Eswar Prasad on the Future of Money

Eswar Prasad is the Tolani Senior Professor of Trade Policy at Cornell University. He is also a Senior Fellow at the Brookings Institution, where he holds the New Century Chair in International Economics, and a Research Associate at the National Bureau of Economic Research. He was previously chief of the Financial Studies Division in the International Monetary Fund’s Research Department and, before that, was the head of the IMF’s China Division. Prasad’s previous books include Gaining Currency: The Rise of the Renminbi (Oxford, 2016) and The Dollar Trap: How the U.S. Dollar Tightened Its Grip on Global Finance (Princeton, 2014). His extensive publication record includes articles in numerous collected volumes as well as top academic journals such as the American Economic Review, American Economic Journal: Macroeconomics, Brookings Papers on Economic Activity, The Economic Journal, International Economic Review, Journal of Development Economics, Journal of Economic Perspectives, Journal of International Economics, Journal of International Money and Finance, Journal of Monetary Economics, and Review of Economics and Statistics. He has co-authored and edited numerous books and monographs, including on financial regulation and on China and India. Prasad has testified before the Senate Finance Committee, the House of Representatives Committee on Financial Services and the U.S.-China Economic and Security Review Commission, and his research on China has been cited in the U.S. Congressional Record. He is the creator of the Brookings-Financial Times world index (TIGER: Tracking Indices for the Global Economic Recovery; Many of his research papers and quotes from his speeches have been cited extensively in prominent media outlets such as the Economist, Financial Times, Forbes, International Herald Tribune, New York Times, Newsweek, Time, Wall Street Journal, Washington Post, and USA Today. His op-ed articles have appeared in the Financial Times, Foreign Policy, Harvard Business Review, International Herald Tribune, New York Times, Wall Street Journal, and Washington Post. He has made frequent appearances on BBC, Bloomberg, CNBC, CNN, C-SPAN, Fox, NBC, NPR, PBS, Reuters and other radio and television channels.
Muxi Li '23 interviewed Dr. Eswar Prasad on on December 2, 2022.
Photograph and biography courtesy of Dr. Eswar Prasad.

Currently, China has the norm of using Alipay or WeChat Pay which are private companies. In the long term, what are some challenges that China faces when transitioning from this norm to using Central Bank Digital Currencies (CBDC)? What are some risks or drawbacks for implementing CBDC that are specific to China?

China is an interesting country case, because Alipay and WeChat pay have done a wonderful job of providing low cost and efficient digital payments that essentially anybody can get access to, even low-income consumers and households, as well as very small businesses. And they have essentially blanketed the economy with these digital payments. There is a question about the use of CBDC in China, because CBDC is essentially supposed to be a payment system, it's not obvious that China really needs yet another payment system. But the Chinese central bank, the People's Bank of China, or PBOC, seems a little concerned that these two payment giants have dominated the payment space. In other words, the concern is that the two large payment platforms are restricting entry into the payments space, which could reduce competition, increase concentration, and thereby also reduce the possibility of more innovation. I think the digital yuan or digital RMB project is an attempt to keep the payment system more open and give Chinese citizens an alternative payment mechanism that is provided by the government rather than by the private sector. Now there is a question about whether there is going to be strong demand for a CBDC, and it looks like in the experiments that the PBOC has done so far, a large number of central banks digital currency wallets have been opened, but the transaction volumes are very limited because I guess people in China don't understand why they would need to bother with CBDC when they are already used to using Alipay or WeChat pay very easily. It is a concern that once the central bank enters a space in a nationwide way, it might inhibit innovation by private sector payment providers.

In your book, you mentioned “central bank money in digital form could become an additional instrument of government control over citizens…” Given the direction of China's current leadership, do you see this becoming a significant part of China’s surveillance system over society?

There is also the risk that we might see Central Bank Digital Currency being used to conduct deeper surveillance over Chinese citizens.  It is true that any digital payment system, whether private or public, is going to make transactions visible to the payment provider because none of them have the anonymity of cash. So, at one level for Chinese households and businesses, it may involve a choice of who gets to see your transactions. Is it a private payments provider? Or is it a government agency? The digital currency could end up becoming an important tool, but what the PBOC is doing in its CBDC experiments is interesting. They've been offering five grades of digital wallets. The highest-grade digital wallet can be used to maintain large balances and large value transactions. And those have to meet very stringent know your customer and other regulatory requirements. But apparently, there are also going to be some very low-grade digital wallets, which can be used only for low value transactions and which can only be used to maintain low balances. Such wallets would give users more anonymity; you can set up one of those digital wallets using just your mobile phone number. There is clearly an attempt by the PBOC to address the concerns of Chinese citizens that the digital yuan might become an additional tool of government oversight. In fact, this concern is one that is relevant not just in China, but around the world. When the European Central Bank conducted a survey of European citizens about how they felt about a potential digital Euro, the number one concern that was expressed by the survey respondents was that they might lose privacy if they didn't have the option of using cash and had to use a digital Euro. So, I think it's a legitimate concern. It's one that governments and central banks are keenly aware of, and it could certainly affect the adoption of CBDCs.

What role do you see China's digital currency play in the global financial system in the context of deglobalization and great power rivalry, and how will it impact the existing financial infrastructure and institutions?

There is a question about whether China moving forward with a digital currency ahead of many other jurisdictions, like the U.S., in particular, could lead to the RMB becoming much more important in global finance. I don't think it'll really make a big difference by itself, because international payments are largely digital already. Second, the PBOC has made it clear that at least in the foreseeable future, it does not anticipate making the digital yuan available for use outside the country. But even if that were to happen, it will not be a game changer, because ultimately, what matters for a currency is the depth and liquidity of the financial markets behind that currency, which affects the cost of trading and the currency, but also the institutional framework of a country -- the rule of law, an independent central bank, a system of checks and balances. Having said that, you know, China is becoming a larger economy, it is already the second largest in the world, it's one of the most important trading countries in the world. So it is quite conceivable that the RMB could start getting more usage as a payment currency for international payment transactions. I don't think it will necessarily mean that the dollar will lose its dominance. I think the dollar may have some erosion of its dominance, but it will remain the dominant payment currency. But certainly, I can envision the Chinese RMB, the Indian rupee, the Brazilian real, and so on becoming more important payment currencies.

In previous interviews, people have argued that China is intending to increase the role of yuan in the international monetary system but would not substitute the dollars as the next global reserve currency. Do you think that the era of digital currency would change this?

Now, when we talk about international currencies as a reserve currency, it's a different matter altogether. There I don't think digitization is going to make much of a difference at all. What really matters for a reserve currency is that foreign investors and domestic investors must trust that currency and the securities they buy in that currency. If you think about what it is that creates the trust among foreign investors, it is the rule of law, an independent central bank, a system of checks and balances… the same elements of the institutional framework I spoke about earlier. And all indications are that China is not moving in a very positive direction in those dimensions, which means that it is hard to see the RMB becoming a major reserve currency. Certainly, we might see many central banks around the world decide to put a little more of their foreign exchange reserve holdings in RMB purely for diversification purposes. But I don't think it is ever going to become a safe haven currency. And this is yet another concept. So, there is the payment currency, there is a reserve currency, and there is safe haven currency. A safe haven currency is essentially one that both domestic and foreign investors run to when there is financial turmoil, and they want a safe place to put their money. For that, you need to trust the government that manages the currency that you're investing in. And I suspect that foreign investors are not going to view the Chinese RMB as a safe haven currency. Again, I don't think digitization is going to fundamentally alter the structure of the international monetary system, although it could make a little bit of a difference at the margins.

China would like to have its currency play a bigger role as a payment currency. That's important because for instance, if China wants to export some goods to India, and in turn import some services from India, to exchange the RMB for Indian rupees directly is quite expensive, because those currencies are not widely traded. It is a lot cheaper to exchange the RMB for dollars and dollars for rupees or the other way around. This is costly, it creates a need for more hedging instruments, and so on. If you could directly transact between RMB and rupees or for that matter, RMB and rubles, you would have two advantages. One, you don't have to worry about having to use a vehicle currency. And second, you might be able to evade the use of the dollar, which is a concern for China. There is something we didn't talk about, which I think is going to be more important than the digital currency, which is the cross border interbank payment system, or CIPS. China’s CIPS could directly communicate with the payment systems of India, Brazil, Russia, and so on. Those payment systems are not yet mature enough to be able to do that. But one day, they could directly communicate with each other, which means that you could directly transact from a Chinese bank to an Indian bank, you don't have to go through a correspondent bank that deals with dollars. So now, you might move to a position where RMB becomes a more important payment currency, I think that is what China would like.

The U.S. has been able to maintain its current account deficit thanks to countries buying up dollar-denominated assets, especially China. Do you expect China to continue to want to hold large quantities of dollars and dollar-denominated assets to maintain its trade relationship with the U.S.? Is the U.S. economy vulnerable to the possibility that China and other countries would dump dollar denominated assets? What would be the consequence of this?

China would certainly like to reduce its own reliance on the dollar as a reserve currency because China does hold a lot of foreign exchange reserves, and a large fraction of those reserves are in dollars. But right now, it doesn't look like there is any viable alternative. And I don't think there is going to be a huge demand for Chinese assets as foreign exchange reserves. Although again, at the margin, there might be some increase in global reserve holdings in RMB given what China has done to make it much easier for foreign investors to invest in its bond and equity markets. And that will certainly help. If you think about foreign central banks, or foreign institutional investors, they can now more easily access China's fixed income markets, both corporate and government bonds. All of this will certainly accomplish two objectives. One is giving the RMB a little more prominence in international finance, but also developing China's financial markets. In my previous book on the RMB, I made the case that RMB internationalization was seen by many of the reformers in China not as an objective in itself, but as something that would help domestic financial market development. Foreign investors come into China's equity and bond markets, making those markets more liquid, more developed, and can get better corporate governance rules and so on. That's the real objective.

It sounds appealing to dump dollars, because after all, China has about $3.1 trillion of foreign exchange reserves. About $2 trillion are believed to be held in dollar-denominated assets. But the question is, what would China do with trying to shift even a smaller amount such as $100 billion out of dollar assets. If you think about buying gold, you know, if you buy 1000 tons of gold, that's about $65 billion at current market prices. So yes, you can buy a little more gold but if a central bank tries to buy 1000 tons of gold, the price is going to rise a lot. And that's not a very liquid market either. If China wanted to use its reserves held in the form of gold, it would find it very difficult to sell those reserves, without the value of those reserves plunging. Could China move some of that money into Euros, Japanese Yen, or so on? Those are also not as liquid markets as the Treasury securities market. China is, of course, very concerned about all the dollar assets that it holds. But realistically, once you start talking about hundreds of billions of dollars, there is no other place to go.

Muxi Li '23Student Journalist

edwinchuen, CC BY 2.0 <>, via Wikimedia Commons

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