By Eric Vandenbroeck and co-workers

In future crises or conflicts in U.S.-Chinese relations, the economic dimension will be critical. Yet Beijing currently has good reason to doubt the credibility of Washington’s sanctions threats. This is because the United States’s response has been muted in the face of recent Chinese provocations, including Beijing’s efforts to erode democracy in Hong Kong, the dispatching of a spy balloon over the United States, and Chinese aggression in the South China Sea.

Sanctions are a crucial part of the U.S. foreign policy toolkit, and they encompass a broad range of economic restrictions, including financial sanctions, export controls, and trade restrictions. They are intended to coerce entities or individuals into a course of action. The United States has many powerful sanctions at its disposal—including those that could eject major Chinese firms from the global financial system, and weaponize the central role of the U.S. dollar in it. But Washington has preferred instead to respond to provocations by imposing controls on a handful of Chinese firms or personal sanctions on Chinese officials. Rather than using more powerful sanctions, the United States has opted for a more limited approach of imposing sanctions related to technology and levying tariffs and trade restrictions to counter China’s economic practices.

This measured response is defensible, as more extreme measures could be seen as an act of economic war and would escalate tensions with China. Yet Washington’s restraint may also be dangerous, encouraging China to assume that it would not face harsh sanctions even if conflict broke out over Taiwan, the South China Sea, or other potential flashpoints. This question is becoming more pressing as the United States grows increasingly concerned about China’s support of Russia’s defense industrial base. That support was at the top of U.S. Secretary of State Antony Blinken’s agenda during his recent visit to Beijing, which was quickly followed by a fresh raft of sanctions on Russia’s defense suppliers, including a handful of entities in China. Washington must decide whether to ramp up the use of its most powerful sanctions on Beijing now, as part of the broader effort to support Ukraine or to preserve its leverage to deter or respond to a confrontation between the United States and China later.

The United States and its partners must urgently devise a clearer sanctions strategy that maximizes the modest economic leverage that they have over Beijing. This strategy should center on keeping China in the global financial system, to maintain a key U.S. advantage. At the same time, however, the United States must work to build the credibility of its threat to impose swift and severe sanctions on China if Beijing crosses certain redlines. It can do this by transforming its economic statecraft policy—that being its use of economic leverage to pursue geopolitical aims—through a strategic process that is integrated with military planning and carried out in cooperation with key international partners. War planning must be embedded within the economic agencies, critical supply chains delinked from China, and this strategy must also clearly convey Washington’s willingness to impose serious sanctions, when warranted. The United States must also work to strengthen its economic resiliency, as well as that of its partner countries around the globe, to withstand the economic shocks that would follow from a military conflict with Beijing.

 

Lashed Together

Research from the Center for a New American Security paints a disturbing picture of how modest U.S. economic leverage is when mapped across the full range of strategic economic activities that would support China’s ability to sustain a military campaign. These resources include access to military and dual-use technology, as well as to strategic globally traded commodities such as energy, and the overall health of the Chinese economy. Most U.S. sanctions would not be imposed unless there were an active conflict. But at that point sanctions could neither deter nor impair Chinese capabilities. To deter, they must be signaled clearly in advance, at a time when Chinese decision-making can still be influenced. But the reality is that political resolve to impose sanctions is unlikely to emerge until a crisis is well underway, which limits their strength as a deterrent.

The United States has already imposed a high level of restrictions on China related to military goods. Washington has sought for decades to limit the strength of the People’s Liberation Army (PLA), and successive U.S. administrations have used export controls to try to degrade Chinese military capabilities, including through a long-standing arms embargo and controls on dual-use items, including satellites, aerospace technologies, and microelectronics. And yet China’s military modernization has continued apace. According to the Department of Defense’s annual report on China’s military in 2023, Beijing is increasingly capable of projecting its power globally and countering U.S. interventions in a conflict along China’s periphery.

Having already denied the export of goods with direct military application, the United States now faces the difficult task of slowing the growth of China’s commercial technology ecosystems in areas that might have military use, regardless of whether the technologies are designed specifically for military purposes. The Biden administration’s export controls on advanced chips, AI, and supercomputing were imposed to freeze China’s indigenous development of these technologies, on the assumption that any advances would eventually benefit the PLA. Washington’s expansive export control policy, which China has denounced as containment by another name, complicates U.S. efforts to align with international partners, many of whom support “de-risking” from China but hesitate at the more provocative approach of freezing China’s technological development. Moreover, these efforts cannot swiftly degrade China’s military capacity, meaning that their value lies not in their ability to deter China in the near term but in their ability to reduce Chinese capabilities to such an extent that Beijing’s long-term decision-making will have to change.

U.S. export control policy is currently focused on denying China access to chokepoint technologies, which are those critical technologies of which the United States, along with its close allies, are the dominant global producers. This bid to deny Chinese access was seen most clearly when Washington imposed strict export controls and proposed investment restrictions to end Beijing’s access to the software and machinery needed to make advanced chips. Focusing solely on chokepoint technologies, however, is too narrow a perspective, as it does not eliminate Chinese leverage to exert its own coercive economic pressure on the United States at other points in the supply chain. Even in the semiconductor sector, for example, controls could theoretically be tightened to ban all exports of chip-making machinery to China. But U.S. leverage is counterbalanced by China’s ability to impose costs on the United States at other points, including back-end packaging and final electronics assembly, not to mention China’s growing share of legacy chip manufacturing. This pattern is replicated across sectors whose goods pass through the United States and China.

Nor will it be easy for Washington to deny China access to key commodities, including energy, which can be easily acquired from a diverse range of suppliers. This is particularly true of a product like oil, which is available from producers in many countries that will not align with U.S. sanctions—Russia and the Gulf states, in particular. More aggressive measures, such as secondary sanctions that threaten third-party countries that sell energy to China, could be considered. They are, however, unlikely to fully halt supply, and secondary sanctions have a bad track record of worsening relationships with international partners and being difficult to enforce. If the United States wants to fully halt energy supplies to China, economic tools alone will be insufficient.

Walking past U.S. and Chinese flags in Beijing, April 2024

 

The Almighty Dollar

The United States does, however, enjoy a clear advantage in the financial sector. The dollar has a privileged position in the global financial system, as most international transactions are denominated in the currency. Those international transactions that are not nonetheless rely on U.S. financial institutions. This is a problem for China, which holds 56 percent of its foreign exchange reserves in U.S. dollar assets. Beijing’s ability to neutralize this vulnerability is constrained by the basic structure of the global financial system and by China’s own capital control policies, which limit the utility of the renminbi for cross-border transactions. U.S. sanctions that weaponize the essential role of the U.S. dollar would undoubtedly cause significant harm to China’s economy.

But there are important caveats to this U.S. advantage in the financial sector. A credible threat of severe sanctions on major Chinese banks, which are the largest in the world, is the most powerful economic tool that the United States can use to deter China from invading Taiwan. Actually imposing these sanctions, however, could trigger global financial instability and spark turmoil in U.S. dollar markets. European cooperation would be essential, for the euro’s easy convertibility and the maturity of European financial markets would allow the currency to replace the U.S. dollar in many international transactions. This could potentially enable international transactions outside the scope of U.S. sanctions.

Cutting off Chinese banks would also mean that they could no longer facilitate the international transactions that enable China’s exports, leading to negative repercussions across global supply chains. China is so broadly and deeply integrated into the world’s economy that if U.S. policymakers were to impose heavy restrictions on the country the shocks would be felt around the globe. Such heavy financial sector sanctions would almost certainly provoke strong resistance from other major economies, as well as the global South, which would be hit particularly hard by spillover effects.

 

Time And Chance

Sanctions alone cannot deter Chinese aggression. Instead, they should be used as an important component of a broader strategy of integrated deterrence that deploys all instruments of national power to influence Chinese thinking about the costs of its aggressive foreign policy, including any potential actions against Taiwan. An effective U.S. sanctions strategy should play to U.S. strengths in the financial sector while reserving the most severe measures for acute crises or conflicts. The United States may not be able to escalate to a full sanctions attack on China’s financial sector, including full blocking sanctions on the major Chinese banks and the People’s Bank of China, given the high risk of unintended consequences. If and when financial sector sanctions are used, they will necessarily be deployed on a smaller scale, heightening the importance of timing to ensure they have the most disruptive effect. Maximizing impact requires resisting prematurely frittering away U.S. leverage by using financial sector sanctions to manage tensions with China that do not rise to a crisis or conflict threshold. Beijing’s economic interests are a powerful incentive for it to remain integrated in the U.S.-dollar-dominated global financial systems. Rather than pushing China out through increased use of financial sanctions, keeping the country enmeshed in the global financial system preserves an unmatched point of U.S. leverage.

Strategic restraint on financial sector sanctions must be balanced with the need to build credibility for the threat of their imposition. For example, the United States may be approaching the point where it needs to impose sanctions on Chinese banks facilitating the continued flow of microelectronics to Russia, thereby powering its war machine. Months of U.S. diplomatic efforts and more limited technology sanctions have failed to dissuade Chinese companies from shipping these critical goods to Russia. A U.S. response that does not use powerful sanctions, after repeatedly calling out problematic Chinese actions, risks being read by Beijing as indicative of Washington’s reluctance to robustly target Chinese financial institutions. Separately, the United States should also consider the role of financial sector sanctions in responding to China’s nonmilitary coercion of Taiwan. The United States must strike a delicate balance: using these tools enough that they are taken seriously without using them so much that they make China flee dollar-based systems.

The most credible sanctions threat will be one that is supported by U.S. allies and partners. In nearly every strategic sector, U.S. leverage will be strongest when coordinated with other advanced industrialized nations. A broad sanctions coalition reduces, though it does not eliminate, China’s evasion options. But constructing a coalition will be no easy task. Although the United States may be able to count on Five Eyes partners and the G-7, cooperation from the global South is a much more doubtful prospect. The United States should seek to secure these countries’ support by offering them positive inducements to remain neutral, and engage with them in good faith to mitigate the damage that sanctions would inevitably cause to their economies.

 

Guarding The Home Front

Conflict with China would impose staggering economic costs on the United States before even a single sanction is imposed. Economic resilience is, therefore, essential and requires delinking critical supply chains from China, a process that is well underway. In the event of war with Beijing, Washington must be prepared to establish emergency economic support measures and stimuli to soften the blow to U.S. workers, farmers, consumers, and firms. As part of this, deeper economic integration with close partners, including through a reformed trade policy that firmly centers security and resiliency interests, must be on the table. Continued U.S. prosperity, whether in wartime or through a prolonged process of delinking from China, will require securing enhanced market opportunities elsewhere in order to compensate for the loss of the Chinese market.

The U.S. government must also transform its bureaucracy to prepare for what would be the most complex sanctions program in the modern era. Although war planning is a well-established practice within the U.S. defense community, it is pursued on an ad hoc and reactive basis in the economic agencies. Washington must, therefore, institutionalize a strategic planning process for economic statecraft, as well as planning for a range of potential crisis or conflict scenarios with China. Such planning would mature economic statecraft strategy, enable greater integration of economic tools with military options, and facilitate deeper conversations with international partners.

War with China would be an economic catastrophe. Sanctions can help avoid it, but only if the United States plays its modest hand well. A better sanctions strategy is essential to this effort, and so, too, is ratcheting up pressure on Russia. If the United States and its partners cannot effectively isolate Russia from the global economy, then there is little hope that they would fare better against the far greater challenge of China. Both Beijing and Washington are learning important lessons from the ongoing battle over Ukraine, and the United States must make sure that China is impressed by U.S. credibility and resolve. If Beijing is not, then the U.S. sanctions threat, modest though it may be, will be removed as a meaningful deterrent from U.S.-Chinese conflict scenarios. That would make the current situation even more dangerous.

 

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