Redefining Sovereignty in a Borderless Financial System ft. Zoe Liu

[00:00:07] Zoe

Now they can basically connect your digital ID with facial recognition and with your banking activity almost instantaneously. From a strengthening control perspective, that’s pretty good. But they are afraid of anonymous freely moving cryptocurrencies or stablecoins. And more importantly, China doesn’t issue dollars, hence dollar backed stablecoin. Freely moving system is going to be a threat to the party both domestically and internationally.

[00:00:39] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

Before we begin today’s conversation, remember to keep two things in mind. All the discussion we’ll have about investment performance is about the past, and past performance does not guarantee or even infer anything about future performance. Also understand that there’s a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions. Here’s your host, veteran hedge fund manager Niels Kaastrup-Larsen.

[00:01:35] Niels

For me, the best part of my podcasting journey has been the opportunity to speak to a huge range of extraordinary people from all around the world.

In this series, I have invited one of them, namely Kevin Coldiron, to host a series of in-depth conversations to help uncover and explain new ideas to make you a better investor. In the series, Kevin will be speaking to authors of new books and research papers to better understand the global economy and the dynamics that shape it so that we can all successfully navigate the challenges within it. And with that, please welcome Kevin Coldiron.

[00:02:11] Kevin

Okay, thanks Niels, and welcome everyone to the Ideas Lab podcast.

Despite all the headlines and chaos surrounding tariffs, the US Is still going to run large current account deficits with China. And that means China is still accumulating vast amounts of US dollars. If it’s not investing those assets directly back in US markets, where are they going? And what is happening with China’s project to create a currency to rival the dollar? In particular, how is China thinking about and responding to efforts by the US to extend the dollar’s international role by promoting dollar stablecoins? These are very important questions, and our guest today is the perfect person to answer them.

Dr. Zoe Liu was a guest on the Ideas Lab podcast two years ago when we discussed her book Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions, and I asked her back on the show after reading a new piece she published in Foreign Policy called China Is Worried About Dollar Backed Stablecoins. So, Zoe, thanks so much for joining us today and welcome back to the show.

[00:03:23] Zoe

Kevin, thank you so much for inviting me back. I really appreciate it.

[00:03:28] Kevin

It’s our pleasure. So first of all, I just want to say, hey, congratulations on the success you’ve had with the book. I mean, I know you’ve had some great reviews in places like the Financial Times. It’s kind of hard to believe that it’s been two years since we spoke and the topic is still really relevant.

[00:03:44] Zoe

I certainly hope so. And again, thank you for inviting me to talk about my book when it was first out. And the timing is interesting because two years ago when you first invited me to join the podcast, that was when the hard copy was out. And in August of this year, the paperback was released. So, now I hope more people can buy it at a cheaper price.

[00:04:14] Kevin

Well, that’s definitely a mark of success when it goes to paperback. So, congratulations.

[00:04:20] Zoe

Thank you.

[00:04:20] Kevin

Okay, so we want to do two things today. First, we want to get a sense for how China is managing its ongoing accumulation of dollars, and then we want to talk about how it’s responding to the threat it perceives from dollar backed stablecoins.

So just, I guess, starting with the managing of dollars, I mean, I looked at the official statistics and for 2024, the US ran a current account deficit with China of around US$260 billion. Now, that’s less than the average over the last decade or so, which was around US$315 billion, but still a very significant amount.

So, I guess my first question is, do we have, do you have any idea how all the tariff chaos is going to impact this in 2025? Is it too early to say anything about that about and, particularly, where we might end up in terms of an ongoing kind of scale of the current account deficit with China?

[00:05:22] Zoe

Yeah, sure, Kevin. And I think here an important background footnote is that China has been running persistence trade surplus against the United States. And the number, in terms of current account surplus, has been relatively stable since the first trade war back in 2018 to now. The number of around US$260 billion has been stable over the past few years despite persistent tariff.

And in some ways, if we take a step back, back in 2018, that was the first round of US/China trade tension that started with President Trump jacking up tariffs. And then in 2020, in January, that was the phase one trade deal. And then Covid happened and then Biden came into power.

During this whole period of time tariffs against China were there. President Biden did not remove any of the tariffs. And now, when President Trump came back, it’s just that the heat of tariff level has gone up.

So, I guess, viewing from China’s perspective, they have been engaging with a low-level trade or tariff war with the United States for over seven or eight years. So, from that perspective, I do not necessarily think the trade deficit is going to be significantly narrowed because they’ve gone through this period of time.

And if anything, I’d imagine that a lot of these on and off 90-day extensions and then another 90-day extensions might accelerate some of these front loading anxieties by American importers. So, that might be a factor contributing to the relatively stable size of America’s current account deficit with China, like trade deficit with China against China.

But putting that aside, I’d also want to share a little bit of interesting results that I find in my recent research with regards to this trade tariff and inflation because I think everybody has been curious about why inflation has not been increasing as much as people imagined. And in particular conventional economics principle would inform us once you increase the tariff, consumers would bear the cost, inflation would go up.

But so far that’s not the case. And I’d say that this perhaps has a lot to do with the structure of trade, especially the supplier and the buyer relationship – how contracts get worked out, and also in international logistics or shipping.

[00:08:24] Kevin

Can you give us some example of that? Are you saying that, essentially, these contracts are already established months or years in advance and so the prices only adjust slowly, is that what you’re saying?

[00:08:41] Zoe

I think there is a part of that, but Chinese suppliers are very nimble and there are hundreds of them producing almost a similar product. So, I guess the contract aspect of that is that for a lot of these Chinese suppliers, especially when evolutionary competition at home means profit killing and exporting to the United States elsewhere means they can make more money. So, we would put a higher premium on having access to the US market – having access to US consumers.

So, a lot of them, once they have a contract, once they are in the supplier ecosystem of, say, big box buyers like Walmart, we won’t want to lose that. Hence, this is why when Liberation Day tariff was just imposed, you started to see news stories like Walmart trying to pass the tariff costs to their Chinese suppliers, saying that, well, you have to absorb at least a 10% or 15% of the tariff cost.

But here, given that Chinese suppliers, most of them are small and medium sized companies. And numbers, as of last year, showed that the average profit level of small and medium sized Chinese exporters, their profit level as of last year was around 5.2%. So, they would not have the ability to absorb 10% or 15% of the tariff.

So, when we look at the numbers though, Chinese customs publish the price level of Chinese export and that number has gone down since Liberation Day tariffs. That means the Chinese exporters, they have absorbed some of the cost given the rise of tariff.

And we are confident to say that a lot of this has a lot to do with lowering tariffs to America. Because after all, China still exports a lot to the United States, in terms of direct trade, as well as indirect. Although Southeast Asia has become China’s largest trading partner, a lot of those intermediary goods eventually get shipped to the United States.

But if you look, the US census has published import prices from different places including China, interestingly their number, their import price from China has gone slightly up. So, something does not really mesh here.

So, when I was in China in the summer, I talked with a lot of Chinese exporters and manufacturers. So, the one example folks gave me is that they asked me, have I heard, like in TV commercials for example, have I encountered this phenomenon where a product can be sold for US$1, but the shipping fee can be US$299, things like that.

So, this is quite interesting because when we think about exporters, they will think through the lens of total cost of goods sold. And if the buyer were taking care of the logistics, then you don’t really have to think about the shipping fee. But give that China, over the past few years, has invested a lot of money in increasing the efficiency of supply of logistic, lowering the cost of shipping, fundamentally, that means that in a buyer and supplier contract renegotiation because of tariffs, the supplier would have more leverage in terms of, ‘Although I am not willing to lower the price by 15%, 10%, what I can do is I take care of the shipping fee.’

Now, from American importers perspective, that actually is not necessarily a bad deal. Especially when you can think about this in terms of a total cost of goods you imported and it’s still total cost of goods. But now you get a better way trying to readjust what is the cost of the goods that will be subject to tariffs versus the shipping fee.

[00:13:14] Kevin

Oh, I see. So, let me see if I can repeat this back to you. So, you’re saying that essentially the total cost involves basically what you sell the good for as well as the shipping fee. The tariffs are applied to what the goods are sold for. So, what we can do is kind of rebalance those two things and we won’t lower the cost of the goods sold, but we’ll lower the shipping fee.

[00:13:41] Zoe

Or the Chinese exporters can potentially bear all the cost of shipping.

[00:13:46] Kevin

Gotcha. I gotcha.

[00:13:47] Zoe

But from an importer’s perspective, your total cost… There are ways that people can go through an agent trying to either inflate or deflate the cost of goods imported or exported. But I’d say that is fairly risky because the penalty would be quite hefty. However, what is hard to manipulate is the shipping cost. And if you can transfer the shipping cost not from you, but to the exporters, then that would be money saved.

[00:14:30] Kevin

I see, I see. But still, either way, the total cost of the goods is going to reflect both the cost sold and the shipping fees. So that should work its way through to inflation at some point, right?

[00:14:43] Zoe

I think at some point, yes. But the trade structure between US and China are slightly different, and are very different than trade between US and the EU.

So now, when we look at export; the sectors in China that are mostly most dependent or most sensitive to the US market, meaning they are very sensitive to the increase in tariff, these are mostly low value added products, not advanced or sophisticated equipment. So, from that perspective, these lower value-added goods, they ship in terms of big containers and you can manage the shipping fee.

So, when exporting get augmented, in terms of containers, and when China or Chinese exporters can get better prices on shipping, this deal can make a decent amount of money although they lowered the profitability from the goods that they manufacture, but they can still maintain the order access to American market.

But I do think the inflation would work through the way, especially in terms of tariffs on European or Japanese equipment, because, those take a longer time to translate into inflation and equipment and they tend to depreciate more, over a longer period of time, than toys or umbrellas.

[00:16:26] Kevin

I gotcha. Well, that’s fascinating. We could probably spend the rest of the show talking about just that.

But I mean, I guess what I like to do is say, okay, at a high level, I think what you’re saying is, hey, since 2018, there’s been this ongoing trade war and it changes its nature, but it’s been there, and the exporters have had to deal with it. And, at the end of the day, there’s still a kind of consistent structural surplus that China has with the US. What that means is that they’re collecting US$250 billion, US$260 billion a year in dollars and that money needs to be invested in some way.

And, you know, of course there’s been a lot of talk about foreign sovereign wealth funds not wanting to hold US treasuries for various reasons given the instability in US Policy since Trump took office. And so, I’d like to talk about what China’s actually doing with those dollars that it’s earning. And when we talked in September 23rd, basically you said there are, based on your book, three main actors involved in China. There’s Central Huijin, there’s CIC (China Investment Corporation), and there’s SAFE (the State Administration for Foreign Exchange). And I was hoping you could just give us kind of like a high level overview of the main focus of each of those.

Now, I know that’s kind of unfair because their activities are very complex and they’re involved in a lot of different things that overlap. But maybe just to set the stage for us, tell us (for anyone who hadn’t listened to that first podcast) just who those three actors are, what their focus is, and then we can talk about what they’ve been focusing on over the last year or two and what you think they’ll be doing going forward.

[00:18:23] Zoe

Sure. So, the three actors that I explain in the book, primarily the number one is the Central Huijin. It was established back in early 2000s with the purpose to restructure Chinese banks. In those days, the Chinese banks were suffering from huge nonperforming loan issues. But Central Huijin’s restructuring of them was so successful that not only these banks, like ICBC, became largest banks in the world, but Central Huijin, itself, has become an important player behind almost every single one of Chinese financial institutions, banking or non banking. Or, for that matter, also includes Chinese policy banks. And related to what CIC, Central Huijin has been doing now or since the end of Covid would be teaming up or beefing up the so-called national teams.

I guess since early 2023, in the newspaper, folks have been talking about China is building up its national team to stabilize the economy, stabilize the stock market in particular. But when newspapers were putting out stories like that, the important background is that this is nothing new because they have been doing this for the past almost two decades. And so that is what Central Huijin has been doing. It has been deploying a lot of resources to stabilize China’s equity market in particular.

And interestingly some of the companies in its portfolio, this is all public information, the Chinese government or the Communist Party of China considers strategic industries. One such example would be BYD. Central Huijin is one of the largest shareholders of BYD’s publicly listed stocks. And this is all public information.

So, that’s that. And then the second player I explained in my book is so called a CIC or China Investment Corporation. I think a lot of people are very familiar with the CIC. They debuted into the international market back in 2007, right in the running up of the global financial crisis.

And CIC, over the years, has greatly expanded its portfolio, but mostly in developed markets. And when CIC was established, or China Investment Corporation was established, it also absorbed into Central Huijin as its domestic arm.

So, the important footnote here is, yes, the central CIC is gigantic depending upon the year that you are looking at. Back in 2020, back in 2022 or 2023, around that time, it was briefly the world’s largest sovereign wealth fund as people call it. But since then it has become number two or number three. It’s no longer the largest, but still quite large.

But it’s important to know that, yes, CIC might have a very large portfolio, large asset under management, but about 2/3 of CIC’s portfolio is under Central Huijin, meaning it’s held domestically.

Now, internationally CIC has been, I’d say, it has been expanding. But especially since 2018, during the first Trump administration, the US government strengthened its investment review process and it also strengthened its export control system. The idea, the whole idea is, you know, the US Government does not want strategic investors with ulterior motive to invest in US assets that might have negative national security concerns.

Since then, CIC’s expansion in the United States has suffered tremendously. Suffered to the extent that, by 2022, CIC had to close off its office in the US simply because deal making is becoming so difficult. But over the years, despite this obvious challenge, this strengthened investment review by CFIUS, CIC has been seeking partnerships with stakeholders or institutional investors based in the United States. One such example would be CIC’s partnership with Goldman Sachs. I think that was a… That can be considered as an achievement or a deliverable coming out of President Trump’s visit to Beijing back in 2017. And through this partnership, CIC has been able to invest in the United States over the years, despite rising tensions between these two countries.

[00:24:02] Kevin

Are those partnerships… Because I remember we talked about that Goldman Sachs partnership when we first met, is that still operating and still investing?

[00:24:12] Zoe

Yes, it is still operating. And to my knowledge, I haven’t heard anything about them being closed or shut down. The partnership is still viable and they are still looking for opportunities. From Goldman’s perspective, the US China Joint Investment Fund is fully owned and fully managed by Goldman Sachs. So, depending upon how you view it, how you evaluate it, you can say that this is a US entity, although the money comes from CIC, from China, but this is the US entity. It is not a foreign entity trying to invest in the US. So, that’s the CIC.

And then the third entity that we discussed, and I analyzed in the book, is this institution called a SAFE or State Administration of Foreign Exchange, that is the foreign exchange management arm of the PDOC. Oftentimes the head of SAFE would be at least a deputy governor of the People’s Bank of China.

And SAFE has, broadly speaking, two different portfolios. One is the official foreign exchange reserves that has been relatively stable around slightly higher than US$3 trillion despite rising Chinese current account deficit. So, the question is, what is the discrepancy and where do they manage the money?

So, on the discrepancy part, I’d say Chinese exporters tend to have the practice of overly inflating the export invoices because there are two benefits of that. You inflate it so that you can get more export rebate. In a lot of export sectors, the Chinese government, especially the local government, pays an exporter tax rebate for the exporters. So, there is the incentive there. And then the other incentive is, through invoice inflation, folks can transfer some of their money overseas because China remains under a stringent capital control regime.

But there is also a significant amount of money that doesn’t really go into the official statistics of foreign exchange. Instead, SAFE has, over the years, established several investment arms. These are investment companies managing a pot of money that ultimately comes from Chinese exporters. But because they do not get deposited, or it does not get accounted towards foreign exchange reserves, they can do all sorts of other risk bearing and longer-term investment activities also including helping Chinese companies to conduct mergers and acquisitions using this mechanism called SAFE co-financing.

What the mechanism is, SAFE basically allows designated Chinese banks or policy banks to take out foreign exchange from SAFE and then these banks can then pass on the money to Chinese companies who need to pay the bills or need to lease the money for buying an overseas mine or company.

[00:27:52] Kevin

You know, when SAFE is making these FX entrusted loans, is that in some way reinforcing the dollar-based trading system? Because presumably they’re making these loans in US dollars; they’re collecting US dollars and then they’re going and saying, okay, well we’re going to make you a trade finance loan or a loan for M and A and we’re going to make this loan in dollars. So, it’s a way to earn returns on their dollar reserves. It’s not investing in US treasury (so that’s sort of strategically good in that sense), but it’s also not promoting a competition to the dollar in terms of foreign trade (if I’ve got that right).

[00:28:38] Zoe

I think, Kevin, that’s a very interesting observation. I think that is very insightful. In a way, yes, as long as Chinese companies are using FX for overseas mergers and acquisitions, they are part of this dollar based global trade and financial system. They are participating in that.

But that being said, if you look at what SAFE’s overall portfolio is, on the one hand they have been diversifying foreign exchange reserves and not parking additional earned foreign currency into the official reserves account. So, that is one way to diversify away. And then on the other hand, they have also been slowly but steadily decreasing the holding of US treasuries.

I think as of the last time I checked was around April, I think the Chinese holding of US treasury was already below US$760 billion. So, at its height, a few years ago, it was over US$1.3 trillion. So, now they have slowly but steadily decreased that.

[00:29:50] Kevin

But if they’re going to do that, either by not reinvesting money in treasuries that mature, or by selling, they still have the dollars, and if they want to maintain the currency peg, they can’t sell the dollar. So, they have to reinvest it elsewhere. So, at that point do the FX reserves become sort of shadow reserves where they disappear into these other activities?

[00:30:22] Zoe

I’d say, I described this foreign exchange asset, held by SAFE affiliated institutions or the Chinese banks or companies that conduct overseas activities, I describe these as part of this shadow reserve system. But we ought to think of it differently in the sense that official foreign exchange reserves, they cannot be used for investment or risk bearing activities.

When you think about how IMF defines foreign exchange reserves, they are low risk bearing or invest primarily in zero risk assets that should be US treasuries or, for that matter, it has to be ultimately very liquid. So, that basically means the moment money is moved outside of the official foreign exchange reserves, it’s no longer part of the reserve system. Hence, they can be used for a lot of other activities.

Now, for all these so-called shadow reserves assets, it’s not easy for them to be reclassified as foreign exchange reserves specifically because they are neither liquid nor risk free. So, if you have a company used it to invest in an overseas mine, it takes time to liquidate that, right?

So, I guess to just complete this thought, what they have also been doing simultaneously with reducing holding US treasuries, they have also been buying gold. So, buying gold is another way to sort of diversify. But then, at the same time, you can buy gold through using official foreign exchange reserves. You can also use all these shadow reserves.

From that perspective, yes, SAFE has, by using entrusted loans to participate or support Chinese companies to conduct overseas mergers and acquisitions, this is part of this dollar based international financial system. However, that is not the entire picture.

They’ve been diversifying, they’ve been reducing holding of US treasuries, buying gold. And then at the same time, simultaneously, China, the PBOC, has been signing a lot of currency swaps to facilitate the use of renminbi in trade and to facilitate the use of renminbi in investment.

Chinese banks have been also setting up a lot of overseas branches or renminbi settlement centers in Europe, in the Middle east, in Latin America and in the context of BRI, with the Chinese government specifically. And this also has something to do with another SAFE funded institution called the Silk Road Fund.

The Silk Road Fund received injections in renminbi, and the head of the Silk Road Fund specifically talked about the role of the Silk Road Fund in promoting the use of renminbi in international trade and finance.

Then of course you also have the PBOC developing renminbi-based financial infrastructure commonly known as CIPS or the Cross-Border Interbank Payment System. So, what the renminbi doesn’t have right now is a complete currency recycle system unlike the US dollar.

So, now China trades a lot. China doesn’t have a trade problem. What China has is a currency problem. And they know that. Exactly as you were saying, Chinese companies conducting international investment are reinforcing the role of dollar. So, what are they going to do? For them, they have this dilemma of the largest trading country but not really a reserve currency status.

They hold a lot of reserves of other countries. So, what are they going to do? They need to increase the international demand for renminbi and renminbi denominated assets.

And they cannot just force other countries to, say, take renminbi or take Chinese government bonds, please. They cannot do that, especially knowing that China has capital control. So, what they can potentially do is to slowly make taking renminbi more attractive. If countries already trade with China a lot through currency swap, you can trade using renminbi. The idea is to strengthen the role of renminbi in international transactions or a means of exchange – the function of currency, means of exchange.

What they can also do is to, in the case of Argentina for example, you can, through currency swaps, through the expansion of currency swaps, you can have another country pay off their dollar loans using renminbi. So, that’s in the context of Argentina’s debt to the IMF.

So, then finally they can also try to increase the acceptance of renminbi in financial markets such as by working with the exchanges allowing renminbi denominated assets to be part of the collateral composition. That is also a part of actions that they can implement to drive up demand for renminbi assets. So far, I think we have been making progress in all these directions.

[00:36:07] Kevin

Okay, well I think that’s a good, maybe, segue to talk about stablecoins because you wrote this article saying that China is very worried about stablecoins and from a slightly different perspective, but basically the concern is that the use of bank issued stablecoins could actually accelerate or promote the dollar’s role internationally.

So, before we get into that, I just wonder maybe could you just give a very simple overview to listeners who might not know what a stablecoin is, to just explain what it is to them, and then we’ll talk about why China might be so worried about.

[00:36:53] Zoe

I think, broadly speaking, stablecoins would be in the broader universe of the so-called cryptocurrency ecosystem. But it has a unique role. It’s not just any other type of cryptocurrency. It’s different.

It’s unlike most of other cryptocurrencies like Bitcoin. Bitcoin prices can swing widely. They are very volatile. But a stable coin, they are stable in the sense that they are designed to have a relatively stable value. And the way they can be stable is that they are supposed to be pegged to non-digital assets like fiat currencies, like the US dollar, or Euro. And I think the World Gold Council is going to peg a stablecoin with gold.

So, this is why they are called stable, specifically because they are pegged to non-digital assets so that their price is less volatile in terms of as a medium of exchange.

[00:37:58] Kevin

Okay, thanks. Yeah, and the US has just passed the Genius Act and that kind of specifies a regulatory framework for stablecoin issuers. If they follow a certain amount of rules and if they limit their investments to things like cash, or reserves at the Fed, short term treasury bills, deposits at insured banks, they can be classified as stablecoins.

In other words, they can only invest in a very, very limited range of low-risk dollar assets, which is supposed to give the owner of the coin confidence that it will always be worth $1. So, the US is aggressively pushing these stablecoins, and this has got a lot of people outside of the US worried.

And you say, in your article, that China not only sees this as economically disruptive, but an outright political threat. And can you explain to listeners why something like a stablecoin would be a political threat to China?

[00:39:08] Zoe

Sure. I think there are two levels of this. There are things universally challenging to other countries monetary sovereignty, and there are some things unique to China which is specifically in regard to capital control and the centrality of the Communist Party of China in the financial system and capital allocation.

So, the first part, why I think dollar backed stablecoin as well as the potential strengthening or rehabilitation of the US dollar is because a lot of people are talking about how sanctions might erode the dominance of the dollar. I think dollar backed stablecoin could potentially restrengthen the dominance of the dollar specifically because this, exactly as what you were saying, the dollar back stablecoin basically makes stablecoin a unique form of programmable money that they can, once issued, freely circulate around the world almost instantaneously and remain anonymous.

So, this, for a lot of countries, basically means this is the erosion of their monetary sovereignty because this eliminates the barrier between any other participant in international trade or international finance to obtain dollars. In cases where countries have capital control, they have to apply for licenses, and this applies to China. They have to apply to get a dollar. Now, you have a new vehicle to literally, through dollar backed stablecoin, essentially get dollars almost instantaneously.

So, this basically means…The way that I think about a dollar backed stablecoin is like a digital form of a dollar bill because dollar bills circulate around in the system. And when you give me US$1, or when I give you US$1, we don’t know where or with whom this US$1 has gone through. So, I think, in the digital world, a dollar backed stablecoin operates almost like that. Once issued, once minted, it can circulate like that. So, it’s highly liquid and the cost of moving money across borders is also very low.

[00:41:40] Kevin

I’m just going to think like in the old days, you know, when you travel around to a country, say, in South America or even parts of Eastern Europe, when I was younger you could pay for things with US dollars, dollar bills.

[00:41:55] Zoe

Exactly.

[00:41:56] Kevin

You’re saying, essentially, now, I could be in Europe, I could be in China, and I could go out to dinner, or whatever, and just if they accepted it, I could pay with my dollar stablecoin and just transferred from what, my phone to your phone.

And so, that has the potential then to, as you said, it could replace the domestic currency, or maybe not replace but could compete quite effectively with domestic currencies which, I mean, I know the Europeans are worried about this, so, I can see why that would be an issue. Can you talk about kind of the second level of threat that that’s sort of unique to China?

[00:42:39] Zoe

Unique to China – this has a lot to do with capital control as well as the centrality of the party in China’s financial system. Because a pillar of the party’s political power is such that they can control the flow of money and they can also allocate money favorably to sectors or institutions that they consider as more important or more strategic than others.

So, within this structure, what dollar backed stablecoin could potentially disrupt is to displace the party’s centrality in the system. Imagine a Chinese exporter, Chinese exporters, they would probably be very much open to using dollar backed stablecoins. Part of the reason is because, well, you lower the international transaction cost. That’s economic motivation.

Then secondly, related to what we were talking about earlier about inflating your export invoices, the idea is rather than going through an underground money laundering system, trying to move your money overseas, now you have a ready-to-go, dollar backed stablecoin system. That is, you can move your money overseas easily and without the ability of being tracked by the Chinese government.

I think the anonymous aspect of it and the highly liquid aspect of it, of the dollar backed stablecoin, the monetary authority in China, more than others, specifically because the Chinese government would want to be able to stop undesired capital outflow and stop it anytime they would want to. But if exporters move to a dollar backed stablecoin system then the Chinese government would lose all the ability to monitor it. So that’s for the exporters.

[00:44:48] Kevin

Let’s say you’re a Chinese exporter and you adopt US based dollar stablecoin. I can see where, as you say, that would be useful if you wanted then to move those dollars that you earn outside of China. But let’s say, you know, you need to keep some money in China. You have to pay your suppliers, you have to pay people. So, you would then have to essentially sell those stablecoins to the central bank to get local currency. And the central bank might just say, well, we’re not accepting those stablecoins. So, you’re kind of stuck. You’d have to operate totally with dollar stablecoins.

[00:45:37] Zoe

That is a very interesting point, and I think this is exactly why, right after the Trump administration passed a Genius Act, Hong Kong jumped forward with their own stablecoin bill, which is, they are experimenting in a sort of a regulatory sandbox relative to the mainland.

The idea is to figure out a way to issue perhaps a Hong Kong dollar backed the stablecoin or even offshore renminbi backed stablecoin. The vision is that, on the one hand, they realize there is this potential threat of reinforcing the role of the US dollar. But then, on the other hand, they are also developing this mechanism, trying to take part of the pie, if you will.

Now, if they do move forward with that, then for the Chinese exporters or, for that matter, importers, it becomes very convenient because a lot of Chinese exporting companies, they register in Hong Kong anyways. So, what you need to do is to just apply for a license so that you can get Hong Kong dollar back to stablecoin and you can do all the transactions offshore.

And in fact, to your point about how are the exporters trying to handle this? I think it’s very revealing that China’s largest e-commerce platform like Jingdong, like Alibaba, they were all very enthusiastic. They were among the first to, not just endorse potential renminbi or Hong Kong dollar backed stablecoin, they were also among the first to apply for the licenses.

So, you end up having an offshore market that can do all these transactions. But for Beijing, in the mainland aspect, in mainland China, capital control is still very rigid and they are doing all that they can trying to not be displaced by US dollar backed stablecoin through Hong Kong, and then they also try to have capital control.

So, fundamentally, what I see the Chinese government trying to do is, how to maintain the relevancy of the renminbi and the renminbi system in an era where the digital dollar might restrengthen the role of the US dollar. And they also want to have and maintain, and tighten capital control.

There is also an international aspect of it which is the re-strengthening of the dollar/yen international system, through dollar back to stablecoin, would also mean a setback for the Chinese government, or the PBOC, to promote the renminbi based financial system. Because since 2000… They launched the CIPS system back in 2015, and over the past few years, since President Putin’s war against Ukraine, we started to see China actually having expanded trying to very aggressively, very actively expand the renminbi-based system. And they do this specifically because they were also concerned about falling victim of US financial sanctions.

So, the re-strengthening of the US dollar through dollar backed stablecoin, I guess just to close off this part, is, on the one hand, there is domestic threat threatening its centrality in capital allocation or the monetary sovereignty. And then, on the other hand, it also renders China even more vulnerable to financial sanctions.

In terms of how a renminbi, or dollar backed, or Hong Kong dollar backed stablecoin would look like, so far, it’s important to realize that it’s still blockchain based technology. But the Chinese blockchain is very different from foreign blockchain. It’s all, from a foreign perspective, it’s public chain. Everybody can have access to it. But in China it’s not, it’s permissible blockchain meaning folks have to apply, be vetted, you get a permission to join. In other words, at the entrance level, at the gate, you already know who is who.

In other words, the blockchain, the anonymous aspect of blockchain in China, doesn’t exist. In other words, anything happening in China, despite that it could just be a number, you think about it as a bank number.

Now in the blockchain systems in the US, the system that we are familiar with, a number is a number. You don’t necessarily know who is who. But in China the number is associated with identifiable entity or person or things like that.

Now, a Chinese stablecoin is also very likely to have a lot of features strengthening financial transaction monitoring, and the technology is already there. But through their practice of the e-renminbi or the digital renminbi, the idea that the core feature of that is they are willing to offer a Chinese Hong Kong dollar or offshore renminbi stablecoin, but the very distinctive part of that is highly monitored. And the government could also potentially put in criteria for specific usage. This Hong Kong dollar stablecoin could potentially only be used for e-commerce in this domain or that domain.

Now, I think there are good or bad aspects of it. It’s not all bad. You know, when we think about monitoring financial transactions, especially in this particular case, if all transactions move to a government monitored or government censored blockchain system, that literally means that the government can stop financial transactions anytime it’s convenient for them.

But then, on the other hand, I think the good aspect of that could be that you can program in the special usage of this stablecoin, you can also program in the expiration date. This basically means it makes financial physical stimulus, in particular, much more easier. You can program it such that the money is going to be expired within a month or so. And you can use this money to buy EVs or you can use it to buy this and that for consumption purposes.

So, I think there is some upshot to it. But I’m not exactly sure my optimism is necessarily shared by policymakers. Fundamentally, through my conversation with monetary authority in the mainland, they are still deeply, deeply skeptical of stablecoins or cryptocurrency in general.

[00:52:31] Kevin

So, just to be clear about that, you’re saying they’re deeply skeptical about the renminbi stablecoins, but they accept that the dollar stablecoins are here and that they’re going to be a threat.

[00:52:47] Zoe

Their position has always been skeptical about a cryptocurrency, period. But they like the technology. So, this is why since December 2013 up to 2020, they systematically basically banned all cryptocurrency related financial activities. But they did not ban cryptocurrency ownership.

You can still own it as virtual asset, but in terms of domestic transactions or foreign entities transaction in China, these are all ban as financial activity. Then they like the technology. Even President Xi Jinping, himself, talked about prioritizing the development of blockchain technology.

They want to harness the technology and are hoping that, by allowing or determining who gets to participate in this system, it can help modernizing the financial, the digital economy. Because digital economy is part of China’s priority. They want everything to go digital. And it can ultimately be facilitating the strengthening of the party’s control in the financial system because you already have the digital ID card – you already have everybody’s official recognition and everything.

Now, they can basically connect your digital ID with facial recognition and with your banking activity almost instantaneously. From a strengthening control perspective, that’s pretty good. But they are afraid of anonymous freely moving cryptocurrencies or stablecoins. And more importantly, China doesn’t issue dollars. Hence, dollar backed stablecoin, freely moving international system, is going to be a threat to the party both domestically and internationally.

[00:54:37] Kevin

So, they’re trying to promote the use of the renminbi internationally, but if you’re a holder of a Hong Kong based, Hong Kong issued renminbi backed stablecoin, that has all these programmable features, that doesn’t seem very attractive to me because it feels like you could lose access to it at any point. The CCP could just say okay, well we’re changing the programming terms on this and all-of-a-sudden it’s gone. I mean the whole point… And so, I could be wrong about that, but to me, and I’m not sure I believe this as much anymore now with Trump, but prior to Trump the attractiveness of the dollar as a reserve currency was basically, well, you’ve got it and you can do what you want with it. It’s the ultimate freedom. And now I’m not so sure that’s the case anymore. But it clearly doesn’t seem to be the case with these renminbi backed stablecoins, if I’m understanding you correctly.

So, I guess my question is two parts. One, am I understanding it correctly? And two, wouldn’t that kind of reduce the attractiveness of that as something a non-Chinese person would want to hold?

[00:55:59] Zoe

I think your understanding is accurate. But so far Hong Kong’s experiment with this stablecoin bill is fairly new. So, we don’t exactly… I haven’t seen concrete measures, in terms of how they are going to address what the actual Hong Kong dollar backed currency is going to look like, to what extent they are going to allow or to what degree they are going to allow anonymous.

So, if it were similar to the United States then it literally means they would allow access to public blockchain. And so far, we don’t see any political appetite for that from the mainland government. They don’t like this anonymous feature.

Then, in terms of the programmable feature and how attractive it is, I think it really depends upon who you ask. For a lot of people, especially for folks who do a lot of transactions with mainland, and they are there to stay, or for that matter, take Hong Kong as an example. Hong Kong as an international financial center, it has transformed tremendously and is more oriented to serving as a bridge for China to the rest of the world. It is now more that China views Hong Kong as a bridge for foreigners to come into China as well as for China to experiment with policies in the global system in a controlled environment. And China is still a very, very big market. A lot of major international financial institutions, they won’t want to lose access to China. So, this is where I feel like the attractiveness of a monitored stablecoin potentially, for some people, is still there.

It’s just that as long as folks are doing legitimate transactions, as long as folks are not using… The biggest critique of this cryptocurrency including, I guess, stablecoins, is that they facilitate a lot of illicit financial transactions. So, putting that aside, China is not going to get rid of capital controls, period.

So, if an offshore renminbi maybe, or CNH, if an offshore backed renminbi stablecoin means it provides a higher liquidity, and stablecoins can transact with each other at a lower cost, faster, then probably, for portfolio diversification purposes, or for mitigating currency risk purposes, you might as well want to hold some of CNH based stablecoin or Hong Kong dollar backed stablecoin. But of course, you would have to accept the premise that China is not going to get rid of capital control. However, offshore renminbi backed Stablecoin or Hong Kong backed stablecoin would allow a higher degree of freedom to make transactions with the international markets or, for that matter, converted to other currencies.

And, so far, there is a limit to how much dollars an individual can transfer overseas per transaction. I think it’s $5,000 per person, per transaction, and there is also an upper cap limit in terms of how many over a year – how much over a year. But there is no such limit in the stablecoin world yet. So, I guess this is also the challenge that Chinese regulators need to deal with.

You can imagine a scenario, if they do not do this carefully then you would end up having a scenario where a lot of mainlanders are going to go to Hong Kong and convert renminbi into Hong Kong dollar backed stablecoin and once you do that it becomes a very easy way to move capital overseas.

So, this is why I think fundamentally the Chinese monetary authorities are deeply skeptical and they are moving very slowly about renminbi backed stablecoin. And in some conversations that I had, folks explained to me that China is not going to implement Renminbi stablecoins anytime soon. But they are closely monitoring the progress and closely monitoring the field. If they come to the determination that they are confident to control and monitor the flow of money in the stablecoin world, China can catch up and catch-up very quickly. That’s what was explained to me. So, they are happy to play the catch-up game but they are not willing to experiment or go run with it anytime soon.

[01:01:23] Kevin

Well, listen, I think we’ll leave it there. I really appreciate you taking the time to explain and your level of expertise is really quite impressive and this is an area that’s, yeah, this is only just getting started. So, thanks so much for joining the show again.

[01:01:42] Zoe

Kevin, thank you so much for inviting me. I enjoyed our conversation.

[01:01:49] Kevin

Okay, well just to remind you, Zoe’s book is called Sovereign Funds: How the Communist Party of China Finances Its Global Ambitions. And her most recent piece, which you can read at the Council on Foreign Relations website, is called Why China is Spooked by Dollar Stablecoins and How It Will Respond. So, please make sure to go and get a copy of her book, and her latest piece, and follow her work. Because I think, as you can tell from our conversation, that a lot of these issues are not being discussed enough on mainstream media. So, for all of us here at Top Traders Unplugged, thanks for listening and we’ll see you soon.

[01:02:31] Ending

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