By Sam Bowers
Projections for 2021 estimate that this new year will see $6.69tn worth of digital transactions take place. China, in stark contrast to the US, will account for a disproportionate 43.6% of this volume. Reflective of the rising power’s rapid progress towards a cashless economy, this trend is part of China’s broader bid to displace the dollar as the modal international currency with its digital yuan. Will this drive bear fruit and prove to be the key to China overtaking the US’ dominant position in the global economy?
China has shown exceptional enthusiasm for cashless payment methods, now boasting an estimated 987.5m digital payments users. The modal Chinese payment system works by assigning every merchant and every payment option, a bank account for example, a QR code. Then, in contrast to the merchant always providing the connection to the payment system, either the payer or the merchant can scan the other’s code using a third-party app, enter the amount of money and complete the transaction. The smartphone replaces the card reader, the app is the interface for the transaction and the QR code effectively plays the role of a debit card. However, this system doesn’t immediately require an internet connection. The other component of this is the digital wallet. The idea of the digital wallet is fairly self-explanatory. The link between the digital wallet and the banking system, though, is created and managed by the third-party apps. Alibaba, the Chinese equivalent of Amazon, and Tencent, the Chinese equivalent of Facebook, provide the virtually unrivalled payments systems Alipay and WeChat Pay respectively. The practical differences between the Chinese system and what others may be familiar with is the substitution of the hardware. The technology driving the system though does differ.
This system fundamentally relies on widespread bank account and smartphone ownership, without which such digital transactions would be the reserve of a small minority. Beyond these structural considerations, the reluctance of Chinese merchants to adopt card readers, largely due to the expense of processing payments via banks, was what prompted the divergence between Chinese and Western digital payment systems. Big tech firms filled this void with a mutually beneficial solution. Digital payments in the style that has been described are comparatively very cheap, and virtually free for small businesses. Transactions are free for consumers, and a maximum 1% commission is charged to the merchant if they surpass a given threshold (variable depending on platform). The reward for firms such as Alibaba and Tencent, is the huge amount of data that they can then harvest as a result of these transactions, allowing them to refine existing products or create new ones based on masses of up-to-date consumer data.
How do Western countries compare in terms of the progress of domestic digital payments systems and cashless economies? GlobalData assessed that Finland as the most cashless economy as of this time last year, with ‘decashing’ an active government policy. Sweden was similarly highly ranked, with analysts suggesting that they will become the first truly cashless country by 2023, but are currently lacking the pervasiveness of online banking and card technology boasted by other nations. Interestingly, China was placed below these two countries in terms of being the most cashless economy. However, it was pertinently noted that China’s population is drastically larger than the countries it was being pitted against and the rapidity with which digital payments systems have grown in popularity is exceptional. The UK then follows, cited as the seat of fintech progress and second only to China in terms of the value of e-commerce transactions as a percentage of the GDP, the UK could be cashless by the mid-2020s. Coronavirus has naturally prompted a widespread increase in the volume of digital payments. However, only time will tell as to whether this will be indicative of more permanent international movement towards the adoption of cashless solutions.
America would be the natural competitor to Chinese progress in digital payment technologies due to its size and economic pre-eminence. However, the US’ reluctance to embrace such innovation signals a host of broader concerns surrounding the possibility of a cashless future. As of 2019 the volume and value of US cash in circulation was approaching record levels. Despite coronavirus, and the risk of transmission attached to using cash, cash is still being spent at the same rate as it was in 2019. Why then, is America seemingly going against the grain? Aside from cultural issues such as tipping and gift-giving, America’s significant unbanked and underbanked minority represents the lack of a major pillar of cashless society which has played a key role in the Chinese case. 6.5% of American households, which amounts to 14.1m adults and 6.4m children, are unbanked. Broader social issues are also at work here. Many commentators suggest that commercial banks have unreasonably high barriers to entry which exclude people of colour. One such barrier to entry is physical access to banks. For example, in New York neighbourhoods of colour there is only 1 bank per 10,000 people, compared to 3.5 in predominantly white communities. This indicates that regardless of other concerns, America simply isn’t ready to attempt to transition to a cashless economy even if it wanted to. More general concerns also contribute to the US’ antipathy towards digital payment systems. One notable argument relates to privacy, which is vastly more secure when using cash. Regardless of the context in which this privacy is benefitted from, whether making tax-free payments or buying gifts, it is important that use of cash remains a consumer choice. So much so, Philadelphia, San Francisco and New York, amongst others have banned merchants from exclusively accepting card and contactless payments. This is indicative that a cashless US economy is currently a very distant dream.
Why exactly should we care though? The answer is that the development of digital payments systems in China has led to designs from their government to create a new digital currency to rival the dollar. The ancient historian Thucydides predicted the inevitability of conflict between established and emerging powers. Dubbed the ‘New Cold War’ by some commentators, rivalry between the US and China has famously come to the fore in recent years. It could very well be the case that as in the first Cold War, the battle is technological, and that rather than a space race, competing digital payments systems could determine its outcome. Niall Ferguson, Millbank Family senior fellow at the Hoover Institution, argues that systems such as Alipay and WeChat Pay are the preliminary stage for an international payments system dominated by China. In this narrative, these privately-owned digital payments solutions would create a native economy sufficiently cashless to support a digital national currency and payments system. These initiatives could then be scaled to supplant the dollar and existing international payments systems. This, in Ferguson’s opinion, would see the death of the dollar and therefore strip the US of what has become a defining feature of its foreign policy, economic sanctions.
China’s attempts to construct such an international payments system have already begun. The PBOC (People’s Bank of China) is developing DCEP (Digital Currency Electronic Payment), effectively the digitization of the yuan. This is a clear development of the digital wallet used in Alipay and WeChat Pay. The PBOC’s public motivations for this initiative are to eliminate the costs of managing cash, improve monetary policy via real-time data and speeding up and reducing the cost of international payments. This digital currency is set to partner CIPS (Cross-border Interbank Payment System). The purpose of this is to rival Brussels-based Swift (Society for Worldwide Interbank Financial Telecommunication) and provide a platform to allow the popularity of the digital yuan to grow. This is the specific mechanism via which participating financial institutions could relieve themselves of pressure applied by US financial sanctions. This is because the vast majority of international settlements go through Swift in dollars. When the US applies sanctions, this affects the value of the sanctioned currency with respect to the dollar. Use of an alternative currency, via an alternative payments system, could therefore alleviate the impact of US economic sanctions.
To evaluate the threat of the Chinese international payments system which is taking shape to the dollar and US international diplomacy, a couple of key questions must be asked. First of all, just how key are economic sanctions to US foreign policy and subsequently their international standing? The simple answer is very. This tool was first used following 9/11, with economic sanctions issued against financial backers of Al-Qaeda to great effect. Since then, sanctions have been routinely used against countries as a lever of foreign policy. As of May 2019, the US had 7,967 sanctions in place. This trend has continued. Just last month, the US imposed sanctions on Turkey following its purchase of a Russian S-400 missile for example. Therefore, it is right to suggest that if the dollar and Swift could really be displaced in favour of Chinese-backed alternatives, it would significantly impact America’s ability to continue to exert such international influence, as they would no longer have the primary tool of their foreign policy.
So, is it really feasible for the digital yuan to overtake the dollar as the pre-eminent international currency? Is CIPS to rival Swift? At present, it looks unlikely. In terms of the internationalizing the yuan, investors favour stable currencies backed by strong economies, which are easily convertible and widely used, they are relatively unconcerned how innovative the technology behind it is. Nearly two-thirds of global currency reserves are in the dollar, compared with a meagre 2% in the yuan. This demonstrates that consensus sees the dollar as a much safer asset, and that the yuan isn’t currently powerful enough to really reap the aforementioned benefits of its digitization for China. The course of global recovery from Coronavirus could see change in the relative economic strengths of the two countries, but frankly the yuan seems distinctly outgunned and there’s no indication of this changing. The digitalization of the yuan is unlikely to help either. This largely spans from the very reasonable security concerns that come with digital currency. Even the most fervent Chinese optimist must struggle to envisage many countries surrendering their transaction data to the Communist Party of China by trading on any great scale with the digital yuan. In terms of CIPS, its attractiveness will instantly be reduced as a result of having to work predominantly in yuan, which has the aforementioned privacy issue. However, it remains a viable alternative to Swift which could help countries feel the full force of US economic sanctions. The problem is that CIPS is currently incredibly small compared to Swift, with just 980 subscribing financial institutions, less than 10% of its counterpart. The net result of this is that the vision of a grand Chinese international payments system is, for the moment, a figment of the imagination.
Looking into 2021, fears of China using the development of digital payments systems to usurp US hegemony should not be entirely dismissed though. The power of the pandemic to cause unexpected economic change goes without saying and the progress of wider Chinese challenges to US dominance continue. With Facebook’s Libra, the would-be Western alternative to Chinese digital payments systems, looking to be rejected due to security fears, Chinese dominance of digital payments systems will continue to grow with little impediment. Therefore, China’s challenge to the dollar will only strengthen, and we could be bearing witness to the formative stages of a fundamental paradigm shift in the global balance of power.
The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.