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The writer is founding partner of Gavekal Dragonomics, a China-focused economic research firm
At the Winter Olympics in Beijing, China’s government unveiled two initiatives. One was the statement by presidents Xi Jinping and Vladimir Putin declaring that China and Russia have a friendship with “no limits”. The other was a trial of the digital yuan, or e-CNY, which was offered for use by both domestic and foreign athletes and spectators.
Following Russia’s invasion of Ukraine, and the imposition of harsh financial sanctions by the US and its allies, it is reasonable to ask whether China’s digital currency paves the way for a new, dollar-free global monetary system that would enable countries to evade American sanctions.
In the short run, the answer is clearly no. For one thing, while China has complained about the sanctions, it has largely abided by them. Its companies and banks are avoiding business with sanctioned Russian firms, for good reason.
China’s economic relations with the US and its allies in Asia are far greater and deeper than those with Russia. In 2021, nearly half of China’s $3.3tn in exports went to the US, EU, UK and US treaty allies in Asia; only 2 per cent went to Russia. China’s technology industries still depend heavily on equipment and knowhow supplied by the US and its friends.
For another, the e-CNY is not even close to ready for large-scale international use, and has a negligible place even in domestic payments. Chinese policymakers have been clear from the outset that their main goals for the digital yuan are domestic: improving payments efficiency, serving the unbanked and fighting corruption.
From its first trial launch in April 2020 until the end of 2021, total e-CNY transactions in China were Rmb87.5bn ($13.5bn). This represented just 0.002 per cent of the $715tn of online payments in China during the same period.
Finally, efforts to internationalise the conventional, non-digital renminbi over the past decade have stalled. The renminbi accounts for 2.5 per cent of global reserves. Russia, which tried to sanction-proof its economy by shifting its reserves out of dollars, holds just 13 per cent of those reserves in renminbi — less than the euro, gold or even the hated dollar.
The picture in payments is similar. The share of China’s trade settled in renminbi has hovered at around 10-15 per cent since 2016, and the Chinese unit accounts for less than 3 per cent of foreign exchange transactions handled by the Swift messaging system.
The failures of renminbi internationalisation reflect structural problems. The main obstacle is China’s tight capital controls, which it needs in order to keep monetary independence and ensure the stability of its heavily-leveraged domestic financial system.
These controls, combined with the immaturity of China’s bond and money markets, mean that international investors have little incentive or ability to hold large renminbi balances. They rightly fear that such holdings cannot easily be liquidated at any time and in any amount. Until they have such confidence, the use of the renminbi for cross-border payments will remain limited.
Another factor is the network effect — the tendency of people to use a service because everyone else uses it. The infrastructure and institutional arrangements making it convenient to pay in dollars will be hard to change. It is not easy to see how the e-CNY, by itself, could overcome these constraints. One way it might is by creating a vastly more efficient channel for international payments. But this will take a lot of technical effort, which has barely begun.
Some argue that by starting early, China has a “first-mover advantage” in creating the digital currency norms of the future. More likely, network effects will overwhelm this edge. China has begun experiments on payments with Hong Kong, Thailand and the UAE.
But seven major central banks, including the Federal Reserve and European Central Bank, have joined with the Bank for International Settlements to set digital currency standards. Any effort by that group to build a digital payments network is sure to be more successful than a group of smaller central banks managing a system built around China’s partially convertible currency.
In response to expert advice that the US and its allies pick up the pace on digital currencies, US president Joe Biden has issued an executive order mandating a study of a digital dollar. This is appropriate. But the goal should be to carefully build a modern payments system marrying efficiency and privacy, not to stave off an illusory threat from China to the dollar’s dominance.