- Hubert Walas
Digital Yuan.
Already 21 million users in China use the e-Yuan, a digital currency issued by the People's Bank of China in the form of computer code. We’re in the age of cryptocurrencies and the Chinese have decided to use blockchain technology in a way that fits the strategy of the Chinese Communist Party. In the long run, the new system may even threaten the current omnipotence of the US dollar in the financial markets. Why?
In the Age of Digital Currencies
It might seem that money is already virtual as credit cards and payment applications such as Google Pay in Europe or the US, and WeChat in China eliminate the need for banknotes or coins. However, these are only the electronic flows of what is still the paper money that we all know. However, now legal tender is being turned into computer code.
Digital currency is money that exists only as electronic data. While it can be used just like regular money, it has no physical - i.e. paper - form and transactions can be sent and received from anywhere in the world. However, it should be noted that digital currencies are not cryptocurrencies. The key difference between the two lies in the difference in their use of blockchain technology. Cryptocurrencies use blockchain to remain decentralized and anonymous, avoiding the need for a supervisory authority such as a central bank. Digital currencies also use blockchain, but they operate with a centralized authority and require user identification.
In a nutshell, e-currencies are the central banks' answer to cryptocurrencies, which pose a threat to the government's monopoly on money creation. On the one hand, e-currencies share with cryptocurrencies one of their main advantages, namely minimal transaction costs. This technology allows a nearly free transfer of resources across borders, which makes it possible to significantly reduce costs generated by the banking sector. And these can be huge. Annually, such transactions cost approx. $350 for every person in the world, that is a total of almost 3 trillion dollars. Or more than the GDP of Great Britain. However, digital currencies also negate the basic value of cryptocurrencies, which is the anonymity of the user.
Of course, there are two sides to every coin. On one side, the supporters of the welfare state, for example, could consider the possibility of the government sending financial support directly to a particular person as an advantage. This will be possible as digital currencies could have a defined purpose and an expiration date. For example, in case of a flood, affected citizens will receive money valid for 2 months, which can be used to buy food and water, but will not allow the purchase of a new game console. A similar definition will apply to social transfers made by the state, such as for raising children. In theory, this money could be restricted to be used only for the purchase of goods for children and not, for example, alcohol.
On the other side of this coin is a significant increase in state control and reduction of citizens' freedom, or how and when they can spend their money. This will cause a great temptation for governments to move towards widespread surveillance and potentially even authoritarianism - banning the sale of alcohol during the week, banning support for specific NGOs, banning the ability to buy products of a particular brand - these are just some of the possible examples of applications straight out of Orwell's dystopia, 1984. In addition, cybercrime and hacking attacks will inevitably grow even more as criminals move from the street and into cyberspace where entire schemes can be carried out from one computer.
In summary, we get: bypassing US monetary hegemony, cross-border money transfer systems, greater surveillance of the public, and the ability to control the market at will - the People's Party of China didn't need to think twice about this move. Beijing quietly began exploring a digital RMB in 2014. However, if you think that only China wants to introduce digital currencies, you are wrong. According to a Bank for International Settlements survey of central banks - 86% of them are researching digital currency. The European Central Bank wants to introduce digital euros by as early as 2025. And the American Federal Reserve is also conducting research in this field.
Dollar Hegemony Under Threat
Back to China. In late 2019, the People's Bank of China launched e-Yuan pilot programs. Trials reached a ceiling of nearly 35 billion Yuan in transaction value and nearly 21 million users have set up a digital wallet. China is in pole position in this race for many reasons. Digital payment systems like WeChat and Alipay are ubiquitous in China. In big cities like Beijing, these methods of transferring money are so common and physical cash so scarce that beggars on the street carry laminated QR codes to receive donations. China has announced that the digital yuan will be in circulation alongside banknotes and coins for some time. For now, it is unclear whether Beijing is pursuing the digitization of all Yuan.
Nevertheless, it seemed natural that the technology would only be for domestic use, giving China's central bank tight control over digital money. It therefore came as a shock to the financial markets when a white paper released on July 16, 2021, announced that the e-Yuan was potentially also to allow cross-border payments.
Therefore, e-currency technology appears to be Beijing's latest and most serious idea to shake the global dominance of the dollar settlement system. According to reports from the White House, Washington sees the digital RMB as a potential tool to undermine the status of the dollar. And the latter is already in crisis due to the massive printing done by the US Fed in recent months. Governments holding their foreign exchange reserves in the dollar are worried about their devaluation. China, which holds the largest dollar reserves in the world, is the most affected.
Some analysts compare the current situation to one that occurred almost exactly 50 years ago. In August 1971, Richard Nixon, the 37th president of the United States, abolished the convertibility of the dollar into gold, marking the end of the previous monetary era - the Bretton Woods system. The system, in which currencies are not tied to other currencies or gold, meant that exchange rates were determined solely by national economic conditions and confidence in a country's policies. This brought gigantic benefits to the United States. The power of the U.S. economy, confidence in U.S. institutions, and its role as a global arbiter made the dollar the gravitational center of global finance. This system continues to this day, but dark clouds are looming on the horizon of this order.
Washington's omnipotence in financial markets in the form of the dollar and control over SWIFT - the system that is responsible for cross border banking transfers - has over time turned it into a powerful geopolitical weapon in the hands of the Americans. The Iranians, twice disconnected from SWIFT, know something about it. Similarly, for China or Russia, a sudden disconnection from SWIFT poses an almost existential problem. Therefore, a system that bypasses SWIFT and reduces the strength of the dollar is a real game changer for the geopolitical rivals of the United States. And this is exactly what the digital Yuan is supposed to provide.
"In the future, we will continue to steadily promote the Yuan internationalization to serve the real economy, based on market principles," the People's Bank of China said in 2020. The Chinese outright declare that the digital Yuan aims to protect China's "monetary sovereignty," including by offsetting the global use of the dollar.
Sanctions imposed by the U.S. on Iran or North Korea, could be undermined by the free access to the Chinese market beyond SWIFT with e-Yuan. But in the long run, the success of China's digital currency depends on the adoption of the technology by other countries. Beijing has joined an initiative to develop protocols for cross-border use of digital currencies working with the Bank for International Settlements and the central banks of Hong Kong, Thailand and the United Arab Emirates. Digitization brings with it the possibility of democratizing the system by allowing cross-currency exchange without having to exchange them first into dollars, as is the case now. This is a real revolution.
Cheaper and seamless interstate transactions could be particularly attractive to emerging markets that are held back by expensive access to dollar-based global payments. “Any unipolar system is unsuited to a multi-polar world,” - these words of Mark Carney, Governor of the Bank of England, state the essence quite well. Moreover, he adds that the new technology could solve the problems caused by the hegemony of the dollar by giving back to the rest of the world, especially developing countries, control over their own monetary policy.
The cross-border use of Yuan has increased by 24% in the past 3 years. At the same time, China's trade with other countries in Asia and Africa is also growing rapidly, allowing China to increasingly run its accounts in Yuan. Charles Gave of Gavekal Research calls this "Asia's new monetary order."
Trade between Asian countries is still mostly Dollar-denominated, but a "parallel infrastructure" is now in place. The dollar exchange could hypothetically be rejected within a few days without causing a breakdown in regional trade due to a lack of tender. During the 2008 financial crisis, Asian countries with huge Dollar reserves were unable to mobilize their resources quickly and had to borrow money from a dollar liquidity swap.
According to Gave, the new system isolates Asia's intra-regional trade from a future Dollar or Euro crisis, making another crash in those markets highly unlikely. In the new system, the potential lender of last resort is not the US Federal Reserve or the International Monetary Fund, but the People's Bank of China through swap agreements signed with other central banks.
Even analysts from the Asian Development Bank - an institution in which Japan and the United States are the largest shareholders - indicate the need for greater autonomy in relation to the Dollar. "It is important to further develop local currency bond markets to reduce the region's dependence on US dollar funding and thus reduce vulnerability to external shocks," said a recent report.
Not so Troublesome After All?
In all of this, however, it is important to remember the current balance of power. Digital currencies, including the e-Yuan, while a threat to the dollar, are still hypothetical.
Skeptics of the potential of this threat argue that for the e-Yuan to start displacing the Dollar, firstly governments, corporations, and/or ordinary people would have to want to acquire it to transact at all. The range of options for entities that have thousands or millions of Yuan is minimal compared to that of Dollars, Euros, or Yen. China holds far fewer high-quality assets and the government's reluctance to let capital flow out makes the risk of not being able to recover much higher. In addition, there is an element of trust in an authoritarian government. Transactions can be faster than traditional bank transfers, but for large global corporations, immediacy is not the most important thing. Digitization could bypass U.S. sanctions, but most multinationals won't and sanctions are not a major factor in the limited use of the Yuan abroad.
Moreover, dry statistics show from what level the Chinese are starting. An International Monetary Fund study released in 2019, based on a 2016 survey, finds that about 93% of China's imports and 95% of its exports were denominated in Dollars. The Yuan's share of global reserves is marginal at 2.5% which leaves the Yuan behind the Dollar, Euro, Yen, and Pound Sterling. The Dollar remains the king of global financial markets, accounting for nearly 60% of global reserves.
However, the bigger picture is that it’s not strictly the e-Yuan that is a threat to the dollar, but the entire e-currency system in which the e-Dollar is only one of many currencies. Beijing's ultimate goal then is to create a new international system that will lift the dollar monopoly. Or so says Josh Lipsky, a former IMF employee, now an analyst at the Atlantic Council - “Anything that threatens the dollar is a national-security issue. This threatens the dollar over the long term.”
Meanwhile, Americans are also working on e-Dollar. However, the people behind the digital greenback assure that the US is not China and privacy will be a very important aspect of the new exchange technology. Still, US Policymakers are mainly trying to maintain the hegemonic position of the dollar whether it’s physical or digital. The matter was briefly summarized by Fed chief Jerome Powell with the words, "We don't have to be first," he said. "We have to do it right."
Americans' fears are not unfounded. China's recent moves may be the biggest threat to the status of the Dollar and the monetary system that was created after World War II. Of course, the Dollar has survived many doomsday scenarios in the past. However, this one may prove to be the most refined and challenging.
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