It was on Thursday, July 11th 2019 that the former Peoples Bank of China governor Zhou Xiaochuan told an event in Beijing that Facebook’s Libra project was a ‘new risk’ that should motivate the government to ‘make good preparations and make the Chinese yuan a stronger currency’.
This ‘new risk’ of Facebook’s Libra cryptocurrency appears to have acted as validation to the ongoing tinkering of a Chinese organisation tasked to investigate digital currencies. This organisation is called the ‘Research Institute of Digital Currency’ and they had been looking into digital assets as early as 2014.
However the year 2019 saw things heat up in this space and China dramatically accelerated the release of the new digital currency. In fact this was prioritised so much that China moved the deputy director of the payments and settlement division at the People’s Bank of China (PBoc) into the lead role at the ‘Digital Currency Research Institute’ in the second half of 2019, accelerating China’s wish for itself of prosperity. This aint your granddaddies global currency project.
Financial Systems and Geo-Politics
In 1944, over a year before the smoke settled from the final bombs dropped in World War 2 a new world order had already been organised. This new world order saw the US Dollar become the worlds reserve currency, as liberalism of a social and cultural style dominated Europe and a materialistic liberalism of free markets and trade was embraced by the United States.
Created with a new sense of hope regarding global institutions and co-operation post World War 2, the structures of this new Economic System were inevitably used as political weapons, especially geo-political weapons by the United States, who have not been shy to restrict access to payment systems such as SWIFT and enforcing sanctions against geo-political opponents, restricting their access to a global financial system dependent on the US greenback.
As a response, some countries such as Russia, Iran and China have been forced to develop physical strategic assets to work around the global system to work their economy, project their power and achieve their ends. Russia’s attempts to build a new system were signalled as early as 2009, when then president Medvedev presented a ‘united future world currency’ to the G8 summit in London; a city that Russia does not mind assassinating old foes in when it is not acting as world leader in financial experimentation; and where noises were being made to kick Russia from the global banking networks as early as 2015 in 2017 they developed a new system – the Mir Payment system.
However the payment system was relatively expensive (5 cents per transaction) and had been claimed as operational (but could only be used in business hours) but worked with 90% of Russian ATM’s.
But a new desire for independence from the Global Financial System stems from major political differences between Putin’s Russia and the EU / US / Western Bloc who Russia would claim use the system as a political weapon. In this, Russia’s own actions speak far louder to their intentions. Although it would make sense that she desires independence from the whims of political winds, Russia was also recently reported to be building infrastructure to confiscate cryptocurrencies. This action shows that it is not so much about freedom from externalities as it is about the ability for the Russian government to project their political power externally and domestically as well.
China’s Monetary Ambitions
China has historically built pressure against the US Dollar dominance in major global institutions where they had appealed to using a basket of currencies to finalise trade, similar to the Libra project.
Although it had been in the making since 2014 with the ‘Research Institute of Digital Currency’, the development of the Chinese Digital Yuan was a major news item of 2019. The Chinese interest reflects a determination to use technology to further their goals, especially cutting edge technology such as A.I., quantum computing and CRISPR amongst others. In Binance’ report into the Digital Yuan they named retail payments, interbank clearing and cross-border payments as practical reasons for replacing their M0 with a CBDC. Major goals of the currency were described ‘To display a turnover rate as high as cash, while achieving /manageable anonymity’ ‘The first layer would use identities and the second layer would be anonymous from the perspective of users’.
The digital yuan is to be capable of transferring between users without an account, mobile or internet network and instead relies on mobile phones with a wallet and having the two phones in physical contact, presumably by near-field communication.
China’s domestic population is already very comfortable with using smartphone apps to pay for goods. China’s other delivery mechanism of the new digital Yuan appears to include the Industrial and Commercial Bank of China (2nd largest in the world), the Bank of China, the Agricultural Bank of China, two of China’s largest technology companies; Alibaba and Tencent, Union Pay, an association of Chinese banks and presumably WeChat Pay and AliPay.
Of course the major advantage in promoting the new system is in being a centrally controlled Economy, such a powerful delivery mechanism can ensure that transactions occur in the new currency.
Externally, with this significant and international demand for a non-US controlled financial system, the Chinese ability to deliver on a digital Yuan would be to an existing, significant market in international trade. The market for competing systems may include India; a country enjoying a growing independence and national pride, also seeking a self-determined existence outside of the global financial system. Of course there is also North Korea, Russia, Iran, every country on the road and belt initiative (126 countries and 29 international organisations) and whoever else China does trade with.
Besides that, the Chinese Yuan is already an official world reserve currency as of October 1, 2016. It represents 10.92% of the IMF’s special drawing rights currency basket, the third largest after the US Dollar and Euro.
But even a fully functional Digital Yuan could have huge problems.
China has faced obstacles before in enforcing capital controls (protecting capital from leaving China) in its borders – a net 2.5 trillion US dollars was reported to have left in the decade to 2017. The currency trade within China and over the China/Russian border is reported to be huge in US Dollar denominated digital currencies, likely an uncontrollable practice.
It is hard to imagine how the digital transfer of value does not open the floodgates of Chinese capital flight. A digital Yuan would essentially create a free-market mechanism – how long would it take to create mechanisms that devalue the Yuan uncontrollably?
And if they could control it, would anybody trust the Chinese government would not use their digital currency to project political power? Could they restrict, cancel and remove the currency from accounts on a whim, as if they never happened?
How would attempts to control capital work in a digital framework? Is a digital Yuan a capitulation to Cryptocurrency, a white flag that has been raised being unable to win and so willing to join?
You catch more flies with honey than you do with vinegar
So just how stupid is the Chinese Communist Party? If you chipped all in on ‘not at all’ we must speculate that the reports of massive gold purchases by China, represented in record trade in Gold in 2019, reports of compulsory buying of all Gold mined within China, and reports of huge Chinese buying in Australian Gold markets mean that China intends on backing the Digital Yuan with Gold.
A Chinese plan emerges that includes an asset-backed digital currency that includes Gold, potentially Bitcoin and that will create a currency with a superior profile for maintaining monetary value than the US Dollar.
If this is the case, it’s bad news at a bad time for the US Dollar with its rapidly expanding monetary supply that is increasingly backed by a single institution (the US Fed) and a hyper-correlation between asset prices and the decisions of that institution.
This inbred financial system is beginning to barely look like a system at all, breaking major rules of systems theory.
Presented without comment.
We leave you with two quotes from Martin Chorzempa, a research fellow at the Peterson Institute for International Economics on the Chinese plans to digitise their currency.
Firstly, that ‘they are definitely one of the most advanced central banks in the world in thinking about and moving forward on this issue.
‘The term that the central bank officials in China have used is ‘controllable anonymity’ which is one of the most Orwellian statements one could think about,’
Written By: Thomas Kuhn, CFA
Thomas is a 12-year veteran of financial markets working to bring digital assets into the fold of traditional financial markets. With an interest in fundamental analysis with a technical overlay, Thomas actively takes positions in the markets he covers. As well as producing education for traders, Thomas writes for Mine Digital, CFA Asia-Pacific Research Exchange and Hackernoon.
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