services. Among other things, this will hinder the development and deployment of artificial intelligence (AI) across the country, hindering China’s progress in e-commerce, autonomous vehicles, cybersecurity, medical imaging, drug discovery, climate modeling, and much more. China’s own semiconductor sector is unable to produce

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the advanced chips used in AI applications. This sharp escalation in technology decoupling has been justified by the US with the national security argument portraying China’s high-end computing as an urgent military threat with AI as a surveillance tool. However, the fact that semiconductors and AI can also be seen as common dual-use, general-purpose tools means that denying them can also be seen as an economic constraint for both countries, a point emphasized by the cooperationists (Bateman, 2022b). China, being active in the numerous initiatives oriented toward economic development, strongly promotes technological development of the country. An example of such policy are the standards related to the Internet and other aspects of digitalization (Park, 2022). They focus on the one hand on production of technologically advanced goods while on the other hand on development and application of new technologies like AI and machine learning. From an American perspective, three new interconnected phases can be observed in the US–China economic–technological decoupling in 2022, namely the rebuttable presumption, the impact of global supply chains and a new tool for economic statecraft. The first concerns a new law that prohibits the importation of goods or raw materials from China that have been produced with forced labor under a “rebuttable presumption”. The act’s rebuttable presumption assumes that all US importers have supply chains that are in any way connected to the use of forced labor unless the importer can prove that their supply chains are free from forced labor through a complicated, costly public review process. The second related point concerns the impact of global supply chains. For example, billions of USD worth of raw materials, minerals, and products that are banned from importing to the US are exported every year from Xinjiang. This will further decouple the US and Chinese economies by forcing multinational companies operating in the US to source the same materials from other countries, probably at higher prices. This will pose significant challenges to the already fragile global supply chains for green energy products, rare earth minerals, food products, and pharmaceutical precursors. In addition, a new economic statecraft tool could emerge in this way if authorities consider using the rebuttable presumption more broadly for national security authorities and legislation. For example, the rebuttable presumption fits a missing regulatory and enforcement gap in existing export control authorities. Currently, the US government is struggling to enforce export control

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regulations on a large scale due to the “knowledge requirement”, which states that companies must “know” that they are exporting controlled technology to military end users in China, Russia, and other high-risk countries (Conklin, 2022). The next phase of Sino-US technological decoupling is likely to be more unpredictable and risky as it is not clear whether allies and partners will continue to follow America’s leading position. It is clear that the US government needs the commitment of its allies not only to enforce their export controls, but increasingly to coordinate industrial policy, share economic information, harmonize digital regulations and collectively shape a future international economic order to put more pressure on the Chinese authorities. Therefore, the Americans have been urging their allies to anchor their tech goals in a trilateral pact. However, this is not easy for most Asian countries to implement because of their deep economic ties with China that they are reluctant to break. As a minimal precaution, it is an option that some tech companies in the region could create dual supply chains, one facing America, the other China (The Economist, 2022). As with the trade war, China will also respond through symmetric retaliation, for example by blocking US imports of critical minerals or, more subtly, by undermining the recent agreement between the US and China on accounting standards for public companies. A greater threat could come from Chinese retaliation against US allies and partners such as South Korea, Japan, or Taiwan who have to implement US controls and together dominate much of the semiconductor industry. China has more influence over these countries and will want to drive a wedge in America’s economic coalition. In addition, it is likely that China will file a WTO complaint that would put many of the US’ techno-nationalist policies, such as export controls and blacklists, at odds with the principle of nondiscrimination. The US justifies its actions by interpreting the “national security exception” broadly, but it has wisely avoided testing this argument in formal dispute resolution. An unfavorable ruling could therefore reduce the commitment of pro-WTO partners such as the EU (Bateman, 2022b). Despite the current strong technological competition in many areas, it seems that the complete China–US decoupling in science and technology is not likely. The current global market is deeply integrated and benefits from the global industrial chains. At the same time both countries are strongly interdependent, and the interconnectedness will remain for

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long time. It means that despite strong tensions between China and the US, technological cooperation should be elaborated. Meantime, the SinoUS technological relations will provide many tensions, and this can be treated as one of the most intensive future battlegrounds between those two countries.

References Bateman, J. (2022a, April 25). U.S.-China technological “decoupling”: A strategy and policy framework. Carnegie Endowment for International Peace Publications Department. https://carnegieendowment.org/2022a/04/25/u.s.china-technological-decoupling-strategy-and-policy-framework-pub-86897 Bateman, J. (2022b, October 12). Biden is now all-in on taking out China. Bessler, M., (2022, November 16). Demystifying the debate on US-China decoupling. Center for Strategic & International Studies (CSIS). https://www.csis. org/blogs/new-perspectives-asia/demystifying-debate-us-china-decoupling Calhoun, G. (2021). The U.S. still dominates in semiconductors; China is vulnerable. Forbes. https://www.forbes.com/sites/georgecalhoun/2021/ 10/11/the-us-still-dominates-in-semiconductors-china-is-vulnerable-pt-2/? sh=79c538570f78 Conklin, K. (2022, June 17). The next phase of US-China economic and technological decoupling. Atlantic Council. https://www.atlanticcouncil. org/blogs/geotech-cues/the-next-phase-of-us-china-economic-and-tech-dec oupling/ Kahata, A. (2020). Managing U.S.-China technology competition and decoupling. https://www.csis.org/blogs/technology-policy-blog/managingus-china-technology-competition-and-decoupling Lim, D. (2019). The US, China and ‘technology war’. Global Asia. https:// www.globalasia.org/v14no1/cover/the-us-china-and-technology-war_dar ren-lim Ma, W. (2020, August 22). Tech cooperation also benefits US companies. https://www.chinadaily.com.cn/a/202008/22/WS5f40753aa3108348 17262044.html Mark, J., & Roberts, D. T. (2023, March). United States-China semiconductor standoff: A supply chain under stress. Atlantic Council. Park, J. (2022). Breaking the internet: China-US competition over technology standards. https://thediplomat.com/2022/02/breaking-the-internet-chinaus-competition-over-technology-standards/ Qin, J. Y. (2019). Forced technology transfer and the US–China trade war: Implications for international economic law. Journal of International Economic Law, 22(4), 743–762. https://doi.org/10.1093/jiel/jgz037

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Sun, H. (2019). U.S.-China tech war: Impacts and prospects. China Quarterly of International Strategic Studies, 5(2), 197–212. https://doi.org/10.1142/ S237774001950012X The Economist. (2022, December 3). America’s Asian allies dislike its tech war on China. https://www.economist.com/asia/2022/12/01/americas-asianallies-dislike-its-tech-war-on-china Whalen, J. & Alcantara, C. (2022). Nine charts that show who’s winning the U.S.-China tech race. The Washington Post. September 21. Wu, X. (2020). Technology, power, and uncontrolled great power strategic competition between China and the United States. China International Strategy Review, 2(1), 99–119. https://doi.org/10.1007/s42533-020-000 40-0

CHAPTER 10

The Future Sino-US Financial Coupling or Decoupling Accompanied by Their Fierce Rivalry with Different National Approaches

Abstract Over time, the financial rivalry between China and the US has become increasingly important. As of 2018, the US has started a trade war that eventually also led to a tech war that resulted in financial decoupling. Competition can concern both international dimension as well as the functioning of internal financial markets in China and the US. The bilateral financial relations between those countries, however, are characterized by a big dichotomy. Despite the processes of financial decoupling the Chinese financial markets are very attractive for Western investors due to their size and fast growth, relatively high bond yields initially, and the largely uncorrelated assets which enable more diversification possibilities of the asset portfolio. The current policy implemented by the Chinese government regarding access to the financial markets is also more open. On the one hand, there is a deepening of a process of financial liberalization, but on the other hand, the Chinese state policy and far-reaching interventionism still plays a significant role in the financial coupling with the US economy. Both US and Chinese financial regulators are especially aware of cybersecurity and are taking action on significant data flows behind which lies an increasingly hidden geopolitical competition between Beijing and Washington. There have been several US initiatives to decouple the financial services sector from China, which may be possible in the short term but unlikely in the long term as total financial © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_10

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decoupling is much more complex than technological decoupling. Due to the strong integration of the Chinese and US financial markets and the costs and limits of financial and physical capital, especially for technology, constructive financial cooperation between China and the US is essential to maintain the existing international monetary system. The liberalization of China’s financial markets creates great potential for China and its plans for financial internationalization. It is likely that the opening of China’s financial markets will lead to market expansion with a positive impact on the entire real economy. Keywords Constructive financial cooperation · Technological competition · Tech war · Trade war · International monetary system · Cross-border payments · Slowbalization · Dichotomy · Geopolitical competition

In addition to technological competition between the Chinese and the US industry, due to the processes of digitization, a certain form of this competition also takes place in the financial markets of these countries. On the one hand, there is a transformation of banks and an increasing involvement of financial technologies in banking services (Łasak & Gancarczyk, 2022), and on the other hand, regulatory actions are being taken to reduce the risks arising from this digitization (Xiang et al., 2017; Xu & Xu, 2019). Over time, the issue of financial rivalry between China and the US has become increasingly important. Competition can concern both international issues (relating to various aspects of international finance) as well as issues related to the functioning of internal financial markets. International competition refers to the mechanisms of functioning of the international monetary system. As Zhang (2021) emphasizes, this rivalry has four dimensions: structural, relational, institutional, and ideological. The structural dimension refers to the ability of a country to influence the behavior of other countries. This capacity results from the structural position of a given state in international finance and certain international financial structures. The relational dimension concerns international relations in areas such as investment, debt, or the exchange rate. The institutional dimension refers to the ability of a country to influence the behavior of other states by influencing the business activities and regulatory functions of the relevant international institutions. The

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ideological dimension concerns theoretical aspects related to individual elements of international finance (e.g., ideas of mainstream economics) (Zhang, 2021). The competition on the level related to the functioning of internal financial markets has to a large extent a regulatory dimension. As Resano (2021) points out, cultural differences and political priorities are crucial in this aspect. On the one hand, the development of financial markets and, in this context, the possibility of using financial technologies is proceeding in accordance with the expectations of a given society and spontaneous processes based on emerging technological opportunities. On the other hand, local authorities intervene when there is a threat to the functioning of the real economy, or when their expectations are different from the processes involved (Fernandes, 2020; Huang, 2021). As of 2018, the US has started a trade war that eventually also led to a tech war that resulted in financial decoupling through tighter regulatory scrutiny of Chinese companies listed in the US, and individual Chinese companies delisting from the US stock market. Despite several US initiatives to decouple from China in the financial services sector, it is a scenario possible in the short term, but it is rather unlikely that this trend will continue in the long term, given that the total financial decoupling is much more complicated than technological decoupling. It involves the securities markets, cross-border payments, and capital flows, as well as the performance of the international monetary system. Considering the costs and limits of financial and physical capital (especially for technology), and the trend of integration in the Chinese and US financial markets, it can be concluded that constructive financial cooperation with China is still necessary for the US to maintain the existing international monetary system. In addition, US investors have been able to find increasingly favorable opportunities to invest in the Chinese financial markets. Until now, international capital transactions have been mainly denominated in USD, thus forming the basis on which the international monetary system is maintained. If the USD does not participate in the Chinese economy and its financial markets, it could ultimately weaken the entire USD-based monetary system. In short, there is no “win–win” situation for financial decoupling and the future Sino-US financial cooperation has never become so important. US and China are not only the world’s first- and the second-largest economy and the world’s second- and first-largest trading nation, but also having the world’s first- and second-largest capital markets, respectively.

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However, the global monetary system is still dominated by the USD. There is a significant asymmetry in the proportion of the US economy, trade, and the USD in the international monetary system. So far, about 80% of the global trade settlements are done in the USDs. Although China is the main promoter of world trade, a large part of trade is still settled in USDs. The USD share of global foreign exchange reserves diminished below 59% in the final quarter of 2021 and is gradually declining since the launch of the euro when it was around 71%, but it is still used more than all other currencies combined. The RMB, on the other hand, only accounts for less than 3% share of global foreign reserves at the end of 2021, as opposed to the 11% share of the IMF’s Special Drawing Rights (SDR) basket (IMF, 2021). The RMB’s expansion in both foreign exchange reserves and global payments will help stabilize the currency’s exchange rate amid a wave of global economic and geopolitical uncertainties. However, it should not be underestimated that nearly 88% of global foreign exchange transactions is still denominated in USDs. Although China’s foreign exchange reserves have declined significantly in 2022, not only does it have the largest reserves in the world at approximately USD 3.1 trillion in 2022, but these are also mainly denominated in USD, which poses the risk of a dollar trap. If China does not use the USD but chooses the EUR or other currencies to settle its trade deals, it will shock the USD system. Thus, the US will not risk a financial decoupling from China, as it will weaken the USD system. Although in recent years a slowbalization trend with a falling share of global GDP made up by trade has been observed, it is difficult to reverse the financial globalization trend which has become increasingly digitized. The global allocation of financial assets is determined by the nature of arbitrage for financial capital. Since the GFC the US Fed’s balance sheet has expanded dramatically and the proportion of securitization in developed economies has reached 120% of outstanding loans or securities, which is much higher than that in developing economies where that fluctuates between 60 to 70% (Wang, 2020). The expansion of the balance sheet of central banks in major economies has led to a sharp expansion of financial assets against a background of financial innovation. The international expansion of financial capital presents an irreversible trend, which is determined by the financial capital’s nature to seek arbitrage opportunities globally. Chinese companies will do everything to be listed in the US even if the US government tightens regulatory scrutiny.

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Globalization means that many enterprises can leverage the international capital market to get better development opportunities. With the acceleration, broadening, and widening of financial globalization, the power of the international capital dominates over the development of global financial markets. Enterprises can choose the ways of financing, but there are certain differences determined by the cost of financial capital arbitrage. The financial integration between China and the US has entered a new stage, which is mainly determined by the high-quality opening up of China’s capital markets and the profit-seeking behavior of the US capital. Globalization in the financial markets has made the Sino-US financial systems increasingly interdependent. For instance, US investors hold a large amount of securities in China’s capital market, which was about USD 260 billion in 2018, accounting for 2.3% of their holdings of foreign securities (in 2021 the Chinese stocks and bonds accounted for less than 2% of US portfolio holdings) (Borst, 2021). Chinese investors also hold a large number of US securities, including more than USD 1 trillion in treasury bonds (as for 2021) (Brettel & Pierog, 2021). As of 2018, the US has only accelerated its investment in Chinese financial markets. For example, in 2020, JPMorgan received approval to open a wholly foreign-owned futures company and American Express received approval to form a joint venture with Lianlian DigiTech Co Ltd. In addition, AmEx became the first foreign bank card provider to do clearing operations in China. These developments clearly demonstrate that the US is not decoupling from the Chinese financial sector and hence the US does not want China to reduce the use of the USD and switch to the use of the RMB or other currencies in international transactions (Wang, 2020). In general, the newly introduced regulations in China are oriented toward opening the financial markets and have the intention to promote competition and attract foreign capital in China’s financial sector. In the coming years from now, foreign firms will be able to own up to 51% of domestic securities, insurance, and management firms. The authorities also promised to remove limits on foreign shareholdings in banks (which is 20% for an individual foreign investor, and 25% for a group of investors). The same liberalizations should be made in the insurance and securities sectors in the following few years. Moreover, foreign rating firms can now rate all bonds traded on China’s interbank market and exchanges. Some of the new regulations are related to bilateral Sino-US financial relations. An example is that China agreed to ease access to most

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of its financial services for US investors since April 2020 (Chen et al., 2021). All these initiatives create more opportunities for future Sino-US financial cooperation. The liberalization of China’s financial markets opens more opportunities for US financial firms looking to expand their presence in China’s increasingly open financial sector. It also creates a big potential for China and its plans for financial internationalization. It is assessed that the China’s financial market opening will lead to expansion of the market and trigger positive impact on the whole economy. The inflow of multinational investors should increase investments and RMB-denominated assets (Xinhua Silkroad Information Service, 2021). In response to the Chinese initiatives, the US counterparts are more careful than they were before the trade war in 2018. The US experts highlight that for this country the national security must be protected in the financial area (Global Times, 2020). It means that the whole process of financial opening for the Chinese investments is not so enthusiastic, quick, and comprehensive. The prejudices against Chinese entities were reflected in the actions undertaken by the US regulators as well as the White House administrations since Donald Trump’s presidency. Among examples of measures undertaken against the Chinese counterparts might be included: the block for federal government pension plans from investing in Chinese equities and the higher requirements of transparency of financial reporting from foreign companies listed on US exchanges (Magnus, 2020). Another restriction is the financing ban imposed on some Chinese companies that are on the US Department of Commerce’s Entity List or on the US Department of Defense’s list of companies backed by the Chinese military (Monan, 2021). Despite an inevitable further financial cooperation, US authorities have recently introduced several additional restrictions in response to China’s initiatives aimed at deeper financial coupling. The described processes show the evidence that now the bilateral financial relations between China and US are characterized by a big dichotomy. To a certain extent it is the result of the Chinese approach. The Chinese financial markets are very attractive for Western investors due to their size and fast growth, relatively high bond yields, and the largely uncorrelated assets which enable more diversification possibilities of the asset portfolio. The current policy implemented by the Chinese government regarding access to the financial markets is more open, but not so attractive to US

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investors. On the one hand, there is deepening a process of financial liberalization, but on the other hand, the Chinese state policy and far-reaching interventionism still plays significant role in the financial coupling with the US economy. As a result of such circumstances, both sides, Beijing and Washington have their own fears. While Beijing is afraid of financial instability and wants to keep ambitious private companies and entrepreneurs in check, Washington is afraid of leak of sensitive data and random political initiatives which targets financial assets (Magnus, 2021). There are a number of examples how both sides take actions against financial cooperation, foreign financial investments, entrance of foreign companies on their domestic capital markets, and other related processes. The list of such initiatives embraces Chinese actions against domestic companies which intend to enter the US stock market. One example is the suspension by the Chinese regulators of the IPO of the Chinese company Ant Group in Shanghai Stock Exchange in November 2020 and another example is the investigation and penalties for the Chinese company Didi in July 2021, two days after its US stock market debut (Fernandes, 2020). Regarding the US actions, there must be mentioned the US block against buying the Chicago Stock Exchange by a Chinese-led group of investors (Horowitz, 2018). When considering the motives, it is significant that financial regulators on both sides, China and the US, are especially aware in the cases of cybersecurity and they undertake actions related to significant data flows (consumer data, financial statistics of the public companies, some sensitive information, etc.). Behind these arguments is a hidden growing geopolitical competition between Beijing and Washington (Triolo & Hirson, 2021). Some of the threats are even bigger—Beijing considers prohibition for the Chinese companies’ access to US capital markets, where they must obey the US regulatory and disclosure requirements. Washington announces that adequate measures will be taken (Magnus, 2021). Some US financial analysts, like Jaret Seiberg, expect that President Biden’s administration will put more restrictions on China and will block US investments in Chinese banks and include more Chinese companies to the US investment blacklist (Cheng, 2021). Such actions, undertaken by both sides, are responsible for significant impasse over the bilateral financial cooperation. Despite the obstacles, the Sino-US financial decoupling is far from the expected results. The cooperation between both markets is very deep. It involves the securities market, cross-border payments, and capital flows, as well as the performance of the international monetary system. A financial

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decoupling would presently be too damaging a situation for both China and the US. The US needs China to keep the whole monetary system working properly. Moreover, the financial integration between China and the US has entered such a stage, which is mainly determined by the high-quality opening up of China’s capital markets and the profit-seeking behavior of the US capital (Wang, 2020). Despite the Covid-19 lockdowns in especially China, the capital flows into China’s securities market have increased the last year and a large part of the funds came from US investors and vice versa many Chinese companies are listed in the US. Major reasons for the current Sino-US financial coupling trend are the large amount of capital available, willingness of investors to undertake higher risk than on the domestic markets, prestige, and the willingness to enter the Western capital markets (Goldkorn, 2021). A fundamental problem that will gradually affect the Sino-US interdependency more and more in 2022 and the years after is the strong appreciation of the USD against the euro, renminbi, and other major currencies. Fueled by an expansive fiscal policy to address the Covid19 problems and the sharp rise in food and energy prices partly caused by the lockdowns in China and the war in Ukraine, the Fed has introduced a highly restrictive monetary policy through several rate hikes to curb inflation. Ultimately, this led to a capital flight to the US during the pandemic, fueled in part by the legacy of China’s currency manipulation. That has made it cheaper for US companies to import from the rest of the world, while at the same time the pandemic has decimated US domestic retail chains (Hirsh, 2022). As the RMB fell sharply against the USD in 2022, the PBC could have raised interest rates like the Fed, but a tighter monetary policy would be at odds with the needs of China’s weaker economy, hampered by a slump in the property market and very strict Covid-19 controls until the end of 2022. Compared to 2015, when a poorly executed devaluation of the RMB caused capital outflows that further undermined the currency, the RMB target zone is currently better managed, capital controls are better enforced and the currency is much less overvalued. Therefore, the RMB’s decline against the USD will now become less disorderly and there will be less need for intervention (The Economist, 2022). For several decades until early 2021, financial ties between the US and China had become closer, as evidenced by a wave of IPOs on Wall Street by Chinese companies, the pumping of money into Chinese startups by US venture capitalists and the flood of US institutional investment capital

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in China’s public equity, bond, and derivatives markets. However, international finance has become an important part of the geopolitical dynamics, and tensions between the US and China have led to a rift between the two rivals’ financial systems, which could increase the risk of volatility in global financial markets. Chinese companies are finding it more difficult to raise capital in the US, as US regulators want to limit the listings of Chinese companies on US exchanges due to compliance checks (Liao et al., 2022).

References Borst, N. (2021). How exposed are U.S. investors to China? https://www.seafar erfunds.com/prevailing-winds/2019/08/how-exposed-are-us-investors-tochina/ Brettel, K., & Pierog, K. (2021, April 1). China unlikely to wield U.S. bond weapon as tensions stay high. Reuters. https://www.reuters.com/article/usabonds-china-idINL1N2LT255 https://www.globallegalinsights.com/practice-areas/banking-and-finance-lawsand-regulations/china Cheng, E. (2021, April 9). Biden’s China policy is tougher on financial firms than Trump’s was, report says. CNBC. https://www.cnbc.com/2021/04/09/bid ens-china-policy-greater-risk-for-us-financial-firms-than-trump.html Fernandes, N. (2020). Why the Chinese regulators were right to cancel ant financials’ IPO. Forbes. https://www.forbes.com/sites/iese/2020/11/23/whythe-chinese-regulators-were-right-to-cancel-ant-financials-ipo/ Global Times. (2020). Wall Street finance firms looking for more not less in China: Expert. https://www.globaltimes.cn/content/1200317.shtml Goldkorn, J. (2021, July 7). Did China take another step to financial decoupling with new VIE rules? SupChina. https://supchina.com/2021/07/07/ did-china-take-another-step-to-financial-decoupling-with-new-vie-rules/ Hirsh, M. (2022, June 22). The U.S. and China haven’t divorced just yet. Foreign Policy. https://foreignpolicy.com/2022/06/22/united-states-chinadecoupling-business-ties/ Horowitz, J. (2018, February 15). A Chinese takeover of the Chicago Stock Exchange just got blocked. CNNMoney. https://money.cnn.com/2018/02/ 15/investing/sec-chicago-stock-exchange-china/index.html Huang, R. H. (2021). Fintech regulation in China: Principles, policies and practices. Cambridge University Press. IMF Data. (2021). Access to macro economich & financial data. https://data. imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4

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Liao, C., et al. (2022, September 1). Trading geopolitics: The long view on growing U.S.-China tensions. PIMCO. https://nl.pimco.com/en-nl/insights/viewpo ints/trading-geopolitics-the-long-view-on-growing-us-china-tensions/ Łasak, P., & Gancarczyk, M. (2022). Transforming the scope of the bank through fintechs: Toward a modularized network governance. Journal of Organizational Change Management, 35, 186–208. Magnus, G. (2020, December 30). A Messy financial divorce for the US and China | by George Magnus. Project Syndicate. https://www.project-syndicate. org/commentary/us-china-financial-decoupling-by-george-magnus-2020-12 Magnus, G. (2021, July 20). Markets haven’t even begun to reflect China-US decoupling risks. Financial Times. https://www.ft.com/content/471feda8bae1-426a-b57f-a845baefe79b Monan, Z. (2021). China-U.S. financial coupling or decoupling: That is the question. China-US Focus. https://www.chinausfocus.com/finance-eco nomy/china-us-financial-coupling-or-decoupling-that-is-the-question Resano, J. R. M. (2021). Regulating for competition with bigtechs: Banking-as-aservice and ‘beyond banking’ (SSRN Scholarly Paper No. 3982500). https:// doi.org/10.2139/ssrn.3982500 The Economist (2022, October 8). China gives up the fight. https://www.eco nomist.com/finance-and-economics/2022/10/06/why-chinas-policymakersare-relaxed-about-a-falling-yuan Triolo, P., & Hirson, M. (2021, July 12). Didi debacle highlights weaknesses in regulatory coordination, but it’s not decoupling. SupChina. https://supchina. com/2021/07/12/didi-debacle-highlights-weaknesses-in-regulatory-coordi nation-but-its-not-decoupling/ Wang J. (2020, September 21). Why US won’t ‘decouple’ from China in finance. China Daily. https://www.chinadaily.com.cn/a/202009/21/WS5f67fceca3 1024ad0ba7aa9e.html Xiang, X., Lina, Z., Yun, W., & Chengxuan, H. (2017). China’s path to FinTech development. European Economy, 2, 143–159. Xinhua Silkroad Information Service. (2021). China’s financial opening-up to bring more business opportunities for foreign institutions. https://en.imsilk road.com/p/318879.html Xu, Z., & Xu, R. (2019). Regulating fintech for sustainable development in the People’s Republic of China. Zhang, F. (2021). Power contention and international insecurity: A thucydides trap in China–US financial relations? Journal of Contemporary China, 30(131), 751–768. https://doi.org/10.1080/10670564.2021.1889229

CHAPTER 11

The Current Intensifying Sino-US Rivalry and Its Impact on the Possible Future Scenarios About the International Economic Order

Abstract The growing rivalry between the US and China over trade, investment and technology, and their intensification of military, diplomatic and ideological differences of opinion have increased the prospect of decoupling between the two largest economies in the world. The “socialist market economy with Chinese characteristics” has changed significantly since the 20th National Congress of the CCP in October 2022. In foreign relations, the aim is to improve China’s national security by struggling to gain dominance on the international stage. This policy can be described as a continuation of the “dual circulation” strategy referred to an effort to rebalance the Chinese economy by reducing its reliance on net exports and fixed asset investment, both of which have become unsustainable to boost growth. Dual circulation means reducing the role of foreign trade in powering the Chinese economy while improving the quality of trade. The increased emphasis on self-sufficiency and strengthening domestic science and technology also means that foreign importers may face tougher competition from Chinese companies. This includes diversifying trade away from reliance on the US and Europe and improving supply chains in China and promoting the role of private consumption and services within the Chinese economy. In that regard, China is taking a two-pronged approach by continuing to open up to the © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_11

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world while enhancing self-reliance and reducing vulnerability to external shocks. Domestically, this means more self-sufficiency to strengthen the economy driven by consumption and innovation. The Sino-US competition and accompanying difficulties and economic tensions leading to the economic decoupling between China and the US may become a new normal and reshape the global economic landscape. For this reason, it is significant to focus on the possible scenarios, considering the most gentle, through intermediate solutions, to far-reaching and most radical processes. The most typical decoupling scenarios embrace: cooperation despite some antagonism, selective economic decoupling, gradual loosening of ties and comprehensive escalation. The Sino-US relations have a great impact on the processes in the international economy. If the comprehensive escalation scenario is implemented, the other countries would be forced to choose sides, and the world will be divided into two camps. A new cold war is possible which could lead to wasted resources, and harm long-term prospects for peace and prosperity. Also, a kind of multipolarity of the economic and political world is possible. Keywords International economic order · Chinese economic order · “Dual circulation” policy · Sino-US trade war · Technological self-reliance · “Open door” policy · Two-pronged approach · “Global Security Initiative” · Neo-classical globalization · Government-controlled globalization · “Asymmetric decoupling” · Cooperation despite some antagonism · Selective economic decoupling · Gradual loosening of ties · Comprehensive escalation

The growing rivalry between the US and China over trade, investment, and technology, and their intensification of military, diplomatic, and ideological differences of opinion have increased the prospect of decoupling between the two largest economies in the world. In recent years, business relations between the US and China have been increasingly scrutinized by looking at the net effects on the welfare of both countries and their longterm security situation. Although economic and technological factors are important here, the geopolitical disputes between both countries will ultimately play the decisive role in determining the future of a new or adapted international economic order and the accompanying developments of (de)globalization. Contrary to what US proponents of market capitalism

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and engagement with China had expected about a new era of globalization, the integration of China in the international trading system did not lead to the liberalization of its economic and political systems. Although under Deng Xiaoping’s “open door” policy in the 1980s, China increasingly distanced itself from the rigid central planning and state ownership of the means of production, the Chinese Communist Party (CCP) maintained its determination to maintain a monopoly on domestic political power and thus the ultimate control over the country’s economy (Friedberg, 2022). The “socialist market economy with Chinese characteristics” under Deng and his successors has never completely surrendered to the irresistible charms of liberal-democratic capitalism, but gave the highest priority to economic progress. However, this has changed significantly since the 20th National Congress of the CCP in October 2022, which became apparent sooner since Xi Jinping took office, who secured his third term as the CCP’s head and no longer made the economy the number one priority. After a decade in power, he is increasingly proving his domestic priority to maintain the security of the regime by fighting potential threats to the CCP’s monopoly on state power. In foreign relations, the aim is to improve China’s national security by struggling to gain dominance on the international stage (Wu, 2022). The result of the 20th National Congress of the CCP in October 2022 is an even greater scrutiny of private companies and the rest of society, a broadening of surveillance and tightening of censorship under Xi Jinping’s absolute leadership, despite the negative consequences of China’s rigid zero-covid policy on the domestic economy which, after the necessary protests, has been somewhat relaxed at the end of 2022 with all the associated health risks. This “new chapter” or “new reality” policy with an unusual third term for Xi can be described as a continuation of the “dual circulation” strategy referred to in the 14th FYP in an effort to rebalance the Chinese economy by reducing its reliance on net exports and fixed asset investment, both of which have become unsustainable to boost growth. Dual circulation means reducing the role of foreign trade in powering the Chinese economy while improving the quality of trade. The increased emphasis on self-sufficiency and strengthening domestic science and technology also means that foreign importers may face tougher competition from Chinese companies. This includes diversifying trade away from reliance on the US and Europe to learn lessons from China’s vulnerability to political pressure from the West. At the same time, it also means improving supply chains in China

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and promoting the role of private consumption and services within the Chinese economy to learn from the reliance on fixed asset investments, which have shown declining returns (Hung Tran, 2022). In that regard, China is taking a two-pronged approach by continuing to open up to the world while enhancing self-reliance and reducing vulnerability to external shocks. Domestically, this means more self-sufficiency to strengthen the economy driven by consumption and innovation, whether or not including repression. Abroad, China is trying to create a new world economic order more sympathetic to autocrats. To this end, China is taking a two-pronged approach, working to co-opt international bodies and redefining the principles that underlie them. Bilaterally, it recruits countries as supporters with the economic weight helping to turn poorer countries into customers, with China’s own rise exemplifying countries dissatisfied with the American-led status quo. The aim of the Chinese policymakers is not to make other countries more like China, but to protect China’s interests and set a standard that no sovereign government should bow to anyone else’s definition of human rights. In other words, it seems that China’s main concern is China’s own interests themselves. The aim, then, is to reverse the Western international economic order built up over decades to ensure that the actions of governments, international institutions, and private companies are not primarily guided by the Western-imposed “universal values” as core principles. The Chinese authorities want to preserve elements of the current international order that helped their country grow, such as world trade rules as part of the WTO that have boosted their exports and stimulated the inflow of foreign capital and technology, while undermining or ignoring principles that do not fit with China. President Xi calls for a “Global Security Initiative” with a community of shared futures for humanity which could not be interpreted as rejecting any order guided by shared, universal values. In that regard, current Chinese leaders often praise Henry Kissinger, a former US Secretary of State who calls on governments to seek “balance”, accepting the “legitimacy of sometimes opposing values”, which is in line with what is meant in China by “mutual respect” and “non-interference”. Recently, with the rise of populism in many Western countries, as more liberal democracies are increasingly turning inward and losing interest in emerging regions, Chinese leaders see an opportunity to create a strippeddown, interest-based world order. While the details of Xi’s “Global Security Initiative” are still unclear, it promotes a long-standing Chinese

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desire to allow each country to find its own development path without prejudging a degree of autocracy. In recent years, fueled by the Sino-US trade war, the neo-classical globalization trend has increasingly turned into a government-controlled globalization in which the rise of China is a major driver. China has arguably benefited from openness to foreign capital, technology, and expertise over the past four decades, but is now determined to reshape the open international order. The Biden administration accuses China of pursuing “asymmetric decoupling” as it seeks to dominate key technologies from electric car batteries to quantum computers that will make China less dependent on the world and the world more dependent on China. Not only the US, but also the EU deplored a “growing politicization” of the Chinese business environment prompting Western companies to reconsider existing operations and planned investments. One example is China’s use of economic coercion to punish countries that don’t please it, as it did Lithuania in 2022 after it was deemed too kind to Taiwan. From a Chinese perspective, the current two-pronged approach based on the “dual circulation” strategy is justified by the “new reality” that as a form of self-defense China is now focusing on technological selfreliance and secure domestic supply chains. They point to tariffs and export bans imposed by the Trump administration and largely enforced by his successor. In addition, Sino-US and Sino-EU relations have deteriorated in part due to US and EU mechanisms to screen Chinese investments and prohibit Huawei and other Chinese companies from building 5G telecom networks. For many years from the inception of the “open door” policy in the 1980s to the mid-2015s, Western leaders have expected that China’s growing prosperity would lead to ideological convergence with advanced economies. After all, it seemed likely that an emerging middle class would begin to demand more and more structural reforms and individual rights just like those present in Western economies. China’s accession to the WTO in 2001 was taken as a sign of an irreversible commitment to openness, and that confidence boost led to a strong inflow of foreign investments (see Chapter 4). However, China’s increased WTO commitment to openness to China has also increased pressure on foreign companies to transfer technologies as compensation for gaining market access, and these companies have subsequently increasingly faced subsidized state rivals. From China’s point of view, it’s understandable that, with an increasingly innovative economy, the government wants to be better represented

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in international bodies that set industrial and technical standards, setting everything from how the Internet works to steel used in railroads. Still, many foreign companies and governments shy away from the country’s ambitions to set their own technical standards. An essential point of contention is the way in which the technical standards are implemented by China and the West. In the West, standards are a form of self-regulation by the private sector, while in China these standards are completely set by the state. Instead of removing barriers to trade, many Chinese standardization campaigns increase the risks of decoupling. Sometimes Chinese companies try to export their country’s domestic standards through infrastructure projects related to the Belt and Road Initiative, making access to the markets of participating countries more difficult for foreign investors. At other times, the Chinese government encourages its companies to set international standards for all countries, which can increasingly lead to ideological clashes. For example, Western governments have resisted when Chinese companies promoted technical standards that risk entrenching authoritarian standards such as facial recognition systems that mark Uyghurs or other ethnic groups. As the more autocratically ruled China can increasingly deploy public and private funds in research into technologies such as AI, 5G, and batteries, and the more powerful and purposeful the Chinese economy grows, the greater its geopolitical power is likely to be. This is especially true if it can dominate certain key enabling technologies, make other countries depend on them, and set standards that lock them up. This is why Western governments are now treating Chinese innovation as a matter of national security. Many are encouraging subsidies for industries such as making chips. The Biden administration has gone much further, openly attempting to cripple China’s technology industry. This will slow China’s progress in areas America considers threatening, such as AI and supercomputers. It will also harm Chinese consumers and foreign businesses, who may eventually find ways to circumvent the new rules, so it remains to be seen how effective these new US policies will be (The Economist, 2022). The Sino-US economic and financial interdependence is very often ignored when considered the processes of strong rivalry between the two countries. Usually, the relations between these two countries in the context of the tensions which took place in recent years rise to the rank of strategic competition. On the other hand, expectations based on rational premises are contrary, and further cooperation is necessary

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to ensure proper economic relations between these countries. Moreover, it is highlighted that the Sino-US relations are significant not only for both countries but also have a great importance and implications for the rest of the world. The global community expects that China and the US will take a lead for the international economic order and keep the bilateral ties stable. The development of these relationships will shape world and economic order in the twenty-first century. In a situation where it is difficult to ensure proper economic relations and to achieve proper coexistence due to strong trade and technological competition, and on the other hand, there is a need to normalize these relations, it is necessary to consider scenarios for the development of these relations in the future. The difficulties accustomed us to new reality and in the context of the last few years of economic tensions the economic decoupling between China and the US may become a new normal and reshape the global economic landscape (Hu et al., 2021). For this reason it is significant to focus on the possible scenarios, considering the most gentle, through intermediate solutions, to far-reaching and most radical processes. The most typical decoupling scenarios embrace: 1. Cooperation despite some antagonism. 2. Selective economic decoupling. 3. Gradual loosening of ties. 4. Comprehensive escalation. According to the first scenario, cooperation despite some antagonism, China and the US would not decouple. This scenario assumes that they will continue to compete economically with each other but a kind of multilateral cooperation on shared issues is possible. Such scenario is possible because both countries have strong economic relations. The arguments supporting this approach focus on the fact that decoupling would be harmful or even damaging for both countries. For this reason the US and China will compete where they must, but they will restrain the strong strategic competition to minimize the likelihood of hostilities and to maximize the opportunities for pragmatic cooperation on common interests (Ross, 2020). Such an approach is supported by the past, when there was a lot of pressure toward decoupling in rhetoric, but both countries were continuing their cooperation leading to greater interdependence. It is highly possible that such a trend will occur also in the future. Regarding

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the technological advancements, both countries have some technological advantages, like world-class research expertise, deep capital pools, data abundance, and highly competitive innovation ecosystems. Both of them are benefiting from their advantages over other countries and they will remain at the frontiers of innovations for the next years or even decades (Hass, 2021). Moreover there are external incentives for them to continue their cooperation. Currently the global community in the face of many transnational challenges needs a more united society and China together with the US can promote a new globalization framework which will be beneficial for many other countries. This scenario is especially beneficial for such countries which support the proactive and pragmatic cooperation instead of engagement in rivalry (Li & He, 2022). According to the second scenario, selective economic decoupling , both countries, China and the US are on the economic decoupling path, but the process has a rather selective form. When competing, they focus on the most sensitive branches of industry, especially fields related to science and technology. In such a scenario they will keep the cooperation related to a broad range of different branches which do not belong to the most advanced scientifically and technologically. The important question here is if such selective approach can be sustained for a longer period of time, or whether it will lead to a greater dichotomy in the long term (Lewis, 2022). The positive expectations related to this scenario express the hope that despite rising tensions, China and the US will remain cooperative. The arguments supporting this scenario can be drawn from the fact that there have been for a very long time many restrictions on the R&D and technology transfer between China and the US, especially from the Chinese side. The examples embrace the Chinese limits to the access by foreign entities to the partnership with the Chinese companies, or the Chinese “self-reliance policy” created in the MIC 2025 strategic plan. The Great Firewall is another example of such obstacles. From the US side, academic and cultural exchanges are currently being limited in particular (Shambaugh, 2019). These examples and many others show that the competition and decoupling is in their normal behavior, however, it has a very selective nature. The positive aspect of this scenario is that there are still strong connections between businesses of both countries. The Chinese companies want to enter the US stock market, whereas the US companies do not want to waste the several years of time, effort, and investment they have put into developing a presence in China (Morrison, 2021). One dimension of these scenarios is the greater integration of the

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Sino-US capital markets. The question of how the Western and especially the US capital markets will be connected to the Chinese capital markets is one of the most important questions for the future international economic order. The degree of integration between Chinese and Western capital markets influences the economic growth of China and the US. As China continues to gain access to Western capital, China may soon be in a better economic position to challenge the Western liberal capitalist model. The selective economic decoupling scenario would be beneficial not only to these two countries (by limiting the risks related to national security), but also it would strengthen multilateral cooperation on shared issues and help to bring about a more inclusive form of globalization (Miao, 2020). According to the third scenario, gradual loosening of ties, the Sino-US economic linkages and interdependence will unravel slowly, giving more space for other countries. In this scenario the processes of decoupling will enable adaptation of businesses but at the same time their search for new, third-party jurisdictions. Despite the strong political support for the decoupling processes, both the Chinese and the US businesses are very reluctant in supporting the processes. The business relationships, investments, and supply chain are strong, and it takes work to finish such cooperation quickly. The Chinese market is very attractive for the US businesses, while Chinese companies still benefit from the US advanced technology and the learning processes (Lewis, 2022). The businesses approach does not correspond with the political goals. The active player in this strategy is China, which is following a long-term strategy of reducing its dependence on foreign technology and capabilities. From the Chinese perspective it is a strategic shift from economic growth to economic control. It is a strategy designed for few decades and three points here are crucial. First, to eliminate the Chinese dependence on foreign countries and corporations for critical technology and products. Second, facilitate the domestic dominance of indigenous firms. Third, leverage the dominance into global competitiveness (Morrison, 2021). It is the Chinese quest to dominate the industries-of-the-future. For this reason the country expands its hard and soft power around the world. In response the US implement the techno-nationalist countermeasures (Capri, 2020). In such a shape it is a constant process according to which the decoupling will play a more and more important role and accelerate in the future.

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The current “chip war” resembles a game of Weiqi or “Go”, the millennium-old Chinese board game in which black and white stones try to surround each other. Little by little, the Americans are cutting China off from the world’s most advanced semiconductor technology, the lifeblood of economic and military progress. After all, chips are the brains of our electronics in telephones, computers, cars, refrigerators, pacemakers, tanks, drones, and rocket launchers. In this battle between the US and China for the world’s most critical technology, various future scenarios or alternative directions are conceivable in which China can escape from encirclement. For example, China could consider creating its own advanced chip industry, where the Sino-US technological decoupling will encourage the Chinese authorities to become even more technologically sovereign. However, catching up in the production of lithography, for example, takes decades. However, China can increase the share of old chips helped by massive government subsidies. For example, by conquering the market for car chips, China can still build up a dominant position. Since Taiwan produces 37% of all processor chips, this poses a potential threat of invasion by China. Although Xi has used rather threatening language toward the “renegade province” especially in 2022, shelling and bombings will not help Taiwan’s hypersensitive chip machines and immediately render TSMC’s factories unusable. After all, they depend on Japanese, American, and European factories for software updates, parts, and chemicals, which would break ties after an invasion. On the other hand, computer chips are made from silicon, germanium, rare earths, and other metals that are mainly mined in China. Not only chips, but also magnets in wind turbines and batteries in electric cars are therefore dependent on China. Should China ever decide to embargo those crucial metals, the consequences would be dramatic, resulting in huge price increases and likely shortages of MRI scanners, wind turbines, cars, and computers (Witteman, 2022). Instead of the increased integration, we are now witnessing, “strong decoupling” or “muddling through” could prove more likely, depending on changing perceptions of China and its financial markets in the US. Geopolitical tensions or “strategic competition” between Washington and Beijing could hinder further financial integration between the US and China. US policymakers increasingly recognize that national security is linked to economic security, making international finance an important part of geopolitical dynamics. For example, institutional investors, international banks, private equity, and venture capital are becoming

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increasingly entangled in US national security affairs. As a result of this trend, the Biden administration, concerned about US companies supporting China’s military-tech rise, will introduce new legislation to increase screening of outward FDIs. Beyond private markets, there is a pattern of Sino-US competition for dominance in global banking and potential conflict in banking markets. As a further indication of the tensions between the US and China in banking markets, US banks in China have recently begun publicly expressing disagreements with the Chinese financial authorities. With regard to portfolio investment in China, both the Trump and Biden administrations have issued executive orders to prevent US capital investments in China’s military-industrial complex. The US government will not hesitate to prevent US capital from flowing into China’s defense and equipment sector, including companies that support China’s military, intelligence and intelligence agencies, including companies that develop or use Chinese surveillance technology to inhibit repression or enable serious human rights violations. Given the significant overlap between the military, security, and civilian components of China’s economy, a wide range of Western portfolio investments in China may eventually become subject to outflow restrictions. From an American perspective, a debate will take place in the coming years to what extent American institutional investors should be excluded from holding Chinese financial assets. As with the cooperative and centrist approach (see Chapter 9), also in the financial sector, there are strong advocates of deepening US–Chinese capital market integration despite the inevitable risks. Proponents of expanding US–China financial integration seem less concerned about the geopolitical implications of their investments in China. In accordance with the approach of separationists or restrictionists, opponents of this further deepening US–Chinese capital market integration, on the other hand, emphasize that portfolio investments in China are detrimental to US national security. In late 2021, the US–China Economic and Security Review Commission (USCC) pointed out that the influx of Western portfolios into China’s stock and bond markets is undermining US national security in several ways. First, Western money directly funds Chinese military and national security companies. Second, outside investment can flow into Chinese conglomerates, including military and civilian components. Third, civilian companies apparently continue to contribute to China’s military and security technology through China’s

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military–civilian fusion programs, business ecosystems that facilitate financial and technological know-how, and other transfers between civilian and military companies. Fourth, Western investments in China’s stock and bond markets generally make China richer and thus enable the CCP to expand its military budget. Geopolitical motives will likely trump business and economic considerations, with the Sino-US financial systems increasingly seen as an integral determining factor. Over the past decade, the US and Chinese financial systems have gradually become closer and more intertwined despite the ongoing trade and tech war. One future scenario is that the US further separates the US and Chinese capital markets. The structure of international capital markets can be split, with one focused on the Asian or Chinese economic order with the RMB as the main international currency and the other on the American economic order, with the USD fulfilling a similar role as in the current international monetary system. A partial financial decoupling with the effect of sucking or locking trillions out of China at once could cause global contagion and financial instability. How China will respond and whether it will try to deter financial decoupling from the US remain pertinent questions. For the US, an additional problem preventing Western institutional investors from entering the Chinese market is ensuring that European portfolio investors exit their exposure to China. This could cause transatlantic chaos with additional adverse consequences (Hellendoorn, 2022). Given the diverging trade and investment relationship between the various EU member states and China, the latter scenario is a difficult China strategy for the US government to achieve. According to the fourth scenario, comprehensive escalation, China is convinced that the further development of its country requires a policy of “dual circulation”, and renminbi internationalization. According to such a scenario China must break the USD hegemony, and renminbi must decouple from the USD system. There are also solid motivations for the US to continue the decoupling from China. The pro-Russian attitude of China during the war in Ukraine and the Taiwan tensions provides strong motivation to the US to continue the decoupling strategy. It is likely that this process will become more pronounced in the near future (Fan, 2022). In such a scenario the Sino-US economic relations will turn into great powers’ strategic competition. On the other hand, further steps in the Sino-US cooperation in the coming years are not only inevitable,

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but at the same time it can also enhance the technological advancement and stimulate further economic growth. The considered scenarios are related to the Sino-US economic relations but they will also exert an impact on the other countries. The example is the US Chips and Science Act, which exerted a great pressure on other countries. Among them are Japan, South Korea, and EU countries. Despite their skepticism against China it is not easy to convince these countries to the participation in decoupling and abandonment of the cooperation with China (Lewis, 2022). Based on the previous experience in economic relations, two different conceptions emerge. While the US supports the trade regionalism, China is a stronger supporter of development regionalism (Terada, 2018). The US opt for keeping the values which existed in the post-war time, while China is oriented toward reshaping the whole international economic order and implement its own characteristics. The crucial question is to what extent China is able to reshape the economic order and to change the liberal norms and values that have guided global and regional governance and practice over the past 70 years. Among countries which are interested in protection these liberal rules and values apart from the US are countries such as Japan, Australia and perhaps India. The dynamics of changes will define the next processes, with a greater scope and significance. For the foreseeable future, however, not many changes can occur as every country needs to have good relations with both China and the US. It is likely that no country will always neatly align all its interests in all policy areas with either the US or China. Apart from minor changes and adjustments in terms of cooperation between different countries, crucial aspect is the whole international economic order. The Sino-US relations have a great impact on the processes in the international economy. If the comprehensive escalation scenario is implemented, the other countries would be forced to choose sides, and the world will be divided into two camps. A new cold war is possible which would lead to wastages of resources, and hurt long-term prospects for peace and prosperity. Also a kind of multipolarity of the economic and political world is possible. The very complexity of SinoUS relations, their multidimensional character, and the current economy makes it unnecessary for any country to align all its interests along one axis. Such an approach contributes to the emergence of a multipolar world that is very likely to emerge in the coming years. Unfortunately, such

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economic relationships threaten the world’s inability to develop sustainably. It is, however, still an acceptable scenario. In the worst-case scenario it can be created a Sino-centric Asian system with a marginalized role of the US in this part of the world. Such a scenario is highly possible as China actively contests the current international economic order. It does not mean far-reaching, sudden changes. It will rather incrementally move the lines in the current system than attempting to create everything new or entirely reshape the global economic order (Rolland, 2020). Nevertheless, the emergence of a new consensus, new institutions, and new initiatives leads toward a new international economic order with Chinese characteristics. The possibility to restrain such a scenario depends on whether the US can keep up with the Chinese competition in the long term.

References Capri, A. (2020). Strategic US-China decoupling in the tech sector. Why and how it’s happening. Hinrich Foundation Report. Fan, G. (2022). Get ready for the super-charging of US-China decoupling. https://blogs.tslombard.com/get-ready-for-us-china-decoupling Friedberg, A. L. (2022). The growing rivalry between America and China and the future of globalization. The Strategist. Hass, R. (2021, August 12). The “new normal” in US-China relations: Hardening competition and deep interdependence. The Brookings Institution. https://www.brookings.edu/blog/order-from-chaos Hellendoorn, E. (2022, August 3). Trading geopolitics: The US-Chinese capital markets. Atlantic Council. https://www.atlanticcouncil.org/blogs/econog raphics/trading-geopolitics-the-us-chinese-capital-markets/ Hu Y., Tian K., Wu T., & Yang C. (2021). The lose-lose consequence: Assessing US-China trade decoupling through the lens of global value chains. Management and Organization Review, 17 (2), 429–446. Hung Tran. (2022, October 24). Dual circulation in China: A progress report. Atlantic Council. https://www.atlanticcouncil.org/blogs/econograp hics/dual-circulation-in-china-a-progress-report/ Lewis, L. (2022, August 7). The US and China are decoupling, but not as fast as you think. Financial Times. Li, Y., & He, Z. (2022). The remaking of China-Europe relations in the new era of US-China antagonism. Journal of Chinese Political Science, 27 , 439–455. Miao, M. L. (2020, July 15). Three scenarios for future US-China relations: A view from Beijing. Italian Institute for International Political Studies. https://www.ispionline.it/en/pubblicazione/three-scenarios-futureus-china-relations-view-beijing-26944

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Morrison, A. J. (2021, May–June). The strategic challenges of decoupling. Harvard Business Review. Rolland, N. (Ed.). (2020, August). An emerging China-Centric order. China’s vision for a new world order in practice. The National Bureau of Asian Research 87th Special Report, Seattle. Ross, R. S. (2020). It’s nor a cold war: Competition and cooperation in USChina relations. China International Strategy Review, 2, 63–72. Shambaugh, D. (2019, December 19). U.S.-China decoupling: How feasible, how desirable? Foreign Policy. Terada, T. (2018). The competing U.S. and Chinese models for an East Asian economic order. Asia Policy, 13(2), 19–25. The Economist. (2022, October 15). Special report: The world China wants. https://www.economist.com/special-report/2022/10/10/china-wants-tochange-or-break-a-world-order-set-by-others Witteman, J. (2022, December 17). The Netherlands is a pawn in the chip war between the US and China. de Volkskrant (Dutch newspaper). Wu, G. (2022, October). For Xi Jinping, the economy is no longer the priority. Journal of Democracy. https://www.journalofdemocracy.org/for-xi-jinpingthe-economy-is-no-longer-the-priority/

CHAPTER 12

Conclusions and Recommendations

Abstract China’s initial monetary response to the Covid-19 pandemic has been moderate. It was accompanied by a policy of deleveraging and avoiding risk in the financial system. In the past few years, deeper reforms have improved the stability and efficiency of the Chinese financial system and transformed it from a controlled indirect bank-based to a more direct market-oriented diverse and interconnected global financial system. The development of the Chinese financial markets during the last decades, similarly to the US, was accompanied by the digitalization and an increasing application of financial technologies. As a result, both US and China have become the world’s largest financial centers based on financial technology. The economic competition between China and the US in recent years has ultimately led to an economic and technological decoupling between these two largest trading nations in the world. At the same time, in the last decade, the Sino-US financial ties are more characterized by financial coupling because of their interconnectedness even though this Sino-US financial interdependency has recently come under increasing pressure due to geopolitical tensions between the two countries. It is likely that the current geopolitical competition between the US and China will affect the future of both China’s capital markets and the structure of global finance. The rapid development of new technologies and their potential for economic and social changes require international

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7_12

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standards to minimize such effects. Amid the current Sino-US technological rivalry with opposing national interests, this pivot ultimately analyzes the possibilities for further Sino-US financial cooperation and regulation in light of the current intensification of the Sino-US rivalry and its impact on the international economic order. Keywords Global direct market-oriented financial system · Sino-US trade and subsequent tech war · Sino-US economic–technological decoupling · Financial coupling · Sino-US competitive interdependence · Financial technology · Digitalization of financial services · Coordinated Sino-US financial regulation · International economic order

While the Chinese economy has not been as adversely affected by the GFC as the US economy, authorities have learned important lessons from the vulnerabilities of the more deregulated and market-oriented US financial system. In response to the GFC, the US has placed more emphasis on regulation, legislation, and the creation of macro-prudential oversight to monitor future systemic financial risks, while Chinese authorities have made their financial sector more diverse and one of the strongest in the world combined with market reforms which have led to greater integration with the global financial markets. The rapid expansion of China’s more market-driven financial sector with the emergence of unregulated shadow banking has been accompanied by an inevitable slowdown in real economic growth. This new development has contributed to a massive growth of primarily corporate debt with increasing NPLs of which a significant portion is backed by risky, opaque assets. While Chinese authorities have long been hesitant to use “direct” funding channels due to risks to financial stability, in recent years China has made unprecedented progress in building a more market-oriented registration-based IPO financial system that supports the rapidly recovering real economy during the pandemic. This new financial environment has led to strong inflows of foreign capital into the Chinese capital markets but has also been accompanied by stricter disclosure requirements for IPO applicants, publicly traded companies, and bond issuers. Apart from long-term forms of capital, significant role plays also short-term inflow of capital to China. This form of capital flow is the subject of many analyzes and considerations. As the official US stance on portfolio investment in China is still

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evolving, international policymakers, market participants, and observers should adjust accordingly. The most important thing all three groups can do now is to closely observe the US debate over geopolitical competition with China and realize that this debate is likely to affect the future of both China’s capital markets and the structure of global finance. Most important of all, this era of financial geopolitics requires international financial institutions to learn to consider national security every step of the way (Hellendoorn, 2022). Depending on the economic circumstances and with the goal of guaranteeing financial stability, the Chinese authorities sometimes tighten the reins and other times loosen them a bit. In recent years, they have taken many measures to manage the unregulated part of the financial system with the result that the shadow banking market and the associated systemic risks and its impact on monetary policy have been significantly stagnated and become more like many other financial markets. Despite the trade war, Sino-US financial systems have become increasingly similar and interdependent in recent years. At the same time, China and the US have increasingly entered a “titfor-tat ” game as they compete for global economic and technological dominance in this decade. While both countries are currently competing technologically applying numerous restrictions, they are also tied to each other via the still-existing “dollar trap” which is a given phenomenon for both countries that the politicians can’t really avoid. It is not yet entirely clear how to evaluate the relationship between the US and China under the Biden administration. It is expected that a digital state-led high-tech authoritarianism with a technology transfer for its “Made in China 2025” plan will continue the Sino-US competitive “economic decoupling” for the time being. At the same time, the increasing Sino-US financial interdependence will entail more and more “financial coupling” in the coming years. Current developments have become more complicated as the US and China now increasingly dominate the global business. Private firms of the two countries dominate the frontier of new technologies such as Fintech and electric cars backed by a vast home market, deep capital markets and a growing number of risk-taking investors. The companies from both countries are more focused on a “linking” strategy, while the political authorities are much more skeptical about this development. The opposing approach of the business community on the one hand and the politicians on the other makes it difficult to implement the inevitable financial cooperation. As the Biden administration encourages domestic competition and improves the social safety net to protect workers in

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declining industries, Xi Jinping’s government fears that big private firms such as Alibaba and other big tech firms pose a threat to social stability and legitimation of its CCP. While the US threatens a new wave of protectionism resulting in more economic decoupling from China, the Chinese authorities in response will be more focused on achieving political goals, such as national selfsufficiency in some technologies protected from foreign competitors in line with the 14th FYP “dual circulation” strategy referring to keep China open to the world, while reinforcing its own market. A part of this strategy is a two-way precautionary mechanism or two-pronged approach where China will minimize the linkages to the global economy if they are found to create vulnerabilities like during the GFC, but once these linkages create benefits, China wants to expand them. China may well benefit in key sectors from semiconductors to robotics as focused on in its “Made in China 2025” strategy. However, it remains to be seen to what extent this strategy of global import-substitution which can also be accompanied by a less efficient allocation of financial means will eventually lead to more long-term sustainable growth (The Economist, 2021, July 3). In response to the GFC, many new regulations have been introduced in the US financial sector under the “Dodd–Frank Act ” that has been relaxed somewhat under the Trump administration and needs to be reevaluated under the Biden administration to make an appropriate tradeoff between economic growth and regulatory costs and benefits on the one hand, and safety of the financial system on the other hand. Although the Chinese government can lean on its profitable banks, it is very important that regulators accurately determine the level of “bad loans” so that they cannot endanger the financial system. This requires ongoing efforts to counter regulatory arbitrage, curb the restructuring of loan terms that postpone problems without resolving them as well as applying strict oversight in general. Transparency will also be key so that all stakeholders can rely on the accuracy of the balance sheets. In addressing these issues, it is beneficial that the Chinese financial system is maturing, with direct market-oriented financing becoming more important and institutional investors gaining more and more impact on the financial markets. The latest phase of the financial markets’ development is characterized by the very rapid growth of financial technology (Fintech). The Chinese market is more advanced in financial technology than the US market, what might trigger a leapfrogging certain phase of development (e.g.,

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in payments after cash immediately were accepted QR codes and mobile payment applications instead of credit cards). Financial services based on advanced technology in China are more prevailing in retail market (e.g., payment services, online lending, etc.) than in wholesale sector. In the US it is the opposite—the retail market is based more on traditional channels of distribution financial services, while more advanced technology is applied in more advanced services and processes, big deals, and big IPOs. In any case, recent developments in the still ongoing Sino-US tech war clearly show that the wider adoption of financial technology in financial services will become more prominent in both countries in the future. It might be expected, however, that in China the application of financial technology and the processes of financial services digitalization apart from retail services improvement, will be oriented toward solving some social problems, like poverty alleviation, financial inclusion, etc. In the case of US, it might be also expected broader application of financial technology in the retail market, but undoubtedly, the greatest application of such technological solutions will be in the wholesale market and wealth management services. When considering the possibility of the unification of the processes, the most likely is the unification of payments and transaction settlement. It is the area which can be treated as relatively safe for both sides. It seems much more difficult to implement the process of technological unification in other, more sophisticated services where strong competition is observed instead of cooperation. Moreover, both countries, China and the US try to protect their sensitive data at all costs. For example, in May 2023, access to Chinese (financial) business information and economic data has been severely restricted as a result of Beijing’s expanded new anti-espionage law which makes it more difficult for foreign firms to conduct research on key business partners in China. In more and more areas including the financial sector, the economic development is being subordinated to national security. It means that cooperation in financial technology solutions and implementation of a common, unified system is rather impossible in the foreseeable future. Since the US–China trade war started with “tit-for-tat” tariffs in 2018, tech and finance frictions have flared between the two countries. In addition, geopolitical considerations, with sanctions against Russia and rising tensions over Taiwan, are likely to weigh more heavily on investment decisions. The trade war disrupted trade flows between the US and China in 2018–2019 and reverberated through global supply chains.

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While initially very rigid and then again strongly loose zero-covid-19 policies and regional geopolitical conflicts have wreaked havoc on the global manufacturing sector, subsequent stimulus packages in several countries have boosted demand for Chinese exports again. Many US companies have established factories in China in recent decades, and their supply chains are closely linked to China. For example, China is the world’s largest consumer of semiconductors ahead of the US, due to the size of its domestic electronics market and its status as a manufacturing base for entire industries. It is therefore likely that many such factories in China will continue to meet local demand, as evidenced by China’s robust FDIs since the trade war. Given the complexity and interdependence of countries in the global semiconductor value chain, any potential disruption to the semiconductor supply chain could have global consequences. While the US has recently passed new legislation, such as the Chip Act, in an effort to thwart and compete with China’s technology development, revenue exposure to China within the technology sector remains high. With the aim of avoiding a new GFC, the initial monetary and fiscal response to the Covid-19 pandemic has been moderate, accompanied by a policy of deleveraging and avoiding risk in the financial system. Certain measures should be also taken to prevent the occurrence of a financial crisis in the future. Soon it will be essential for both countries as the largest international lenders with increasing access to each other’s financial systems, to find a way of regulation that will reduce the chances of creating excessive systemic risk and hence a credit crunch. It is essential that national, Chinese, and US, as well as international regulatory bodies work toward a common financial ground or global financial level playing field. It is especially important that the US and Chinese regulatory authorities work together to unify the bilateral financial regulatory environment. This requires intensive research into which parts of current global financial standards really should be applied globally to large financial institutions lending abroad and which parts can be adapted to specific national circumstances. Due to the increasing Sino-US financial interdependence, it is desirable that the PBC and the Fed, and possibly also other regulatory bodies from both countries, could initially take the lead in the joint regulatory architecture. At the time of writing, several future scenarios for Sino-US relations are possible in a troubled geopolitical atmosphere where cases such as the balloon saga in February 2023 do not make mutual negotiations any

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easier. On the one hand, this could lead to a new cold war with the necessary waste of resources and a deterioration in the prospects for peace and prosperity in the long term. On the other hand, these developments may also move in a different direction toward a kind of multipolarity of the international economic order. Over the past decade, the financial systems of the US and China have gradually become closer and more intertwined, despite the ongoing trade and tech war. The extent to which the Western and especially the US capital markets will be linked to the Chinese capital markets will partly determine the direction of the future international economic order. The crucial question is China’s ability to reform the international economic order and change the liberal norms and values that have guided global and regional governance and practice for the past seven decades.

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Index

0–9 14th FYP, 16, 32, 131, 148

A allocation of financial products, 29 artificial intelligence (AI), 35, 58, 59, 67, 99, 101, 105, 113 asset growth, 11, 25 asset securitization, 12 asymmetric decoupling, 133

B balance-of-payments, 76 bank-based financial system, 10, 13 Belt and Road Initiative (BRI), 80, 134 big data, 58, 59, 69, 99, 101 Big Tech companies, 67, 69, 101 blacklist of technology companies, 104 Bond Connect, 16, 37, 38

Build Back Better infrastructure program, 46 burgeoning technology industry, 35

C capital flows, 3, 10, 26, 28, 38, 121, 125, 126 central bank digital currency (CBDC), 8, 83 centrist approach, 112, 139 China Standards 2035, 101 Chinese economic order, 140 Chinese financial system, 2, 3, 5, 7, 8, 11, 13, 15–17, 19, 25, 30, 32, 50, 51, 70, 140, 148 Chinese Securities Regulatory Commission, 38 Chips Act, 44 ‘chip war’, 7, 100, 138 clearing centres, 82 cloud computing, 59, 101 Cohen’s Matrix, 78

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 R. W.H. van der Linden and P. Łasak, Financial Interdependence, Digitalization and Technological Rivalries, https://doi.org/10.1007/978-3-031-27845-7

171

172

INDEX

comprehensive escalation, 135, 140, 141 constructive financial cooperation, 121 controlled indirect bank-based, 6, 7 cooperation despite some antagonism, 135 cooperative approach, 111, 112 corporate and sovereign bonds, 33 counter-cyclical interest rate instruments, 26 Covid-19 pandemic, 2, 3, 39, 43, 46, 51, 53–55, 95, 96, 150 cross-border capital inflows, 30 cross-border payments, 10, 59, 81, 121, 125 cryptoization, 3 currency manipulation, 95, 98, 126 current account, 5, 28, 77, 85

D declining industries, 96, 97, 148 deleveraging, 3, 8, 18, 51, 150 demand-driven, 11, 13, 44 deregulation, 10, 52 dichotomy, 124, 136 digitalization, 3, 7, 8, 17, 63–65, 83, 84, 114 digitalization of financial services, 7, 62, 149 Digital technologies, 58–60 direct financing channels, 31 direct funding channels, 146 direct market-oriented financial system, 6, 7 Dodd-Frank Act , 14, 148 dollar trap, 77, 104, 122, 147 domestic stock futures market, 16, 38 domestic systemically important banks, 32 dual circulation, 131, 133 dual circulation policy, 140

E e-commerce, 51, 63, 68, 69, 113 economic decoupling, 4, 10, 94, 135, 136, 147, 148 economic statecraft, 114 e-finance, 51 Entity List, 113, 124 equity market cap, 33 e-RMB, 83–86 exchange rate system, 77, 78

F financial conglomerates, 11 financial coupling, 2, 5, 10, 119, 125, 145, 147 financial dependency triangle, 25, 26, 36 financial deregulation, 50 financial derivatives, 13, 33 financial globalization, 11, 122, 123 financial intermediation, 5, 10 financial liberalization, 12, 125 financial regulation, 10, 15, 16, 32, 33 financial sector, 4–6, 10, 11, 14, 19, 25, 30, 32, 34, 50, 53, 61, 65, 67–69, 87, 123, 124, 139, 146, 148 financial technology, 4, 6, 7, 17, 19, 32, 53, 58, 61–63, 65, 66, 148, 149 Fintech, 6, 16, 19, 25, 57–70, 147, 148 Fintech ecosystems, 62, 69 first Phase One trade agreement, 94 Five Year Plan (FYP), 14, 30 fix exchange rate, 78 flexible exchange rate, 26 forced technology transfer, 98, 104 Foreign Direct Investments (FDIs), 42–46, 139, 150

INDEX

foreign exchange reserves, 5, 36, 76, 77, 80, 82, 122

G geopolitical competition, 125, 147 global chip supply chain, 113 global financial crisis (GFC), 2, 3, 8, 10–17, 24, 33, 43, 50, 54, 122, 146, 148, 150 Globalization, 10, 123, 131, 136, 137 Global Security Initiative, 132 global supply chains, 2, 94, 111, 112, 114, 149 government-controlled globalization, 133 gradual loosening of ties, 135 greenfield investments, 42, 43 guidance capital, 35

H hedging instruments, 33 high-risk, 29, 115

I implicit guarantees, 26, 27 inbound investments, 5, 44 Inflation Reduction Act, 108 informal financial system, 51 information and communication technology (ICT), 10, 44 institutional investors, 37, 38, 52, 138–140, 148 intellectual property rights, 93 interbank bond market, 37 international economic order, 7, 8, 115, 130, 132, 135, 137, 141, 142, 151 International Monetary Fund (IMF), 3, 28, 29, 36, 78, 82, 122

173

international monetary system, 10, 77, 81, 120–122, 125, 140 investment- and export-led model, 25

L liberalization, 10, 30, 31, 33, 36, 124, 131 linking strategy, 5, 147 Local government financing vehicles (LGFVs), 36

M macroeconomic shock absorbers, 26 macro-prudential, 13, 14, 16, 17, 146 Made in China 2025 policy, 4, 6, 98, 147, 148 managed exchange rate, 80 market capitalization, 11, 25, 33, 34 market-oriented financial system, 5, 13, 32 medium of exchange, 79, 80 micro-prudential, 15, 16 minority-owned joint ventures, 30 MSCI Emerging Markets Index, 38 Mundell-Fleming policy trilemma, 80, 82

N neo-classical globalization, 133 neoliberal capital markets, 12 non-bank financial institutions, 25, 52, 53 non-bank financial service providers, 61 non-Chinese entities, 28 non-creditworthy loans, 25 non-performing assets, 51, 53 non-performing loans (NPLs), 29, 146

174

INDEX

O off-balance-sheet, 11 opaque assets, 29, 146 ‘open door’ policy, 131, 133 outstanding corporate debt, 31

P pawn shops, 25 peer-to-peer lending, 6, 19 People’s Bank of China (PBC), 13, 16–18, 32, 33, 50, 77, 81, 83, 86–88, 126, 150 Phase One agreement, 30, 99 planned economy, 25 portfolio investments, 42, 139 poverty alleviation, 19, 149

Q QR code, 62, 63, 149 Qualified Foreign Institutional Investors (QFII), 16, 37 quantum computing, 105, 109

R rating agencies, 5, 15, 37 rebuttable presumption, 114 registration-based IPO system, 32 regulatory reform, 16, 18 renminbi, 5, 28, 82, 126, 140 restrictive approach, 111 restrictive monetary policy, 33, 126 risk management, 32, 54 RMB-denominated Chinese securities, 33 RMB internationalization, 7, 77, 78, 80–82, 84, 87

S SDRs basket, 78

securities markets, 10, 121 seigniorage, 76, 78 selective economic decoupling, 135–137 separationists, 111, 139 shadow banking, 2, 3, 6, 8, 16–19, 50–54, 146, 147 shadow financing, 26, 53–55 Sino-US economic-technological decoupling, 6, 114 Sino-US tech war, 99, 112, 113, 149 Sino-US trade war, 7, 8, 45, 94, 133 slowbalisation, 122 small- and medium-sized enterprises (SMEs), 2, 6, 50, 51, 53 social safety net, 28, 147 sovereign wealth funds, 37 Special Drawing Rights (SDR), 36, 78, 82, 122 state capitalism, 11, 96 state-owned banks, 2, 15, 24, 25, 46 Stock Connect, 16, 37, 38 store of value, 79, 80 supply-driven, 13 Swap Connect, 39 T technological competition, 105, 110, 115, 120, 135 technological decoupling , 4, 7, 8, 111–113, 121, 138 technological developments, 11 technological self-reliance, 34, 133 technology-based services, 61 technology-focused markets, 35 tech war, 4, 8, 94, 99–101, 104, 121, 140, 151 Tier 1 capital, 24, 25 ‘tit-for-tat ’ game, 104, 147 trade settlements, 80, 122 traditional banking, 11, 13, 50, 54, 65

INDEX

two-pronged approach, 132, 133, 148

U unbundling, 101 unit of account, 78–80 universal banking, 11, 13 US-China tech war, 46 US-China trade war, 32, 99, 149 US financial system, 3, 6–8, 10, 12–14, 146

V Venture Capital investments, 42

175

W wealth management products (WMPs), 17, 18, 50, 51 wholly foreign-owned financial institutions, 30 World Trade Organization (WTO), 43, 96, 101, 112, 115, 132, 133 WTO commitments, 96 X Xi Jinping, 4, 11, 35, 96, 131, 148 Z zero-sum game, 111