Will Central Bank Digital Currencies Doom Dollar Supremacy?
Some believe that the issuance of central bank digital currencies will change the international monetary status quo by eroding the US dollar’s supremacy of cross-border payments and considerably reducing transaction costs. However, this is unlikely to happen.
Berkeley – August 13-15 stamps the 50th anniversary of “the weekend that transformed the world,” when Richard Nixon, US President at the time, suspended the dollar’s convertibility into gold at a fixed price and brought down the drape on the Bretton Woods international monetary system. The following fifty years brought many shocks. Among the strongest was the dollar’s continuous supremacy as a vehicle for cross-border transactions from a monetary standpoint.
Under Bretton Woods, the dollar’s dominance was easily explicable. America’s financial setting after the second world war was impregnable. Changes in the value at which dollars could be converted into gold were unimaginable, initially due to that financial strength and afterward, as the nation’s monetary position weakened, as a result of the possibility that one devaluation would generate expectations of another.
Many believed that Nixon’s move would reduce the dollar’s international role. With the currency varying like any other, it would be high-risk for banks, companies, and governments to place all their eggs in the dollar basket. They would undoubtedly diversify by holding more reserves and performing even more transactions in other currencies.
Why this did not happen is now evident. The dollar had the benefit of incumbency: the fact that customers and distributors likewise used dollars made it uncomfortable to move to alternatives. What is more, the options were, and still are, unattractive.
As for the euro, there is a deficiency of AAA-rated euro-denominated government bonds that reserve banks can hold as reserves. Those authorities are reluctant to enable those they control to do business in euros, considering they cannot lend the currency to banks and companies in need. China’s capital controls complicate the global use of the renminbi, while there are practical concerns that Chinese President Xi Jinping could suddenly change the regulations of accessibility. Furthermore, smaller-sized economies’ currencies lack the scale to move a considerable volume of cross-border transactions.
Some say that the issuance of central bank digital currencies, or CBDCs, will change the status quo. In this bold new digital world, any national currency will undoubtedly be as easy to use in cross-border payments as any other. The argument says that this will erode the dollar’s dominance and considerably reduce transaction costs.
The conclusion does not follow. Suppose that South Korea issues a “retail” central bank digital currencies that individuals can keep in electronic wallets and use in transactions. A Colombian exporter of coffee to South Korea can be paid in electronic won, assuming naturally that nonresidents are permitted to download and install a Korean wallet. However, that Colombian exporter will certainly still need somebody to transform those won into something more useful. If that person is a corresponding bank with offices or accounts in New York City, and also if that something is the dollar, after that, we are right back where we began.
Instead, the Colombian and South Korean central banks could issue “wholesale” CBDCs. Both would undoubtedly transfer digital currency to domestic commercial banks, which would then deposit it into customer accounts. Now, the Colombian exporter would indeed wind up with credit in a South Korean bank instead of in a South Korea wallet -assuming that nonresidents can have Korean bank accounts. However, again, the merchant would need to ask the South Oriental bank to locate a correspondent to convert that digital balance into dollars and, afterward, pesos to have something of use.
If CBDCs were interoperable, that would be a game-changer. The South Korean payer would then request its bank for a won-denominated depository receipt. A corresponding amount of CBDC in the payer’s account would undoubtedly be snuffed out. That depository receipt would certainly be moved into a dedicated international “corridor,” where it may be traded for a peso depository receipt at the best price offered by dealers licensed to work there. Ultimately, the Colombian payee’s account would be credited with the equivalent amount of electronic pesos, extinguishing the depository receipt. Voilà! The transaction would undoubtedly be finished in real-time at a fraction of the current expense without involving the dollar or correspondent bank.
However, the conditions for doing this work are tough. The two central banks would need to agree on a design for their digital corridor and jointly govern its operation. They would need to license and regulate dealers holding reserves of currencies and depository receipts to ensure that the currency exchange rate inside the corridor did not diverge from that outside. And they would have to settle on who gives emergency liquidity, against what collateral, in case of a serious order imbalance.
In a universe of 200 currencies, arrangements of this kind would need numerous thousands of bilateral agreements, which is unfeasible. And corridors of numerous nations would need guidelines and governance arrangements considerably more elaborate than those of the World Trade Organization and the International Monetary Fund. This, obviously, will not happen.
CBDCs are coming. However, they will not alter the face of international settlements and will not dethrone the dollar.
Originally published on the Project Syndicate.
