It’s not the first time a long-time winner loses its crown. Do you think China’s Digital Yuan will take over the world? Read this article to understand the mechanics, benefits, and cons of a new digital currency in the making.
Why Central Bank Digital Currencies Matter
Is the Chinese digital currency set to dethrone the dollar? I think over the long-term the answer may be yes, and it is happening just now.
China's Central Bank Digital Currency, The Digital Yuan (DCEP) is in the works. I want to be very clear, this is not speculation or tinfoil hat stuff. This is already in the making, and it's been in the news for several months.
How would the DCEP system work?
- App Download: The individuals using the digital currency like businesses and the average Joe would first download an app to their phone. This automatically gives them a bank account with their Central Bank.
In this case, they'd have access directly to digital Yuan.
2. Seamless lending: The Central Bank could lend directly to the business and the consumer, not just lend but give them stimmy money as well. The currency could expand with demand for productive uses.
This is key because one of the features of something like Bitcoin or gold is that they are scarce to a certain degree. Some people, like a lot of Keynesians, would see that as a bug, not a feature.
From the standpoint of the central banks, a currency that can expand, elastic, is going to win in the end. Their words, not mine.
3. Efficiency: DCEP is very efficient and similar to Bitcoin or another cryptocurrency without the benefit of scarcity and decentralization. It is easy storage that, unlike gold, it doesn’t need a physical location.
It's not even like Bitcoin, a key is not necessary and it's much easier than carrying cash around with you. The accounting it's very seamless. You can rehypothecate it and repledge collateral used against the digital yuan or DCEP.
Payment is as easy as Bitcoin, cross-border, from peer-to-peer, business to consumer, or consumer to business and location is irrelevant. This is a big key that I think nobody is talking about and everyone is missing.
We get hyper-focused on…
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What if the Fed had their own digital currency?
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What would it mean for Americans?
We forget that the Central Bank could allow anybody to download the app and start using their digital currency.
In this case, the People's Bank of China could encourage their business partners in other regions, like Africa, to download the app and start using the Digital Yuan.
The key takeaway is the DCEP eliminates the need for banks, it is critical to understand this.
I also want to point out the Central Banks don't have a P&L, so they can issue loans without having to worry about being paid back. They could create limitless currency units as long as there were productive uses for those loans.
It would be straight MMT. However, in this case, it could be global MMT coming directly from the People's Bank of China.
I examined this through the lens of the Central Bank's balance sheet. They have assets and liabilities. On the liability side, they create bank reserves, in this case, they would be Digital Yuan.
Liabilities go out to all the individuals as loans, grants, stimulus checks…
Who knows?
The Central Bank only needs to type in some additional numbers in their computers to create more bank reserves and liabilities. They would probably back that up by issuing some form of debt against those liabilities.
If they were giving loans to corporations, as an example, those loans would then be assets on their balance sheet. But in practice, they wouldn't even have to do that, they could have all liabilities and no assets whatsoever.
As they are a Central Bank, they're not restricted by profit, loss, or the requirement of positive equity. They could be completely insolvent and it wouldn't matter, they could continue to create more digital currency units.
I want to introduce you to a couple of characters that will help you grasp the topic: the average Joe's Chinese cousin, China Cho, and his African cousin, Africa Yo.
So Africa Yo and China Cho download the DCEP app. Africa Yo is in Tanzania, and Africa Corp is in Nigeria. China Corp is located in Beijing.
After downloading the app, the two cousins could get stimulus checks or loans directly from the People's Bank of China. It doesn't matter what country they're in anymore.
Here the network effect could apply and give China a huge edge, especially because they already have a massive presence in South America and Africa. The key I want to point out is this completely gets around the banking system.
Before, if Africa Yo needed a loan or Africa Corp, they'd have to go through a bank, but now they go directly to the Chinese Central Bank.
Once Africa Yo and China Cho have their Digital Yuan, then they can transact with one another seamlessly, like any other cryptocurrency.
They'd have the app on their phone and could transfer money to the corporation or the business. The business could transfer money to its employees. Africa Yo could transfer money directly to China Cho in China. It would be quite efficient.
The Digital Yuan has the same efficiencies as Bitcoin or any other cryptocurrency. This, among many other reasons, is why China could take over the world, not with their military, but with their digital currency.
What Is Wrong With The Current Dollar/Eurodollar System?
You must get your mind around the problems with the Eurodollar system so you can determine the probabilities of the Chinese Digital Yuan replacing the Dollar as the Global Reserve Currency.
How does it work?
The Fed is seen as the center of the dollar monetary system, which is not true. It's banks outside of the United States that create dollar loans. In other words, they can create dollar deposits or dollar liabilities in the commercial banking system.
Imagine a South American bank and an African bank. They can lend dollars to each other, create derivatives out of dollars or dollar-denominated loans to corporation XYZ in South America or corporation ABC in Africa.
The issues begin when the Eurodollar system breaks down like it did in 2008. Today, Covid-19 has shown us how it can be extremely inefficient.
If the banks decide not to lend and tighten lending standards because they're really worried about a global pandemic. Of course, they don't want to loan any money because they know they most likely won't be paid back. It all goes back to the commercial banks having to be concerned with a P&L, profit, and loss.
You may think “Well, of course, George, they're a business. Of course, they're concerned with the P&L.” Bear in mind the central banks, like the PBOC, are not worried about a balance sheet.
They're not worried about a P&L (profit and loss), they can lend money and create additional currents units even if they know they're not going to be paid back. That is a huge, huge difference.
If the Eurodollar system freezes up and corps. Like XYZ and ABC. can't get the liquidity in dollars they need, the Fed has to come in and set up swap lines.
The swap lines are faulty because all they do is give additional dollars to the commercial banks. But we're still reliant on the commercial banks to issue loans to entities that they see as insolvent, or at the very least, having a cashflow problem.
Even if the banks have access to dollars through the Fed's swap lines, those dollars still aren't getting to corporations -like XYZ in South America or ABC in Africa- as they would in the United States, where the Fed can set up a special purpose vehicle and proceed to buy the junk debt of corporation 1, 2, 3.
If you were a corporation XYZ or ABC…
Which system would you choose in the future?
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The system that's broken, that's flawed, if we have a disaster or a pandemic, they're not going to be able to get the funding they need?
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Or are they going to choose a system that goes directly to the Central Bank of China?
Corps XYZ and ABC have the app on their phone, just like China Cho and Africa Yo, and the PBOC can give them a loan. They can give them the liquidity they need to weather the storm.
It completely cuts out the banking system and goes to a limitless balance sheet that can take any amount of loss it needs to prop up the system. For more insights, I examined a recent Forbes article titled China Will Use Its Digital Currency To Compete With The US Dollar:
A digital version of the renminbi lets China inter-operate between different currency contexts where the US Dollar may start to fade. For example, central banks that don't have established swap lines with the Federal Reserve for USD during this COVID crisis may see a spate of debt demand for USD within each of their markets, heightening the value of the USD in the short term, but probably determining a long-term reckoning on US Dollar-denominated debts.
… Across the African continent, inflation has been at all-time highs… A digital currency that can interoperate between different African systems and South American systems or other Belt and Road Initiative Partners, as well as what may be their largest trading partner, China, backed by some government force may be able to sweep the area as people question the value of holding US dollar debts amid collapsing domestic currencies.
(End of transcript)
In other words, in the future, they're going to want to try to diversify out of the dollar because of the problems they're having right now with the swap lines.
In a crisis, countries in Africa and South America are left with a very difficult choice. Either allow businesses to go bust or create hyperinflation as they can't get the dollars they need. So they have to print more of their currency units, not a very good choice to have to make.
I have dived into the subject at corporate, country, or continent level, but it also goes down to the individuals like China Cho and Africa Yo.
Do they want to hold their local currency that's prone to having the value destroyed by inflation?
They want cheap loans, let's not forget about that.
If they downloaded the Central Bank of China's app, they could get one denominated loans. Therefore the interest rate would be far lower than in their local currency.
It checks a lot of boxes for the individuals, as well as the corporations. Please keep in mind the balance sheet of the PBOC is limitless, they can extend as many loans, stimulus checks, or UBI to individuals like China Cho and Africa Yo.
When it comes to loans, the PBOC could have a competitive edge on other cryptocurrencies, even Bitcoin, because they could issue those loans at a far lower interest rate since they don't have to worry about being paid back.
It's a completely perverse system, I know, but we have to think through the realities to determine the probabilities of the Chinese digital currency taking over the world and replacing the dollar.
How China Takes Over The World
It starts with young demographics in places the PBOC is targeting with foreign direct investment and they'll most likely be targeting with the Digital Yuan.
In regions like Africa and South America, DCEP creates a network effect because young people adopt it, use it and they don't want to handle anything else.
We've seen this with Facebook, Amazon, Google, and several other tech companies. It'd be the same way with digital currency. Also, easy access to cheap credit is crucial to facilitate massive adoption.
It cuts out the banking system. You can go directly to the central bank that has an unlimited balance sheet. The currency is stable, countries in Africa and South America no longer have to deal with the concern of hyperinflation over again.
The ease of use of a cryptocurrency with payments, storage, and accounting offsets the banking system as I mentioned earlier. The logical inference would be the Digital Yuan could replace the entire Eurodollar system we have today.
In other words, it could replace the Global Monetary System we've had in place since 1944 with Bretton Woods.
It's not just me stating this. There are many guys out there talking about this that are a heck of a lot smarter than I am. As an example, I included a transcript from a recent podcast episode, one of my favorites, The End Game with Grant Williams, Bill Fleckenstein, and James Atkins:
“Really what we're sketching out here is a profound change, or to begin with an intense competition around who runs the financial system of the future.
Are we going to have a dollar-backed financial system as we knew it or are we going to have a digital renminbi-backed financial system with, quite frankly, all of the horrible problems that will entail?
That's what this is about.
So, to be clear, it's very tricky to try it. I mean tricky to try it, but we all have to be aware of what's happening as market participants. We need to keep an eye on it. I, for one, have set up all these alerts on DCAP on my Bloomberg so I get all these headlines, and I'm getting 25 a day.
I mean, they now got the trial running in Shanghai for DCAP. Now they're rushing it out in other parts of China. They're going for it. Right? They're going for it because frankly, up until very recently, Washington has been asleep at the switch. But it's extraordinary to watch the, I mean, no surprise about Xi Jinping's breathtaking ambition on so many fronts, but this one, for us, for those of us work in financial markets and thinking about asset allocation and everything else, I mean, I don't know about you fellas, but I don't particularly fancy opening a digital renminbi wallet in mainland China, given the data I would have to hand over.
And that's just for starters, right? Assuming, of course, that was the only way I could do any transactions in mainland China. To be clear, I don't, but these are, to me, is a really important, difficult, complicated topic. But it's the biggest planning question I've been confronted with in my career.”
(End of transcript)
A quick wrap-up around the network effect: The PBOC launches its digital currency, the DCEP. All of the average Joe's in South America and Africa download it onto their phone. They have very young demographics.
So the kids download it to their phones, go back and forth because of the ease of use and easy access to credit.
Then we have Africa Yo downloading it to his phone and the average Joe’s cousin, South America Joe.
So South America Joe and Africa Yo downloaded the app onto their phones, and they're using the Digital Yuan going back and forth. They're using it for payments to the corporations and these are borrowing money in the currency from the PBOC.
This is what creates this network effect, not to mention foreign direct investment yet, which is a key component.
For more on the One Belt, One Road Program and foreign direct investment, I checked out an infographic created by the National Development and Reforming Commission/Hong Kong Trade Development Council/ South China Post/Asian Development Bank:
“Pegged as the most ambitious infrastructure mega project of all time, China's One Belt, One Road Initiative will stretch from the very edge of East Asia to East Africa, Central Europe connecting nearly two-thirds of the world's population. Through continuous networks of highways, railways, ocean routes, and ports, the scheme will open up cross border connectivity and encourage further integration of international markets.
Aside from kick-starting economic growth across China in many developing nations, many have questioned the true political intentions behind Beijing's master plan, fearing potential renminbi internationalization.
Whatever happens, with the 1 trillion worth of infrastructure works planned or already underway, One Belt, One Road will transform the Eurasian landmass and reshape global trade as we know it. How China will fund the works remains to be seen.“
This is where I think it gets really interesting, what the authors didn't understand is MMT. Now that we realize how popular MMT is and how it's being adopted by governments and the central banks.
The PBOC is not worried about issuing bonds. All they need to do is create the bank reserves out of thin air and use those bank reserves as legal tender by sending the digital currency units or bank reserves themselves to the individual's phones in Africa, South America, India, Russia, or wherever else they're instituting this One Belt, One Road plan.
There is no need for debt or issuing bonds, as they can create the currency units out of thin air, MMT for the globe.
The images below display data and maps I found relevant to get insights as to how quickly this Chinese digital currency could be adopted.
When you look at Africa, in areas like Zambia, Nigeria, Tanzania, Ethiopia, Zimbabwe, South Africa, the Chinese are investing heavily in infrastructure and energy. These are old maps, I think the extent of the foreign direct investment of the Chinese is far greater now.
Look at how many Chinese workers are in Africa as of 2016. They would immediately adopt and start transacting in the Chinese digital currency. Even in South America, the Chinese have been investing heavily. I think there's more foreign direct investment than we see here. This is old data.
I know from personal experience when I was in Ecuador, in Quito and Guayaquil, their two main cities, Chinese folks were everywhere and they weren't there just living; they were there investing, building companies, infrastructure, and controlling resources.
Huge amounts of foreign direct investment will rapidly increase the adoption rate for the Chinese digital currency and the network effect I referred to earlier.
Just on a side note: Everything that China is doing with this initiative in Africa, South America, India, Russia, the Middle East, and the Eastern part of Europe is going to increase the number of goods and services potentially.
The wealth of a society isn't necessarily how many currency units it has but how many goods and services it can produce efficiently. Whether China will accomplish it or not, this system has the potential yet to be seen, but they're moving toward creating vastly more wealth for these developing countries.
On the other hand, the United States, Western Europe, Australia, and New Zealand are adopting the policies of Klaus, Bigglesworth, the World Economic Forum, and the IMF with their great reset agenda.
They are pushing for equality of outcome, not equality of opportunity. They want to eliminate all private property. Remember you'll own nothing, and you'll be happy.
They want the average male to have the same testosterone levels as a ten-year-old girl. This creates an economic environment with less output and, therefore fewer goods and services making societies like Western Europe and the United States much poorer. While Asian, South American, and African countries get richer.
I also want to point out that what gives the dollar the world reserves status isn't just a green piece of paper, it's the infrastructure for the global monetary system or the global dollar monetary system. That's what gives it its power and its staying power.
The adoption of the Digital Yuan and Foreign Direct Investment is completely replacing the old infrastructure with a new infrastructure the Chinese and the People's Bank of China would control completely.
If China and the PBOC control the infrastructure, if everyone is using it, by definition, they would have the global reserve currency.
And it's not about military power these days. I know a lot of people are saying, “Well, the United States would never let that happen because they have the world's largest military.”
If you control the infrastructure and the monetary system, that's a far greater power than having a big military.
You can use sanctions, you can cut off these countries and get them to do whatever it is you want.
Who is the main supplier to the United States' Military?
China.
I know a lot of people right now are pulling out their hair saying, “George, what you're talking about is Bitcoin. It has efficiencies. It has the network effect. The People's Bank of China, their currency, it's not going to take over, it's going to be Bitcoin that's going to win.”
I hope so. But what you need to remember is the edge the Chinese currency has and that's, they can extend credit very inexpensively because they have an infinite balance sheet. They don't have to worry about profit and loss.
Bitcoin's greatest feature is potentially its greatest bug: It can't expand. There's not much elasticity to a currency that is extremely scarce and only has 21 million units, no matter how divisible it may be.
I'm not saying that Bitcoin won't win. I prefer a decentralized system to this type of tops down approach any day of the week. I hate central planning.
This, from an Orwellian standpoint, definitely keeps me up at night. I am saying that Bitcoin and other central bank digital currencies are going to have their hands full competing with the DCEP.
I know the rest of you are probably saying to yourself, “George…
What about the United States dollar? What about the Fed creating their digital currency?
Isn't that an easier sell for the entire world because we're already on a dollar-denominated system?”
I would say, yes, the dollar, The fed, and the United States can compete with China, but they are way behind with digital currencies.
The closer the United States comes to competing with China, the closer they take all Americans to 1984 in a total state of surveillance.