Digital currency and the new cold war

Evolving international monetary and financial system

This article originally appeared in the Digital Monetary Institute Journal.

Just as the US Treasury was mailing out physical stimulus cheques, the People’s Bank of China began its beta testing of a national digital currency in four cities. Future economists will look back on these counterpoints as the start of the digital currency era.

Discussions about alternatives to fiat currency were speculative, until last August. At the 2019 Jackson Hole Symposium, Bank of England Governor Mark Carney stated that a new form of global digital currency could be ‘the answer to the destabilising dominance of the dollar in today’s global monetary system’.

Instead, Carney said, the international monetary system could use a synthetic hegemonic currency. A proportion of the world’s financial transactions would no longer be dollar-denominated, and the demand for dollars would fall.

As Robert Kaplan, president and chief executive officer of the Federal Reserve Bank of Dallas said last year, ‘The dollar may not be the world’s reserve currency forever, and if that changes, and you tack on 100 basis points to $20tn, [that is] $200bn a year and all of a sudden we’ve got a tremendous problem.’

People seem to use the terms digital money, electronic cash, cryptocurrency and digital currency interchangeably. Electronic cash is a specific kind of digital money that allows value transfer without intermediaries. Cryptocurrency is a mechanism for such value transfer. Digital currency links the values being transferred to an external benchmark.

A globally-acceptable SHC in the form of a digital currency made from digital money denominated in a synthetic unit of account sounds similar to Facebook’s much-discussed Libra. The Libra Association recently issued a white paper in which it talked about creating stablecoins tied to national currencies alongside the original ‘basket’ stablecoin.

The consortium hopes that, ‘as central banks develop digital currencies, these CBDCs could be directly integrated with the Libra network, removing the need for Libra networks to manage the associated reserve’.

At the same time, Facebook renamed its Calibra digital wallet ‘Novi’, presumably to emphasise that its ambitions extend beyond simply serving as a personal storage mechanism for Libra value.

Many observers believe the People’s Bank of China’s work on CBDC is the most important current initiative in the world of digital fiat. The PBoC has been looking at a digital currency strategy to replace cash for years.

Three years ago, Governor Zhou Xiaochuan set out the bank’s thinking about digital currency, saying, ‘It is an irresistible trend that paper money will be replaced by new products and new technologies.’

He added that as a legal tender, digital currency should be issued by the central bank. After noting that he thought it would take a decade or so for digital currency to completely replace cash, he went on to state his intention ‘to gradually phase out paper money’.

Yao Qian, founder of the PBoC Digital Currency Research Lab, wrote in 2017 that CBDC would have consequences for commercial banks, and that it might be better to keep those banks as part of the new monetary arrangement. He described what has been called the ‘two tier’ approach, noting that to offset the shock to the banking system imposed by an independent digital currency system (and to protect the investment made by commercial banks on infrastructure), it is possible to incorporate digital currency wallet attributes into the existing commercial bank account system ‘so that electronic currency and digital currency are managed under the same account’.

This is noteworthy, and I agree with historian Niall Ferguson, who said in The Sunday Times: ‘If America is smart, it will wake up and start competing for dominance in digital payments.’ He is concerned about hegemony and argues that a good way for the US to rival Chinese initiatives such as Alibaba and Tencent is to support Libra, an argument repeated by David Marcus, the head of Libra.

Alipay and WeChat wallets store renminbi exchanged in and out of bank accounts, but as the PBoC has made clear in recent pronouncements, these will soon store the digital currency electronic payment, known as DC/EP or E-CNY, the Chinese digital currency that is being tested in Shenzhen, Chengdu, Suzhou and Xiong’an.

The contrast brings into focus the ‘new cold war’ that Ferguson has talked about. Imagine if, say, 2bn people along the Belt and Road trading corridors start using Alipay and WeChat wallets. They may begin by using their own currencies, but could shift to the digital renminbi if it offers speed, convenience and person-to-person transfers. A trader in Africa may soon find it more convenient to order goods from a Chinese partner via WeChat and settle via Alipay. And if they can settle instantly with their Chinese digital currency (or, to be fair, Libra or similar) then they will find themselves accepting the same in payment.

Along the Belt and Road, not only might digital currency be acceptable, it could be highly beneficial to trade and prosperity.

Not everyone would cheer such a development. The dollar’s ‘destabilising dominance’ gives the US the ability to use the international payments system as an arm of its foreign policy. The real and serious implication of replacing the existing payments systems with the new infrastructure based on digital currency is that no clearing and settlement means no transactions going through the international banking system. No transactions going through the international banking system means that the US’ ability to deliver soft power through Swift disappears. For anyone interested in the evolution of the international monetary and financial system, this deserves attention.

David Birch is a Member of the OMFIF Digital Monetary Institute Advisory Council. Listen to his podcast with Philip Middleton, chairman of the DMI.

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