Deputy Dean of Academics, Professor of Finance and Director of the Fintech Research Center at Fanhai International School of Finance, Fudan University
Associate Professor of Practice in Finance at Fanhai International School of Finance and the co-director of the FISF Fintech Research Center, Fudan University
We live in extraordinary times, where the current COVID-19 epidemic which started at the beginning of 2020 has developed into a global black swan event, causing massive suffering and disruption for societies world-wide. The epidemic exacerbated an already dangerously precarious economy, and could cascad into a rolling financial crisis throughout the world that cuts across all sectors of industry and levels of society. China has responded effectively and admirably to this Herculean challenge by implementing unprecedented quarantine measures restricting the movement.
These positive measures have been highly successful in effectively preventing the exponential spread of the disease in China. However, this has come at a great cost to the nation, as the resulting disruption in lost productivity and long-term economic contraction has yet to be fully assessed. China’s PMI has fallen to the lowest levels in recorded history as labor mobility, transportation linkages, supply chains, and retail activity across the country have been seriously affected by the outbreak. Large corporations and SMEs alike have face bleak prospects, with two-thirds of companies (even huge, well-resourced companies such as Haidilao) that were surveyed reporting that they have runways of less than just a few months of cash on hand. The imminent and systemic closure of large swathes of the economy combined with the inability to provide credit to the most fragile sectors of society could likely result in the largest economic depression the world has ever seen. Even as the country began relaxing travel restrictions and companies are opening up back for business in early April, the full scope of the challenge ahead to stimulate the country's economic recovery remains an extremely challenging task.
One key potential weapon in the central government's arsenal to allow the country to recover is the digital RMB that was announced by the PBOC at the end of 2019. As the world’s first central bank digital currency (CBDC) to be issued by a G20 nation, the digital RMB will instantly become the largest fully fiat-backed digital currency globally. It turns out that the extremely serendipitous timing in the deployment of the digital RMB can give the PBOC powerful new technology-enabled monetary and fiscal policy tools that can be effectively leveraged to stimulate the economy.
The Superiority of a Central Bank Digital Currency
A CBDC represents an electronic fiat liability that a central bank can use to settle payments. This concept of an electronic currency has existed for decades in the form of electronically settled with Real Time Gross Settlement (RTGS) systems that can adjust reserve balances that are held by commercial banks at the central bank. In the case of a CBDC, the central bank may issue fiat money that has the potential to be universally accessible and be used as a means of payment for the general population, not just as a settlement tool for commercial banks. As stated by PBOC, the digital RMB is initially meant to replace the M0 money supply, i.e. notes in circulation and other assets that are easily convertible into cash.
The three hallmarks of a currency are as a unit of account, store of value, and medium of exchange. A digital currency is superior to its physical banknote predecessor as well as related money instruments in each of these critical attributes. Currently, when ordinary people want to use central bank money to store value and medium of exchange, the only available option with no credit risks are paper-based banknotes. Therefore, they bear the costs of handling and storing banknotes safely (e.g. counting cash and depositing in a bank account). As a stable unit of account and store of value, the digital RMB represents a secure store of value as it is a fiat issued directly by the PBOC, without any of the risk associated with payment platforms from private companies and accounts at banks, all of whom can default in a crisis. As a medium of exchange, the digital RMB can be exchanged in a completely friction-free, costless manner as well as exchanged peer-to-peer (e.g. between digital wallets on mobile phones). As a practically costless medium of exchange, the digital RMB would significantly enhance the efficient and secure settlement of financial transactions, from retail transactions to cross-border payments.
The Digital RMB Improves Market Efficiency
The digital RMB effectively combines the efficiency of existing forms of digitized deposits with the additional capability for the peer-to-peer transaction of cash. China has already largely gone cashless due to the dominance of existing mobile and other digital payment systems in China. Having the digital RMB allows the inclusion of risk-free fiat currency to complete the full digitalization of money and payments in the country. These economic benefits would become more pronounced if the digital RMB is eventually rolled out to encompass bank deposits as well, in which case they could reduce the scale of the commercial banks’ credit intermediation. For example, models developed by the Bank of England have shown that the aggregate effect of CBDC issuance of 30% of the GDP has the potential to permanently raise GDP by as much as 3% due to reductions in transaction costs, real interest rates, and distortionary taxes .
At the same time, the introduction of the digital RMB into the ecosystem would provide a necessary alternative system for cashless payments which is currently dominated by the duopoly of Wechat Pay and Alipay(representing a combined market share of over 96% of overall online retail payments by transactional volume). This would provide banks and other financial institutions to be competitive to participate as alternative financial service providers, which is healthy for the robustness of a diversified payments ecosystem. The resulting financial sector would be more competitive in providing greater benefits to end users. It represents a reorganization of the existing third-party payment sector to include already-established financial institutions and creates opportunities to effectively monitor and regulate the industry, reducing overall system-wide financial risk. Indeed, with the digitization of fiat, there are opportunities for synergies with information technologies combining big data analytics and Blockchain. Entire histories for transactions would be available, providing massively more data to policymakers, including the ability to observe bad actors or to measure the economic response to shocks or to policy changes almost immediately. This would provide for significant enhancements to monitoring and regulation in a data-driven and real-time way.
Notably, the payment efficiencies of the digital RMB would have the most pronounced benefits for lower-income households and small businesses, the most vulnerable in economic downturns. Lower-income households tend to rely heavily on cash, and small businesses incur substantial costs for handling cash and interchange/exchange fees for processing payments such as via credit and debit cards. Given that the initial focus of the digital RMB is to be used to support small retail transactions, and will be separate and distinct from the nation’s bank deposits, it would be highly effective as a way to provide financial services efficiency and resilience for the underserved. The digital RMB could result in the reduction of many transaction costs and would radically increase financial inclusion for the rural and unbanked population by obviating the need of even owning a bank account. Additional opportunities for these constituents include the possibility to hold interest-bearing currency and to have access to micro-loans and credit facilities through online banking. The nationwide roll-out of the digital RMB would cater specifically to these underserved segments of society, notably the estimated 800 million people classified as China’s rural population.
As such, the introduction of the digital RMB would dramatically boost economic growth through efficiency gains and increased productivity from the most fragile segments of the population. Because of the transaction efficiencies, the velocity of money in circulation can be dramatically increased, thereby encouraging consumption and increasing volume of trade and economic activity. The digitization of fiat currency also allows a larger percentage of the money supply to be accounted for, which in turn would allow for more big data opportunities, such as credit risk analysis for low-default micro-loans. This would result in a large improvement in extending lending and credit facilities for the underserved over the existing system. As example, for many SMEs and private companies, currently the only way to access credit is through the shadow lending market, which is completely nontransparent to regulators and results in layers of middlemen seeking rents at usury rates. The introduction of the digital RMB would avoid these credit supply/demand market dynamics that can contribute to systemic crises.
The digital RMB is also designed to be pseudonymous (and hence pseudo-private). Put simply, it does not require any bank card, linked bank account, or even working internet connection to conduct small-scale digital RMB transfers. The digital cash would be held in a purpose-specific digital wallet. This makes it completely fungible and infrastructure-free, in a way unlike all other payment and remittance systems ranging from Alipay to Apple Pay to SWIFT. Again, this allows the digital RMB to directly serve those without access to traditional financial services. Larger transactions could require higher levels of KYC/AML verification and could be tracked by monitoring the fiat on-ramps and off-ramps to the accounts/wallets, akin to existing controls in the traditional banking industry. The digital RMB would reduce exposure to the risks of tax evasion, money laundering, and other illegal activities. In the long run, this would re-directed mis-appropriated money back to the productive economy.
The Digital RMB as a Monetary Policy Tool and Conduit for Economic Stimulus
In addition to the positive impact on payment efficiency, there is strong potential for banks' fund disintermediation and improving the transmission mechanism of monetary policy, facilitating a systematic and transparent channel for the PBOC. This would give the PBOC powerful new instruments to conduct monetary policy with more direct connection to the real economy and with much more fine-grain controllability. As the digital RMB can be programmable, there are opportunities for digital innovation to enabling brand new forms of smart money. These functions may include various forms of meta-data and information processing that could allow the potential for smart contract-enabled automated execution of transactions. These new types of capabilities can facilitate transactions and efficient interactions much better than the static currencies of today. One such innovation is an interest-bearing digital RMB, which could provide a truly secure store of value. This type of digital RMB functionality could be distinct from and non-substitutable with bank deposits, providing an alternative policy tool for efficient deployment of monetary and fiscal policy. Such a tool could also be used as a stabilization measure for business cycles by controlling either the quantity or the price of digital currency in a counter-cyclical fashion.
Mu Changchun, the Director-General of the Institute of Digital Currency for the PBOC, has indicated that the digital RMB would not be initially interest bearing. However, there have long been strong arguments made by various economists that government-issued money should ideally bear the same rate of return as other risk-free assets in order to be a more useful medium of exchange. Implementation of these concepts was impossible with traditional paper banknotes, so modern money has been designed to steadily deflate rather than maintain true price stability. With a digital currency, the PBOC could create a truly stable store of value that would not lose value over time due to inflation. An appreciating/interest-bearing digital RMB could provide the ultimate stable unit of account and secure store of value which would facilitate it as a globally recognized medium of exchange. The real value of the digital RMB could be held stable over time relative to a price index/CPI basket, resulting in a new instrument with fundamental purchasing power stability.
Targeting true price stability would be substantively different from the current practice of inflation forecast targeting. Currently, monetary policy by most central banks around the world consists of aiming for positive inflation rates targets of around 2% or so. In the wake of the global financial crisis, some economists have advocated even raising those targets to provide more room for monetary policy flexibility. The lower bound on nominal interest rates has been a primary motivation for maintaining such a positive inflation buffer. With an interest-bearing digital RMB, there would no longer be a compelling need to maintain any inflation buffer since the PBOC could directly realize purchasing power stability. Thus, an interest-bearing function would contribute to greater macroeconomic stability.
Furthermore, when circumstances call for Quantitative Easing, which has been widely discussed/deployed during the COVID-19 Crisis, the digital RMB also has the potential to provide direct transmission of monetary and fiscal policies, with the ability to selectively bypass inefficient credit intermediation of banks. Since the Credit Crisis of 2009, massive quantitative easing stimulus plans across the major global economies resulted in inefficient allocations of credit that were of limited impact in stimulating real economic growth. QE was directed through banks, so the benefit of the stimulus accrues inequitably to the institutions that have access; namely the banks, state-owned enterprises, and large corporations. Furthermore, in that instance, capital was directed to banks because the root of the Crisis was ostensibly in the solvency of banks and the confidence of investors in the stability of the financial system. The Crisis was viewed as having started in the investment and poor operating behavior of the financial sector, which in turn impacted the real economy. QE sought to fill bank reserves and re-establish trust in the solvency of the banking system. Even so, in the U.S., exclusive access to easy credit by the top 1% of society has drastically exacerbated income inequality, destabilizing society. Banks and corporations have used this easy credit to systematically initiate massive stock buy-backs, essentially leveraging accounting tricks that consolidate wealth in the hands of company executives and equity holders but do not translate into more real growth in the economy. This has resulted in rampant stock and bond market excesses that are now rolling into the end of the current long-term debt cycle which is now causing the systemic crash in the markets as we speak. As example, the U.S. airline industry spent $39B in government stimulus for stock buy-backs since the 2008 crisis, and now is asking for another $50B bailout as they face bankruptcy because worldwide travel has halted from the COVID-19 pandemic.
In the COVID-19 crisis, the root of the downturn lies in a global slowdown in economic activity not silo-ed within a particular industry or country. It has impacted the real economy directly by destroying consumption, corporate earnings, wages, and employment rather than through the financial system. As a result, funding a particular industry or a small number of large banks or corporations will not likely lead to an effective, speedy recovery. Here, the ability of governments to provide funding directly to businesses and individuals is critical. The digital RMB provides an opportunity for the government to directly stimulate consumption through quantitative easing targeted to individual households. It is estimated that in the U.S., 40% of Americans would struggle to pay an unexpected $400 USD expense due to limitations in available cashflow and financial planning. The U.S. government is now considering an emergency bill to distribute U.S. citizens $1000 USD as essentially a universal basic income-style subsidy.
Similar relief programs can be used to provide operational funding and credit to businesses. The programmable functionality of the digital RMB could facilitate the provision of credit subsidies or cash relief to existing loans. Stimulus funds could be deposited directly into the digital RMB accounts/wallets of vulnerable SMEs, thereby cushioning the effects of a downturn. Conversely, it could be programmed with restrictions for non-desired use cases, such as real estate speculation, P2P lending, or corporate stock buybacks. This would direct funding to properly stimulate the economy as intended. In the United States, a program was proposed to Congress during the COVID-19 Crisis that included the use of digital dollar to deliver cash stipends directly to citizens in need. In that particular bill, funds direct deposited into digital wallet issued to citizens was included as an alternative to traditional checks. The legislation ultimately was not passed with the digital dollar provision. However, in China, where the relevant authorities would have the wherewithal to execute such a program through the policy banks, no such legislative risk would be present and could provide immediate relief. In contrast, indirect stimulus would have to trickle down from the central bank to policy banks, to commercial banks, to SOEs, to SMEs and individuals. At each stage, the capital faces potential losses from transactions costs, from the inability to effectively deploy, from inefficiencies in allocation of capital to enterprises or persons who do not need it, and from time wasted. Direct-to-recipient stimulus avoids all of these costs.
Indeed, an interest-bearing digital RMB could serve as alternative tool of monetary policy, thereby mitigating the need to deploy more brute-force monetary techniques such as quantitative easing or other direct fiscal interventions. This would allow households and businesses to have better visibility and ability to properly forecast their costs across long periods of time. Again, such stability could be particularly beneficial for lower-income households and small businesses, which typically have limited access to sophisticated financial planning advice or complex financial instruments that can help hedge against such inflationary risks. The monetary and fiscal policies conducted in this way would be more straightforward, transparent and systematic, resulting in greater financial stability of the overall monetary system.
The Global Impact of the Digital RMB and the Digital Future of Assets
Finally, it is worth noting that the digital RMB could facility cross-border settlement, particularly as the RMB is internationalized to Belt and Road partners, now representing over 152 countries that cover all of the high-growth developing nations in the world and representing 65% of the world's population and well over 40% of global GDP. The Digital Silk Road is connecting the people in these developing nations online for the first time, many of which are unbanked or small SMEs. These people represent the last untouched, high-growth markets in the world, and the financial products and e-commerce opportunities would be very enticing to Chinese companies. Their first exposure to an internationally exchangeable money would be in the form of digital RMB. which would encourage most of the developing world to shift from the U.S. dollar to the RMB as a global reserve currency as economic interests with China across the world expand. This would massively facilitate cross-border transactions, (specifically inbound capital flow into the country which could bolster the mainland economy) and for SMEs in particular who focus on producing goods and/or trading with international partners. The digital RMB would also allow international tourists and other visitors to access the nation's mobile payment services ecosystem without the need for first needing to open a bank account with a Chinese bank. The positive dynamics of networks externalities (i.e. network effect) of the friction-free global payments infrastructure enabled by the digital RMB, will result in huge positive effects of economic growth and resilience not only for the China economy, but the global ecosystem as well.
The world's digital economy has become an increasingly important part of the overall economy, now representing 30% of the S&P500 in the span of two decades. China's digital economy totaled 26 trillion RMB in 2017, accounting for around 32 percent of national GDP, according to the China Academy of Information and Communications Technology. Its 18% growth substantially outpaced the overall economy, which grew 6.9% in 2017. This growth trend is likely to continue in the future with the value of China's digital economy expected to hit US $16 trillion by 2035. These digital economy trends will be even more pronounced as the COVID-19 epidemic forces a new normal for working remotely and new online business models.
These trends will massively accelerate as adoption of new technologies such as blockchain will drive the next digitization revolution, this time providing the ability to digitize anything of value and innovating on the new modes of transacting that value. Digital assetization, the first true killer application of blockchain, enables radically disruptive digital financing and business model innovation that can allow any ecosystem or interest group to effectively create a customized incentive structure to optimize their own digital economy. Blockchain technologies will allow the ability for the trusted sharing of data and digital assets worldwide and for new modes of international collaboration on an unprecedented scale. Goldman Sachs indicates that digital finance could increase the GDPs of all emerging economies by 6 percent, or a total of $3.7 trillion, by 2025. This is the equivalent of adding an economy the size of Germany to the world, or one that’s larger than all the economies of Africa. This additional GDP could create up to 95 million new jobs across all sectors of the economy.
Given all the compelling advantages outlined above, the digital RMB represents the key for China’s recovery and future growth from the emerging global financial economic crisis.
The digital RMB will massively drive the future of the digital economy along with the adoption of regulated digital assets by becoming essentially the "reserve currency" for translating the exchange of any digital asset pairs and for denominating the digital assets of the future. China is clearly already leading the world in the development of both the future financial and technology infrastructure that will allow the nation to take a leadership position in digital assets. This turbocharged digital economy will be driven by the securitization and exchange of digital assets, empowered by big data analytics and automated by AI and smart contracts which rely on digital data. With the deployment of the digital RMB, the nation can rapidly drive the Chinese economy past the current COVID-19 epidemic and global economic crises into recovery and propel itself into future as the world’s undisputed economic power.