Digital yuan threatens euro
Cryptocurrencies,  Politics

EU has five years to combat China’s digital yuan

German think tank dGen editor Maggie Clarendon warns the euro will be overtaken by the Chinese central bank digital currency unless the EU launches its own by 2025

Up to five countries will completely replace their currency with a central bank digital currency by 2030—and the euro will be overtaken by the digital yuan unless Europe launches a CBDC within the next five years, a new report has warned.

Although the German not-for-profit think tank dGen doesn’t believe that China’s CBDC has the potential to unseat the almighty dollar, its researchers claim that the greenback could become more vulnerable unless Washington starts looking into digitization soon.

According to the report, the euro’s growth has stalled—and the proliferation of CBDCs could jeopardize its status as the world’s second most important currency. However, dGen believes that a digital euro could help remedy this, and potentially help strengthen ties between member states in the increasingly fractured European Union.

“The euro, while quite strong now, cannot bet on its global relevance in the future,” author Edwin Kinoti wrote. “However, with the launch of a well-designed digital currency, the euro has the opportunity to become an effective settlement method for international trade outside of the politics of the U.S.-China currency war.”

Kinoti listed several key ingredients for success. He said the CBDC must deliver frictionless transactions, nearly instantaneous money transfers, and government disbursements—and the European Central Bank would need to pursue a sound technical infrastructure, global expansion, and incentivize adoption to maximize the chance of success.

But there are threats on the horizon. With the U.K., France and Sweden all pursuing their own CBDCs, the dGen report warns that a collection of national digital currencies could fragment Europe’s financial system—“further weakening and endangering the euro.” 

Who would be the winner in all the chaos? The dollar.

What’s at stake

In the report, Kinoti acknowledges that a digital euro will have major implications for the eurozone, its member states, and global trade. A strong digital euro would make foreign products cheaper—and if this tempts European businesses to invoice using the CBDC, it would considerably increase the share of global trade that is denominated in euros.

That said, strength would harm local businesses that depend on exports, as it would make their wares much less competitive on price than they are now. Italy in particular—already a country whose politicians have repeatedly shown an interest in following the U.K.’s lead by exiting the trading bloc—would be hardest hit by a strong digital euro.

But dGen argues that a CBDC could still be the best way to heal divisions within the EU.

Maggie Clarendon, the think tank’s editor, told Modern Consensus via email that maintaining a fiat currency for so many different nations and economies already poses a huge challenge.

“Germany wants a stronger euro, while Italy and Greece want a weaker euro,” Clarendon said. “And, with Brexit, as I’m sure you’ll remember, several member states threatened to opt out. While that would be a pretty drastic step, a digital euro would offer the chance to revisit the purpose and goals of a shared currency, and cement the unity of the eurozone.”

Who will be first?

Elsewhere in the interview, Clarendon told Modern Consensus that countries attempting to fully switch from fiat to CBDCs within 10 years will face a gargantuan challenge. When asked which countries they believe could be first to take the plunge, they said:

“Sweden is definitely a top contender for that. Other Scandinavian countries also have a low reliance on cash. On the other side, there have been movements in some African or Latin American countries to shift away from cash. They might not be the first countries to be cash-free… but there’s definitely interest.”

Central banks around the world will likely be keeping a close eye on Sweden to see how the launch of its CBDC goes. What would happen if everything doesn’t go smoothly? Clarendon argued:

“If the e-krona fails, it will definitely be a setback. But, really this depends on why it fails. If it’s due to a technical problem, a design that doesn’t account for the needs of the population, or just low adoption. Ideally, everyone will learn from the issues, and build better CBDCs going forward. Blockchain communities are no stranger to this approach, but of course it will be slightly different if people are storing their life savings in a state-issued currency.”

Nonetheless, they remain optimistic that a complete flop of a CBDC wouldn’t be enough to kill off digitized currencies altogether. Although it may affect adoption in other economies, they believe most economies would slow the development of CBDCs rather than halt projects entirely.

The challenges

Although the dGen report is enthusiastic about CBDCs, it expresses concerns about the drive to go cashless. 

There have been fears of growing financial exclusion in Sweden, where the vast majority of transactions are digital and 90% of the over-12 population has a smartphone. Shops are allowed by law to refuse cash payments—meaning cash might not get you very far on buses and even in pharmacies. Of course, this could end up being more of a short-term issue than a long-term one as levels of adoption increase.

And then there’s the thorny issue of inflation. As the British business journalist Ian King has noted, there is evidence that cash helps economies keep down inflation. “It is perhaps no coincidence that the two advanced economies where inflation has been most benign during the last few decades, Japan and Germany, are also the two developed economies furthest from becoming cashless,” he wrote.

“Central banks would continue to set monetary policy to control inflation, and arguably could have more control,” Clarendon said. “Central banks are not careless about the effects digitization could have, and will take steps to offset any major waves.”

Nonetheless, the societal challenges associated with the full adoption of CBDCs are not to be taken lightly—especially given that the world has an aging population. Clarendon admitted that this is a sticking point that won’t go away—and said central banks must also take other vulnerable groups into account as the process proceeds:

“There are also people with disabilities, minors, foreigners, immigrants, and people without access to the internet or devices. Part of designing a CBDC is accounting for the whole population and making sure that you don’t lock anyone out of the financial system.”

With credit and debit cards, Clarendon added, “we’ve seen that it’s not impossible to shift payment methods over. Some people do still have issues with these, which should not be ignored. But these aren’t government issued, and didn’t necessarily come with a concerted effort to educate and serve populations who are at risk for having issues with them.”

Clarendon told Modern Consensus that central banks will need to provide educational materials to teach people, especially older generations, about this new technology. New infrastructure may also be required for those who have limited internet access.

Despite the challenges, the dGen editor is clear on the rewards for economies who get this right. With online payments continually on the rise, and adoption increasing even further during the coronavirus pandemic, CBDCs could make digital purchases simpler and more anonymous, they said. 

“To do this in 10 years will be a push, but even with more educational materials and infrastructure, the potential savings and benefits of not having to maintain two systems has already attracted attention,” said Clarendon. “And, if not in the next 10 years, then when? At a certain point, it doesn’t make sense to keep putting it off.”

What about the U.S.?

Finally, Clarendon said that the U.S. “will certainly be more vulnerable” if it fails to actively pursue a digital dollar in the near future. (Last December, the Treasury Secretary Steven Mnuchin said he doesn’t see a need for one until at least 2025, a statement that probably hasn’t aged well in light of the COVID-19 pandemic. Last month, it was confirmed that the Fed is actively researching the technology.)

Clarendon noted that China is currently on an aggressive path to de-dollarization, and one its forthcoming CBDC could pave the way for reduced rates for trade conducted using the digital yuan.

But would businesses and consumers around the world readily embrace the digital yuan with open arms? Last November, one Chinese central bank executive spoke of how this CBDC could achieve “controllable anonymity”—potentially paving the way for transactions to be monitored. As Douglas Tuman, an advocate of the privacy coin Monero, said at the time: “There should be zero expectation of privacy.”

Clarendon believes all of these concerns could stand in the way of the digital yuan achieving world domination—no matter how quickly and aggressively Beijing attempts to roll it out:

“There is still a lot of skepticism about privacy in China, and this may deter some businesses, and likely individuals, from using a digital yuan. This is why we believe the dollar will continue to be the global reserve currency if it comes down to a battle between the two. But, that’s not to say that it won’t increase the yuan’s position, and put a strain on other reserve currencies, the dollar included.”

C Sephton is a journalist with an interest in cryptocurrencies, personal finance, and financial inclusion—as well as the challenges the crypto industry faces in achieving mainstream adoption. He owns cryptocurrencies.

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