Long Read: Can China’s Digital Currency Challenge The Supremacy Of US Dollar?

In the midst of chaos, there is also opportunity: Sun Tzu in The Art of War

In June 2006, in a series of articles published in the New York Times, the Wall Street Journal, and the Los Angeles Times, it was reported that shortly after the attacks of 11 September 2001, the United States Treasury Department had been secretly tracking ‘suspected’ terrorist financing through a programme, later coined as the Terrorist Financing Tracking Program, by gaining access to records from a network that handled international financial transfers.

Part of the George Bush administration’s war on terror, the programme gained access to records from SWIFT (Society for Worldwide Interbank Financial Telecommunication). The programme was operating under a series of subpoenas and gave analysts working for the US counter-terrorism force access to records of billions of transactions and thus the information about suspected terrorist activities.

As per the statement from the Treasury to Wall Street Journal, the programme had been a massive success and had aided the disruption of many sleeper cells, and also yielded information about the blasts that happened in July 2005 in London.

Trump’s Trump Card For Economic Sanctions

SWIFT was formed in 1973 by major international banks. In 2015, it served more than 11,000 institutions in more than 200 countries. As an industry cooperative responsible for enabling financial transaction messaging service, SWIFT acts as an electronic gatekeeper for the world’s major banks, brokerages, and other investment institutions. However, SWIFT itself does not handle any funds but is critical to cross-border transactions.

Using SWIFT, banks, across the globe, transmit information to each other about financial transfers. The information includes identification of the senders and receivers, amount, account numbers of respective banks being used. Passed through forms, the information is transmitted over a secure network. The transfer of funds, however, is taken care of by banks or other clearing institutions.

SWIFT’s significance in global transactions is unparalleled. On 17 March 2020, SWIFT FIN (FIN is a message type that transmits financial information from one financial institution like banks, clearing agencies, etc, to another) registered close to 44 million messages.

Each day, an average of 33 million messages, facilitating transactions worth $5 trillion, are registered on the platform. Headquartered in Belgium, the organisation is registered under the Belgium law. However, given SWIFT’s closeness to the US, as revealed in 2006, many nations are now choosing to move away from the platform.

In 2012, SWIFT, for the first time, on the orders of the European Council, stopped providing services to Iranian banks sanctioned by the European Union. This move was aligned with the larger goal of US foreign policy.

By disrupting services to sanctioned Iranian financial institutions under SWIFT, the EU was able to hinder Tehran’s trade with the rest of the world and thus pressurise them into giving up its nuclear ambitions. In March 2017, SWIFT removed sanctioned financial institutions in North Korea.

Swiftly Moving Away From SWIFT

Seeing the influence of the West in SWIFT, countries like Russia and China have put forward their own alternatives to SWIFT. Russia’s System for Transfer of Financial Messages (SPFS) was launched in 2014. In 2015, China came up with Cross-Border Inter-Banks Payment System (CIPS).

In 2018, President Donald Trump walked out of the Iran nuclear deal and slapped more sanctions on the Middle-East state, thus hindering its trade with other signatories of the deal. France, Germany, and the United Kingdom, in 2019, went on to create the Instrument in Support of Trade Exchanges (INSTEX), a special purpose vehicle, to facilitate non-SWIFT and non-USD transactions with Iran.

Later, Finland, Belgium, Denmark, Netherlands, Norway and Sweden chose to go with INSTEX to trade with Iran. Their decision was welcomed by China in late 2019, and earlier this year, Russia called for INSTEX to be expanded beyond the European borders. In 2014, Russia, after its invasion of Crimea, had been put under numerous sanctions too.

In November 2019, there were reports of India, China and Russia exploring an alternate financial mechanism to trade in their own currencies. Given US’ sanctions against Russia, New Delhi and Moscow had been trading through rupee-rouble mechanism already for procurement of defence equipment.

A Small Step For China, A Giant Leap For Currency Wars

In a world not ravaged by the coronavirus outbreak, the news of China testing its digital currency in four large cities would have made headlines. However, since April, the West has been focussed on fighting the virus outbreak, the origins of which are alleged to be in China.

Launched in four cities, China’s digital currency is not one of those many projects that are best ignored as superficial investments by Beijing, but one that could dent the influence of SWIFT and thus of the United States in the long run.

As early as 2014, more than two years before the world would witness a tectonic shift in US’ foreign affairs, China’s central bank began work on its digital currency. With critical pillars like artificial intelligence, blockchain technology, and digital-payment platforms already in place, Beijing wanted to use the digital currency to secure its financial autonomy and assert itself on the global scale.

What aggravated their pursuit of the ideal digital currency was Facebook’s own proposed digital currency Libra in 2019. While the introduction of digital currency is being touted as one of the preparatory programmes for the 2022 Winter Olympics scheduled in China, the programme is all set to go beyond 2022 and far beyond ‘Made in China 2025’.

No, Digital Currency Is Not Your Regular Digital Wallet Or Any Cryptocurrency

Firstly, to address the elephant in the room, the digital currency being planned by China is not another addition on the buffet of cryptocurrencies. China’s digital currency is going to be backed by its central bank, unlike other cryptocurrencies which are not issued or backed by any central party and are therefore too volatile to have a reliable value.

As Facebook tried with Libra, where the cryptocurrency was being backed by a basket of other currencies, there are other crypto-assets known as ‘stable coins’ that can be used. However, these are not without risks, and therefore, a digital currency coming from the central bank is risk-free and can be expected to perform all the essential functions of money.

While the early testing of China’s digital currency cannot be seen as the final version, a discussion paper by the Bank of England, from March 2020, offers insights on the possibilities associated with central bank going digital and what China could achieve.

Firstly, the nature of the currency itself as compared to other forms of money. One, the banknotes. Two, the commercial bank deposits or electronic bank deposits, and lastly, the reserves with the central bank where commercial banks hold their accounts.

Two, the opportunities associated with the digital currency. This would include supporting a resilient payments landscape, meeting future payment needs in a digital economy, improving the availability and usability of central bank money, addressing the consequences of a decline in cash, and most importantly, as a building block for better cross-border payments.

While cards do offer an instantaneous payment mechanism, it can take anywhere between three days to a fortnight for the payment to reach the seller.

Three, its application. The rise of digital currency, backed by the central bank, could give rise to ‘programmable money’. This would allow for enabling of transactions for only certain events, under specified rules, or for specific regions.

This could include payments made over devices connected by IoT, disbursement of dividend to shareholders, and so forth. With digital currency, micropayments, that otherwise come with a cost today, could be made, further giving rise to a number of industries.

For instance, allowing people to pay for each article they read and not for the complete subscription. The central bank could also flirt with the idea of customised monetary policy for certain sectors, like aviation or hospitality in the aftermath of a virus outbreak.

Four, the challenge of high-value payments. Coordination between central banks of all countries could enable interoperability around a defined set of standards, especially for nations trading extensively amongst themselves. For instance, China with Australia, or with nations under the Belt-Road Initiative.

Five, the usage. While a digital currency could be used to make payments by households or individuals to business or vice versa, or from businesses to businesses, the ideal way going forward would be to have digital currency payment system interoperable with those of other countries and to have room for services to be built on the top of the payment platform.

Under the model discussed by the Bank of England, a core ledger, maintained by the central bank, could have regulated API access for payment interface providers from the private sector, and then the users could register themselves with these payment interface providers.

Overall, the platform for digital currency would have to factor in individual privacy, scalability, security, accessibility, expansion, transparency and inclusiveness.

One Belt, One Road, One Currency?

What makes the introduction of digital currency a giant leap forward is the impact it can have on the banking industry. This can be looked at in multiple ways.

Firstly, the digital currency would enable households to directly make electronic payments using central bank money. While at the user-end this may come across as a trivial change, it could usher in a new era for monetary stability, on how interest rates are passed on to the consumers, and the cost of credit.

Two, if on the introduction of the digital currency, individuals, households, and small and large businesses choose to move their savings to the central banks, the commercial banks could be staring at a contraction in their balance sheets, for people would like to deal directly with the central bank.

This could constrain the lending abilities of banks, and increase the cost of credit. This, in turn, could have an impact on the financial stability of the system. For instance, in an alternate universe, what if the collapse of one private bank on Wall Street enabled every household to move their savings from a commercial bank to the central bank.

Three, the interest rate offered by the central bank. What if the central bank of China was able to offer an interest rate greater than that offered by commercial banks in other nations, especially the ones under the Belt and Road Initiative?

This is where China could use its influence to create a global trading system that moves away from SWIFT and the dollar. For nations trading extensively with China, there would be an incentive to use its digital currency.

Today, China has investments worth $200 billion in the Middle East and North Africa, around $115 billion inAustralia, around $288 billion in East Asia, $175 billion in South America, and more than $300 billion in Sub-Saharan Africa. In West Asia alone, the investments are worth $300 billion.

While moving to a digital currency will not be a challenge for China’s 1.4 billion people, given 80 per cent of them already make digital payments, Beijing could get Africa and the Middle East to use its digital currency in the 2020s.

While nations in South America may want to trade in greenbacks more than a digital yuan, inroads could be made by virtue of incremental investments.

With Africa, Middle East, and South-East Asia under its influence, China’s digital currency could cover 50 per cent of the global population by the early 2030s. The coverage could come in the form of e-payments for retail, wages, investments, IPOs, and so forth. The greater the market for the digital yuan, the greater the influence, and the greater dent for US’ influence.

China’s Digital Push Against The Dollar Status Quo

Since the early twentieth century, the dollar has been the dominant currency across the globe, thus giving the US tremendous economic leverage in geopolitics. Close to 40 per cent of the global trade is invoiced in dollars and it is used in 88 per cent of the foreign exchange trading across the world, even when US exports constitute only 8.8 per cent of the total global exports.

Thus, China’s digital currency, in the short term, poses no threat to the dollar’s hegemony. However, with many nations now wanting to work outside SWIFT, and already working on their own digital currency programmes, China’s digital currency, giving it the first-mover advantage, could offer an insight into a future where the dollar is seen as one of the reserve currencies, and not the only one.

The rise of China’s digital currency may not be the end of the dollar by any means, but would surely dent Oval Office’s favourite tool, that of economic sanctions using SWIFT, and would challenge the West, striving hard to maintain the status quo, as the world, led by China, moves on.

With this pilot project, China may well have offered the spark for a currency war, apart from the ongoing trade and tech war.

This is the second article in a four-part series on China’s emergence as a global dictatorship and its consequences on the economic, technological and military front. The later parts will focus on China’s tech and military capacities). Read the first part here.