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Central Bank Digital Currency: PKU Prof. Huang Yiping's caution
"The most important is to comprehensively weigh pros and cons."
Professor Huang Yiping 黄益平, Deputy Dean of the National School of Development, and Director of the Institute of Digital Finance, Peking University, recently spoke about the central bank digital currency (CBDC).
Prof. Huang received his Ph.D. in Economics from Australian National University. He served as a member of the Monetary Policy Committee of the Chinese central bank between 2015 and 2018. Last year, Prof. Huang was the head of a PKU task force studying the “platform economy,” the Chinese term for internet companies. Pekingnology has a translation.
China hasn’t rolled out its CBDC en masse, but conducted small-scale experiments. The stake is huge, and there are a lot of speculations. The Wall Street Journal published a very detailed report. In May last year, Zhou Xiaochuan, the respected former central bank governor, delivered a long speech. Pekingnology has a translation.
Prof. Huang’s speech, translated below, is not long. Helpfully, you don’t need a Ph.D. to understand it and, perhaps, sense his caution.
A central bank’s issuance of digital currency should be the result of weighing the pros and cons. From the perspective of economic analysis, on whether to issue central bank digital currency (CBDC), a central bank should pay attention to influences on at least three aspects.
First, the impact on financial intermediation, That is, the impact on the current financial system, including the impact on credit creation, bank runs, and financial stability.
Second, the impact on investment. This involves the macro-economy. An important role for financial intermediaries to support economic activities is in investment. In this regard, attention should be paid to the impact of the CBDC on corporate investment and overall investment in society.
Third, the impact on the overall welfare. In academic research, we can establish a theoretical model to analyze whether the CBDC increases or decreases net welfare. However, there isn’t a clear conclusion from academic research. The final conclusion is highly dependent on the market environment and the specific mechanism of the CBDC.
For example, a CBDC could lead to a shock to banks, which would reduce welfare. But if a country's banking system is insufficiently competitive, a new tool now could instead increase welfare.
The lesson is that when designing the CBDC, we must first consider the specific market environment and design according to local and specific conditions, so as to achieve the expected purpose. Different countries have different situations, considerations, and priorities.
According to the Bank of International Settlement survey of central banks around the world, developing countries and developed countries pay different attention to digital currency. Specifically, developing countries pay more attention to domestic payment efficiency, security, and outstanding inclusiveness. Developed countries pay more attention to the efficiency of cross-border payment and cross-border security issues. The different priorities are due to different needs.
At present, the proportion of cash used in many countries has been declining, and the proportion of digital payments has increased significantly. At this time, it is not a question of whether to digitize, but a question of whether central banks should participate in digitization. For example, China already has (sophisticated) mobile payments, so why does the central bank have to create a digital currency and electronic payment system? There is an academic point of view that the payment system made by the private sector is efficient, but there are some problems such as negative externalities, which can be solved by the public sector.
Therefore, although the private sector’s digital payment system can solve most of the problems, it is not necessarily optimal looking at the big picture. A system by the central bank may be more effective at solving some of the problems.
The People's Bank of China has been studying the central bank's digital currency issue since 2014. June 2019 was a watershed for central banks to change their attitude towards CBDC (central bank digital currency). After that, we clearly felt that central banks' interest in CBDC has increased and the pace of research has accelerated.
This is because, on June 18, 2019, Facebook released the Libra white paper. Before that, almost everyone believed that Bitcoin was just a digital asset and could not really replace the currency in use. However, a stable currency such as Libra is supported by the underlying sovereign currencies and thus is inherently valuable.
If Libra were successful, it would instantly become a cross-border payment system, because Facebook has 3 billion users and Libra can be rolled out in many countries. If people are willing to use it, Libra may become an international currency. That would be a direct problem for the central banks of various countries, and the international function of the yuan/RMB may be squeezed in the future.
It cannot be even ruled out that some countries are now making more efforts to study CBDC because if they succeed, they will be one step ahead. If some countries get one step behind or even fail to catch up in CBDC, they would lose the chance.
This is not only a competition between private currency, sovereign currency, and digital currency but also a competition between countries. Therefore, the release of the Libra white paper may have been the most direct trigger for the formation of "competitive pressure" in the CBDC market, although Libra was later renamed Diem and the plan was eventually abandoned.
In the larger context, CBDC is also related to the digitalization of one country’s financial sector and payment system. The most important thing in issuing CBDC is to comprehensively weigh the pros and cons of developing digital currency.
There are three questions worth paying attention to.
First, the impact of CBDC on the disintermediation of financial institutions such as banks may be underestimated. At present, China's central bank's assumption of CBDC’s function is in retail and not paying interest. In other words, replacing the M0. The assumption also includes that CBDC will not have a great impact on the intermediary role of banks, and will not cause a disintermediation effect on banks.
But (currently) money in the wallets of Alipay and WeChat Pay does not pay interest. Normally, rational people would not put their money there, but in fact, there is a lot of money in the wallets of Alipay and WeChat. Considering that a very important aspect of people's demand for CBDC is convenience, so (it’s foreseeable that) they would be willing to hold a lot of money in their wallets (of the CBDC system). Then, maybe the impact on financial intermediaries in the future will not be as small as we now imagine.
Second, if digital currency's cross-border payment system is established, it may become a parallel system competing with the (existing) international payment system, including SWIFT.
Developed countries attach great importance to the efficiency and safety of cross-border payments. China's CBDC is mainly engaged in domestic payments. At present, it has also begun to test cross-border payments with the Hong Kong Monetary Authority and Middle Eastern countries. Is it possible to use digital currency for peer-to-peer cross-border payment between countries in the future?
Is it possible to build a new cross-border payment framework out of CBDC or make it a new infrastructure? Because payment in digital currency is a peer-to-peer form, so maybe based on this form, the CBDC system will become a new international system in cross-border payment, thus undercutting the importance of the current international payment system including SWIFT.
Third, it is necessary to clarify the significance of CBDC on data collection, analysis, and protection. According to one research, the quality of a country's data protection has a great impact on people's willingness to use CBDC. In other words, if the data is well protected, people will have a high willingness to use digital currency. If data protection is poor, people's willingness will be much lower.
The starting point of the research just considers the transition from cash to CBDC, but the situation in China is different. China already has private-sector payment systems such as Alipay and WeChat Pay, and payment data already exist in the private sector payment system.
Users use Alipay and WeChat to pay, and there is closed-loop data in the system. Although Alipay cannot see the payment data of the whole China, it can see all the payment data within Alipay, which makes it possible for the payment platform to provide other financial services based on the payment data, such as loans.
What impact will China’s CBDC have on data collection, analysis, and protection in the future after using the two-tiered system? Data is a big problem for CBDCs, as situations vary from country to country.
Some countries just used cash and would change from the absence of payment data to the availability of payment data. Most countries, including China, now have digital payments. That means payment data would be transferred from one payment platform to another. Therefore, there is an urgent need to clarify the CBDC’s significance in data collection, analysis, and protection.
Read former Chinese central bank governor Zhou Xiaochuan’s speech on CBDC here.