After more than 70 years of dominance, the US dollar-centric global monetary system is under challenge.
While the USD is not expected to lose its global currency status any time soon, many countries – mainly but not limited to the developing ones – have started to question the dollar system’s robustness since the 2007-09 Global Financial Crisis and seek alternatives to mitigate the USD risk.
But there is no clear alternative so far. The euro has internal problems, the yen lacks the ambition to be the global reserve currency and the renminbi still has structural problems that make China unable to let go of capital controls anytime soon.
DOLLAR DOMINANCE BEING ERODED
So the shift away from the US dollar-centric system has been a collection of fragmented actions. But they still add up to chipping away at the USD dominance; see the gradual erosion of the dollar’s share in the global FX reserves.
Dollar dominance is not just about what currency to use, but also about the clearing and payments systems. In recent years, from China to Europe and the Middle East there is a growing incentive to shift away from the US dollar-based system.
China set up its Cross-Border Inter-Bank Payments System (CIPS) in 2015. The EU developed the European Payments Initiative (EPI) in 2020. And in early 2021, China’s PBoC affiliate, the Digital Currency Institute, launched the Multiple Central Bank Digital Currency Bridge Project (or m-CBDC Bridge project) together with Hong Kong Monetary Authority, the Bank of Thailand and the Central Bank of the United Arab Emirates.
This latest effort is a central bank digital currency project for cross-border payments endorsed by the Bank for International Settlements Innovation Hub Centre in Hong Kong.
A DIGITAL REVOLUTION
China has leapfrogged the US, and the developed world, in the fintech race since the early 2000s. Its digital economic development has since progressed by leaps and bounds.
China is the world’s largest cashless economy with the most advanced digital payments network processing more than US$500 trillion a year of cashless payments since 2015, compared with less than $100 trillion in Europe and the US.
The creation of China’s (and the world’s first) official digital currency, the Digital Currency Electronic Payment (DCEP) in 2019, after five years of research and design, has consolidated its digital revolution.
While no one expects the renminbi to displace the USD anytime soon, the digital renminbi could prompt revolutionary development in China’s domestic and the world’s payments system and virtual finance, with investment implications on sectors related to digital currency transactions.
All this could, in turn, help push renminbi internationalisation, especially by breaking the costly, inefficient, corresponding banking model and through the digital Belt and Road Initiative (BRI).
Banks are starting to utilise emerging technologies, such as distributed ledger technology (DLT), which underlies China’s DCEP, to automate functions such as regulatory reporting and risk management, thus reducing transaction costs, speeding up the transaction process, increasing regulatory oversight and reducing risks.
Transactions using the digital renminbi are an integral part of China’s financial evolution, and Beijing is trying to expand it to other countries through the m-CBDC Bridge project by increasing central bank cooperation on DLT research and application and by developing a prototype for real-time cross-border FX transactions and payments in a round-the-clock and multi-jurisdictional context.
This is all part of the long-term global effort to manage/reduce the USD risk by shifting away from the US dollar-centric system and also China’s effort to challenge the USD’s supremacy via its leading edge on digital currency development.
DIGITALISATION BOOSTS THE RENMINBI
Structural changes behind the G3 currencies – the US dollar, the euro and the Japanese yen – have eroded their basic currency functions for international transactions since the GFC so that their global influence should fade over time.
Meanwhile, China has gained from what the G3 currencies have lost through renminbi internationalisation and the BRI.
The geopolitical reality behind the future monetary order is that China’s global influence is rising at a time when that of the US and Europe are fading.
China’s BRI reflects its intention to build a renminbi bloc of trade, investment and technology with all roads leading to Beijing.
Financial innovation has reinforced this global change and boosted China’s influence through digitalisation.
The Covid-19 crisis has opened up an opportunity for China to advance its BRI in digital form, extending its soft power and technological and economic influence to the developing world, as I have argued previously.
Generally, the pandemic has sped up the shift away from using cash, thus boosting digital banking and non-bank payment systems development, which are areas that China has a global leading edge.
A GLOBAL CURRENCY DISRUPTOR?
The USD’s dominance in the global financial and trade system has enabled the US to police cross-border transactions and payments and, thus, to advance its global political and economic interests.
However, if China’s digitalisation enables other countries to engage in international transactions using DCEP, that would be totally outside the US surveillance and, thus, erode its global control.
China’s digital sovereign currency would also make international loans and aid faster, more transparent and traceable. When the recipient countries use DCEP to pay for trade or infrastructure investments contracted by China, the USD and related technology will be replaced in those markets.
If there is enough penetration and acceptance of the digital renminbi in a separate jurisdiction or region, it is conceivable that a trade and finance system parallel to the USD-system can gain critical mass.
It is clear that when China sets up CIPS, pushes digital revolution, creates DCEP, implements the digital BRI and launches the m-CBDC Bridge project, they all aim at building a renminbi bloc of finance, trade, investment and technology mainly with, but not limited to, the developing world.
Digitalisation has created a whole new ballgame for China to advance its interests in the global stage, making the digital renminbi a potential contender to challenge the USD’s hegemony in the longer term.
China’s incentive to reduce the USD risk is, arguably, stronger than any other countries because deterioration in Sino-US relations has made Beijing very worried about Chinese banks’ exposure to the USD-centric financial system.
The possibility of cutting off Chinese banks’ access to USD clearing is seen as the “nuclear option” for the US to contain China’s advance. Although going down this route would be apocalyptic for the world and the US, China is unwilling to take that chance.
However, China’s official digital currency is not a silver bullet to its economic problems as many of them are structural (notably a distorted financial system with an under-developed financial market).
Ultimately, China needs to establish the renminbi’s global credibility to gain acceptance, in digital or physical form. But arguably, the structural decline of the G3 currencies has become a structural advantage for China to increase its global influence and the Covid-19 crisis has increased that advantage for China as it moves to reform its system.
LAYING THE GROUNDWORK
Before the Covid-19 crisis, the global reach of Chinese tourists already meant that Chinese digital payment providers were ubiquitous globally.
While the health crisis may have disrupted the tourism/services trade, the digital payment infrastructure for global usage of the renminbi has been set up. It can be quickly revived when tourism is normalised, and easily be adopted for other commercial and trade activities in renminbi.
A key objective of using the digital renminbi for transactions in the 2022 Beijing Winter Olympics is for foreigners to take the renminbi digital wallets back to their home countries, thus extending the reach of digital renminbi infrastructure.
Meanwhile, Chinese banks and payment service providers are continuing to build up capacity to handle increasing volumes of digital transaction volumes.
All this resonates with China’s efforts in the late 1990s to pave the way for the BRI countries to use Chinese technology while the West was ignoring it.
The Covid-19 crisis has increased the developing world’s acceptance of and demand for Chinese telecommunications and surveillance tools for fighting the coronavirus. This has enabled China to increase its global influence by advancing the BRI in digital form, and it will be easy to incorporate DCEP in the process.
DIVIDED WE MAY STAND
Nevertheless, Beijing is still unsure about what to do with the digital currency technology in a global context, as DCEP’s technical capability is inconsistent with the inconvertibility of the renminbi.
Yet these issues were defined well before the Fintech age. Before Beijing can sort out the structural problems underlying its currency inconvertibility, it is probably happy for the renminbi to be a minor player in the fast-changing global financial system.
But it appears determined to define the terms of the next, digital, financial paradigm.
Since the developing world (led by China) is more willing to accept and use the renminbi than the developed world (led by the US), when China launches the digital renminbi, a tri-polar world may emerge with a US dollar zone, a euro zone and a digitalised renminbi zone.
This is indeed how China sees the future global development. It sees itself moving into a new paradigm where the global system would be divided into three main regions, Asia, North America and Europe, with each region led by a super-regional power.
It also sees itself as the centre of Asia, engaging regional and global capital, plus financial and technological markets to enhance domestic growth and drive regional growth.
Such a new world might also lead to an internet bifurcation into a Chinese-led system and a non-Chinese internet led by the US11 with political implications.
It could create regulatory systems with different tech-management policies adopted by those countries that use the Chinese system and those that do not – to the extent that the digital BRI helps recipient countries to better manage their digital communications networks, with data management, filtering and content surveillance as a part of the process.
In a nutshell, full digitalisation of China’s monetary system may be a long way away, but the global implications, and disruptions, are becoming apparent.
The renminbi’s challenge to the dollar may come more readily in digital form than in physical form. But China does have to sort out its currency convertibility issues first despite its digital advancement.
• Chi Lo is a Senior Economist for Greater China at BNP Paribas Asset Management.
This report was upgraded on January 17, 2022 for style purposes.