The Chinese Communist Party (CCP) is playing the long game to establish its dominance and supplant the US as global hegemon. This is not conjecture but the stated policy objective of the CCP. The application of this overarching strategic objective for China’s resurgence on the world stage is no less relevant to the area of monetary policy than it is to political, military, and commercial realms.
Here is what we might expect from China in this area.
First, China needs to develop an alternative global financial infrastructure outside of the US led and controlled system. As long as the US has the economic equivalent of the nuclear threat to sanction China’s banks and disconnect the entire Chinese banking system from the rest of the world, their options for acts of aggression (e.g. annexing Taiwan) may be limited. Secondly, China needs to ensure a slow and controlled bleed of America’s monetary lifeblood, weakening the dollar and the US’s financial power over time. This must be gradual so as not to prematurely precipitate a massive devaluation of the dollar, which would not be in China’s interests.
Some argue that the CCP’s objective is to establish the renminbi as the world’s reserve currency, unseating the dollar from that role. This may indeed be Chairman Xi’s long-term aspiration, but China has more to lose in the near term by rapid dollar destabilization. China is a substantial dollar based creditor, not only to the US government but to governments and corporates around the world. A devaluation of the dollar would have a material negative impact on the Chinese national balance sheet. The PBOC holds about $3.2 trillion in foreign currency reserves. While China’s US dollar reserves have been reduced – from 79% of total reserves in 2005 to 58% based on latest estimates – dollars still predominate. China also holds over $1.1 trillion of US Treasury bonds, and total Chinese financial system exposure to the dollar is a multiple of this figure. Further, China is nowhere near willing to open up its capital accounts to the rest of the world, a pre-requisite to reserve currency status, and to allow the yuan to float freely. So, in the meantime, the CCP looks to other means to shift monetary power, ensuring the Party’s ability to maintain centralized and total control over its economy, its currency, its people, and to chip away at the US’s position.
One important recent step is China’s creation of a central bank digital currency (CBDC) based on the yuan. Last week the Wall Street Journal highlighted that the People’s Bank of China (PBOC) had become the first central bank of a major economy to roll out a digital currency at scale. The Digital Currency Electronic Payment (DCEP) is China’s version of a CBDC, and it is backed by the renminbi. The US is running far behind in its own efforts towards a CBDC.
China’s DCEP can be thought of as the anti-Bitcoin. Bitcoin is a complete crypto alternative to fiat currency, while the DCEP is simply a digital version of China’s fiat currency. Bitcoin is pseudonymous, whereas DCEP transactions can be surveilled by the CCP. Bitcoin lives on a public ledger, while the DCEP is centrally controlled. Bitcoin has a finite quantity controlled by algorithm, but the DCEP’s supply is discretionary. The DCEP can be set to expire, forcing use and thereby controlling the velocity (and quantity) of money. Bitcoin’s value is market determined and independent of any fiat currency, unlike the DPEC, which is directly linked to the exchange rate regulated yuan. Ideologically, Bitcoin can be thought of as a libertarian dating an anarchist, while the DPEC is more like the lovechild of Stalin and Mao, totalitarian through and through.
The CCP increasingly views Bitcoin as a threat. An estimated 85% to 95% of all Bitcoins were mined in China until 2018, which today still represents over 60% of Bitcoins in existence. China initially took a hands off approach to crypto, and the industry flourished. However, in 2017 the government began to crack down on cryptocurrencies, making exchanges and initial coin offerings (ICOs) explicitly illegal, and trading by ordinary citizens nearly impossible. The CCP is terrified of what Bitcoin represents: transparency, decentralization, privacy, and loss of control. After all, a citizen with financial independence outside of the yuan is dangerously at risk of ideological independence, which can’t be tolerated. At the same time, the government has whole-heartedly embraced the blockchain for other applications, most notably their own digital currency.
Bitcoin still circulates in China, albeit illicitly or with restrictions. But the CCP may yet take more draconian actions. China’s Great Firewall is sophisticated and effective, and could be used to completely shut down Bitcoin domestic and cross-border trading in China. If this embargo was combined with state sponsored mining continuing within China, the bifurcation could potentially destabilize the global ledger system. The crash of Bitcoin in 2017 is partially attributed to the actions of the Chinese government at that time. There is sizable risk to Bitcoin today that China and their allied governments may be able to pull similar strings in 2021, bringing the house of Bitcoin tumbling down from its current price above $60,000, a nearly tenfold increase from just one year ago.
So, what are the CCP’s motivations here? First, the CCP is determined to create a parallel universe for payments outside of the US dollar and SWIFT payment network. Secondly, the CCP is determined to have absolute and centralized control over its people and economy, and for this it needs complete surveillance power. As long as cash or, even worse, cryptocurrencies remain an important part of domestic transactions, this is not possible.
As I wrote in these pages nearly a year ago, the US is slowly being undermined through the loss of control of the global funds flow. China and Russia, along with others, are working together to create an alternative to SWIFT, the US-based and controlled global money transfer network over which more than half of high-value cross-border transactions occur. Today, most US dollar transactions utilizing SWIFT are routed through US banks, which enables the US government to surveil transactions and seize payments, even if they are between non-US banks. This is an intolerable situation for China. Further, the US has used SWIFT as a geopolitical sledgehammer by threatening and enforcing sanctions against Russia, Iran, and others. By cutting off a country’s banks from the network, the US effectively shutters the target country’s import and export markets at great economic cost. And, as the US has become more aggressive and frequent in the use of this tactic in recent years, it has convinced its adversaries to accelerate their pursuit of viable alternatives and alliances.
Today, the news is full of excitement about Bitcoin. Yet, China’s creation of its digital currency may, in the long-term, be more significant. Through the DCEP, China is undertaking to break away from SWIFT and the US controlled global monetary regime. If they succeed, the ripple effects will be broad. Perhaps the next time the US imposes sanctions on Iranian oil, the DCEP will be in place as a backdoor alternative.