The Weaponization of Global Financial Public Goods

The US-led Western countries have imposed financial sanctions against Russia after the Russia-Ukraine crisis broke out in 2022.Since last year, the “weaponization of global public goods” suddenly appeared regularly in academic studies and media reports worldwide.The financial sanctions led by the US had a long history before the Ukraine crisis.For example, the United States has imposed various sanctions against Iraq, the Democratic People’s Republic of Korea (DPRK),Iran and Russia for some time.Scant academic studies and media reports discussed the weaponization of global public goods before, and the reasons were that the scale of earlier financial sanctions was limited, and the influence of the sanctioned countries was also limited.Those sanctions did not directly threaten global public goods, so researchers have not lifted these issues to the level of weaponization of global public goods.

However, the situation has changed significantly after the Ukraine crisis.Western countries have used global public goods to exert financial sanctions on an unprecedented scale against Russia, the world’s secondlargest military power.They also threatened to adopt secondary financial sanctions against China, the world’s second-largest economy.The moves push the weaponization of global public goods to the extreme and promise to significantly affect the world.The issue attracts widespread attention from domestic and international academic circles in this context.1References to the weaponization of global public goods emerged after the Western financial sanctions imposed on Russia in 2022.See Wu Xinbo, “China Will Play a Constructive Role in Reshaping International System,” Wen Wei Po, May 28, 2022; Lu Gang, “The Kindleberger Trap Facing China and the United States,”https://column.cankaoxiaoxi.com/2022/0414/2475904.shtml; Huang Yiping, “Sanctions against Russia Lead to the End of Globalization?” https://mp.weixin.qq.com/s/70Kgl_-K_X40pP2l9210gQ; Martin Wolf,“A New World of Currency Disorder Looms,” https://www.ft.com/content/118e1835-02a0-441-8751-7 de7facbas4e.

Under the Russia-Ukraine crisis, the weaponization of global public goods means that the West uses public financial goods to impose financial sanctions on Russia.Sanctions include freezing or confiscating the financial assets of Russian individuals and companies invested in Western countries,freezing Russian banks’ foreign exchange and gold reserves, restricting some Russian banks from using the Society for Worldwide Interbank Financial Telecommunications (SWIFT) secured messaging system, etc.2Reports on the ban of seven Russian banks from using the SWIFT system, see “SWIFT: to Disconnect from 7 Russian Banks on the 12th,” http://www.chinanews.com.cn/gj/2022/03-03/9690658.shtml.The sanctions over facilities and instruments include international financial markets, capital markets, currencies, and settlement systems.They share two features in common: firstly, they are both global financial public goods; secondly, they are mainly controlled by Western countries from design to operation.Thus,the essence of Western financial sanctions against Russia is the weaponization of global financial public goods.3Cissy Zhou, “China Scrambles for Cover from West Financial Weapons,” NIKKEI Asia, April 13, 2022.At the same time, as a new strategic move,there is no uniform agreement among academics and the media on the description.Common references include “weaponization of the US dollar”and “financial weaponization.”4Yu Yongding, “Reflections on the Weaponization of Finance,” China Economic Weekly, May 11, 2022,pp.98-101; Shi Donghui, “Weaponization of the US Dollar will Shake up Its Dominance,” https://www.thepaper.cn/newsDetail_forward-17223485.

Western countries use global public goods as a weapon to impose financial sanctions on other countries, leading to the weaponization of global financial public goods.It has a close link with globalization.During the Cold War, the West and the socialist camp were geopolitical rivals in two isolated economic systems.Since non-Western countries had not developed a high level of dependence on Western public goods, Western countries were not in a position to implement the weaponization of global financial public goods.They can only impose financial sanctions on hostile countries by prohibiting these countries from using their financial resources.

However, globalization has changed the whole situation.One of the important changes that globalization has brought to the world economy is that countries have become highly dependent on the financial public goods provided by Western countries while integrating them into their financial system.The integration has provided the condition for Western countries to use global financial public goods to impose sanctions.Since the beginning of the 21st century, the US government has frequently used global financial public goods as a weapon and imposed sanctions against its adversaries.

The Mechanism Behind the Formation of Global Financial Public Goods

One of the necessary conditions for forming the weaponized financial public goods is the assumption of the supply of global financial public goods by sovereign states.In this case, sovereign states can use their privileged position to impose financial sanctions on other countries.Thus Western countries enjoy the prerogative to weaponize global financial public goods.

For sovereign states, governments are usually the provider and operators of public goods, but the international community does not have the equivalent of a governing administration like the sovereign government.Therefore, only a portion of sovereign states can take up the supply of global public goods.Kindleberger’s hegemonic stability theory is one influential theory on who should provide global public goods.He argues hegemonic states usually provide global public goods, and whether hegemonic states can provide enough global public goods is a matter of economic stability.5Charles P.Kindleberger, The World Economic Depression 1929-1939, Song Chengxian, trans., Shanghai Translation Publishing House, 1986.As the Kindleberger Trap emphasizes, the incumbent countries cannot meet the demand for global public goods in the process of hegemonic transfer, and the rising countries do not yet have the capacity and willingness to provide global public goods.The resulting lack of global public goods will trigger economic depressions and wars.

Although the hegemonic stability theory emphasizes the need for the hegemonic state to provide global public goods, it does not pay sufficient attention to the problems that may arise from the system.After the end of World War II, the United States became the main provider of global public goods, and the US dollar became the dominant international currency.But when the national interests of the United States run against the global public interest, the US government naturally puts itself first, which is inevitably detrimental to the global public interest.After the subprime mortgage crisis of 2007, the Federal Reserve adopted the quantitative easing policy to stimulate domestic demand and guide the US dollar to lower This led to a depreciation of the US dollar and put the foreign exchange reserves held by countries around the world losing in value.This phenomenon reflects the inherent contradiction of having sovereign states provide global public goods.As the provider of an international public good, the United States must keep the dollar’s value stable.However, as a sovereign currency, the US can change the dollar’s value to suit its domestic agenda.6Hua Min, “The Internationalization of the US Dollar and the Challenges,” https://www.thepaper.cn/newsDetail_forward_17937486.

In light of the subprime crisis and its serious consequences, the UN Commission of Experts on Reforms of the International Monetary and Financial System and Zhou Xiaochuan, then governor of the People’s Bank of China, successively proposed reforms to replace the US dollar with a supra-sovereign reserve currency.7The United Nations, “Report of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System.”; Zhou Xiaochuan, “Reflections on Reforming the International Monetary System,” http://www.pbc.gov.cn/hanglingdao/128697/128719/128772/2847833/index.html.This proposal aroused widespread concern in the international community once it was put forward.Many heads of government and renowned scholars participated in the discussion.In this context, then-French President Nicolas Sarkozy proposed including the Special Drawing Rights (SDR) currency basket for the Chinese Yuan to promote the diversification of the international monetary system.8Li Zengxin, “Sarkozy Wants to Set a Timetable for Expanding the SDR Currency Basket,” https://international.caixin.com/2011-03-31/100243670.html.The discussion on the reform of the international monetary system hastened the International Monetary Fund (IMF)’s inclusion of the RMB in the SDR currency basket.On December 1, 2015, the IMF officially announced that the RMB would be added to the SDR currency basket on October 1,2016.The RMB then became the fifth international currency joining the SDR basket, in addition to the USD, EUR, GBP and JPY.In the long run,the rise of the RMB as an international currency will profoundly affect the diversification of the international monetary system.9The People’s Bank of China, “The Road to SDR Accession of RMB,” China Financial Publishing House, http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/3145762/index.html.

The US subprime crisis triggered the discussion on the SDR currency basket of supra-sovereign financial public goods, and the international community has also optimized the structure of global financial public goods through institutional reforms.However, the main problems of global financial public goods remain unsolved.After the outbreak of the Ukraine crisis in 2022, the United States used its privilege to impose financial sanctions on Russia, and the move raised questions about the rationale of the current system of global financial public goods.Some scholars and policy researchers believe that the weaponization of global financial public goods manifests the US blatantly putting its interests over global interests, reflecting the conflict between sovereign national and global public interests.The conflict has some new features:

The first is the changing patterns.In the past, the US took advantage of being the global financial public goods provider to prioritize its national interest if conflict affected the country.This time the US has used global financial public goods as a weapon to sanction other countries, and the move blatantly displays a new pattern of abusing global financial public goods.In other words, the weaponization of global financial public goods is a new pattern manifesting the conflict between the interests of sovereign states and the global public interest.

The second is the differences in motivations.The United States used to pursue its economic interests in two ways: one is to use the privilege of providing an international reserve currency to uncontrollably issue the US dollar, causing the devaluation of the dollar and caused the loss of purchasing value to global foreign exchange reserves holders; the other is to adopt economic policies favorable to the US itself and hurting others, particularly during the time that the US economic cycle is not in-sync with that of the world.Unlike its previous motives of simply pursuing economic interests,this time, the United States is also using the financial public goods as a tool to pursue its geopolitical interests and imposing financial sanctions on other countries for its political interests.

The third is the difference in sponsors initiating sanctions.The United States was normally the one that triggered previous conflicts between the interests of sovereign states and the global public interest.In earlier sanction episodes, other Western countries were also victims.However, the US and other Western countries’ current weaponization of global financial public goods against Russia is a collective move.The US plays the leading role, and other Western countries are followers.The weaponization reflects the conflict between the national interests of a group of sovereign states and the global public interest of others.

The second condition for the weaponization of global financial public goods is the high level of global financial integration driven by financial globalization.Financial sanctions can only have a deterrent effect if the sanctioned country is highly integrated into the global financial system.In other words, it can only be an effective weapon if the sanctioned country is highly dependent on global financial public goods.

On the weaponization of global financial public goods, a phenomenon worth considering is why the West start to use global public goods to impose financial sanctions so frequently in the 21st century.Since the end of World War II, the United States has had the privilege of providing global public goods.In the first few decades, its national capability as a provider was at its peak.The United States did not use global financial public goods as a weapon against hostile countries then.But after entering the 21st century,Western countries led by the United States began frequently using global financial public goods to impose financial sanctions on other countries.From the Iraq war to the Iran nuclear dispute, from the Crimean crisis to the Russia-Ukraine crisis, financial sanctions have become the main weapon to fight the opponents of Western countries.

Why has the weaponization of global financial public goods prevailed in the 21st century and not in earlier periods? The answer relates to the connection between the weaponization of global financial public goods and financial globalization.In the 1960s and 1970s, when financial globalization was not in place, financial markets in Western and non-Western countries were fragmented and non-Western countries had limited reliance on global financial public goods.In this context, financial sanctions based on financial public goods by Western countries on non-Western countries would have a little deterrent effect.But the advent of financial globalization has completely changed this situation.Financial globalization has brought new opportunities for the economic development of developing countries.Still, it has also increased their reliance on global financial public goods, providing favorable conditions for the weaponization of global financial public goods.

An important cause of financial globalization is related to capital account liberalization.10For the causes of financial globalization, see Zhou Yu, RMB Exchange Rate Mechanism, Shanghai Academy of Social Sciences Press, 2007, pp.12-17.After the end of World War II, the international community established a free trade system, but it failed to lead to financial globalization.At that time, global capital account controls hindered financial globalization.Given that competitive currency devaluation was a major cause of the outbreak of World War II, the postwar reconstruction of the international monetary system learned this lesson and opted for a fixed exchange rate system in which the world’s currencies were pegged to the US dollar.11On competitive currency devaluation during the two world wars, see Zhang Zhenjiang, From the Pound to the Dollar: The Shift in International Economic Hegemony, People’s Publishing House, 2006.From the perspective of the triadic paradox, global capital controls are necessary to maintain the independence of national monetary policies under a fixed exchange rate system.Therefore, before the collapse of the Bretton Woods system, the International Monetary Fund endorsed national governments to implement controls on capital accounts.Governments must implement capital account controls to maintain the independence of monetary policy.Global capital account controls were once a major obstacle to the development of financial globalization.

After the Bretton Woods system collapsed, the world embraced the floating exchange rate system, and capital account controls were no longer necessary.Countries have started to open their capital projects, laying the institutional foundation for financial globalization.The competition for twoway capital account opening in developing and developed countries emerged during this period.On the one hand, the governments of developing countries have launched the competition of opening capital projects to attract more foreign investment.On the other hand, developed countries also launched a competition to accelerate the opening of capital accounts to tap the advantage of low labor costs in developing countries.12On the two-way capital account liberalization, see Zhou Yu, “The Three Stages of China’s Financial Opening: From Partial Opening to Full Opening,” World Economy Studies, No.2, 2021, pp.90-101.The two-way capital account liberalization has brought about two major changes.First,given that Western countries can provide a mature international financial market, developing countries have started to use this market for investment and financing business, promoting global financial integration.Second, the two-way capital projects have left the door open for multinational companies to shift their production bases to developing countries with low labor costs,promoting a high level of integration between Western and developing countries’ industrial chains.

However, the global financial integration enabled by financial globalization has also facilitated Western countries’ use of financial public goods to contain rival countries.Developing countries deposit their foreign exchange receipts from exports in monetary investments in financial institutions and financial markets, making it possible for Western countries to freeze or even confiscate these assets.In addition, developing countries tend to use Western countries’ currencies and payment systems for international settlements, which facilitates Western countries to disrupt a developing industrial chain by cutting off international settlement networks.

Financial globalization is a double-edged sword.It brings economic opportunities to late development comers but simultaneously increases their risk of suffering financial sanctions from Western countries.The same dilemma applies to China.Financial globalization provides China with development opportunities, but the high dependence on global financial public goods also makes it possible for Western countries to impose financial sanctions on China.13Graham Edison and others point out that financial sanctions against China is already under discussion in the United States.See Graham Allison, Nathalie Kiersznowski and Charlotte Fitzek, “The Great Economic Rovalry: China vs the U.S.,” https://www.belfercenter.org/publication/great-economic-rivalry-china-vs-us.

The third condition for the weaponization of global financial public goods is the de-facto monopoly on the supply of such goods.Imagine that if a sovereign state can only partially supply a certain type of global financial public goods, then it is difficult to use it as a weapon to sanction political adversaries.The target country can find alternative providers of similar public goods and render the sanctions futile.In contrast, as Chinese scholar Pei Changhong points out, if a global public good is provided only by the United States, then it has an arbitrary character.14Pei Changhong, “Global Economic Governance, Public Goods and China’s Openness,” Economic Research Journal, No.3, 2013, pp.4-19.

The monopoly of global financial public goods can lead to global market failure.Its weaponization is not based on the rules market but instead a manifestation of global market failure.Contrary to Pei’s assumption, the US dollar is not the only international currency, and the US has no absolute monopoly over international cross-border transactions.The available alternatives limit its ability to impose financial sanctions alone.If the US were to impose financial sanctions on Russia alone, it would force Russia to use the euro for international trade settlements,thus making the sanctions fail to reach their intended purpose.To make sanctions work, the US must find ways to unite with other Western countries for the monopoly on global financial public goods and achieve the objectives of getting the full deterrence impact of weaponizing global public goods.15Zhu Jiejin, “The G8 and Its Provision of Global Public Goods from a Collective Hegemonic Perspective,” The Journal of International Studies, No.1, 2009, pp.118-131.

The international reserve and share in transaction payment currency are two important indicators reflecting the internationalization of currencies.At the end of 2021, the share of the US dollar in both was 58.8 percent and 40.5 percent, respectively.The US has not reached a monopoly on international currencies, and it weakened its ability to impose effective financial sanctions.

The US has restricted some Russian banks from using the US dollar for settlement after the Crimean crisis, forcing Russia to adopt a de-dollarization strategy and significantly increase its euro and yuan assets holding.In mid-2017, the share of the US dollar in Russia’s international reserves reached 46.5 percent, but by the end of 2021, it had fallen to 10.9 percent, lower than the euro and yuan.During the same period, the share of the Chinese yuan in Russia’s international reserves rose from 0.1 percent to 17.1 percent,a blowout; gold rose from 16.1 percent to 21.5 percent; the euro from 25.1 percent to 33.9 percent; and other currencies from 12.4 percent to 16.6 percent.Thus, without a market monopoly of the US dollar, the US financial sanctions against Russia will fail to meet expectations and may make other international currencies squeeze the share of the US dollar in the basket of Russia’s international currency reserves.

It is based on the above “l(fā)essons” that this time, after the outbreak of the Ukraine crisis, the US government urged other Western countries to pick sides and join in its financial sanctions with the rhetoric of political correctness, thereby intensifying its financial sanctions against Russia.In the beginning, the EU countries opposed kicking Russia out of the SWIFT information reporting system and restricting Russia’s international payments in a bid to secure EU energy supplies.But eventually, at the strong request of the US, the UK and some Baltic countries, the EU accepted the decision to impose SWIFT restrictions on some Russian banks.16On Western sanctions against Russia, see Jonathan Guthrie, “SWIFT Delay Highlights Divisions in US-Led Sanctions Alliance,” https://d2b0shd2ijglgd.cloudfront.net/story/001095379/en?archive; Xu Chao and Fan Yu, “Can Russia Withstand Western Sanctions?” http://www.news.cn/2022-03/01/c_1128425865.htm.

By engaging the EU in financial sanctions, the US has entrenched the Western monopoly over international currencies and blocked Russia’s access to the global financial public goods for foreign economic activities.17Valentina Pope, “Financial Weaponization: How the US and the West Are Waging Deterrence against Russia?” http://column.cankaoxiaoxi.com/2022/0408/247515.shtml.Western currencies account for 97.2 percent and 97.3 percent of global foreign exchange reserve and international payment currency, respectively, almost a total monopoly.18The countries issuing international settlement currencies other than the RMB are all involved in this round of sanctions against Russia, so this is an accounting of the share of international settlement currencies other than the RMB.

In light of the eventual EU participation in financial public goods sanctions, Russia has misjudged the position of the EU countries to some extent.Considering the EU’s high dependence on Russia’s energy supply,Russia has always believed that the EU would not accept SWIFT sanctions against it and would not freeze its foreign assets.Russia took preventive measures to reduce its holdings of US dollar assets and increase its holdings of euro assets before the Russia-Ukraine crisis broke out.But the result showed that the principle of political correctness took precedence, and the EU countries joined the US financial sanctions.19Yu Yongding, “Reflections on Financial Weaponization,” China Economic Weekly, May 11,2022, pp.98-101.

The Characteristics and Impacts of Global Financial Public Goods

The weaponization of global financial public goods also needs the motivation and will of Western countries to put it into action.Political rather than economic interests are driving the decisions and actions.On economic interests, the sanctions hurt Western countries more than benefitting them.The business transaction is based on trust, and imposing sanctions hurts one’s reputation, which will backfire and hurt the economy.

The public discourse of US policymakers helps to understand the motives of the US in weaponizing global financial public goods.On June 2, 2014, the Center for Strategic and International Studies and the US Department of the Treasury co-hosted a seminar entitled “The Evolution of Treasury’s National Security Role.” Then-US Treasury Secretary Jacob Lew delivered the keynote address, stating that the weaponization of finance “has opened up a new battlefield for the United States, one that enables us to go after those who wish us harm without putting our troops in harm’s way or using lethal force.”20“Remarks of Secretary Lew at CSIS,” https://home.treasury.gov/new/press-release/jl2414.In a speech in Warsaw at the end of March 2022, US President Joe Biden emphasized that “economic sanctions are a new kind of economic statecraft with the power to inflict damage that rivals military might” and “these international sanctions are sapping Russian strength, its ability to replenish its military, and its ability to project power.”21Valentina Pope, “Financial Weaponization: How the US and the West Are Waging Deterrence against Russia?”

The remarks above revealed the weaponization of global financial public goods has two characteristics.Firstly, it is a new policy tool and a new form of warfare introduced by the United States.It has taken shape over the past two decades and has come to the front after the Ukraine crisis.Secondly, in terms of political positioning, it will become a regular means for the US government to suppress rival and hostile countries as an alternative to military warfare.The shift from military to financial war is not an illconceived expedient measure but a systematic adjustment and represents a new strategic trend.

In the 21st century, Western countries’ use of global financial public goods as an important weapon against geopolitical rivals is related to three factors.

First, compared to military wars, financial wars have lower political costs and are more acceptable to the US public.Therefore, the US government is inclined to use global financial public goods as a conventional weapon against geopolitical opponents.To win voters’ support in elections,the two major political parties in the United States must choose a form of war that the public can accept.Wooing the electorate is the main reason the US government promotes the weaponization of global financial public goods.An opinion piece in the Financial Times noted, “It is an approach to conflict two decades in the making.As voters in the US have tired of military interventions and the so-called ‘endless wars’, financial warfare has partly filled the gap.Without an obvious military or diplomatic alternative option,sanctions—and increasingly financial sanctions—have become the national security policy of choice.”22Valentina Pope, “Financial Weaponization: How the US and the West Are Waging Deterrence against Russia?”

Second, the world’s growing reliance on global financial public goods has increased the West’s initiative to weaponize it.As mentioned earlier, globalization has dramatically increased the effectiveness of such weaponization and provided favorable conditions for Western countries to impose sanctions, enhancing their willingness to weaponize global public goods to suppress their geopolitical rivals.

Third, Western countries attach particular importance to financial sanctions among all kinds of economic sanctions.The preference is that financial sanctions are usually more effective than others.Since countries mostly use Western countries’ public goods for financial transactions,weaponization can affect all economic transactions between countries,including non-Western and sanctioned countries.This pattern increases the deterrence of such weaponization.23Shi Donghui, “Weaponization of the US Dollar Will Shake up Its Dominance,” https://www.thepaper.cn/newsDetail_forward-17223485.Among the financial sanctions imposed on Russia, the SWIFT ban is the most powerful and can be described as a“financial nuclear bomb.” An important feature of the SWIFT sanctions is that, if fully implemented, they would interrupt economic ties between Western countries and Russia but also between all other countries and Russia since almost all international payment settlements use the SWIFT-secured messaging system.Although the RMB cross-border payment system is equipped with a backup information reporting system, it still relies on the SWIFT system for transactions, as other global financial institutions mainly use it.

In addition, Western countries have frozen or confiscated the foreign exchange reserves and foreign assets of sanctioned countries, blocking overseas economic activities not only between Western countries and sanctioned countries but also between all other countries and sanctioned countries.Western currencies account for up to 97 percent of the global foreign currency reserves and international payment currencies.In this case,once the foreign assets of the sanctioned countries are frozen, these countries cannot use the US dollar and euro to pay the goods and debts of other countries.

The above analysis shows the motives of Western countries to weaponize global financial public goods.However, the more disruptive impact the weaponization of global financial public goods caused on sanctioned countries will also generate a stronger backlash against the Western countries.24The word “backlash” is a good illustration of the harm the weaponization of global financial public goods has caused Western countries.See Zhong Sheng, “Weaponization of Economy Must Bring Backlash:US Hegemony in Light of the Ukraine Crisis,” People’s Daily, April 6, 2022.This backlash may restrict Western moves.While imposing sanctions on Russia, the EU faces an energy crisis, and Western countries suffer from rising energy prices and inflation rates.In the long run, the backlash may weaken the incentive of European countries to continue these sanctions and erode the international standing of the US dollar, limiting the willingness of the United States to launch financial sanctions.

Conclusion

The weaponization of global financial public goods has become a major new way for Western countries against their geopolitical opponents.But they cannot always use global financial public goods as a weapon for themselves or their allies as such weaponization will eventually undermine the conditions for the initiating country to impose sanctions and weaken their ability to control the supply of global financial public goods.This weapon will inevitably lose its potency once the targets find alternatives to evade the sanctions and make them ineffective.

Specifically, a necessary condition for Western countries to weaponize global financial public goods is that the sanctioned country is highly dependent on that public good.If more countries reject to use the public goods provided by Western countries for fear of such sanctions, these sanctions will be ineffective, and their weaponization will not work.

Some countries have strategically diversified their foreign exchange reserves and developed alternative international payments under the “dedollarizing” and “de-euro” principles after the financial sanctions imposed on Russia.The essence is to reduce dependence on Western countries’global financial public goods.The faster this process evolves, the sooner the weaponization of global public goods will be bypassed as a policy tool.Moreover, “de-dollarizing” and “de-euro” will force Western countries to end weaponizing the global financial public goods they once dominated.