Many observers are treating China’s plan for a central bank digital currency (CBDC) as a strictly progressive, technical move that other nations should emulate. The United States, in particular, is concerned that China already has a large head start, which may threaten the dollar’s dominance as a reserve currency. Although the alleged purpose of supplying a digital yuan is to reduce transaction costs and make the payments system more efficient, the Chinese people themselves have good reasons for not sharing that sanguine opinion. The real intent of introducing a digital yuan is more likely to be to increase state control of the payments system and to closely monitor transactions and even personal behavior.
China’s Move toward a Cashless Society
The claim that the digital yuan is needed to supply the Chinese public with more efficient alternatives to paper money overlooks the alternatives already available to them through non-state payments service providers. China has moved quickly toward a cashless society via the widespread use of Ant Group’s Alipay and Tencent’s WeChat Pay. Mobile phones are ubiquitous, and it is very easy to pay once an account is set up. The convenience of using mobile payment apps and e-wallets has enticed more than 900 million Chinese citizens to enter the digital payments market.
The increasing popularity of non-state payment providers has given the PBOC an incentive to issue its own digital currency: the electronic Chinese yuan (e-CNY), also known as the digital currency and electronic payment (DCEP) system. Pilot programs have been set up in major cities; and, in June, Beijing ran a lottery to pay out RMB 40 million ($6.2 million) in digital cash. Residents entered the lottery by using two banking apps for the chance to win one of the 200,000 digital yuan “red packets,” each worth about $31, which could be used for purchases at officially designed businesses.
The experiment with the e-CNY is reminiscent of China’s earlier economic reform movement, beginning in 1979, that allowed localities to test new ownership arrangements and create special economic zones. In that sense, the launch of a digital yuan is not solely top-down. Instead of mandating the new system, the PBOC is allowing markets to test it before full implementation at the national level. The lottery is a clever way to spur adoption. However, it is important to recognize that, unlike Alipay and WeChat Pay, the digital yuan itself is not a particularly sophisticated alternative to cash. Its main advantage is that the government can more readily track private transactions.
The Threat to Freedom
The PBOC’s goal in developing a digital yuan, as stated in the bank’s recent White Paper, is to build “an open, inclusive, interoperable and innovative currency service system for the . . . digital economy” (p. 1). The PBOC’s White Paper also states:
“As long as there is demand for the physical RMB, the PBOC will neither stop supplying it, nor replace it via administrative order” (p. 4).
“The e-CNY supports managed anonymity [i.e., China is willing to tolerate a degree of anonymity for now], which helps protect privacy and user information” (p. 5).
Those statements may be reassuring to those who fear moving to a cashless society. Yet, as Cornell economist Eswar Prasad warns in his new book, The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance, “digital central bank money is only as strong and credible as the institution that issues it.” More importantly, “In authoritarian societies, central bank money in digital form could become an additional instrument of government control over citizens rather than just a convenient, safe, and stable medium of exchange.”
That certainly appears to be the case under President Xi Jinping, who has clamped down hard on both economic and personal freedom. There is no free market for ideas in China, no genuine rule of law to protect basic human rights, and the Chinese Communist Party (CCP) has a monopoly on power. That institutional infrastructure is not conducive for a robust civil society, a free financial market, or trust in governance.
It would be foolish to think that there is a zero probability that China would never abolish cash or that the privacy afforded by physical cash could be approximated by “managed anonymity” under a digital yuan regime. So, while it is true that digitizing cash and coins would reduce the costs of issuing fiat money—as Fan Yifei, deputy governor of the PBOC, has argued—it is also true that a digital yuan would diminish individual freedom.
Alex Gladstein, chief strategy officer at the Human Rights Foundation, has recognized the danger to financial freedom and privacy inherent in central bank digital currency (CBDC), especially in repressive regimes like China. According to Gladstein, “The end of cash and the insta-analysis of financial transactions enable surveillance, state control, and, eventually, social engineering on a scale never thought possible.” He points to China’s social credit system, in conjunction with a digital yuan, as paving the way toward “financial omniscience.” Thus,
When the government can take financial privileges away for posting the wrong word on social media, saying the wrong thing in a call to parents, or sending the wrong photo to relatives, individuals self-censor and exercise extreme caution. In this way, control over money can create a social chilling effect.
It is instructive, as Andrew Liu has reported in the Cato Journal, that government authorities have used regulations on mobile payments “to help the Communist Party maintain full political, social, and economic power,” even though the official rhetoric is that those regulations were intended “to prevent criminal activity and improve mobile payment security.” There is little doubt that Xi Jinping and his cadres in the State Council will be tempted to politicize the digital yuan to serve their own interests.
The e-CNY System: Its Operation and Risks
The PBOC has competent economists, but they are under constant pressure to follow the rule of the CCP. The e-CNY system will be a two-tier retail system: the central bank will distribute digital currency to state-owned commercial banks, which will then meet consumer demands for e-CNY. Unlike bitcoin, which is a peer-to-peer, decentralized cryptocurrency using blockchain, China’s digital yuan will be state-directed from start to finish. With a flick of a computer key, the PBOC, which oversees all the state-owned banks, could make digital yuan currency disappear from the accounts of those viewed as enemies of the state. Without an independent judiciary, users of e-CNY ultimately would be at the mercy of the state in digital yuan disputes.
The risks from a fully operational CBDC, particularly in an authoritarian regime like China, should not be discounted. Among those risks, Gladstein includes: giving central banks “fine-grained control over fiscal stimulus” by allowing them to target specific groups; paying negative interest rates on CBDC; and helping “governments more easily confiscate funds from political opponents or even auto fine people who violate certain laws.”
China has already cracked down on bitcoin, as well as other cryptocurrencies, to prevent circumvention of government control of money and banking, and to stem capital outflows. It is prudent to expect future crackdowns on e-CNY competitors and to expect an even greater concentration of political power.
One risk the United States should not be overly concerned about is the threat to dollar dominance posed by a digital yuan. The U.S. dollar’s position as the world’s most trusted reserve currency is not about to end with the introduction of e-CNY. China’s CBDC is intended for domestic use, not cross-border transactions, at least initially. The dollar has earned its status as a safe-haven currency because it is backed by trust in U.S. institutions that safeguard basic freedoms and private property rights.
China lacks those institutions and trust. The yuan (whether digital or physical) will not become a valued international currency until global traders gain confidence in China’s adherence to the norms of civil society and the rule of law. Introducing a digital yuan will not change that fundamental fact. Eswar Prasad reinforced these ideas in a recent interview with Fortune magazine when he stated:
What really matters for a reserve currency is a country’s economic size and the depth and liquidity of its financial markets. It needs an institutional framework that wins the confidence of foreign investors, including an independent central bank, the rule of law, and institutionalized checks and balances among various arms of the government. Most of the existing reserve currencies have those attributes. China is showing no indication of moving in that direction.
As China moves closer to a cashless society, we should be less concerned about the impact of a digital yuan on U.S. dollar sovereignty than on the future of freedom in China, and how that may impact U.S.-China relations. As Martin Chorzempa, a research fellow at the Peterson Institute for International Economics, has warned:
[The Chinese people] have already largely given up privacy by giving up cash to adopt digital payment systems, and they may end up in the next stage transacting CBDC in Alipay or WeChat Pay wallets, giving their data to both the government and private-sector wallet providers. That would be the worst-case scenario for civil liberties.
The fact that paper currency still remains popular in China is at least partly because of its unique capacity to allow people to keep their transactions private. That feature should not be undervalued.