Digital Yuan – Is it a war on cash or something else?

Estimated reading time: 15 minutes.

Photo by Karolina Grabowska on Pexels.com

The Digital yuan is an attempt by Chinese authorities to replace some of the cash in circulation with digital currency. This is a first-of-its-kind of an initiative by a major economy to create a sovereign digital currency. However, is this a war on cash or this is something that will create a tectonic shift in the global economy?

Human civilization has risen through channeling energy. We invented fire to use chemical energy. We built our homes next to the river to store water and utilize hydro energy. Lasers are channeling photons.

To better human lives, we need to continuously store and channel energy.

Money is an expression of energy and we use it to support our lives. Money is considered a store of value, and it allows us to trade with almost anyone.

If we look at the history of money. We have grown from commodity money to coinage of those commodities, to fiat currencies, and now we have cryptography as the basis of money.

CHINA IS NO ALIEN TO DIGITAL PAYMENTS

It would be hard for anybody living outside China to understand how digital payments are now commonplace in the world’s second-largest economy. Most merchants in China, from fruit vendors to Walmart, or even luxurious hotels accept digital payments. Much of this growth has taken place on the back of quick response (QR) codes, which were invented in Japan in 1994 but never really gained traction until taking off in China.

Pre-Covid China’s e-commerce was already clocking a decent $2 trillion. As per eMarketer, 52.1% of the country’s retail sales is estimated to come from e-commerce in 2021, up from 44.8% a year prior. This is unmatched worldwide. The countries with the next-highest rate of e-commerce as a share of total retail sales are South Korea and the US, where they are estimated to account for 28.9% and 15.0% respectively in 2021.

Ant Group’s Alipay and Tencent Holdings’ WeChat Pay control the majority of China’s mobile payment market.

I believe there are two parts to this whole story behind experimentation with digital yuan:

  • Firstly, Alipay and WeChat Pay are becoming too big, and almost all the digital transactions are happening on their platform (>90%)
    • Mu Changchun, director of the People’s Bank of China’s digital currency research institute, mentioned that the digital yuan could serve as a backup to Alipay and WeChat Pay, if they were to experience financial or technical problems — which could potentially affect China’s financial stability
    • WeChat Pay and Alipay own wealth of consumer’s data, and high utilization of digital yuan will eventually help the Chinese government to control big data
    • Alipay and WeChat Pay apps initially described themselves as alternatives to the government-backed banking system. However, in response to the government’s scrutiny, Alipay and WeChat deliberately now mention that they are partners to banks, not competitors. Several government-owned funds and institutions are investors in Ant Group, Alipay’s parent company
  • Secondly, this is almost a perfect time for China to dominate the world economy when the developed nations are reeling under Covid pressure. US national debt is likely to double from 102% in 2021 to 202% of its GDP by 2051 (as per Congressional Budget Office); the UK has exited from the EU in January 2020, and the EU is sliding towards a budget deficit of €976bn and the debt reaching almost 100% of the GDP. All these will have a major effect on the most favored currencies – US Dollar, Euro, and Pound sterling

The Digital yuan should not be considered as just one of the attempts by the Chinese to overtake the US in the technology field and a war on cash, however, this signals something which might further shake an already trembling US dollar-dominated global financial system.

LET’S FIRST TRY TO UNDERSTAND SOME FACTS

  • Dollar, Euro, Pound Sterling, Japanese Yen, Yuan, etc. are all fiat currencies, which are not backed by a commodity such as gold
    • The 1944 Bretton Woods agreement kickstarted the dollar into its current dominant position
    • The U.S. dollars are known to be backed by the “full faith and credit” of the U.S. government. In this sense, U.S. dollars are “legal tender,” rather than “lawful money,” which can be exchanged for gold, silver, or any other commodity (as per Investopedia)
    • Fiat money gives central banks greater control over the economy because they can control how much money is printed, and can control other important economic factors such as Inflation
  • It is a common practice for central banks all over the world to hold a significant amount of reserves in their foreign exchange. Most of these reserves are held in the U.S. dollar since it is the most traded currency in the world (as per Investopedia)
  • As per Bank for International Settlements, Dollar remains the pre-eminent international funding currency
  • However, Dollar is facing a lot of challenges:
    • The dollar’s share of global currency reserves dropped in the 4th quarter of 2020 to around 59%, the lowest in 25 years, according to International Monetary Fund data
    • The dollar’s share of official foreign-exchange reserves has declined from a little over 70% in 2000 to a little less than 60%

ENOUGH OF ECONOMICS AND POLITICAL LINGO. LET’S GET BACK TO THE ANALYSIS

Under a 2-tier distribution system, The People’s Bank of China issues the digital currency to banks, which passes the money to individuals, merchants, and companies.

While conducting beta testing in recent months, more than 100,000 people in China have downloaded a mobile phone app from the central bank enabling them to spend small government handouts (approx. 200 million yuan or $40 million in total circulation) of digital cash. However, there is no official timetable for the launch of China’s digital yuan despite various pilot programs in the cities of Shenzhen, Suzhou, Xiongan, and Chengdu. If some internal sources are to be believed, then China plans to launch digital yuan during Winter Olympics in 2022 to be held in China.

As China’s digital currency is controlled by its central bank. China’s government will now be able to monitor the flow of its currency and its people!!!

At this point, I am sure you must be thinking that isn’t this also similar to what THE Chinese do with Alipay or WeChat.

Well, to put it succinctly — When you’re sending payments over WeChat, you’re still transferring physical cash over an electronic medium. Digital Yuan meanwhile is a wholly different enterprise.

Digital yuan is more of programmable money.

As an article in Wall Street Journal notes:

“The money itself is programmable. Beijing has tested expiration dates to encourage users to spend it quickly, for times when the economy needs a jump start. It’s also trackable, adding another tool to China’s heavy state surveillance. The government deploys hundreds of millions of facial-recognition cameras to monitor its population, sometimes using them to levy fines for activities such as jaywalking. A digital currency would make it possible to both mete out and collect fines as soon as an infraction was detected.”

In a nutshell, programmable money could mean that it can be programmed to be used for a specific purpose. For example, if someone has to transfer money to merchants to buy groceries, then the money could be programmed in a way such that it could only be used to buy groceries. The money could be easily tracked to see where people are spending it. So, this is not like the money in your traditional e-wallet. This is a completely out-of-the-box beast.

WELL, WHAT ABOUT PRIVACY CONCERNS?

As per an article on coindesk:

“The director of the People’s Bank of China’s (PBoC) Digital Currency Research Institute says designing its digital currency to be fully anonymous isn’t “feasible. The anonymity of the central bank’s digital currency is limited under the premise of controllable risks”.

‘Controllable risks’ are the essence here. This could mean that China will monitor transactions, however, the identity of transacting entities is likely to remain private – Maybe until and unless they aren’t breaking any rules!

WHAT ABOUT INTERNATIONAL TRANSACTIONS?

Currently, most cross-border payments happen over SWIFT (The Society for Worldwide Interbank Financial Telecommunication) —the international payment messaging system and most transactions are denominated in US Dollars.

SWIFT dominance is already under threat due to disruptive technologies such as cryptocurrencies (Bitcoin, Dogecoin, Ethereum, Litecoin).

In April 2021, the Crypto market cap surged to record US$2 trillion (bitcoin at US$1.1 trillion). The number of transactions and the acceptance of many mainstream investors and companies are making way for a new system, which may kill fiat currencies and most recognized settlement systems such as SWIFT, Ripple, TARGET Instant Payment Settlement (TIPS), and The Clearing House (TCH).

SWIFT has set up a joint venture with the Chinese central bank’s digital currency research institute and clearing center, in a sign that China is exploring global use of its planned digital yuan.

CONCLUSION

It is true that the next big disruptive force on the horizon could be a digital dollar, which could resemble cryptocurrencies such as bitcoin or ethereum in some limited respects. The Federal Reserve Bank of Boston and the Massachusetts Institute of Technology have been developing prototypes for a digital dollar platform. However, this is still many years away.

The Digital euro is also in the making. EU is still developing the concept and conducting practical experimentation.

Digital Yuan certainly has the first-mover advantage. The U.S. central banks are taking it seriously because it may threaten their power to freeze individuals and institutions out of the global financial system by barring banks from doing transactions with them (a practice criticized as dollar weaponization).

It would surely be interesting to watch how global currencies will fare in the race to go digital. However, I sincerely hope that in this race we do not forget that the actual purpose of harnessing energy was to better human lives.

Sources: The New York Times, The Wall Street Journal, The Japan Times, PYMNTS.com, The Financial Times, Bloomberg, Reuters, Bank for International Settlements, The Development Bank of Singapore Limited, European Central bank, eMarketer, Investopedia, Stansberry Research

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: