A digital currency war

Lee Jong-wha
The author, former chief economist at the Asian Development Bank and a senior adviser for international economic affairs to former president Lee Myung-bak, is a professor of economics at Korea University.

Major central banks are studying virtual form of their currencies. The People’s Bank of China has been testing out e-CNY (Chinese yuan). The European Central Bank and the U.S. Federal Reserve as well as a number of other central banks are engaged either in a study or project on a centralized electronic currency. The Bank of Korea has joined the bandwagon and consigned an outside team to explore the project. Although it is too early to expect a form of central bank digital currency (CBDC) soon, humanity is moving toward a turning point of a hard-cashless society.

Central banks cannot sit on their hands amid a surge of decentralized digital currencies due to a rapid advance in technologies. Digital money can be used for online payment and instant processing. Cryptocurrencies and stablecoins — a type of digital token backed by a reserve asset — cannot be fully relied on, and their values are volatile. Also, consumer protection is weak and the system could be rattled upon a sudden wave of withdrawals. The recent fiasco with discount app operator Mergeplus and its point system underscores the vulnerability of digital assets due to a lack of legal protection.

At first glance, there won’t be a great difference in everyday life if coins and bills are replaced by CBDC. Cash is no longer much used. Still, if CBDC is widely used for retailing, the impact on the economy, financial system and government policies won’t be small. Since individual and corporate transactions will be digitally stocked, anonymity and privacy could be impaired. A state authority with access to the economic activities of individuals could abuse its power. In the financial sector, use of commercial banks’ services and their intermediary role could be significantly scaled back. If a central bank adjusts the deposit rate for CBCD as part of its monetary policy, that could directly affect consumer and corporate spending.

A government also can utilize CBDC in its fiscal policy. When handing out relief grants, it could simply hand out the money in CBCD accounts or e-wallets instead of going through credit card issuers. If the money is not used, it could be removed automatically, too. Financial activities and funding also will become easier for the socially underprivileged lacking bank accounts or credit cards. That’s why the central bank should be extra careful in designing and operating the digital currency to minimize any shocks and maximize the benefits to the economy.

When major economies come up with digital currencies and allow foreigners to use them, backed by international guidelines, cross-border transactions could become simpler. At the same time, instability in financial and foreign-exchange markets could worsen due to faster cross-border capital flows. The U.S.-China conflict could intensify when a fight over currency hegemony is added. The U.S. has been enjoying exorbitant privileges through the dollar’s supremacy as the reserve currency. Countries without internationally-traded currencies have to stock dollars or U.S. Treasuries in case of foreign currency shortages. The U.S. government can effectively control foreigners and other governments through the dollar-backed international settlement system.

But if challenges from a digital yuan grow, the greenback’s supremacy could come under fire. In July, the Chinese central bank announced a plan to use digital yuan for international settlements to bolster the international status of the CNY. Despite the rise of the Chinese economy, CNY makes up a mere 2.5 percent in international settlements and foreign reserves at central banks. It is hardly a match for the greenback or euro. The CNY lacks appeal in international settlements due to excess regulations on cross-border transactions and low reliability in the state-led economy’s monetary policy and currency value. Less positive “network externality” of the CNY also prevent its use in place of the dollar. Still, economies with greater reliance on capital and trade with China would wish to increase their Chinese currency holding. South Korea could be sandwiched if the dollar and CNY contest in the digital realm intensifies.

August 15 marked the 50th year of President Richard Nixon’s ending of the convertibility of dollars into gold. The currency and foreign exchange system were rocked by that sudden decision. The dollar’s supremacy may not last forever if the U.S.-led global order is shaken. The rise of CBDC could bring about a far-reaching impact on the global currency and financial system. The BOK must carefully study the merits and demerits of CBDC and also closely watch international movements. It also should actively join in the discussions to create a stable international settlement system based on digital currency.

Translation by the Korea JoongAng Daily staff.