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The Ascent of Digital Money

Niall Ferguson
 

“How would you like to pay for that, sir?” For most of my lifetime, there have been three possible answers to that question: cash, a cheque or a plastic card. Go to Beijing, however, and you will see few transactions in those forms. People pay with their phones, using systems created by the two biggest Chinese tech companies, Alibaba and Tencent.

And not only in Beijing. For the Chinese way of paying is spreading around the world — from taxis in Tokyo to the Harvard giftshop in Cambridge, Massachusetts. I think this is a big deal. Indeed, it could be a much bigger deal than China’s dominance of 5G telecommunications networks.

Since 1971, when Richard Nixon severed the last link between the dollar and gold, the world has been on a fiat monetary system (meaning the money supply is unconnected to any scarce reserve asset such as gold). Because of the size of the American economy and its dominance of financial and commodity markets, the US dollar has been the No 1 currency since that time.

To varying extents, governments abused their ability to print money, leading to an era of high inflation. But gradually a variety of rules evolved (central bank independence, inflation targets) that brought down inflation in most places. Indeed, in the early 21st century, it began to seem as if the central banks had done too well. People began to worry about deflation. That worry intensified after the 2008-9 financial crisis.

The crisis led to monetary policy innovations, notably zero (and then negative) interest rates and quantitative easing. Despite all this, the dollar has remained the dominant currency in international transactions and central bank reserves. Confident in dollar dominance for the rest of history, American policymakers have grown used to exploiting it as a lever of foreign policy. That financial sanctions were a very powerful tool was only really appreciated after September 11, 2001, when US Treasury officials went after the financial supporters of al-Qaeda. People tend to focus on the seeming failure of the military interventions in Afghanistan and Iraq. But the assertion of US financial power after 9/11 was much more effective and less expensive.

Before too long, America was using financial sanctions against other enemies too, notably Russia, Venezuela and Iran, and even against friends (Switzerland, for example) suspected of protecting tax dodgers or other kinds of criminal, not to mention allies that wished to trade with Iran.

Because international payments between banks have to go through a Belgium-based but US-controlled entity known as Swift (Society for Worldwide Interbank Financial Telecommunication), America has the power to kick an individual, company or country out of the cross-border payments system. This power has grown increasingly irksome to other large economies.

Until recently, there seemed to be no real alternative to the dollar. Indeed, the world’s appetite for dollars and dollar-denominated securities has tended to grow even faster than their supply, resulting in a strong dollar and historically very low interest rates (as US bond prices have risen). As Mark Carney, the governor of the Bank of England, said at this year’s Federal Reserve conference in Jackson Hole, Wyoming, this is not a satisfactory system. Donald Trump also finds it unsatisfactory, though for different reasons: he would simply like to see a weaker dollar, but finds that he cannot unilaterally will that.

The advent of various kinds of digital currency creates a new state of affairs. Since the launch of bitcoin, the world has seen a wave of monetary innovation. Cryptocurrencies have proliferated. Many of these, it is true, have been mere experiments. Some have been downright frauds. And maybe it will turn out that blockchain as a technology has more appropriate uses than money. But those who have written off digital money will soon look as silly as the people who said the internet would never replace the fax machine.

The proof is in China, where digital payment systems established by Alibaba (Alipay) and Tencent (WeChat Pay) have grown explosively. Partly because of timing, partly because of regulation designed to protect banks and credit card companies, Americans never switched as enthusiastically to digital payments.

Phase two of this story is the expansion of Chinese fintech. One emerging market at a time, China is building a global payments infrastructure. Right now, the various systems are distinct national versions of the Chinese original. But there is no technical reason why the systems should not be linked internationally. Indeed, Alipay is already being used for cross-border remittances.

If America is stupid, it will let this process continue until the day comes when the Chinese connect their digital platforms into one global system. That will be D-Day: the day the dollar dies as the world’s No 1 currency and the day America loses its financial sanctions superpower.

If America is smart, it will wake up and start competing for dominance in digital payments. The shortest cut to a system to rival Alibaba and Tencent is Libra, the digital currency proposed by Facebook, which, with its 2.4bn active users, is uniquely positioned to create something on a Chinese scale — and fast. This would not be a true blockchain cryptocurrency, but more like a digital currency in the Chinese style, with the difference that it would be backed by a reserve, held in Switzerland, of dollars and other main currencies.

There are many obvious arguments against letting Facebook do this, not least its questionable track record when it comes to harvesting and exploiting users’ data. However, as Carney said in Jackson Hole, something such as this needs to happen, with the sponsorship and regulatory oversight of government.

Right now, the US Treasury is opposed to Libra and the Federal Reserve seems sceptical. But these attitudes seem symptomatic of the risk-aversion that presages decline. From a national security perspective, there is an urgent need to compete with the Chinese before they dominate digital payments globally. And from Trump’s perspective, backing Libra could offer perhaps the only way out of the problem he currently cannot solve, which is the strength of the dollar.

Libra would be partly dollar-backed, not wholly. So it would be a kind of dollar substitute, reducing international demand for dollars. But it would not offer an alternative to Treasury bonds, so it would not reduce the global demand for those.

History teaches us power is inseparable from financial power. The country that leads in financial innovation leads in every way: from Renaissance Italy, through imperial Spain, the Dutch republic and the British Empire to post-1930s America. Only lose that financial leadership — just ask poor Mr Pound, once worth $4.86 — and you lose your place as global hegemon.

The US-China rivalry today (what I call the Second Cold War) is too focused on trade and telecoms. Washington needs to turn its attention, as a matter of urgency, to the race for monetary leadership, which America is in danger of losing.

Niall Ferguson is the Milbank Family senior fellow at the Hoover Institution, Stanford

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