Implications for the US Dollar of Central Bank Digital Currencies

Central Bank Digital Currencies (CBDCs) are coming. Central banks around the world are in the process of building CBDCs for testing in trials and pilots, both domestic and cross-border. However, when we talk about CBDCs—especially in international discussions—it is clear that confusion persists about what a CBDC is, how it could work, and what its use cases might be. In my recent paper, I seek to bridge this gap by promoting conceptual clarity in our thinking about CBDCs and their characteristics, which is necessary for understanding their potential impacts on the international payments and financial system. One such impact is the potential for CBDCs to disrupt the continued dominance of the US dollar in this international system—which will come with a range of consequences for the US and, to some extent, its allies.

While CBDCs promise to significantly improve the cost and speed of international payments, their development also presents an opportunity for states looking to reduce reliance on the US dollar.

The US has enjoyed many benefits of issuing the preeminent global currency. These range from paying less interest on its foreign debt to minimising the foreign exchange costs borne by US companies when transacting overseas. The phrase ‘privilège exorbitant’ was coined by Valery Giscard d’Estaing, when Finance Minister of France in the 1960’s, to describe these many benefits.

One might expect the US to guard this exorbitant privilege carefully. However, this has not been the case. By repeatedly using sanctions—culminating in the freezing of some $300 billion of Russia’s foreign exchange reserves—the US has put at risk the centrality of its dollar in international finance, as such conduct strongly motivates many nations to put themselves beyond the reach of its sanctions.

There are currently two leading means to significantly reduce the cost and dramatically increase the speed of international payments: either through CBDCs or the connection of nations’ fast payment systems through payment hubs. Either development will enable the direct exchange of two nations’ currencies through a platform, without going through the US dollar, thereby reducing the usage of the dollar in much international trade. Today some 90% of international transactions involve the US dollar and estimates are that about 40% of those transactions involve the dollar even when the US is not a party to the transaction. We could see these numbers, especially the latter, fall considerably over time.

This decline in demand for the dollar will probably reduce the proportion of dollars nations elect to hold in their foreign exchange reserves, thereby exacerbating the current long-term decline in the dollar as the world’s principal global reserve currency.

While it is unlikely that the US Dollar will lose its dominance in the near future, owing to the depth of US capital markets, the current configuration of the global payments infrastructure, and US dollar borrowing by non-US banks and corporates, among other factors, its policymakers need to think long term.

My paper makes the argument that, if the US is to protect the dominance of its dollar in international payments, it needs to develop a CBDC. It is here that the oft-overlooked distinction between a retail and wholesale CBDC for offshore use becomes critical. Retail and wholesale CBDCs may well be much the same instrument, with the differences lying not in their construction, but in their functionality and geographical applicability. Yet a domestic digital dollar will not affect the international financial system appreciably, while a wholesale digital dollar for offshore use most certainly will. I am thus suggesting that the US should develop a wholesale digital dollar for use in international transactions.

A major impetus for this is China’s development of its CBDC, the e-CNY. While the e-CNY is today a domestic digital currency within China, my recent paper argues that it also has a clear role to play in China’s long-term project to move the global financial system away from the US dollar to one in which there are three or more reserve currencies of which the CNY is one. In pursuance of this end, when China eventually releases the e-CNY for offshore use, I expect to see its use be free and quite possibly its use in purchasing Chinese outputs made mandatory because China is pursuing a long-term geopolitical goal, not a short-term profit-oriented one.

Since it is very likely that China will issue the e-CNY for use in international trade, which will be fast, reliable and free to encourage adoption, it is only by engaging with this technological revolution that the US will be able to compete. To the extent there is a choice, merchants will opt for the more trustworthy US digital currency if it exists. But a digital US dollar will, in time, have to exist or demand for the dollar in international transactions may well fall precipitately and the US cease to enjoy its exorbitant privileg

The author’s paper can be found here.

Ross P. Buckley is the Scientia Professor at the University of New South Wales Law & Justice, School of Private & Commercial Law.