Cryptocurrency mania has gripped the world as the increasing acceptance of blockchain technology by major financial institutions has propelled the likes of Bitcoin into the mainstream. Whether you believe in crypto or not, the emergence of cryptocurrencies threatens to usurp fiat money. The Chinese government has identified the threat early, and has taken significant steps to ensure they have a meaningful head start on digitizing their commercial sector and money supply. China’s long-anticipated and recently released digital Yuan threatens to undermine the US dollar’s (USD) supremacy, as we know it.
China’s digital Yuan project is the first of its kind for any major global economy. It is a version of the normal Chinese currency, deployed on a blockchain; the highly encrypted and secure online ledger technology that underpins digital coins like Bitcoin and Ethereum. The People’s Bank of China (PBOC) has led work on the digital Yuan project, which is classed a central bank digital currency (CBDC) that aims to replace some of the cash in circulation.
China has been trialing the digital currency since late 2020, and in 11 different regions since April —including major cities such as Suzhou and Shenzhen, where the digital Yuan has been used for transport, food and retail. The digital Yuan bypasses the need for central banks in transaction processes, eliminating service fees and speeding up transaction times. China has plans for the international use of the digital Yuan by 2024 or 2025, and has already established partnerships with the UAE, Hong Kong, and Thailand to promote international use of CBDCS. Given the vast extent of China’s bilateral trade relations globally, and the increasing likelihood that China will overtake the US as the world’s largest economy; the internalization of the digital Yuan is seemingly inevitable.
Decline of USD
The emergence of the digital Yuan coincides with a difficult period for the USD. The USD has become increasingly fragile of late, perhaps mirroring America’s decline within the international system, with its status as the ultimate reserve currency looking increasingly likely to be challenged in the longer term.
The USD has seen a steady fall since the start of the COVID-19 pandemic. It is down about 10-12% relative to America’s major trading partners. Some have even suggested that the USD will decline in value by 35% by the end of 2021 (REFERENCE). On-going political instability in the US has had a detrimental effect on global trust in the USD. The debasing of the USD through massive US government debt and central bank stimulus raises the question of the dollar’s long-term viability as the ultimate reserve currency.
To demonstrate this effect, we can look at the declining market of US-China bilateral trade. US imports from China dropped by US$87.3 billion in 2019 from 2018, and continue to drop so annually. The Chinese need for USD is declining. The use of USD in China-Russia transactions has declined from 90% in 2015 to less than half at present. At a rate of 10% annual decline, it will not be long before the USD is no longer used at all in China’s transactions. This vacuum left by the USD will allow for the growth of other currencies such as the digital Yuan. As more countries decide not to use the US dollar, the use of alternative currency reserves will increase. Given China’s extensive trade relations, the digital Yuan is well-positioned to take over.
China not attempting to replace USD
While it appears that the USD and digital Yuan are moving in opposite directions, Chinese officials have claimed that the development of the digital Yuan is not intended to ‘replace the USD’ as the ultimate reserve currency. Deputy governor of the PBOC Li Bo claimed that ‘efforts to create the digital Yuan are aimed at domestic use’, while Governor of the PBOC, Zhou Xiachuan, echoed that Beijing is not aiming to immediately take on the USD as a currency reserve.
Regardless of China’s intentions for the digital Yuan, the reality is that the growth of the new digital currency will likely further contribute to the weakening and destabilization of the USD. Much like when China developed paper currency in the 7th century during the Tang dynasty, China is leading the way in a key transitional phase of the global financial system. The CBDC space certainly has the potential to be a key battleground in the larger US-China struggle for hegemonic dominance. Perhaps it is time for US central banks to explore the implementation of such a CBDC project more urgently. Should they fail to do so, there is a pressing case that the USD may get left behind.
This article was first published on The Pangean.