January 13, 2021 | How will the Chinese government benefit from issuing its own digital currency?
Comments on China's regulatory development; How does China benefit from issuing its own digital currency?
Happy Wednesday, and welcome to all new subscribers!
Today’s focus:
Comments on China’s regulatory development
Ways the Chinese government can benefit by issuing its own state-backed digital currency
We start today’s notes by examining how I anticipate China’s technological advancements and its accompanying regulations will be perceived by the west throughout this decade.
For more information on the regulation I’m about to discuss: click here.
Firstly, I must emphasize that I do not advocate for China’s technological supremacy. Far from it. I’m merely sharing my personal observations based on the assumption that China may pull ahead of the United States in several key technological areas. These areas include, but are not limited to: artificial intelligence, quantum computing, self-driving vehicles, and financial technology (fintech).
Assuming the gap between the US and Chinese technological development can continue to expand, it’s reasonable to assume that the existing regulatory models in advanced economies are not relevant to China’s circumstances.
Rapid technological advancement will compel China into an informal ‘standard-setting’ role for outlining regulations for the future-shaping technologies I just mentioned.
China’s recent push to establish a regulatory framework to guardrail novel financial institutions like Ant Group marks the beginning of what will be a sustained interplay between state regulators and private corporations.
Again, I must emphasize that I’m in no way making the case that China’s political system could be a viable substitute for western liberal democracy. The wholesale implementation of China’s authoritarian model in the west would be an unmitigated disaster.
With this in mind, I sincerely hope policymakers in the US and EU will pay close attention to China’s attempts to craft novel regulation to mitigate the malign societal impact of the aforementioned emerging technologies. In the same vein, I urge those same policymakers to resist the urge to dismiss China’s regulatory developments as inherently illiberal or authoritarian.
I believe it is a mistake to disregard or make light of China’s regulatory innovation simply because “we think the Chinese government is bad”. Please consider that China’s regulation may be rooted in universal principles that can also apply to liberal democracies. Such principles have no bearing in ideology or cultural differences. I firmly believe the west can learn from both China’s successes and mistakes.
How will the Chinese government benefit from issuing its own digital currency?
On Monday, we explored the significance of the US dollar’s position as the world reserve currency. Additionally, we touched upon the RMB internationalization concept and presented the view that the wider international adoption of China’s currency, the RMB, could represent a direct challenge to the dollar.
In yesterday’s notes, we explored the obstacles to international adoption of both the RMB and its digital version DCEP. We concluded that RMB internationalization would be unlikely in our current free-floating currency regime; however, there are ways for the digital RMB to gain traction.
Today we will take a closer look at how internationalization and wider domestic adoption of China’s digital currency (DCEP) would benefit China. We consider this question in terms of facilitating internationalization and improving oversight over all transactions.
According to Harrison Dent of Georgetown University, China’s digital currency helps fulfill two main goals:
Increased internationalization of the RMB
Provides the Chinese government with increased oversight over transactions
On Monday, we discussed why China views the internationalization of its currency (the RMB) favorably. On Tuesday, we reviewed the main reasons why RMB internationalization will be extremely difficult, if not impossible, as long as China’s capital account remains close.
Let’s explore Dent’s reasoning and uncover the essence of what China would like to achieve with its new digital currency.
1) Increased Internationalization of the RMB
The digital RMB (DCEP) can circumvent the traditional RMB’s obstacles, as Dent illustrates:
With digital currency, a citizen of any country with access to a cellphone or computer and a digital wallet can—absent anticipated regulations—effortlessly transfer his or her country’s currency into the renminbi-backed DCEP. The DCEP will allow China to increase the appearance that its currency is marketized for more international adoption while still being able to control the flow of money in and out of its economy.
To simplify this, let’s remember that the RMB is not freely convertible to other reserve currencies like the dollar. This is the single biggest obstacle to RMB internationalization. The digital RMB is directly pegged to the fiat RMB. But unlike the fiat RMB, the digital RMB will be freely convertible on international exchanges.
2) The digital RMB also increases government oversight over all transactions
Referring again to Dent’s paper:
A drawback with paper fiat currency is the difficulty in tracing who spent the paper currency and for what. Payment intermediaries pose a similar problem for the GOC. By utilizing distributed ledger technology, the GOC can possess a record of every transaction of the DCEP. This ability will allow the GOC to monitor its citizens and companies to a historically unprecedented degree. Furthermore, if the DCEP becomes the sole Chinese currency, the record of DCEP transactions will allow the GOC to track every financial transaction involving individuals and businesses in Chinese currency. In addition to being able to limit money laundering and money for criminal enterprises in Chinese currency, the government can use a distributed ledger or digital token-based record to ensure individuals and businesses report income correctly for taxes and comply with regulations when receiving and extending loans or exchanging currency.
Conclusion
How will the Chinese government benefit from the increased internationalization of its digital currency?
Supports RMB internationalization
Allows for greater oversight over all transactions, including overseas
The Chinese government fundamentally views currency as a means of obtaining greater power and leverage in the international system. Although China views the internationalization of its currency as a geopolitical objective, it is wary of absorbing the potential negative effects of the global adoption of the RMB. Namely, China fears the price volatility from liberalizing its capital account and allowing the RMB to float freely.
The digital RMB resolves the volatility and capital account limitations by treating DCEP as a proxy asset collateralized by the fiat RMB. This means DCEP is fully convertible with fiat RMB at a 1:1 ratio while also being fully convertible with all other global reserve currencies without restrictions.
In future notes, we will examine the potential impact of China’s digital RMB on trade and explore the potential for geopolitical conflict sparked by a struggle for world reserve currency primacy.
Thank you for reading!
Best,
Kevin
US-China Relations
Americans Won’t Be Banned From Investing in Alibaba, Tencent and Baidu (Wall Street Journal)
The U.S. government is expected to let Americans continue to invest in Chinese technology giants Alibaba Group Holding Ltd. BABA +5.33%, Tencent Holdings Ltd. TCEHY 3.63%and Baidu Inc., BIDU +0.01%after weighing the firms’ alleged ties to China’s military against the potential economic impact of banning them.
New York-listed Alibaba and Baidu, and Hong Kong-listed Tencent, were among a dozen companies being examined for inclusion in a Defense Department list of firms deemed to support China’s military, intelligence and security services, according to people familiar with the matter. U.S. investors have until November to divest their holdings of any firm on the list.
Power Dynamics, More Than Ideology, Drive US-China Tensions (East-West Center)
Many commentaries discuss a resurgent ideological struggle between China and the United States. Ideology plays a role in the current downturn in US-China relations, but it is easy to oversimplify or misunderstand this dynamic. Importantly, ideology is neither the main cause nor the most dangerous aspect of China’s challenge to the United States.
The prominence of ideology in analyses of the bilateral relationship is understandable. The governments of both China and the United States use ideological struggle as a domestic political rallying cry.
Joe Biden poised to name foreign policy expert as Asia tsar (Financial Times)
Joe Biden is poised to name Kurt Campbell, a veteran foreign policy expert, to serve in the newly created role of Asia tsar, in a move designed to reflect the growing importance of US-China relations. The president-elect will announce his choice of Mr Campbell, a former top Pentagon official who also served as the top state department official for Asia during the Obama administration, soon, said three people familiar with the move.
Biden’s pick for top Asia official should reassure nervous allies (Washington Post)
Until now, the incoming Biden foreign policy team had no senior officials with a specialty in Asia. But Biden plans to soon announce a new Asia-related position inside the National Security Council and has chosen former State Department official Kurt Campbell to fill it. The move should reassure nervous Asian allies that the Biden administration is taking the China challenge seriously.
Campbell will join the administration with the title of “Indo-Pacific coordinator,” a job that will give him broad management over the NSC directorates that cover various parts of Asia and China-related issues, several Biden transition officials told me. Early reports called this position an “Asia czar,” but the Biden team doesn’t like that term. Campbell will report directly to incoming national security adviser Jake Sullivan, officials said. The Biden NSC will have several of these “coordinators,” who will have more authority than the “senior directors” below them.
The secret plan for countering China: Trump should have followed his own strategy (Sydney Morning Herald)
A highly sensitive document outlining the United States' strategy for the Indo-Pacific represented a strong blueprint for the region but Donald Trump never followed it.
The declassified document outlines how the US and its allies, including Australia, should defend against the threat of a rising China.
Dated February 2018, the strategy was previously classified "secret" and "not for foreign nationals".
It was supposed to be released in 2043 but instead was declassified by the Trump administration last week and released on Wednesday afternoon Australian time.
The 10-page document commits the US to being able to deny China sustained air and sea dominance inside the first island chain – which includes Kuril Islands, the Japanese Archipelago, the Ryukyu Islands and Taiwan – in the event of a military conflict.
U.S. Strategic Framework For the Indo-Pacific
‘Bombard the headquarters’
The image of a national leader calling on supporters to oppose his second-in-command — and the government itself — brought to my mind a moment in China’s history: The start of the Cultural Revolution.
Máo Zédōng 毛泽东 had led the Communist Party to victory in the Civil War and established the People’s Republic of China. But by the late 1950s, there were signs that he might soon pass the reins. Liú Shǎoqí 刘少奇, the head of state who had been loyal to the chairman ever since Mao assumed leadership of the Communist movement, became the chosen successor.
China Economy
China’s credit tightening measures to put pressure on property, local government financing vehicles
China may have started to rein in the pace of credit growth at the start of 2021 as December’s financial data fell below market expectations, and with policymakers signalling that they are leaning toward tapering off the expansionary monetary policy conducted last year.
Weak financial data released by the People’s Bank of China (PBOC) on Tuesday has reinforced the belief held by many analysts that the central bank has started to gradually tighten credit.
However, to ensure financial stability and continued progress in the nation’s economic recovery, steps taken by the central bank are expected to be relatively modest. Tighter credit conditions would test certain parts of the economy, with analysts pointing to the property sector in particular, and would likely result in the issuance of fewer bonds by heavily indebted local governments and their financing vehicles.
Thanks for reading, see you tomorrow!
Kevin
Photo by Tomasz Frankowski on Unsplash
Hi Kevin,
“The digital RMB is directly pegged to the fiat RMB.But unlike the fiat RMB, the digital RMB will be freely convertible on international exchanges.”
I don't think there is any way to wall off DCEP and fiatRMB. If fiat RMB is freely convertible to DCEP, and then able to be converted to other currency, then there is no difference between allowing DCEP to be freely convertible and normal RMB to be freely convertible (and all the issues, such as capital flight and currency appreciation that comes with it).
If digital RMB is not freely convertible (e.g. limited to foreigners), then I don't see how it will have a base big enough to support internationalization, as foreigners will have no interest in holding DCEP. Foreigners won’t be using it for trade between non-China counterparts, and for trade with Chinese counterparts, they will want to convert to the native currency which will then have to be done by China's central bank and dip into China'sforeign exchange reserves. e.g., if that is the case, then it is pretty much just settling everything in foreign currency.
Let me know if I missed something, but I just don't see how DCEP and normal RMB can have different policies and outcomes.