China’s “digital yuan” and the race for a global digital currency – InsideSources

China recently unveiled its own national digital currency. The development poses an immediate threat to the role of the US dollar as a world reserve currency. It gives China a powerful new tool for the exercise of “soft power” and massively undermines one of the most important foreign policy weapons of the United States. Failure to respond effectively will seriously damage the US reputation around the world.

China’s “digital yuan” represents the natural evolution of fiat currencies. When the US government finally removed the dollar from the price of gold in 1971, it severed the link between “paper money” and real, hard assets. The dollar, like most other government-issued currencies, became worth as much as the market was willing to pay for it.

It didn’t take long for currencies to break free from the paper itself. The face value of dollar transactions far exceeds their actual existence in the real world.

According to the Federal Reserve, there is roughly $ 2.1 trillion in cash and coins in physical existence. In contrast, there are currently approximately $ 12.7 trillion in deposits with US banks. If everyone in the world owed a dollar, demanded it right away, there wouldn’t be nearly enough to get around.

Most currencies are digital. It exists as computer code that travels freely at the speed of light between central banks, financial institutions, merchants and individuals. However, most of the world still maintains banking systems that work as if the currencies were being held in huge vaults at the local bank. China appears to be the first government to adapt its financial system to the real world.

A digital yuan acknowledges the reality that fiat currencies no longer require a deposit-based banking system to circulate widely in an economy. It enables the Central Bank of China to open a bank account on behalf of any user of its currency. By downloading an app, a user has their own vault at the People’s Bank of China without the need for a custodian to stand between the user’s currency and their issuer.

China wasn’t the first country to recognize the power of allowing individuals to have their own central bank account. In a 2018 paper entitled “The Case for Central Bank Electronic Money and the Non-case for Central Bank Cryptocurrencies,” the Federal Reserve Bank of St. Louis wrote:

“We believe that there are good arguments in favor of central bank money in electronic form and that it would be easy to implement. Central banks would only have to allow households and businesses to open accounts with them, which would enable them to make payments with central bank electronic money rather than commercial bank deposits. “

Unfortunately, only the Chinese government seems to have been paying attention. The US’s failure to be quick to adopt a central bank digital currency could prove disastrous.

The US dollar has been the world’s reserve currency since the end of World War II. This means, among other things, that the world’s most important assets are valued (and ultimately paid for) in US dollars. Gold, oil, debt, to name a few, are all effectively fungible against dollars.

The supremacy of the dollar also enables the US to impose sanctions on its enemies. By banning access to the US banking system, the US was able to starve its opponents out of the money they need to finance terrorist operations or to build nuclear weapons, for example.

When it created an electronic currency with a ledger held directly at the central bank, China developed the power to exclude the US from the payment process. As more countries (and individuals) appreciate the ease and hassle-free cost of using the digital yuan, the dollar could lose its leading position in the world economy.

Discomfort at the idea that China is acting as the world’s banker could hurt its prospects, but ultimately the market will belong to the technology leader – and China is in the class right now.

After allowing China to take the lead, America’s best option now may not be with central bank money. Facebook has proposed issuing its own digital currency. With literally billions of users, one “Facebook dollar” would instantly be able to access a worldwide network that China (and others) would find difficult to reach. Also, since it is not a government entity, Facebook would potentially enjoy a trust that government-controlled accounts lack. And as a US company, US regulators would likely still be able to have at least some leverage over their operations and provide US officials with resources they would lack if the digital yuan replaced the dollar.

So far, Facebook’s efforts have met with strong opposition from US politicians. Given the threat posed by the digital yuan, this is short-sighted. America cannot afford to fall further behind in the race for a global digital currency.

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