The world first moved to paper money from gold and silver more than 1,000 years ago during China’s Song Dynasty. The next revolution - from paper money to digital currency - could happen in China as well, realizing the nation’s critical goals but with complex implications for global trade and economic order.
This transformation is being driven by China's domestic and geopolitical priorities, enabled by technology, and accelerated by the chaotic trade war initiated by the current US administration.
By mid September, US President Donald Trump announced tariffs on $250 billion worth of Chinese imports, while threatening a further $267 billion-worth. In 2017 China exported $505.5 billion in goods and services to the US, versus $130 billion from the US to China. China has vowed to retaliate with counter-tariffs. But as the smaller importer, China will need to go beyond its trade ammunition. One strategic move China could make is to release its dark horse: a digitalized renminbi (RMB).
In the ashes of the 2008 global financial crisis, a mysterious person or group of people going by the name Satoshi Nakamoto created Bitcoin. Their aim was a more decentralized world, free from intervention by centralized institutions such as central banks. How a tool is adapted generally reflects the principle, not the tool, however - and the irony Satoshi’s original libertarian followers might have to swallow is that one of the most powerful centralized institutions in the world, PBOC (People's Bank of China) - China's central bank - could be adopting Bitcoin’s underlying technology, blockchain, to digitalize the RMB.
This is not just a theory. In recent months, it has repeatedly been reported that PBOC is researching and developing its own digital currency. On 5th October, China Finance, PBOC’s official magazine, published an article analyzing the necessity of issuing an official digital currency, starting on a controlled scale. China is well placed to leapfrog to a digital currency and the Chinese government sees great domestic and geopolitical advantages in creating one.
China is already the most cashless large economy in the world, thanks to the duopoly of mobile payment apps - WeChat, by Tencent, and Alibaba’s Alipay. In 2017, the US hosted a total of $337 billion in online payments. In China, it was a whopping $15.7 trillion, $3.2 trillion more than Visa and Mastercard’s combined global volume. But Alibaba and Tencent are not owned by the state and it is highly unlikely the Chinese government will allow such a crucial shift to be controlled by private companies.
As the global reserve currency, one of the many reasons the US economy remains competitive is the dollar’s dominant role in global trade. Around $10 trillion is floating around outside the US, and despite the immense national debt, the dollar remains solid for now.
But predicting when the US dollar will lose its global dominance has become economists’ favorite sport. The Eurozone has its own internal challenges and the yen lacks global ambition. The real question now is how the PBOC will form and execute its RMB internationalization strategy.
China’s GDP will overtake that of the US in nominal terms in just a few years. But China is struggling to reconcile its ambition to internationalize its currency with its desire to maintain very tight capital controls.
The One Belt One Road initiative could allow China to control the artery of trade in global emerging markets, where most growth will take place in the coming decades. If the PBOC issues its own cryptocurrency and uses it to replace the dollar for trade along the belt and road, it could challenge the dollar’s dominance and offer optionality to these countries. A considerable portion of the belt and road trade and investments are being carried out by Chinese state-owned enterprises with a political mandate. This could make the implementation of a PBOC-backed cryptocurrency more efficient. Such a digitally controlled approach could allow China to strike a balance between capital control and RMB internationalization that wasn’t possible before.
China’s digital currency revolution would expedite the accelerating retreat of the US in international trade while serving the Chinese government’s key domestic agendas and potentially have a profound impact on the society as we know it.
Technically speaking, current limitations of the scalability of many blockchains is a barrier to creating a fully functional, efficient payment currency, especially at the scale China will need. However, the immutable nature of the blockchain technology and its smart contract capabilities offer unique incentives. If PBOC digitalizes the RMB, it would provide an immutable digital ledger directly between individual citizens, corporates and local governments. It would allow the central bank to have a perfect capital control mechanism, since PBOC’s private blockchain would create records of all capital flows. The enormous ledger would also provide reliable references for tax collections, which could even be written directly into the currency’s code.
Eradicating extreme poverty by 2020 is a key promise made by President Xi Jinping. China has lifted 66 million people out of extreme poverty in the past five years. Some 30 million people, mostly living in remote rural areas, are still living under the official poverty line of RMB2,300 (around $360) a year. The central government’s aid to those populations is often siphoned off by layers of corrupt local officials. With an account from the central bank, these families would receive this aid directly.
President Xi most recently announced $60 billion of aid to African countries focused on building infrastructure. With a digitalized RMB, China would be able to track how such financial aid is spent locally.
Such progress could serve China well globally and, in many aspects, domestically. But who will bear the costs of the disruption in the long term? Globally, a comprehensive prediction on the chain effect and the macroeconomic impact is very difficult to make.
Domestically, if every individual and business had an account directly with the central bank, it would obviously replace many key functions of the retail and commercial banks. This would require a major overhaul to an already challenged banking system. How would the PBOC facilitate all the individual and corporate lending? One path is perhaps leveraging China's world-leading supercomputers and machine learning to automate lending, like some tech startups in China are doing today with micro-lending. It could be an interesting way to prevent corruption, because it’s hard to bribe an algorithm. But it would be reckless if China left its 275% debt-to-GDP ratio to the machines.
Furthermore, immutability - the fundamental aspect of blockchain - is a commitment to fairness and potential transparency. This should be progress, but only if the government is ready for it. On the flip side, the individual price for immutability is the privacy and the personal right to be forgotten in any given financial transactions.
Most important of all - and this goes well beyond China - excessive digitalization, surveillance, and centralized data ownership are our generation's greatest and most pervasive threats to personal freedom and the modern democracy. We are witnessing by far the largest political and psychological backlash against technology globally since the first internet boom. A central-bank-backed cryptocurrency might well be a smart and inevitable step to serve crucial national interests. It might also provide great convenience in our daily lives. However, without much reflection, we have already given tremendous amounts of valuable personal data to centralized institutions and corporations in exchange for convenience or to satisfy our vanity. If countries start to issue digital currencies and we subsequently surrender our personal transaction data as well, how much more convenience we need before we realize it is too late and too impossible to be free?
With that in mind, as we release the dark horse of national currency digitilazation, the question of whether it is progress towards a better society for our future generations becomes ever-more pressing.