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China's move on digital currency secures it an edge, but ...
WILL China's central bank digital currency (CBDC) experiment be a success? Offering 50,000 Shenzhen citizens a wallet containing around US$30 in a lottery has created momentum.
Banning the prospect of any other blockchain-based money and adopting a rigorous approach to encouraging retailer acceptance has been helpful. The citizens of Shenzhen were ready for a CBDC - two million of them applied to participate in the experiment.
The architecture of money is changing. The pandemic has led to a collapse in the use of cash around the globe. A desire to avoid touching notes and coins has combined with the expanded availability of cashless payment options in shops and a surge in online shopping.
Central banks everywhere have been jolted into action. It seems inevitable that the squeeze on cash will trigger multiple CBDC initiatives. Many will share some of the technological characteristics of crypto currencies such as Bitcoin, but will differ in three important ways.
First, a CBDC will probably exist on a centralised platform, and therefore be subject to government oversight. Second, it will be denominated in the local fiat currency at a constant value. Third, a CBDC and domestic cash will be interchangeable.
In the euro area, cash transactions account for around 10 per cent of gross domestic product (GDP). In the UK and US, it is around
5 per cent. In Sweden, which has been described as sleepwalking into a cashless society, it is less than 1 per cent. The Swedish central bank Riksbank has reacted by launching a CBDC trial, but stating openly the need to preserve a role for cash. It has stressed that cash remains the anchor for the economic system, and could be usefully complemented by a CBDC.
Nowhere is resistance to a CBDC greater than in the US, and that is in part because the commercial banking lobby is strong. Commercial banks are concerned that their role as deposit takers could be undermined by a CBDC that would be "gilt-edged". This would weaken their role in the money creation process. Federal Reserve chair Jerome Powell has defended the slow pace on a CBDC by arguing that the US payments system works effectively.
China does not have private-sector banks. All have some degree of state ownership, so there is no comparable lobby pressure. Most Chinese consumers have never known banking that was not via a mobile device, and already have limited expectations of privacy. In short, as evidence from the lottery scheme in Shenzhen suggests, China is an ideal testing ground for a CBDC.
Four state-owned banks will distribute the digital yuan, known as the digital currency electronic payment (DCEP). They will therefore be integral to its existence.
There are concerns about commercial banks being disintermediated, but there are suggestions that the People's Bank of China could re-lend DCEP deposits to the commercial banks. This would give the central bank even more oversight - and perhaps control - over the use of DCEP in the Chinese economy.
A DIGITAL CURRENCY REVOLUTION
The fact that the wins from the Shenzhen lottery could be cancelled if not spent highlights that a CBDC could be a useful monetary policy tool. Crisis support payments could be targeted at those citizens most in need, with immediate effect, rather than written on cheques and mailed to citizens (some of whom were dead) as was the case in the US earlier this year.
The international monetary system is prone to sudden change after long periods of stability. A digital currency revolution might become a threat to the role of the US dollar, in a similar way that World War II shunted sterling out of its role as the world's primary reserve currency.
The Chinese media is always keen to talk up the potential for the yuan to rise, and the digital currency experiment has given them an opportunity to do exactly that. In the longer term, the Belt and Road initiative (BRI) will provide the means for an expanded use of digital yuan for making international payments, and in particular, remittances. At the moment, the US dollar dominates BRI trade and remittance flows. Beijing will be happy to see the renminbi have an expanded role.
There is no doubt that the US is at the back of the pack in terms of the CBDC revolution. But it is home to the world's most powerful and innovative tech firms. It is well placed to catch up with China via a public-private partnership if the political will can be marshalled.
China has secured a first-mover advantage, but how decisive this will be in boosting the internationalisation of the yuan will be played out over years, not months. OMFIF
- The writer is managing director of Sovereign Focus and a consultant for Tabula Investment Management.
This was first published by the Official Monetary and Financial Institutions Forum.