Opinion | What impact will the new digital currency have on the international currency competition landscape?

Author: Hu Jie (Professor of Practice Advanced Institute of Finance, Shanghai Jiaotong University)

Source: Nonsense Finance

Editor's Note: The original title was "Impact of New Digital Currency on International Currency Competition"

The emergence of new digital currencies will have an impact on the international monetary competition that cannot be ignored. The main conclusions are as follows:

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The new sovereign digital currency has little impact on the international currency competition pattern, only the significance of technical reserves;

Super-sovereign new digital currencies have a significant impact on the international currency competition landscape and need to be taken seriously;

It is suggested that China consider issuing new super-sovereign digital currencies at an appropriate time to accelerate the process of RMB internationalization.

Current international currency competition landscape

There are more than a hundred official currencies worldwide. When they run within the issuer's economy, there is no competition between them. Competition arises when currencies cross borders. The so-called currency competition refers to the competition of currencies on the following two indicators:

The total amount serving as a trading medium in global cross-border trade (referred to as the total amount of cross-border settlement);

The non-issuing entity reserves the total amount of the currency (referred to as total external reserves).

Why does an economy care about the international competitive position of the currencies it issues? This is because if a currency has a higher share of cross-border trade and foreign exchange reserves, its economy will have three advantages:

Reduce or even eliminate the problem of reserves, facilitate cross-border trade, investment and financing, and reduce related costs;

The influence and even control of the cross-border clearing and settlement system has been improved, which is conducive to its economic security;

Obtain mintage tax from outside its economy every year (but the amount is generally small and can be ignored).

The international competitiveness of a currency depends on three factors:

Economic support: The currency-issuing economy has a large number of rich products and services;

Currency stability: Users have firm expectations of the currency's stability relative to products and services;

High availability: freely convertible, wide acceptance range, safe and convenient payment.

The current international currency competition pattern is as follows:

Ranking of cross-border trade settlement currencies (Data source: SWIFT 2019-01)

USD: 40.1%;

Euro: 34.2%;

GBP: 7.1%;

Japanese yen: 3.3%;

RMB: 2.2%;

Other: 13.1%

Ranking of foreign exchange reserve currencies (Data source: International Monetary Fund IMF 2018-12-31)

USD: 61.7%;

Euro: 20.7%;

Japanese yen: 5.2%;

GBP: 4.4%;

RMB: 1.9%;

Others: 6.1%;

SDR component of the International Monetary Fund IMF Special Drawing Rights (Monetary composition of the IMF when issuing loans)

USD: 41.73%;

Euro: 30.93%;

RMB: 10.92%;

Japanese yen: 8.33%;

GBP: 8.09%

Current cross-border clearing and settlement system pattern

Cross-border clearing and settlement system for each currency: For any currency, the issuer's clearing and settlement system is the core of its clearing and settlement. It opens accounts for clearing banks of this currency worldwide, clearing banks open accounts for other banks, and banks open accounts for businesses, institutions, and individuals. In this way, the account system for cross-border clearing and settlement of this currency is formed. E.g:

US dollar cross-border clearing and settlement system: CHIPS (started in 1853) and FEDWIRE (started in 1918);

Euro cross-border clearing and settlement system: TARGET2 (started in 1999 / upgraded in 2007);

RMB cross-border clearing and settlement system: CIPS (started in 2015);

Japanese yen cross-border clearing and settlement system: FXYCS (since 1980);

Cross-border clearing and settlement systems for the British pound: CHAPS (starting in 1984) and BACS (starting in 1968)

Communication hub SWIFT: In the account systems of the above currencies, the communication between various institutions is mainly completed by the Global Banking Financial Telecommunications Association (that is, SWIFT: Society for Worldwide Interbank Financial Telecommunication). Therefore, SWIFT has become a communication hub for clearing and settlement of various currencies around the world.

SWIFT was established in 1977 with the purpose of being an international, non-profit and neutral inter-bank communication service agency.

Attempts to circumvent SWIFT: After 9/11, SWIFT's business information was shared with the US government, so many countries worry that too much payment information is known to the US government, and then consider circumventing the SWIFT system. But the effect is not good for the following reasons:

A large number of cross-border payments are based on the US dollar: When cross-border payments are made in US dollars, CHIPS and FEDWIRE, the clearing and settlement core institutions of the US dollar, are usually not bypassed, so bypassing SWIFT alone is not meaningful;

Communication has a network effect: that is, banking institutions tend to "get together" in the same communication network, so it is cumbersome to enter a communication network separately for each currency, and it is unavoidable to do so.

Here are a few examples of attempts to bypass SWIFT:

EU: On sanctions against Iran, the EU and the United States disagree, and on June 28, 2019, a trade support tool INSTEX independent of SWIFT was launched. However, the system is just a way of evading cross-border payments by bartering and serving the settlement of pharmaceutical and food transactions between the EU and Iran, not aside from SWIFT's general clearing and settlement system.

Russia: Since 2014, it has been subject to financial sanctions from the United States, so the SPFS payment system was set up without the need to support communications with SWIFT. According to reports, as of 2018-9, 416 Russian companies have joined the system, and China, India, Turkey and other countries intend to join.

China: While the RMB CIPS system supports SWIFT communications, it also supports clearing banks around the world to connect with them directly via dedicated lines, bypassing SWIFT communications.

Japan: According to Reuters, the Japanese government is developing a SWIFT-like system to support the payment of new digital currencies around the world, but details are unknown. The news shows that this new system is not likely to support the payment of traditional sovereign currencies, that is, it will not replace SWIFT, but will fill areas that SWIFT has not yet covered.

Possibility brought by new technology: The adoption of distributed ledger supported by blockchain technology greatly simplifies the logic of cross-border payment, can realize point-to-point payment of funds, and is an implementation that bypasses communication intermediaries such as SWIFT Program. If this new type of digital currency is adopted in the future, it is possible to establish a new cross-border clearing and settlement system.

What is the new digital currency

Let's first look at what is digital currency.

There are two types of currency carriers, one is physical objects, such as paper and metal, and the manifestations are banknotes and coins that we are familiar with. The other is the ledger, which is represented by numbers in the account, and bank deposits are a typical example. Ledgers can be paper or electronic. The currency carried by the electronic ledger is called digital currency. In this sense, more than 95% of the RMB's manifestation is already a digital currency.

Look at what is the new digital currency.

The new digital currency must first be digital currency; secondly, it refers to the use of some new technologies in its electronic ledger, such as: blockchain technology, cryptography technology, peer-to-peer communication technology, etc.

But in essence, the reason why we pay attention to the new digital currency is not because the technology used is novel, but whether its currency characteristics have changed substantially. Specifically examine six aspects (referred to as six-dimensional indicators):

-Issuer

Whether it is still the central bank (or the public authority in the economy that controls currency issuance);

Whether it is a private private institution;

If it is a private institution, whether its governance mechanism is decentralized;

-Line logic (related to whether the price of goods and services is stable)

Whether it is issued as appropriate based on economic analysis (eg USD, RMB);

Whether it is issued based on an algorithm that is independent of human judgment (such as Bitcoin);

Whether to anchor high-quality asset issuance (such as DC / EP in HKD and RMB, Libra in Libra);

-user experience

Whether it is easier to open an account;

Whether it is possible to open an account independently (without the intervention of a third party such as a bank);

-Whether the transaction is anonymous

Whether the transaction is controlled anonymously (only for a specific institution in the economy, such as the central bank);

-Clearance and settlement system

Whether it is independent of the existing clearing and settlement system;

Whether its control is decentralized;

Can the transaction information flowing through the clearing and settlement system be kept secret and how?

-Regulatory practice

Whether it can be easily integrated into existing regulatory systems;

Whether a new regulatory system is needed;

Whether the new regulatory system can achieve all aspects of regulatory logic requirements (see below)

-Monetary Policy

How to influence the monetary policy of existing currencies

The emergence of a new currency, or the new expression of an old currency, if some or all of the above changes have occurred, whether or not it uses new technology, we need to pay attention. Based on this, this article redefines "new digital currency" as a currency with new features in the above aspects.

There are many new types of digital currencies, but this article focuses on two categories: the sovereign category that anchors a single fiat currency, and the supersovereign category that anchors a basket of fiat currencies. A typical example of the former is the digital currency DC / EP that the People's Bank of China intends to issue; a typical example of the latter is Libra, which Facebook plans to jointly issue with 99 institutions.

The focus of the discussion is how these two new types of digital currencies affect the competitive landscape of international currencies and the structure of the clearing and settlement system.

Analysis of Sovereign Digital Currency

First look at the new digital currency DC / EP that the People's Bank of China intends to launch. Its mission is to replace banknotes and coins. In the specific scheme of the DC / EP, the People's Bank of China adhered to the principle of technology neutrality, and did not deliberately use blockchain technology, but emphasized that the technology needs to meet the requirements of controllable anonymity. The six-dimensional indicators of its currency characteristics are as follows:

-Issuer

Still the central bank (second-hand resale of commercial banks)

-Issue logic

Anchor RMB 1: 1 Issue

-user experience

Opening an account still needs to go to the bank and cannot be completed independently

Controllable and anonymous transactions, that is, the identity of the user is only known to the central bank

-Clearance and settlement system

Fully integrated into existing clearing and settlement systems

-Regulatory practice

Fully integrated into existing regulatory systems

-Monetary Policy

Because it is a 1: 1 replacement for coins and banknotes, it does not affect the existing monetary policy models and parameters of the RMB

To sum up, the DC / EP of the People's Bank of China is another carrier of RMB (other carriers include coins / banknotes, bank deposits, third-party payment company balances, etc.), and there is not much difference in currency characteristics from other expressions of RMB. Therefore, it has no significant additional benefits for the internationalization of the RMB.

According to reports, the World Bank Group and the International Monetary Fund's IMF released a report in early July 2019 that states that so far, nearly 70% of central banks have been studying new expressions of their existing currencies, namely the Central Bank Digital Currency (Central Bank Digital Currencies), referred to as CBDC.

According to incomplete statistics from Axonomy, the CBDCs of Ecuador and Uruguay have declared failures; in addition, 4 countries including Tunisia, Senegal, Marshall Islands, and Venezuela have issued CBDCs; 7 countries including China are promoting the development of central bank digital currencies ; 3 countries are studying; but there are several developed countries including the United States, Russia, Germany, Japan, and the European Union.

Throughout the world's economies, the application of new technologies such as blockchain and encryption algorithms to re-express their sovereign currency is still in its early stages. Existing new sovereign digital currencies have not significantly affected their participation in international currency competition. However, this type of exploration is conducive to testing various technologies, adapting clearing settlement models and regulatory schemes, accumulating relevant experience and talents, and laying the foundation for more meaningful currency innovation.

Analysis of New Sovereign Digital Currency

This section mainly analyzes Libra, which is planned to be jointly launched by Facebook and 99 institutions. It not only uses blockchain technology, but also has innovations in currency characteristics. Its six-dimensional indicators are as follows:

-Issuer

Private private institutions and decentralized governance mechanisms

-Issue logic

Similar to eSDR proposed by Zhou Xiaochuan, that is, anchoring a basket of high-quality fiat currencies

The proportion of a basket of fiat currencies is proposed to be: 50% of the US dollar, 18% of the euro, 14% of the Japanese yen, 11% of the British pound, and 7% of the Singapore dollar.

-user experience

Accounts can be opened more conveniently, because apps such as Facebook and Facebook can embed wallets;

Can open an account independently: technically feasible, how to do it depends on consultation with the regulatory authority;

Transactions can be anonymous or controllable anonymous: how to do it depends on consultation with the regulatory authority

-Clearance and settlement system

Independent of existing cross-border clearing and settlement systems (including SWIFT)

-Its control is decentralized

Transaction information flowing through the clearing and settlement system can be kept confidential: Whether it is kept confidential depends on consultation with the supervisory authority

-Regulatory practice

The economy that embraces it needs a new regulatory system

Whether all aspects of regulatory logic requirements can be achieved: logically, technically

-Monetary Policy

For economies that allow it to land, the monetary policy model of the original currency needs to be adjusted;

If its use is limited to cross-border transactions, it will have limited impact on the monetary policy of an economy's original currency

If Libra is successfully launched, it will likely quickly become a strong currency with high international competitiveness, because it has great advantages in terms of economic support, stable currency value and strong availability: essentially, it A five-nation coalition, a combination of five high-quality fiat currencies, with 2.7 billion potential individual users.

Impact on five economies

The proportion of Libra's basket of currencies roughly corresponds to the actual proportion of 5 legal currencies in international trade settlements and external reserves, so the five related economies (the United States, the Eurozone, the United Kingdom, Japan, and Singapore) will not worry too much about Libra The currency Libra threatens its fiat currency in the international currency competition. In fact, coalition forces should expand faster than singles alone.

The five economies are concerned about other issues with Libra: the control of the clearing and settlement system, the implementation of regulatory measures, and the impact on the monetary policy of the original fiat currency.

In terms of clearing and settlement mechanism, Libra adopts distributed ledger supported by blockchain technology, which greatly simplifies the logic of cross-border payment, can realize point-to-point fund payment, and is a communication intermediary that bypasses SWIFT and other Implementation scheme. The United States will certainly pay attention to how to ensure that this new clearing and settlement system is not out of control.

At the regulatory level, how to solve the following problems will be new challenges: understanding customers (KYC), protecting users, protecting data privacy, anti-money laundering (AML), anti-terrorism (ATF), crime prevention (FinCEN), tax protection, and financial system Stable etc.

The impact of the original fiat currency policy depends on whether the five economies allow Libra to land in the local economy or limit it to cross-border trade payments. If it is in the local economy, then the monetary policy model and parameters of the original fiat currency will need to be adjusted; if it is limited to cross-border trade payments, it will have limited impact on the monetary policy of the original fiat currency.

Therefore, the current basic attitude of the United States-led G7 towards Libra is that it cannot be promoted until there is a satisfactory answer to the above questions. But we do not expect G7 to categorically deny Libra's exploration of Libra.

Even if Libra is aborted due to inadequate specific measures, the next similar super-sovereign new digital currency will appear. In fact, the consensus expressed by the U.S. Treasury Secretary and the Fed Chairman not long ago is that he does not oppose the launch of Libra, provided that it meets regulatory requirements.

Impact on non-Five economies

Non-Five economies may be divided into two groups. One group will not allow Libra to land in the local economy to avoid its direct impact on the local market. The other group will accept the landing of Libra coin, forming a dual currency competition situation in the local economy. Due to Libra's strong position, the result of the dual currency competition may lead to the local economy of Libra being tokenized.

Non-Five economies will accept Libra as a legal foreign currency with a high probability. Accordingly, they need to explore how to achieve cross-border supervision of Libra. Especially for economies with foreign exchange control, how to deal with the technical characteristics of Libra should be carefully considered.

In the international currency competition, currencies issued by non-Five economies will face more powerful challenges, especially the weaker currencies will be marginalized more rapidly.

【Suggestions】

The emergence of super-sovereign currencies has responded to the needs of global economic integration. After the 2008 financial crisis, on behalf of China, Zhou Xiaochuan called on the International Monetary Fund's IMF to consider issuing super-sovereign currencies based on special drawing rights (SDRs), which caused the attention and discussion of the international community. The Libra project was proposed at this time. It has the catalysis of blockchain technology and the logical support of economic development. To this end, we must attach importance to the role and influence of new digital currencies with supersovereignty in the international currency competition landscape.

There are three specific suggestions:

1) Test water DC / EP

Actively explore how to apply new IT technologies in the currency field through the practice of the People's Bank of China in DC / EP;

Accumulate experience in monitoring new digital currencies;

Cultivate relevant talents, including financial talents and IT technical talents.

2) Participate in Libra

Issue level: Encourage Chinese enterprises to actively participate in the issuance of Libra, including acting as bookkeeping nodes (management committees), resellers, exchanges, and custodians. This is the best way to learn. After the conditions are mature (including free exchange of RMB), the RMB RMB will be entered into a basket of currencies anchored by Libra Libra.

Use level: it is allowed to exist as a foreign currency, which can be exchanged according to law and used overseas.

Regulatory level: Actively explore how to regulate currencies such as Libra. When conditions are ripe, you can consider local pilot flows in the country to accumulate more skills to deal with this currency.

3) Release Cibra

Consider releasing a Chinese version of Libra, Chinese Libra, or Cibra for short.

The core difference between Cibra and Libra is that the RMB RMB in the anchored basket of fiat currencies is one of the main components and also contains other high-quality fiat currencies.

It is recommended to implement it after the RMB is freely converted, and it should be used in cross-border trade and investment to form competition with Libra.

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