0659 GMT September 18, 2021
China’s central bank has plans to roll out a digital yuan, which could circumvent the U.S. dollar in important global financial transactions. Here are some ways the digital yuan could pose a challenge to the dollar’s prominence.
Central bank digital currencies (CBDC) are digital tokens issued by central banks. In a way, they are the digital version of cash; their value is guaranteed by a central bank.
Unlike money held in credit cards and mobile wallets, CBDCs are not a mere representation of physical money stored elsewhere.
Instead, they are a complete replacement for currency notes. While several countries are developing their digital currencies, China is well positioned to take the lead with the digital yuan.
This paper highlights ways in which China can use its digital yuan to internationalize the renminbi (RMB) and gradually chip away at the hegemony of the dollar.
The first part of the paper focuses on the dollar’s dominance in the global financial system and the privileges the United States accrues as a result of the dollar being the world reserve currency.
The United States has a tight grip on the world’s payment rails, especially in the case of cross-border transactions. For example, the Society for Worldwide Interbank Financial Telecommunications (SWIFT)—the largest cross-border payment clearinghouse in the world—has to comply with and implement unilateral U.S. sanctions. These sanctions seriously hinder trade and damage the economies of the countries affected by them.
Once a country is cut off from SWIFT’s network, it becomes extremely difficult for it to trade with the rest of the world. Thus, via the dollar’s dominance and its geopolitical muscle, the United States is positioned to maintain a tight grip on the world’s financial system.
In an increasingly multipolar world, this outdated, decades-old system of the dollar as the apex currency and the United States’ position of power that allows it to pursue its own geopolitical interests has become outdated.
The U.S. dollar’s hegemony has been challenged by economies like those of the European Union (EU), Russia, and China.
Of all the countries, China finds itself in a dominant position to gain from this transition. In order to challenge the dollar’s hegemony and internationalize its currency, China will have to move away not just from the dollar but also from the payment rails dominated by the dollar.
The best way to simultaneously do both would be to introduce a new payment rail like CBDCs.
China’s CBDCs could greatly enhance its currency internationalization prospects. Considering China’s growing economy and influence over the world, China’s CBDC launch could bring a period of momentous change in the global financial system.
In order to challenge the dollar, China will have to build the payments infrastructure required to facilitate the use of its digital yuan. It will also have to incentivize other countries to adopt its digital currency. China’s ability to successfully promote its currency using CBDCs will depend heavily on the country’s ability to relax capital controls and maintain the world’s trust in its institutions.
China’s geopolitics will play a key role here. In the last decade, some of China’s major geopolitical efforts have set the stage for its CBDC launch.
As China continues to use its foreign policy and technological capabilities to grow its influence in the global financial system, the launch of the digital yuan could be a significant step forward in this direction.
China has made efforts at currency dominance and explores ways in which the country can use its CBDC to further internationalize its digital yuan.
*Rajesh Bansal and Somya Singh are senior advisers at Carnegie India. Their researches focus on digital payments, central bank digital currencies, and technology policy.
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