Can China win the financial cold war?

Chips, Chats, and Swift. They refer to the machinery of international finance that gives America extraordinary leverage. Like so much else, they're also weapons in the coming cold war between China and the US The People's Republic resents Washington's dominance over global payments and wants its own alternative.

Some of these acronyms have surfaced in a court case in Vancouver,^[1] where Huawei Technologies Co.'s finance chief is battling extradition to the US on bank fraud charges brought by the Department of Justice. Meng Wanzhou's case is instructive. The Huawei founder's daughter is accused of deceiving banks, including HSBC Holdings Plc, into clearing millions of dollars in violation of US sanctions against Iran.

There's plenty of finger-pointing, though the one crucial dispute that keeps coming up involves $100 million in transactions between 2010 and 2014 that HSBC processed for Skycom, a Hong Kong company that sold equipment in Iran. Huawei calls Skycom a  "business partner" and the Justice Department says it was an unofficial subsidiary. Doing business with Iran in itself doesn't violate sanctions laws, as long as such activity doesn't involve US entities, persons or equipment. But HSBC routed the money through the Clearing House Interbank Payments System, or Chips, meaning the money was technically on American soil. 

Chips handles 95% of all dollar transactions, or $1.6 trillion a day. After moving through an elaborate correspondent banking network, most international transfers gravitate to this New York private club, whose 43 members settle the payments using a pre-funded account at the Federal Reserve. They all maintain US offices, and are subject to US law. Huawei argues that that since HSBC knew of its Skycom links, the bank should have cleared the funds through the Clearing House Automated Transfer System, or Chats, an offshore dollar clearing system in Hong Kong.

The reality, though, is more complex. When money crosses borders, it's accompanied by instructions transmitted by the Brussels-based Society for Worldwide Interbank Financial Telecommunication, or Swift. Since the Sept. 11 attacks, the US has pressed the European Union hard to let it use Swift as a "financial data panopticon" and choke point, according to political scientists Henry Farrell and Abraham L. Newman. Hong Kong's US dollar Chats has run on Swift messaging since 2009. Had HSBC settled Huawei's payment offshore, the US could still have known — and found a way to punish it.

Beijing doesn't want to do business this way. It's upset by the weaponization of global finance to meet American foreign policy objectives. US interference in dealings with Iran or North Korea is bad enough. Now, the Trump administration has vowed sanctions against mainland and Hong Kong officials for eroding the city's autonomy, and to punish banks that deal with them. This potentially threatens more of China's elite, and comes at a time of a broader downward spiral in relations.

An alternative to the US-dominated web is sketched out in a recent report by Bank of China Ltd.'s investment banking unit, written by a former foreign-exchange regulator: Use Cips, China's fledgling Cross-Border Interbank Payment System, which settles international claims in yuan and can potentially use its own messaging protocol. Guan Tao, BOC International's chief economist, also suggests suspending the use of the dollar for foreign exchange controls and for Beijing to copy the European Union's Blocking Statute to maintain trade relations with US-sanctioned nations. "A good punch to the enemy will save yourself from hundreds of punches,"  according to a Reuters translation of the report.

For a knockout, China will need three separations: from Swift, from Chips, and from the dollar itself. The last will be especially hard. Such is China Inc.'s hunger for the US currency that its banking system has $1 trillion in observed dollar liabilities, a risky dependence for a country that doesn't enjoy a swap line with the Fed. It could get worse. Some advisers of US Secretary of State Mike Pompeo have discussed cutting Hong Kong banks' access to the greenback: a nuclear strike against the city's 37-year-old dollar peg.

The dollar's exorbitant privilege isn't unshakable. A coalition of US foreign policy targets — North Korea, Russia, Iran, Venezuela, and now China and Hong Kong — may be a nonstarter. But what if the US over-reaches and its own allies revolt? The Europeans bristled after President Donald Trump reimposed sanctions on Iran. They could seek to replace correspondent banking — and Swift messaging — with a digital euro based on cryptography. China can internationalize its digital yuan.

For banks caught in the middle, this is a danger zone. HSBC has been in China's doghouse since Meng's arrest in December 2018. An opinion piece in the Communist Party's People's Daily newspaper last month said the bank was a US accomplice and had fabricated evidence against Huawei. HSBC has denied colluding with the US or "framing" the company. It said in its July 25 statement that the "objective facts" it gave the Justice Department were in response to the latter's requests. (HSBC is not a party to the case.)

The British lender gets more than a third of its revenue from Hong Kong, and endorsed the controversial national security law that China recently imposed on the territory. Yet the bank can't afford to upset Washington. In 2017, HSBC ended a five-year deferred prosecution agreement after paying the Justice Department a then-record $1.9 billion fine for helping Mexican drug cartels launder money.

Beijing is embroiled in a trade spat with Washington and a technology tussle with the wider West  — also involving Huawei. However, the battle for money will be the most crucial. Syracuse University professor Daniel McDowell argues that the more the US wields its unmatched financial power, the less it may have left.  That's just what might give China an opening in this cold war.

1. The case is being heard in the Supreme Court of British Columbia under case file 27761.

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

Nisha Gopalan is a Bloomberg Opinion columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Disclaimer: This article first appeared on Bloomberg.com, and is published by special syndication arrangement.