Can Central Bank Digital Currencies Displace The Dollar?
With China’s central bank expected to be issuing its very own digital currency this year, other central banks are wondering whether or not to follow suit, which begs the greater question if any of these would ever displace the dollar’s dominance?
In the Outer Rim region of the fictitious galaxy created by George Lucas’s Star Wars, alien spice merchants trade with humanoid looking “offworlders” through translator droids like C3-PO and haggle with each other over price the price of the galaxy’s goods.
Meanwhile, alien smugglers, bounty hunters and the galaxy’s more nefarious elements indulge in all manner of exotic tipples in the the cantina on Mos Eisley, as a boyish wannabe Jedi, Luke Skywalker (played by Mark Hamill) negotiates off world passage with the infamous smuggler (played by Harrison Ford).
Common to these very negotiations is the underlying unit of value, one common throughout the galaxy — the Galactic Credit Standard.
In a galaxy as vast and as far away as the one in Star Wars, a common currency — Credits for short, are like the force which binds all living creatures, an essential ingredient to binding all galactic trade and commerce.
“Information is a commodity. It can be traded, sold, and purchased. And in the end, credits are only as valuable as the secrets they can buy.”
— Darth Bane
Yet somehow, on a planet in our own galaxy, a common currency has eluded generations of earthbound humans, but that hasn’t been for want of trying.
Coining A Better Money
In the six months since social media giant Facebook announced its plan to launch Libra, its very own cryptocurrency that would be backed by a basket of stable government securities and other currencies, the global discussion on the future of money has been irreversibly altered.
And while Libra’s prospects have dimmed, the central banks of major economies, no doubt pressured by China’s announcement of its own central bank-issued digital currency, are starting to consider whether they too ought to throw their hat into the digital currency ring.
There are some analysts who suggest that the addition of private digital currencies such as Libra and central bank-backed digital currencies such as China’s digital yuan, could give dollar dominance, a run for its money (no pun intended).
Outgoing governor of the Bank of England, Mark Carney, even went as far as to suggest recently that technological advances, such as blockchain technology, could become the ingredient for a “synthetic hegemonic currency” — a basket of digital reserve currencies — the world’s very own Global Standard Credit, to borrow the language of Star Wars.
Yet if there is to be a revolution in the constitution of what qualifies as “money”, in the near term at least, the challenge presented by central bank-issued digital currencies are not likely to pose a significant threat to dollar dominance.
The Indomitable Dollar
To be sure, improvements in payment technology have lowered the cost of switching from cash to digital payments.
China’s WeChat Pay and Alipay offer seamless integration of multiple services on a single platform, driven by a low-cost and user-friendly payment system.
But outside of digital payments within borders, there has been little progress in reducing the costs of moving money between currencies and across borders and not all of these costs are pecuniary.
The widely-held perception of the dollar’s safety and stability have kept it dominant in the post-war international monetary system.
And the dollar holds strongly self-reinforcing roles in trade invoicing, accounting for five times the U.S. share of world trade and global banking, which creates significant network effects for the dollar.
The more people use the dollar, the more useful it becomes to everyone else.
It’s just like Facebook in that sense. You may never have wanted to create a Facebook account, but because all your friends were on it, you didn’t want to miss out on anything happening in their lives, so you had no choice but to sign up.
That powerful network effect has been why so many lawmakers and regulators across the world have been so opposed to Facebook’s Libra.
And as emerging markets increase their share of global economic activity, which currently stands at 60%, their already heavy reliance on the dollar has increased as well.
In many emerging markets, from Africa to Asia, the dollar is still held in high regard and accepted sometimes in favor of their own local currency.
The demand for the dollar is not something that digitizing say the yen or the euro will change anytime soon.
Because while a central bank-issued digital currency may help reduce payment friction, it doesn’t ultimately address what it takes to become a global reserve currency.
Not All Currencies Are Created Equal
When the euro was created, many hoped that it would one day become a viable contender to dollar hegemony.
Two decades on and the euro has struggled, thanks to the fragmented nature of the economies that support it, varying levels of economic development of eurozone countries and inadequate fiscal co-ordination and risk-sharing.
Today, the euro represents an aspirational currency, with tremendous promise of representing a diverse economic region, but without living up to its full potential.
And uncertainty over the eurozone’s long term stability and cohesion do little for the euro’s ability to challenge the dollar.
So what about the Chinese yuan?
Chinese efforts to internationalize the yuan have met with limited success. Despite concerted policy pushes by Beijing and liquidity support through bilateral swaps with over 30 central banks, the yuan only makes up just over 2% of global transactions, despite China being the world’s second largest economy.
And digitizing the yuan may do little to accelerate its use in global trade and transactions, because it’s not just technology that forms the basis of a global reserve currency, it’s institutions as well.
When governments, investors, traders and central bankers are confronted with a choice of digital currency for a cross border transaction, they are likely to base that choice on the same factors as they have in the past — liquidity, stability and convertibility — with one additional factor, the technological superiority of the issuing country.
Because privacy and security are genuine concerns when it comes to a digital currency, counterparties will no doubt also have to take into account the technological soundness of the issuing sovereign of a digital currency.
Few countries outside of the United States will meet all of the criteria required for a globally relevant digital currency.
The U.S. is a global leader in combating money laundering and terrorism financing. As the world’s strongest economy and with the most powerful military, it’s role as a global policeman, a role established since the Truman administration, means that the dollar represents far more than the cotton paper it’s printed on.
Blockchain technology, in and of itself will not a global digital reserve currency make.
Bully For Blockchain
Trade and financial contracts continue to be overwhelmingly denominated in a single currency — the dollar — rather than a basket of currencies.
For a “synthetic hegemonic currency” to work, it wold have to be supported by a coordinated effort by individual central banks whose currencies underlay it to ensure stability and reduce perceived risks.
And if the experience of the euro is anything to go by, that level of coordination and cooperation required to support a multilateral “synthetic hegemonic currency” would be challenging to achieve at best.
Consider that a truly “global hegemonic currency” would require cohesive fiscal and monetary policy responses across vast geographical regions, separated by national interests, cultural differences and timezones and it’s not hard to see why the world is still very far from a “Galactic Standard Credit.”
Because global needs often conflict with monetary policy objectives at home, there is often little incentive for leading reserve currencies to participate in the creation of such a global “synthetic hegemonic currency.”
And with populations becoming increasingly disillusioned with globalization and with the rise of populism and nationalism, it is hard to say if the world is entering another era of introspection and de-globalization.
Repeated attempts at globalization have not turned out well, often ending in global conflict. The past 65 years of relative global peace and internationalization remain an exception in world history, not the norm.
And much of that peace and globalization has been due in large part to the global harmonizing role of the United States, as a global financier and a global watchdog — a role which the current U.S. administration seems to be taking the United States away from.
American isolationism, not another sovereign’s digital currency would be the biggest threat to the dollar.
One oft attributed quote to former U.S. President Abraham Lincoln perhaps sums it up best,
“America will never be destroyed from the outside. If we falter and lose our freedoms, it will be because we destroyed ourselves.”
The same perhaps could be said of the global role of the dollar.
The dollar will never lose its dominance because of another currency, it will lose its role in international trade and finance if America decides to turn its back on the rest of the world.
Within the euro, the yen, the yuan or even Bitcoin, these nascent currencies, in and of themselves, as yet do not have the wherewithal to mount a serious challenge to the dollar.
Consider that the euro, yen, yuan and even Bitcoin have their values measured against the dollar — because the thing that is being measured cannot be larger than the thing that is being used for the measurement — and it becomes clear that the dollar is not going away anytime soon.
But the past three years of the Trump administration have done untold damage for America’s global standing and reliability in foreign policy.
Historians will pour over this period in American history for decades from now, to try to discern if the Trump administration marked a watershed moment or merely a speed bump in America’s global role and leadership.
And how the world perceives America’s global leadership will have profound effects on the role of the dollar in global trade and finance.
Broken, Please Fix
To be sure, the international monetary system needs work.
Even in a country as technologically advanced and as financially developed as the United States, as recently as 2017, almost 7% of the American population remained unbanked.
Across the globe, millions of migrant workers lose as much as 14% remitting money to their homes.
But because global remittances affect the poor and unrepresented more than any other demographic globally, they are often easy to dismiss and forget.
That does not detract from the fact that the world needs cheaper and faster cross-border payments — settlement of cross-border remittances continues to be lethargic, expensive and prohibitive to those who can least bear these costs.
It is in this regard specifically, that Bitcoin and blockchain technology was mooted as a technological solution to this seemingly intractable human problem.
Since cross-border transactions rely so heavily on so-called “trusted third parties,” why not have the technology platform itself become the platform to ease trust out of the equation.
And while Bitcoin and blockchain technology have yet to live up to their potential, that is not for want of trying.
Blockchain technology has the potential to bring quick gains in global remittances and to improve financial inclusion.
And recognizing blockchain’s potential and risks, the G20 as well as the IMF have both started reviewing the macroeconomic implications of global stablecoins such as China’s impending digital yuan.
But technology in and of itself does not a global reserve currency make.
The dollar continues to dominate primarily because of the strength of its institutions, while the euro struggles under the eurozone’s fiscal and monetary architecture.
And global acceptance of the yuan has been tepid in the absence of stronger domestic institutions, transparency and market liberalization.
Against this backdrop, it would be tempting to tout Bitcoin and blockchain technology or some other cryptocurrency as a silver bullet.
Given the current state of development of cryptocurrencies, blockchain technology and Bitcoin, that envisioned monetary and fiscal utopia remains somewhere in the future.
To be fair, Bitcoin hasn’t been around all that long, just over a decade — sufficient time to establish its nascent code-derived institutions, but far shorter than the almost two-and-a-half centuries that the United States has had to define hers.
Bitcoin and blockchain technology could one day assist in mounting a credible challenge to the dollar, but technology in and of itself is insufficient to unseat the greenback from its current pedestal — for that, stronger institutions, both political and technological will be needed.
So far Bitcoin’s institutions are purely technological, only time will reveal if it will become political as well.
A currency is more than just a store of value, a unit of measurement and a medium of exchange — it is also very much an expression and a subscription to an ideology and a particular set of values.
The dollar represents democracy and freedom, values that cannot be reasonably applied to even a digital version of the yuan.
Because what gives something value is not just what it can buy, but also what it comes to represent.
In this regard, the dollar is still heads and shoulders above all other currencies.