Since Bretton Woods, the U.S. dollar has been the world’s “reserve currency” accounting for 58 percent of all foreign exchange reserves in the world, according to the IMF, and 40 percent of all the world’s debt. However, recent moves by the People’s Bank of China (PBoC) might signal a serious move for China to internationalize the yuan, and the central bank is doing so by digitizing the national currency.
Attempting to Globalize the Renminbi
Since 2009, the PBoC has worked to reduce China’s reliance on the U.S. dollar. The impetus to do so was the 2008 global financial crisis, which saw liquidity contract around the world. To begin, the country began growing and nurturing offshore renminbi (RMB) centers like London, Luxembourg and, of course, Hong Kong and Taipei. However, the onshore and offshore markets were insulated from each other, so when China launched the Shanghai FTZ (a pilot Shanghai Free Trade Zone in September 2013), it was supposed to open up the onshore markets. The model proved to be ineffective, however, and China tried other avenues.
In October 2016, the RMB joined the U.S. dollar, Euro, British pound and Japanese yen as the Special Drawing Rights reserve currency basket. This move was considered an important move by China to open up its national currency for international trade and business. Following this move, China signed swap agreements with more than 30 countries. Specifically, the central banks of Turkey and China concluded a Turkish lira-Chinese renminbi swap deal on Nov 30 2016, using both their local currencies in a bilateral trade and investment deal worth $132 million. The PBoC reported in October 2017 that, “The Chinese currency has taken steady steps on its global march and the yuan’s use on the capital account has been liberalized steadily.” China followed this move by the Belt and Road Initiative connecting Asian, European and African infrastructure agreements promoting RMB as a global currency through modern trading routes.
China has approached top oil suppliers like Russia with the yuan as payment for crude oil imports. China and Pakistan have also agreed to conduct bilateral trade in their own currencies, whereas in the past they used they U.S. dollar (in January 2018, the State Bank of Pakistan officially announced the Chinese yuan would be the foreign currency to be used in all imports and exports between the two countries). Bangladesh Bank, the country is a key participant in the 2st Century Maritime Silk Road, similarly followed suit in August of the same year declaring the yuan the currency of the Sino-Bangladesh trade agreement.
While the ongoing success of the Belt and Road Initiative may be substantial (Chinese President Xi Jinping can count 100 countries and organizations in only a few years time), it has not moved the needle enough, and one of the main reasons why has come from within. A cashless society had emerged in China thanks to Alipay and WeChat. Consumers sent US$1.7 trillion in total payments through Alipay in 2016 compared to only US$70 billion in 2012, according to the UN-based Better Than Cash Alliance, while WeChat Pay processed US$1.2 trillion, up from US$11.6 billion in 2012.
Further complicating this digital acceleration was none other than Mark Zuckerburg. This year, the announcement of Facebook’s Libra lit a fire under the PBoC, and neither side cared to hide that a race was on. While Libra may not be a decentralized cryptocurrency like bitcoin, Libra does have the potential to foster greater acceptance given Facebook’s considerable resources.
“I believe that if America does not lead innovation in the digital currency and payments area, others will,” David Marcus, the Head of Libra told the man told members of the House Financial Services Committee in a prepared testimony on July 17.
Based on patents filed by the PBoC’s Digital Currency Research Institute, China has been working on a digital RMB since 2014, but Libra changed the calculus. If a corporation was allowed to pervade China’s economy – effectively acting as an American power – it could topple the global financial gains China had made over the years and double the currency power of the dollar. So, to counter Facebook and the conglomerate national corporations on the board (none of which are Chinese), the PBoC pushed aggressively forward to be the first nation to issue a sovereign digital currency.
The Central Bank Digital Currency (CBDC) Experiment
The PBoC has created a two-tiered digital coin backed 1:1 to the renminbi. This simple system will not upset the current monetary system of the country – as it is pretty standard with the first layer being handled by the central bank who issues currency and handles redemption and the second layer is where the commercial banks operate within the retail landscape – and will also probably not use blockchain technology. According to more patents and Bloomberg reporting, consumers and businesses would download a mobile wallet and swap their yuan for the digital money, which they could use to make and receive payments. Binance, the world’s largest digital asset platform wrote a research report on the potential CBDC and they believe, “Undeniably, the two-layer network supporting the CBDC targets to achieve transaction performance of “at least 300,000 transactions per second“. As of today, blockchains do not achieve performances as high as the target requirement.”
The system will be highly centralized, and there is naturally fear that it will be a used as a tool for easy surveillance of citizens. There are ongoing questions that need to be answered like what it will take to open a wallet and whether third parties can freeze assets. Capital flight is a primary concern of the PBoC as Chinese nationals are restricted from transferring more than $50,000 out of the country per year. There are benefits in a digital RMB as it would cut infrastructure costs to maintain paper currency, which can be as high as 0.5% of GDP. Furthermore, a digital RMB would enable the calculation of more precise macroeconomic financial metrics like inflation rate.
All told, the CBDC might look a lot like Libra – also not decentralized and not on a blockchain of any note. Mu Changchun, deputy director of the PBOC’s payments department, even acknowledged as much.
Circle CEO Jeremy Allaire believes the CBDC would immediately give China an expanded role in global economic activity, and if the PBoC were to partner with some of the homegrown tech giants, it would have a consortium that could easily compete with Libra and aid in distribution. When speaking with Reuters, Director Mu confirmed that the national digital currency will work seamlessly with WeChat and Alipay, and that it also would work without access to an internet connection. These latter declarations from Mu seem to spell one thing for WeChat and Alipay: bend the knee.
Mu added that the CBDC was necessary because both Alipay and WeChat were organizations that could go bankrupt, and the CDBC will outrank these as it will launch itself into the status of legal tender – giving it a serious leg up on Libra, which has come under fire in recent Congressional hearings in the US.