Asia | Bitcoin & Crypto | China | Economics & Growth
A couple of weeks ago, China gave away 10 million digital yuan to a few lucky participants to spend in shops in the city of Shenzhen. While the amount itself is small, a total of $1.5m, the experiment is unprecedented. All the talk globally about the incoming central bank digital currency (CBDC) era is just that at the moment; except for China. While China has spent nowhere near what other countries have on stimulus in 2020 following the Covid crisis, it might soon embark on an extraordinary fiscal policy experiment – one which clearly blurs the lines with monetary policy.
If the success of the Shenzhen CBDC pilot test is any guide, China is ready to proceed with a real-time, on-demand monetary/fiscal policy mix which is
• Targeted on a specific area of the country, town, district, and even shops,
• Focused, since the money can only be spent on consumption,
• Time-constrained, since if unspent within a specific time frame, it expires.
The Shenzhen Digital Currency Pilot Test
China’s CBDC is called Digital Currency Electronic Payment (DCEP). The authorities started experimenting with it in real life situations in April this year. So far, more than 3 million transactions, worth more than 1 trillion CNY, have gone through. The pilot test in Shenzhen was the largest to date in scope and size. Residents were urged to register starting on 9 October through iShenzhen, a blockchain-based online service, for the chance to receive 200 yuan each – to be spent in 3,000+ shops in the district of Louhu. The 50,000 randomly selected individual winners were announced on 12 October, with each sent a link to open a digital wallet containing the prize money.
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Summary
- China’s 6-month experiment with CBDC has scaled up, with the recent Shenzen test the biggest so far
- The bank-based nature of the CBDC can facilitate targeted stimulus given the banks are state owned, while its temporary nature can ensure timeliness
- Widespread rollout of the policy would clearly blur the link between monetary and fiscal policy
Market Implications
- Medium term, Bullish CNY on the back of improved Chinese growth perspective and continued positive real rate differentials with other major global economies.
A couple of weeks ago, China gave away 10 million digital yuan to a few lucky participants to spend in shops in the city of Shenzhen. While the amount itself is small, a total of $1.5m, the experiment is unprecedented. All the talk globally about the incoming central bank digital currency (CBDC) era is just that at the moment; except for China. While China has spent nowhere near what other countries have on stimulus in 2020 following the Covid crisis, it might soon embark on an extraordinary fiscal policy experiment – one which clearly blurs the lines with monetary policy.
If the success of the Shenzhen CBDC pilot test is any guide, China is ready to proceed with a real-time, on-demand monetary/fiscal policy mix which is
- Targeted on a specific area of the country, town, district, and even shops,
- Focused, since the money can only be spent on consumption,
- Time-constrained, since if unspent within a specific time frame, it expires.
The Shenzhen Digital Currency Pilot Test
China’s CBDC is called Digital Currency Electronic Payment (DCEP). The authorities started experimenting with it in real life situations in April this year. So far, more than 3 million transactions, worth more than 1 trillion CNY, have gone through. The pilot test in Shenzhen was the largest to date in scope and size. Residents were urged to register starting on 9 October through iShenzhen, a blockchain-based online service, for the chance to receive 200 yuan each – to be spent in 3,000+ shops in the district of Louhu. The 50,000 randomly selected individual winners were announced on 12 October, with each sent a link to open a digital wallet containing the prize money.
Unlike AliBaba (AliPay) and Tencent (WeChat Pay), which have so far dominated the digital payments infrastructure in China, the DCEP digital wallets are operated by the four largest Chinese banks (Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China and China Construction Bank), backed by the PBOC. However, the money in these new DCEP wallets cannot be saved and must be spent in the designated shops (an internet connection is unnecessary – payment is via QR code) within a specified time period. If not, the money simply ‘expires’. Once the money is spent, these constraints are removed; the currency is fungible with the ‘regular’ CNY and becomes part of the money supply.
Three Advantages of DCEP
First
DCEP will not replace the existing digital wallets (AliPay, WeChatPay, etc.). Unlike the previous payment system, which sidestepped the banking system, DCEP is bank-based. The idea is to retain the integrity and profitability of the Chinese banks. But also, thanks to the fact these banks are state-owned, it is to extract valuable information that can help the authorities manage the economy better. Eventually, DCEP can give real-time spending updates for the whole economy.
The PBOC can then use this data to conduct ‘on demand’ monetary policy, a kind of Goldilocks scenario: not too much and not too little, but just enough money supply. This will significantly benefit financial stability. In other words, once DCEP becomes fully functional, there will be few changes from a user perspective but many from the perspective of economic policy, central bank supervision, social governance etc.
Second
If DCEP distribution/circulation forward follows the Shenzhen example, Chinese authorities will have designed a very efficient way of spurring consumption. And that’s now their new economic plan’s centre piece (see below). Not only does this directly increase household incomes, which has been the strategy’s weak link so far (Chinese authorities are historically reluctant to shift compensation away from the state/corporate sector and towards consumers). But also, this extra income cannot be saved and has to be consumed or be lost.
Finally, armed with real-time data on spending countrywide, authorities can direct stimulus precisely where needed, not just to individual households but even specific shops. Compare this with US fiscal stimulus distribution, for example. Only 29% was used for consumption, 36% was saved, and 35% was used to pay down existing consumer debt. The last portion was a ‘wash’ on purchasing power as, at the same time, US households took on the equivalent of mortgage debt. China can probably achieve a much better outcome with only a portion of that fiscal stimulus money (also considering Chinese households have much less debt than US ones).
Third
That the state backs DCEP guarantees its survival. While some European countries implemented similar schemes of time-constrained money distribution during the Great Depression,[1] they were quickly discontinued. Despite successfully stimulating consumption, the authorities feared these new currencies would eventually replace the state-run ones if allowed to continue. It is no coincidence Chinese authorities rushed DCEP implementation after seeing details of Facebook’s Libra project and the global success of some cryptocurrencies.
German economist Silvio Gesell first introduced the idea behind expiration money in Currency Reform as a Bridge to the Social State (1891), a book he wrote responding to the depression in Argentina at that time.[2] Gesell’s revelation was that two of money’s three main attributes, medium of exchange and store of value, directly conflicted: if people believed money had value, they would ‘hoard’ it and so prevent it circulating.
By imposing an expiration date on DCEP, the PBOC is effectively instituting a negative interest rate on digital cash. Given negative interest rates in many European countries and Japan, it’s not an outlandish idea. It is, though, a much more effective one because it preserves the integrity of the credit and interest rate markets in China. The Chinese government bonds curve is nicely upward-sloping and carries the highest interest rates of similarly important global economies.
DCEP and Dual Circulation
Only a few days after completing the Shenzhen digital pilot test, President Xi gave a speech stressing the importance of China’s new economic strategy: ‘dual circulation’. This refers to the two engines of economic growth – overseas markets and home consumption – with Beijing signalling from the start that more emphasis should be placed on domestic developments. Data released earlier this week of Q3 GDP growth showed how the second leg of this ‘dual circulation’ strategy is currently failing to perform: on a Y/Y basis, fixed capital formation and exports contributed to GDP growth, while domestic consumption subtracted from it.
Chinese authorities have struggled to boost domestic consumption, even with rising real wages. Part of the problem has been the lack of a properly functioning institutional infrastructure of social security, insurance, and, most importantly, pension system (granted, it is probably very difficult to design one for a population of 1.4 billion). Consequently, Chinese households’ savings rate has remained stubbornly high. The new DCEP system, if used with the features described above, solves that problem and becomes a legitimate tool to boost consumption until the implementation of a fully functional, more permanent system of social assistance. That President Xi chose to give the speech in Shenzhen, only a few days after this DCEP pilot test, is probably no coincidence!
Conclusion
China’s new policy mix exemplifies its tactics during past centuries: a balanced approach of pre-existing ideas. The economic tools applied are nothing new. But combined with advanced technology, they produce an outcome superior to both the status quo and that which is implemented abroad. Ideology, in this case state-controlled money creation, meets pragmatism. And so every problem has a solution. China was the first country to use physical fiat money successfully; it may also become the first country to succeed in using a digital version of it.
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For example, Ester Barinaga, The Miracle of Wörgl (Brighton: Harvard Business Publishing, 2020). ↑
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Many others soon picked up on the idea, one being US economist Irving Fisher (in reference to the Great Depression). See Irving Fisher, Stamp Scrip (New York: Adelphi Company, 1933). But there have been others in more contemporary settings. See Stanley Fischer, ‘The Low Level of Global Real Interest Rates’ (Central Bank Speech, 2017); Katrin Assenmacher and Signe Krogstrup, ‘Monetary Policy with Negative Interest Rates: Decoupling Cash from Electronic Money’ (IMF Paper, 2018). ↑
Anton Tonev is a former HSBC & Morgan Stanley researcher & trader with more than 20 years of experience across New York, London & Asia. His focus lies in Global Macro asset management with an Emerging Markets undertone based on risk factor investing, core trends, non-conventional economics and cross-discipline ideas.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)