The decoupling of the United States and China is affecting a broad range of industries. Supply chains in the semiconductor, rare earths, pharmaceutical, and battery industries, for example, have been identified for strategic reshoring within the United States, Europe, and Japan, among other countries.
However, the global financial sector—which is experiencing a transformation in terms of digital payment technology and other fintech-enabled commerce—could face its own decoupling scenario in the near future. This is a corollary of techno-nationalism, and it is accelerating as central bank digital currencies grow (CBDCs).
China, for example, is investing heavily in R&D and infrastructure for a digital currency as part of its 14th five-year plan. The e-CNY, or e-yuan, is expected to play a significant role in the domestic affairs of the Chinese Communist Party and in the pursuit of its geopolitical interests.
The advantages of central bank-issued digital currencies.
In contrast to a decentralized cryptocurrency released by a private non-state actor—such as Facebook’s proposed Diem cryptocurrency—CBDCs are digital representations of national currencies that serve as a store of value backed by a central bank.
CBDCs have a number of social and economic benefits. National currencies that have been digitized allow financial inclusion for people who are “unbanked,” or do not have a traditional bank account. CBDCs will allow the unbanked to participate in a burgeoning digital economy as mobile smart devices spread across the world’s poorest regions.
Unlike private cryptocurrencies, CBDCs significantly minimize money launderers’, terrorists’, and tax evaders’ illegal funding choices. Additionally, by retaining state control over monetary policy and accountability standards, CBDCs avoid the risks of ceding too much power to private, non-state actors such as Facebook or Alibaba.
According to a Bank for International Settlements (BIS) study from 2021, 86 percent of the world’s central banks are experimenting with CBDCs in the hope of increasing their citizens’ retail-level commercial access through the use of CBDCs.
Geopolitics and CBDCs are inextricably linked.
Digital currencies have been drawn into geopolitical conflict, and just as strategic supply chains are decoupling, CBDCs could fragment the global financial landscape into distinct blocs.
This is a foregone conclusion due to two fundamental problems.
To begin, Beijing is attempting to reduce its reliance on the US dollar and its vulnerability to US sanctions. In 2021, the US dollar fell to its lowest level in 25 years, accounting for less than 60% of global reserve currency reserves. Meanwhile, Beijing is doing everything possible to internationalize the yuan, including promoting it as the transactional currency for credit and exchange along the Belt and Road initiative.
Despite this, Washington proceeds to weaponize the greenback as the world’s dominant reserve and trading currency. For example, the majority of foreign transactions must pass through SWIFT, a dollar-denominated cross-border clearing system. Any Chinese corporation, organization, or person listed as a restricted entity in the United States—as well as any third parties doing business with such a restricted entity—are effectively locked out of the international banking system.
This lesson became abundantly evident when Washington sanctioned Carrie Lam, Hong Kong’s chief executive, in retaliation for Beijing’s 2020 implementation of the Hong Kong National Security Law. Lam was officially unable to access banking services in Hong Kong after that. She allegedly required payment in cash and maintained “piles of money” in her home.”
As a result of geopolitics, Beijing’s attempts to establish a parallel banking system and trading currency in place of SWIFT and the US dollar have accelerated. The Chinese recognize that this is a long-term objective that will require a robust and well-funded fintech ecosystem.
Not unexpectedly, the central government has directed Ant Group, Tencent Holdings, and JD.com, all highly sophisticated Chinese technology giants, to collaborate with the People’s Bank of China (PBOC, China’s central bank), other state-owned banks, and China’s Digital Currency Research Institute to expedite the digital yuan’s rollout. Huawei, China’s national champion in telecommunications equipment manufacturing, has been developing mobile technologies that link consumers’ mobile devices to the PBOC’s and other state-backed banks’ digital infrastructure.
All of this creates a perplexing risk environment for international investors and multinational corporations doing business in China. As the US-China hybrid cold war intensifies, Washington would almost certainly adopt a guilt-by-association approach when evaluating alliances between foreign companies and Chinese institutions connected to Beijing’s CBDC ecosystem.
Despite Wall Street’s obstinate bullishness on China’s long-term fintech prospects, sanctions could occur at any moment, making decoupling inevitable.
This would have repercussions for fintech companies and investors worldwide, from Singapore to Tel-Aviv, to Copenhagen and Silicon Valley.
The clash of cultures between ideology and digital currency.
The second justification for financial decoupling is ideological. Consumers’ adoption of digital currencies would result in an ever-growing ocean of data. CBDCs provide governments with a citizen’s complete digital footprint, which can be used to track and reward or punish behavior—think of China’s Sesame social credit scheme.
The e-use yuan’s of a CBDC to advance domestic and international policies has set it at odds with liberal democratic governments. Again, foreign companies embedded in China’s fintech ecosystem may be seen as assisting and abetting Beijing’s techno-authoritarian model, and may be barred from doing business with Tencent and Alibaba. This would encourage both state and non-state actors to investigate alternative CBDCs, such as the US dollar—or even a trade-oriented cryptocurrency.
To navigate such murky waters, sophisticated know-your-customer (KYC) capabilities will be needed. Large and small businesses alike would need to increase their transparency and traceability in order to ascertain, for example, whether their business partners are connected to the Chinese state through Beijing’s military-civil fusion initiative or are part of a state-owned conglomerate.
This raises the question of whether a multilateral rules-based system for CBDCs is possible. For instance, the Monetary Authority of Singapore (MAS) and the Bank of Canada recently collaborated on the Jasper-Ubin Project to investigate the use of Blockchain technology for cross-border payments.
Another possible venue for the adoption of international standards or guidelines is the G-20. However, as is the case with cross-border digital trade, countries are coalescing into coalitions of the willing, forming small groupings, or attempting to incorporate digital standards into bilateral or regional free trade agreements.
Thus, China’s adoption of the e-yuan would exacerbate geopolitical rivalry and accelerate the fracturing of the global financial landscape over the medium to long term.