February 4, 2021

editorial

CHINA: Digital currency is a hedge against dollar supremacy

BY Gabriel Wildau

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( 5 mins)
  • Among global central banks, the People’s Bank of China (PBoC) has been among the most aggressive in research and development of a blockchain-based digital currency, including at least 130 pending patent applications.
  • Beijing appears to have diverse motivations, including technological leadership, better visibility into payment transactions, and a hedge against risks from dependence on the US dollar.
  • A digital renminbi is highly unlikely to threaten to the dollar’s dominant role in international payments or as a reserve currency.

The PBoC formed a dedicated research team for digital currency in 2014 and declared in 2016 that the launch of a PBoC-backed digital currency was a “strategic goal.” The PBoC appeared to accelerate its efforts following Facebook’s proposal in June 2019 for Libra, a digital payment system backed by a basket of global reserve currencies. The PBoC launched a pilot program for the issuance of so-called digital currency/electronic payment (DCEP) in four cities in April 2020, with RMB 200bn (USD 31bn) in transactions completed by November. Beijing plans to showcase DCEP at the 2022 Winter Olympics.

The government’s motivations for pursing DCEP are diverse. In announcing the strategic goal in 2016, the PBoC cited mostly technical benefits: financial inclusion, efficient payments, lower costs associated with issuing and managing physical currency, increased control over the money supply, and improved enforcement against tax evasion and money laundering. While the technical rationales are persuasive as such, geopolitical and national security considerations are likely also at work.

Not a threat to the dollar

Wang Xin, head of the PBoC’s research bureau, warned in 2019 of risks to China if Libra gained wide acceptance and was based on a dollar-dominated currency basket: “There would be in essence one boss, that is the US dollar and the United States. If so, it would bring a series of economic, financial and even international political consequences.” His comments fueled suspicions that China’s leadership views DCEP as a tool to displace the greenback from its dominant role in international payments and as a reserve currency.

Chinese policymakers have paid lip service to “renminbi internationalization” since at least 2010 but have also demonstrated an unwillingness to embrace the difficult financial reforms that would be required to achieve this goal. The most important would be loosening of foreign exchange controls that restrict cross-border capital flows, which would entail significant financial risks associated with capital flight and exchange-rate volatility. Indeed, the PBoC has indicated that some capital controls will remain in place indefinitely. Moreover, despite occasional griping by Chinese officials, the dollar-based system has served China well, enabling it to become the world’s largest exporter and to conduct significant foreign investment through the Belt and Road Initiative. Overturning this system – while perhaps desirable in principle – is not a high priority given the potential downsides.

Though DCEP could streamline renminbi cross-border payments, the lack of an efficient payments system has never been a primary obstacle to greater international use of the renminbi. In 2015, China launched a new platform for cross-border renminbi payments, the Cross-Border Interbank Payment System (CIPS), modeled after the widely used Clearing House International Payment System (CHIPS) for US dollar payments. Though technically functional, CIPS has failed to spur greater international adoption of the renminbi, which accounted for only 1.9% of international payments in December 2020, down slightly from two years earlier, according to Swift.

A hedge, not a replacement

Beijing likely views DCEP as a hedge against dollar supremacy, rather than a replacement for the dollar. Even if a renminbi DCEP never captures a significant share of total international payments, DCEP could still be useful for conducting certain sensitive transactions outside the reach of US financial sanctions and surveillance. Though US action to cut China off from the US dollar-based financial system is unlikely in the short and medium term, in the long term Beijing must plan for this contingency. Digital renminbi could mitigate – though certainly not eliminate – the resulting damage to China’s economy. Beijing is likely also seeking to reduce China’s reliance for international payments on the SWIFT network, which US intelligence agencies have thoroughly penetrated, according to documents leaked by Edward Snowden.

Data and surveillance

In terms of access to valuable payments data, DCEP could shift the balance of power between the government and private technology companies. As previously discussed, a significant motivation for the government’s recent crackdown on Ant Group is concern that Ant and rival Tencent maintain a near-monopoly on transaction data from mobile payments. Law enforcement and other agencies have mechanisms to obtain data from Ant and Tencent, but their access is far from seamless.

In the near term, as previously noted, regulators may force Ant and Tencent to feed their proprietary data into a PBoC-backed centralized database that would be accessible to both other financial institutions and government agencies. In the long term, DCEP could replace the current settlement and clearing infrastructure underlying Ant’s Alipay and Tencent’s WeChat Pay platforms. This change would be undetectable for average users but could enable both financial institutions and security services greater access to transaction data for purposes ranging from credit rating to law enforcement to authoritarian surveillance.

Technological leadership

A final motivation for China’s pursuit of DCEP is technological leadership. Around 80% of the world’s major central banks are doing some form of work on digital currencies, according to researchers at the Bank for International Settlements. The PBoC had filed at least 130 DCEP-related patent applications by September, more than any other central bank. The PBoC likely believes that if and when central bank-issued DCEPs become widely adopted, China will enjoy a first mover advantage and increased influence on global standard setting – though it remains uncertain what, if any, concrete geopolitical benefits such influence would deliver. In addition, PBoC probably believes that blockchain is a key emerging technology with potentially broad applications and that government-led research can generate unpredictable positive externalities for the economy and national security.

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