Central bank digital currencies (CBDCs) are coming. Around the world, central banks are building CBDCs for testing in trials and pilots, both domestic and cross-border. However, when we talk about CBDCs – especially in international discussions – it is clear that confusion persists about what they are, how they work, and how they could be used.
In a new paper, I seek to clear up this confusion, a task necessary for understanding the potential impacts of CBDCs on the international payments and financial system. One such impact is the possibility that CBDCs will disrupt the dominance of the U.S. dollar in this international system – an event that will come with a range of consequences for the United States and, to some extent, its allies.
While CBDCs promise to significantly improve the cost and speed of international payments, their development also presents an opportunity for states to reduce reliance on the U.S. dollar.
The United States has enjoyed many benefits from the dollar’s preeminence global currency. They range from less interest on U.S. foreign debt to lower foreign exchange costs for U.S. companies that engage in transactions overseas. To describe these many benefits, Valery Giscard d-Estaing coined the phrase privilège exorbitant — exorbitant privilege — when finance minister of France in the 1960s.
One might expect the United States to guard its exorbitant privilege carefully. However, this has not been the case. By repeatedly using sanctions – culminating in the freezing of some $300 billion of Russia’s foreign exchange reserves – the nation has put at risk the centrality of its dollar in international finance, as such conduct strongly motivates many nations to put themselves beyond the reach of its sanctions.
There are currently two leading means to significantly reduce the cost and dramatically increase the speed of international payments: CBDCS or the connection of nations’ fast payments systems through payments hubs. Either development would enable the direct exchange of two nations’ currencies through a platform, without going through the U.S. dollar, thereby reducing use of the dollar in much international trade. Today, some 90 percent of international transactions involve the U.S. dollar, and estimates are that about 40 percent of those transactions involve the dollar even when the United States is not a party to the transaction. We could see these numbers fall considerably over time.
This decline in demand for the dollar would probably reduce the proportion of dollars nations elect to hold in their foreign exchange reserves, thereby exacerbating the current long-term decline in the dollar as the world’s principal global reserve currency.
While it is unlikely that the U.S. dollar will lose its dominance in the near future, owing to the depth of U.S. capital markets, the current configuration of the global payments infrastructure, and U.S. dollar borrowing by non-U.S. banks and corporations, among other factors, its policymakers need to think long term.
In my paper, I argue that, to protect the dominance of its dollar in international payments, the United States needs to develop a CBDC. It is here that the oft-overlooked distinction between a retail and wholesale CBDC for offshore use becomes critical. Retail and wholesale CBDCs may well be much the same instrument, with the differences lying not in their construction, but in their functionality and geographical applicability. Yet a domestic digital dollar will not affect the international financial system appreciably, while a wholesale digital dollar for offshore use most certainly will. I am thus suggesting the United States should develop a wholesale digital dollar for use in international transactions.
A major impetus for this is China’s development of its CBDC, the e-CNY. While the e-CNY is today a domestic digital currency within China, I argue it can also play a clear role in China’s long-term project to move the global financial system away from the U.S. dollar to a system of three or more reserve currencies of which the CNY is one. When China eventually releases the e-CNY for offshore use, I expect to see payments using it be very economical or free and quite possibly mandatory for purchasing Chinese products and services, because China is pursuing a long-term geopolitical goal, not a short-term, profit-oriented one.
Since it is very likely China will issue the e-CNY for use in international trade and will encourage adoption of this fast and reliable currency by making it highly affordable or even free, the United States can compete only by engaging with this technological revolution. To the extent there is choice, merchants will opt for a more trustworthy U.S. digital currency if it exists. But unless it does exist, demand for the dollar in international transactions may well fall precipitately, and the United States will cease to enjoy its exorbitant privilege.
This post comes to us from Ross P. Buckley, Scientia Professor and ARC Laureate Fellow at the University of New South Wales. It is based on his recent paper, “Implications for the Dollar of Central Bank Digital Currencies,” available here.
