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Things Heat Up Between China the Digital Yuan & The United States and the Digital Dollar

Things Heat Up Between China the Digital Yuan & The United States and the Digital Dollar

China is poised to launch a digital version of its yuan and could be about to create serious problems for the U.S. banking system—potentially forcing the U.S. to digitalize the dollar to compete.

Now, the Federal Reserve has warned central bank digital currencies might one day replace commercial banks, creating “a deposit monopolist” and playing “havoc” with the banking system.

“The introduction of digital currencies may justify a fundamental shift in the architecture of a financial system, a central bank ‘open to all,'” Federal Reserve of Philadelphia researchers wrote in a 32-page paper titled “Central Bank Digital Currency: Central Banking for All?”

The paper examined the potential effects of “giving consumers the possibility of holding a bank account with the central bank directly”—something that could potentially replace commercial bank checking accounts.

“If the competition from commercial banks is impaired (for example, through some fiscal subsidization of central bank deposits), the central bank has to be careful in its choices to avoid creating havoc with maturity transformation,” the paper read.

If people started to exclusively hold cash with the country’s central bank, the Fed and other central banks could end up becoming a “deposit monopolist,” attracting deposits away from the commercial banking sector.

Theoretical discussions around central bank digital currencies, sometimes called CBDCs and often inspired by bitcoin’s blockchain technology, have swirled for the past few years but central bankers have been kicked into action by China’s efforts to digitalize its yuan and Facebook’s plans to launch its own currency.

The Fed’s paper echos a warning raised by the International Monetary Fund in December last year, which said digital currencies could see deposits “withdrawn from commercial banks.”

Digital currencies are expected to work just like regular coins and notes issued by central banks but exist entirely online—with some floating the possibility of government-run FedAccounts being used to distribute digital dollars.

China has already begun trialling payments in its new digital currency in four major cities, local media reported at the end of April.

Other countries around the world, including Norway, Sweden and Japan, are all working on digitalizing their own currencies.

Digital currencies, expected to make it quicker, cheaper and more efficient to buy, sell or transfer money from place to place” according to one commentator, could put pressure on the dollar’s dominance.

“We may be heading towards a post-dollar world,” the Financial Times reported last month, pointing to China’s digital currency regime as one of a number of ways the dollar’s position is being eroded.

It’s very possible that other countries adopt the China framework, and then a first-mover advantage turns into a strong network effect. Donald Trump is unlikely to take this sitting down.

“We have only one real currency in the U.S.A., and it is stronger than ever, both dependable and reliable,” Trump said last year in a Twitter conversation against Facebook’s libra, bitcoin and unregulated cryptocurrencies.

In order for the dollar to maintain its pole position, China could force Trump and the Fed into difficult decisions about the future of the financial system.

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