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Saturday, February 3, 2018

Peterson Institute - China's Central Bank Backed Digital Currency

A thank you to Dr. Warren Coats for alerting me to this article on The Peterson Institute site. It says that the central bank in China is now ready to launch a central bank digital currency which would just be used as a replacement for cash. This would be the first major central bank to implement such a thing. Below are some excerpts.

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THE PBOC ANNOUNCES PLAN TO ISSUE ITS OWN DIGITAL CURRENCY

"While the Chinese government views digital currencies it cannot control as a threat, it wants to capture some of their benefits by embracing the technology underlying bitcoin without relinquishing control. The PBOC has been exploring issuing its own digital currency since(link is external) at least 2014. Ramping up this exercise in 2017, the bank set up small scale experiments(link is external) with mock transactions between it and commercial banks. But on January 27 of this year, the PBOC went much further into this experiment than many people expected.

In an interview(link is external) with Yicai, one of China’s leading business news publishers, PBOC Vice Governor Fan Yifei made a groundbreaking announcement detailing the PBOC plan for issuing a digital currency. There will be little to no resemblance to cryptocurrencies like bitcoin. It will remain centrally controlled and aim primarily to replace cash, rather than compete with bank deposits and other financial products. In effect, the plan allows China’s government to use digital currencies to increase control. Cash is virtually untraceable and can be transacted with no records, but the digital version replacing it will have “controllable anonymity.” The plan has clearly made strides not only on the technical side but also in the arguably more difficult process of obtaining consensus in a cautious political system and buy-in of banks. The plan could have a powerful effect beyond China, as other central banks learn from China’s example and ponder their own plans to issue digital currencies.

Much of the PBOC announcement focuses on the limited scope of the proposal, surely meant to reassure banks that their traditional functions will not change and that they will have a strong role to play in the digital currency. The crux of the proposal is to replace only cash (in monetary economic parlance: M0) with the digital currency, not bank deposits (M1 or M2). In a traditional financial system, cash and reserves represent central bank money (direct claims on the central bank). Bank deposits, though they are denominated in the same unit (say renminbi) as central bank money, are actually liabilities of commercial banks. This is a public-private partnership, where the central bank permits commercial banks to create money in exchange for submitting to its regulation. Some speculation has focused on whether central bank–issued digital currencies would upend this longstanding tradition by allowing individuals to have an account directly at the central bank(link is external) rather than rely on commercial banks. The PBOC says this will not be the case in China, and that it will aim to “avoid disintermediation.” In fact, Vice Governor Fan makes the insightful argument that bank deposits are already digital, making it redundant to make then digital once more. Cash is what is not yet digital."

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                                                Assessment : Bold yet cautious plan


"The proposal is a bold, if cautious step towards issuing a central bank–backed digital currency. There are many technical details to iron out, and keeping a system with so much monetary value secure will be of great concern. I expect that other central banks will follow the Chinese example, starting only with a digital substitute for cash that allows for institutional learning and experimentation without requiring a fundamental rethink of money and monetary policy. That said, the limited scope will surely not last forever if the pilot proves successful. The trade-off between privacy and control will be one of the great political battlegrounds of the coming decades, and these currency experiments are sure to raise the urgency of these debates. Central banks like China’s that have built up trust and credibility over decades or centuries have little use for “mining” or other systems that allow one to put trust in computer code instead of in centralized institutions. Characteristics of the plan show that political authorities will try to capture some of the benefits of digital currencies like bitcoin to marginally improve their existing monetary systems and control, while eschewing the decentralized, mostly trustless ledgers that made bitcoin truly innovative."


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My added comments: Often I see articles on China that imply that China is about to issue a gold backed Yuan. However, this article which features actual PBOC plans, again illustrates that there is no indication that China plans anything like this anytime soon. Some have said that the PBOC will first implement a central bank digital currency and then later back that with gold. However, there is no mention of backing this central bank digital currency with gold by the PBOC. Instead, they talk in terms of a slow and cautious process of simply using it to replace physical cash.




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