Does the Chinese Digital Yuan have a Chance of Overcoming the U.S. Dollar? [Part 3]

With China streaming ahead of the United States in the digital finance space, does the U.S. have a chance of falling behind?

(Image credit: fpri.com)

China’s digital yuan (CNY) is set to challenge the dollar’s domination of international trade in the upcoming decade.

“Remember, China is the largest trading country and you’re going to see digital yuan slowly supplant the dollar when buying things from China,” according to Richard Turrin, author of “Cashless: China’s Digital Currency Revolution.

China has been ramping up efforts to roll out its central bank digital currency and is currently far ahead in the space compared with its global peers and even the United States. Turin said the world’s second-largest economy is currently “ahead in all financial technology by a decade.” He added the U.S. would take “easily another five years” just to get out of planning and trials for a potential digital dollar.

However, while the potential is certainly there, the U.S. dollar has too big of a foothold in the global economy for China to unseat it as the #1 global reserve currency. The U.S. dollar currently makes up 51% of central bank reserves, while the CNY makes up 2%. Likewise, the U.S. dollar is involved in 88% of global F.X. transactions, a figure that has remained stable for the last two decades despite China’s meteoric growth, while the CNY is involved in only 2% of global F.X. trades. Its exposure into the foreign exchange market is expanding, but not at a pace that can compete with the United States any time soon.

Currently, the currency is having its worst month ever, hitting the lowest levels since September 2020. The currency has lost around 7% of its value against the dollar in the past three months. While China is currently the second-largest economy in the world and a key driver of global growth, its digital yuan is nowhere near the level of compensating for its weight in China’s economy. Currently, China’s government and corporate debt securities markets are quite large but still seen as having limited trading volume and weak regulatory frameworks. Strengthening its financial markets would be necessary for China’s own economic development and for promoting the international use of its currency.

History suggests that a country seeking “reserve currency” status must have a sound institutional framework. This includes an independent judiciary, an open and transparent government with institutionalized checks and balances, robust public institutions, and a credible central bank, free from heavy currency manipulation. These elements have traditionally been seen as vital for earning the trust of foreign investors, both private as well as official, including central banks and sovereign wealth funds. China currently operates as a private socialist economy that does not promote free and minimally regulated trade like the United States capitalist model. This one-party system helps with the nation’s legislation, allowing China to get laws and regulations approved faster than in a two-party system. This enables China to stream past the United States in many technological aspects as they do not need to deliberate an idea for months before applying resources to get it done. However, the complete socialist control of the Chinese economy will continue to draw red flags from investors. In order for China to reach this reserve currency status, it would have to drastically loosen its grip on the economy and deploy a more capitalist system.