China digital currency: Biden administration steps up scrutiny of e-yuan over potential threat to US dollar dominance

The Biden administration is stepping up scrutiny of China’s plans for a digital yuan, with some officials concerned the move could kick off a long-term bid to topple the US dollar as the world’s dominant reserve currency, according to people familiar with the matter.

Now that China’s digital currency efforts are gathering momentum, officials at the US Treasury, State Department, Pentagon and National Security Council are bolstering their efforts to understand the potential implications, the people said.

American officials are less worried about an immediate challenge to the current structure of the global financial system, but are eager to understand how the digital yuan will be distributed, and whether it could also be used to work around US sanctions, the people said on the condition of anonymity.

A US Treasury spokeswoman declined to comment, while a National Security Council spokeswoman did not reply to a request for comment.

What is China’s sovereign digital currency?

The People’s Bank of China (PBOC) has rolled out trial issuance of a digital yuan in cities across the country, putting it on track to be the first major central bank to issue a virtual currency. A broader roll-out is expected for the Winter Olympics in Beijing next February, giving the effort international exposure.

Many key details of the digital yuan are still in flux, including specifics on how it would be distributed. China’s recent establishment of a joint venture with SWIFT, the messaging nexus through which most cross-border settlements pass through today, suggests it is possible a digital yuan could work within the current financial architecture rather than outside it.

US officials are reassured that China’s intentions are not to use the digital yuan to evade American sanctions, according to people familiar with the matter. The US dollar’s current dominance in cross-border transactions gives the US Treasury the power to cut off much of a business or even a country’s access to the global financial system.

China’s officials have said the main intentions of the digital yuan are to replace banknotes and coins, to reduce the incentive to use cryptocurrencies and to complement the current private-sector run electronic payments system – dominated by Ant Group’s Alipay and Tencent’s WeChat Pay. The PBOC has been working for years on the digital yuan, also called the e-CNY, having set up a specialist research team in 2014.

​​“To provide a backup or redundancy for the retail payment system, the central bank has to step up” and provide digital currency services, Mu Changchun, the director of the PBOC’s digital currency research institute, said at an event last month.

The PBOC is also examining the potential for using the digital yuan in cross-border payments, launching a project studying the issue with a unit of the Bank for International Settlements along with the United Arab Emirates, Thailand and Hong Kong’s monetary authority.

The Biden administration is not currently planning to take any action to counter longer-term threats from China’s digital currency, the people familiar with the discussions said. However, China’s plans have given renewed impetus to efforts to consider the creation of a digital dollar, they said.

Members of the US Congress have also been increasingly interested in a digital US dollar, aware of China’s moves, and asked US Federal Reserve chair Jerome Powell and US Treasury Secretary Janet Yellen about the issue in hearings earlier this year.

Which central bank will launch world’s first digital currency?

Powell said in February the US Federal Reserve was looking “very carefully” at a digital dollar. “We don’t need to be the first. We need to get it right.”

Yellen has signalled interest in research into the viability of a digital US dollar, a shift from a lack of enthusiasm under her predecessor, Steven Mnuchin.

“It makes sense for central banks to be looking at” issuing sovereign digital currencies, she said at a virtual conference in February. Yellen said a digital version of the US dollar could help address hurdles to financial inclusion in the US among low-income households.

A recent report from the US Director of National Intelligence said the extent of the threat of any foreign digital currency to the US dollar’s centrality in the global financial system “will depend on the regulatory rules that are established.”

China’s currency makes up little more than 2 per cent of global foreign exchange reserves compared with nearly 60 per cent for the US dollar. Policy decisions, rather than technical developments, will also be necessary to push forward yuan internationalisation, as China maintains a strict regime of capital controls.

China’s financial system is too “fragile and weak” to pose a real threat to the dollar’s status as the world’s reserve currency, according to Mark Sobel, US chairman for the Official Monetary and Financial Institutions Forum.

“At the end of the day the markets have more confidence in the Fed” than China’s central bank, said Sobel, a former senior US Treasury official for international matters.

In an interview broadcast on Sunday, US Federal Reserve chair Powell said the central bank was involved in a large-scale research and development project on the digital US dollar, and that questions of whether adopting such a currency would provide a public benefit have yet to be resolved.

“It’s a very, very large, complex project. And, you know, this is really just table stakes,” Powell said in an interview with 60 Minutes on CBS. “This is understanding the technology and the possibilities so that you can really address the policy issues.

“We have not made a decision to do this because, again, the question is will this benefit the people that we serve? And we need to answer that question well. And we need to involve the public and Congress deeply in that process, because it would be an important step if we were to do this.”