Almost 900 years ago, the Chinese government of the Song Dynasty, then the world’s most advanced civilization, issued the world’s first centralized paper currency. A hundred years later, during the Yuan dynasty, when Marco Polo found money from the “bark of trees” circulating throughout the Mongol Empire, he witnessed a financial system with efficient long-distance transactions and a centralized banking authority with the full trust of the people. Today, the world is on the cusp of another technological revolution in the way people trade. Again, China is at the forefront, leading the way from cash to cryptocurrency with a new central bank digital currency (CBDC), the e-CNY, commonly known as the digital yuan. Although the US dollar remains the world’s dominant fiat currency, an analysis of the geopolitics surrounding the struggle for currency supremacy shows that China’s digital yuan will seriously challenge the dollar status quo throughout the 21st century.
The digital yuan
China’s 13th Five-Year Plan, covering 2016-2020, aimed to “promote the RMB [Chinese currency] Internationalize and see RMB capital go global.” China’s rationale for internationalizing RMB includes escaping US monetary policy, hedging against dollar shortages and achieving lower borrowing costs. From 2009 to 2019, 20 trillion yuan was exchanged across borders. Yet the RMB accounts for only 2 percent of global foreign exchange reserves, compared to 60 percent for the dollar. The basic premise of any reserve currency is support for a large economy, high volume of trade, and net creditor status (meaning that a country’s international investments are greater than the external debt it owes). China lags just behind the United States in terms of GDP and trade volume and is a fifteen percent net creditor compared to the United States’ net debtor position of eighty percent. Beyond pure economic calculus, however, currency hegemony rests on a balance of factors that still remain clearly in favor of the dollar. Crucially, China’s rule of law, trustworthiness and tightly controlled economy discourage investors from relying on the Chinese currency. So what is China’s path to an internationally impressive RMB?
The answer may lie in China’s digital yuan. The cryptocurrency has been in development for over eight years since the People’s Bank of China (PBoC) began investigating a government-run bitcoin in 2014. In the early 2010s, Chinese crypto miners were responsible for an estimated 95 percent of all newly minted bitcoin. The Chinese government discovered this mining activity in 2012 after investigating suspicious power usage, as Bitcoin mining is extremely energy intensive. A decentralized, anonymous currency posed a major threat to China’s tight social and financial controls. When officials began to ban and regulate cryptocurrencies, they also saw their potential. By 2021, all private cryptocurrency activities were banned and the Chinese economy had also largely moved away from the paper yuan. Last year, 80 percent of Chinese adults paid digitally. Tests for the digital yuan began in 2020, but early adoption numbers were less encouraging than Chinese officials might have hoped. As of October 2021, there were a total of 123 million individual wallets, although the average total in each was just 47 cents (RMB three), suggesting many consumers were not actively using the new currency. Adoption numbers then doubled by January 2022 in the run-up to the Beijing Winter Olympics. China planned to use the Olympics to introduce the digital yuan to the world, similar to the country’s flamboyant displays in 2008 that launched a modern China onto the global stage. Due to China’s strict Covid guidelines, few foreign visitors were actually present. Still, the PBoC reported around US$300,000 (RMB 2 million) in daily transactions with the digital yuan during the Games. Though China’s top digital payments companies, AliPay and TenPay, are eclipsed domestically, China’s ambitions for the digital yuan are undoubtedly international.
The Geopolitics of Monetary Hegemony
The struggle for monetary hegemony can be characterized more as an insurgency than a Cold War, and China may be ready to use geopolitical tactics to outmaneuver the current hegemon. There are three main ways China could use its geopolitical clout to achieve RMB internationalization through the digital yuan.
The first and most powerful lever available to China is the Belt and Road Initiative (BRI). Heralded in 2013 as Xi Jinping’s foreign policy project, the BRI has projected lifetime spending of over $1 trillion. Consisting of both a land economic belt and a maritime Silk Road, the initiative spans an estimated 60 countries, representing two-thirds of the world’s population. The domestic goals of the BRI are largely economic in nature. China has overcapacity in commodities like steel and coal, and producers are desperate for new export markets. The BRI also aims to economically develop impoverished regions in western China as part of planned trade routes through Central Asia. However, the economic goals alone do not justify the price of the initiative, and the foreign policy ambitions inherent in the BRI are enormous.
At the regional level, China hopes to counter the US pivot to Asia, which began with the Obama administration strengthening economic ties with neighboring countries and promoting new investment opportunities. Globally, China aims to fund infrastructure spending in developing countries, gaining favor and potentially political influence in recipient countries. Sometimes referred to as “debt trap diplomacy,” this practice has recently been criticized for contributing to Sri Lanka’s economic crisis.
China also plans to use the BRI to internationalize the RMB. In fact, the majority of recipients of BRI projects expressed interest in conducting cross-border transactions in RMB. This is where the digital yuan comes into play. According to researcher Mahima Duggal, the BRI is a “perfect mechanism for accelerating the international use of a digital yuan.” In many developing countries, the banking infrastructure is severely lacking and transactions can take weeks. The digital yuan bypasses any third-party banks or local institutions, virtually eliminating fees while transactions are instant. Stanley Chao, an expert on doing business in Asia, says many countries within the BRI “would jump at the idea” of adopting a digital yuan. Another facet of the BRI is the Digital Silk Road (DSR), which aims to export Chinese technology to BRI participants, including high-speed internet, artificial intelligence and mobile payment systems similar to China’s own AliPay. With Chinese technology comes Chinese control, as many technology companies in China operate only nominally in the private sector. With greater control over a country’s digital infrastructure and widespread use of a digital yuan, Duggal writes, China could even “rewire the financial networks” in countries heavily involved in the BRI.
China’s BRI is primarily a foreign policy outreach program aimed at developing new allies and gaining influence in emerging economies. But for a project as ambitious as monetary hegemony, China is also turning to old allies to help implement an international CBDC. A majority of countries that are members of the International Monetary Fund (IMF) are investigating or have already developed a CBDC. Many of these CBDCs are restricted to domestic use, but China is one of the first countries to seriously evaluate cross-border transactions using a CBDC, a crucial first step towards global adoption. Their experiments have spawned the Multiple CBDC or mCBDC Bridge Project, a collaboration between four financial jurisdictions – China, Hong Kong, Thailand and the United Arab Emirates – that aims to create an infrastructure to enable efficient, low-cost remittances between CBDCs and simultaneously comply with existing regulations and data protection standards in each jurisdiction. The project identified 15 use cases of CBDC transfers between countries, including commercial payments, wealth management, bond issuance, trade settlements and supply chain finance. Several of the financial institutions participating in the mCBDC such as Goldman Sachs (US), HSBC (UK) and UBS (Switzerland) are based in western economies. This may indicate a broader reach of cooperation than just Chinese allies and regional banks.
Finally, international sanctions present a unique opportunity for China to demonstrate the benefits of a currency outside of US control. When Russia invaded Ukraine, one way the United States retaliated was by cutting Russia off from the Society for Worldwide Interbank Financial Telecommunication (SWIFT). SWIFT is responsible for almost all international cross-border transactions. Since 95 percent of all dollar payments are processed in New York, SWIFT is monitored by the USA. The White House vowed that without SWIFT, Russia would have to rely on “the phone or a fax machine” to conduct international business. The digital yuan offers a possible solution. By bypassing SWIFT and conducting a secure cross-border transfer using China’s CBDC, Russia could theoretically trade with anyone willing to flout US sanctions. If China itself were the target of sweeping sanctions, the digital yuan could be crucial to continuing trade ties with close allies. China could also offer the digital yuan to any country that wants to disrupt US hegemony, such as its ally Iran. More support for the digital yuan increases its reach and recognition, which in turn drives the internationalization of the RMB.
Notwithstanding the current shortcomings of China’s CBDC experimentation, the United States may be too far behind when it comes to producing a viable competitor. After the digital yuan debuted on the international scene back in March 2022, Biden issued an executive order to begin investigating a US CBDC. Despite being a dominant market player in privately traded cryptocurrencies, the United States has not spent the past decade seriously researching and testing CBDCs like China has. There is some hope as early versions of a US CBDC, developed in collaboration with MIT, have proven to be more sophisticated than the digital yuan, being able to handle more than five times more transactions per second. However, this technology is still a long way from being traded across borders. As the vice president of a Beijing-based cryptocurrency firm Ian Wittkop writes, CBDCs are “a one-field” for now. In our post-pandemic world, with trends such as e-commerce, social media and remote work, it is clear that the world is becoming increasingly digital. A financial system dominated by CBDCs, and by extension China, could become an inevitable reality.