February 24, 2021 | China begins testing its digital currency overseas
Overview of China's digital currency and first international trials
China begins testing its digital currency overseas
Today’s notes focus on China’s digital currency, commonly referred to as DCEP or the Digital Yuan/RMB.
For a highly in-depth analysis of the prospects for internationalization of China’s digital currency, I highly recommend Harrison Dent’s paper titled International Trade Law Concerns With China’s Digital Currency: How Sovereign-issued Stablecoin Can Destabilize International Trade.
I’ve also written on this subject in previous notes. I encourage you to refer to the links below:
The US Dollar’s Global Dominance and the Internationalization of the Chinese Yuan
How will the Chinese government benefit from issuing its own digital currency?
To contextualize China’s digital currency's importance and position within US-China relations, let’s start with a simple high-level overview of my US-China relations framework.
The US-China relationship essentially revolves around three key areas of US dominance, these areas are:
US Military
US dollar
US Semi-conductors
US military, US dollar, and semiconductor supremacy are the pillars of US global influence. They’re also areas that China cannot easily supplant or avoid through technological and economic growth.
Although China’s GDP growth is projected to surpass that of the United States before the end of the decade, this has no bearing on whether China can find ways to work around US dominance in these three critical sectors.
For today’s purposes, our primary focus is the broad category of US dollar hegemony.
Why is the US dollar such a powerful geopolitical tool?
We can view the US dollar as the “operating system” of the global financial system. Nearly every country, company, and person in the world are dependent on US dollars for conducting international transactions and thereby dependent on the United States government and central bank.
The dominant currency in the global financial system is known as the “world’s reserve currency.”
American US dollar supremacy grants leverage to the United States in numerous areas. Because the United States controls the dollar, it also controls the global banking system. As a result, the United States uses this control to cut foreign governments, corporations, and individuals off from the international banking system, which essentially their life-blood.
Although there’s a growing body of evidence to support the idea that sanctions don’t work, that hasn’t stopped the United States from rapidly stepping up the total number of sanctions designations deployed annually.
From China’s perspective, the United States’ dependence on what it perceives to be reckless and economically destructive sanctions poses a significant threat to its own stability and security.
More problematic is the fact that China is deeply dependent on the US dollar. China relies on its massive $3 trillion pile of foreign exchange reserves to artificially suppress the Yuan's value. “Weakening” the yuan is widely regarded as currency manipulation and is used to make its exported goods cheaper on the global market. Internationally, financing for China’s Belt and Road Initiative (BRI) is conducted entirely in US dollars, not Renminbi.
The United States’ increased willingness to use sanctions to further or protect geopolitical interests coupled with China’s deep dependence on the US dollar is a significant contributor to rising geopolitical tensions.
For China, the solution to reducing dependence on the US dollar-dominated global financial system is to work around it and to promote the internationalization of its currency, the Renminbi (RMB), also known as the Chinese Yuan.
Internationalization of China’s currency is easier said than done, and the biggest obstacles to achieving this are China’s central authorities themselves. China restricts the Renminbi flow out of China using a policy tool called capital controls, which are another tool China uses to control the value of the RMB.
Capital controls prevent the Renminbi from floating on international foreign exchanges and stand in the way of increasing the adoption of China’s currency internationally.
How can China reconcile its conflicting goals of reducing dependence on the US dollar, promoting RMB internationalization, and maintaining a tight grip on the value of its currency?
We still don’t know if China can pull this off. But, China’s proposed solution is to create a digital version of the RMB formally known as DCEP and colloquially known as the Digital Yuan, or Digital RMB.
Theoretically, Chinese authorities can deploy the digital yuan internationally while maintaining a tight grip on currency outflows while and without having to rely on intermediaries that are heavily influenced or controlled by the United States.
“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.”
Until recently, DCEP’s capabilities have been largely theoretical. However, China has already started deploying DCEP to outside monetary jurisdictions. Today Technode reported that China would begin testing digital currency transactions in Thailand and the UAE.
The results of this early trial period will begin to give us a better sense of how the digital RMB performs internationally and whether or not it can develop into a viable alternative to the US dollar.
In the meantime, we’ll be paying close attention to how the United States responds to the potential global expansion of China’s digital currency. We’ll be sure to provide updates in future notes.
China Digital Currency
Joint statement on the Multiple Central Bank Digital Currency (m-CBDC) Bridge Project (Hong Kong Monetary Authority)
The Hong Kong Monetary Authority (HKMA), together with the Bank of Thailand (BOT), the Central Bank of the United Arab Emirates (CBUAE) and the Digital Currency Institute of the People’s Bank of China (PBC DCI), today announced the joining of the CBUAE and the PBC DCI to the second phase of Project Inthanon-LionRock1, a central bank digital currency project for cross-border payments initiated by the HKMA and the BOT. This joint effort is strongly supported by the Bank for International Settlements Innovation Hub Centre in Hong Kong and the project has been renamed as “m-CBDC Bridge”.
China's Central Bank–Backed Digital Currency Is the Anti-Bitcoin (PIIE)
The trade-off between privacy and control will be one of the great political battlegrounds of the coming decades, and these currency experiments are sure to raise the urgency of these debates. Central banks like China’s that have built up trust and credibility over decades or centuries have little use for “mining” or other systems that allow one to put trust in computer code instead of in centralized institutions. Characteristics of the plan show that political authorities will try to capture some of the benefits of digital currencies like bitcoin to marginally improve their existing monetary systems and control, while eschewing the decentralized, mostly trustless ledgers that made bitcoin truly innovative.
China Tech/Semiconductors
The Future of China’s Semiconductor Industry (American Affairs Journal)
Over the past four years, the Trump administration—driven by growing concerns over China’s rise as a technological competitor and the coupling of its military and civilian industries—has ratcheted up controls on semiconductors and semiconductor manufacturing equipment destined for Chinese end-users. China hawks in the administration viewed American companies’ dominance of key semiconductor subsectors, particularly in areas such as electronic design automation and other tools needed to produce advanced semiconductors, as a key policy lever. They sought to use this lever to punish Chinese companies for specific types of activities deemed problematic by U.S. officials, and to push back on Beijing’s heavy subsidies to the semiconductor industry that some fear will distort market-driven global supply chains.
China Still Far From Semiconductor Self-Sufficiency, Report Says (Caixin Global)
China aims to domestically produce 70% of its semiconductors by 2025 as part of its broader plan to attain global leadership in manufacturing in high-tech industries like artificial intelligence and information technology. That goal was made against the backdrop of tightening U.S. restrictions on American and overseas chipmakers that hope to ship to Chinese tech firms like Huawei.
US-China Relations
America Is Not ‘Back.’ And Americans Should Not Want It to Be.
“America is back,” President Biden has declared in every major foreign policy speech he has given since taking office. He means to restore what he sees as the essence of global leadership — the United States joining with allies to “fight for our shared values” — that his predecessor defiled. Back, then, is America’s quest to order the world in the name of democracy, human rights and the American way.
A U.S. strategy paper on China draws a tepid response in Beijing (CNBC)
A recent U.S. strategy paper on China that’s widely read in Washington, D.C., has drawn only a passing response in Beijing where limited public discussion has focused on one point: The author got China wrong.
“The Longer Telegram” released in late January proposed how the new U.S. administration should deal with a rising China by laying out a detailed critique of the Communist Party government under President Xi Jinping.
US and allies to build 'China-free' tech supply chain
U.S. President Joe Biden is set to sign an executive order as early as this month to accelerate efforts to build supply chains for chips and other strategically significant products that are less reliant on China, in partnership with the likes of Taiwan, Japan and South Korea.
The document will order the development of a national supply chain strategy, and is expected to call for recommendations for supply networks that are less vulnerable to disruptions such as disasters and sanctions by unfriendly countries. Measures will focus on semiconductors, electric-vehicle batteries, rare-earth metals and medical products, according to a draft obtained by Nikkei.
The rise of geoeconomics and the need for a resilient European semiconductor industry (Merics)
Globalization over previous decades has created economic interdependence between states allowing supply chains to benefit from cross-border openness and the division of tasks in production processes. The US-China trade dispute, however, has called these collaborative advantages into question. As part of the MERICS European China Talent Program 2020, Brigitte Dekker of the Clingendael Institute and Anna-Lena Rhiem of the Infineon Technologies AG examined the effects on the semiconductor industry – a key building block of nearly all high-tech products – and recommend a way forward for Europe.
UK-China
We need to talk about trade with China, UK parliament tells PM Johnson
British Prime Minister Boris Johnson is locked in a battle with parliament over the country’s approach to trade with China, fuelled by criticism that his government is lagging its peers in its condemnation of the treatment of Uighur Muslims in Xinjiang.
China Economy
On infrastructure, is China ‘eating America’s lunch’?
After getting off the phone with Xi Jinping, Joe Biden warned his senators that on infrastructure 'and a whole range of other things', China was spending much more than the US, and America risked being left behind. So just how interconnected is modern China and is it really a good growth model to emulate?
Thanks for reading, see you tomorrow!
Kevin
Photo by Eric Prouzet on Unsplash