As the People’s Bank of China (PBoC) rolls out a digital yuan, officially designated as the Digital Currency Electronic Payment (DCEP), monetary relations in China could be revolutionized. Digital currencies differ from both physical cash and traditional electronic payments in that they are digital tokens that use distributed ledger technology (DLT), commonly known as “blockchain”. However, unlike private cryptocurrencies, these tokens are official state-backed tender, issued in a centralized and regulated manner by central banks. The PBoC’s objectives for the launch of the DCEP are manifold, ranging from a substantial improvement of financial efficiency to the enhancement of state authority and supervision of monetary operations. This article explores the implications of the DCEP for the creation of new monetary relations in China and yuan internationalization.
Since at least the 2008 Global Financial Crisis, the Chinese government has undertaken concerted efforts to internationalize its currency, the yuan or renminbi. These efforts have scored successes, such as in 2016 when the International Monetary Fund included the yuan within the basket of currencies that constitute Special Drawing Rights. Overall, though, the yuan’s international use punches far below the weight of China’s economy. In January 2021, it was the fifth most active currency for global payments by value, with a share of 2.42 percent globally.
The reasons for the yuan’s relative underperformance compared to the weight of the Chinese economy are often explained by benchmarking the yuan against a set of preconditions necessary for internationalizing a currency. Accordingly, the yuan is not widely traded since China has not yet developed open, deep and liquid domestic capital markets. In particular, China has not followed neo- liberal economic guidance dominant after 1980 to establish a freely floating fully convertible currency with open cross-border flows of capital, as most advanced industrialized economies have.
Quite to the contrary, Chinese authorities have chosen a particular way of managing the “monetary trilemma” or “impossible trinity”. This trilemma specifies that any territorial economy can only obtain two of three desirables: exchange rate stability, free cross-border capital flows and domestic monetary autonomy. Chinese authorities have not been willing to sacrifice exchange rate stability. Rather, they have employed active policy intervention to stabilize foreign exchange markets. This has been combined with targeted and selective capital account opening while retaining monetary independence. Beijing has thus attempted to juggle the constraints of the monetary trilemma in novel ways.
Nonetheless, limits on convertibility have hampered yuan internationalization. Cross-border capital flows have been channeled in “pipelines” that are subject to specific conditions. This means that Chinese authorities can throttle large cross-border capital movements at will, as occurred after China’s botched exchange rate liberalization in 2015.
It is for this reason that most analysts do not see the yuan rivalling the US dollar any time soon. Even the launch of China’s new digital currency, officially designated as the Digital Currency Electronic Payment (DCEP), will, according to these analyses, change little. Eswar Prasad, for example, argues that the yuan will only become prominent as an international currency after the Chinese government removes major restrictions on capital flows: “the DCEP on its own will not be a game changer that elevates the renminbi’s role in international finance”.
These analyses are not incorrect. The lack of a fully liberalized capital account and, more generally, the lack of full trust and faith of international creditors in the politico-economic stability of China make the yuan as a safe-haven currency a tricky proposition. Yet, legal and institutional certainty in international finance is relative. Already the yuan has played somewhat of a safe-haven role, though still minor, during the Covid-19 pandemic of 2020.
Doubts about the DCEP’s role in furthering yuan internationalization continue to focus on the stark trade-offs laid out by the monetary trilemma. Yet, DCEP is not only set to revolutionize China’s domestic monetary relations, but also could enable new avenues and tools to push yuan internationalization forward. I will in the following briefly lay out the DCEP’s basic characteristics and the opportunities it creates in remaking monetary relations in China. I will end with an analysis of its possible influence on the trajectory of yuan internationalization.
Revolutionizing monetary relations
Over the past decade, the digital payments market in China has developed rapidly to become a world leader. Now the People’s Bank of China (PBoC) hopes that this advanced infrastructure can be used to launch the first major state-backed digital currency, or Central Bank Digital Currency (CBDC). Such currencies differ from both physical cash and traditional electronic payments in that they are digital tokens that use distributed ledger technology (DLT), commonly known as “blockchain”.
The PBoC has been conducting research on a digital yuan since 2014, illustrating the priority Chinese policy-makers attach to this effort. Several key characteristics of the DCEP are important for understanding its implications. DLT promises to provide a programmable digital currency that boasts much greater security, practically removing the possibility of counterfeiting. All this implies much lower costs to run financial infrastructure and much greater transparency and traceability regarding financial transactions.
Decentralization and anonymity are often held to be essential attributes of DLT, underlying Bitcoin and other cryptocurrencies. However, DCEP introduces measures of centralized control in a “permissioned” system, restricting who has access to it. This is a major distinction. All DLT-based digital currencies are inherently decentralized, since their tamper-proof characteristics rely on a multitude of nodes “validating” all information on the blockchain. However, a degree of centralized control and management is necessary to function as legal tender.
The DCEP is thus a hybrid digital currency, combining the decentralized aspects of DLT with centralized management under the PBoC. Full anonymity is not assured. Even if banks and individuals cannot trace all transactions on the blockchain, the PBoC will have complete oversight. The DCEP will thus give the PBoC the ability to trace and track economic activity in real time, preparing Chinese monetary management for what is likely to be the future of money.
The use of DLT technology combined with Artificial Intelligence (AI) to analyze the mountains of data generated could substantially boost the supervision of monetary operations. As with so much else in the 21st Century, data is king. For example, in an economic recession, monetary authorities can easily pinpoint areas of the economy in most dire need of support. DCEP transactions can evidence exactly where revenue shortfalls are occurring, hence enabling highly targeted interventions. In contrast, monetary operations undertaken in the West at present, such as Quantitative Easing (QE), are crude tools that push money out into the economy regardless of need. Such a sledgehammer approach carries grave risks since currency over-issuance can create rapid asset inflation and financial bubbles.
Unheard-of levels of financial transparency can transform monetary management and radically lower financial risks, since banks can better track and analyze the businesses of their borrowers and, with this, non-performing assets. In this manner, the PBoC might be able to solve many chronic problems in the Chinese financial system, especially an overreliance on debt, shadow banking and illicit uses of borrowed funds.
Finally, the DCEP will make it easier to fight crimes including corruption, money laundering, the financing of terrorism and, perhaps most significantly, tax evasion. In one specific application, DCEP could help Chinese authorities curb the one trillion yuan (US$153 billion) in gambling money that flows out of the country each year via private cryptocurrencies.
There are drawbacks to this brave new world of money. Some commentators in the West see the digital yuan as another effort by the Chinese Communist Party to exert greater control over Chinese citizens. Based on information released so far, anonymity will be only assured in smaller transactions between users, while the PBoC will be able to trace every movement of the DCEP given its electronic footprints. No wonder that the introduction of digital money raises distinct privacy concerns. Even in China, these are likely to create some societal pushback to total surveillance.
In the final analysis, the jury on who wins the competition for furnishing new forms of money – mass public adoption – is still out. There remain a host of uncertainties, technical hurdles, as well as regulatory and legal challenges. Nonetheless, the DCEP represents a fundamental and deliberate initiative by Chinese authorities to revolutionize money itself. Quite ironically, a technology that was invented to circumvent centralized coordination and power is now likely to trigger a substantial enhancement of monetary control and, hence, state authority.
At this point, the PBoC is proceeding very cautiously. Like many other significant policy initiatives, the Chinese government is using a trial-and-error approach, first testing the DCEP in various localized trials throughout China, including Shenzhen, Suzhou and Chengdu. One major test is slated for the 2022 Beijing Winter Olympics, including limited international utilization. So far, it is not yet clear when the DCEP will be officially launched for widespread use.
The DCEP and yuan internationalization
One of the most important dynamics to watch is how the competition to furnish a widely used CBDC will play out internationally. The PBoC has assured other countries that the DCEP is not a threat to existing national currencies. Nonetheless, the race is clearly on to be a first mover in this crucial new space of financial innovation.
Given this backdrop, can the DCEP enable China to push yuan internationalization forward? As mentioned, the DCEP will enable new levels of control over currency flows. This could enable more effective, yet more subtle and less intrusive ways of managing China’s capital account opening.
The “pipelines” in use now (e.g., the stock and bond connects between Hong Kong and the mainland) could be radically opened and altered with the use of DCEP. In fact, much enhanced control would lie with the PBoC, since all capital movements via DCEP would be visible in real time. Combined with AI tools to flag suspicious behavior and large capital movements, the PBoC could target certain flows in times of crisis, creating more targeted and pinpointed means for managing China’s capital account and exchange rate.
The DCEP thus fits China’s strategy for capital account opening: to broaden channels for capital flows while keeping overall control. In this context, a DCEP-based international payments system could help the Cross-Border Interbank Payment System (CIPS) that China has established gain wider acceptance. CIPS reported processing 135.7 billion yuan ($19.4 billion) a day in 2019, with participation from 96 countries and regions. Nonetheless, this is a drop in the bucket in international payments compared to Belgium-based SWIFT’s $5 trillion per day.
The use of a DCEP-based international payments system would reduce dependence on the U.S. dollar, including American ability to view China’s global payments data via SWIFT. The PBoC argues that launching the digital yuan is aimed at protecting China’s foreign exchange sovereignty. The DCEP’s ease-of-use, especially if combined with a fully digital international payments infrastructure, could usher in increased global adoption of the yuan, allowing it to bypass the conservative nature of traditional banking institutions. DCEP could therefore become a mechanism to break the US dollar’s global monetary dominance.
So, quite to the contrary of those casting doubt on the DCEP’s significance for global monetary affairs, the characteristics of this digital currency could lay the foundation for effective yuan internationalization. The DCEP should be seen as a highly strategic move by the PBoC to enable the international distribution of the yuan with much more oversight and control than would be possible now.
Specifically, the considerable uncertainty and volatility that large cross-border capital flows introduce could be reduced, because authorities can easily track all flows. Indeed, the PBoC has undertaken promising simulations using AI to test policy-making scenarios for the management of money supply on foreign currency exchanges with DCEP. And the emergence of DCEP could fill the demand for currency diversification in the rest of the world. The wide use of financial sanctions by the United States based on the U.S. dollar’s global supremacy has generated a need for an alternative payments system.
Most prominently, the European Union (EU) fears being squeezed by financial sanctions between the United States and China, necessitating greater “strategic autonomy” for Europe. Although the EU is focusing on the global role of the euro, the DCEP could trigger an evolution to a more distributed version of monetary power than the one now centered on the United States. In contrast to the U.S. Federal Reserve, which has been lukewarm on the concept of a digital dollar, the European Central Bank is actively pursuing a digital euro project. Christine Lagarde, the President of the Bank, announced recently that a digital version of the euro could be launched in the middle of the 2020s: “We need to make sure that we do it right. We owe it to the Europeans. The whole process, let’s be realistic about it, will in my view take another four years, maybe a little more”.
Much still remains uncertain, including various technical, legal and regulatory aspects of new digital sovereign currencies. However, the DCEP’s historical significance, both as a first mover and as the currency of the second largest economy globally, is substantial and mostly overlooked. Chinese President Xi Jinping himself has underscored the vital role of DLT in the next round of technological innovation and industrial transformation, urging more efforts to develop this crucial field. The DCEP stands at the forefront of these efforts. Its characteristics promise to usher in a brave new world of money across the globe.
 For overviews of the basic preconditions needed to foster an internationally accepted reserve currency, please see Kenen, P. (1983) “The Role of the Dollar as an International Reserve Currency”, Group of Thirty: Occasional Papers no. 13; as well as Chinn, M. and Frankel, J. (2005) “Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?”, NBER Working Papers no. 11510, Cambridge, MA, National Bureau for Economic Research.
 McNally, C.A. and Gruin, J. (2017) “A Novel Pathway to Power? Contestation and Adaptation in China’s Internationalization of the RMB”, Review of International Political Economy, 24(4):599-628.
 An attempt to liberalize the yuan exchange rate by allowing three consecutive daily devaluations during mid-August 2015 sent the signal that China was willing to let the yuan depreciate – what followed were large-scale capital movements out of China which forced authorities to reimpose strict capital controls. See Investopedia (2020) “The Impact of China Devaluing the Yuan in 2015”, 20 December, available online
 As noted in Gregory Chin’s contribution to this collection.
 Nonetheless, the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology (MIT) are examining the feasibility and various technical options for a digital dollar.
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