New Digital Currency Could Augment China’s Strategic Influence

Tue, Jun 2, 2020 - 3:04pm

“The Chinese government is quietly unleashing a financial innovation that will reshape its economy and improve its strategic standing for decades to come,” wrote Aditi Kumar, a recent guest on FS Insider. She explained China’s push for national digital currency, how this digital yuan will directly impact the U.S. and how the U.S. is already far behind in its own digital currency innovation. See below for excerpts from her interview with FS Insider.

For audio, see China Launches First Shot in Digital Currency Wars.

You recently wrote an article discussing China’s push for a national digital currency. Can you explain how China got to this point and where they are in the process?

China undertook their digital currency project about five years ago, in 2014, to introduce something called the DCEP project, which stands for Digital Currency Electronic Payments project. It was part of this broader strategy to modernize the high-tech sectors in China, and particularly, to respond to broader financial technology developments. As part of that effort, the People's Bank of China has been conducting research into digital currencies.

In 2019 those efforts seemed to accelerate when Facebook introduced the concept of Libra, which was Facebook's version of a digital currency that they would offer on their platform. At that time, top officials in the PBOC, the People's Bank of China, commented that it was Facebook’s introduction that was accelerating their own efforts to develop a digital yuan because they did not want to cede ground to a Facebook digital currency that would undoubtedly gain rapid adoption given the fact that Facebook has billions of users around the world.

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So, 2019 was when we really saw this acceleration. Recently, in April of this year, China piloted their digital currency in four cities. It was mostly used to compensate civil servants and to give them the option to use the digital currency to buy transportation benefits, and to use it at select retailers. Officials have said they would like the currency to be in ubiquitous domestic use by the Winter Olympics in Beijing, which are slated to be held in 2022.

Would this be replacing all physical cash in their economy?

China is already one of those economies that uses digital cash today. About 80% of payments in China are on mobile platforms. So, the switch from using digital cash as it exists today and using the digital yuan, which they have developed, is actually not that disruptive to the Chinese economy or society.

Instead of using Alipay or WeChat pay, which are some of the apps that consumers are using today, they could switch to a government provided app or possibly just use those existing apps which interface with the digital yuan. We do expect that in the next couple of years, the digital yuan will predominantly be the mode of transaction for most, if not all, transactions in China.

In your article, you wrote this development could significantly improve China’s strategic standing for decades to come. Why is that?

I've been thinking hard about why China has invested so much money into moving to a digital currency given everything I just said about most of the transactions in the domestic economy already being digital or on the mobile platforms and given that the government has close relationships with those firms. I think one of the main reasons that China would invest in this is to facilitate cross border payments.

Right now, cross border payments, whether it's trade between countries or remittances going back and forth, are primarily handled in some fashion by U.S. institutions. One way is through what's called correspondent banks. These are banks that act as intermediaries. If I want to send a payment from the U.S. to India, for example, there are some banks in the middle that will help get that payment from point A to point B, and a lot of correspondent banks tend to be American. And, a lot of the payment infrastructure is overseen by U.S. authorities.

One reason that digital currency could augment China's strategic influence is that if cross border payments end up moving to this architecture using their digital currency technology, then it could disintermediate a lot of U.S. institutions that are currently part of the payment system. What that means strategically, is that the U.S. relies heavily on the influence it has on cross border people payments, it helps us implement sanctions policy. When we cut countries off from our institutions, it literally means that they can't send payments abroad. So, we break that dependency.

Another reason is that U.S. authorities rely on monitoring the payment infrastructure to get information on terrorist financing and other types of illicit flows. We might lose that visibility as well. So, there are geostrategic benefits to China sort of moving into this space and introducing a technology that could eventually, not in the next two years, but in the long term, be something that could be an alternative to the U.S. dominated payment system.

Given that scenario, it seems like the U.S. has a huge motivation to launch its own digital currency to compete with the digital yuan. Is that the case?

I think we certainly need to start exploring and do it in a very meaningful way. As of now, China, of course, is years ahead, but even some of our allies like the European Central Bank, they have convened a working group that’s exploring digital currencies among six central banks. Canada, Singapore, Hong Kong and Thailand and a host of other countries are already piloting different projects.

The point is that the U.S. is just now starting to have the conversation. We haven't even done the basic work of convening a working group of the Federal Reserve, the Treasury and all the other actors that need to be involved in this, to begin exploring the benefits and the risks of it.

I think the first step would be for the U.S. to engage in the conversation. This should be both domestically, and along with our allies, as this technology is further explored in order to understand what a response to the digital yuan might be, and how we might manage some of the risks of a digital currency.

For us to do this in a responsible way, we need to think through what it means for user privacy. We need to think through what it means for cybersecurity. We need to think through how the Federal Reserve will develop the operational capacity to undertake a lot of things that the private financial sector does today. These are really difficult problems. And of course, it's taken China five to six years to get where they are today. It'll take us a similar amount of time. The main thing is that we need to start the work.

To listen to our full-length interview with Aditi Kumar click here. If you're not already a subscriber to our FS Insider podcast where we interview book authors, strategists and industry experts from across the globe on all things economics, finance and markets...

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