Xiao Lei: Digital currency will change the global currency landscape

Currency Change and the Fate of Great Powers

Seventy years ago in 1944, World War II was basically over. Due to the severe damage of the war, the British Empire slipped from its position as the world's hegemon and gradually became a debtor country from a creditor country. The United States became the world's largest creditor country, with the largest gold reserves in the world (accounting for 59% of the world's total official gold reserves), as well as a complete financial operation plan (including plans to establish the World Bank and the International Monetary Fund).

In July 1944, at Bretton Woods, New Hampshire, the United States, 44 countries around the world passed an agreement led by the United States, which pegged the U.S. dollar to gold and other currencies to the U.S. dollar. The British pound eventually gave way to the U.S. dollar, which has since replaced the British pound as the world's only reserve, settlement and trade currency.

Seventy years later, thanks to reform and opening up, global trade, and the expansion of US debt, China has gradually become the world's largest creditor country. However, due to the solidified global dollar operation system, the internationalization of the RMB has been slow. Under the existing economic and trade system, it is almost impossible for China to create a RMB version of the Bretton Woods system in the new century. The United States does not even want to participate in the "Asian Infrastructure Investment Bank" initiated by China.

However, the global economy is also very dissatisfied with the dollar-dominated monetary system. Every time the dollar fluctuates cyclically, the world bears the greatest risks and losses, and the United States is always able to overcome the danger. Accepting the dollar as an international currency has become largely "passive" and "coerced." However, the logic of replacing one sovereign credit currency with another sovereign credit currency to serve as an international currency is no longer attractive. What the RMB has to face is the demand for change in new currencies from countries around the world and all people.

Only digital currency has the conditions to replace the US dollar

The 2008 US financial crisis once again impacted the global economy. Relying on the global purchasing and financing capabilities of the US dollar, the US stimulated the economy at a very low cost and quickly recovered from the shadow of the financial crisis, but the global economy can never return to the growth level before 2008. Especially in the past two years, with the continued strengthening of the US dollar, countries have had to deal with capital outflows and economic downturns by devaluing their own currencies to an unlimited extent.

What kind of currency can overcome this cyclical and sovereign trap? It seems that apart from gold, no other currency can play such a reliable role. However, due to its strong physical properties, gold has a high cost in acting as a transaction medium. In addition, the Federal Reserve and other central banks in various countries are unanimously opposed to gold playing a monetary role again, which may lead to the long-term suppression of gold's monetary properties.

With the development of science and technology, especially the rapid development of Internet technology, some of the original solidified logic of the world has been directly changed. People have not only begun to use the Internet to protect their own rights and interests, but also to use the Internet to create things that should have been created by the government. The financial crisis in 2008 once again made people around the world see the defects of paper money. The real digital currency was born in 2008. A man named Satoshi Nakamoto invented a payment method that not only does not require intermediaries such as banks, but also does not even require the central bank to provide a transaction medium (currency).

Today, Bitcoin has become a household name, and millions of people around the world are paying attention to its development and future with unprecedented enthusiasm. Bitcoin-based digital currency encryption technology and distributed blockchain technology have attracted the participation of professional institutions around the world, including the People's Bank of China, Goldman Sachs, and Morgan Stanley.

Some people believe that Bitcoin is the first technology in human history to truly realize the inviolability of "private property" through technical means rather than legal means. It is this technology that touches the hearts of the people and creates a strong sense of trust, and Bitcoin has begun to circulate rapidly around the world. Currently, the market value of Bitcoin has exceeded 10 billion US dollars, and the daily trading volume exceeds 1 billion US dollars, which is comparable to the explosive growth of a listed company.

For China, the real significance of RMB internationalization is not to replace the US dollar from a historical perspective and become the second US dollar. Even if it really replaces the US dollar one day, the final result is not an ideal or sustainable development path. What will replace the US dollar in the future will definitely not be a second currency similar to the US dollar, just like what will replace gold as the world currency is the paper credit currency such as the US dollar, not another metal currency.

In the future, the currency that can defeat the US dollar should be a currency that surpasses the credit of the US dollar, or surpasses its convenience, fairness and trust. For the time being, only digital currencies based on encryption technology and blockchain architecture can break away from the inherent US dollar system in theory and practice and reach the standard of replacing the US dollar.

Digital currency is of great significance to China

For the United States, studying digital currency may be just a way to improve the dollar economic system, but for China, this is a major historical opportunity. If this opportunity is missed, no matter how strong the Chinese economy is (like Japan in the 1980s and 1990s), the final result may still be that the RMB will have to become a lifelong shadow currency of the US dollar like the Japanese yen. The only thing we can wait for is a major turmoil in the United States and the withdrawal of the US dollar from the historical stage, but this kind of waiting seems to be too time-consuming. Therefore, studying digital currency is actually looking for a bigger way out and more possibilities for the future of the RMB.

Recently (November 9, 2016), the People's Bank of China published a recruitment notice on its website. Its subsidiary "People's Bank of China Printing Science Research Institute" is recruiting three positions, which are responsible for the architecture design and development of the software and hardware systems of digital currency and related underlying platforms, as well as the research of key cryptographic technologies used in digital currency, symmetric and asymmetric cryptographic algorithms, authentication and encryption, etc. Applicants are required to have experience in system architecture design, blockchain technology development or application, and big data platform development.

Regarding the "People's Bank of China Printing Science Research Institute", I can explain a little bit. It was founded in August 1959 and is affiliated to the People's Bank of China. It is a professional scientific research unit for banknote printing, focusing on application development research and taking into account applied basic research. It has research laboratories such as ink, plate making, banknote paper, anti-counterfeiting technology, and banknote printing machinery design, as well as plate making and banknote printing experimental workshops. It is the only scientific research unit in the country that focuses on the printing of securities and new anti-counterfeiting technologies.

In other words, the issue of the issuance of digital currency by the People's Bank of China has entered the implementation stage, rather than a simple preliminary investigation or discussion. Because the Printing Science Research Institute of the People's Bank of China is responsible for how to specifically implement the issuance and printing of banknotes, as well as anti-counterfeiting work. This is the last link in the issuance of currency. After completing this step, the "banknotes" will enter the field of social circulation.

There are three reasons why the People's Bank of China wants to issue digital currency:

1. Strategy

Regarding strategy, a lot has been said in the previous article. The future game between the RMB and sovereign credit currencies such as the US dollar involves the final distribution of global financial dividends. China is certainly not satisfied with just staying at the stage of sharing the population trade dividend. Financial dividends require a strong monetary credit and financial settlement network to support them.

Even if the U.S. dollar reaches its end, it is difficult for the RMB settlement system to replace the U.S. dollar system in terms of settlement and payment, because it is very difficult to change trading habits unless the original trading model is completely overturned. This is like saying that Microsoft today does nothing and still has enough patent income every year to keep Bill Gates at the top of the world's richest list.

This is also why the Cross-Border Interbank Payment System (CIPS) has been online for a long time, but from a longer-term perspective it is difficult to shake the SWIFT system (Society for Worldwide Interbank Financial Telecommunication), because from a practical level it has not surpassed all the functions and modes of SWIT and cannot change users' habits.

However, the world is so wonderful, and at this moment, the great digital currency experiment began. Based on encryption, decentralization, blockchain distribution and other digital currency technologies, it completely subverts the logic of the original settlement system such as the SWIFT system. It is the only technology that can completely replace the existing global dollar settlement system and operate independently.

Bitcoin is just an experiment. At present, the capacity and efficiency of the blockchain under Bitcoin cannot support global financial trade settlement. However, the security and stability of its operation, as well as the enthusiasm for participation, far exceed the imagination of currency researchers. Therefore, strategically investing in the research of digital currency and conducting experiments in China as soon as possible will help to apply it to the international market in the future, and it has a very important strategic significance for the rise of the RMB and even the Chinese financial sector.

2. Trends

Since 2000, China's money supply (M2) has increased from 13 trillion to the current 150 trillion, but the proportion of cash in circulation (M0) has been decreasing. In 2000, M0 accounted for 13% of M2, but now M0 accounts for only 4% of M2. In other words, for every 100 yuan of currency we issue, only 4 yuan is actually printed as paper money, and the other 96 yuan exists in the form of bookkeeping. To put it bluntly, it is just a number placed in various financial accounts.

The digitalization of currency has become a trend. Three years ago, no one could have imagined that nowadays, with a mobile phone and WeChat or Alipay downloaded, one can receive and pay money anytime and anywhere. The need to hold cash has become less and less.

Not only China, but the world is also facing the same trend. Statistics from the Swedish Central Bank show that the circulation of Swedish paper banknotes has fallen by 40% since 2009. The country is considering issuing digital currency and withdrawing cash from circulation. In fact, as early as the middle of last year, the Danish government announced a series of motions, including a plan to promote a cashless society. Stores and service places can choose completely cashless transactions, and retailers should be allowed to accept only mobile payments and credit card payments. Denmark may become the first cashless country.

Paperless currency is a trend, which has two meanings: one is to digitize the existing currency, and the other is to completely change the system and issue new digital currency to replace the existing currency. The former does not require much technical content and is just a change in the way of use, while the latter directly changes the money supply and management method, which is also the biggest challenge of issuing digital currency.

For China, the mere electronicization of currency is unlikely to meet future needs. Whether from the perspective of security or the internationalization of the RMB, mere electronicization still cannot get rid of the central settlement system, and cannot generate competitive advantages and higher levels of trust than the US dollar in the international market. The latter is the direction and end point.

3. Reality

At the beginning of this year, the Agricultural Bank of China broke out a "bill case" involving an amount of up to 4 billion yuan. Its employees were suspected of illegally withdrawing 3.8 billion yuan in bills, and at the same time used the illegally withdrawn bills to repurchase funds without establishing a ledger. A considerable part of the repurchase funds illegally flowed into the stock market, and due to the decline in stock prices, a huge funding gap could not be redeemed. Soon after, similar situations broke out in CITIC Bank, Tianjin Bank, Qilu Bank, etc. Later, the central bank planned to establish a bill trading platform to solve this problem, and all paper bills will be withdrawn from the market in the next two to three years. But from the current situation, the bill trading platform cannot solve the problem of information asymmetry, its efficiency may not be improved too much, and it is difficult to have a significant improvement in supervision.

At present, China's digital currency, especially the digital currency that the central bank is preparing to issue, is likely to be tried in the bill market first. This distributed blockchain payment technology can fully record all transactions and all destinations, does not rely on a single trading platform, and cannot be tampered with. You know, if digital currency can be realized in the bill trading market first, it will not be far from the real social digital currency, because the annual bill trading volume of ICBC alone exceeds 10 trillion. If it can meet this order of magnitude of transactions, digital currency will be half successful. This is a great breakthrough for blockchain technology like Bitcoin. Bitcoin's order of magnitude cannot meet this transaction demand for the time being.

Time is of the essence:

In July, representatives of the U.S. House of Representatives called on the U.S. government to develop a national policy for related technologies, specifically mentioning digital currency and blockchain. In September, representatives of the U.S. House of Representatives passed a non-binding resolution calling for the development of a national technology innovation policy, which included statements in support of digital currency and blockchain technology. Although the resolution is not yet binding, it is also historic. The bill supporting digital currency and blockchain passed the U.S. Congressional vote, and the members of the House of Representatives have a real interest in technology.

Singapore, which has developed rapidly in recent years, has recently decided to become the latest central bank to test its own digital currency. This digital currency will be used for interbank payments in the institution's blockchain system trial. The purpose is to simplify inter-bank payment processes and reduce transaction costs. Participants include the Singapore Stock Exchange and 8 banks.

In fact, most of the world's top 10 exchanges, financial institutions and investment banks have already been involved in the development and research of blockchain technology and digital currency. China is in the stage of overtaking others and should boldly try various new breakthrough technologies. If other markets push digital currency into the global trade and transaction system, the international financial transaction landscape will change again, and perhaps China will get the last piece of the pie. (Text/Xiao Lei)