Is the US Dollar Going to Be Challenged
By the Chinese Central Bank's Digital Currency?
In the digital age, the future of currency is also getting the public's attention. On April 16, the Libra 2.0 White Paper was released, which stated that in addition to being a currency based on a basket of fiat currencies, the Libra would also be pegged to one single currency. During the same period of time, the Chinese central bank launched its digital currency. According to media report, this digital currency was piloted by some large state owned banks in Suzhou and Xiong'an, therefore making its formal entry from the digital world into the real world.
The Chinese central bank's digital currency is called DCEP (Digital Currency Electronic Payment) or CBDC (Central Bank Digital Currency). Based on the details revealed so far, at its current stage, DCEP is primarily to replace the cash in circulation (M0). It is backed by sovereign credit and is equal in value to China's fiat currency - the RMB.
There are many views of the DCEP, the most radical of which is that by making this move, the Chinese central bank aims to overtake its competitors through technological means, and DCEP might challenge the US dollar's status and end its hegemony. As DCEP is becoming a reality, people wonder, what is the true capacity of DCEP, and how will it change our life or the financial ecology?
Will DECP challenge the status of the US dollar?
One radical view believes that by being the first to promote a fiat digital currency globally, China can occupy the dominant position in the area of global electronic payment. DCEP therefore represents not only progress in fin-tech, it will also be a shock to the US dollar's status as the tool of international settlement. In this view, DCEP will not only challenge the status of the US dollar, it will also accelerate the global de-dollarization process. Against the backdrop of the US-China trade disputes, this political consideration is particularly easy to gain currency.
However, the fact is, a currency's international standing depends primarily on the country's comprehensive national power and the degree of health and stability of its economy, instead of the form the currency takes.
Although DCEP, to a large extent, can increase the RMB's convenience of use in electronic payment, convenience is only one of the factors people consider in using a currency. Equally important are the stability of the currency's value, and the degree of identification with the currency by the other parties involved in a transaction. Although the US economy has seen big fluctuations this year with the twin shocks of both Covid-19 and oil crisis, US dollar continues to be the dominant currency in the international market. While it is a nice aspiration to have the DCEP weaken the hegemony of the US dollar, the only sure way to raise the RMB's international standing is through economic development and the strengthening of China's comprehensive national power. The overly high expectation of DCEP is actually beyond its designed capability.
In terms of a currency's scope of use, whether the DCEP will be used extensively remains to be observed. Compared with digital currencies such as the Bitcoin, which have already been in operation, DCEP is yet to be extended to large-scale use. DCEP not only has to compete against traditional paper currencies, it also faces competition from non-fiat digital currencies such as Bitcoin. Yet DECP's advantages over these other currencies are not very obvious.
Meanwhile, China is not the only country promoting central bank issued digital currencies. Advanced economies such as the US, Europe and Japan are also making digital currency plans. If many countries come up with their digital currencies down the road, the global market will see competition among digital currencies of the major economies.
Based on the above, whether DCEP can gain widespread use depends on how its competitiveness can be increased. However, its competitiveness is yet to be seen at this stage. Moreover, it takes a long time for a currency to go from pilot to general use. For these reasons, people should not have too high an expectation of the DCEP in the short term.
In terms of giving China more power in influencing international financial discourses, DECP is yet to touch upon the needed deep level financial reforms. It is some people's opinion that the launch of DCEP enables China to occupy the high ground in global digital currency or even block chain innovation. This makes sense, but to give China more influence in international finance, deep level financial reforms cannot be avoided, as integration into the global financial system is the precondition for increasing China's power in global financial discourses.
With important reform measures such as the marketization of RMB exchange rate and capital account convertibility still in the air, DCEP cannot substantially give China more power in global financial discourses without the successful implementation of financial reforms and open-up at the same time. On the contrary, financial innovations stimulated by DCEP may end up increasing regulatory difficulties and creating new constraints on related reforms.
In terms of international currency system reform, DCEP will not necessarily be able to push the current system towards revolutionary changes. The challenges facing the current US dollar dominated international currency system are becoming more and more prominent, the reasons for which are very complex, but at the deepest level, it is because the international currency system is based on a sovereign credit currency. The US dollar, serving as both an international currency and a sovereign currency, faces the dilemma of having to serve the economic and social development needs of the US, while safeguarding the stability of international reserve.
To solve the problems in the current international currency system, a super-sovereign currency must be constructed. Viewed from this perspective, the birth of DCEP has not addressed the real challenge, i.e., having a sovereign currency serving as an international currency.
Digital currency in the age of digital economy
Although the impact of DCEP may fall below some people's expectation, and won't necessarily cause revolutionary changes in the current international currency system, this does not deny the importance of DCEP. It can be said that DCEP is precisely the link to the digital age. While the birth of DCEP itself is not revolutionary, its full traceability feature, closely connected with blockchain, might re-construct the exchange system in the digital economy world, and stimulate the unleashing of a new generation of potentials of the digital economy.
A digital currency's importance lies in the fact that it combines the basic features of a currency and fixes the disconnection between the old currency system and the new digital economy. Under the conditions of an advanced commodity economy, a currency has five major functions, i.e., measure of value, means of value circulation, means of value storage, means of value payment, and currency of the world. In the operation system of the future digital economy, a new generation of international currencies still needs to have the above features. Meanwhile, strengthening the integration of a digital currency with the development model of a digital economy to help unleash the growth potential of such an economy is still important. Because a digital currency is in the form of electronic payment and is easy to use globally in a digital format, a digital currency itself does satisfy the function of being a world currency.
First, as measure of value, any digital currency must maintain value stability. DCEP is backed by China's sovereign credit, and will consistently keep its value stable through the 1:1 exchange rate with the RMB. According to Libra White Paper 2.0, Libra might be pegged to a sovereign currency to maintain value stability. In comparison, crypto currencies like Bitcoin and Ethereum are not anchored and experience wide value fluctuations, making them difficult to serve as currencies in the future digital economy.
Secondly, as means of value circulation, any digital currency must channel the flow of the data element. On April 9, 2020, the Opinions of the Central Committee of the Community Party of China and the State Council on Constructing A More Perfect Market-oriented System for Allocation of Factors was promulgated. That was the first time that data was listed together with land, labor, capital and technology as the 5 factors. Although at the current stage, DCEP focuses more on replacing paper currencies, it will not be limited, mid- and long-term, to only purchases of physical commodities and offline assets.
Thirdly, as means of value storage, any digital currency must connect the pricing of digital assets. With the addition of the data factor, the participating entities of an economy will make generalized digitalization transformation an reality, at which time huge amount of digital assets will be born, while blockchain technology will become the key to the rational use of digital assets. Problems of property rights determination and rent seeking existing in the traditional Internet economy will result in the need for a great deal of legal and regulatory safeguards after digital assets are formed, therefore hindering the production and circulation of digital assets.
Lastly, as means of value payment, any digital currency must unleash digital payment's potentials. Although DCEP is not based on block chains, through its specific issuance and management models and technical constructs, it still retains the basic features of a cryptocurrency, including anonymity, security, unforgeability and anti-double spending.
"One currency, two databases, and 3 centers" is DCEP's core operation framework. One currency means there is only one DCEP, a fiat digital currency backed by the credit of the Chinese central bank, and exchanged at equal value with the RMB; two databases refer to the issuance database and the commercial bank database, which constitute the 2 layered operation system of DCEP. This means that the central bank only manages the issuance database and exchanges DCEP with commercial banks instead of directly facing the public; three centers refer to the certification center, the registration center and the big data analysis center. The registration center records DCEP flow and ownership; the certification center verifies identity; these two centers are independent of each other, thereby safeguarding the anonymity of DCEP transactions. With regards to suspicious transaction records, only the central bank has the final tracking right and can effectively control illegal transactions such as money laundering. The above controllable anonymity continues paper currency's transaction features, while stops the possibility of DCEP become involved in illegal actions.
Because of the above, DCEP also provides an important method in balancing between technological innovation and contemporary governance issues. At the same time that technological revolution is bringing tremendous increase in economic and social efficiency, it may also cause big shocks to contemporary governance models. The use of non fiat digital currencies such as Bitcoin in drug trafficking, guns and ammunitions and money laundering has alerted people that attention must be paid to the negative shocks or risks posed by technological innovation.
DCEP, as a vivid case of an official act to balance against the advantages of digital currencies such as Bitcoin and their impact upon contemporary international currency system, has provided an important experience to the international community in how to have a coordinated response to the negative shocks brought by technological revolution while simultaneously unleash its maximum positive effects.
A look at human history shows that the development of currencies has 3 stages. The 1st stage was the age of commodity credit currency, which reached its zenith with the establishment of the status of gold; the 2nd stage is the sovereign credit currency system represented by the USD. In the future, human currencies will enter into the 3rd stage in which digital technology and state sovereign credit are combined.
The new generation of digital economy, with digital currency as its infrastructure, is the key to increasing a currency's international competitiveness. DCEP has updated the form of currencies and made RMB easier to get, carry and use; it is also more efficient in settling transactions. Even though DCEP's impact might turn out to be lower than what some people have expected, it is undeniable that DCEP has many unique advantages that are different from a paper currency.
Human societies are in the midst of the transformation from physical into digital world. Even though people's production and consumption habits are gradually being reformed by digital technology, a digital economy is not just a simple industrial revolution. The older orders, old ideas and old strata rooted in the traditional economic models cannot fully adapt to the ways of value creation in the digital world. In the post-pandemic world, to ensure the continued success of DCEP, we will still need to face many technological difficulties and constraints from traditional models.
The age of digital currencies ignited by block chain technology has already become an unstoppable trend, not only to the Chinese central bank, but also to the US Federal Reserve and the central banks of other countries. In the face of this trend, no country can afford to avoid the issues of how to promote, in a secure and effective manner, the use of a digital currency in one's own country and its settlement and operation in the international financial system.
About the Author
CHEN, Gen, renowned FinTech scholar, popular technology author and successful financier in China and Hong Kong SAR.
Chen is an invited professor of Beijing University, postgraduate student advisor of Beijing Forestry University, Visiting Professor of Nanjing University of Aeronautics and Astronautics. He is a media commentator of China Daily,
China First Financial Magazine.
Chen has undertaken a number of projects entrusted by China's National Ministries and Commissions, involving financial technology, financial services, real estate and other fields. He was commissioned to conduct research and lectures by General Electric of U.S., the United States Wall Street Stock Exchange, NASIDAQ, Samsung, Hyundai, LG, Volvo, Siemens, Mercedes-Benz, China Securities Regulatory Commission, Hong Kong Stock Exchange, Hong Kong Securities Regulatory Commission, Apple, Google, IBM, Agricultural Bank of China, China Life Insurance, Bank of Communications, Citibank, Xinhua News and CCTV.