De-Dollarization in the Age of Blockchain and Digital Currencies

Andy Yee wrote . . . . . . . . .

Emerging technologies such as blockchain and digital currencies could accelerate de-dollarization as countries question the continued supremacy of the US dollar, the growing use of financial sanctions, and American monetary and fiscal discipline, writes Andy Yee of the University College London Centre for Blockchain Technologies.

Calls for de-dollarization have been made for decades. As early as 1965, French finance minister Valéry Giscard d’Estaing denounced the “exorbitant privilege” of the dollar which allows the US to indulge in expensive foreign wars. The 2007-08 global financial crisis put the dollar’s supremacy and American monetary and fiscal discipline increasingly into question. De-dollarization has again become a trending topic following the Russia-Ukraine war and the weaponization of the greenback against Russia.

In an attempt to achieve financial and geopolitical autonomy, countries and coalitions of nations including China, Russia, the BRICS (Brazil, Russia, India, China and South Africa), and the European Union have been developing alternatives to the dollar-based payment system and financial infrastructure. In recent years, technological developments, in particular blockchain and digital currencies, have promised new ways to achieve these policy objectives and give new impetus to the de-dollarization agenda.

Blockchain and digital currencies offer key attributes such as neutrality, efficiency, and programmability capable of supporting novel financial applications outside of the traditional financial system. In the framework outlined by Tufts University scholars Zongyuan Zoe Liu and Mihaela Papa in their 2022 book Can BRICS De-dollarize the Global Financial System, these technologies are among the “go-it-alone” strategies (in contrast to “reform-the-status-quo” approaches) that can create entirely new non-dollar-based infrastructure, institutions and market mechanisms to challenge the dollar’s hegemony.

Notwithstanding the recent crisis in the cryptocurrency sector, the emerging international consensus is to put in place appropriate regulations to harness the potential of these new technologies while providing necessary guardrails. Arguably, challenger nations have all the more incentive to do so, given that radical innovation could permit their financial systems to leapfrog that of the US.

An instructive way to assess the potentially transformative impact of these digital technologies is to use the financial power framework developed by German researchers Benjamin Braun and Kai Koddenbrock. They introduced the concepts of leverage power, infrastructural power and enforcement power in global finance. In all the key stages in the life-cycle of financial claims, namely creation, trading and enforcement, the US dollar’s position remains strong. Yet, the potential for digital technologies to shift power away from the US dollar is also significant.

Leverage power

The financial system revolves around actors with the greatest leverage power. The US enjoys an “exorbitant privilege” as the issuer of the global reserve currency, with the US dollar accounting for 60 percent of global reserve portfolios. The unprecedented seizure of some US$300 billion in Russian central bank assets by the US and its allies, however, calls into question the status of fiat reserve currencies as “safe-haven” assets.

In this context, nations seeking a neutral reserve asset will find appeal in decentralized cryptocurrencies such as Bitcoin. Econometric analysis by Harvard University researcher Matthew Ferranti found that a modest risk of sanctions faced by central banks significantly increases optimal gold and Bitcoin allocations. To date, small nations such as Bhutan and El Salvador have started adding Bitcoin to their reserves. If this trend takes hold, it can lead to a redistribution of leverage power away from the largest states and their ability to expand their balance sheets at will.

On the other hand, the tokenization of assets enabled by blockchain technology has the potential to increase the borrowing power of smaller nations and businesses, making them less reliant on US-dominated capital markets. Global bank Citi has estimated that up to US$4 trillion of real-world assets could be tokenized by 2030. Blockchain technology can create niche capital markets characterized by disintermediation, efficiency, inclusive access, and improved liquidity. Perhaps the best known example is El Salvador’s anticipated issuance of tokenized “volcano bonds” to fund Bitcoin mining infrastructure and a “Bitcoin City”. Another possibility is the use of blockchain-based security tokens to unlock global pools of capital for green financing in developing countries.

Infrastructural power

Actors in the global financial system who provide infrastructure for financial activities such as payment and trading wield significant power. They can exercise influence over global norms and rules and the imposition of sanctions. This has been powerfully illustrated by the exclusion of Russia and Iran from the SWIFT bank-messaging system. By leveraging blockchain and digital currencies, nations that attempt to establish alternatives to US-controlled financial infrastructure can offer significant advantages in terms of costs, efficiency, ease of use, and applications. This allows their currencies to scale up faster and achieve network effects.

The prospect of this happening is particularly strong in international trade and settlement. The rise of central bank digital currencies (CBDCs) will make cross-border payments vastly more efficient. As the world’s most advanced CBDC initiative, China’s digital yuan could accelerate an increase in the share of trade denominated in yuan. The digital yuan is expected to interact efficiently with the digitalization of the trade process driven in part by China’s Blockchain-based Service Network (BSN). It can also interoperate with other CBDCs as they emerge through the Project mBridge of the Bank for International Settlements (BIS). In time, its geographic reach could expand, especially across the Belt and Road Initiative (BRI) network and to other key trading partners of China.

More broadly, major jurisdictions around the world are vying to be cryptocurrency hubs hosting next-generation financial infrastructure for digital assets. Hong Kong’s Web 3.0 policy pivot, announced in October 2022, aims to develop a vibrant ecosystem for virtual assets including exchanges, exchange-traded funds, tokenized assets and stablecoin. In April 2023, the European Parliament passed the Markets in Cryptoassets (MiCA) Regulation, positioning Europe as an attractive region for cryptoasset service providers. And despite the market disruptions last year, Singapore still wants to become a responsible digital asset hub, experimenting with programmable money and tokenizing financial assets. By contrast, US regulators have taken a hostile attitude to drive cryptocurrency businesses out of the financial system, with industry players dubbing the approach “Operation Choke Point 2.0”. This risks the US losing key cryptocurrency financial infrastructure and innovation advantages, with the US dollar not being the denomination of choice for digital assets.

Enforcement power

In the dollar system, existing enforcement power is concentrated in the legal systems of Western financial centers and international institutions such as the International Monetary Fund (IMF). We are, however, in the age of lex cryptographica or code-as-law, as blockchain scholars Primavera De Filippi and Aaron Wright have proclaimed.

Through the use of programmable smart contracts, values, norms and conditionalities can be hard coded into blockchain-based financial infrastructure. This bestows nations that build them with enormous enforcement power and innovative governance mechanisms, reducing the influence of existing US institutions.

One example is again the digital yuan, which provides China with enhanced enforcement of capital controls and an innovative means of opening its economy and financial markets at the same time. The digital yuan enables the Chinese central bank, the People’s Bank of China (PBoC), to monitor real-time capital flows and refactor the digital yuan code to halt excessive capital outflows. Cross-border digital yuan payments will reduce friction and further globalize the yuan while allowing greater supervisory oversight of cross-border flows.

Blockchain technology can also foster trust among de-dollarizing nations by guaranteeing an equitable sharing of enforcement power. As they jointly establish new financial institutions and mechanisms such as the New Development Bank (previously the BRICS Development Bank) and a BRICS payment system, “designed vulnerabilities” or mutual dependencies can be built into blockchain’s modularized and decentralized governance. This could be done by splitting the core functions and decision-making and arbitration power within the system across multiple countries to ensure that no one can dominate. Enhanced trust will increase the adoption of this new financial infrastructure.

Across the full spectrum of power in global finance, blockchain and digital currencies can help rising powers to de-dollarize the global financial system and mitigate the risk of dollar hegemony. At the same time, they have the potential to usher in a fair, efficient, and inclusive financial system. As technology accelerates the move towards a more balanced and multipolar monetary order, it is important that countries collaborate with each other to ensure a new and better financial architecture that is globally integrated rather than geo-economically fragmented.

Source : Asia GLobal Online

Russia Plans to Use Digital Rouble in Settlements with China, Says Lawmaker

After launching a digital rouble early next year, Russia plans to use the currency in mutual settlements with China as it seeks to reduce Washington’s global financial hegemony, a senior Russian lawmaker said on Monday.

Russia, like many countries, has been developing digital money over the last couple of years to modernise its financial system, speed up payments and head off the threat of cryptocurrencies like bitcoin gaining influence.

The central bank is already conducting digital rouble tests with banks at a time when sanctions against Moscow over its actions in Ukraine have slashed Russia’s access to large swathes of global financial market infrastructure.

With that in mind, Russia is on the hunt for alternative means of carrying out transactions, said Anatoly Aksakov, head of the financial committee in Russia’s lower house of parliament, in an interview with Russia’s parliamentary newspaper.

“The topic of digital financial assets, the digital rouble and cryptocurrencies is currently intensifying in society, as Western countries are imposing sanctions and creating problems for bank transfers, including in international settlements,” Aksakov said. He added that the digital direction is key because financial flows can bypass systems controlled by unfriendly countries.

The central bank and government have been at loggerheads all year over cryptocurrency regulation. Aksakov said he hoped legislation would emerge this year.

He added the next step for the digital rouble would be to launch it for mutual settlements with China, which has already tested its digital yuan.

“If we launch this, then other countries will begin to actively use it going forward, and America’s control over the global financial system will effectively end,” said Aksakov.

As Western nations have shunned Russia, cooperation with Beijing has become increasingly important for Moscow. The two nations have increased trade with one another and Russian companies have started issuing debt in yuan.

Some central bank experts have also suggested the new technologies mean countries would be able to deal more directly with each other, making them less dependent on Western-dominated payment channels such as the SWIFT system, to which many Russian banks have lost access due to sanctions.

Source : Reuters

Chart: Where Central Banks Have Issued Digital Currencies

Source : Statista

The Hong Kong Monetary Authority Calls for Public Feedback on Retail Digital Currency

In a paper released last week, HKMA examined the benefits, challenges and use of the potential e-HKD. It also looked into design considerations such as the issuance mechanism, interoperability with other payment systems, privacy and data protection, as well as legal considerations. The paper is accepting public feedback until May 27.

Read the paper . . . . .

Next Phase of Hong Kong’s Fintech Journey – Eddie Yue

Opening remarks by Mr Eddie Yue, Chief Executive of the Hong Kong Monetary Authority, at The Hong Kong Association of Banks (HKAB) Fintech Seminar: Next Phase of Hong Kong’s Fintech Journey – “Fintech 2025”, 8 June 2021.

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Good afternoon everyone. Thank you for taking out the time to attend this HKAB Fintech Seminar. I’m glad to be able to meet all of you online via this live stream. I’d like to take this opportunity to firstly thank the HKAB for organising the event and for inviting me to speak.

Today, it gives me great pleasure to share with you the HKMA’s new fintech strategy – Fintech 2025.

It is commonly accepted that the future of banking hinges on technology. The quality of any banking experience will, in today’s time, be very much correlated to how much of that experience is digital.

Banks in Hong Kong were early movers in Asia. We embraced digitalisation long before fintech came into the limelight. You have truly done a great job in using technology to streamline your banks’ operation and provide excellent customer experience.

The Fintech 2025 strategy we are announcing today aspires to help the financial sector adopt technology comprehensively by 2025; so that they will deliver fair and efficient financial services, benefitting Hong Kong people and the Hong Kong economy. We believe this new fintech strategy would provide the shot in the arm to elevate the banking industry to new heights.

Brief recap of key achievements

Before I delve more deeply into the strategy, let us have a look at where we currently stand.

Last year, eight virtual banks launched their services to the public, marking a key milestone in Hong Kong’s Fintech Journey. The usage of Faster Payment System (FPS) has witnessed substantial growth since launch. So far, it has recorded over 8 million registrations, and is used by the general public in person-to-person payments, government payments, and payments to merchants. On average, more than 630,000 transactions are conducted daily, over twofold than a year ago. Our Fintech Supervisory Sandbox was also well received and more than 200 initiatives have been tested since launch.

These encouraging figures show how the HKMA’s Smart Banking initiatives have significantly driven the digital transformation of banking services. They also demonstrate Hong Kong people’s willingness to embrace fintech; and set us up for further fintech developments.

Customers’ digital appetite will outlast the pandemic

Unfortunately, the city and the world were subsequently battered by COVID-19. But Hong Kong’s pre-pandemic fintech efforts were sufficient, for the time being at least. So we were able to enjoy largely uninterrupted high-quality digital financial services during the pandemic, allowing a wide range of commercial activities to continue in the city. In fact, COVID-19 demonstrated the sheer power of fintech. Fintech can fulfil gaps when traditional banking services are compromised.

Now, we must recognise and accept the fact that COVID-19 has permanently changed customers’ behaviour. Their digital appetite will outlast the pandemic. The only way to satisfy their increasing digital appetite is to increase our fintech offerings, which in turn, will make them hungrier for more.

The HKMA believes now is the right time for the banking industry to double down on fintech development. It is time to work together as a whole to embrace the numerous untapped possibilities that fintech can bring. Fintech has the potential to become a major economic growth engine in the post-pandemic era; and it would be in the banking industry’s best interests to be a part of this progression.

With this in mind, we have talked to a lot of stakeholders in the past few months to map out what needs to be done to take Fintech development to a higher level. Our conclusion is that we must build an ecosystem where the value of fintech is experienced across all levels and by all groups of people. When we bring sufficient benefits to customers, investors, and the public at large, we will create a virtuous cycle that generates even more demand for fintech solutions, in turn energising the whole industry.

As we build this ecosystem, we also need to ensure that we maintain the right factors for the ecosystem to grow further. Data, infrastructure, talent, and funding will all be vital to this growth. This thinking process has culminated in a strategy that we call Fintech 2025, which I am pleased to share with you here. .

All Banks go fintech

The first part of our fintech strategy is called “all banks go fintech”. In short, we want banks to go “all in” with fintech, and fully digitalise their operations, from front-end to back-end.

The future is full of uncertainties. This is something we have all witnessed first-hand over the past two years with the pandemic. Challenges and interruptions to day-to-day activities, including banking activities, can happen unannounced. The only thing certain and that has been a constant throughout these ups and downs is digitalisation.

Indeed, the banking industry also recognises the value of digitalisation. At least we like to think this is why banks have so positively embraced the HKMA’s fintech drive so far – rather than due to any regulatory pressure! Jokes aside, I trust the figures I quoted earlier are proof that the earlier Smart Banking initiatives have laid a strong foundation for our banks to take this next step in their fintech journey.

The HKMA is keen to support banks during this process. Under the Fintech 2025 strategy, we will be rolling out a Tech Baseline Assessment to help the HKMA identify those areas that we may be able to offer support. As part of this exercise, we will be inviting banks to submit a Three Year Plan for technology adoption within Q4 2021. We will then assess and benchmark the results against overseas peers to identify whether there are firstly, any business areas – such as Investech, Wealthtech, Insurtech and Greentech – where technology is underused, or secondly, any specific technology types, including artificial intelligence and blockchain solutions – that are not receiving sufficient attention. Based on the findings of this exercise, we will consider what support the HKMA can offer to help the banking sector reach the next level of fintech sophistication. If everything goes according to plan, you can expect to see the results in the first half of 2022.

In parallel, we will continue to provide guidance on fintech areas that may present opportunities or risk management challenges to the banking industry. This will help banks adopt novel technologies with more confidence and less apprehension that regulators may come knocking! As an example, as part of our two-year Regtech roadmap, we will soon be publishing a “Regtech Adoption Practice Guides” series to address how Regtech solutions can be applied to cloud computing, blockchain and anti-money laundering surveillance.

Despite this promise of support, we recognise that banks, especially smaller ones, may still have doubts about going “all in” with fintech given the heavy talent and resource investments required. However, we are confident that by offering support that is targeted, specific to local market circumstances, and where it is needed, banks of all sizes will soon grow to appreciate the case for “going” fintech. The HKMA looks forward to being a long-term partner with you on this journey, and I hope you can offer us your unwavering support too.

Future-proofing Hong Kong for Central Bank Digital Currencies (CBDCs)

As we look beyond banks to the wider financial system, we turn our attention to initiatives that will have an impact on the financial system as a whole, one of which is CBDCs, the focus of our second strategy.

As the world becomes more interconnected than ever, cross-border and cross-boundary transactions have never been more frequent. Many of us have witnessed how payment instruments have evolved over time, from banknotes to credit cards to cross-border payment networks. While CBDCs may not see mainstream adoption any time soon, this is something that has the potential to profoundly alter the global payment landscape. We must work with the industry and international community to ensure that we address both the technical and non-technical issues involved.

For this reason, we have been researching wholesale CBDCs as they have great potential in addressing the long-standing pain points in cross-border payments. Lately, the HKMA’s joint research with the Bank of Thailand has been ranked by the market as one of the most mature of its kind in the world; a testimony that we stand at the forefront in the realm of wholesale CBDCs. We recently expanded the scale of the project to include more participating jurisdictions.

Some of you may already be aware that the HKMA has begun researching retail CBDCs (r-CBDCs). We have been working with the Bank for International Settlements (BIS) Innovation Hub Hong Kong Centre on Project Aurum, which will focus on the technical aspect of issuing r-CBDCs and the possible architectural designs.

Similar to the majority of central banks, we see that a lot of issues need to be thought through before issuing r-CBDC. For instance, how should we strike a right balance between privacy and traceability? How do we mitigate cybersecurity risks? How will it affect the effectiveness of monetary transmission? These are important questions that need to be answered before reaching a conclusion.

Against this backdrop, the HKMA will soon begin a comprehensive study on e-HKD to understand its use cases, benefits, and related risks. This is to increase our technical readiness so that we are prepared for all kinds of circumstances in the future, including the potential for Hong Kong to issue e-HKD. We have already established an internal cross-departmental working group within the HKMA to study the relevant technical, policy and legal issues, and we hope to offer our initial thought on this complex matter in 12 months’ time.

Needless to say, CBDC will remain one of the most important topics among the global central banking community in the months or years to come. The HKMA will continue to work with the BIS and other international institutions to prepare Hong Kong for the evolving landscape.

Creating the next-generation Data infrastructure

Our third strategy is to create a high-performing and functional data infrastructure so that banks can benefit from data instead of being weighed down by it. We often hear comments that the lack of data has been a major impediment to banks’ competition with the big techs. But the reality is that a lot of data is scattered across different sectors, entities, and platforms. It is just that there is no efficient way for traditional financial institutions to tap into these treasure troves, with the consent of data subjects where necessary.

In order to leverage data to launch innovative financial solutions, and to unleash our city’s potential for the next generation of banking, we need to enhance Hong Kong’s financial data infrastructure. For example, as a start, we are building the Commercial Data Interchange (CDI). After joining CDI, you will be able to safely and quickly access corporates’ data, which, although always there, was previously almost inaccessible. What’s more, once CDI has been built, and related mechanisms established, your bank can connect with new data providers with minimal efforts. The need for customising connectivity for each partner will become a thing of the past.

In many ways, CDI is unlike our existing financial infrastructures, such as the RTGS and FPS. For one thing, the architecture of CDI is more complex. Multiple parties are involved-banks, data providers, commercial entities, government departments, you name it. And for another, we need to factor in various considerations to keep up with the latest international standards, including measures to uphold and protect data privacy. Therefore, enhancing our financial data infrastructure must be a concerted effort by the banking and tech industry as a whole. A team effort will ultimately lead to public goods that deliver value, benefit all the parties, and at the same time are commercially viable.

By improving our data infrastructure, we are empowering the industry and encouraging creativity for developing innovative financial products and solutions, in turn building up the overall appetite for fintech solutions.

Expanding the fintech-savvy workforce

The three strategies I just mentioned will, hopefully, generate demand in the industry for fintech solutions. However, from what we learnt from the industry, the supply of fintech talent remains a pressing issue. Therefore, our fourth strategy is that we want to foster a fintech-savvy workforce and nurture all-round fintech talent, including students and practitioners.

We don’t need reminding of how Hong Kong boasts an extremely strong talent pool – be it in law, finance, accountancy, or other professions. We are a city that thrives on our people’s high agility and efficiency. We pride ourselves on keeping up with international standards as well as customer and market requirements.

With fintech being a relatively new area, it is understandable that we currently face an acute fintech talent shortage. Hong Kong is in need of grooming all-round fintech talent and expertise. We need professionals who can develop fintech solutions, instead of merely being users of it. Given the intellect and work ethic of our students and professionals, I am confident that this is an objective we can achieve without difficulty.

As mentioned, fintech is, comparatively speaking, a nascent industry. That is why insights about the industry, such as the kinds of jobs available, the skillsets required, and career path, remains largely a mystery to outsiders, let alone fresh graduates and new joiners. We want to help these new comers gain industry knowledge and practical industry experience. Of course, we have not forgotten about existing banking practitioners. It is equally important, if not more, to upskill practitioners and deepen their fintech knowledge.

In order to do this, we have joined hands with the industry and local universities to launch the Industry Project Masters Network (IPMN) scheme. Starting from September this year, months-long internship opportunities will be provided to some master students for them to gain hands-on experience in areas including AI and federated learning. By the end of this year, we will also launch a new fintech module for the Enhanced Competency Framework to raise the professional competencies of existing banking practitioners.

A collective effort with the banking industry as well as our strategic partners will enable us to nurture home-grown fintech talent and maintain our competitive edge as an international finance centre.

Nurturing ecosystem with Funding and policies

We understand that good ideas alone would not come to fruition without either one of the following: funding support and a conducive environment that allows mistakes and failures. In fact, numerous success stories in history prove that trial and error is necessary for innovation. To encourage banks to try more, in turn stimulating innovation in the banking industry, we are going to channel our focus on two areas: funding and policies.

Today, I am excited to announce that the HKMA is doing preparation work to further upgrade our Fintech Supervisory Sandbox. To begin with, we are exploring the possibility of providing funding support to qualified fintech projects. Our discussion with the Innovation and Technology Commission has just started, and I hope to share more details with you in due course. We hope the enhanced Sandbox could speed up the launch of innovative financial products and solutions, ultimately reducing their Time to Market and facilitate banks in making commercial gains while serving the public.

To ensure that no banks, regardless of their size, will be left behind in the cascading wave of innovation, the HKMA will join forces with our strategic partners, including the Hong Kong Science and Technology Parks (HKSTP) and Cyberport, to introduce utilities and necessary support to banks to speed up their technology adoption.

Through supportive measures, we want to foster an encouraging environment, in which all stakeholders, be they banks, non-banks, or the academia, can trust and flourish.

Closing

As a takeaway, when you think about the Fintech 2025 strategy, I want you to envision a virtuous cycle.

As all banks adopt fintech to capture new opportunities in the digital economy, strong demands will be created for fintech talent, data infrastructure, new payment instruments, and supportive policies. Our strategy will meet all these demands, in turn reinforcing fintech adoption, and ultimately catalysing the growth of a healthy fintech ecosystem that benefits both banks and customers.

Back in 2017, when the HKMA announced the seven smart banking initiatives, they were well received, though not everyone could tell their significance and the changes they could bring. Today, nobody will question the impact of, for example, the FPS and virtual banks, on your business and our daily lives.

I believe the same could be said for Fintech 2025. This new, forward-thinking strategy will set the scene for important fintech developments to take place in the coming years. I urge you to join us and take our city’s fintech ecosystem to new heights.

Thank you.

Source : BIS

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Read also at Ledger Insight

Cross border CBDC trial to involve Hong Kong, Thai stock exchanges, 30 banks . . . . .

Fed Explores ‘Once in a Century’ Bid to Remake the U.S. Dollar

Victoria Guida wrote . . . . . . . . .

The Federal Reserve is taking what may be the first significant step toward launching its own virtual currency, a move that could shake up banks, give millions of low-income Americans access to the financial system and fortify the dollar’s status as the world’s reserve currency.

The idea of creating a fully digital version of the U.S. dollar, which was unthinkable just a few years ago, has gained bipartisan interest from lawmakers as diverse as Sens. Elizabeth Warren (D-Mass.) and John Kennedy (R-La.) because of its potential benefits for consumers who don’t have bank accounts. But it’s also sparking strong pushback from those with the most to lose: banks.

“The United States should not implement a [central bank digital currency] simply because we can or because others are doing so,” the American Bankers Association said in a statement to lawmakers this week. The benefits “are theoretical, difficult to measure, and may be elusive,” while the negative consequences “could be severe,” the group wrote.

The explosive rise of private cryptocurrencies in recent years motivated the Fed to start considering a digital dollar to be used alongside the traditional paper currency. The biggest driver of concern was a Facebook-led effort, launched in 2019, to build a global payments network using crypto technology. Though that effort is now much narrower, it demonstrated how the private sector could, in theory, create a massive currency system outside government control.

Now, central banks around the world have begun exploring the idea of issuing their own digital currencies — a fiat version of a cryptocurrency that would operate more like physical cash — that would have some of the same technological benefits as other cryptocurrencies.

That could provide unwelcome competition for banks by giving depositors another safe place to put their money. A person or a business could keep their digital dollars in a virtual “wallet” and then transfer them directly to someone else without needing to use a bank account. Even if the wallet were operated by a bank, the firm wouldn’t be able to lend out the cash. But unlike other crypto assets like Bitcoin or Ether, it would be directly backed and controlled by the central bank, allowing the monetary authorities to use it, like any other form of the dollar, in its policies to guide interest rates.

The Federal Reserve Bank of Boston and the Massachusetts Institute of Technology’s Digital Currency Initiative are aiming next month to publish the first stage of their work to determine whether a Fed virtual currency would work on a practical level — an open-source license for the most basic piece of infrastructure around creating and moving digital dollars.

But it will likely be up to Congress to ultimately decide whether the central bank should formally pursue such a project, as Fed Chair Jerome Powell has acknowledged. Lawmakers on both sides of the aisle are intrigued, particularly as they eye China’s efforts to build its own central bank digital currency, as well as the global rise of cryptocurrencies, both of which could diminish the dollar’s influence.

Democrats have especially been skeptical about crypto assets because there are fewer consumer protections and the currencies can be used for illicit activity. There are also environmental concerns posed by the sheer amount of electricity used to unlock new units of digital currencies like Bitcoin.

Warren suggested the Fed project could resolve some of those concerns.

“Legitimate digital public money could help drive out bogus digital private money, while improving financial inclusion, efficiency, and the safety of our financial system — if that digital public money is well-designed and efficiently executed,” she said at a hearing on Wednesday, which she convened as chair of the Senate Banking Committee’s economic policy subcommittee.

Other senators highlighted the potential for central bank digital wallets to be used to deliver government aid more directly to people who don’t have bank accounts. A digital dollar could also be designed to have more high-tech benefits of some cryptocurrencies, like facilitating “smart contracts” where a transaction is completed once certain conditions are met.

Neha Narula, who’s leading the effort at MIT to work with the Boston Fed on a central bank digital currency, called the project “a once-in-a-century opportunity to redesign the dollar” in a way that supports innovation much like the internet did.

Still, there are a slew of unanswered policy questions around how a digital dollar would be designed, such as how people would get access to the money, or how much information the government would be able to see about individual transactions. The decision is also tied to a far more controversial policy supported by Democrats like Warren and Senate Banking Chair Sherrod Brown to give regular Americans accounts at the Fed.

“What problem is a central bank digital currency trying to solve? In other words, do we need one? It’s not clear to me yet that we do,” Sen. Pat Toomey (R-Pa.) said. “In my view, turning the Fed into a retail bank is a terrible idea.”

And, “the fact that China is creating a digital currency does not mean it’s inevitable that the yuan would displace the U.S. dollar as the world’s reserve currency,” he said.

For their part, banks fear a Fed-issued digital currency could make it easier for customers to pull out large amounts of deposits and convert them to digital dollars during a crisis — the virtual equivalent of a bank run — putting financial stress on their institutions and making less money available to provide credit for people, businesses and markets.

It could also potentially deprive them of customers, something the lenders say would interfere with lawmakers’ vision of increased financial inclusion.

“While it is true that deposit accounts are often the first step towards inclusion, the benefits of a long-term banking relationship go well beyond a deposit account,” the ABA said in its statement. “The same is not true of a [central bank digital currency] account with the Federal Reserve, which would not grow into a lending or investing relationship.”

The Bank Policy Institute, which represents large banks, has also argued that many of the benefits of a digital dollar are “mutually exclusive (because they are predicated on different program designs) or effectively non-existent (because the program design that produces them comes with costs that are for other reasons unbearable).”

“The decision on whether to adopt a central bank digital currency in the United States is appropriately a long way off,” BPI President and CEO Greg Baer said. “There are also complex and serious costs that will need to be considered.”

But many lawmakers think it’s worth the effort to look into it.

“The Federal Reserve should continue to explore a digital [currency]; nearly every other country is doing that,” Sen. Bill Hagerty (R-Tenn.) said at the hearing, citing the risk for the U.S. to lose its ability to deploy economic sanctions as effectively with decreased usage of the dollar.

Source : Politico

China’s Digital Currency Is a Threat to Dollar Dominance

Michael Hasenstab wrote . . . . . . . . .

Markets have been gripped by cryptocurrency fever. The price of bitcoin has attained new highs while debate has raged over the emergence of cryptocurrency technology.

But these may be a sideshow for a big developing trend — the rapid digitalisation of the renminbi.

This shift, combined with other macroeconomic and political factors, could be the key that accelerates the decline of the dollar’s dominance as the world’s leading reserve currency. It could also hasten the acceptance of the renminbi as the main rival to the US currency.

Central banks around the world have been grappling in recent years with the concept of digital currency technology. Few nations, though, are as aggressive as China in their approach to developing a so-called central bank digital currency.

Such a currency would be overseen by a central governmental authority, removing the element of anonymity that is fundamental to the decentralised, blockchain-ledger of popularised cryptocurrencies like bitcoin or ethereum. The theoretical benefits of government oversight of these new digital assets are numerous.

CBDCs allow for greater prevention of fraud or crime, enable instantaneous international transactions, reduce transaction costs, permit greater financial inclusion and aid the provision of direct fiscal stimulus to individual citizens.

For China, adoption of a CBDC both within and beyond its borders would allow its financial system to reduce reliance on the dollar and limit the role and oversight of foreign financial institutions and regulators. While many countries have started discussing the potential future application of CBDCs, China has pushed ahead with development.

In April 2020, Beijing piloted a digital currency in four cities, allowing commercial banks to run internal tests converting between cash and digital money, account-balance checks, and payments. The pilot programme expanded to 28 major cities in August. Aiming for broad circulation in 2022, China plans to test the digital currency in additional major cities, including Beijing and Shanghai, this year.

This pioneering approach should accelerate the elevation of the renminbi on the world stage. Some users outside China, particularly in the US, might be reluctant to use a digital currency controlled by China. However, early adoption in parts of Asia, Latin America and Africa is likely to proceed significantly faster.

Global reserve currencies’ relative importance historically is explained by the macroeconomist Barry Eichengreen. Currencies are more prized as reserve assets when they satisfy two conditions: first, when they are stable, liquid and widely used in international transactions; and second, when they are backed by a country to which another state has important security links.

China’s development in recent years puts it on a clear path to satisfy these criteria as its government has maintained relative policy stability. The country accounted for 16 per cent of global output in 2019, but the renminbi represented a little over 2 per cent of global reserves as of the second quarter last year.

Lack of renminbi-denominated assets for foreigners to own has inhibited its rise as a reserve currency. But now the renminbi will be supported by the Chinese authorities opening their $15tn domestic bond market to foreign participants. Greater demand for these bonds will push down yields, lowering borrowing costs.

More important, if China captures the first-mover advantage to meet the world’s demand for use of digital currencies to settle international financial transactions and own digital assets, the appeal of its CBDC could rise sharply.

China has also made great strides in invoicing its trade in renminbi. The security and geopolitical rationale for holding renminbi has become stronger through such measures as China’s Belt and Road Initiative financing of projects in developing countries.

Covid-19 might also be a catalyst for the greater acceptance of the renminbi as a global reserve currency. The economic carnage of the pandemic has sent already large fiscal deficits ballooning and driven even more accommodative monetary policy in the US.

This historically unique combination of impending massive fiscal and vaccine-led growth, where short-term interest rates are anchored at zero, will expand an already large current account deficit, putting further pressure on the value of the dollar.

The digitalisation of the renminbi will add to these economic and geopolitical factors. This will have a durable, transformative impact on the international economy.

Source : FT

Make No Mistake: Programmable Digital Currencies Are Weaponizable Money

Peter C. Earle wrote . . . . . . . . .

Earlier this year, China began to roll out a project that had long been in the works––a digital version of its currency, the yuan, is now being used in four Chinese cities. The Chinese government sees two major potential benefits to the experiment: a tangible challenge to the U.S. dollar’s global ubiquity, and a way to control how Chinese citizens spend their money.

As a government-issued currency, the digital yuan can be manipulated and monitored in a number of ways. Importantly, it is programmable. Writes The Wall Street Journal, “Beijing has tested expiration dates to encourage users to spend it quickly, for times when the economy needs a jump start.”

Although the concept of a currency which is artificially inflatable/deflatable on demand seems novel, it has its roots (as do so many concepts) in the theorizing of a long-dead economist. A German entrepreneur by the name of Silvio Gesell witnessed Argentina’s 1890 financial crash firsthand. The ensuing unemployment, poverty, and economic stagnation convinced him that something needed to change. Such crises occurred, he theorized, because people hoarded money out of fear and brought business to a halt, argued Gesell––this he dubbed “poverty amid plenty.”

To encourage quicker spending, disincentivize saving, and therefore avoid more catastrophic financial crashes, Gesell proposed money with an expiration date. “Currency Reform as a Bridge to the Social State,” his first published work, detailed a system in which paper bills would expire unless they were stamped––renewed––for a fee. This ultimately meant that holders of money incurred a demurrage cost, which is the cost of holding a given currency. Because of Gesell’s proposed renewal fee, savings had a negative interest rate.

He called this Freigold, or “free money.” Speaking of his system’s perceived benefits in The Natural Economic Order, Gesell wrote,

Only money that goes out of date like a newspaper, rots like potatoes, rusts like iron, evaporates like ether, is capable of standing the test as an instrument for the exchange of potatoes, newspapers, iron and ether. For such money is not preferred to goods either by the purchaser or the seller. We then part with our goods for money only because we need the money as a means of exchange, not because we expect an advantage from possession of the money. So we must make money worse as a commodity if we wish to make it better as a medium of exchange.

At a time when nations were largely on the gold standard, Gesell’s idea was unorthodox (and unpopular).

Gesell died in 1930, having never seen his monetary system realized. But just two years later, in the deepest depths of the Great Depression, a handful of small and medium towns in the United States and Europe looked to his proposal to soothe their economic distress. The best-known of these cases was the small town of Wörgl, Austria, in which town official Michael Unterguggenberger convinced Wörgl to issue stamped money known as “Certified Compensation Bills.” The experiment came to be known as the “Miracle of Wörgl,” reflecting the town’s success in reducing unemployment and the relative ease with which Wörgl weathered the Depression compared to the rest of Austria. Hawarden, Iowa, and Anaheim, California, inspired by Wörgl’s experience, soon enacted similar policies.

But it must be said that Wörgl’s experiment was likely successful because it, similar to the currency itself, had an expiration date. After just one year, the town put the project to rest. As Jonathan Goodwin wrote, “Once the taxes in arrears were completely paid and when people had paid enough taxes in advance to feel safe and comfortable (at some point they would stop paying forward), the scrip would lose a key part of its attractiveness.”

Of course, even if consumption drove economic growth (and there are a number of both economic and reductio ad absurdum arguments that point out the flaw in that concept), the idea of money that can be coded to decay at tailorable rates is disconcerting.

Central banks are monetary central planners, and the many criticisms that apply to central planning in every other field apply here as well. Their insularity, the blizzard of information they face, and political manipulation result in a preponderance of erroneous, ineffective, or late policy choices, all of which bring about unintended consequences. At times, those unintended consequences become new crises, which demand further policy intervention. Given this inevitability, any expansion of policy armamentaria should be viewed with deep concern. This is true of China’s digital yuan, the Wörgl experiment, and any number of other unconventional monetary policy tools in use now or in the future.

In the specific case of a currency engineered for customizable demurrage, pernicious applications come to mind immediately. The extent to which those are realizable, however, pivots upon a degree of theorizing as to how “targetable” the programmed change of purchasing power will be. (Because such a system will ultimately require the elimination of cash to be fully effective, the warnings associated with a closely-related unconventional monetary policy, negative interest rates, apply here as well.)

A preliminary question is to what extent, or even whether, the induced loss of purchasing power will be communicated by the implementers of monetary policy. It is conceivable that in some nations the disclosure of an impending demurrage operation will be disseminated well in advance and will include specifics regarding the anticipated amount of change; other governments may be less forthcoming. This will likely derive as much from the authoritarian character of the state as from specific policy aims. Further, while in the 1890s the average farmer understood the basics of inflation and deflation (owing to their dealings in grains and other commodities), it may be difficult to expect the same of citizens in the modern age.

By announcing that money will be debased by a discrete amount at a certain point in time, individuals, firms, and other institutions holding money––again, assuming these policies are applied on something akin to an M3 basis––will make decisions based not upon their tastes and needs, but rather upon the desire to convert money to another form in anticipation of the loss of purchasing power. The effect of individuals and large financial institutions singling out certain goods as stores of value under the artificial upward ratcheting of time preference would, as do most other forms of monetary tinkering, inevitably create price distortions and possibly shortages, depending on the availability of local goods and services.

Should the ability to direct the demurrage be more precise, the implications are much starker. It is conceivable that financial institutions might make the case that their money (more precisely, money in their accounts) should be insulated from those policy measures, thus creating a corporatist monetary system: consumers and unfavored economic actors wrestling with concocted losses of purchasing power, economic elites, their firms, and other court favorites receiving, or being left with, unimpinged purchasing power. Exactly where the lines between the favored and not are drawn, and the occasions upon which they are invoked are left to the reader’s imagination. A look at the influence exerted by both special interest groups and corporations on public policy is instructive.

But this only opens the proverbial door. History is rife with examples of political initiatives which, however nobly intended or narrowly designed, became blunt tools of widespread oppression.

Could a demurrage feature of a programmable digital currency, nominally designed to spur consumption and increase monetary velocity, not ultimately become a broad punitive instrument? It could serve as an intermediate form of a fine for misdemeanors or other legal sanctions: Rather than forfeiting a lump sum, a violator’s account balance could be rigged for an accelerated loss of purchasing power. The argument in support of such a measure may well be that it punishes wrongdoers virtuously, afflicting the health of their bank balance whilst “supporting the economy” or “fostering economic growth.”

Although it tempts speculation of a particularly Orwellian tenor, one may imagine––I stress the term imagine as distinct from predict or expect, as this is not a conspiracy theory––the tying of anything from mandatory insurance coverage to getting vaccinated to compulsory voting to be enforceable under the threat of individually-targeted monetary penalties. Whether or not such a measure would fall under the legal category of a Bill of Attainder would also, likely, be a matter of considerable controversy.

A state determining that its populace is insufficiently supportive of a military campaign may decide that hardships are not being sufficiently shared: A sudden, unannounced attack on bank balances resulting in an immediate loss of purchasing power could be imposed to align interests. Could a failure to consume certain goods––say, domestic versus foreign––trigger a government-decreed, disciplinary lopping of an offender’s bank balances? In the same way that a former president allegedly used the Internal Revenue Service to terrorize and harass political opponents, a currently innocuous programmable digital currency may, over time, morph into nothing less than weaponizable money.

China, by launching its digital yuan project, is traversing new territory in the realm of authoritarian monetary planning. Unfortunately, this endeavor may not be an isolated experiment for much longer; already, officials with the U.S. Federal Reserve are engaging in research to build and test a digital dollar. Central bankers the world over, in fact, are signaling increasing openness to experimental policy initiatives. This particular project is still in its infancy, but one thing is certain regardless of differing cultures or political systems: Central banks of all colors are prone to the pitfalls of central planning and will necessarily inflict unintended consequences upon the populations they serve.

Money, in its most basic form, is an irreplaceable facilitator of economic calculation and a social instrument making cooperation possible on a global scale. Policies of the sort which programmable digital currencies bring into the realm of possibility potentially turn those on their head, introducing new possibilities for intentional––and systematic––coercion.

Source : American Institute for Economic Research

‘Britcoin’ Not Bitcoin? UK Considers New Digital Currency

Huw Jones and David Milliken wrote . . . . . . . . .

British finance minister Rishi Sunak told the Bank of England to look at the case for a new “Britcoin”, or central bank-backed digital currency, aimed at tackling some of the challenges posed by cryptocurrencies such as bitcoin.

A BoE-backed digital version of sterling would potentially allow businesses and consumers to hold accounts directly with the bank and to sidestep others when making payments, upending the lenders’ role in the financial system.

“We’re launching a new taskforce between the Treasury and the Bank of England to coordinate exploratory work on a potential central bank digital currency (CBDC),” Sunak told a financial industry conference.

Soon after, Sunak tweeted the single word “Britcoin” in reply to the finance ministry’s announcement of the taskforce.

Other central banks are also looking at whether to set up digital versions of their own currencies, essentially widening access to central bank funds which only commercial banks can use at present. This could speed up domestic and foreign payments and reduce financial stability risks.

China is a front-runner to launch a CBDC. Last week the European Central Bank said it was studying an electronic form of cash to complement banknotes and coins but any launch was still several years away.

The BoE said a digital version of sterling would not replace either physical cash or existing bank accounts.

“The Government and the Bank of England have not yet made a decision on whether to introduce a CBDC in the UK, and will engage widely with stakeholders on the benefits, risks and practicalities of doing so,” the BoE said.

BoE Governor Andrew Bailey has previously said bitcoin, the best known cryptocurrency, fails to act as a stable store of value or an efficient way to make transactions, making it ill-suited to serve as a currency and a risky bet for investors.

Central banks also took a dim view of efforts by Facebook to set up its own digital currency.

Even so, cryptocurrencies have received growing interest from mainstream financial institutions, and bitcoin hit a record high of nearly $65,000 on April 14, up tenfold in the space of a year.

DARK TRADING

Sunak, launching the UK FinTech Week conference, also announced other measures aimed at maintaining the post-Brexit competitiveness of London, which vies with New York to be the world’s largest financial centre.

Since Britain’s departure from the European Union’s orbit on Dec. 31, the financial sector has faced restrictions on serving EU customers.

Sunak proposed removing restrictions inherited from the EU, including on who can trade shares in London and the double volume cap.

This would help Britain attract more “dark” or anonymous trading by big investors after Amsterdam toppled London as Europe’s top share trading centre in January.

“The consultation process aims to deliver a rulebook that is fair, outcomes-based and supports competitiveness, whilst ensuring the UK maintains the highest regulatory standards,” Sunak said.

Britain would also propose changes to companies’ share prospectuses to ensure the rules are “not overly burdensome”, Sunak said.

Source : Reuters

U.S-China Decoupling, Digital Currency, and the Consumer of Last Resort

It would be accurate but incomplete to think of the global economy in terms of the circulation of goods and services around the world. There’s regional variation in what people consume, mostly driven by income differences, and there’s regional variation in what they produce, driven by a wider variety of factors that range from historical accidents to entrepreneurs to government policy to natural resource endowments. Another view, that’s surprisingly accurate but still limited, is to view the entire global economy in terms of the circulation of savings: there’s one dominant producer of reserve assets, the United States, and everyone in the world either directly or indirectly demands them. And there’s a third model, which has the same traits. It works like this: China is the best country in the world at adding value to raw materials and intermediate goods; raw materials and components flow into the country, and finished goods flow out. In this model, the function of the global economy is to find end consumers for more of these goods, and the result of that process is demand for certain high-value input goods that can’t be made there just yet—M1 chips from Taiwan, memory chips from Korea, storage chips from Japan; oil, iron, copper, and food from around the world.

In a world without widely-trusted fiat currency, the first model would have all the explanatory power we needed. There might be countries that chose to accumulate savings, and others that chose to grow their debts, but over time, these imbalances would even out through financial crises, which would tend to hit the local economy hard while leaving the rest of the world unscathed. (The way to claw your way out of debt when you can’t issue currency is to reduce imports and/or increase exports, i.e. for a given level of labor and capital, you need more of the returns to go to people other than the local laborers or capitalists.)

The modern world does not work that way; there are countries that can issue widely-circulated currencies, and thanks to the network effects of money, the most widely-circulated ones are in the highest demand. This leads to a dynamic where the US is the consumer of last resort ($): a financial crisis is often ultimately a shortage of dollars, and America can print those just fine.1 Since currencies adjust to exports, the usual rule is that countries that want to pursue an export-driven policy end up accumulating dollars (and, to a lesser extent, other foreign currencies) to keep their currency from appreciating. Sometimes this takes the form of a currency peg—Saudi Arabia can keep the riyal steady because it sells lots of oil and stashes away lots of dollars—and sometimes it takes a softer touch, as in this in-depth look at how Taiwan’s currency policies work.

Industrializing through exports is a policy choice, and often a good one, but every country that makes that choice puts the US in an annoying position: those countries can’t be net exporters and dollar-accumulators unless someone is willing to take the other side of the trade, by running a trade deficit that’s financed by allowing trade counterparties to accumulate assets. This is not a terrible deal for America by any means; for a given level of production, we get more consumption, at the cost of some ugly financial statements. It’s certainly a choice that China made; China’s forex reserves total some three trillion dollars. What does that buy them?

The flexibility to set their exchange rate wherever they want it to be, at least within reason, while still allowing enough wiggle room to get price signals from the market.

The ability to provide liquidity to Chinese companies should they find themselves short of foreign currency.

Export-dependent countries are vulnerable to crises because they rely on demand in other parts of the world, and a huge cache of reserves (plus capital controls to keep money from leaking out) is a way to ride out the crises.

The US obviously benefits from this relationship in an immediate material sense: the products China exports are much cheaper than the alternatives, and the complex global supply chain enabled by this—specialized components produced in places that have very narrow competitive advantages, natural resources produced wherever they can be found, and all of the above assembled affordably and flexibly in China—has made the global economy much more functional. Replacing that is, in practical terms, impossible: there just aren’t other parts of the world with the requisite mix of labor market slack and state capacity, and even if a shift did happen, the world would lose some of the unique advantages of having so many different suppliers all crammed together in specific specialized cities, from Shenzhen’s electronics to Dafen Village’s oil painting replica assembly lines. The next-best alternative is for US imports to be more expensive, and for the hardware supply chain to be far less adaptable. It might be an acceptable cost, but it will be a steep one, and the companies exposed to that cost—US hardware companies that sell to Chinese manufacturers, retailers that buy Chinese products, American brands like Starbucks, Marriott, and Nike that have expanded into China and rely on it as part of their growth story—will no doubt lobby fiercely against this outcome.

If the US plans to decouple from China, it’s a multi-decade process involving a little bit of reshoring and a whole lot of different-shoring; convincing manufacturers to move out of China and into India, Vietnam, Mexico, and other places that combine a) cheap enough labor, and b) closer diplomatic ties to the US than to China. There are parts of Africa that seem like good options, but China is years ahead there, and has also invested a lot in getting closer to governments in that part of the world—partly to access natural resources, partly to have more influence in international bodies that weight each country equally.

China has a very different problem in decoupling from the US: the problem of finding a replacement for the utility of owning a vast amount of FX reserves and having a trade relationship with a country that has an effectively unlimited appetite for goods.

And this is where things get interesting. The WSJ has written a piece on China’s digital currency ($) with some very telling details. For example:

The U.S., as the issuer of dollars that the world’s more than 21,000 banks need to do business, has long demanded insight into major cross-border currency movements. This gives Washington the ability to freeze individuals and institutions out of the global financial system by barring banks from doing transactions with them, a practice criticized as “dollar weaponization.”

* * * * * * *

The digital yuan could give those the U.S. seeks to penalize a way to exchange money without U.S. knowledge. Exchanges wouldn’t need to use SWIFT, the messaging network that is used in money transfers between commercial banks and that can be monitored by the U.S. government.

A good reason to hoard a lot of currency is the risk of losing access to more of it while still needing to use it; a popular alternative reduces that risk.

Even more interestingly:

The money itself is programmable. Beijing has tested expiration dates to encourage users to spend it quickly, for times when the economy needs a jump start.

Programmable money, tied to real-world identities, and universally tracked by a central bank, starts to look suspiciously like a substitute for the consumer of last resort. Every year that China gets richer, domestic consumption plays a bigger role (exports were 26% of China’s GDP in 2010, and 18% last year). If domestic consumption can be tightly controlled, then it’s a way to not just increase the volume of consumption but to control the variance of demand for the goods China produces. It’s not yet enough to match the size and variability of global demand for China’s exports, but every year it gets closer.

The US and China are both talking seriously about decoupling, but the digital yuan indicates that China’s government is more effectively planning for it.

Reserve currencies are incredibly sticky, but technology shifts have a way of making some economic variables less important. The real risk is not so much that the dollar loses its reserve currency status, it’s that owning reserve currencies—and having a good relationship with their issuers—becomes less important.

Source : The Diff