By Kumar David –
Though paper money was invented in China during the Song Dynasty in the 11th century it is fast phasing out in consumer transactions; about 80% of payments in China use mobile payment modes meaning cell phones or computers and the market size in 2020 was $6.2 trillion-equivalent in US dollars. Wechat, Alipay and Unionpay are the most used platforms. Some beggars in big cities will not accept alms in cash; you gotta scan their QR codes, enter the donation into your mobile phone and press Transfer. But then begging is dying out in China while homelessness is growing in the USA, so it’s all happening in the wrong place. How topsy-turvy the world has become! No wonder then that the government is exploring and expanding digital transactions linked to the central bank (People’s Bank of China) and also for international payments. The two together will make the Yuan an international currency alongside the US Dollar, Euro, Yen, GB Pound and the Swiss Franc but in a very different way. The Digital Yuan (DY) is supported by block-chain technology similar to Bitcoin making it tamper-proof and it is issued by China’s central bank as a national currency. The motives for internationalising the Yuan are, countering US dollar dominance of global finance, weakening SWIFT and curbing the clout of its own “fintech” giants such as Ant-Group, Lufax, 360-Digitech, LexinFintech and FinVolution. Recently China put the brakes on the listing of Ant; the reason probably was to prioritise the unfurling of the DY.
The Monetary Authority of Singapore and Tamasek have experimented with JPMorgan to establish a Multiple Central Bank Digital Currency Bridge (CBDC). In contrast to a platform unfurled by China, a more neutral and inclusive platform may be acceptable to more countries, but China is already using the DY on a trial basis for transactions with Shenzhen, Hong Kong (HSBC), Thailand (eight banks), the UAE and the Bank of International Settlements. With this CBDC system users bypass services like SWIFT which are used to communicate money transfers between two banks. DY bypasses this system via CBDC links and implements Yuan denominated transactions directly. Since the system is backed by the full faith of the Chinese Government it is rather like an amalgamation of SWIFT and the Fed.
In domestic transactions within China using DY renders credit cards redundant and gives notice to Wechat, Alipay and Unionpay that their days are numbered. Looking a little ahead it may render the banking system itself a creature of the past. You can open an account with the central bank (People’s Bank) and do all your payments and standing order processing in DY without needing a cheque book or credit card – and of course give the government a ring-side view all your financial involvements including those Valentine’s Day roses and Swiss chocolates you gifted to each of your mistresses. What about concealing illicit sources of income and tax avoidance – well on second thoughts, maybe a digital yuan account with the central bank is not such a good idea if you belong to the class whose income is two orders of magnitude larger than this humble columnist’s! So moving all your cash into a digital transactions account with poor out-foxed-by-everybody Lakshman’s Central Bank may be a bit tricky. Still, poor Lakshman’s CB, though on course to crash, will survive for a while longer than the Bank of Ceylon, People’s Bank and Sri Lanka’s commercial banks.
Since DY transactions will not need SWIFT or the dollar, the dollar’s role in international trade and its global hegemony will decline giving the world more choice. Will Iran be able to breathe a sigh of relief? China is the biggest trading partner of 120 countries, why should they depend on the dollar as an intermediary in settling their accounts? Transactions will also be free of the financial risk of adverse intermediate dollar exchange rate movements. The other advantage is that the SWIFT platform entails fees. It is difficult to disentangle what portion of bank charges for an international transfer accrues to SWIFT and how much is pocketed by the bank. My guess is that the total fees collected by SWIFT worldwide runs to hundreds of billions of dollars each year.
There could be a mix of motives in the moves of Chinese regulators. In addition to the overtly political ones I noted, this time it is also leading an assault on Big Tech lenders, stamping out monopolistic behaviour and providing a degree of protection to the public. With the advantage of data monopoly Fintech firms hinder fair competition and seek excessive profits. It is a winner-takes-all industry and no doubt also interferes with the monopoly of snooping on people’s privacy so loved by national security agencies. Ant Group’s IPO halt reflects a turning point. Regulators hit out with antitrust laws targeting bundled sales and price discrimination, tighter rules for online insurance sales and lower annual interest rates after a ruling by the Supreme People’s Court capping rates on personal loans at 15.4% – four times the government one-year loan prime rate of 3.85%. Thousands of court cases show China curbing interest rates of licensed financial institutions at 24%. What about Sri Lanka; is there hope for poor borrowers from rapacious microfinance providers?
The hegemony of the US dollar is anchored in the petrodollar. A 1945 agreement between the United States and Saudi Arabia cemented the relationship between the dollar and oil and the petrodollar was conceived. In 1971 when US stagflation prompted runs on the dollar the value of the dollar plummeted and other countries wished to redeem their dollars for gold, but to protect declining US gold reserves Nixon removed the dollar from the gold standard where dollars were convertible to gold at a fixed rate of $35 per ounce. Currently the gold price is about $1850 per ounce. This devaluation of the dollar also helped the US economy as its export values decreased, making them more competitive but a falling dollar hurt oil-exporting countries whose prices were denominated in dollars. The cost of imports, denominated in other currencies, increased.
In 1973 the US provided military aid to Israel for the Yom Kippur War enraging the Organization of Petroleum Exporting Countries which halted oil exports to the US and Israel’s allies. The OPEC oil embargo quadrupled the price of oil in six months which remained high after the embargo ended. Then came the punch line; in 1979 the US and Saudi Arabia agreed to use US dollars for oil contracts and then recycle the dollars back to America through contracts with US companies. The petrodollar, an arrangement by which all oil will be globally priced and sold in dollars was fully formed and born. Everybody including Iran, Russia and China are caught in this trap. The petrodollar is the mechanism by which the US maintains dominance over the global financial system and it uses this financial power to enforce its foreign policy. For example, the US sanctioned Iran for refusing to halt its development of potential nuclear weapons and hit Russia with trade embargoes for invading Crimea and the crisis in the Ukraine. The countries of the Middle East don’t fight back because their regimes are beholden to US military assistance to hold their own populations in thrall; they also fear that a collapse of the petrodollar system would disrupt their oil trade.
Oil producing countries hold huge dollar reserves and recycle them through sovereign wealth funds. The funds are used in non-oil related businesses. The world’s five largest petrodollar recyclers ranked by assets are: Norway’s Government Pension Fund ($1.2 trillion), the UAE’s Abu Dhabi Investment Authority ($700 billion), Kuwait Investment Authority ($530 billion), Saudi Arabia’s SAMA fund ($490 billion) and the Qatar Investment Authority ($330 billion). These monies are held in US bonds and Treasuries making them partners in the preservation of dollar hegemony.
Sometime in this decade the US economy will fall behind China’s in size to second place. It is not possible for the currency of Mr Number Two to indefinitely remain the global monetary hegemon. But it is going to be a complicated and drawn out process. Though China calls for a replacement of the US dollar as the global currency, ironically, it is the largest foreign holder of dollars. Currently China influences the dollar by pegging the Yuan to it but this an intermediate stage until the DY comes into its own. For the near future there is no sign of collapse of the dollar’s global hegemony. There is also a different kind of threat to the petrodollar as the world shifts from oil to renewable energy. People are limiting greenhouse gas emissions to fight global warming and shifting to solar and wind power generation and to electric vehicles. This threatens oil-producing nations. The US has lost its competitive edge in these technologies to China and the European Union. As a result the role of the dollar as the world’s dominant currency is in decline.