by Diana Matonis, MBA
Economics, including behavioral economics, is a hobby for me. My progress over the years in understanding behavioral economics required me to learn to challenge basic assumptions about how the world is and why it is this way. Some of the most interesting cases involve formulating incentives so they work. So, this article is my own write-up to understand the local and global impact of China’s new digital currency including a separate but global digital currency impact. The question I asked myself was, “How will the purchasing power of the dollar evolve going forward if nations begin using digital currencies?” “How much will each issuing central bank know about your finances?”
Later I write how digital currencies will allow any government not just the Chinese government full access to everyone’s finances because the central bank will certainly be able to track the movement of money since it’s controlled by them. As an American, I would love to think this will never happen in the US except it already is. We recently downsized and purchased a frugal 2-bedroom small home. The lender, GuildMortgage, was as thoroughly invasive of our financial lives from years of tax returns down to our most recent and actual bank statements, exactly as we predict the Chinese are and will be with their digital currency. In the US, we have always told we have a choice, but the consequence of your “free” choice is if you don’t agree with the providers invasively written contracts, you don’t get what you need or want as we have oligarchies now, far fewer choices on providers than we enjoyed decades ago.
So how are we all going to enter the digital currency era? First, I will begin with Bitcoin and cryptocurrency that I started studying and learning about in 2014 when individuals could compete for “blocks” with a regular at-home computer. This is no longer true. You can buy it at market price using fiat money or you can still earn cryptocurrency without having to put down “real money” for it. I will elaborate on this shortly. Since these days there seems to be a race to turn physical money into digital money with China blazing ahead, I have been following China’s progress with interest. The People’s Bank of China (PBOC) is deploying its own blockchain-powered digital currency, a digital version of the yuan or the e-RMB. It is controlled by China’s “central bank”, a Central Bank Digital Currency (CBDC).
I would say this has cemented China’s trailblazer status in digital currencies far ahead of all other major nations including the US. I think of this as the Sputnik déjà vu of digital currency for America.
However, China is actually the second country behind the Bahamas in 2020 to issue its own digital currency, but it is the first major economy to roll out a digital currency. [ Central Banks Are Getting Serious About Digital Money: Map] China’s rollout guarantees its potential objective to be gain foreign exchange sovereignty. China is now experimenting the actual digital payments by consumers using their new digital currency in four cities using their existing digital online payment providers such as Alipay, owned by Alibaba’s Ant Financial, and WeChat Pay, owned by Tencent. China already leads the world in digital money transactions, so this move made sense. [ China starts major trial of state-run digital currency ]
Let me take a step back and provide some definitions of cryptocurrencies, Bitcoin, block, blockchain, digital currencies, and fiat money as these are critical to understanding their roles in the whole digital currency rollout, but also to note their similarities and differences. This should help you begin to realize the impact of China releasing a digital currency.
First, cryptocurrencies are decentralized; their economics and supply are not normally controlled by a single entity or government. There are a lot of different types of cryptocurrencies. Bitcoin is the most heard of publicly and is described as a cryptocurrency, but they are also a form of digital currency since you can theoretically buy products with Bitcoins. Bitcoin is best described as a type of unregulated virtual currency because it is completely based on people running cryptographic algorithms on computers. People who run the special software to solve math problems are called “miners” and they carry out “bitcoin mining”. What miners are doing is trying to come up with an unknown 64-digit hexadecimal number, called a target “hash”, that is less than or equal to this target hash. A miner is eligible for a reward, issued a number of bitcoins, once they have verified 1 MB (megabyte) worth of bitcoin transactions, known as a “block”. Not everyone who verifies transactions will get paid out. I will leave this for another day.
Blockchain is a specific type of database that is a tamper-proof online ledger that underpins digital coins like Bitcoin. A blockchain wallet is a digital wallet that allows users to store and manage their bitcoins, allows for transfers in cryptocurrencies, and the user’s ability to convert their cryptocurrency back into a user’s local currency.
Bitcoin is underpinned by a public ledger and this ledger records every transaction ever conducted under one blockchain. It is a mistake to think that Bitcoin provides a user full anonymity and a reason governments don’t trust it. It does provide pseudonymity as it can be very difficult, but not impossible, to connect a user’s bitcoin wallet address to the user. If you were to get that information, the wallet’s address, it would reveal that user’s entire financial history including the complete flow of funds to and from their wallet. The easiest way to get the wallet’s address is by owing some Bitcoin to another person. That person will have to give you their wallet address for you to send them the Bitcoin you owe them. Then all you need to do is plug that address into one of these special tools like a blockchain data analytic platform and see every transaction they have ever made from that wallet.
Their main advantage of digital currencies is that they will be issued and released by a country’s central bank, thereby, they will be regulated by the issuing central bank akin to our current physical currencies, and unlike cryptocurrencies. This should help prevent illegal activities including counterfeiting, money laundering, and even tax evasion because it will be easier to monitor digital currencies in real-time and keep track of the origin as well as their movement. In other words, bookkeeping is far easier using a digital currency than cryptocurrency.
Just apply what I wrote above about a blockchain wallet and getting its address. Here, with China’s digital yuan being issued by their central bank, means the ledger is centralized at their central bank and is not available to the public as Blockchains and wallets are. However, I think we can be sure that any government particularly an authoritarian government as China will have full access to your digital currency wallets and will be tracking the movement of your digital money.
Basically, this developing new technology will allow for an entirely new level of surveillance on the financial transactions of its users. Contrast this with our current paper currency, where the government usually has no idea where, when, and on what you spent your money on. As China shifts towards a fully digital currency, it will have unrestricted surveillance on all its citizens’ finances.
I also read how many believe digital currencies will help the poor and rural households who tend not to have bank accounts by reducing bank transaction costs or even better, banks may not be needed in a world of the digital currency world. It will also be far simpler to expand access to this new financial system to the poor and rural households and increase the speed of domestic and cross-border transactions. A potential negative impact of moving to digital currencies is they could undermine the existing business models of conventional banks and their role in the financial system of which countries as the US Central Bank operates largely through its banking system.
Of greater concern should be the Chinese digital currency’s impact on the US and countries who trade and borrow in US dollars. One could say that the Chinese e-RMB can become a highly effective “Chinese” financial weapon against the US (dollar) and its allies. Consider “Central banks outside Europe have been caught in this dollar vortex. They have been selling dollars and buying gold in an effort to stem the advance and recovery of the dollar. China also has a debt problem with many provinces and companies who borrowed in dollars.” [China & Buying Gold – Why?] Today, “China is also the world’s biggest consumer and producer of gold.” To add to this possibility, the International Monetary Fund (IMF) has already given its support of China’s creation of their own trial yuan digital currency.
Just imagine how the Chinese or another global digital currency could shake the very pillars of not only the American dollar as a world reserve currency but also strip America’s power to enforce sanctions. A digital yuan or other digital currency would not be disposed to US control giving countries, e.g., Russia or Iran, a way to trade without U.S. approval and circumvent the US called for sanctions.
This has already happened this past decade with US-imposed financial sanctions on Iran to prevent Iranians from using conventional bank payment methods. Naturally, Iran found a way around these sanctions by trading its oil and gas for gold with countries like Turkey. In 2013, the US expanded the sanctions by imposing rules that theoretically would halt all gold and currency trade by Iran. The US would not have this power over another country including China if the digital currency becomes adopted by a growing number of countries.
Should we believe this will never happen? I think we should be concerned. Many Democrats believe in something called the Modern Monetary Theory (MMT) which is the key factor behind President Biden’s and Democrats’ huge spending proposals. Essentially, Democrats propose to sizably expand government by borrowing trillions, while the congressional Republicans’ proposal is to drastically reduce government. One way the US borrows trillions of US dollars is by selling US Treasury bonds, government securities, which other countries and institutions typically buy, or they borrow hard cash. So, the US national debt is owned mostly in the US, but $5.4tn of our debt is owned predominantly by Asian economies.
This has caused much of the severe political divide we see in the US. It is the amount of cash infusion that remains debated between the two parties. There are always consequences behind spending as borrowing too much even if MMT says we can print our way out of our own debt. Most importantly, the more money the Treasury prints, the more it devalues the dollar. In unison, this will push inflation upward and push involved government entities to issue fiscal and monetary policies to stabilize the value of the dollar and control inflation. This will open the door for countries to seek a more stable currency than a US dollar while we decide on policies to stabilize our economy, the value of the dollar, …, and the digital currency presented by China this year may become more attractive.
To be fair, similar fiscal relief packages have been enacted in most countries over this past year due to the pandemic and will face many of the same economic woes as the US.
China may already be thinking of this and having its digital yuan become the world’s reserve currency than the US dollar. “The size of the shipments signals China’s dramatic return to the global bullion market. Since February 2020, the country has on average imported gold worth about $600 million a month, or roughly 10 tonnes, Chinese customs data show.”[Bloomberg, “EXCLUSIVE China opens its borders to billions of dollars of gold imports – sources”]
There are many hurdles ahead for China’s digital yuan to begin to achieve global adaptation. It would need to negotiate to work with trading partners or regional financial hubs to have a platform where the digital yuan is technically, legally, and financially interoperable with other countries’ digital currencies. Of course, I already mentioned It already has the support of the IMF and a joint venture with SWIFT.
As a side note on policy and a global digital currency, I’d like to say this move to a global currency is not new. “In March 2009, China and Russia called for a new global currency. They wanted the world to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.” [Why the US Dollar Is the Global Currency]
Additionally, the IMF recommended the world to adopt a global currency called the “Bancor” in 2010 and to establish with a global central bank to administer this global digital currency. Their chosen term Bancor is interesting because “Bancor” is the name of a hypothetical world currency unit once suggested by John Maynard Keynes. The IMF reported that this is only a partial move away from the U.S. dollar as the world reserve currency and urges the adoption of a currency unit that would truly be an international currency.
Thus, I opine that China could be planning to overtake the US Dollar in the future as the global reserve currency to gain a world market status and greater input into the global economy. Today, an increasing number of countries besides China feel a new one-world currency as the IMF has expressed, one not backed by any one nation, is long overdue as the economies of most nations are increasingly integrated into one.
For a long time, US businesses were basking in profit by sending so many of their jobs to China. They flourished with greater and greater profit. In return, China then sent America a growing list of cheaper products which we paid for in US dollars. Remember our debt is owned by predominantly Asian countries. Why? One good reason I deduce is that China invests heavily in U.S. Treasury bonds to keep its export prices lower. China focuses on export-led growth to help generate jobs that the US businesses have been gingerly sending over. The issue then becomes how to keep exchange prices low so China must keep its currency, the renminbi (RMB), low compared to the U.S. dollar. If China were to begin dumping US debt, this could trigger a sell-off in the bond market globally, sending US interest rates higher and possibly slowing down our economic growth. I believe China gained more in this arrangement than we did. China grew to become the world’s second-largest economy right behind the US and a major international market competitor.
Everyone seemed happy with this arrangement until the pandemic hit the world in 2020. President Trump had already pointed out that our trade philosophy with China was in China’s favor more than the USA’s favor in the long run. Tensions between the United States and China escalated as the two nations with the largest economies in the world began imposing increasing tariffs on each other’s products before the pandemic. The pandemic opened our eyes, but can we turn this around for Americans and our economy? So we have to balance how we deal with China as it does hold a lot of our debt as previously written.
I am pretty sure that China realizes that the US dollars’ days are numbered as even Europe established a special payment channel back in 2018 to allow European and other companies to continue to conduct business with Iran avoiding exposure to the U.S. sanctions. The IMF recently stated the U.S. dollar, world reserve currency, has dropped to 59% in all the transactions. If the dollar collapses, gold, digital currency, and even Bitcoin will most likely rise.
In conclusion, some of the advantages of being a world reserve currency include lower inflation and interest rates, i.e., favorable borrowing rates, than it would otherwise have. In the past though, much of the threats towards an international currency were coming from China and Russia, but now Europe has also pushed away from the U.S. dollar in 2018 with Iran. One could interpret this move by the EU as finding ways to provide a financial infrastructure for companies to avoid U.S. sanctions through our dominant world reserve status. This unanticipated additional push by America’s strongest allies may be the final key that ultimately removes the US dollar position as the global reserve currency and all the advantages the US has enjoyed over the decades.
I believe the US will have to enter the digital currency era but maybe this time learning from others than forging away and taking care of major issues known before…
I wrote this in hope that more experts in this field begin to look at how to improve our situation before it grows into an irreversible reality we will have to live with. To just give this most complicated subject some thought. I also state I am an amateur economist, and you may find some errors. Please comment to let me know!