Thanks to a mandate for outside investment and its strong rebound from the coronavirus pandemic, China’s financial markets are drawing record high chunks of global capital — particularly from U.S.-based investors — and are poised to keep growing.

Why it matters: As more money flows to China’s markets, its political leaders will have a clear mechanism to increase the country’s political power, giving China another potent weapon to challenge the United States’ position as the world’s financial superpower.

What we're hearing: China's goal is "renminbi internationalization," says Nicholas Borst, director of China research at Seafarer Capital Partners.

What it means: As more foreigners invest in mainland Chinese companies, government bonds and other securities that trade in renminbi (RMB) — China's currency — they are forced to buy and hold the currency.

• The more global investors hold these Chinese assets, the more international and important China's currency becomes.
• "You can’t have a globally important currency unless you give investors a safe place to park it," Borst tells Axios.

The big picture: China has long weaponized access to its domestic consumer markets for geopolitical gain, forcing airlines, hotels, Hollywood studios, and many other companies to avoid crossing the Chinese Communist Party's red lines.

• As China's capital markets become more lucrative, we can expect that China might leverage access to those markets in the same way.

The key principle at play: More international investors investing directly in China's markets could strengthen Beijing's ability to exert extraterritorial enforcement of its domestic laws through freezing investment accounts and initiating arbitrary audits.

• As a financial superpower, the United States has displayed relative restraint in how it regulates and polices those markets. It has implemented guidelines primarily aimed at ferreting out fraud and protecting investors while facilitating global capital flows.
• With some notable exceptions during the Trump era, U.S. sanctions have usually targeted terrorism funding, weapons proliferation, rogue regimes, and gross human rights violators, rather than punishing people for their political views.
• But domestically, and increasingly on the international stage, China views political opposition as equivalent to terrorism or money laundering, and aims to punish it accordingly.

One case study: In Hong Kong, China's national security law requires banks to freeze the assets of pro-democracy activists accused of "terrorism" or "sedition" for their normal political organizing activities.

By the numbers: As of 2020, the market cap of Chinese companies listed on mainland, Hong Kong and overseas indexes like the New York, London and Singapore stock exchanges, totaled nearly $17 trillion, with the vast majority ($11.7 trillion) on mainland exchanges.

• That total rivals the combined market cap of the London Stock Exchange and the Euronext exchanges.

What's happening: Even as the Trump administration banned U.S. investors from owning shares in certain Chinese companies linked to the military and Congress passed legislation to delist Chinese firms from American exchanges, China has become one of the largest single-country exposures for U.S. investors, according to Seafarer's data.

• "China is now both the second largest economy and the second largest capital market," Linda Zhang, CEO of Purview Investments, tells Axios.
• "Most U.S. investors are exposed to Chinese firms ... either directly or indirectly through their brokerage accounts or 401ks."

Yes, but: China has a long way to go before the RMB becomes an internationalized currency. That's in part because China's leaders are reluctant to make the currency fully convertible, since doing so would relinquish some control over capital outflows and domestic fiscal policy.

Between the lines: Banning Chinese companies from U.S. stock exchanges could push Chinese companies to the Shanghai and Hong Kong stock exchanges, which in the long run would increase the relative power of these exchanges over the U.S. exchanges, said Bob Bartell, global head of corporate finance at New York-based financial consultancy Duff & Phelps.

What to watch: China is developing a digital RMB, and the global payments giant SWIFT has partnered with China's central bank to help develop it.

• A digital RMB could speed the internationalization of China's currency and expand Beijing's geopolitical sway around the world.