Could China’s digital currency push unseat the dollar?

Posted on : 2022-02-03 10:25 KST Modified on : 2022-02-03 10:25 KST
Many countries are considering a switch to a central bank digital currency, but China appears to be the first to implement such a system

This year, China is poised to become the first major country to have its central bank issue a digital currency. Now that mobile payments through Alipay and other services have become widespread in the country, the People’s Bank of China is reportedly planning to soon issue a digital currency backed by the state. China’s proposed issuance of a central bank digital currency (CBDC) is being closely watched by financial observers around the world because it has the potential to rock the international monetary system’s decades-old orientation around the US dollar.

According to sources in the Chinese financial industry, the People’s Bank of China has nearly finished preparing to issue a CBDC and is currently weighing the timing.

“Along with establishing the Digital Currency Institute in Shenzhen in 2017 and building a blockchain platform for trade and finance, the People’s Bank of China has already applied for 74 patents related to digital currencies. We’re planning to issue a government-backed digital currency for the first time in the world,” said Tang Jianwei, chief finance researcher at China’s Bank of Communications.

“Facebook’s announcement [in 2019] that it will be releasing ‘Libra’ has spurred officials to accelerate work on issuing [the CBDC],” said an official in the Shanghai financial industry who asked to remain anonymous.

China is considering releasing a digital version of its legal currency. Several countries are currently exploring the adoption of a CBDC because the central bank’s imprimatur and guarantee of payment would make them highly credible. That contrasts the low confidence in privately issued cryptocurrencies such as Bitcoin, which have extreme price swings and aren’t legal tender.

“We need to set up a dedicated team to research central bank digital currencies and deepen our pool of experts while also aggressively participating in the discussion in international bodies,” said Lee Ju-yeol, governor of the Bank of Korea, in his 2020 New Year’s address.

China apparently means to get a head start in the market by releasing a CBDC before other countries have a chance.

Sources in the Chinese financial sector who spoke with the Hankyoreh in Shanghai noted that a CBDC would replace cash currency, which would serve to eliminate counterfeiting, money laundering and tax evasion, bringing much of the underground economy into the light. In addition, they said, it would make exchanging funds and remitting money overseas much faster and cheaper.

At present, most financial transactions pass through multiple networks, which means it takes two or three days for funds to transfer between accounts. But since a CBDC would be managed on a single network, financial transactions could be handled instantaneously.

China’s central bank reportedly felt an urgent need to counter Libra. Once Libra is issued and makes its way into China, it would complicate efforts by the People’s Bank of China to carry out monetary policy and would give American companies extensive knowledge of the particulars of Chinese transactions.

“The People’s Bank of China is looking into a two-layer operational approach under which it would issue the digital currency to [China’s] four state-owned banks, which would then supply the currency to the general public,” said a Chinese financier who was on a joint task force with the central bank.

China’s plan to issue a CBDC is being followed so closely by the international financial community because it could be a catalyst in transforming the international monetary system, in which the US dollar has been the key currency for more than 70 years. Some side effects of the current international financial system are that emerging economies’ financial markets are disturbed by the influx and outflux of US dollars and that their foreign debt obligations are aggravated in times of crisis.

Mark Carney, governor of the Bank of England as of 2020 and a mainstream figure in international finance, proposed in August last year to set up a new global digital currency system to replace the US dollar.

But the US Federal Reserve has been quite skeptical about the potential issuance of the Libra or CBDCs, presumably out of concern that they might erode its influence.

Will China manage to make a truly revolutionary move in this new domain? For that to happen, China’s CBDC would have to be circulated internationally, but Chinese financial sources agree that’s probably not going to happen any time soon.

“Before a currency can be used in international transactions, there needs to be trust in the state that’s backing that currency and stability must be assured. But China’s not in that position at the moment,” said a source in the Shanghai financial industry who spoke on condition of anonymity.

That’s demonstrated by the fact that China’s renminbi (RMB) currency, only accounts for 2% of international transactions at the moment, even though China has been pushing to internationalize its currency for several years now.

“Even after the American economy had grown larger than the British economy, it took 70 years before the dollar’s international status exceeded that of the pound. Therefore, the internationalization of the renminbi will be a slow process, and more expansion is needed in the Chinese economy as well,” said Zhou Yu, director of the Research Center of International Finance at the Shanghai Academy of Social Sciences.

But circumstances could be different in a decade or two. If the Chinese economy continues to expand, eventually eclipsing the American economy, the currency used in settlements would need to change. That process could be sped up if China develops a CBDC that’s fast and economical.

“Just as technology has disrupted media, politics and business, it is on the verge of disrupting America’s ability to leverage faith in its currency to pursue its broader national interests,” wrote Kenneth Rogoff, prominent scholar of finance and Harvard University professor, in a 2019 column.

“Western governments need to start thinking about their response now, before it is too late,” Rogoff added.

China reportedly hopes that its CBDC will be circulated in international remittances and trade settlements with countries participating in its Belt and Road Initiative. Through this initiative, launched in 2013, China seeks to build a massive economic network that connects Central Asia, South Asia, Southeast Asia, Africa and Europe through overland and maritime “silk roads.”

Currently, projects related to the Belt and Road Initiative are underway in more than 60 countries, and the leaders of 37 countries attended a Belt and Road Summit in Beijing in April 2019. China disclosed at the time that it had developed a platform for cross-border electronic transactions with 17 countries.

“China is not only building infrastructure but also providing financial assistance to countries that form links in the Belt and Road Initiative. China is likely to ask them to use a Chinese digital currency in cross-border electronic transactions and payments,” said the source who had been on the joint task force with the People’s Bank of China.

But the source added, “We probably won’t be seeing South Korea or Western countries reaching the point of using a Chinese digital currency for payments in the near term.”

By Park Hyun, staff reporter

※Editor’s note: This article was originally published in January 2020 in Korean.

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