Skip to main content

Will Central Bank Digital Currencies Doom Dollar Dominance?



Some say that issuance of central bank digital currencies will transform the international monetary status quo by eroding the US dollar’s dominance of cross-border payments and greatly reducing transaction costs. But this is not going to happen.

BERKELEY – August 13-15 marks the  of “the weekend that changed the world,” when US President Richard Nixon suspended the dollar’s convertibility into gold at a fixed price and rung down the curtain on the Bretton Woods international monetary system. The subsequent half-century brought many surprises. From a monetary standpoint, one of the greatest was the dollar’s continued dominance as a vehicle for cross-border transactions.

Under Bretton Woods, the dollar’s supremacy was readily explicable. America’s financial position coming out of World War II was impregnable. Changes in the price at which dollars could be converted into gold were unthinkable, first because of that financial strength and then, as the country’s monetary position weakened, because of the possibility that one devaluation would create expectations of another.

Many thought that Nixon’s move would diminish the dollar’s international role. With the currency fluctuating like any other, it would be too risky for banks, firms, and governments to put all their eggs in the dollar basket. They would thus diversify by holding more reserves and conducting more transactions in other currencies.

Why this didn’t happen is now clear. The greenback had the advantage of incumbency: the fact that one’s customers and suppliers also used dollars made it awkward to move to alternatives. What’s more, the alternatives were – and remain – unattractive.

As for the euro, there is a shortage of AAA-rated euro-denominated government bonds that central banks can hold as reserves. Those authorities are therefore reluctant to allow those they regulate to do business in euros, since they are unable to lend the currency to banks and firms in need. China’s capital controls complicate international use of the renminbi, while there are justifiable fears that Chinese President Xi Jinping could abruptly change the rules of access. And smaller economies’ currencies lack the scale to move a large volume of cross-border transactions.

Some say that issuance of central bank digital currencies, or CBDCs, will transform the status quo. In this brave new digital world, any national currency will be as easy to use in cross-border payments as any other. This will not only erode the dollar’s dominance, the argument goes, but also greatly reduce transaction costs.

In fact, the conclusion doesn’t follow. Imagine that South Korea issues a “retail” CBDC that individuals can hold in digital wallets and use in transactions. A Colombian exporter of coffee to South Korea can then be paid in digital won, assuming of course that nonresidents are permitted to download a Korean wallet. But that Colombian exporter will still need someone to convert those won into something more useful. If that someone is a correspondent bank with offices or accounts in New York, and if that something is the dollar, then we’re right back where we started.

Alternatively, the Colombian and South Korean central banks could issue “wholesale” CBDCs. Both would transfer digital currency to domestic commercial banks, which would deposit it into customer accounts. Now the Colombian exporter would end up with a credit in a South Korean bank rather than in a South Korean wallet – assuming this time that nonresidents are allowed to have Korean bank accounts. But, again, the exporter would have to ask the South Korean bank to find a correspondent to convert that digital balance into dollars and then pesos in order to have something of use.

The game changer would be if CBDCs were interoperable. The South Korean payer would then ask its bank for a won-denominated depository receipt, and a corresponding amount of CBDC in the payer’s account would be extinguished. That depository receipt would be transferred into a dedicated international “corridor,” where it could be exchanged for a peso depository receipt at the best rate offered by dealers licensed to operate there. Finally, the Colombian payee’s account would be credited with the corresponding number of digital pesos, extinguishing the depository receipt. VoilĂ ! The transaction would be completed in real time at a fraction of the current cost without involving the dollar or correspondent banks.

Unfortunately, the conditions for making this work are formidable. The two central banks would have to agree on an architecture for their digital corridor and jointly govern its operation. They would have to license and regulate dealers holding inventories of currencies and depository receipts to ensure that the exchange rate inside the corridor didn’t diverge from that outside. And they would have to agree on who provides emergency liquidity, against what collateral, in the event of a serious order imbalance.

In a world of 200 currencies, arrangements of this type would require 200 factorial bilateral agreements, which is obviously unworkable. And corridors of many countries, though sometimes imagined, would require rules and governance arrangements considerably more elaborate than those of the World Trade Organization and the International Monetary Fund. This, clearly, isn’t going to happen.

CBDCs are coming. But they won’t change the face of international payments. And they won’t dethrone the dollar


https://www.project-syndicate.org/commentary/central-bank-digital-currencies-will-not-end-dollar-dominance-by-barry-eichengreen-2021-08

Comments

Popular posts from this blog

Menon meets Karzai, discusses security of Indians

Kabul/New Delhi/Washington, March 5 (IANS) India Friday said that the Feb 26 terror attack in Kabul will not deter it from helping rebuild Afghanistan as National Security Adviser Shivshankar Menon met Afghan President Hamid Karzai in Kabul to review the security of around 4,000 Indians working in that country. Menon, who arrived here Friday morning on a two-day visit, discussed with Karzai some proposals to bolster security of Indians engaged in a wide array of reconstruction activities, ranging from building roads, bridges and power stations to social sector projects. The Indian government is contemplating a slew of steps to secure Indians in Afghanistan, including setting up protected venues where the Indians working on various reconstruction projects will be based. Deploying dedicated security personnel at places where Indians work is also being considered. Menon also met his Afghan counterpart Rangin Dadfar Spanta and enquired about the progress in the probe into the Kabul atta

Iran is losing the game to regional actors in its strategic depth

Rethink before It’s Too Late http://www.irdiplomacy.ir/index.php?Lang=en&Page=21&TypeId=15&ArticleId=7108&BranchId=19&Action=ArticleBodyView Iran is losing the game to regional actors in its strategic depth –Afghanistan. By Houman Dolati It is no more a surprise to see Iran absent in Afghanistan affairs. Nowadays, the Bonn Conference and Iran’s contributions to Afghanistan look more like a fading memory. Iran, which had promised of loans and credit worth five-hundred million dollars for Afghanistan, and tried to serve a key role, more than many other countries, for reconstruction and stabilization of Afghanistan, is now trying to efface that memory, saying it is a wrong path, even for the international community. Iran’s empty seat in the Rome Conference was another step backward for Afghanistan’s influential neighbor. Many other countries were surprised with Iran’s absence. Finding out the vanity of its efforts to justify absence in Rome, Iran tried to start its

Pakistani firm whose chemicals were used to kill US troops seeks subsidy for Indiana plant

By Jennifer Griffin, Justin Fishel Published March 22, 2013   A Pakistani fertilizer maker whose chemicals have been used in 80 percent of the roadside bombs that have killed and maimed American troops in Afghanistan is now seeking U.S. taxpayer subsidies in order to open a factory in Indiana.  The request appears to be on hold pending further review, but the situation has stirred outrage in Congress, where some accuse the Pakistani government of halting efforts to clamp down on the bomb-making.  For the past seven years, the U.S. government has known that the raw material calcium ammonium nitrate, or CAN, is making its way across the border into Afghanistan where the Taliban use it to fuel their most deadly weapons, namely the improvised explosive device. IEDs have long been the number one killer of U.S. and coalition troops.  The material largely comes from Pakistani fertilizer maker the Fatima Group. But the Pakistani government has stymied attempts by the Pentagon to stop the