China’s digital currency (CBDC) being tested
has caught the world’s attention.
And a Foreign Affairs article painted a picture
as such.
In 2022, Iran is purchasing critical components
for its nuclear and missile programs.
The funds come from selling oil to China and
Europe.
And all transactions are done with the digital
yuan that bypasses U.S.-controlled financial
systems.
America’s ability to sanction its enemies
is significantly weakened.
In this video, we’ll discuss whether the
digital yuan can challenge the USD dominance.
What risks will it bring?
And how is it different from the current digital
payments and cryptocurrencies?
The Leader in Large-Scale Testing The People’s
Bank of China, China’s central bank, started
working on its own digital currency back in
2014.
In May 2019, the BBC revealed Facebook was
planning to launch its version of cryptocurrency,
Libra, by the first quarter of 2020.
This motivated the Chinese Communist Party
to speed up the digital yuan’s development.
And regardless of whether the Libra would
be approved by western governments, the CCP
wanted to win the race.
In April 2020, the central bank introduced
a pilot program in four of China’s large
cities.
And screenshots of the digital wallet mobile
app were circulated on the internet showing
functions of making and receiving payments.
In Suzhou, a large city west of Shanghai,
the government employees would start receiving
half of their transport subsidies in digital
yuan.
In July, China’s ride-hailing company, Didi,
said it was working with the People's Bank
of China to test the digital yuan on its transportation
platform.
And in mid-August, China’s Commerce Ministry
said it would expand the pilot program to
regions that include Beijing and Hong Kong.
The central bank also indicated the plan to
test the digital yuan system’s capabilities
and risks in cross-border transactions, which
will take place during the 2022 Beijing Winter
Olympics.
Under the proposed timeline, a digital yuan-based
international payment system will start running
in about a year and a half.
It will likely be the world’s first government-operated
digital currency system.
As an authoritarian regime, the Chinese Communist
Party might not be concerned about violating
people’s privacy when pushing for the digital
yuan.
Once the tests turn out successful, large
scale adoptions might complete very quickly.
So how will the digital yuan work?
“Controllable Anonymity” The digital yuan
doesn’t have an official name but is known
internally as “DC/EP,” which is just short
for “digital currency/electronic payment,”
Unlike the current digital payment systems
such as Alipay and WeChat Pay, digital yuan
users will not require bank accounts.
And according to Mu Changchun, the People’s
Bank of China official in charge of digital
yuan’s development, the digital wallet will
allow some form of touch payments where transactions
can occur even without the internet.
Compared to Bitcoin, which is believed to
be decentralized and anonymous, the digital
yuan will be highly centralized.
Although the central bank claimed the parties
to the transactions will be anonymous, in
practice, it seeks quote “controllable anonymity.”
It will be able to track the users’ purchases.
And therefore, the system could help fight
money laundering, gambling, and terror financing.
The People’s Bank of China has also claimed
the digital currency was intended to replace
some physical cash in circulation, also known
as M0.
That was not very convincing.
China already has a very high level of cashless
rate.
According to the central bank’s report,
by the end of 2018, 82.39% of China’s adults
used digital payments.
There are 900 million people that use Alipay.
And, in 2019, cash only accounted for 4% of
household financial assets versus 24% in the
United States.
It would be hard to believe all the resources
spent are just to erase the 4%.
“Actually, replacing the M0 would be just
a start.
It will not be limited to M0.
Instead, it should replace all the currency
and maximize the digital currency’s functionality
and value.
Otherwise, there will be issues with return
on investment,” writes Wang Yongli, former
vice president of Bank of China.
Therefore, the CCP is will more likely use
the digital yuan to replace all the renminbi
in circulation and increase its surveillance
on China’s economy and every Chinese citizen,
especially political dissidents.
When the central bank can create and issue
money digitally, it can seize the citizens’
money with one push of a button.
And will the digital yuan help the CCP challenge
the US dollar?
“The Digital Belt and Road” On August
7th, the U.S. Treasury Department sanctioned
11 Chinese Communist Party and Hong Kong officials.
The targets included the director of the CCP’s
liaison office in Hong Kong, Luo Huining,
and Hong Kong’s chief executive, Carrie
Lam.
On August 12th, Bloomberg News reported that
China’s largest state-controlled banks are
taking steps to comply with U.S. sanctions.
This might sound surprising to many people.
Why would China’s banks do anything against
their government by a foreign country’s
order?
But the reality is the U.S. dollar currently
holds a dominant position in global finance.
And in 2019, almost 90% of international transactions
were conducted in US dollars.
The U.S. government can ask all banks that
process US dollar payments to stop providing
services to those under sanctions.
And, apparently, the CCP does not want to
be put in such a position.
It intends to bypass the dollar payment system.
In the state media CGTN’s words, the digital
currency provides quote “a functional alternative
to the dollar settlement system and blunts
the impact of any sanctions or threats of
exclusion both at a country and company level.”
Aditi Kumar and Eric Rosenbach at Harvard
Kennedy School, authors of the Foreign Affairs
article, believed once the digital yuan is
successfully launched in China.
Beijing could simply share this technology
to countries with the same motives.
For example, Iran could adopt the same technology
and build a compatible digital currency system.
And the trade between the two countries would
technically be no longer trackable by the
US government.
And what might happen when the People's Bank
of China does become the first central bank
to introduce a digital currency that works?
Matthew Graham is the chief executive officer
of Sino Global Capital.
He predicted quote: “It’s very possible
that other countries adopt the China framework,
and then a first-mover advantage turns into
a strong network effect…This is the best-case
scenario for China.”
Beijing could ask the Belt and Road Initiative's
participating countries to start accepting
the digital yuan.
And this might include using the digital yuan
to make loan payments.
It could pay to install infrastructures such
as point-of-sale terminals and lower the transaction
fees, effectively create a digital belt and
road.
As Bank of America’s analysts pointed out,
Asian countries like Thailand, Singapore,
and South Korea are assessing their digital
currencies.
Those currencies might be integrated with
the yuan-based systems and quote “especially
if it entails significantly lower transaction
costs and real-time transfers.”
In fact, the CCP has already been doing that
under current systems.
On August 3, China waived transaction fees
between the yuan and 12 currencies, including
the Russian Rouble, the Singapore dollar,
the Korean Won, and the Thai Baht.
According to the State Administration of Foreign
Exchange, this move was to quote: “actively
cooperate with the national belt and road
development strategy.”
A cheaper, faster payment system that can
also avoid US sanctions would be viewed as
a challenge to the US dollar’s dominance.
Then what should the United States do about
it?
Obstacles to The Digital Dollar The People’s
Bank of China is not the only central bank
working on the digital currency.
According to the Bank for International Settlement,
about 50 countries participated in the Central
Bank Digital Currencies projects in 2019.
Michael Casey at CoinDesk believes there is
a lot at stake.
“A China victory in the digital currency
race would have profound negative effects
for the U.S., and Western capitalism generally,”
he said.
"If the U.S. doesn’t catch up soon, it’s
going to lose.”
Kumar and Rosenbach suggested the United States
develop the dollar version of digital currency.
And they hope it will quote: "combine the
strength and stability of the US dollar with
the convenience and efficiency of digital
technology."
The Federal Reserve has indeed been conducting
research and tests on hypothetical digital
dollars.
But, on August 13, Governor Lael Brainard
brought up some significant obstacles to having
a digital dollar.
Among them was whether the Fed can build a
digital currency system that can resist cyberattacks.
And another would be to settle the legal question
of whether the over 100-year old Federal Reserve
Act allows issuance of digital currency at
all.
On top of those, we should expect to see pushbacks
from Americans who value privacy and limited
government surveillance.
It seems a lot of debate will take place before
the Fed receives a go-ahead.
And the chance the Fed will roll out a digital
dollar before the digital yuan would be minimal.
The Future of the Dollar “Remember that
credit is money.”
This was a quote by Benjamin Franklin.
And it revealed the essence of modern currencies.
Since 1971 when President Richard Nixon declared
that the dollar was no longer convertible
to gold, we lived in a world with only fiat
currencies backed by the faith in their respective
governments and economies.
More importantly, a fiat currency's fundamentals
depend on whether a country has checks and
balances, the rule of law, and a market-driven
exchange rate.
The CCP provides none of those.
Therefore, in reality, the Chinese yuan has
very low credibility.
And although China is the second largest economy,
the yuan’s usage falls behind the EURO,
the Japanese Yen, and the British Pound.
The trust in the CCP has been deteriorating
even among belt and road countries.
Some of them have canceled, downsized, or
postponed the projects to avoid potential
debt traps.
It is hard to say whether they will gladly
adopt a digital yuan issued under the CCP’s
control.
But that doesn’t mean we can ignore challenges
faced by the US dollar.
We believe in the long run, the dollar's dominance
will have to be secured by the US economy's
strength, not the other way around.
Therefore, instead of merely catching the
digital currency trends, the US government
and the Federal Reserve should focus on introducing
responsible fiscal and monetary policies that
protect the market’s confidence in the dollar.
How much international acceptance do you think
the digital yuan will receive?
Leave your comments below.
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