14 05 2023

Is dedollarisation a chimaera or is it real? (II)

The digital Yuan, E-CNY, is promoted during an expo in Dalian, Liaoning province. The digital Yuan, E-CNY, is promoted during an expo in Dalian, Liaoning province. Photo by Lyu Wenzheng - https://www.chinadaily.com.cn/a/202107/29/WS610201faa310efa1bd66528b.html

Central Bank Digital Currencies are coming, and even if they initially will be used only domestically, they are bound to start playing a role in international payments too. This will diminish the need for US dollars in international trade and hence also lessen the US control with the international payment system. No surprise that the US is not at all enthusiastic about this development.

The Central Bank Digital Currencies should not be confounded with Crypto Currencies, so we are not talking about Bitcoin and the like, but about digital Chinese Yuans, Indian Rupees, Russian Rubles, Euros etc., emitted by the respective Central Banks. How will that work?

As Central Bank Digital Currencies is a recent phenomenon, there is a lot of confusion regarding what it is about. To make it easier to understand, it may be useful to think of digital currencies as cash, just now sitting in an electronic wallet in the Central Bank instead of in a wallet in our pockets. So payments with digital currencies are like cash payments. They go directly from one person to another. There is no need to involve a bank (no need for a bank account, debit card, mobile pay system etc.). The main difference from a traditional cash transaction is that instead of being anonymous, the transaction is registered in the Central Bank (just as a traditional bank payment it registered in the commercial bank).

Among the big economies, China is the most advanced when it comes to digital currencies. The digital Yuan (eCNY) has been in trials since 2020, and the eCNY app is now installed by 260 million individual users. However, the transactions are still overshadowed by other digital payment systems such as AliPay, WeChat Pay etc., but the use of the digital Yuan is being steadily expanded. A recent example is Changshu, a suburb of the Suzhou metropolitan area and home to 1.5 million people, which will pay civil servants and employees of state-owned companies in full with the digital Yuan. Other big countries piloting digital currencies are India, Brazil, Nigeria and Russia.

Of course, the introduction of digital currencies raises questions about the banks’ future role in the economy, but that is another story. The banks are obviously lobbying for the digital currency system to be set up through them, and have apparently partly succeeded in the case of Russia (even if it is the Central Bank that has the liability for the digital Ruble, not the bank, just as for cash), while the role of the banks appear to be much more limited in the case of China.

The Indian Central Bank is piloting a digital Rupee. https://en.wikipedia.org/wiki/Digital_rupee

Potentially, the digital currency can be used for international transactions as well, with no need for SWIFT or other messaging systems, correspondence banks, and so on. This would simplify international transactions radically, and bring down transaction costs to virtually nothing. Take the example of, say, a company in Brazil, buying goods from a company in China, in a situation where both countries have functioning digital currencies. It can then pay the Chinese provider directly with digital Reals from its Electronic Wallet. The Chinese provider will then probably want to convert these digital Reals to digital Yuans, just as if the trade had been carried out in cash, so the two digital currencies have to be convertible, at least mutually. If there are international electronic exchanges for all currencies, this can be done easily at the current rate. Otherwise, we are back to the need for bilateral swap agreements between the Central Banks to ensure the exchange can be done (and the challenge with unbalanced trade, if there is not free convertibility). However, transactions would be simple, blistering fast and with minimal costs.

One effect of the shift to digital currencies for international payments is that these payments would be registered in the Central Banks, but nowhere else. Presently, most international payments are through SWIFT and since 2001 the US has had free access to supervise all transactions. Furthermore, as the banks are at the origin and end of all the international transfers, the banks can be used to control the transfers for illegal operations (terrorism, drug trade, evasion of US sanctions, etc.). As no banks will be involved, that would not be possible any more. So in the transaction above between Brazil and China, the US would have no knowledge of this transaction. So only the national Central Banks can carry out this control.

Brazil is piloting the digital Real in a pilot called ‘LIFT Challenge’. https://liftchallenge.bcb.gov.br/site/liftchallenge/en

It is therefore no surprise that the US is not particularly interested in digital currencies as it will undermine the present US centred dollar system, and the country is an absolute laggard when it comes to digital currencies. There are presently no concrete plans for a digital dollar, and even so it has already become a hot potato in the always polarized US political system. Some republican politicians see the digital dollar as one more attempt to enable authoritarian government control over the citizens (as if it did not have this control already through the commercial banks, to which CIA and NSA in practice have free access).

So will the digital currencies upend the present international financial system? I think they will, particularly because of the present abuse of the control of this system by Western powers for political ends. The challenge is that there are no international institutions presently, which can unify a potentially fragmented new international financial system and put in place a system to avoid illicit transactions as for example drug trade or terror networks. So institutions would have to be created to that end. But for that cooperation, not confrontation, is necessary.

In the next article we shall discuss the future for the international financial system. To read this third and last article in this series, click here.

To read the first article in this series, click here.

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Thorbjorn Waagstein

Thorbjørn Waagstein, Economist, PhD, since 1999 working as international Development Consultant in Latin America, Africa and Asia.

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