Issue 108

The future of money

Delivered on 12 April 2021 by Justin Pyvis. About a 4 min read.

China has a digital currency. Or more precisely, the People's Bank of China (PBOC – its central bank) has a digital currency, the e-CNY:

A thousand years ago, when money meant coins, China invented paper currency. Now the Chinese government is minting cash digitally, in a re-imagination of money that could shake a pillar of American power.
Cryptocurrencies such as bitcoin have foreshadowed a potential digital future for money, though they exist outside the traditional global financial system and aren't legal tender like cash issued by governments.

China's version of a digital currency is controlled by its central bank, which will issue the new electronic money. It is expected to give China's government vast new tools to monitor both its economy and its people. By design, the digital yuan will negate one of bitcoin's major draws: anonymity for the user.

There has been a lot of fearmongering surrounding the news (it's not actually news – the PBOC has been working on a digital currency since at least 2014) – including from the influential Niall Ferguson and Peter Thiel.

Writing for Bloomberg, Ferguson worries that:

Not only are the American monetary authorities underestimating the threat posed to dollar dominance by China’s pioneering combination of digital currency and electronic payments. They are also treating the blockchain-based financial innovations that offer the best alternative to China’s e-yuan like gatecrashers at their own exclusive party.

Ferguson rightly points out that blockchain-based financial innovations are a threat to governments and central banks – cryptocurrencies such as Bitcoin and Ethereum are indeed "stateless money". And he's right that one of China's motivations for moving into the digital space is to one day usurp the mighty US dollar.

However, he quickly veers off course, drawing the bold conclusion that China has got it right – that "the future of money... [will arrive] in the form of a widely adopted e-CNY", all while the US twiddles its thumbs:

This new Chinese system not only defends the CCP against the twin threats of crypto and big tech, while ensuring that all Chinese citizens' transactions are under surveillance; it also includes an offensive capability to challenge the U.S. dollar's dominance in cross-border payments.

Ferguson assumes far too much in terms of both the outlook for China's new digital currency and its threat to the US dollar's hegemony. This is a country that, while large, has a GDP per capita only marginally above Kazakhstan – i.e. it's poor. In terms of wealth, China is about where Japan was in 1985 – which, coincidentally, was around when American economists were worried about "a growing role for the yen, at the expense of the [US] dollar".

It was also when influential US government officials, such as Treasury Secretaries Blumenthal, Baker and Bentson, "suggested that the dollar was too high against the yen... [and] attempts to talk the dollar down were accompanied by intense trade negotiations aimed at forcing the Japanese to open or share this or that market".

If that all sounds very familiar, it should. It's exactly what the US government has been attempting for the past 4 years – just replace Japan with China and yen with yuan.

Back then, people were also worried about a 'Yen Bloc' that Japan was forming in the Asia Pacific. Now, it's "the Multiple Central Bank Digital Currency Bridge, a project exploring cross-border payments using distributed ledgers... [a] step towards Beijing's long-term goal of internationalising the yuan at the expense of the US dollar".

As we all now know, the fears about Japan's yen displacing the US dollar in the 80s were unfounded. But maybe you think it'll be different this time around because, as Ferguson notes, China's government now has a big, scary weapon called a digital currency (something the Japanese could only imagine), while the US Federal Reserve has sat back with a "What me, worry?" approach.

Allow me to allay your fears – all one has to do is take a quick look at the information we have available on China's new digital currency – or rather, don't have – to realise it's unlikely to become dominant outside of China.

For one, we don't even know if it's blockchain based. That means we have no idea if it's secured by proof of stake, proof of work, or privately (i.e. authoritatively). However, the odds that China opts for proof of stake (e.g. Cardano, Stellar) or proof of work (e.g. Bitcoin, Ethereum) are low, because to do so the e-CNY would have to have to be somewhat public and decentralised (i.e. censorship-resistant). Those words don't exist in China's vocabulary.

If it's blockchain-based – that's a big IF – it's probably going to be private and centralised. In other words, it'll be exactly the same as the existing CNY, only more efficient from the government's point view (spying on its people). If anything, the PBOC's national digital currency would be a blow to Alipay and WeChat Pay, not the US dollar. To use Ferguson's own words:

In 2020, some 58% of Chinese used mobile payments, up from 33% in 2016, and mobile payments accounted for nearly two-thirds of all personal consumption PBOC payments. Banknotes and credit cards have largely yielded to QR codes on smartphones.

China is already digital. The problem is, from the Chinese government's point of view, is that most of the transaction data are held by large private companies run by 'capitalist' billionaires. Moving transactions to a government-controlled private blockchain solves the problem of the private sector's growing financial influence without completely dismantling what they've built.

Hyman Minsky famously claimed that "everyone can create money; the problem is to get it accepted". China can force its own people to accept its new e-CNY, but it can't force anyone else. To an outsider, the new e-CNY offers no advantages over the existing CNY (more data and control for the Chinese government, yaayyy...). It will not be the "future of money", nor will it come close to challenging the US dollar's global dominance in global financial transactions.

Issue 108: The future of money was compiled by Justin Pyvis and delivered on 12 April 2021.