Is the US Dollar Falling Behind in the Move Toward Digital Currencies?
China recently became the first major world economy to launch a central bank digital currency (CBDC). It’s the culmination of a five-year development project — and something that over 60 other countries are currently investigating. Undoubtedly, the world will be watching the rollout of the digital yuan with interest.
What Is a Central Bank Digital Currency?
There are many existing digital currencies, commonly referred to as cryptocurrencies. They are developed using sophisticated mathematical and computer engineering protocols. These prevent them from being counterfeited and mask the identities of their users, making transactions anonymous.
Cryptocurrencies can be centralized, in which case their value is determined by a central hub that also verifies their authenticity. They can also be decentralized, meaning their value is constantly being verified globally by multiple devices datamining transactions. Bitcoin is an example of a decentralized cryptocurrency.
Where CBDCs differ is that they are a digital version of a country’s existing currency. As such, they are legal tender and can be used ubiquitously. They are also centralized and backed by a central bank in the same way fiat currency is. However, there is no anonymity with a CBDC — governments know exactly who holds the currency and what they do with it.
How Does a CBDC Benefit China?
China realizes several benefits from the development of the digital yuan. The most innocuous of these is to get its sizeable unbanked population participating in the mainstream economy. In the absence of a digital currency, this would involve expansive traditional banking infrastructure. But digital currencies don’t require bank accounts, and they can be rolled out rapidly and cost effectively.
Digital currencies also bypass the SWIFT transfer system. In China’s case, this offers protection from possible future US sanctions. Many experts see this as the main reason behind China’s rush toward currency digitization. Others are more concerned about the implication for the dollar in the rise of another, more readily tradeable major currency.
Currently, almost 90 percent of international transactions are settled in dollars, compared to 4 percent in yuan. That makes the dollar the most popular reserve currency. Central banks and other institutes maintain stocks of the American currency to cover debt obligations and transactions. Plus, commodities like oil and minerals are generally priced in dollars. But with China’s trade transactions growing and the dollar being highly regulated, its reserve status could be threatened.
Finally, a digital currency allows China to track spending patterns more precisely. This shift can improve planning decisions while allowing the government more insight into its citizens’ private activities.
Will America Develop a CBDC?
In February, Federal Reserve Chairman Jerome Powell confirmed that a digital dollar was a high priority for the institution. But also, he alluded to numerous technical complications and policy concerns that necessitate the need for consultation. It appears the Fed is working with MIT on the matter, but the project is still in its early stages. Powell doesn’t appear to be spooked by being beaten to the punch by China — he emphasized the need to get it done right rather than first.
What Do Countries Consider When Assessing CBDCs?
Americans will need to wait for clarification on the issues Powell refers to. In the meantime, the European Central Bank’s (ECB) Report on a Digital Euro gives some insight into the complexities countries face with CBDCs. The report acknowledges the need for careful consideration of a digital euro. However, it states that given the bank’s mandate to secure trust in money, ensuring the euro is ready for the digital age is critical.
The report lists the ECB’s requirements for a digital euro as:
· Accessibility
· Robustness
· Safety
· Efficiency
· Privacy
· Legislative compliance (including legislation on money laundering and the financing of terrorism)
What Does the Future of Money Hold?
Digital currencies are currently being designed to co-exist with cash. However, the ECB’s report provides context to a situation where digital currencies become essential — one being a significant decline in the use of cash. The resulting exclusion of unbanked persons from the economy would force central bank involvement.
Another possibility referred to in the ECB report is one where foreign digital money largely displaces existing means of payment. While it’s not clear if this refers to the dollar or the yuan, it’s clear the ECB regards a digital euro as essential to EU sovereignty. A view other countries are sure to share is adding support to future wide-scale use of CBDCs, at least for those countries that have the resources to fund the development and rollout of a CBDC — but what of those that don’t?
What role would commercial banks play in the world of digital currencies? Will we see an end to the intermediation function of banks and their funding costs? Those still feeling the after-effects of the 2008 financial crash may hope so. But it’s more likely the banking industry will be a key stakeholder in any consultations in the future. The ECB’s report already seems to indicate a preference for public sector control over ancillary, user-facing services, with issuance remaining centrally controlled.
