The Future of Currency Starts with China

Introduction

Money forms the basis of an economy. It is a store of value and is vital for trade. As such, those who control the currency, control the economy. That is the main reason that currencies are regulated by a central authority(central banks) so that the economy doesn’t disintegrate. This control over the currency by the Central Bank(CB) can be manifold- they can issue the currency, demonetize it(make it valueless), toggle the interest rates so that that the supply of money is controlled etc.

Overtime, money has taken several forms – Barter, grains, precious metals, bank notes, e-banking etc. Out of these, though physical bank notes are in circulation, with the increasing penetration of internet, e-banking appears to be on the rise. Even CBs push for increased e-payment adoption. The primary reason is that it makes it easy to track illicit funding. This lets CBs have a better control over the currency and thus the economy. In the US, the government implemented it stimulus package electronically. They did not need to print trillions of physical notes. So it does make sense to promote e-banking.

US and the Dollar

USD has been the reserve currency since the Bretton Woods Conference in 1945. The shift to fiat currency in 1971 further hardened its position. Thereafter, the demand for USD grew as every country wanted it for foreign trade. This made the Federal Reserve(CB of US) more powerful.

It used this power to impose economic sanctions on parties whom they found required condemnation. These sanctions basically prevent such parties from using the currency. By cutting off the ability to transact in dollars, the United States can make it difficult for those it blacklists to do business. For example, in 2015, the French bank BNP Paribas was given a record penalty of nearly $9 billion for violating U.S. sanctions by processing dollar payments from Cuba, Iran, and Sudan. This has led some major economies to find methods to reduce their dependencies on the greenback.

Russia and China last year tried to build a cross-border inter-bank payment systems parallel to the SWIFT. Both these countries have significantly reduced their US sovereign debt holdings significantly. Other countries like India, UAE, Japan etc. are entering into currency swap agreements to bypass using USD.

China and the Digital Yuan

Though China is the largest exporter in the world, the Yuan just accounts for 2% of global trade as against 62% of USD. This coupled with the sanctions US imposes made led to China trying to look for an out from the USD regime.

One way how China tried to increase its influence is through overseas lending, lending to foreign banks and governments. According to HBR Review, the Chinese State and its subsidiaries have lent a total of $1.5 trillion in direct loans and trade credits to more than 150 countries worldwide – making China the biggest lender surpassing World Bank or IMF! But still, transacting over the existing payment infrastructure makes it easy for the service provider to collect data on them. This, China is not much fond of.

The other move is what we are interested in. The Digital Yuan or a Central Bank Digital Currency(CBDC).
A digital currency is like a cryptocurrency in the sense that it is a block of code. But unlike cryptos, the CBDC is centralized and controlled by an authority – Central Bank(CB) in this case.

China has been looking at the possibility of a Digital Yuan since 2014. For a country where there is already a greater penetration of e-payments, a shift to digital currency does not change a lot for the users. But for the CB, it gives them more power. Earlier, CBs could not directly give money to the individuals. But now, CBs can target individuals and transfer money. It will also enable the government to track the money more efficiently and prevent illicit funding.

Fan Yifei, deputy governor of the PBOC, said last year that there is a “pressing need to digitalize cash and coin” as producing and storing these currently is expensive. In 2020, China did a test with people in some provinces and it seemed to work. For every digital Yuan made, physical ones are destroyed so as to avoid excess money in the system. They are planning to phase out physical currency eventually.

Closing Comments

Being the first to the game, China has a lead over all other economies at this point. Once this becomes the mainstream in China, they will push it out to its trade partners and their debtors. This will increase the Digital Yuan’s circulation and will eventually bring the global economy under its hands if others don’t follow suit.

Default image
Shreesha S
Shreesha writes about Business, Finance and Tech for The Snippets Journal. He is also the Founder and Head of Content Development.
Articles: 192

Leave a Reply