China’s central bank needs to head off rising challenge posed by cryptocurrencies
Published: Jul 15, 2019 07:08 PM

Illustration: Luo Xuan/GT

Facebook's announcement of calling Libra a digital currency has sparked much debate, which is still continuing in the technology, finance and political fields. In addition to criticism toward data privacy and trading security, attention has been given to the future challenges to central banks' rights to issue currency. Some Chinese scholars and central bank officials have also weighed in on the issue.  

Realizing the inevitable trend toward digitalization of currencies, China's central bank seems to have changed its past rejection of Bitcoin. Zhou Xiaochuan, former central bank governor, said last week that it remains uncertain whether Libra will succeed or not, but it has introduced a concept that will impact the traditional cross-border business and payment system. Libra's idea to peg to a basket of currencies points to a possible alley for a global currency. "A more international globalized cryptocurrency may appear in the future," Zhou said. "It won't necessarily be Libra. Judging from the trend over the past few years, many institutions and people will try to create a currency that is more conducive to globalization."

Zhou's remarks indicate that competition between digital and sovereign currencies is actually one between strong and weak currencies. He further pointed out that the birth of Libra is inseparable from the global dollarization trend. Libra is likely to be a strong currency and erode weak currencies, much like the dollar does. Under the influence of strong currencies, capital in countries with weak currencies may flow to areas with strong currencies to seek a safe haven.

Regarding the impact of the new digital currency on Chinese yuan and the central bank, Mu Changchun, deputy director of payments at the People's Bank of China (PBC), stated that besides its payment function, Libra will likely pose challenges to global central banks in monetary supply, foreign exchange rate formation and financial supervision. For instance, Libra won't be pegged to one specific fiat currency, but will be backed by a basket of assets with low volatility. This may require international institutions, such as the International Monetary Fund, to control Libra's circulation and monitor currency exchange rates. Otherwise, this could lead to exchange rate arbitrage, where countries compete to print money to exchange for Libra. In addition, Facebook has not made clear its commitment to measures to prevent money laundering or anti-terrorist financing, nor how it will protect the privacy of its users, according to a Bloomberg report which cited Mu. 

Apparently, from the perspective of the Chinese central bank, digital currencies represented by Libra will not only pose international competition to the yuan by taking advantage of the strong dollar in international trade, liquidation, and investment, but will also affect the usage of the yuan as a fiat currency in the domestic market due to Libra's digital cross-border characteristics. In this sense, the PBC needs to study and develop its own sovereign digital currency, and bring digital currencies under its supervision. 

In the meantime, the central bank needs to accelerate the yuan's internationalization and the opening of the capital account to improve the yuan's global status before digital currencies become widely used. According to Mu, the emergence and development of such kind of stable coins, whether from the perspective of the implementation of monetary policy or of macro-prudential management, cannot take place without the support and supervision of central banks, which should be incorporated into central banks' regulatory frameworks. Meanwhile, considering the cross-border usage of such digital currencies, especially the internet impact that may see the winners take all, measures must be taken to prevent monopolies. This all requires supervision and cooperation from central banks and international organizations around the world, which may even lead to the emergence of an international central bank. 

In terms of the full convertibility of the yuan, in the long run, if the yuan is not convertible it will be like other weak currencies, eroded by other digital currencies such as Libra. The only effective response is to make the yuan convertible as soon as possible to withstand erosion from Libra and other digital currencies.

Statements from central bank officials indicate that digital currencies are an unstoppable trend. Regardless of whether Libra succeeds or not, digital currencies will impact sovereign currencies. For the Chinese yuan, this impact should not be underestimated, because it will not only affect the yuan's status as a fiat currency in the domestic market, but also pose competition for the yuan's internationalization. Fundamentally, digital currencies still depend on the strong US dollar, which will further consolidate the status of the dollar in the international market. China's central bank needs to prepare and take precautions if it does not want to lose the initiative.

The article was compiled based on a report by Beijing-based private strategic think tank Anbound.