China’s rapid development of its sovereign digital currency, the so-called digital yuan, is causing the United States to worry that it could fall behind in the race for financial technology innovation, analysts said.
The digital yuan is one of the most advanced central bank digital currency (CBDC) initiatives in the world, with the People’s Bank of China having been conducting experiments and proceeding with tests for more than five years.
And its potential success could not only mean a superior representation of central bank money to strengthen China’s domestic economy, but it could also increase international currency competition that could threaten the dominance of the US dollar, analysts added.
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“The US has been behind the curve. [But] even now the [US Federal Reserve] and Treasury are getting worried about the Chinese creating a digital currency and having it replace the US dollar as a global reserve currency,” said Nouriel Roubini, professor of economics at New York University’s Stern School of Business.
Creating a digital dollar would be a defensive move against the digital yuan. But it’s taking the US too long to make this decision if it wants to beat other countries
The US dollar currently accounts for 60 per cent of global foreign exchange reserves, well above the yuan’s 4 per cent, according to the International Monetary Fund. The US dollar’s share as a global payments currency also stood at 38 per cent in January, compared to the yuan’s 2 per cent, SWIFT data showed.
However, the US dollar’s global dominance may also be one of the main reasons the US is reluctant to move to a new form of central bank money, analysts said.
In contrast, China’s willingness to develop a digital yuan could enhance the efficiency of yuan-denominated cross-border payments and create new avenues for China to bypass the global US dollar monetary system.
“The advances of the digital yuan have pretty much caught everyone off guard in the West,” said Oriol Caudevilla, chief strategy officer at cryptocurrency banking service provider ScallopX.
“Creating a digital dollar would be a defensive move against the digital yuan. But it’s taking the US too long to make this decision if it wants to beat other countries.”
Caudevilla said it was possible that the digital yuan – officially known as the Digital Currency Electronic Payment – could have important international implications in shaping the future monetary system, even if the new currency does not become widely adopted for everyday purchases in the US and other Western countries.
The Regional Comprehensive Economic Partnership trade agreement, signed at end of last year by 15 Asia-Pacific countries including China, and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership trade bloc, which China says it wants to join, could redirect foreign direct investment flows and provide opportunities for using the digital yuan, he added.
“If everything goes well, China may have a bigger area to extend the digital yuan, much more than before,” Caudevilla said.
“You just don’t know how many countries will be willing to use it for cross border transactions and settlements, or to what extent it may replace the US dollar. This is the concern for the US.”
Over 2 billion yuan (US$307 million) has been spent by Chinese consumers using the new digital currency in 4 million transactions with retail shops, restaurants and online in four major test cities in the past year.
China should accelerate the pace of developing a digital society, raise the level of a digital government, and build a digital China
China’s digital yuan tests have predominantly been in the form of smaller-sized consumer payments in recent years, but two fuel trading companies in Dalian, in the northern Liaoning province, recently completed the nation’s first business-to-business (B2B) digital yuan payment transaction for the shipping industry, underscoring a deepening integration across industries and in the real economy.
The trial operation of the B2B online platform pilot project was carried by the China Postal Savings Bank, Dalian Detai Holdings and Xinte Digital Technology Group.
“China should accelerate the pace of developing a digital society, raise the level of a digital government and build a digital China,” Premier Li Keqiang said in the government’s 2021 work report earlier this month.
A recent survey by the Bank of International Settlements (BIS), the association of major national central banks, showed that 86 per cent of 65 respondent central banks are now doing some kind of research or experimentation with central bank digital currencies.
Central banks representing one fifth of the world’s population also plan to issue central bank digital currencies in the next three years, with US policymakers in recent months appearing to be stepping up in their focus on a digital US dollar after initially showing a lack of enthusiasm for the concept.
In August, the Federal Reserve Bank of Boston, part of the US central bank system, announced that it would conduct research with the Massachusetts Institute of Technology Media Lab on a hypothetical, retail digital US dollar, although there has been no commitment to pursue the policy processes needed to launch a CBDC.
In the US Congress, there has been a focus on ensuring the focus has been on sustaining the US dollar’s international dominance.
The Biden administration has shown support for research into the viability of a digital US dollar for the first time, with US Treasury Secretary Janet Yellen saying that, among other things, it could potentially help Americans that do not have a bank account, according to a virtual conference held by The New York Times last month.
Yellen’s immediate predecessor, Steven Mnuchin, showed less interest pursuing the idea. In 2018, he said the US Federal Reserve and US Treasury were studying the pros and cons of a digital US dollar, but “we don’t think there’s any need for that at this point.”
But at a US Congressional hearing last month, US Federal Reserve chairman Jerome Powell said the central bank was looking carefully at the possibility of issuing a digital US dollar, calling it “a high-priority project”.
If the central bank of any international reserve currency were to issue a CBDC, this may make it easier for users in other countries
Hyun Song Shin
Other central banks have also indicated some urgency to elevate their work on CBDCs beyond the research stage into actual proofs of concept or pilot testing in response to China’s advances in use of the digital yuan.
The European Central Bank said it would decide this spring, most likely in April, whether to move ahead with the preparatory work needed to launch a pilot programme for a digital euro.
The Bank of Japan is expected to begin its first phase test of a digital yen with private businesses in the first quarter of the year, while the Bank of Korea plans to test a digital won in a virtual environment this year. Some provinces in South Korea have already launched local digital currencies, using them to distribute coronavirus relief aid.
“If the central bank of any international reserve currency were to issue a CBDC, this may make it easier for users in other countries, particularly emerging markets and developing economies, to use this currency in daily transactions or financial contracts,” said Hyun Song Shin, economic adviser and head of research at the BIS. “This could accentuate the international status of the respective reserve currency.”
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