Will China’s new digital yuan threaten King Dollar’s rule?

China is the first major economy to issue a digital version of its currency, the yuan, which is blockchain-compatible, and this development has raised concerns among some in Washington that the status of the US dollar as a global reserve currency is threatened.

“Anything that threatens the dollar is a national security issue. This threatens the dollar in the long run, “the Atlantic Council’s Josh Lipsky told the Wall Street Journal, in an article describing the digital yuan as” a reimagining of money that could undermine a pillar of American power. ”

China certainly has reason to be irritated by a global economic order in which nearly 90% of foreign exchange transactions involve dollars and where more than 60% of all global central bank reserves are held in assets denominated in dollars, as the US government increasingly relies on leverage. this reality in order to sanction countries and companies that it considers to be acting against its national interest.

Read more: Why the coming recession could force the Federal Reserve to swap greenbacks for digital dollars

Diana Choyleva, chief economist of China-focused Enodo Economics, argued in a note to clients on Monday that recent events, including the leaks from National Security Agency contractor Edward Snowden, that the US government monitors transactions on the Society for Worldwide Interbank Financial’s global interbank telecommunications network, which serves as a “wake-up call” to Chinese policymakers.

“The Chinese Communist Party, obsessed with control and very opposed to any foreign interference in its internal affairs, realized that it depended on a global payments system that could be exploited by American intelligence agencies and that Washington could use it to deny Chinese banks access to dollar financing, ”she wrote.

However, while China has geopolitical incentives to reverse the dollar as the world’s reserve currency, it is not clear that a digital yuan will support this goal, according to Eswar Prasad, former head of the China division of the Monetary Fund. international and professor of economics at Cornell University. .

“Most cross-border payments, whether for commerce or finance, are already digital, so it’s hard to imagine a digital yuan having a huge impact on international payments,” he said. A bigger development, he argued, was the introduction in 2015 of China’s cross-border interbank payment system, a rival to SWIFT. This system, paired with a digital yuan, would allow countries facing US sanctions, including Russia, Iran and Venezuela, to be paid in yuan for oil or other exports.

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But Prasad said that a digital yuan is unlikely to threaten the role of the US dollar as a global reserve currency, which depends on the unparalleled size and liquidity of the US debt markets, the flexibility in the dollar’s exchange rate, laws that allow capital to enter and leave the country freely, and an institutional framework of checks and balances, an independent judiciary and central bank.

While China has made strides in developing its financial markets, allowing the value of its currency to be set by market forces and allowing capital to flow more freely, there is little reason to expect it to quickly embrace the kind of Western institutions that global investors are looking for. as an environment to protect their economies, he said.

Indeed, even the share of China’s own merchandise trade settled in renminbi, as the yuan is also known, remains well below its peak in 2015, before the government cracked down on capital flight abroad, tilting its hand to international investors that for China, financial liberalization is not one-sided.

Domestic politics, rather than geopolitics, is the real motivation for deploying the digital yuan, according to Stephanie Segal, senior researcher at the Center for Strategic and International Studies.

“A lot of financial activity in China takes place on platforms like AliPay and WeChat Pay, and the central bank and other regulators did not have much visibility on this activity and this is something the Chinese authorities do not like. not, ”she said. .

Meanwhile, the Chinese economy relies heavily on abstaining from state-owned banks, which renew nonperforming loans to avoid disruption from the failure of economically important institutions. “It can be maintained as long as you have a constant source of funding,” in the form of consumer deposits, but a growing system of private money could undermine that, Segal said.

Indeed, the primary reason many governments, including the United States, are experimenting with central bank digital currency is for the convenience of their citizens and to improve the efficiency of macroeconomic policy.

During the coronavirus stimulus negotiations, liberal lawmakers pushed for legislation to include the creation of a digital dollar backed by the Federal Reserve that could be held by Americans in individual accounts with the United States. central bank. The move would have made it easier for the federal government to issue stimulus money to individuals, especially the millions of Americans with no relationship to private banks.

The Federal Reserve is currently studying the idea of ​​a digital dollar, but President Jerome Powell has said it will not budge without first gaining the support of a large majority of the American public and Congress. In March, Powell said that “because we are the main reserve currency in the world, we don’t need to rush this project – we don’t need to be the first to market.”

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