“To be sure, the dollar’s indefinite dominance is not a foregone conclusion, but the yuan will have to be far more than just digital to give the greenback a run for its money, literally.”
The croupier chuffed at the thick stack of red 100-yuan bills with Mao Zedong’s slightly smiling face staring back up at him.
Without even looking up from arranging his chips, he pushed aside the wad of Chinese yuan notes (worth several tens of thousands of U.S. dollars) and in heavily accented-Laotian English grunted,
“No yuan, dollars only.”
Pointing to a sign written in simplified Chinese script hanging on the wall that stated the casino only accepted Japanese yen, euros and U.S. dollars.
The irate Chinese gambler protested in Mandarin,
“What are you talking about? This is a Chinese casino, paid for with Chinese money, why can’t I gamble with yuan?”
To which the Laotian croupier simply blinked back blankly.
The Chinese gambler’s female companion held him back from carrying on, lest casino security should see to a premature end to the evening’s entertainment, and she should fail to receive her fat tip for her services – unlike the casino, yuan was just as good as dollars for her.
In many parts of the world, the lack of full convertibility of the Chinese yuan, or renminbi, as it’s officially known, has meant that even in a secluded casino, nestled in the thick jungles of Laos, dollars are still accepted over yuan.
Despite being the world’s second largest economy, the Chinese yuan, according to data from the Bank of International Settlements, only comprised less than 2% of global foreign reserves and in 2019, just 4.3% of international currency transactions.
By way of comparison, the almighty greenback made up 88% of international currency transactions that same year, according to data from the Bank of International Settlements.
Nonetheless, Beijing believes that it can mount a serious challenge to the greenback, not necessarily by allowing a fully convertible currency, but by creating a digital doppelganger of the yuan.
China’s Cryptocurrency Challenger
In every major city in China, local merchants and even taxi drivers chuff at physical cash the way a Laotian croupier chuffs at a Chinese gambler’s fat stacks of paper yuan.
Having grown accustomed to using digital payment service platforms like Alipay or WeChat Pay to do everything from split a dinner bill to hail a ride, most Chinese find the concept of actual cash money and coinage, archaic, like the silver and gold ingots of Imperial China.
And now Beijing is betting that its digital yuan may not just pose a challenge to the dollar, but also extinguish the exorbitant privilege that the greenback enjoys as the world’s dominant reserve currency.
Even Niall Ferguson, a British financial historian has called on the U.S. to wake up to the peril of letting China “mint the money of the future.”
But how does digitalising money make a difference?
Some argue that by digitalizing the yuan, U.S. sanctions-hit countries, many of which Beijing is more than happy to do business with, could potentially find an avenue to circumvent Washington’s heavy handedness.
Because the dollar (as mentioned earlier) makes up almost 90% of global currency transfers, Washington can punish foes (and friends sometimes as well) with punitive sanctions that genuinely bite.
Despite the number of counterparties that use the dollar, almost all global dollar transactions have to flow through a clutch of around 150 banks clustered around Manhattan Island.
Being excluded from this dollar-based chokepoint essentially means being left out of the global financial system, where there will be weeping and gnashing of teeth.
Which is where the digital yuan (supposedly) comes in.
Digital Denizens Demand Due Diligence
Instead of donning sackcloth and atoning for your sins against Washington, countries and counterparties could potentially use the digital yuan to facilitate commerce and Beijing wouldn’t judge.
China has long taken the tact that so long as you afford the Emperor the homage to which he is entitled to, the rest is your business.
African dictator? Who’s asking? Warlord? Not to my knowledge.
Beijing’s approach towards counterparties and countries has long been one of aloof pragmatism – basically, if it’s not Beijing’s business, Beijing doesn’t care.
Far be it for Beijing to throw the first stone.
Which is why over the past five years, China has built an impressive network for yuan trading around the world.
Despite the yuan’s lack of full convertibility, Washington was unable to persuade allies to stay out of Beijing’s Asian Infrastructure Investment Bank and it’s striking that many yuan-trading hubs established by China, are in financial centres ostensibly strong allies of Washington, including London and Singapore.
And it is in this regard that Washington perhaps has good reason to worry about a digital yuan.
The emergence of the digital yuan as a credible alternative to the greenback, sans judgment and admonitions, would undermine a key cornerstone of American power – sanctions.
Thus far, sanctions against countries that Washington consider “rogue” like Iran and North Korea, have had substantial bite because of the dollar’s centrality to global finance.
In 2013, after the U.S. hit North Korea’s main foreign-exchange bank with sanctions, the Bank of China stopped serving its North Korean client, and a year earlier, at the nadir of American pressure on Iran, China grudgingly cut imports of Iranian oil.
But a digital yuan that allows banks and companies to move money around the world on a financial superhighway delinked from the dollar could dramatically undermine the effect of U.S. sanctions.
And Washington would also find it much harder to track who is using the China International Payment System and for what purpose, even though a digital yuan is trackable – unlike Bitcoin, the digital yuan doesn’t reside on a public blockchain, meaning that transaction records are only viewed by the People’s Bank of China and whichever apparatchiks have access to such records.
But beyond removing the teeth behind American sanctions, China could also use its digital yuan to propagate its way of thinking.
For instance, when heads of state meet Taiwanese leaders, they may find that digital yuan transactions for their country’s businesses no longer work or worse, get placed at the back of the transfer queue and still be none the wiser.
And all that could happen without Beijing ever having to openly declare a single sanction.
But making a currency digital doesn’t make it any more attractive than putting an “i” in front of an appliance makes it any more intelligent (iToaster anyone?).
Digital Is as Digital Does
That the yuan still makes up a fraction of global currency transactions despite China being the world’s second largest economy should be telling.
After all, if everything is made in China, shouldn’t everyone be paying in yuan (digital or otherwise)?
Because today’s reserve currencies are not backed by gold (or anything else for that matter), their value is far more ephemeral, and a function of supply and demand.
Why anyone chooses to deal in the dollar is testament to the strength of America’s institutions, no matter how much they are challenged.
Deep financial markets, a robust legal system and a generally (and I use this term to the broadest extent of its interpretation) transparent political process, underpin the dollar.
That these United States were able to survive the Trump administration should be testimony to the robustness of America’s democratic institutions, tested to the point of failing, but never beyond.
For China’s yuan to emulate the dollar or undermine its dominance would require Beijing to build a similar complement of institutions to persuade investors that the yuan is as reliable.
Ease of use and avoidance of sanctions are features of the digital yuan, but not their core value proposition.
A yuan that could rival the dollar would need to be truly convertible, free from exchange rate intervention and require the construction of a large, liquid, transparent bond market.
That Beijing has repeatedly acted as the (very) visible hand of its own markets, propping up stocks when they crash and causing their crash with policy measures, shows just how far the Middle Kingdom is from developing a mature financial system.
And finally, China would, like America, need to operate on the proper rule of law, which would allow courts to go against the whims of the Communist Party in the pursuit of justice and fairness for all, a situation that is for now at least, inconceivable.
So while there will no doubt be some takers for a digital yuan, it’s more likely than not that such users have either been strong armed into doing so, or are consistently on the wrong end of relations with Washington.
To be sure, the dollar’s indefinite dominance is not a foregone conclusion, but the yuan will have to be far more than just digital to give the greenback a run for its money, literally.
