ACCESS A BROADER MARKET PERSPECTIVE

CHINA AND THE DAWN OF DIGITAL CURRENCY

BY GEOFF YU BY THE NUMBERS

RMB 10 MILLION The amount of “free money” included in the PBoC’s central bank digital currency (CBDC) pilot in October 2020 (approximately $1.6 million)

2 MILLION Number of residents in Shenzhen that applied to participate in the PBoC's CBDC lottery

50,000 Number of Shenzhen residents randomly selected to receive CBDC in the PBoC pilot

RMB 200 The amount of CBDC renminbi each participant received in the PBoC pilot program (approximately $30)

CHINA IS EXPERIMENTING WITH A DIGITAL RENMINBI, THE FIRST TIME A MAJOR NATION HAS PILOTED ISSUING A DIGITAL CURRENCY. THE IMPLICATIONS ARE HUGE, FROM ENABLING MICRO-TARGETED ECONOMIC STIMULUS TO TRANSFORMING TRADE WITH THE RISING SUPERPOWER.

BY GEOFF YU

magine you are at the super- Putting funds directly into the hands major central bank began creating market checkout, wallet in hand, of households is certainly consid- money without any reported con- about to pay for your groceries ered positive for growth, but policy- straints and subsequently handed I with cash. Suddenly, a helicopter makers often grapple with regional it out to random households in the lands in the parking lot, and out steps disparities that a one-size-fits-all Chinese city of Shenzhen. Although Federal Reserve Chairman Jerome approach such as quantitative easing the amounts received by households Powell with a bag of freshly printed cannot address. were small and the central bank did dollar bills of various denominations. COVID-19 has made the problem not have an explicit mandate for the He walks up to you with a small even more acute due to area-specific exercise, the potential implications for bundle and stuffs it into your wallet. lockdowns, the economic recovery a new form of targeted monetary policy He tells you the money is to help with from which will depend on local were clear. the weekly shopping or a little extra to and esoteric support that most cen- The People’s Bank of China (PBoC) spend at local businesses struggling tral banks are currently ill-equipped distributed RMB 10 million (around with the pandemic. There is no need to provide. USD 1.6 million) through a lottery — to pay it back. Central bankers have also previously except it was not distributed with heli- Finally, Chairman Powell strongly observed that attempting to provide copters and paper money: it was done advises you against saving it or using economic stimulus utilizing such blunt digitally. Recipients had wallet apps it to repay debt, explaining that this instruments brings its own problems. at the ready on their mobile phones, doesn’t do as much for the economy Money “created” by a central bank primed to receive a central bank dig- as spending. He jumps back into the requires the acquiring of an offset- ital currency (CBDC). helicopter and flies off for his next ting asset, so genuinely “free money” Fifteen hundred years after inventing drop. is difficult to deploy in large amounts the banknote, China is now attempting This narrative sounds far-fetched, without adversely affecting the value of to take money truly into the digital age. but the concept of targeted “heli- the monetary base. However, the rest of the world is still copter drops” of money by a central Nonetheless, in October 2020 as not sure whether it would like to follow bank or a government is not new. part of a controlled experiment, a suit. Fifteen hundred years after inventing the banknote, China is now attempting to take money truly into the digital age.

A DIGITAL RENMINBI same form of credit risk. In contrast, these notes were real money and car- At first glance, this doesn’t seem like a physical banknote issued by a mone- ried the same sovereign imprint as their such a big deal. After all, people have tary authority carries no such risk, nor paper counterparts. been paying for goods and services should a banknote in digital form: both with their phones for many years. For are legal tender. LIMITED APPLICATION many, adding a payment application Under a fully functional CBDC frame- THUS FAR or mobile wallet on top of the variety work, the two forms of money are fully For all of its innovations in creating the of options offered by an individual’s fungible and hold equal status as legal world’s first functional CBDC (a recent bank or other providers seems an tender. The latest amendments to the report listed 84 related patents filed by inconvenience. PBoC’s governing law, proposed in late the central bank), the PBoC is some- Yet a CBDC mobile wallet is not October 2020, would seek to enshrine what circumspect regarding the speed the same as a payment-enabled app this in law: Article 18 establishes the and scope of its adoption. provided by a commercial bank. renminbi as legal tender. Article 19 fur- The aforementioned proposed new The bank’s app is merely a replace- ther states that “the renminbi includes central bank law clearly states a role for ment or substitute for a debit card in physical and digital form.” physical currency to remain. a physical wallet. In contrast, a CBDC In April this year, after the prelimi- Despite the high penetration of mobile wallet is the physical wallet nary pilot of China’s CBDC (formally mobile wallets in China — with over itself, and the money contained in the called Digital Currency/Electronic 800 million people utilizing payment CBDC wallet is no different to physical Payment or DC/EP) was launched, apps launched by banks and payment notes and coins inside its old-fashioned screenshots surfaced on social media companies as of the first half of 2020 leather counterpart. of the central bank’s digital wallet app. (or 86% of internet users, see Figure 1) Similarly, the money held in a com- The functionality within the app — there are no explicit plans for mass mercial bank account, which can be (such as scan to pay, send and receive proliferation of CBDCs in the near accessed in physical or electronic money, etc.) was quite standard for a future. form, is subject to credit risk associ- payment application or digital wallet. The only tangible target currently ated with the bank. The same is true However, the screenshots also pre- is for “general adoption” during the with the plethora of “digital wallets” sented what may be the world’s first- upcoming Beijing Winter Olympics launched by commercial banks and ever digital banknote issued by a cen- in February 2022 — hardly ambitious payments companies — money con- tral bank: a one renminbi note com- given the pace of innovation. tained in these wallets is linked to funds plete with serial number, but it was on For now, the PBoC is probably con- held in a bank account and carries the a screen. The PBoC made it clear that tent to simply observe the household A NETWORK NATION Growth in proportion of Chinese internet users utilizing mobile wallets, between 2011 and 2020

100

Mobile Payments Mobile Commerce 80

60

40 % of Internet Users

20

0

Jun - 11 Nov - 11 Apr - 12 Sep - 12 Feb - 13 Jul - 13 Dec - 13 May - 14 Oct - 14 Mar - 15 Aug - 15 Jan - 16 Jun - 16 Nov - 16 Apr - 17 Sep - 17 Feb - 18 Jul - 18 Dec - 18 May - 19 Oct - 19 Mar - 20

SOURCE: BLOOMBERG, CHINA INTERNET NETWORK INFORMATION CENTRE FIGURE 1

response to the digital renminbi and near zero-cost. as monetary policy and central banks let usage grow organically. The recent Furthermore, as a central bank is are concerned, near-zero rates and lottery program in Shenzhen was not in the business of providing other unorthodox policy is here to stay — so essentially an information-gathering services such as paying utility bills central banks need to innovate. exercise for the central bank, and and buying movie tickets, the func- One criticism often leveled at quan- the results will help determine future tionality of a CBDC wallet will be lim- titative easing is that the “printed development. ited. Households would likely transfer money” does not reach those who One major hindrance for wider pro- balances to existing universal-ser- need it most: households and busi- liferation is that while any renminbi in vice platforms. A central bank should nesses. Central banks create money the PBoC’s own digital wallet is legal not see any problem with this: ulti- through purchasing assets (normally tender, places where it can be spent mately, a foundational principle for a government bonds) in secondary directly from the CBDC wallet itself are CBDC — as established by the Bank for markets from eligible counterparties, actually quite limited. The PBoC has International Settlements (BIS) — is for a mostly banks. The central idea is that been cooperating with goods and ser- CBDC to complement and coexist with lower borrowing costs and a general vices providers, such as online retail public and private forms of money. reduction in risk premia can encourage platforms and ride-hailing apps, and spending and investment, which would more companies are signing up as MICRO-TARGETED ultimately benefit households and “strategic partners.” STIMULUS businesses. However, it is difficult to see In normal times, central banks would The pandemic has certainly focused CBDC wallets challenging existing not have any interest in printing any minds on the limitations of this frame- and well-established payment plat- money for anyone. Yet a return to work. Around the world, social dis- forms where transactions between normality, in any sense of the word, tancing has placed limitations on individual and business counter- seems a distant prospect amid the the ability of individuals to work and parties are already seamless and at ongoing pandemic. This means as far for businesses to operate. Yet there a The CBDC wallet application can be programmed in such a way that funds can only be spent in designated areas and also have a certain expiry date.

are still bills to pay for all. instantaneous quantitative easing for close during a lockdown period (as Central bank action prevented the household can be highly targeted. opposed to nationwide chain stores). liquidity crunches in the financial For example, at present, Brooklyn has Central bank stimulus can therefore be system, but governments were left a higher COVID-19 infection rate than skewed toward helping a designated to do most of the work to buttress other boroughs in New York City and is sector. households, mainly through grants most at risk of a lockdown, leading to Time expiry in CBDCs would solve and loans. In the US, the govern- potentially serious economic problems a perennial problem with quantitative ment actively sent $1,200 checks to for households and businesses. easing and other forms of cash-based individuals. Assuming that each CBDC wallet will stimulus: too much of the money cre- Although authorities acted quickly, be linked to its holder’s domicile as a ated can often be left sitting on balance the process still required legislation, security feature, the Federal Reserve sheets and not being spent or invested. additional scrutiny, and cooperation can technically provide quantitative On a micro-level, households would with commercial banks, among other easing to Brooklyn zip codes. be informed that specific CBDC funds cumbersome procedures. In contrast, would need to be spent within a certain central banks — providing there is argeting can extend time frame on goods or services and enough legal authority — can act much well beyond a regional not be eligible for transfer into bank faster. With a CBDC wallet, theoreti- approach: the CBDC accounts for savings or debt repayment cally, money can be created and sent T wallet application can be purposes. to wallet holders instantaneously. programmed in a way such that funds The fact that China has been There will be questions over what contained within can only be spent in focusing its efforts and partnerships exactly the asset is on a central bank’s designated areas and also have a cer- with goods and services providers is balance sheet through such direct tain expiry date — an exercise almost an indication that the PBoC, for now, household injections (notes and coin impossible to implement with physical primarily sees CBDCs as a pro-growth are central bank liabilities), but that can notes and coins. tool and may wish to develop them in a be easily resolved ex-post. For example, CBDC wallet funds can manner consistent with China’s efforts Furthermore, from a monetary be restricted to legal tender status in to rebalance the economy in favor of policy point of view, this kind of small local shops that were asked to consumption. A DIGITAL REVOLUTION Value of cashless payments in selected nations around the world, 2015 to 2019

600

China France + Germany USA

500

400

$ Trillion 300

200

100

0 2015 2016 2017 2018 2019

SOURCE: BANK FOR INTERNATIONAL SETTLEMENTS SOURCE: OPIMAS FIGURE 2

A GLOBAL CURRENCY itself into the wider economy. It is worth noting that despite the DISRUPTOR? Indeed, China’s embrace of cash- radical advances the PBoC has made The examples provided above do not less payments has eclipsed the enthu- in this field, China does not appear even scratch the surface of the possibil- siasm seen in other nations around once in the 26-page report — not even ities presented by a central bank digital the globe. As Figure 2 attests, annual in the references. Striving for interop- currency. cashless payments in China have con- erability and common standards is in Perhaps alarmed or impressed by sistently breached the $500 trillion the world’s interest, yet prospects for China’s test programs, central banks threshold in the five years to 2019, deeper cooperation appear limited as around the world have accelerated while comparable values in the US only de-globalization and decoupling con- their own plans, from proofs of concept just surpassed the $100 trillion mark tinues apace. to pilots of their own. last year. The future of money itself will be Outside of China, Sweden’s “e-krona” In addition, there is barely concealed defined under these conditions as dif- pilot is perhaps the most advanced. concern at the prospect of a Chinese ferent financial blocs strive for domi- However, unlike China’s recent real-life CBDC and its potential to disrupt the nance. The implication is clear: from experiment in Shenzhen, the Riksbank international financial system — even the G7 and their partners’ point of is only creating the e-krona in “an iso- if the disruption itself may not neces- view, development of their own CBDCs, lated test environment” and has explic- sarily be negative. should it happen at all, must be com- itly stated that “there is currently no In October 2020, the BIS joined the pletely independent of the PBoC’s decision on issuing an e-krona.” European Central Bank and the cen- efforts. The report also contains the China may only be taking baby steps, tral banks of Canada, Japan, Sweden, following sentence: “A CBDC of one but the rest of the world is not entirely Switzerland, the UK and the US to issue jurisdiction could impact on anoth- sold on the concept, and no country the first report setting out the “founda- er’s monetary policy or financial sta- has come close to China’s willing- tional principles and core features” bility (e.g., through ‘dollarization’) or ness to actually launch the currency of CBDCs. be used to avoid laws and regulations Owners of CBDC wallets in a non- US dollar currency can engage in cross-border transactions fully outside of the visibility of the US.

outside a jurisdiction where sufficient can exert some degree of supervision the US (notably, Fedwire and CHIPS, controls are not in place.” through the International Monetary which clear cross-border US dollar The sentence acknowledges the Fund. Such rescues, be it passive or transactions). cross-border impact of a CBDC: trans- active, take time and can even involve If there is sufficient penetration of actions can take place between users of bringing physical cash into a monetary wallets and acceptance for this par- the same CBDC in a geographically neu- system at great risk. ticular CBDC in a separate jurisdiction tral manner, subject to the counterpar- A fully functional CBDC can move (akin to dollarization), it is conceivable ties both holding an approved wallet far more swiftly, providing the issuing that a trade and finance system parallel and being able to receive payments. As central bank is willing to allow non- to the US dollar system can gain critical long as both counterparties have confi- residents to hold a digital wallet. It mass in the not-too-distant future. dence in the underlying issuer, then a is foreseeable that a country’s mon- transaction can take place seamlessly. etary system could be supplanted at A DE-GLOBALIZED WORLD If the transaction itself takes place out- rapid speed, with obvious geopolitical For the foreseeable future, there is side the issuer’s jurisdiction, however, implications. obviously only one contender to chal- it will be very difficult for the home The second risk and its corollaries lenge the US dollar system in this way, country to supervise or regulate. are even more profound: CBDCs can and that is the renminbi. If we replace the word “dollariza- become easy tools for capital flight, Throughout the recent deteriora- tion” with something along the lines illicit transactions and sanctions tion in Sino-US relations, Beijing has of “renminbization,” the PBoC’s CBDC avoidance. become increasingly concerned about takes on a geopolitical angle. For The dollar’s dominance in the global Chinese banks’ exposure to the US example, the phenomenon of countries financial and trade system has allowed dollar system. The possibility of poten- experiencing a currency crisis sud- US authorities to vigorously police tially cutting off the access of Chinese denly adopting hard currency (usually cross-border transactions. Owners banks to dollar clearing has been called the US dollar) is well-established. of CBDC wallets in a non-US dollar “the nuclear option” for US authorities. The Federal Reserve is unlikely currency can engage in cross-border To be clear — going down this road to step in to actively provide dollars transactions in the CBDC’s issuing cur- would be a systemically important under these circumstances, but the US rency, fully outside of the visibility of event with huge implications for Full digitization of China’s monetary system has a long way to go, but the global implications are becoming more apparent.

global financial stability, but Beijing is US dollar transactions in this form visitors to take the wallets back to their unwilling to take that chance. While happen on a daily basis, but the ren- home countries. achieving general self-sufficiency minbi is far from achieving that kind of Meanwhile, Chinese banks and pay- within the next generation is now a critical mass, to the extent that Chinese ments firms are continuing to build up policy objective, Chinese companies banks at present are engaged in US capacity to handle greater volumes. will continue to face US dollar risk in dollar lending activities because of the Even so, Beijing itself is still unsure commerce and finance. demand and profitability. what to do with the technology in a Full digitization of China’s monetary global context, as much of the capa- CBDC is certainly not system has a long way to go, but the bility seems incongruous with the ren- a silver bullet in this global implications are becoming more minbi’s current non-deliverability and respect, as even if a apparent. Before the pandemic, the strict capital controls. A foreign trade counter- global reach of Chinese tourists already Yet these issues were defined well party has access to a renminbi digital meant that Chinese payment providers before the fintech age: China is prob- wallet, the counterparty still needs were ubiquitous globally. ably happy for the renminbi to be a to be willing to accept renminbi as The tourism/services trade may be minor player in the twilight of the post- payment. dormant for the time being, but the Breton-Woods era of currencies and the This requires China to establish long- infrastructure can be easily repurposed global financial system, but the country term credibility in the currency’s store for conventional commerce to facilitate appears determined to define the terms of value. Should this happen, and an trade invoicing and settlement — in of the next era. exporter to China is willing to accept renminbi. renminbi through a digital wallet and As CBDC wallets proliferate glob- transfer the renminbi to a custody ally, seamless RMB payments may account in China, in time the funds require the market to re-examine the Geoff Yu is Senior EMEA Market Strategist can be used to purchase goods from “inconvenience” element of RMB. at BNY Mellon. Questions or comments? Chinese counterparties or to pay a third One of the objectives of using the 2022 Write to [email protected], party who also holds a renminbi digital Beijing Winter Olympics to popularize or reach out to your usual relationship wallet for goods and services. renminbi CBDC wallets is for foreign manager. BNYMELLON.COM

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