The People’s Bank of China (PBOC) started working on its digital currency (CBDC) in 2014. In April, the PBOC introduced pilot programs in four large cities. In July, China’s ride-hailing company said it was working with the PBOC to test the Chinese digital currency on its platform. In August, China’s Commerce Ministry said it would expand the program to Beijing and Hong Kong. The PBOC also indicated the plan to test the digital yuan’s capabilities and risks in cross-border transactions during the 2022 Beijing Winter Olympics. The digital yuan is known as “DC/EP,” or “digital currency/electronic payment.” Users will not require bank accounts. The digital wallet might allow touch payments without the internet. Unlike Bitcoin, it will be highly centralized. And the central bank seeks “controllable anonymity.” The CCP is will more likely use the digital yuan to replace all renminbi in circulation and increase surveillance on Chinese citizens. On August 7, the Treasury sanctioned 11 Chinese Communist Party and Hong Kong officials. And China’s large state-controlled banks are complying because the US dollar currently holds a dominant position. Apparently, the CCP intends to bypass the dollar system. Once complete, Beijing could share the digital currency technology with other countries and ask the Belt and Road participating countries to accept the digital yuan, creating a digital belt and road. A cheaper, faster payment system that avoids US sanctions would be a challenge to the US dollar dominance. According to the BIS, about 50 countries participated in the Central Bank Digital Currencies (CBDC) projects. The Federal Reserve has been researching on the digital dollar. On August 13, Governor Lael Brainard brought up some obstacles. Trust in the CCP has been deteriorating even among belt and road countries. Some have canceled, downsized, or postponed the projects to avoid debt traps. It is hard to say if they’ll adopt the digital yuan. That doesn’t mean ignoring challenges to the USD. Instead of merely catching the digital trends, the US government and the Fed should focus on responsible fiscal and monetary policies that protect the market’s confidence in the USD.
TranscriptChinaâ€™s digital currency (CBDC) being tested has caught the worldâ€™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. Americaâ€™s ability to sanction its enemies is significantly weakened. In this video, weâ€™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 Peopleâ€™s Bank of China, Chinaâ€™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 yuanâ€™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 Chinaâ€™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, Chinaâ€™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, Chinaâ€™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 systemâ€™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 worldâ€™s first government-operated digital currency system. As an authoritarian regime, the Chinese Communist Party might not be concerned about violating peopleâ€™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? â€œControllable Anonymityâ€ The digital yuan doesnâ€™t have an official name but is known internally as â€œDC/EP,â€ which is just short for â€œdigital currency/electronic payment,â€ 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 Peopleâ€™s Bank of China official in charge of digital yuanâ€™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 â€œcontrollable anonymity.â€ It will be able to track the usersâ€™ purchases. And therefore, the system could help fight money laundering, gambling, and terror financing. The Peopleâ€™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 bankâ€™s report, by the end of 2018, 82.39% of Chinaâ€™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%. â€œActually, 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 currencyâ€™s functionality and value. Otherwise, there will be issues with return on investment,â€ 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 Chinaâ€™s economy and every Chinese citizen, especially political dissidents. When the central bank can create and issue money digitally, it can seize the citizensâ€™ money with one push of a button. And will the digital yuan help the CCP challenge the US dollar? â€œThe Digital Belt and Roadâ€ On August 7th, the U.S. Treasury Department sanctioned 11 Chinese Communist Party and Hong Kong officials. The targets included the director of the CCPâ€™s liaison office in Hong Kong, Luo Huining, and Hong Kongâ€™s chief executive, Carrie Lam. On August 12th, Bloomberg News reported that Chinaâ€™s largest state-controlled banks are taking steps to comply with U.S. sanctions. This might sound surprising to many people. Why would Chinaâ€™s banks do anything against their government by a foreign countryâ€™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 CGTNâ€™s words, the digital currency provides quote â€œa 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.â€ 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: â€œItâ€™s very possible that other countries adopt the China framework, and then a first-mover advantage turns into a strong network effectâ€¦This is the best-case scenario for China.â€ 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 Americaâ€™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 â€œespecially if it entails significantly lower transaction costs and real-time transfers.â€ 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: â€œactively cooperate with the national belt and road development strategy.â€ A cheaper, faster payment system that can also avoid US sanctions would be viewed as a challenge to the US dollarâ€™s dominance. Then what should the United States do about it? Obstacles to The Digital Dollar The Peopleâ€™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. â€œA China victory in the digital currency race would have profound negative effects for the U.S., and Western capitalism generally,â€ he said. "If the U.S. doesnâ€™t catch up soon, itâ€™s going to lose.â€ 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 â€œRemember that credit is money.â€ 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 yuanâ€™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 CCPâ€™s control. But that doesnâ€™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 marketâ€™s confidence in the dollar. How much international acceptance do you think the digital yuan will receive? Leave your comments below. Thank you for watching Unseen Fortunes. If you enjoyed our content, please click like, subscribe, and share. Weâ€™ll see you next time!