China’s new digital currency inspires tectonic shift in capital flows

China’s new digital currency inspires tectonic shift in capital flows by Michael McKenna
China opens up its capital account, giving foreign investors full access for the first time.

See previous 2021 prediction

The People’s Bank of China (PBOC) rolled out an advanced digital currency experiment in October 2020. The Digital Currency Electronic Payment (DCEP) will be a blockchain-based digital version of the Yuan (CNY). In 2019, 80% of all payments in China were through electronic payment via WeChat Pay and AliPay. The PBOC wants to take this one step further and in the process improve the efficacy of monetary and fiscal policy through an increasingly cashless society and with a goal of enhancing financial inclusiveness.

The next natural step for China’s digital currency would be as an aid in opening up the country’s capital account, which is currently severely restricted, making the CNY essentially unavailable to anyone outside of mainland China. Allowing full access for foreigners into Chinese capital markets will reduce the main barrier of concern for foreign investors for using the CNY in trade and investment: its liquidity and direct access to their investments inside China. Meanwhile, the stability of the Chinese currency and the built-in traceability and oversight that blockchain tech enables would virtually eliminate the risk of capital flight or illegal transfers out of China.

This idea sits well inside China’s Dual Circulation framework, improving transparency within China, while growing the CNY’s use externally as a compelling alternative to the US dollar in transactions, avoiding the latter’s weaponisation by the US. As a government-sponsored centralised currency, it will still be viewed as “fiat currency” and won’t have the appeal of decentralised blockchain-based currencies like Bitcoin; but from China’s perspective this is a feature of the digital Yuan and not a bug, as it allows negative rates for “cash”, and nominal GDP targeting is far easier to achieve as well.

Opening up China’s capital account and creating a currency that rivals the US dollar for reserve status will help boost Chinese consumption, fund an entirely new Chinese pension system and deepen the country’s capital markets.

Trade: Short the US dollar and overweight Chinese government bonds and equities versus the rest of the world.

See next 2021 prediction:
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