Finance & economics | Swapping notes

Will going digital transform the yuan’s status at home and abroad?

Don’t count on it: the new yuan will be a lot like the old yuan

WITH A FEW taps on her phone, Lu Qingqing, a 24-year-old office worker, leapt into the monetary future. She was one of 50,000 people in Shenzhen selected late last year for a trial of China’s digital currency, called eCNY. She downloaded an app, received 200 yuan ($30) from the government and went shopping for books. The app’s display showed a traditional banknote. “It felt like real money,” she says.

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Legally, it is as real as hard cash. All the money in an eCNY app, offered by one of six commercial banks, is backed by an equivalent deposit at the People’s Bank of China. Just as the central bank stands behind any paper yuan, so does it guarantee eCNY. If, say, the commercial bank that made Ms Lu’s digital wallet went bust, her eCNY—linked to her personal-identity number—would be transferred to a new wallet.

Central banks worldwide are considering issuing digital versions of notes and coins. Although China will not be the first (that honour goes to the Bahamas), it is the most important launching ground. It is the world’s leader in mobile payments (see chart 1). More than half a million people have already received eCNY in trials since last year. China’s central bank is studying how to spread it abroad. Niall Ferguson, a historian, has called on America to wake up to the peril of letting China “mint the money of the future”.

China’s digital currency was first conceived as a way to curb the big mobile-money providers. Now three bold claims are being made about it: that it will dramatically enhance China’s surveillance capabilities; that it will allow the state to wield far more control over money; and that it will challenge the dollar for prominence.

Within China, however, many economists are far less bullish. The design of the eCNY, and the nature of China’s economic system, mean that each of these claims is unlikely to be realised soon. “The digital yuan is not magic, so we don’t expect magic from it,” says Gary Liu of the China Financial Reform Institute in Shanghai.

Start with the first claim, that digitisation offers unmatched surveillance abilities, letting the state track all spending. It is not entirely wrong. But it is a limited gain compared with its existing powers.

Most mobile payments today involve a bank card, tethered to users’ accounts on Alipay or WeChat. These must pass through NetsUnion, a central clearing platform. Similarly, foreign-exchange transactions take place on the China Foreign Exchange Trade System. In both cases regulators can see how people spend in real time. For mobile payments that do not touch banks, officials can demand a record and, says an industry insider, may soon require real-time reporting, too.

The upshot is that, even without eCNY, regulators have no real blind spots left, apart from old-fashioned cash. And so long as millions of older citizens do not much like paying for things with smartphones, the government will not phase out cash.

The second bold claim about eCNY is that it will reshape monetary policy in China. According to this view, the central bank will be able to program money to be used for specific purposes and at predefined times. This, however, both understates what the central bank can already do and overstates what the eCNY will let it do.

China already manages both the money supply and interest rates with different sectors in mind. Since 2015, for instance, it has created hundreds of billions of yuan for the construction of affordable housing. More recently it has instructed banks to lower interest rates for small firms.

The eCNY, one might assume, will make targeting more precise. But its design will circumscribe its role. The central bank will replace only a small portion of base money, known as M0, with eCNY, leaving the rest of the money supply undisturbed (see chart 2). It will distribute eCNY through commercial banks, which in turn will make it available to the public. It will not pay interest on eCNY. And it will probably place low ceilings on how much people can hold.

Granted, the central bank may in time expand the eCNY’s role. But the limitations exist for a reason. The government is wary of undermining the financial system. It does not want savers to switch out of bank deposits en masse into eCNY, which would make it harder for banks to fund themselves. Moreover, few serious economists in Beijing like the idea of a 100% eCNY money supply, in which the government could directly control how banks lend. “We don’t want to go back to central planning. That would be a mistake,” says Yu Yongding, a former adviser to the central bank.

The final bold claim is that eCNY will catapult the yuan to global status. But that misunderstands why it accounts for just 2% of international payments today, about the same as the Canadian dollar. When deciding which currencies to use, companies and investors consider how easily they can make conversions to other currencies; how freely they can invest them; and whether they trust the issuing countries’ legal systems. China’s insistence on maintaining far tighter capital controls than any other major economy, as well as deep-seated doubts about its political system, blunt the yuan’s appeal. The limiting factors are policy and politics, not technology.

Even the technological case for eCNY is far from clear-cut. When companies transfer money in and out of China, they already use currency in a digital format: electronic messages on the SWIFT payments network instruct banks to credit accounts in one country and debit them in another. What slows things down is complying with China’s capital controls and with international regulations such as those aimed at stopping money-laundering.

The eCNY will not eliminate such checks, and the Belgium-headquartered SWIFT system, which connects more than 11,000 financial institutions, is likely to remain the most efficient conduit for sharing payment information across borders. “Even in the long term, SWIFT will remain indispensable,” says Liu Dongmin of the Chinese Academy of Social Sciences.

The three more radical claims about it may not be realised, but will the eCNY fulfil the original aim, of giving the central bank a foothold in the digital-payments universe? Probably, but not a giant one. After the eCNY trial in Shenzhen, Ms Lu said that she would use it for some payments, but that Alipay and WeChat were far more convenient because of how they tie into commercial and social-messaging networks. Mr Liu of the China Financial Reform Institute expects others to concur. He predicts that in three years the eCNY will account for less than 5% of mobile payments.

Western governments and central bankers mulling digital currencies of their own may wonder if the outcome of the eCNY experiment will contain any lessons for them. But China is unusual in so many ways—from its sheltered financial system and intricate capital controls to the size of its mobile payments—that its experience could well prove to be unique. And other countries are sure to implement different designs for their digital currencies. Still, China’s caution with the eCNY, if nothing else, hints at how disruptive the technology, if unconstrained, could be.

Correction (May 9th 2021): The scale on chart 2 has been corrected, to yuan trillions.

Dig deeper

The digital currencies that matter (May 2021)
Special report: The future of banking (May 2021)

A version of this article was published online on May 3rd, 2021

This article appeared in the Finance & economics section of the print edition under the headline "The new yuan: a lot like the old yuan"

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