Digital Currency — Modern Warfare
In the last decade, with the rise of cryptocurrencies, the world as we know has changed a lot. The disruption caused by cryptocurrencies in the financial sector is unparalleled and it is evident that in the future cryptocurrency is certainly going to change the fate of traditional currencies or fiats. It wouldn’t be speculation to say that cryptocurrencies are going to play a pivotal role in the rise and fall of economies around the world and whoever will control this technological wand will claim supremacy over the rest. It is also evident that many Central Banks across the world are experimenting with Central Bank Digital Currencies (CBDC) to gain this supremacy.
The use of digital currencies by economics around the world is not something new. Finland Avant store e-money card in 1990s. Central Bank of Sweden initiated e-Krona in November 2016 and this year it has already reached testing phase. However, before going into the details of Central Bank Digital Currencies (CBDC) and how it will impact the future economic warfare it is important to understand what CBDC is and more specifically what should not be considered as CBDC.
Casually speaking, digital currency is a broader term that could be applied to anything from electronic cash or electronic variation of monies which is just like money deposited in bank accounts, electronic wallets such as Google Pay or Paytm to Bitcoin or even tokens/ credits exchanges on video games. Then we have cryptocurrencies that refer to a specific segment of digital currencies built on blockchain technology. However, the major factor that differentiates digital currency from existing electronic cash is the fact that the transaction can be done just the way it happens with cash: peer-to-peer. At the same time settlement of digital currency will end with the transaction (i.e., atomicity) rather than waiting for the reconciliation with the central ledger (which is usually period-specific) in the case of electronic cash. In short, it eradicates the need for middlemen.
As per Central Bank Digital Currencies — Design Principles and Balance Sheet Implications journal published by Kumhof, M., Noone, C. in 2018, The Bank of England has described a CBDC as electronic CB money that:
- Can be accessed more broadly than reserves,
- Potentially has much greater functionality for retail transactions than cash,
- Has a separate operational structure to other forms of Central Bank money, allowing it to potentially serve as a different core purpose, and
- Can be interest bearing, under realistic assumptions paying a rate that would be different to the rate on reserves
The broad idea of any CBDC is to maintain the current use case of cash and increase its functionality, reach, and security. A typical framework of CBDC will look something like this
CBDC has many applications in the development of the digital economy. However, the main reason why Central Banks or economics are interested in developing their sovereign digital currency is to maintain control over the flow of money in their economy and also to safeguard it from foreign forces in the future currency war.
The term currency war refers to the situation in which an economy purposefully devalues its currency to energize its economy. Though the term ‘currency war’ was first introduced by Guido Mantega, Brazilian Finance Minister in 2010, the tactics of currency devaluation was in practice since the 1940s. The idea behind devaluing one’s currency is to ease monetary policy by reducing interest rates or increasing Quantitative Easing.
A devalued currency makes a nation’s export lucrative in international markets and imports expensive in the domestic market. Thus, impacting the production and consumption of more domestic goods. Its leads to a lower current account deficit and higher GDP. Many countries follow this practice in present times, but no one does it better than China. In past and specifically in 2010–2011, the US had followed the measure of quantitative easing program to weaken the U.S. Dollar however the efforts were countered by China.
Pros of currency devaluation:
a) Better Export
b) Focus on Domestic production
c) Increase in employment
d) High GDP growth
Ex: China
Cons of currency devaluation:
a) Too much depreciation leads to higher inflation
b) it can impact the productivity and quality in longer run
c) Can lead to protectionism and trade barrier
d) Increase currency volatility and deter foreign investment
Ex: Argentina
It is no hidden fact that China has always devalued Yuan and it has helped China to increase its export, manufacturing, and domestic consumption capabilities keeping its productivity and quality intact. Not only devaluation of currencies but economic sanctions such as those imposed on Venezuela, Iran before its nuclear treaty, and North Korea by the U.S. and other economics had also been the strategic leg towards economic cold war.
Though these sanctions are not mostly related to currency, they have a drastic impact on the sanctioned countries, for ex: because of the U.S. sanction Venezuela went into hyperinflation and it reached as high as 900% in a year. These sanctions and other economic warfare that is indirectly linked to currency will certainly change once digital currencies become the pivot of economies’ monetary policy in the future.
The U.S. has generally followed the policy of a strong U.S. Dollar to maintain its hold on foreign exchange markets and keep the position of the U.S. Dollar as a global reserve currency intact. However, the situation might change in the future because of digital currencies.
Several economies around the world are in serious talk about launching CBDC, the top contenders among these are the U.S., China, Russia, to some extent European Union, and surprisingly, Iran. Also, Venezuela has already gone ahead and has launched its own digital currency Pedro which it backed its commodity reserve rather than Bolivar, its sovereign currency.
The possibility is also that few nations might come together to launch one unified universal CBDC. In Jackson Hole Symposium, Mark Carney, Governor of the Bank of England said, “ .. perhaps it was time for some form of “synthetic hegemonic currency” to deal with destabilizing dominance of the U.S. Dollar”. One thing is certainly clear the US Dollar might lose its edge if it’s not cautious.
People’s Bank of China started its initiative of digital Yuan in 2014 and in 2016 it started the testing of digital Yuan. Not only did China took sovereign digital currency, but it also went ahead and established a digital currency research institute in 2017 and clear national cryptography law in 2019.
Considering that China is far ahead of its western counterparts in terms of digital adaptation this news was not a cause of shock for many. Now, that the US and Russia are still contemplating the model, cost, and benefits of such initiatives, China has already started a pilot project in its retail domain after it rolled out the test phase of its CBDC with Didi, the cab-hailing giant of China.
Though other countries have already entered a pilot phase of digital currency, the entry of China, the US, Russia are significant considering how these mammoths will use it for economic and political warfare. There are many angles to what situation can rise state-backed digital currencies in futures:
- Freedom to US Sanctioned state from the dominance of the US Dollar: The sovereign-backed currencies can give power to many nations that have to sanctioned by the US. The reason why sanctions by the U.S. or the European nation and to some extend by Russia on certain economics have worked so far is that these countries dominate the current global setup. Major countries would not want to help Venezuela or Iran or North Korea or any other nation that poses threats to US dominance if the country needs a favor from the U.S. In the current financial setup, any favor to any nation by another nation is like an open book, anybody can see them. However, with digital currencies, these favors can become difficult to track.
- Increase in espionage activities: State-backed digital currencies will be certainly used for not only state-led espionage but also economic espionage and Industrial espionage. On one side where digital currencies would give few countries freedom from other country dominance, on the other side one nation might also use the same means to carry out espionage against the other nation as well. This activity might become a burden to those countries whose CBDC will be weak as compared to private digital currencies.
- Digital Yuan overpowers digital Dollar: The Red nation has so far kept its currency devalued. There can be no doubt that some might follow for DCEP (Digital Currency Electronic Payment is the China National Digital Currency). When China does that, it will certainly give it currency power to manipulate the global currency market and exchange rates.
- More dominance of China by using DCEP in ‘belt and road initiative’ (BRI): The Belt and Road initiative stated by China in 2013 aims at investing in 70 countries across Asia- Pacific, Central- Eastern Europe, and African region. The idea is to unify all the international and domestic markets in these regions to enhance cultural exchange, technological advancement, and mutual understanding among member nations which would lead to capital inflow. Consider China using DCEP in all these routes and all these countries. Since China is the only nation among all the members of BRI with digital currency so far, it will give China a tremendous boost.
5. Rise of non-state backed digital currency, supremacy to private players: Last year the announcement of LIBRA by Facebook had caused a ripple in the crypto world. It can happen that while state-backed digital currencies will be fighting with one another private players might launch their digital currencies. Facebook has 2.1bn monthly active users whereas only 80 million crypto wallets have been in use so far. The number of people who trust Facebook out ways the number of people who trust bitcoin or any other cryptocurrency at this point. It would not be a surprise that people in the second world nation run for digital currencies launched by private players whom they trust.
Whatever the scenario be, in the end, digital currency is definitely going to win over fiats. Any country that is not paying attention to these developments might have to prepare for rainy days.
