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The Digital Yuan – A Step Toward Global De-Dollarization?

May 26, 2020

People’s Bank of China Confirms Existence of Digital Currency Electronic Payment 

China launched its nationwide Blockchain Service Network (BSN) on April 25th to provide firms and software developers the opportunity to test and develop blockchain-based applications. The BSN can host about 300,000 transactions per second and was built by the People’s Bank of China (PBoC) with assistance from major Chinese telecom companies.  

Screenshots from a pilot app, circulated on the social media platform WeChat, suggested that the PBoC also began development of a digital yuan. CoinDesk later verified the posted front-end interface, and shortly after, the PBoC confirmed the testing of a Digital Currency Electronic Payment (DCEP) with 19 well-known restaurant chains in Suzhou, Xiong’an, Chengdu, and Shenzhen. The global restaurant chains involved in pilot testing include Starbucks, McDonald’s, and Subway. Enterprises in the city of Suzhou already plan to pay 50% of transport subsidies to local workers in digital yuan. 

The state-owned Agricultural Bank of China owns the mobile app where iOS and Android users can access the test application. The app allows for QR Code payments and fund transfers between users by ‘touching’ two phones together. Payment transfers are also available through NFC technology or Bluetooth without an internet connection. The digital yuan will also function with AliPay and WeChat Pay to prevent money laundering and tax evasion. Plans for digital yuan implementation could be ready for Beijing’s upcoming 2022 Winter Olympics.  

The PBoC began the development of a digital state currency in 2014 and established the DCEP research institute soon after. Blockchain technology was included in China’s 13th Five Year Plan in 2016. Currently, four state-owned banks – the Industrial and Commercial Bank of China (ICBC), China Construction Bank, Agricultural Bank of China, and Bank of China – are involved in the digital yuan’s development, along with the telecom giants China Telecom, China Mobile, and China Unicom. Tencent Holdings is also a partner.  

Unlike other blockchain technology, the DCEP is centralized with the PBoC in total control as its issuer and guarantor. Therefore, the PBOC issues digital yuan through the BSN to commercial banks for further distribution into circulation. Banks will also exchange the DCEP for other fiat currencies and assets, and sources claim that the PBoC already completed the DCEP and is currently drafting laws for its implementation. 

Critics worry that the DCEP will allow for complete government traceability and control over the money supply. Expanded use of the digital yuan would also carry massive consequences in the global economy, international trade, and geopolitics that could intensify the US-China rivalry.  

Although Unlikely, the DCEP Could Further Weaken US Dollar Primacy   

While Chinese officials suggest that the digital yuan will match the fiat RMB 1:1, there is potential for the eventual pegging of a digital yuan to gold. China and Russia have both stockpiled gold for nearly a decade, while consistently developing trade and market opportunities outside of the scope of the US dollar. BRICS meetings, for instance, often serve as a venue for Beijing and Moscow to discuss bilateral trade agreements settled in the yuan or ruble. Beijing also often advocates for the dollar’s replacement with an IMF-approved Special Drawing Rights (SDR) currency basket made up of the dollar, euro, yuan, and yen. Such a shift would slowly diminish the dollar’s importance rather than eliminate its role as a global reserve currency. As emphasized by Brazilian journalist Pepe Escobar, China’s push for SDR usage could be a diversion that does not overtly position the yuan as an eventual strategic competitor; it could be that Beijing plans instead to slowly weaken US dollar primacy through expanding usage of the digital yuan. Gold could eventually guarantee for Chinese bonds or act as collateral, gradually weakening the current system, which maintains that US trading partners export more than they import to secure dollar reserves.  

As clearly outlined in a piece in Phenomenal World, developing countries must ensure a trade surplus to accumulate dollars to prevent currency crises and deflation. The primary issue is that firms with receipts in domestic currencies gain unsustainable US dollar debt when their domestic currency drops. That is why central banks in other countries stockpile US dollar assets like debt by running trade surpluses and suppressing local wages. The other benefactors of the US-dominated international trade systems are corporations, pension funds, and wealthy individuals who avoid the retail banking system and, instead, hold offshore USD assets that grow from suppressed wages and international trade imbalances.  

The US dollar is the dominant currency for international credit and invoicing outside of the scope of the Federal Reserve because most offshore dollars are issued by non-US banks to fund trade through a stable currency. These unsecured USD deposits held outside of the US are ‘Eurodollars’, and they do not need to be related to Europe. US dollars sitting outside of the US – in Africa, China, Latin America, or Germany – are all called Eurodollars. The entire system rests on a complicated relationship of IOUs with banks clearing credit with time accounts and short-term loans collateralized by US treasury debt. Take note, 80% of trade in emerging markets is in US dollars, and this grants US elites an enormous amount of power to make money on international markets with their wealthy counterparts in other countries.  

The geopolitical advantages of the US dollar’s currency reserve status allow Washington to impose sanctions and the Fed to provide dollar liquidity swap lines. Swap lines act as a Fed backstop by arranging agreements between central banks so that the Fed can replenish dollar reserves in exchange for domestic currency during liquidity shocks. Since the Fed sets these arrangements, the central bank chooses who receives these much-needed swap lines. Given the financial infrastructure of the US dollar system, Washington’s power to impose economic sanctions by essentially freezing access to USD is devastating.  

When economic shocks like COVID-19 occur, foreign governments rely on national USD foreign exchange reserves of Fed swap lines for access to US dollars. This also means that countries depend on US monetary policy. Liquidity issues are often most persistent; the demand for USD to finance trade transactions always exceeds the supply. Although the US runs a persistent current-account deficit and maintains an outflow of manufacturing jobs, its lending or spending in US dollars never fulfills the rest of the world’s demand. Growing demand requires the Fed to step in during periods of crisis with expanded swap line programs like the recent Foreign International Monetary Authorities Repo Facility, which allows emerging markets to swap US treasury holdings for USD. The Fed now behaves like a global central bank rather than a national one to preserve America’s supremacy in the international economy and global finance.  

If the PBoC wanted to reduce its dependence on USD, it could do so by first resolving its internal imbalances and then addressing external imbalances with the United States. Capital outflows from China to the United States are ‘exported savings’ because China did not invest the value domestically. Therefore, China’s domestic inequalities, which were caused by its rapid economic rise, simultaneously benefit local financial elites while sustaining the dollar-denominated global trade system. Aside from massive wealth redistribution within China, the only way to address these imbalances would be to establish another reserve currency. Theoretically, the DCEP could be used to purchase sanctioned Iranian crude oil, and therefore bypass US sanctions and undermine the reserve currency status of the US dollar. Further, if multinational companies like Starbucks, McDonald’s, and Subway begin using digital yuan in China, their decision would reduce overall Eurodollar usage. Although a digital yuan could not currently match the US dollar in terms of liquidity and credibility, its launch could spark interest and slowly reduce the dollar’s international supremacy. 

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