China’s Attack on the Dollar

Dear Rich Lifer,

To many people, it may seem like money is already virtual. We use Apple Pay and tap our phone to pay for groceries; we use the Venmo app to split a bill after dinner with friends. The use of paper bills and coins is becoming increasingly uncommon. 

However, these are simply ways we move money electronically. What China is doing is actually turning banknotes into computer code. It is minting cash digitally, a move that could potentially shake the power of the dollar. 

We have seen the signs of this shift to digital money for years; a byproduct of the growing popularity of cryptocurrencies, like bitcoin. However, cryptos are different from digital currencies because they exist outside the global financial system and are not legal tender. 

What China has developed is not a cryptocurrency; it is a digital currency controlled by the central bank, which will issue this new electronic money. 

A digital currency will give China the ability to monitor both its economy and its people because it negates one of bitcoin’s major traits: anonymity. 

China’s central bank has been testing the digital yuan since last year and recently expanded the trial to bigger cities including Beijing and Shanghai. 

Beijing is also setting up the digital yuan for international use and designing it to be free from the global financial system, which has been ruled by the U.S. dollar since World War II. China’s embrace of digital currency seems to be a move to gain more centralized control and get a headstart on the technologies that could likely be the future of commerce. 

Digital money is poised to be the “next big thing” in finance. Just like Amazon was for retail and Uber was for taxis. 

Mu Changchun, who is marshaling the project at the People’s Bank of China, stated, “In order to protect our currency sovereignty and legal currency status, we have to plan ahead.” 

The U.S. Responds 

A national digital currency used to be simply an idea that was floated around in the crypto-enthusiast communities. Now it has become a source of anxiety in Washington as China takes the lead on this new technology. 

Treasury Secretary Janet Yellen and Federal Reserve Chairman Jerome Powell have been questioned recently about how digital currencies might affect the dollar. Both say the issue is being reviewed, and the U.S. will respond cautiously and only consider issuing such a currency if there is widespread public and political enthusiasm. 

At an event with the Bank for International Settlements in March, Powell stated, “You can expect us to move with great care and transparency. We would not proceed with this without support from Congress.”

Currently, the dollar outperforms all other currencies for use in international foreign-exchange trades, at 88% in the latest rankings from the Bank for International Settlements. The yuan was used in just 4% of trades. 

The U.S. has traditionally demanded insight into major cross-border currency movements. This gives the U.S. the ability to freeze individuals and institutions out of the global financial system by blocking banks from doing transactions with them, a practice criticized as “dollar weaponization.”

For example, after the February coup in Myanmar, the U.S. used sanctions to block the movement of top military officials’ financial assets through banks. 

Analysts and economists agree that digitization itself won’t make the yuan a rival to the dollar in bank-to-bank wire transfers. However, this new form of the yuan (also known as the renminbi) could gain traction on the margins of the international finance system. It could give options to members of poorer countries to transfer money internationally, which in turn could make U.S. sanctions less meaningful. 

It could give those the U.S. seeks to penalize a way to exchange money without the U.S. knowing.  Exchanges wouldn’t need to use SWIFT, the messaging network that is used in money transfers between commercial banks and can be monitored by the U.S. government.

Josh Lipsky, a former International Monetary Fund staffer now at the Atlantic Council think tank, said, “Anything that threatens the dollar is a national-security issue. This threatens the dollar over the long term.”

How Does it Work? 

The digital yuan exists in cyberspace. It’s available on the owner’s phone or on a card, and spending it does not strictly require an online connection. When used on your phone, it appears on a screen with a silhouette of Mao Zedong, looking just like the paper money. The whole process is very similar to how other payment apps like WeChat already work in China. 

Over 100,000 people in China have participated in tests of the digital yuan in recent months. The Chinese government has given small hand-outs of digital cash to participants to use at various merchants. It has also allowed users to settle monthly dues with the digital yuan. 

The money itself is programmable, and Beijing has tested the use of expiration dates to encourage people to spend the money quickly, something that could be used to jumpstart the economy if need be.  

Final legislation on the digital yuan has not been published, but the central bank has said it might initially impose limits on how much digital yuan individuals can keep on their person. 

China has indicated it will continue to circulate bills and coins along with the digital yuan, but bankers and other analysts believe Beijing will eventually digitize all of its money. 

The digital yuan is trackable, which will give Beijing a new tool to tighten President Xi Jinping’s authoritarian rule. Elements of this type of control already existed in China, and Mu Changchun says the central bank will limit how it tracks individuals. 

Over the past year, there has been a burst of cash accumulation in China due to citizen’s concerns over the increasing government eye. Song Ke, a finance professor at Renmin University in Beijing, recently said that China’s measure of yuan in circulation, or cash, popped up 10% in 2020.

What About Volatility? 

Cryptocurrencies such as bitcoin are well-known for being volatile; however, this won’t be a concern with the digital yuan as the People’s Bank of China will have strict control over it to ensure there are no valuation differences between the digital yuan and paper bills. 

Anti-counterfeiting measures are also being designed to make it impossible for anyone besides the People’s Bank to create new digital yuan. 

This means there won’t be speculation in the digital yuan like there is with many cryptocurrencies. 

If nothing else, China’s strides toward a large-scale digital currency shine a light on the U.S.’s own need to modernize its financial infrastructure. Currently, over 60 countries are studying or developing a digital currency.

During a recent Senate appearance, Mr. Powell summed up the Fed’s mindset by simply stating, “We don’t need to be the first. We need to get it right.”

To a richer life,

The Rich Life Roadmap Team

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