The co-founder of Ripple recently wrote an opinion piece for The Hill, in which he claimed that there is currently a “tech cold war” going on between two nations with two different visions for the financial future, and that the United States is not currently winning this war. He believes that China has a rare opportunity to take over America’s role in the global financial system, which includes the goal of replacing the dollar with a digital yuan. If this happens, the values that the West holds dear, such as openness and freedom, could be lost.
Others have sounded similar concerns. “There is a new space race. This is the race to build and control the systems and governance that will power the digital economy,” wrote Perianne Boring, president of the Chamber of Digital Commerce. Other advanced technologies may be involved in the race, but blockchain is the most important, as China’s president, Xi Jinping, has noted. Alex Tapscott, co-author of the book Blockchain Revolution, told Cointelegraph:
“China is on the brink of launching its own digital currency while, at least on this issue, the United States is dragging its feet. The two visions for these central bank digital currencies (CBDCs) couldn’t be more different. Whereas the U.S. wants to protect the U.S. dollar as global reserve currency, China wishes to export its own economic model around the world and tighten control at home.”
Overheated rhetoric?
Is the text trying to scare people to gain an advantage? Some people may be worrying unnecessarily about the introduction of a central bank digital currency (CBDC), as global economic trends are moving away from total globalisation. The COVID pandemic is likely to increase the trend of de-globalization, or the decreasing economic interdependence and integration among countries. This could mean that the question of who controls the planet’s reserve currency will become less relevant.
Although the CEO of blockchain solution Concordium Lone Fønss Schrøder belives that the new global CBDC- also known as the digital yuan- is not a threat to Western values, he stated that there has been a recent trend of businesses and consumers looking for opportunities closer to home due to the COVID-19 crisis. A more decentralized world is more likely to see the rise and expansion of local currencies instead of a new dominant world currency.
Schrøder recently participated in a board discussion at IKEA regarding whether the current global economy, which has been disrupted by COVID-19, is the new normal or just a temporary setback for globalization. She shared with Cointelegraph:
“It’s a big tendency — this producing and buying goods close to home — particularly among the younger generation. Not only do they want to support local businesses in an economic crisis, but they don’t want to waste the globe’s energy. They don’t want to sit in Sweden eating a piece of fruit that was grown on the other side of the world.”
According to Barclays’ report, the pandemic has revealed that there are risks associated with depending too heavily on China for goods that are essential for production to take place. Multinational corporations are likely to rethink how to build resilience into their supply chains, which could mean reducing trade with China and relying more on domestic suppliers.
In Schrøder’s view, from a bird’s-eye perspective, the world is more organized and peaceful than it has ever been, despite current U.S.-China tension. Schrøder is non-executive chair of the board at Volvo, a Swedish car manufacturer that has been owned by China-based Zhejiang Geely Holding since 2010.
Speaking to Cointelegraph, Schrøder said that, as someone who has lived in both the East and the West, he believes in partnerships. Volvo has built factories in China that follow the same principles as the ones in Sweden. She believes that people can learn from each other, adding that the binary situation in the U.S. is not what we need now.
An upset to the global monetary order?
Others view China’s CBDC ambitions with trepidation. The Financial Times editorial board stated that China’s development of a digital currency has the potential to disrupt the global monetary system. The new cryptocurrency, called the petro, represents a direct challenge to the U.S. dollar’s dominance as the global currency of choice. It is intended to bypass rival western-operated cross-border payment networks, such as Swift, which the US has used to enforce sanctions, according to the Financial Times.
China is trialing its digital yuan in four city hubs — Shanghai, Beijing, Guangzhou and Hong Kong. This trial area consists of 400 million people, which is about 29% of China’s population. Around the same time, the U.S. The Federal Reserve Bank of Boston announced that it will be partnering with researchers at the Massachusetts Institute of Technology in order to build and test a digital currency that is specifically designed for central banks to use. However, this U.S. effort is very small in comparison to a similar project that is already underway in China, and it is likely that the U.S. project is several years behind.
A digital yuan may not make a difference
Having a digital yuan will not guarantee that China will be the dominant force in the global economy. “Digitalization of the yuan will not make it more freely convertible,” said Andrew Collier, managing director of Hong Kong-based financial research company Orient Capital Research. He added that China’s competition with the dollar is more of a long-term strategy. In other words, even though China’s currency won’t immediately overthrow the SWIFT interbank network, the digitalization of the currency and other settlement systems gives China’s institutions a significant advantage.
” Jason Brett, the founder and CEO of the Value Technology Foundation, said that launching a CBDC before the U.S. does not guarantee global financial preeminence. The Value Technology Foundation is a think tank that focuses on blockchain technology. This suggests that the Bahamas will continue to have a strong currency. Trading partners, weapons technology, all of this matters too.” He added:
“What is more unnerving about the Chinese launching a CBDC might be ways that the technology for their digital yuan may be used to surveil other countries in all of their transactions.”
Larsen argued in his opinion piece for The Hill that the Chinese government’s subsidization of the energy needed to power the nation’s crypto mining industry suggests that China has significant control over Bitcoin. Without the U.S. regulating the world’s financial system, bad things could happen, according to him. Larsen said that a U.S. defense payment to an ally could be blocked or reversed, for example, if U.S. banks don’t comply with Chinese policy goals.
Jonathan Rosenoer, an executive in technology and risk management, suggested something similar in a recent article in Cointelegraph Magazine. He said that China could freeze transactions it doesn’t like or seize digital assets by holding authorization keys and locking customers’ mobile wallets when it wants to.
One tech sector among many
Some people argue that China couldn’t inflict much financial damage to the U.S. if it wanted to. Tapscott said that if the U.S. lost its status as the global reserve currency, it would have less power in financial markets and globally, but it would not be completely crippled.
Mushero stated that it appears a cold war may be forming between the U.S. and China on numerous fronts, such as tech, trade, economics, and human rights.
If one considers the tech sector alone, however, “China does very well in digital payments, and some parts of AI like people tracking, some logistics and gaming, and some consumer stuff like TikTok, but very little else.” In the broader tech world — which encompasses dozens if not hundreds of areas including aerospace, energy, water, weather, agriculture, satellites, autonomous ships, enterprise software, cloud computing, the chip market and others — “China has few, if any, players at all,” said Mushero, adding:
“Broadly the U.S. leads nearly all technologies and generally does not care nor need anyone else; however, individual companies like Apple and some others do, and no one wants to let a big competitor grow up unfettered abroad and then come ashore as Japanese companies did with consumer electronics [in the 1980s].”
Some people worry that China’s authoritarian regime gives it an advantage because it can invest large amounts of money in new technologies like blockchain and artificial intelligence. However, Brett told Cointelegraph that this does not mean that the Chinese way is necessarily better. Although the U.S. may take longer to take action compared to other democratic countries, it is still able to ultimately defeat totalitarian regimes, as was the case in WWII.
Although there is a risk in falling behind, some signs are worrying, such as lower patent activity in the U.S. (the Chinese government owned People’s Bank of China has filed more than 80 patents related to digital currencies, for example) and the Blockchain Service Network, China’s government-backed blockchain initiative that recently launched an official international website.
What are the benefits of the reserve currency status?
The currency that is used as a foreign exchange reserve by the world’s central banks is known as the global reserve currency. Foreign exchange reserves are typically used by countries to:
- Balance international payments
- Manage the exchange rate of their domestic currencies
The balance of international payments is the difference in money going out of and coming into a country. This is affected by the exchange of goods and services and results in a surplus or deficit. A surplus occurs when a country exports more than it imports, and it is manifested by an increase in the country’s reserves of foreign currencies. If a country exports less than it imports, it has a deficit and will amass debt in the reserve currency. If a country needs cheaper imports, it will buy its domestic currency in the open market to strengthen the currency. If a country needs more competitive exports, it will sell its domestic currency to weaken the currency.
The country that emits the global reserve currency enjoys certain advantages over other countries. Advantages that come from being the global reserve currency have mostly been enjoyed by the United States in the last 70 years. They include:
- Political leverage: The country whose currency is used as foreign exchange reserves can reward its allies with liquidity and deny it to its foes. For example, in 2015, BNP Paribas, a French bank, allowed transfers of $30bn to Sudan, Cuba, and Iran, effectively circumventing US sanctions. US regulators subsequently threatened to ban BNP Paribas from clearing USD (which would utterly destroy its business). The bank agreed to cooperate. They stopped making transfers to US sanctioned countries and paid $8.9bn in fines to the US government.
- More flexible fiscal policy: United States can run current account deficits without depreciation of the USD, because growth in international trade spurs demand for USD and transfers foreign currencies to the United States, which compensates for current account deficits caused by trade imbalances.
- Smaller FX risk: Foreign exchange risk for US corporations taking part in international trade is lower, as transactions are predominantly settled in USD, their domestic currency.
Two historical events have resulted in the USD being the dominant global reserve currency. The USD became the reference currency for exchange rates of all major world currencies as a result of the 1944 Bretton Woods Conference. Next, the USSR’s crumbling combined with America’s success in the Cold War resulted in about a third of the world’s economy being controlled by the US. The strong network effects of the USD made it the most convenient choice for a reserve currency for most countries.
Is RMB a suitable challenger to USD?
There is more and more evidence that China wants the RMB to take over the USD’s role as the main global reserve currency. In 2019, China set up RMB clearing banks in 25 countries and used the currency to settle 25% of its $15bn in foreign direct investments in Belt and Road countries. China now uses the Renminbi to settle 15% of its foreign trade, up from 11% in 2015. China is working on making its bond markets more attractive to foreign investors. Currently, foreign investors own three times as much Chinese bonds as they did in 2017. If the RMB continues to expand internationally, it could lead to a series of conflicts and potentially a new financial Cold War between the United States and China. Some of the disadvantages of such a conflict would include:
- Market Fragmentation: This type of financial conflict would result in emergence of an RMB trade block (mostly made of Belt and Road countries) and a USD trade block. International trade could be hindered by inefficiencies stemming from incompatibility of the two systems. Furthermore, the lesser degree of possible diversification in fragmented financial markets would result in overconcentration of risk.
- Triffin Dilemma: A paradox coined by a Belgian-American professor Robert Triffin, which claims that nation state currencies are not well-suited to serve as global reserve currencies, because there is a strong discrepancy between a country’s internal monetary policy requirements and global reserve currency requirements. On the one hand, the United States wants to provide the world with USD liquidity, on the other, it does not want to develop an unsustainable deficit in the balance of payments while doing so.
We should not want a financial Cold War with one single currency to emerge victorious. Alternatives should be proposed and actively discussed. History demonstrates that nation states have been able to utilize dialogue to identify potential replacement currencies for global reserve currencies.
What are the alternatives?
There have been several past attempts to propose supranational currencies that would be more effective in managing global currency reserves. Bancor was the first currency proposed by John Maynard Keynes at the Bretton Woods conference in 1944. It was not a currency itself, but a unit of account that was made up of 30 different currencies. By exchanging Bancor for nation state currencies, countries could get access to a global currency. The original intention for Bancor was to be used as a way to encourage member countries to maintain balanced trade accounts when participating in international trade. If a country had a positive Bancor account, it would mean that it had a trade surplus and was a creditor to countries that needed Bancor to pay for imports. A country with a negative Bancor account balance was running a trade deficit and would need to borrow currency to cover the shortfall. Chronic debtors would be allowed to lower the value of their currency, and chronic creditors would have to raise the value of their currency. However, the proposal was rejected by the United States in favour of other currencies being pegged to USD.
A more recent alternative that has actually been implemented are Special Drawing Rights (SDR) of the International Monetary Fund (IMF). The SDR is a claim on the currencies of the top 5 exporters among IMF members, and it can be exchanged for these currencies without any restrictions. The current SDR basket of currencies consists of USD (41.73%), Euro (30.93%), RMB (10.92%), Japanese Yen (8.33%), and British Pound (8.09%). The USD equivalent of the SDR is calculated by taking the sum of specific amounts of basket currencies and expressing that sum in USD. IMF quotas are used to determine how many SDRs each member country receives. Each member of the International Monetary Fund is given an asset called SDR Holding and a corresponding liability called SDR Allocation. When countries have SDRs, they are able to trade them for currencies from other members of the IMF. If a country holds more than its allotted shares, it will earn interest on the excess. If a country’s Allocations are higher than its Holdings, it will need to pay interest on the difference to countries with SDR surpluses. China has been willing in the past to consider the SDR as the global reserve currency. Zhou Xiaochuan, governor of the People’s Bank of China, suggested in 2009 that the SDR could be a suitable international reserve currency, one that is not connected to any single country’s economic conditions or sovereign interests.
Critics of SDR argue that it lacks the key components of a global reserve currency, such as deep and liquid capital markets, convertibility on international financial markets, and a working clearing system. Another major criticism is the way SDR is governed. The IMF has always had complete control over SDRs, from their value to who is allowed to hold them and what they can be used for. To make major decisions, the executive board or board of governors of the IMF needs approval from 85% of the members. The United States has a unique veto power over major IMF policy decisions, representing 16.52% of the total voting power. It would be difficult for China and Russia to sign up for a global reserve monetary system. There needs to be more transparency, equity, and fairness in the alternative global reserve system.
Blockchain as a solution?
The solution may be inspired by fintech. In recent times, Facebook has proposed the idea of a blockchain-based international stable payment currency that would enable near-instant settlements, called Libra. The Libra project has been put on hold, because it would challenge the power of central banks. However, the blockchain technology behind Libra is still important.
blockchains are digital chains consisting of blocks of information that are hosted on decentralized and distributed networks of computers; these networks cannot be altered. There are multiple copies of the ledger held by different stakeholders who oversee each other’s transactions. This technology allows users to transfer value without the need for a centralized entity to control or oversee the transaction. Facebook has created the Libra currency, a synthetic asset whose value is pegged to a basket of national currencies, borrowing from the SDR design of the IMF. The country is to be privately governed by companies who receive voting rights based on their financial contribution, but with a limit so that no one company has too much power. Libra’s transactions will be verified by private companies, such as PayPal or Amazon. US regulators have halted Libra’s progression due to fears that it may interrupt established monetary policies. Libra’s pausing may have put a hold on the project, but it’s managed to bring attention to how slow and costly processing transactions can be in the traditional financial system. This has led to discussion on the national level about what the future of money looks like.
The future of money
When it comes to crypto, Larsen is asking for a more supportive regulatory approach from the U.S., especially for blockchain and cryptocurrencies developed and used by American companies. He also emphasizes the importance of digital payments, which is an area where the U.S. has been falling behind. As Tapscott told Cointelegraph:
“Every thinking person must understand the stakes, battle lines and consequences of the battle for the future of money.”
. .still remain largely untapped in most industries and companies,” There is still a lot of untapped potential in technologies like AI and blockchain, which could have a big impact on the economy. They will create jobs,” added Brett. Advanced nations need to focus on new technologies as they come up.
The U.S. and China are in a new rivalry that involves more than just technology. It also includes trading partners, economics, geopolitics, weaponry, and human rights. Digital currencies and blockchain technology make up a small part of the tech industry.
Despite this, digital currencies and blockchain technology are still evolving and are expected to have a big impact in the future, so people should not become to comfortable. CBDC’s may not have a significant global impact without being able to convert them to other currencies, having trading partners, and having political and military allies.
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