After a gap of almost a thousand years China is poised for another revolution that reshapes our understanding of what money means and, by definition, how we conduct our day-to-day lives.
The country that invented the concept of fiat money in the 11th century says it will be first to launch its digital equivalent in the 21st.
China’s pacesetting role in the history of money, particularly during the Tang and Song Dynasties, is often overlooked in the West. In more recent times Europe and then the US has moulded more of the global financial system. But the Chinese government is determined to loosen the dollar’s grip by leading the latest changes being driven by the digital era. The past week has been punctuated by a series of announcements and a piece of legislation that could bring that closer to reality – with China ahead of the rest of the world.
All of this was heralded by comments from President Xi Jinping last Friday that China should “seize the opportunities” afforded by blockchain. His pronouncement prompted a spike in internet searches as people tried to understand better what blockchain was. But it was also significant that the government was effectively endorsing a technology it has restricted on fear of losing control over its financial system. Commentators were soon pointing out that China is set to become a leading force in cryptocurrency, despite its previous opposition.
The turnaround prompted similar spikes in the value of companies associated with blockchain. Nasdaq-listed Xunlei’s shares doubled in the space of a single day, for example.
On the day after Xi’s remarks a new cryptography law was announced to regulate data encryption. Then at the beginning of this week, Huang Qifan, vice chairman at the think tank China Centre for International Economic Exchanges (CCIEE), gave a glimpse of the plan to issue the world’s first sovereign digital currency, something that has been dubbed DCEP (digital currency electronic payment).
In a speech to the inaugural Bund Summit in Shanghai, the influential former mayor of Chongqing explained that “for a sovereign state, the only cryptocurrency that works is one backed by government”. What he means is that only governments engender the levels of trust that can convince end users to accept a means of financial exchange with no intrinsic value of its own. In this respect, the new digital currency shares much the same principle as its Song Dynasty predecessor. In 1168 the Song government ruled that its bank notes couldn’t be converted into metal, making China the first sovereign state to issue paper money unbacked by a physical commodity held as a reserve by the issuing institution. (Later European visitors like Marco Polo were astounded, particularly as they didn’t have paper currencies of their own).
Successive dynasties struggled to comprehend how overprinting of money fuelled inflation, corroding the value of the commodity that backed it – i.e. the trust in the government’s ability to make it good (fiat). But Huang’s speech also laid out why China hopes to take more of the lead in the digital era, especially in dismantling the “exorbitant privilege” granted by the dollar’s enduring star power.
The greenback’s dominance hasn’t dimmed, even as China carves out an ever-greater role in global trade flows. The most recent data from the Bank of International Settlements showed that the dollar accounted for 88% of the $6.6 trillion traded on the foreign exchange markets each day in April. China’s yuan came in eighth on just 4%.
Even the projects being financed under Beijing’s Belt and Road Initiative are mainly dollar-denominated, Central University’s Zhang Liqing has noted, telling Yicai.com that just 14% of BRI payments are transacted in the renminbi.
Huang added that global payment systems such as SWIFT and CHIPS have “become financial instruments for the US to exercise global hegemony and carry out long-arm jurisdictions,” such as punishing financial institutions that transfer money to countries, companies or individuals that Washington doesn’t like.
China wants to exert more of that control itself and it would also look to remedy a situation of currency overshoot in which the dollar’s international status has created a ballooning of US debt and the Fed’s balance sheet as it tries to absorb global financial shocks.
Huang says that digital currencies should be linked to bedrocks like sovereign credit ratings, national GDP, fiscal revenues and gold reserves to keep them stable. How this will be achieved under the Chinese plan is still to be articulated, although the outlines are becoming a little clearer. Huang said that the Chinese will launch an encrypted, electronic form of money based on blockchain (a system of digital ledgers or ‘blocks’ of information, maintained across a network or ‘chain’ of computers) that accredited users will have access to. He added that the new round of e-money would be launched in two stages. The central bank would issue DCEP to authorised institutions, which would then make it available to the public.
Huang also made clear that the government doesn’t envisage a “digitisation of China’s existing currency, but an alternative to M0” (defined as coins and notes in circulation outside the central bank).
Forbes has reported that the participating institutions are likely to comprise of China’s big four state-owned banks, plus Alibaba and Tencent. Of course, a digital currency based on blockchain technology would allow the central bank a clearer idea of where the currency ends up, something that is giving the two tech giants their edge in the payments business. Huang said as much when he noted that DCEP would help the government to formulate monetary policy and counter money laundering.
He hasn’t mentioned a launch date for the currency but some commentators believe that regulators have accelerated their plans on concerns about the implications of Facebook’s Libra project, which was launched officially in June.
Facebook’s plan envisages the issuance of digital stablecoins, tied to a currency basket dominated by the US dollar. In theory that should make Libra more secure than cryptocurrencies like Bitcoin, which aren’t backed by anything at all.
Facebook views Libra as a means for its 2.41 billion monthly active users to conduct financial transactions, particularly the millions of ‘unbanked’ customers in the world’s frontier markets. But China sees Libra as more of a threat to its own ambitions, not least as the renminbi hasn’t been included in its currency basket. So too do many of the world’s finance ministers. In a recent Financial Times editorial, French Finance Minister Bruno Le Maire said: “I cannot countenance one of a sovereign state’s most powerful tools, monetary policy, falling under the remit of entities not subject to democratic control.”
Libra would break the contract between sovereigns and the merchant class that has existed since the Bank of England (BoE) was established in 1694. In return for being allowed to create and manage money, banks agreed to governmental oversight and accepted central banks as lenders of last resort by depositing some of their reserves with them.
The BoE’s current head Mark Carney has suggested that central banks should work together to create a public version of Libra, backed by multiple currencies. But many politicians in the US see control of their currency as a security issue. In testimony to Congress last week Facebook’s boss Mark Zuckerberg played to a similar theme, warning that a Chinese alternative would be the main winner if Washington blocked Libra, and predicted this would also weaken America’s financial leadership around the world.
China’s media broadly welcomed the talk of the new currency, with the Global Times describing it as China “striving for a place in the financial world of the future”. But their were more cautious noises. The People’s Daily – concerned by surges in share prices at crypto firms – noted: “Of course the future of blockchain is here but we must stay rational. Blockchain innovation does not mean speculating virtual currencies … We must also see that the blockchain is still in the early stages of development.”
Mu Changchun, one of the principals leading the digital currency initiative, has also pointed out that even the most sophisticated blockchain couldn’t handle the 92,771 transactions recorded each second during last year’s Singles’ Day shopping festival. So as with most new policy ideas in China, expect a pilot scheme in which the new currency will be tested and trialled likely in a couple of cities.
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