Crypto currency mania has gripped the world, as increasing acceptance of blockchain technology by major financial institutions has propelled the likes of Bitcoin into the mainstream. Whether you believe in crypto or not, the emergence of crypto currencies threatens to usurp fiat money. The Chinese government has identified the threat early, and has taken significant steps to ensure they have a meaningful head start on digitising their commercial sector and money supply. China’s long anticipated and recently released digital Yuan threatens to undermine the US dollar’s (USD) supremacy as we know it.

China’s digital Yuan project is the first of its kind for any major global economy. It is a version of normal Chinese currency, deployed on a blockchain; the highly encrypted and secure online ledger technology that underpins digital coins like Bitcoin and Ethereum. The People’s Bank of China (PBOC) has led work on the digital Yuan project, which is classified as a central bank digital currency (CBDC) that aims to replace some of the cash in circulation.

China has been trialling the digital currency since late 2020, and in 11 different regions since April, including in major cities such as Suzhou and Shenzhen, where the digital Yuan has been used for transport, food and retail. The digital Yuan bypasses the need for central banks in transaction processes, eliminating service fees and speeding up transaction times. China has plans for international use of the digital Yuan by 2024 or 2025, and has already established partnerships with the UAE, Hong Kong, and Thailand to promote international use of CBDCs. Given the vast extent of China’s bilateral trade relations globally, and the increasing likelihood of China overtaking the US as the world's largest economy, the internalisation of the digital Yuan is seeming inevitable. 

Decline of the Dollar

The emergence of the digital Yuan coincides with a difficult period for the US dollar. The US dollar has become increasingly fragile of late, perhaps mirroring America’s decline within the international system, with its status as the ultimate reserve currency looking increasingly likely to be challenged in the long term.

The US dollar has seen a steady fall since the start of the COVID-19 pandemic. It is down about 10-12% relative to America’s major trading partners. Some have even suggested that the dollar will decline in value by 35% by the end of 2021. Ongoing political instability in the US has had a detrimental effect on global trust in the US dollar. The debasing of the US dollar through massive US government debt and central bank stimulus raises the question of the dollar’s long-term viability as the ultimate reserve currency. 

To demonstrate this effect, we can look at the declining market of the US-China bilateral trade. The US imports from China dropped by $87.3 billion in 2019 from 2018, and continue to drop annually. The Chinese need for the US dollar is declining. The use of the US dollar in China-Russia transactions has declined from 90% in 2015 to less than 50% in the first quarter of 2020. At a rate of 10% annual decline, it will not be long before the US dollar is no longer used at all in China’s transactions. This vacuum left by the USD will allow for the growth of other currencies such as the digital Yuan. As more countries decide not to use the US dollar, the use of alternative currency reserves will increase. Given China’s extensive trade relations, the digital Yuan is well positioned to take over.

China not Attempting to Replace USD

While it appears that the US dollar and digital Yuan are moving in opposite directions, Chinese officials have claimed that the development of the digital Yuan is not intended to ‘replace the USD’ as the ultimate reserve currency. Deputy governor of the PBOC Li Bo claimed that “efforts to create the digital Yuan are aimed at domestic use,” while Governor of the PBOC, Zhou Xiachuan, echoed that Beijing is not aiming to immediately take on the USD as a currency reserve.

Regardless of China’s intentions for the digital Yuan, the reality is that the growth of the new digital currency will likely further contribute to the weakening and destabilisation of the USD. Much like when China developed paper currency in the 7th century during the Tang dynasty, China is today leading the way in a key transitional phase of the global financial system. The CBDC space certainly has potential to be a key battleground in the larger US-China struggle for global hegemony. Perhaps it is time for the US central bank to explore the implementation of a CBDC project more urgently. Should they fail to do so, there is a pressing possibility for the USD to get left behind.

-Noam Konyn

Noam Konyn is a graduate of the University of Bristol. He is currently pursuing an MA Government Specialisation in diplomacy and conflict at Interdisciplinary Centre Herzliya, Israel. He has previously worked in Elminda, a brain health medical device company in Tel Aviv, Israel.