[US-China Economic War and Korea's Choice Series] ⑤ Financial Interdependence Intensifies Amid US-China Strategic Competition: A Paradox or the Prelude to Weaponization?

I. Introduction

How can we understand the recent intensification of financial interdependence between the United States and China, two nations engaged in a fierce competition for global order hegemony? China, aiming to foster its domestic financial industry and internationalize the renminbi as a new growth engine, passed the "Foreign Investment Law" in 2019 and began its full implementation in 2020, actively seeking large-scale foreign investment. In response, US financial firms have entered into numerous investment agreements and made substantial investments.[2] While the investments by US financial firms in China could be viewed as routine transactions within the framework of global capitalism, it is also noteworthy that the US, since the Obama administration and continuing through the Trump and Biden administrations, has progressively increased economic pressure on China to curb its challenges. The lack of significant action against US financial firms investing in China, which could benefit the Chinese economy, appears unusual. China, too, faces the risk of its economy being dominated by massive US financial capital, which could accumulate immense wealth within China. China's active solicitation of US capital, despite this potential risk, is also not a simple matter.

In reality, the US's economic pressure on China has been escalating. The Obama administration, through the announcement of the National Export Initiative in 2014 and the promotion of the Trans-Pacific Partnership (TPP) excluding China, sought to establish a new US-centered international trade order. In the same year, the US strengthened the authority of the Committee on Foreign Investment in the United States (CFIUS), which reviews direct investments, raising concerns about China's potential to steal US technology and beginning to counter "Made in China 2025." President Trump targeted China more directly. Starting with trade policy agendas aimed at China's intellectual property violations in 2017, the US imposed substantial tariffs on Chinese goods in 2018. In August of the same year, the Foreign Investment Risk Review Modernization Act was enacted to restrict Chinese companies' investments in the US. Furthermore, through the Trade Act and the Trade Facilitation and Trade Enforcement Act, the US designated China as a currency manipulator in 2019, the first time in 15 years since 1994. The Trump administration also regulated Chinese companies' access to the US stock market, restricting US pension funds from purchasing Chinese stocks and strengthening accounting and oversight requirements for Chinese companies listed on US exchanges. It also made it more difficult for Chinese small and medium-sized enterprises to list on Nasdaq by tightening Nasdaq's Initial Public Offering (IPO) regulations (Kim, Chi-wook 2020). The Biden administration, which took office in 2021, has maintained the aforementioned US sanctions against China while further isolating China through the framework of "democratic alliances" with technology regulations in areas such as semiconductors and AI. The CHIPS and Science Act, the Inflation Reduction Act, and the Chip 4 Alliance are representative examples of US technology regulation policies against China. China has also responded to US pressure through various means, including retaliatory tariffs on US goods, and has recently clashed with the US by imposing fines on US semiconductor companies like Micron and implementing mineral regulations.

The intensification of US-China financial interdependence amidst the power struggle could be a typical case of "hostile co-dependency." This explanatory framework centers on leaders of states constructing other nations as security threats for domestic political gain to acquire or maintain power (Lim, Ji-hyun 2005). There are aspects where hostile co-dependency can meaningfully explain US-China financial interdependence. Firstly, the US has experienced extreme domestic political division since the 2000s, with anti-China sentiment becoming almost the sole unifying element, creating a public opinion landscape highly hostile to China. Consequently, it is argued that influential US politicians are competitively positioning themselves at the forefront of anti-China efforts to solidify their standing as national leaders. China, too, has witnessed the unprecedented long-term rule of President Xi Jinping following Deng Xiaoping's reform and opening-up in 1978, and in this process, it is seeking domestic political stability by antagonizing the US.

As if to prove this explanation based on hostile co-dependency, US-China trade has increased for three consecutive years since 2020, reaching a record high of $761.5 billion in 2022. This result belies the loud political rhetoric of US-China power competition and economic decoupling. The high-tech competition between the US and China is also far from decoupling. China's exports of electronic integrated circuits to the US in the first half of 2022 amounted to $1.125 billion, a 14.55% increase year-on-year, indicating a growing US dependence on Chinese electronic integrated circuits. US investors invested $40.02 billion in 251 AI companies in China between 2015 and 2021, accounting for 37% of the total investment raised by Chinese AI companies (Lee, Yong-jae 2023, 4). These figures explain why the discourse on China in US politics is shifting from "decoupling" to "de-risking."[3] In this context, the intensification of US-China financial interdependence may not be an exceptional or peculiar case.

This paper does not exclude the perspective of hostile co-dependency, discussed above, as a hypothesis for US-China financial relations. However, it aims to argue that this interdependence can be weaponized depending on international political dynamics and the bilateral political relationship between the US and China. Scholars in international politics, from Albert Hirschman to Robert Keohane and Joseph Nye, and more recently Henry Farrell and Abraham Newman, have long discussed how asymmetric economic interdependence can be used as a political lever. Based on these theories and the Theory of Financial Statecraft, this paper will examine the deepening of US-China financial interdependence. Specifically, it seeks to explore the strategies and mechanisms through which the US and China can weaponize financial interdependence, using concepts such as the "Influence Effect," "Sensitivity," "Vulnerability," "Panopticon Effect," and "Choke Point Effect" as keywords. The deepening of US-China financial interdependence is still in its early stages, and sufficient empirical data and prior research for a comprehensive explanation are not yet available. Therefore, this paper's analysis is intended to be a preliminary study aiming for persuasiveness.

This paper proceeds as follows. Section 2.1 briefly reviews China's financial liberalization policies, with a particular focus on the Foreign Investment Law. Section 2.2 examines the current status of investments by overseas investors, including those from the US, in China's financial markets following the liberalization of its domestic financial market. Section 3, the core of this paper, explores the potential for the US and China to leverage the growing bilateral financial interdependence as a political lever or to strategically weaponize it. Finally, Section 4 summarizes the implications and suggestions of US-China financial interdependence for South Korea's financial statecraft.

II. China's Financial Liberalization and the Status of US Investment in China

1. History of China's Financial Market Opening and the 2020 Foreign Investment Law

China began opening its domestic financial market to the outside world after the reform and opening-up initiated in 1978. [4] Prior to this, China allowed only a few foreign banks to establish representative offices to conduct business within China. The reform and opening-up signified China's pursuit of economic development through integration with the capitalist world economy, leading to a rapid increase in foreign direct investment into China and the expansion of foreign financial institutions' entry into the Chinese financial market. By the end of 1985, there were 157 representative offices of foreign banks and 17 foreign banks operating in China. During this period, China's financial opening measures were characterized by opening within pilot regions such as Shanghai. It is assessed that the business activities of foreign financial companies and banks in China significantly increased as China entered a period of high growth from 1994 to 1997.

China's systematic improvement of its domestic financial system and a qualitative leap in financial liberalization occurred after its accession to the WTO in 2001. To meet the WTO accession conditions, China revised laws and regulations such as the Commercial Bank Law, Securities Law, and Insurance Law, and began to open up its entire domestic financial market, including banking, securities, and insurance. However, until 2017, regulation was more prominent than opening in China's financial market liberalization. China, particularly after the 2008 global financial crisis, strengthened regulations on foreign financial institutions (e.g., stipulating that foreign banks must maintain a loan-to-deposit ratio of 75%) and postponed the introduction of measures such as allowing short selling and margin trading in the Chinese stock market, which were under discussion. China began to earnestly pursue measures for domestic financial market opening commensurate with financial liberalization from 2017 onwards. Following discussions on expanding the opening of China's financial market at the US-China summit in November 2017, President Xi Jinping confirmed this in his keynote speech at the Boao Forum on April 10, 2018, accelerating financial liberalization. The following day, April 11, Governor Yi Gang of the People's Bank of China announced three principles for financial market reform and opening and an opening roadmap. The three principles are as follows: First, foreign financial institutions entering the Chinese financial market will be treated equally to domestic institutions and a negative list will be applied. Second, financial market opening, exchange rate formation mechanism reform, and capital account convertibility will be pursued simultaneously. Third, along with financial market opening, the pace of financial market opening will be adjusted to match the capacity for financial supervision and management to prevent financial risks. Governor Yi Gang also presented an opening roadmap to be implemented in two phases: the first half and the second half of 2018.

Based on the aforementioned three principles, China introduced specific financial market opening measures in rapid succession in 2019. Premier Li Keqiang, who recently passed away, announced at the World Economic Forum in July 2019 that China would completely abolish the 51% foreign ownership limit in the securities, futures, and insurance sectors by 2020, which had previously been in place. Subsequently, on July 20, 2019, the Office of the Financial Stability and Development Committee of the State Council of China released "Measures for the Expansion of Opening-up in the Financial Sector," outlining 11 new measures for opening up the banking, securities, and insurance markets. These measures allowed foreign investment companies to establish wealth management subsidiaries in China or invest in wealth management companies as controlling shareholders, and also granted them the qualification to issue Class A bonds in the interbank bond market. The conditions for foreign insurance companies to enter the Chinese insurance market were significantly eased, and the foreign capital share limit for life insurance was also to be abolished in 2020. In particular, China comprehensively enhanced the protection of foreign investment profits and the convenience of fundraising in the financial sector as a whole, including securities, banking, and insurance. The Chinese government encouraged foreign financial institutions to participate in the establishment of financial asset management companies and investment in asset management subsidiaries of commercial banks, removed equity restrictions, and allowed foreign capital to independently establish or participate in equity of pension fund management companies and foreign exchange brokerage companies. Furthermore, it shortened the transition period for foreign capital control ratios in securities firms, fund management companies, and futures companies from 2021 to 2020, enabling controlling stakes (51%) in these companies, and implemented financial liberalization easing measures that would completely remove equity restrictions from 2023 onwards (An, Yu-hwa 2020). Additionally, foreign credit rating agencies were allowed to perform credit rating services for all types of bonds issued in China.

Interestingly, during the intense trade dispute between the US and China, high-level talks were held in Washington D.C. on October 10-11, 2019, where China presented its expanded financial market opening measures, which had been underway since 2017, as a major achievement. In other words, the US and China exhibited a situation where the escalation of trade disputes and deepening financial ties coexisted. Following the Washington meeting, the State Council of China successively introduced follow-up measures. On October 15, 2019, the State Council issued the "Regulations on the Administration of Foreign-funded Insurance Companies of the People's Republic of China" and the "Decision of the State Council on Amending the Regulations on the Administration of Foreign-funded Banks of the People's Republic of China." Through these two documents, the State Council established the legal basis for future financial market opening measures and specified the details of the opening. On November 7 of the same year, the State Council released "Opinions on Improving the Utilization of Foreign Capital." This document announced further measures to abolish restrictions on the business scope of foreign-invested enterprises, including banks, securities firms, and fund management companies, confirming the Chinese authorities' commitment to accelerating financial market opening.

Let us examine the "Foreign Investment Law," which can be considered the core of China's financial market liberalization, and the changes in foreign investment management systems resulting from its implementation in more detail. [5] China enacted the "Foreign Investment Law" on March 15, 2019, to newly regulate foreign investment, and this law officially came into effect and began implementation on January 1, 2020. Through the implementation of the "Foreign Investment Law," China pledged to manage foreign investment in a more open, fair, and transparent manner. In this regard, the "Foreign Investment Law" contains two key provisions: First, foreign investment is to be treated equally to domestic investment. Second, items that are prohibited or restricted for foreign investment are managed through a negative list system.

Treating foreign investment equally to domestic investment means granting foreign investors civil rights equivalent to those of domestic investors. Firstly, when foreign companies establish legal entities in China, they are subject to the same procedural standards as domestic companies. Except for sectors on the negative list, foreign companies can now establish legal entities and register with the Administration for Market Regulation, similar to domestic companies. The corporate governance structure also follows the same standards as domestic companies, applying the "Company Law," which allows for the transfer of equity to a third party without the consent of other co-shareholders. The capital contribution system also allows legal entities to operate under the same standards as domestic companies. Foreign companies receive the same examination standards and deadlines for licensing procedures in each sector as domestic companies.

Managing foreign investment through a negative list system signifies the Chinese government's willingness and determination to further expand the opening of China's financial market in the future. This is because the negative list system has fewer restrictions compared to the positive list system. The negative list management of foreign investment is a system that specifically manages prohibited or restricted investment items by listing them, and the scope of management includes foreign direct investment, foreign indirect investment (acquisition of Chinese companies), and reinvestment activities by foreign-invested enterprises within China. The negative list management is evaluated as an internationally accepted system for promoting investment inflows and is currently adopted by over 70 countries. The Chinese government has managed foreign investment by publishing the "Catalogue for Guiding Foreign Investment" since 1995, which includes encouraged, prohibited, and restricted items for foreign investment. China revised the "Catalogue for Guiding Foreign Investment" approximately every three to four years, and after a total of 10 revisions, it was replaced by the aforementioned negative list management measures for foreign investment in 2019. The number of restricted and prohibited items on the negative list has been continuously decreasing: 48 in 2018, 40 in 2019, 33 in 2020, and 31 in 2021 (KOTRA Overseas Market News, 2022/05/26).

In summary, China is significantly liberalizing its financial market, expanding the openness of its domestic capital market to the outside world. Based on the "Foreign Investment Law," passed by the National People's Congress in March 2019 and fully implemented from January 1, 2020, China is promoting national treatment for foreign companies, expanding the scope of permitted business for foreign-invested enterprises, and prohibiting the infringement of intellectual property rights and forced technology transfer for foreign-invested enterprises (Kim, Ye-kyung 2019). Through the "11 New Measures for Opening Up China's Financial Market," the Chinese government has opened up even credit rating services to foreign financial institutions. This demonstrates the Chinese government's active implementation of its strategy to revitalize the domestic financial sector as a new growth engine for the Chinese economy.

2. Status of Investment by Overseas Investors, Including Those from the US, in China's Financial Market

As mentioned above, China began opening its domestic financial market around 2017. This section reviews the status of overseas investors, including those from the US, entering China's financial market in response to China's financial liberalization measures. The review is divided into three key areas of financial investment. First, direct investment by overseas capital in China's financial sector, where direct investment refers to overseas capital operating Chinese financial institutions as controlling shareholders through the establishment of subsidiaries, etc. The second area is the investment by foreign investors in China's domestic stocks and bonds. Finally, the content of overseas capital's entry into China's insurance industry. It can be confirmed that overseas investors have actively utilized the Chinese government's financial liberalization policies in all three areas. However, while overall foreign investment in stocks and bonds has significantly increased, fluctuations in foreign investment are also observed due to changes in China's and external economic conditions.

First, the status of direct investment by overseas capital in China's financial market. UBS Securities became the first foreign-controlled securities holding company in China in November 2018. Subsequently, in April 2019, Morgan Stanley Securities and Nomura Oriental International Securities received approval from the China Securities Regulatory Commission (CSRC) as foreign-controlled shareholders (51%) (Cho, Go-woon 2019, 18). In August 2021, JPMorgan became the first foreign company to establish a wholly-owned (100% stake) securities firm, followed by Goldman Sachs in October 2021, which also received approval to secure a 100% stake in a Chinese securities firm (Lee, Chi-hoon 2022). Overseas investment has also entered the credit rating business. S&P Beijing subsidiary became the first foreign credit rating agency in China to conduct credit rating business in the Chinese bond market in January 2019. Moody's and Fitch followed suit by establishing subsidiaries in Beijing, allowing all three major global credit rating agencies to commence credit rating operations in China. Overseas capital has also begun investing in Chinese futures companies. As of 2019, two foreign joint-venture futures companies, Galaxy Futures and Morgan Stanley Futures, were established in China. Galaxy Futures has a 16.68% stake from Royal Bank of Scotland, and Morgan Stanley Futures has a 49% stake from Morgan Stanley (Cho, Go-woon 2019, 18).

Next, the status of overseas capital investment in Chinese stocks and bonds. The Chinese government had made efforts to attract foreign investment through programs like Stock Connect (launched in November 2014), Shenzhen Connect (launched in December 2016), and Bond Connect (launched in June 2017) even before 2017. [6] Consequently, foreign investors have steadily entered the Chinese stock and bond markets, significantly increasing their investments since 2017. The cumulative investment by foreign investors in Chinese stocks through Stock Connect [7] reached 708.4 billion yuan on November 6, 2019, a 175% increase compared to January 3, 2017. The cumulative investment by foreign investors in Chinese stocks through Shenzhen Connect [8] also showed a significant increase. As of November 6, 2019, it stood at 468.6 billion yuan, approximately 170 times higher than on December 5, 2016, and a 58% increase compared to January 2, 2019, indicating a substantial rise in investment. For bonds, as of September 2019, foreign holdings of Chinese bonds amounted to 2,116.8 billion yuan, a 25% increase year-on-year (Cho, Go-woon 2019, 20).

<Figure 1> Trend of Cumulative Investment Amounts through Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect

Source: Cho, Go-woon 2019

<Figure 2> Trend of Foreign Holdings of Chinese Bonds

Source: Cho, Go-woon 2019, 20

Amidst this trend, foreign investment continued its steep upward trajectory after 2020, as China's financial market liberalization became more visible. In 2020, the proportion of foreign holdings in the total market capitalization of Chinese stocks and bonds reached record highs of 3.6% and 3.8%, respectively (Lee, Chi-hoon 2020, 2). In 2017, foreign holdings accounted for 2.2% of stocks and 2.4% of bonds. Looking at the scale of Chinese bonds held by foreigners in 2020 alone, it increased from 2.2 trillion yuan in January to 3.9 trillion yuan in November (<Kyunghyang Shinmun>, 2020/12/14). In 2021, despite negative factors such as the intensification of the COVID-19 pandemic and regulatory crackdowns by the Chinese government on companies, foreign investors continued to purchase Chinese stocks and bonds. The proportion of foreign holdings in the total market capitalization of Chinese stocks and bonds in 2021 surpassed the 2020 record, reaching 4.7% and 4.1%, respectively (Lee, Chi-hoon 2022; see <Figure 3> below). From 2020 to 2021, approximately 70% of the overseas financial market investment funds flowing into emerging markets were concentrated in China. In January 2023, net inflows of foreign capital into the Chinese stock market reached an all-time monthly high. In January, net inflows of 141.3 billion yuan (approximately 27 trillion KRW) significantly exceeded the previous monthly record of 89 billion yuan (approximately 17 trillion KRW) in December 2021. From January to March 2023, cumulative net inflows of foreign capital into the Chinese stock market reached 186.6 billion yuan (approximately 36 trillion KRW), more than double the net inflow for the entire year 2022, which was 90 billion yuan (approximately 17 trillion KRW) (<Monthly JoongAng>, 2023/4/17).

<Figure 3> Outstanding Foreign Holdings of Chinese Securities (1 Billion Yuan)

Source: Lee, Chi-hoon 2022, 2

In the latter half of 2023, due to the slowdown in the Chinese economy and the brink of default by major real estate companies such as Evergrande and Country Garden, there was a temporary outflow of large amounts of foreign capital from the Chinese stock market. However, most major US financial companies, including JP Morgan, have stated their intention to maintain their strategy of expanding investment in China, anticipating stable medium-to-long-term growth of the Chinese economy (<Seoul Economic Daily>, 2023/9/7). For instance, the consulting firm Oliver Wyman predicted that the size of China's asset management market would grow by 85.2% from $16.2 trillion (approximately 18,054 trillion KRW) in 2019 to $30 trillion (approximately 33,454 trillion KRW) in 2023 (<Chosun Ilbo>, 2021/8/9). Thus, major US financial companies are accelerating their entry into the Chinese financial market, which is currently the second largest in the world after the US and is expected to grow further.

Finally, the status of overseas investment in China's insurance industry. [9] In 2018, following the Chinese government's decision to further open up the insurance market, foreign insurance companies expanded their operations in China. Standard Life established a new insurance company in China. Allianz, AXA, HSBC, Chubb, AIA, and ERGO, which were already operating in the Chinese market, sought to acquire stakes in Chinese insurance companies or joint ventures to expand their Chinese operations. Allianz established its first foreign insurance holding company in 2018 and acquired a 4% stake in China Taiping Insurance Group in 2020. AXA acquired shares in a Chinese joint venture non-life insurance company in 2019 and began operating its own wholly-owned non-life insurance company. HSBC announced plans in 2020 to acquire the entire stake of a Chinese joint venture life insurance company from its Chinese shareholder. Chubb became the largest shareholder (46.2%) by acquiring a 15.3% stake in China Pacific Insurance Group from its Chinese shareholder. AIA converted its Chinese branch into a Chinese legal entity in 2020 and announced plans in 2021 to acquire a 25% stake in China Post Life Insurance Company. ERGO, which operated in the life insurance sector in China, entered the non-life insurance sector in 2021 by acquiring a 25% stake in Taishan Property & Casualty Insurance Company.

General Re Corporation, Swiss Re Group, and Hannover Re, seeing the growth potential of China's primary insurance market due to the opening of the insurance industry by the Chinese government, increased the capital of their Chinese branches. Korean Re and AXA XL, which focus on reinsurance, established Chinese branches and Chinese legal entities, respectively. In summary, foreign insurance companies actively pursued business expansion in China after 2018, resulting in an increase in their market share. The market share of foreign life and non-life insurance companies increased from 8.1% and 1.9% in 2018 to 10.0% and 2.6% in 2020, respectively.

<Table 1> Business Trends of Foreign Insurance Companies in China Since 2018

III. US-China Financial Interdependence and the Dynamics of Weaponization

Ironically, US-China financial relations have strengthened since 2018, when the conflicts between the two countries began to deepen. As mentioned above, China is pursuing financial market liberalization, and leading US financial companies are responding in kind. There are many projections that US-China financial interdependence will further accelerate. Jamie Dimon, Chairman and CEO of JP Morgan, known as the "King of Wall Street," emphasized in a 2021 interview with Fox News that "China is one of the biggest opportunities in the world" (<Chosun Ilbo>, 2021/8/9). Charlie Munger, the late Vice Chairman of Berkshire Hathaway Inc., also commented on the Chinese economy, stating, "It has better prospects for the next 20 years than most other large economic blocs. Firstly, China's leading companies are strong, virtually superior to any others, and their stock prices are cheap" (<Yonhap News>, 2023/11/1). Given that the Chinese government plans to develop its capital market, currently one-third the size of the US capital market, to a scale comparable to that of the US, it is highly probable that US financial firms will continue their expansion into China.

However, amidst increasing uncertainty in the international landscape, this deepening financial interdependence can become a strategic tool for exercising influence over major powers. In fact, the possibility that US-China financial interdependence could be strategic in the unfolding US-China competition already exists. For instance, Jamie Dimon's Fox News interview, mentioned earlier, was made in response to negative public opinion in the US regarding JP Morgan's large-scale investments in China. Dimon argued, "I am a patriot, and JP Morgan follows US foreign policy. We will do what is beneficial for American companies" (<Chosun Ilbo>, 2021/8/9). This implies that when interdependence is asymmetric, the dominant power can weaponize this asymmetric interdependence as a card to coerce or pressure the subordinate power. For this reason, the relationship between asymmetric interdependence and political leverage has been extensively studied in international politics. Due to space constraints, the following will briefly review some of the most important studies and apply their core hypotheses to the deepening of US-China financial interdependence.

Albert Hirschman, through the concept of "Influence Effect," demonstrated two mechanisms by which a great power (Nazi Germany) could use asymmetric interdependence to exert influence over smaller nations (Eastern European countries, Germany's trading partners) (Hirschman 1969). The first mechanism concerns economic size. When trade is severed, a smaller economy suffers relatively greater losses than a larger one, which a great power can exploit to pressure smaller trading partners through trade restrictions or cessation. The second mechanism involves the alignment of domestic political forces in smaller nations with the policies of the great power. As interdependent trade relations continue, domestic political forces whose interests are centered on trade with the great power emerge within the smaller nation. These forces then voluntarily represent the interests of the great power through domestic political processes. This second mechanism can be a strategy that China can actively utilize. For example, leading US semiconductor companies such as Nvidia, Qualcomm, and Intel have recently requested the US government to ease restrictions on semiconductor exports to China. Bethany Allen, in her recent book, argues that China's most potent weapon in its competition with the US is to pressure the US government through American companies (Allen 2023).

Robert Keohane and Joseph Nye conceptualized "Sensitivity" and "Vulnerability" to argue that interdependence can become an object of strategy (Keohane and Nye 1977). Sensitivity refers to the speed and magnitude with which a change in one state within an interdependent relationship is felt by the other state. Vulnerability concerns the availability of alternatives and the cost of substitution when an interdependent relationship is severed due to changes in external conditions. Sensitivity can be linked to Hirschman's second mechanism. A great power can pursue policy changes that sensitively affect the interests of specific forces within a smaller nation, thereby inducing these forces to politically endeavor to align their country's policies with the preferences of the great power. Vulnerability hinges on the availability of alternatives and the cost of substitution for existing interdependent relationships. As long as the US and China define financial capital accumulation as a national interest, they will strive to manage their respective sensitivities and vulnerabilities to their advantage.

Based on this research, Henry Farrell and Abraham Newman have recently argued that interdependence can be weaponized (Farrell and Newman 2019). They utilized network theory to demonstrate how deepened global economic networks can be used as political leverage. The success of weaponization depends on who controls the central nodes within the economic network. A nation occupying a central node can overwhelm other nations through two pathways.

First, the central node nation can use, adjust, or manipulate the flow of information within the economic network to exert pressure on the opposing party according to its geopolitical objectives (Panopticon Effect). Second is the "Choke Point Effect." The central node nation can target the economic vulnerabilities of other nations, forcing or threatening them with financial sanctions, trade sanctions, or exclusion from value chain supply chains to achieve its desired outcomes. This involves exploiting the vulnerability of the other party discussed earlier. According to Harold James, central node nations are susceptible to the temptation of using the economic networks they control for geopolitical purposes (James 2021). This underscores the coercive power of the "Panopticon Effect" and the "Choke Point Effect" in finance and currency. However, there are also counter-reactions. When a specific economic network is weaponized, related countries perceive it as a threat and begin to seek alternatives (e.g., seeking alternatives to the dollar for trade settlement, payment settlements, and China's Cross-Border Interbank Payment System (CIPS) as an alternative to SWIFT). This weakens the network power of the central node nation. [10]

According to Farrell and Newman, the US and China are expected to engage in a competitive struggle over the flow of information within their bilateral financial networks as well as the systemic global financial network, amidst mutual checks and balances. Furthermore, while deepening financial interdependence, the US and China will continuously seek points where they can offensively choke off the other party and strive to compensate for the vulnerabilities in their own financial networks.

Thomas Oatley further proposed three conditions under which the United States can achieve the weaponization of interdependence, based on analyses of various cases including North Korea, Iran, and Russia, which utilize the U.S.'s global financial network to exert a Choke Point Effect (Oatley 2021). Oatley determined the presence or absence of the choke point effect by assessing whether adversarial nations complied with U.S. policies. Oatley argues that the primary reason for the U.S.'s central position in the global economic network stems from the role of the dollar as the reserve currency. The U.S. began to actively weaponize financial interdependence after the 9/11 terrorist attacks in 2001, and through a series of processes, discovered a new mechanism whereby most foreign banks, which conduct transactions with U.S. banks and value access to dollars, comply with U.S. financial sanctions.[11]

In 2006, the U.S. sanctioned Banco Delta Asia in Macau to compel North Korea to return to the Six-Party Talks, and North Korea did return. In 2011, the U.S. threatened to exclude Iranian banks from SWIFT if they did not return to nuclear talks, and Iran eventually returned. However, the U.S. was unsuccessful in its sanctions against Russia. When Russia invaded Ukraine in 2014, the U.S. sanctioned Russian banks and threatened to exclude them from SWIFT, as it had with Iran, but the sanctions ended without significant success. Oatley analyzes that the lukewarm attitude of Western European countries, which were dependent on Russian energy, toward sanctions against Russia diluted their effectiveness. Based on these analyses, Oatley summarized the conditions for successful U.S. financial sanctions into three points. First, the target of U.S. financial sanctions is a small bank or a small country (successful with North Korea and Iran; failed with Russia). Second, the target of financial sanctions does not possess an "Alternative Choke Point" that can be imposed on the U.S. Third, if the target of financial sanctions is a major power like Russia, the U.S. and Western European countries must agree on the means and methods of financial sanctions.[12]

Reflecting on Oatley's analysis with a focus on U.S.-China relations, it ultimately comes down to currency competition. The reason the U.S. is a central node in the global economic network is due to the dollar system. China will not easily abandon its pursuit of internationalizing the RMB, which it has promoted since 2009, and the U.S. will fight to defend the dollar system (Cohen 2019; Germain and Schwartz 2017; Schwartz 2019; Lee 2020). Furthermore, it will actively seek alternative choke points to counter the opponent's chokehold offensive.

In summary, the U.S. and China will pursue financial interdependence and mutual deterrence concurrently in the medium to long term. As Steil and Litan (2008, 193) define "financial war strategy" as "a type of economic war strategy that controls capital flows for military and diplomatic purposes," the U.S. and China will strategically manage capital flows between the two countries. The U.S. and China will build and execute financial war strategies in various forms, including Hirschman's "effect of influence," Keohane and Nye's "sensitivity and vulnerability," and Farrell and Newman's "panopticon effect" and "choke point effect."

IV. Implications of U.S.-China Financial Interdependence for South Korea's Financial War Strategy

Thus far, we have examined the current state of financial interdependence between the U.S. and China and the financial war strategies they may pursue in the future. As the deepening of financial interdependence between the U.S. and China is in its early stages, it is difficult to prematurely predict its future direction. Consequently, the implications or suggestions for South Korea's financial war strategy will inevitably be limited in specificity. Based on the content of this paper, three points will be briefly discussed.

First, it is important to note that interdependence, decoupling, and de-risking will coexist, and one should be cautious not to be prematurely biased towards a specific direction and overlook empirical facts that are actually occurring. Insightful future predictions and systematic policy responses must be prepared by organically connecting various financial indicators, policy discourse of the U.S. and China, actual policies, and domestic political landscapes. Models capable of measuring capital flows and financial network power on a global scale, as well as bilateral financial relations between the U.S. and China, must be established and continuously monitored.

Second, it is necessary to proactively establish information sharing and collective policy response mechanisms with the European Union, the United Kingdom, Japan, Australia, Canada, and others by applying South Korea's middle power diplomacy to the financial sector. These countries, along with South Korea, are significantly influenced by the strategic competition between the U.S. and China, but conversely, they can bring about meaningful changes in the strategic calculations of the U.S. and China. As they are all G20 member states, they could function as a middle power financial war strategy group within the G20, similar to the previous MIKTA.

Finally, South Korea's financial war strategy must consider both bilateral relations and the system or regime level, and prepare both offensive and defensive strategies (Armijo and Katada 2015). South Korea must design its bilateral financial relations with the U.S. and China, respectively. Furthermore, South Korea must clarify its position when the U.S. and China engage in competition over the global financial system. ■

V. Appendix

1. Trends in Inward Foreign Direct Investment

<Figure 4> Trends in Inward Foreign Direct Investment

Source: KOTRA Overseas Market News 2022/5/26

<Figure 5> China's Inward Foreign Direct Investment Trends, 2010-2020

Source: KOTRA Overseas Market News 2022/5/26

References

<Kyunghyang Shinmun>. 2020. “Global Capital Flooding into China… ‘Threatening U.S. Financial Industry Status in a Few Years’.” 2020/12/14. https://m.khan.co.kr/economy/industry-trade/article/202012141631001#c2b

Kim, Ye-kyung. 2019. “Establishment of Foreign Investment Related Laws in China.” *Trends and Analysis of Foreign Legislation* Vol. 15, 1-7.

Kim, Yun-guk. 2021. “Changes in Foreign Investment Management System Since the Enforcement of China's Foreign Investment Law.” *CSF Expert Opinion* KIEP. 2021.03.31.

Kim, Yun-guk. 2022. “Changes in Foreign Investment Management System Since the Enforcement of China's Foreign Investment Law.” *China Expert Forum*, KIEP.https://csf.kiep.go.kr/issueInfoView.es?article_id=44981&mid=a20200000000(Accessed: September 4, 2023)

Kim, Chi-wook. 2020. “The Global Financial Crisis and U.S. International Economic Strategy.” In *South Korea's Choices After the Crisis*, edited by Yeol Son, 39-76. Hanul.

Seo, Bong-gyo. 2018. *Understanding the Chinese Economy and Finance: The Coexistence of State-Owned Banks and Fintech Banks*. Dosa Publishing ORE.

<Seoul Economic Daily>. 2023. “JP Morgan to Maintain Its China Investment Strategy.” 09/07. https://www.sedaily.com/NewsView/29ULAUNT2J(Accessed: November 5, 2023)

Xinhua News Agency Korean Edition. 2023. “China Signals Continued Opening of Capital Markets... Funds That Left Expected to Return in Second Half.” https://kr.news.cn/20230705/5aa5aeb0a8434af79707f42794c714ef/c.html(Accessed: November 4, 2023)

Skita, Hiroki (translated by Lee, Yong-bin). 2021. *U.S. Sanctions Diplomacy*. Hanul.

An, Yu-hwa. 2020. “The Impact of the New Foreign Investment Law on China's Financial Industry.” *Sungkyunkwan China Brief* Vol. 8, No. 2, 113-119.

Lee, So-yang. 2023. “Trends in the Opening of China's Insurance Market and the Growth of Foreign Insurance Companies.” *CSF China Expert Forum* KIEP. 2021/12/21. https://www.emerics.org:446/issueInfoView.es?article_id=44668&mid=a20200000000&board_id=4(Accessed: September 4, 2023)

Lee, Yong-wook. 2020. “U.S.-China Strategic Competition for Global Reserve Currencies and South Korea's Response.” *EAI Special Report*. East Asia Institute. 2020.08.

Lee, Yong-jae. 2023. “Decoupling: Is It Merely Discourse in U.S.-China Supply Chain Competition?” *Online Series CO 23-21*. Korea Institute for National Unification. 2023.08.11.

Lee, Eun-jae. 2022. “Assessment of the Impact of Sustained U.S.-China Conflict on China's Capital Markets.” *International Finance Center* 7.

Lee, Chi-hoon. 2020. “China's Push for Capital Market Opening and its Global Ripple Effects.” *CSF China Expert Forum* KIEP. 2020.11.12.

_____. 2022. “The Bright and Dark Sides of Surging Foreign Capital Inflows into China and Their Implications.” *Issue & Trends* KIEP. 2022.1.14. https://csf.kiep.go.kr/issueInfoView.es?article_id=44981&mid=a20200000000(Accessed: September 4, 2023)

Monthly Chosun. 2023. “Jeon Byung-seo's Re-examination of the Chinese Economy (2) The Real Reason the Western World is Misjudging China.” https://jmagazine.joins.com/monthly/view/337724(Accessed: September 4, 2023)

<Aju Business Daily>. 2021. “[An Yu-hwa Column] Wall Street is Not Leaving China.” https://www.ajunews.com/view/20210524104743314(Accessed: November 5, 2023)

<Yonhap News>. 2023. “Buffett's Partner Charlie Munger: 'China's Economy Will Be Better Than Other Economies for the Next 20 Years’.” https://yna.co.kr/view/AKR20231031184500072(Accessed: November 5, 2023)

Lim, Ji-hyun. 2005. *Hostile Accomplices*. Solnamu.

Cho, Go-woon. 2019. “Recent Trends and Evaluation of China's Financial Market Opening.” *KIEP* 20.

<Chosun Ilbo>. 2021. “Despite U.S.-China Conflict, Wall Street and China are 'Secretly Dating'... JP Morgan Receives License to Establish Chinese Securities Firm.” https://biz.chosun.com/international/international_economy/2021/08/09/BVEZ2DQFGFB7FABHN7M2JNI7OU/(Accessed: November 5, 2023)

Jeong, Won-sik. 2020. “Global Capital Flooding into China… ‘Threatening U.S. Financial Industry Status in a Few Years.’”https://m.khan.co.kr/economy/industry-trade/article/202012141631001#c2b (Accessed September 4, 2023)

<KOTRA Overseas Market News>. 2022. “China Announces <2022 Encouragement and Negative List for Foreign Investment>.”https://dream.kotra.or.kr/kotranews/cms/news/actionKotraBoardDetail.do?MENU_ID=100&pNttSn=194434 (Accessed September 5, 2023)

<Pressian>. 2022. “The US-China Era: Understanding the Dual Strategy of the ‘Powerful Adolescent’ United States [Han Kwang-soo Column] $3.3 Trillion in Mutual Investment vs. Global Supply Chain War.”https://www.pressian.com/pages/articles/2022112109432898708 (Accessed November 3, 2023)

Allen, Bethany. 2023. Beijing Rules How China Weaponized Its Economy to Confront the

World. New York: Harper.

Armijo, Leslie and Saori Katada. 2015. “Theorizing the Financial Statecraft of Emerging

Powers.” New Political Economy 20(1): 42-62.

Cohen, Benjamin. 2019. Currency Statecraft: Monetary Rivalry and Geopolitical Ambition. Chicago: The University of Chicago Press.

Farrell, Henry and Abraham Newman. 2019. “Weaponized Interdependence: How Global

Economic Networks Shape State Coercion.” International Security 44(2): 42-79.

Germain, Randall and Herman Schwartz. 2017. “The Political Economy of Currency Internationalization: The Case of the RMB.” Review of International Studies 43(4): 765-787.

Hirshman, Albert. 1969. National Power and the Structure of International Trade. Berkeley: University of California Press.

James, Harold. 2021. “Weaponized Interdependence and International Monetary Sys-tem.” in Daniel Drezner, Henry Farrell, and Abraham Newman (eds). The Uses and Abuses of Weaponized Interdependence. Washington, D.C.: Brookings Institution Press. 101-114.

Keohane, Robert and Joseph Nye. 1977. Power and Interdependence: World Politics in

Transition, New York: The Free Press.

New York Times. 2023.

Oatley, Thomas. 2021. “Weaponizing International Financial Interdependence.” in Daniel Drezner, Henry Farrell, and Abraham Newman (eds). The Uses and Abuses of Weaponized Interdependence. Washington, D.C.: Brookings Institution Press. 115-129.

Schwartz, Herman. 2019. “American Hegemony: Intellectual Property Rights, Dollar Centrality, and Infrastructural Power.” Review of International Political Economy 26(3): 490-519.

Steil, Benn and Robert Litan. 2008. Financial Statecraft: The Role of Financial Markets in American Foreign Policy. New Haven: Yale University Press.

[1] This research was supported by Korea University (K2309711).

[2] As discussed below, investments by U.S. financial firms in China have fluctuated due to China's economic conditions and political risks, but the increase in investment around 2019 has formed a distinct trend.

[3] China recorded the world's largest inflow of FDI, represented by factory investments, for the first time in 2020, surpassing the United States, and it surged by 23.4% year-on-year in January-October 2021. See Appendices 1 and 2. Lee Chi-hoon (2022) commented that the recent phenomenon is reminiscent of the period of explosive foreign capital inflow for about a decade after China's accession to the WTO in 2001.

[4] The following is a summary based on Cho Go-woon (2019). Cho Go-woon analyzed China's financial market liberalization into four periods: before 2001 after reform and opening up, after WTO accession, after the 2008 global financial crisis, and China's financial liberalization policy during the US-China trade dispute after 2017. See also Seo Bong-kyo (2018).

[5] The following is a summary and organization of the analysis by Kim Yoon-guk (2021).

[6] Foreign capital in the Chinese stock market has shown a net increase every year since 2014 and has never experienced net outflow.

[7]Hugu Tong refers to a system where Shanghai Stock Exchange stocks are traded through a Hong Kong Stock Exchange (HKEX) custodian account, and it is a term used when Hong Kongers or foreigners trade stocks on the Shanghai Stock Exchange.

[8]Xianyu Tong refers to a system where Shenzhen Stock Exchange stocks are traded through a Hong Kong Stock Exchange (HKEX) custodian account, and it is a term used when Hong Kongers or foreigners trade stocks on the Shenzhen Stock Exchange.

[9]The following is a summary based on Lee So-yang (2021).

[10]James (late 19th century) illustrates the counter-effects of weaponizing economic networks through the case of the British government utilizing London, the center of global bill of exchange transactions under the gold standard, as a "panopticon" and a "chokehold." The British government leveraged trade and production information derived from bill of exchange transactions to exert economic pressure on Germany and the United States, achieving favorable outcomes. However, as a counter-effect, Germany, the United States, and others exposed to the weaponization of British bill of exchange transactions began to establish their own central banks to serve as lenders of last resort independent of London and to pave the way for domestic asset utilization. This ultimately led to a weakening of London's status in the UK and the international financial market.

[11]For a comprehensive study on U.S. financial sanctions, refer to Hiroki Shiota (2021).

[12]Despite the large-scale financial sanctions imposed on Russia in 2022, including the exclusion of Russian banks from SWIFT, which differed from the measures in 2014, the chokehold effect was not significant. Considering that China, India, and other major importers of Russian oil and gas provided a cushioning effect, the third condition appears to require careful refinement to include Keohane and Nye's concept of vulnerability (availability of alternatives and cost of substitution).

■ Lee Yong-wook, Professor at Korea University.

■ Managed and Edited by: Lee Ju-yeon, EAI Research Fellow

    Inquiries: 02 2277 1683 (ext. 205) | jylee@eai.or.kr