China’s Digital Yuan Is Aimed at Home, Not Washington
The trial project is no threat to dollar hegemony.
By Danny Li, the inaugural Schwarzman Scholars fellow at the Asia Society Policy Institute.
A sign for China’s new digital currency, the digital yuan, is displayed at a shopping mall in Shanghai on March 8. STR/AFP VIA GETTY IMAGES
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The release of the first white paper from the People’s Bank of China (PBOC) on the digital yuan in July likely came as a relief to U.S. Federal Reserve Chair Jerome Powell. For months, Powell has been under pressure to step up scrutiny on what some American officials perceive to be an imminent threat to U.S. foreign-policy interests. Public hysteria reached such a crescendo that on May 20, Powell announced that the Federal Reserve would begin researching the possibility of a digital dollar.
This announcement came after rapid developments in China’s domestic digital yuan trials, which had expanded to more than 11 cities and provinces, stoked heightened public scrutiny from U.S. policymakers and financial policy experts. Many commentators are concerned that China’s digital yuan could have dire ramifications for the United States: challenging the hegemony of the dollar, undermining U.S. sanctions leverage, and sparking a digital currency race between the United States and China.
Those concerns are vastly overblown. The digital yuan remains a long way off from challenging U.S. foreign-policy interests. Not only does the yuan, also known as the renminbi, lag far behind the U.S. dollar in the global marketplace, but the digital yuan, which remains in a tentative trial stage, is also being primarily geared for domestic usage, contrary to fears that it could be used to skirt U.S. sanctions. Concerns of a global digital currency race are also moot, because China has yet to convince other countries to follow in its footsteps to launch a digital currency. The Federal Reserve’s current stance, balancing healthy skepticism with measured vigilance, is just right.
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Since 2014, the PBOC has been spearheading Beijing’s development of a digital yuan. Beginning in late 2019, the Chinese central bank began conducting trials across multiple cities and provinces across the country. By this June, the digital yuan had been used in over 1.32 million scenarios, with total transaction volume around $5.4 billion. Preparations are underway for the digital yuan to make a global debut at the Beijing Winter Olympics in early 2022.
The digital yuan is distributed by the PBOC to consumers through a wallet app operated by six major commercial banks. Like the physical yuan, the digital yuan is legal tender, and it is meant to coexist with paper cash. The PBOC’s centralized control of the digital yuan distinguishes it from a cryptocurrency, which is typically not issued by a central authority and poses a threat to Beijing’s centralized control over the economy. Recent efforts by Beijing to crack down on cryptocurrency are paving the way for the digital yuan to become one of the only viable digital options in China, if not the only option.
To begin, while the yuan’s role in the global financial system is almost certain to grow, it is far from a certainty that the digital yuan will be able to fundamentally elevate the yuan to become a genuinely competitive alternative to the US dollar. Efforts to internationalize the yuan can be traced back to the early 2000’s but the 2008 global financial crisis hastened the Chinese government’s yuan internationalization efforts. The financial crisis impressed upon Beijing the need to elevate the yuan’s international profile and decrease reliance on the dollar.
The yuan’s share as a global payments currency has advanced steadily on aggregate in the last decade—jumping from 35th place in 2010 to fifth place in 2021, but the reading in August shows the yuan still only accounted for a mere 2.15 percent of global payments. Furthermore, the yuan has stagnated in fifth place since 2016, generally averaging just below 2 percent globally. The lag may be attributed to Beijing’s restrictions on foreign investment access and walled-off access to investible assets, as well as the lack of full convertibility. (Recent signs indicate that Beijing may have eased up, however, with the inclusion of yuan assets in global stock and bond assets as well as the opening up of China’s $50 trillion financial market.) Even then, in comparison, the U.S. dollar still consistently accounts for 38 percent of global payments. Right now, not only is the yuan far behind, but there are also no signs of it catching up.
To gain ground on the dollar, the digital yuan would require extensive international adoption. But there are a lot of obstacles before that happens: restrictive capital controls, lukewarm foreign audiences and lack of applicability, and a crowded international playing field. In particular, Beijing’s efforts to prioritize domestic financial stability through capital controls and tight management of the yuan exchange rate coupled with growing geopolitical assertiveness have tied its hands abroad. Without loosening capital controls, it is difficult to improve the attractiveness of the yuan as a readily accessible currency.
Beijing’s own sensitivities about data security and emphasis on maintaining compliance with Chinese regulations are likely to put off foreign populations and governments from adoption. That may be exacerbated by the mistrust and hostility already engendered between China and its regional and global trading partners by Beijing’s increasingly aggressive foreign-policy posture. And while it has been suggested that countries participating in China’s Belt and Road Initiative (BRI) would be receptive to employing the yuan at the dollar’s expense, the reality is many BRI loans are already denominated using the dollar because it has proved to be effective and less risky. The BRI suffers from a “dollar constraint.”
While the digital yuan has been hyped up as a faster, less costly, and more efficient alternative to the U.S. dollar, none of that has manifested yet. Besides measuring itself up against the U.S. dollar, the digital yuan will also need to prove itself as a better alternative to the euro, the U.K. pound, and Japanese yen, all of which currently account for more percentage share of global payments than the yuan.
American policymakers are also concerned that China may use the digital yuan to maneuver around U.S. sanctions—enforced through SWIFT, the global system for financial messaging and cross-border payment—and to engage with individuals, entities, and states barred from doing business with the United States. They shouldn’t be. For one thing, Beijing appears to have already begun to decouple financially from the United States on its own attempted terms. Thus far, U.S. sanctions have failed to reverse or even arrest that movement.
Recent statements by Chinese officials and the release of a white paper in July by the PBOC have emphasized that the immediate focus of the digital yuan is inward-leaning: It is “designed mainly for domestic retail payments at present.” The digital yuan rollout aligns with Beijing’s priority of “bolstering domestic financial security,” affording the state greater capacity to oversee financial flows and halt the disorderly expansion of capital. At present, the digital yuan is designed to make a big impact in the domestic retail payments space, nothing beyond that. While it could be employed for cross-border payments in the future, scaling up will be difficult without existing networks of other central bank-backed digital currencies to plug into.
And even if China wants to opt out of SWIFT, its options are more limited than one may expect. Notwithstanding North Korea, Iran, and Russia, which are already subject to significant U.S. sanctions and engaged in evasive transactions, other countries will think twice about doing business with U.S.-sanctioned entities. The reality is that half of all global invoices and 60 percent of global foreign exchange reserves are still underwritten by the U.S. dollar. Choosing to opt out of a global economy built on the strength of the U.S. dollar for an emerging, unproven framework that has yet to bear fruit is exceedingly risky.
China doesn’t particularly stand to gain from being a first mover if it does adopt a digital currency. While 86 percent of central banks are reportedly exploring central bank digital currencies, according to the Bank for International Settlements, the share of central banks likely to launch a central bank digital currency over the next six years has not actually increased significantly from a year ago. In other words, most central banks are playing the waiting game and allowing China to test the waters first.
The United States has adopted that approach, too. Back in February, Powell noted that: “We don’t need to be the first. We need to get it right.” His comments are the clearest signal yet that the United States does not want to jump the gun. At the same time, Washington also does not want to be blindsided or perceived as doing nothing. That may be why the Federal Reserve has begun collaborating with the Massachusetts Institute of Technology, and why Fed Governor Lael Brainard has gone on record acknowledging China’s lead, reassuring critics that Washington is homed in on the issue.
One thing is becoming increasingly clear: Speed alone is not enough to guarantee success, and the Federal Reserve understands that the United States’ robust trade linkages, deep financial markets, and credible monetary policy ensure that it is well positioned and in no threat of falling behind. Many of the claims made about the digital yuan are yet to be tested in practice, and those lessons will be just as valuable to Washington as they are to Beijing. As China attempts to work out the various structural uncertainties, the United States will benefit from watching and learning from China’s missteps.
Concerns over the digital yuan’s threat to U.S. foreign policy are best encapsulated by the Chinese idiom “Loud thunder, but small raindrops.” In other words, the hype has gotten ahead of the threat. The United States should refrain from unnecessary panic. Underwhelming internationalization of the yuan, domestic Chinese financial policy priorities, and measured caution from Washington mean that U.S. foreign-policy interests are thus far secure. The United States’ biggest advantage is the dominance of the dollar, and that buys Washington time to scope out the competition and identify the most effective way to proceed. The best approach the United States can take in the meantime is to watch and wait.
Danny Li is the inaugural Schwarzman Scholars fellow at the Asia Society Policy Institute.www.fotavgeia.blogspot.com
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