Monday, 29 February 2016

The Sardex factor (Local Money)

When the financial crisis hit Sardinia, a group of local friends decided that the best way to help the island was to set up a currency from scratch
Sardex’s founders outside their office in Serramanna, Sardinia
©Alessandro Toscano

Sardex’s founders outside their office in Serramanna, Sardinia
Across the island of Sardinia there are more than 7,000 ancient towers built with large blocks of local stone. Known as nuraghi, they resemble giant beehives, jutting out across the landscape. Little is known about the nuraghi or their Bronze Age architects but almost every Sardinian I met had a theory about their purpose. Some told me that they were forts; others that they were residences, places of exchange, even communication beacons. “The amazing thing is that from every single nuragheyou see another nuraghe,” Carlo Mancosu, a 34-year-old Sardinian, told me. “Now imagine a system of communication with flames or light or mirrors. I think there existed a people in a network.”
It was this system, real or imagined, that inspired Mancosu and a group of childhood friends to found Sardinia’s first local currency: Sardex. Arts and humanities graduates with little financial experience, they built it from scratch in their home town of Serramanna as the island reeled from the financial crisis. Their hope was that the project would give them a job in the place where they had grown up. But six years later it has turned into a symbol of local action, spreading to create a new network of thousands of businesses. Together, they have traded nearly €31.3m in Sardex this year.
Serramanna sits just within the agricultural region of Medio Campidano, one of the poorest in Italy. When I visited, its piazza was full of old men drinking their coffee under the shade of Canary palms. Only the occasional roar of a jet engine from the nearby Nato base broke the silence. I met four of the currency’s five founders in their office, an old farmhouse in the town. On the wall was a sign in Sardinian and Italian: “Don’t complain.” Giuseppe Littera, another founder, told me that it was intended for his grandmother, who owns the farmhouse. “I love my grandmother [but] she’s still complaining about the Nato base because they took 10 plants from the best olive field their family had.”
Now in their early to mid-thirties, the founders all grew up together in Serramanna. “I have traced my ancestry back 500 years,” Giuseppe told me proudly. “They didn’t have earlier records.”
They seemed a remarkably disparate group, fiercely debating local politics and the financial crisis. Giuseppe speaks rapidly, moving between Italian and English. Gabriele, his younger brother, is more restrained, carefully balancing his words. Then there’s Mancosu, the most confident of the four. And Piero Sanna, a pragmatic amateur gold trader, whose financial experience initially set him apart from the others.
Life in their home town can seem idyllic, with its old church, public spaces and faded murals. But the four presented a different image. “Youth unemployment is at 50 per cent,” Giuseppe said. “The factories are in a state of crisis. Anyone with minimal linguistic abilities escapes to London or Berlin."
One of the stone towers, or 'nuraghi', found across the island
©Alessandro Toscano

One of the stone towers, or ‘nuraghi’, found across the island
In the 1960s, planners in Rome decided that the future of Sardinia — an island of miners, shepherds and farmers — lay in industrial production. Countless petrochemical plants, factories and refineries were built as part of the state-led Piano di rinascita (Plan for Rebirth). When I asked Sardex’s founders about the town’s problems, they would often repeat the phrase with a tinge of sarcasm. “Bring hell to paradise,” Mancosu said, “and they call it plan for rebirth.” The island’s nascent petrochemical industry, knocked off course by the 1973 Opec price rise, proved unable to compete in the international market. As the plants declined, thousands were laid off. “We had to face, year by year, an emergency in these industries,” said Stefano Usai, an economist at Crenos, a Sardinian research institute. “It is a heavy inheritance.”
Then, in 2008, another wave hit the island: the financial crisis. “Here, 2,000 miles away [from Lehman Brothers], banks stopped lending anything really,” Giuseppe told me. “People stopped going to ask for a loan.” Unable to secure credit, companies started to fold, swelling the ranks of the jobless. “In Serramanna we have a suicide problem.”
A Sardex agent
©Alessandro Toscano

A Sardex agent
At the heart of the financial crisis, explained Giuseppe, was a contradiction: its causes remained distant but its effects were local. “What does the economic system of Sardinia have to do with the mismanagement of Wall Street or London?” he said. The island’s companies still had the potential to produce goods and services; stock was sitting in warehouses and people were able to work. If this was a financial crisis, he began to think, then perhaps there was a financial solution. “There was no other option,” he said, “but to let companies create their own money.”
For at least 150 years, business people, utopians, social reformers and eccentrics have tried to introduce local currencies, often in response to money scarcity. Their creations have taken an array of different forms, such as credit systems, time banks or paper money, and ranged from the ingenious to the absurd. Many have been shortlived — but others have outlasted the conditions that brought them into existence.
Among the most successful is the Swiss WIR, which first appeared during the Great Depression. In 1934, a network of Swiss businesses decided to build a system of mutual credit allowing them to trade without relying wholly on the Swiss franc. The currency proved remarkably resilient, especially during periods of economic downturn. Although it has changed significantly since its inception, the WIR is still going strong and has about 45,000 members.
The office, a converted farmhouse
©Alessandro Toscano

The office, a converted farmhouse
“For his different purposes,” wrote the British economist EF Schumacher, “man needs many different structures, both small ones and large ones, some exclusive and some comprehensive.” For some, local currencies are a financial response to this human need and one that has a strong precedent through history. “The permanent feature of monetary systems in Europe throughout the period from Charlemagne to Napoleon — for a good millennium — [is] a distinction between different moneys for different purposes,” says Luca Fantacci, an economist and historian at Bocconi University in Milan.
Map: Sardinia in Italy
Sardex began as a small, unlikely idea while Giuseppe was a student in Leeds. In 2006 he read about WIR, the Swiss complementary currency, and became obsessed by the possibility of bringing something similar to Serramanna. “When I went to England and I was still studying, I was kind of trying very hard to find meaning in life. And when I discovered the WIR thing — that was like, OK, it’s a battle worth fighting. The other option is: let’s wait for systemic worldwide change.” He discussed the idea over Skype with Mancosu, Gabriele Littera, Sanna and Franco Contu, another founding member and friend, and they began designing a new local electronic currency whose name, Sardex, left no mystery as to its origins.
And so the group of arts students planned a new currency for their island. It seemed absurd: they had little financial or IT experience, no MBAs and no investor, only the outline of an idea. “We said: ‘We are here, the companies are here. [We can do this] without inconveniencing Brussels, Rome or New York,’” Giuseppe told me.
To build Sardex, they turned to financial history, drawing on studies of ancient credit systems, the Swiss WIR and John Maynard Keynes’s proposal for an International Clearing Union at Bretton Woods, a version of which was implemented as the European Payments Union (1950-58). There was logic in this approach; for if the financial crisis proved anything, it was that the history of finance is not linear. “There’s no reason to think that financial markets are more progressive than the financial institutions of the Renaissance,” says Massimo Amato, an economist and historian at Bocconi. “Common sense is never outdated.”
The Mulargia Lake in southern Sardinia
©Alessandro Toscano

The Mulargia Lake in southern Sardinia
While Sardex’s founders borrowed from history, they were not beholden to tradition. In a recent paper, Paolo Dini of the London School of Economics writes that, “Sardex has institutional characteristics that make it almost unique among the thousands of examples of CCs [complementary currencies] that have existed throughout human history and that still exist in almost every country in the world.”
To understand how Sardex works, you have to abandon much of what you may think you know about money. There is no bank that prints Sardex notes; no algorithm that generates Sardex digital coins. Instead, it functions as a system of mutual credit: each firm begins at zero, earning the digital currency — equivalent to but non-exchangeable with the euro — as it offers goods or services to others in the network. Companies may go into debt but only up to a certain limit, determined by what they can offer the other participating firms. Crucially, there is no interest on Sardex; it functions purely as a means of exchange. “[In the circuit] you have a debtor who does not see their debt increase but finds creditors who want to spend,” Gabriele told me. “This should be a natural part of the market.”
When Sardex was first explained to me, I found it easiest to think of it as a simple portrait of human relationships. “Money becomes information,” said Mancosu. “But, above all, money [here] is a system of rights and duties. From the moment that I take from a community — as is the case in Sardex — I am in debt towards that community; when I settle that debt with the community, I have given what I have received. It’s a beautiful thing.”
The founders, from left: Gabriele Littera, Piero Sanna, Carlo Mancuso, Giuseppe Littera and Franco Contu
©Alessandro Toscano

The founders, from left: Gabriele Littera, Piero Sanna, Carlo Mancuso, Giuseppe Littera and Franco Contu
The root of the word finance is the Latin finis, “end”. For Amato and Fantacci, the two Italian economic historians, Sardex’s simplicity reflects finance’s etymology and its true purpose: it allows a creditor and debtor to come together, make a payment and part ways, ending their relationship. Nothing could be further from the unsustainable repackaged debt, the system of delayed payments, which resulted in the collapse of the banking system in 2008. “[Sardex] is money that serves an end,” Giuseppe told me. “And once that end has been reached — it has done its work.”
At the heart of Sardex are its administrators. Using a centralised system, they carefully track member firms’ transactions, occasionally nudging the network to ensure its stability. Did they not, I wondered, resemble those central bankers from whom they had sought to distance themselves? “Sardex is voluntary,” Giuseppe replied. “We have no guns and we have no power.”
It proved easier to design Sardex’s system than persuade firms to adopt it. After registering the company in Serramanna in July 2009, the founders began to approach local businesses with their idea. As a group, they must have presented a curious sight: not one typically associated with financial professionals. Hundreds of firms in Sardinia rejected their proposals; after all, they needed euros to pay suppliers, not an invented currency overseen by a group of idealists. “It was a war,” recalled Mancosu. “They looked at us if we were from outer space.”
Then, at the beginning of 2010, the founders had a breakthrough: a local businessman, believing he was joining an established network, signed up. “We explained it to him,” recalled Mancosu. “And, for the first time, he said: ‘Great. That’s fantastic. Who else is in?’ ‘Just you,’ we said. ‘But we will grow.’ ”


Sardex: how does it work?
● Sardex is an electronic system of mutual credit for Sardinian companies. Lawyers, accountants, media companies, shops, hotels and utility companies all use it.
● To be eligible, a firm must have spare goods or services to offer to participating firms and be willing to make purchases within the network using Sardex.
● All firms begin with zero Sardex, earning the electronic currency as they transact with other members.
● Firms can go into Sardex debt but only up to a limit set by the administrators. No interest is charged on balances.
● Transactions of less than €1,000 must be carried out in Sardex. Larger transactions can use Sardex with euros.
● All transactions are tracked via a centralised system in Serramanna. VAT on transactions is paid in euros.
● Members are charged an annual fee according to size, ranging from €200 to €3,000.
And slowly Sardex did. High-street shops, hotels, media firms, accountants, dentists and restaurants all began to enter the network. By accepting payment in the currency, companies found that they could dispose of unused stock; cash-strapped firms could buy goods and services that they couldn’t otherwise afford. Lacking resources, the founders relied on charm, tenacity and, above all, their connection with the local area to persuade businesses to join. “Human relations have always been at the heart of our project,” Gabriele told me. “It has never been possible to sign up to the circuit via the internet.”
By the end of 2010, Sardex had a total of 237 members and a modest transaction volume of just over €300,000. It was still a struggle to survive, they recall. Initially the team relied on their families for support, later charging companies a small membership fee based on their size. And then, in 2011, they had a piece of luck: dPixel, a Milanese venture capital firm, intrigued by their idea, agreed to invest €150,000 in the company. “That was a real lifeline,” Giuseppe said.
 . . . 
Fifteen years ago, a retired law academic named Giacinto Auriti introduced his own paper money, the Simec, in Guardiagrele, a town in central Italy about the size of Serramanna. A wealthy man, Auriti paid a local printer to produce the currency, distributing it to locals from his own palazzo in exchange for lire. For Auriti, the Simec was not just a local initiative but a front in his long-running campaign against central banks and their monopoly on money production. “Between me and the central banks there is a mortal struggle,” he told The New York Times in 2001. “There is no middle way.”
Serramanna, where youth unemployment is high
©Alessandro Toscano

Serramanna, where youth unemployment is high
Unlike Auriti, Sardex’s founders have always viewed their currency as complementary to the financial system; they are not waging war against the Bank of Italy. State-issued money remains central to Sardex: firms in its network may combine euros and Sardex when making payments; taxes on Sardex transactions must be paid in euros; and the value of Sardex itself is tied to the euro. “We developed the network to be politically agnostic,” Giuseppe told me. “We talk to everybody: we don’t give a shit if you are from the left, the right, the north, the south.”
Auriti did not win his struggle against the Bank of Italy. In 2000 the Italian financial police, the Guardia di Finanza, shut down his experiment. But Sardex continues to grow. Today around 2,900 businesses are using it, including some of Sardinia’s most established organisations: Tiscali, the telecommunications company, and L’Unione Sarda, one of the island’s main newspapers. Stripped of money’s function as a store of wealth, Sardex has circulated quickly; according to the founders’ figures, it has facilitated more than €30m of transactions this year and about €84m since it started.


April 2010: first Sardex transaction
Idea inspired by network of nuraghi
December 2010: 237 company members
2011: venture capital firm dPixel agrees investment
October 2012: €5m credit transactions
€31m traded in Sardex this year
€84m credit transactions facilitated since 2010
Trials under way throughout Italy
“In our circuit, one credit circulates 12 times in a year,” Gabriele said. “No one keeps their [Sardex] credits stuck in their wallet.”
The prize for Sardex is now Sardinia’s biggest employer: the state. The team is currently proposing a scheme whereby the island’s regional government could join the network, disposing of its spare capacity, such as bus tickets or leases on property. The deputy governor of Sardinia, Raffaele Paci, is an economist who seems to represent the opposite of these young arts graduates who were so distrustful of mainstream economic thinking. “If we live in an ideal world then we do not need Sardex,” he told me. But he recognised that in this imperfect world the currency had a role to play. “In general, it’s a good experience that is helping a lot.”
Some six years after it started, Sardex still faces challenges. In an imperfect market, the network must be pushed and pulled to maintain its stability, placing great responsibility and influence in the hands of its administrators. Then there’s the question of cheating. A system that relies on trust, Sardex allows companies to go into unsecured debt, exposing the network to the risk that a member may rack up a negative balance and walk away. In practice it’s happened a few times, said Giuseppe, and the team now has several claims lodged in Italy’s notoriously slow court system. “It is our last-resort scenario,” he told me.
After meeting Sardex’s team, I took a walk around Serramanna to speak with local businesses. The owner of a local store showed me her online Sardex account, indicating her balance and all the firms with whom she could potentially transact. She had sold lingerie to companies in the network, earning Sardex, which she then used to pay her accountant. “It’s ingenious,” she said. “It makes the money circulate here [and] doesn’t allow it to leave the island. It creates a connection.”
The model has already spread in Italy and there are reportedly trials under way to create local currencies in Veneto, Piedmont, Emilia Romagna, Marche, Lazio and Sicily. Last year Giuseppe travelled to Greece to share his knowledge with local currency organisers. Yet his advice to them was less about financial models, credit systems and software than relationships and trust. “Focus on the impact you can have, work every day . . . and try to build communities where there are none,” he told them. “[In Sardinia] the social fabric was destroyed. And we started knitting.”
Edward Posnett is working on ‘Harvest’, a book about commodities, trade and the natural world, to be published by Bodley Head/Viking Penguin, 2017
Photographs: Alessandro Toscano
Source: Dini, P, Van Der Graaf, S and Passani, A (2015). D2.3.d1: Socio-economic Framework for Bold Stakeholders, deliverable, European Commission

Wednesday, 24 February 2016

Peter Schiff: Dollar Collapse Will Be the Single Biggest Event In Human History

Arguably the best assessment I’ve ever come across for what is headed straight for the United States, and sadly, no matter how loud many of us right the bell, there are still those that refuse to look at the facts. Peter Schiff says:
"This will be the first event that will touch every single living person in the world. All human activity is controlled by money. Our wealth, our work, our food, our government, even our relationships are affected by money."
"No money in human history has had as much reach in both breadth and depth as the dollar. It is the de facto world currency. All other currency collapses will pale in comparison to this big one. All other currency crises have been regional and there were other currencies for people to grasp on to."
"This collapse will be global and it will bring down not only the dollar but all other fiat currencies,as they are fundamentally no different. The collapse of currencies will lead to the collapse of ALL paper assets. The repercussions to this will have incredible results worldwide” 
What makes this story even more infuriating, is that it wasn’t necessary. It didn’t have to happen.”
“This collapse will be global and it will bring down not only the dollar but all other fiat currencies,as they are fundamentally no different. The collapse of currencies will lead to the collapse of ALL paper assets. The repercussions to this will have incredible results worldwide,” Peter Schiff, the Berkeley educated financial analyst, stockbroker, author, and one-time Senate candidate AND one of the only economists to predict the collapse of 2007.
“We’re In Deep Economic Sh**!” Peter Schiff tried to warn America over 4 months ago, but mainstream media stayed silent. It’s not like Peter Schiff is some snake charmer, he is after all a Peter Schiff, the one economists who predicted the collapse of 2007.
He had warned the anchors of Fox News in 2008 that a second, much worse collapse was coming in the not so distant future, but I guess Fox didn’t think we’d want to know such things.
“When The Economy Crashes Parts Of America Will Resemble A 3rd World Country,” Schiff says today.
“Now We Are Watching The Meltdown” – Bill Holter Holter, a former columnist for Miles Franklin, worked as a retail stockbroker for 23 years, including 12 as a branch manager at A.G. Edwards. He was also a well-known contributor to the Gold Anti-Trust Action Committee (GATA) commentaries from 2007-present.

The dollar collapse will be the single largest event in human history. This will be the first event that will touch every single living person in the world. All human activity is controlled by money. Our wealth,our work,our food,our government,even our relationships are affected by money.
No money in human history has had as much reach in both breadth and depth as the dollar. It is the de facto world currency. All other currency collapses will pale in comparison to this big one. All other currency crises have been regional and there were other currencies for people to grasp on to.
“This collapse will be global and it will bring down not only the dollar but all other fiat currencies,as they are fundamentally no different. The collapse of currencies will lead to the collapse of ALL paper assets. The repercussions to this will have incredible results worldwide” Schiff.concludes.
What makes this story even more infuriating, is that it wasn’t necessary. Had Obama been a little more cooperative with Putin, instead of imposing sanctions, we wouldn’t be in this mess. But as it was, Obama’s arrogance wouldn’t allow himself to be Putin’s equal. He wad the premadonna of the UN. The world listed to Obama. Then Putin came and stole his thunder and humiliated him by saying that “Obama [the U.S.] was responsible for ISIS. Indeed, the CIA founded, funded, trained and armed the Islamic State. That’s pretty much a given, but where this will go from here, nobody knows.

Tuesday, 23 February 2016

Transcript: Zhou Xiaochuan Interview

The central bank governor discusses a range of issues with Caixin, from reforming the exchange rate regime to adopting a digital currency
By staff reporters Wang Shuo, Zhang Jiwei and Huo Kan
(Beijing) – Recently Governor Zhou Xiaochuan had an interview with Caixin and talked about the yuan exchange rate regime reform, macro-prudential policy framework, digital currency and other topics. The following is an edited transcript of the interview.
Caixin: The central bank convened its system-wide annual work conference in January. We learned that before the Spring Festival, the branch offices were studying the decisions adopted at the conference and discussing ways to implement them. Can you briefly describe the major agenda items of the annual work conference?
Zhou Xiaochuan: In the PBOC's annual work meetings, we usually discuss and analyze the economic situation and financial market developments in China and beyond, and follow up on our tasks to implement the decisions of the Central Economic Work Conference and to advance financial sector reform. This year, we also discussed at length subjects including the foreign exchange market, the exchange rate, macro-prudential assessment, the central bank's digital money and Internet banking, etc.
At present, market participants have different views on the outlook for China's economic growth, which also affects their assessment of the yuan exchange rate. What is your view on this issue?
There are indeed differences in the views of the economic situation and financial market developments. It is necessary to analyze the current state of China's economy in a comprehensive and objective way. Overall, the performance of the economy remains within a reasonably strong range. Against the backdrop of a slowing world economy and global trade, and heightened fluctuations in the international financial markets, China maintained a growth rate of 6.9 percent in 2015, still relatively high compared with other countries.
The change in China's growth rate can be attributed in part to weak performance of the global economy. It also reflects the structural adjustment policies adopted by the Chinese government. Such a change is conducive to the ongoing efforts in China to pursue more sustainable and quality growth and is beneficial to the rebalancing of the global economy. Going forward, China will strengthen structural reform, especially supply-side reform, in order to strike a better balance among economic growth, structural adjustment and risk prevention, and to achieve sustainable and steady development.
In your view, what will be the major driving forces for growth in China?
China's savings rate remains quite high and will continue to be translated into high investment. Though part of this investment will be outward investment, its proportion will be very small compared with domestic investment. This will not lead to a moderation of investment gains and a reduction of investment opportunities in China. There is a good basis to keep domestic investment at reasonably high levels.
Despite the change of comparative advantages in trade, China's manufacturing industry has enormous advantages in upgrading and transformation, by moving up to the middle and high-end of the value chain. The manufacturing industry is going through short-term adjustments, partly due to environmental requirements, to cut expansion into highly polluting industries that consume lots of energy and resources. In 2015, the service sector as a share of GDP increased from 43 percent to more than 50 percent. The space for further expansion is large. In addition, measures have been taken to ease market access for private capitals. Problems are being solved step by step. The scope for mass entrepreneurship is vast.
There are widespread concerns about the fall of the GDP growth rate. After remaining in double digits for many years, the growth rate has declined consistently, and fell to 6.9 percent in 2015. This has given rise to pessimistic sentiments.
Among the views expressed on China's growth, two factors are worth mentioning. First, China contributed enormously to the global GDP growth in 2009 and 2010. With a population that was 20 percent of the world total and GDP less than 10 percent of the world total, China's contribution of the global GDP growth was over 50 percent. We must recognize the special circumstances and the sharp contrast between China and other economies at that time. While the advanced economies in Europe and North America were responding to the shocks of the financial crisis, China adopted a stimulus package. This situation is not to be regarded as a norm. For China, 50 percent is not a sustainable level of contribution to global growth. At present, China contributes around 25 percent to the world GDP growth, and this is relatively close to normal. This is not a hand landing at all.
Another factor is that in the past China put a lot of emphasis on GDP. In fact, looking at worldwide experience, there is not a direct correlation between GDP and the exchange rate, especially the growth of GDP and exchange rate movements. For example, overly rapid GDP growth sometimes causes overheating and high inflation, putting downward pressure on the currency. Some misguided views have been expressed in the debates around the world. In fact, the exchange rate of a currency is related to the international competitiveness and health of the economy of the issuing country.
When we take a closer look at economic theory and international experience, we see that the current account balance, among all the economic fundamentals, is the most related to exchange rate. In 2015, China's current account surplus remains massive. In particular, the surplus in the trade of goods reached a historic high of US$ 598.1 billion. There is another fundamental, i.e. movements of real effective exchange rate, or the relative movements of inflation, that affects exchange rate. The inflation target of the United States, Japan and Europe is 2 percent. At the end of 2015, China's CPI was 1.4 percent, a relatively low level for China. Low inflation is conducive to the stable value of a currency.
Global factors also have an important role to play in affecting the yuan exchange rate. In your opinion, which global factors deserve foremost attention?
Yes, indeed. I will not be exhaustive and will focus on four of them. First, following the protracted difficulties in the wake of the global financial crisis, the U.S. economy showed some positive signs of recovery, and the U.S. dollar started to appreciate while the euro and the Japanese yen depreciated significantly. Due to multiple reasons, the yuan exchange rate depreciated against the U.S. dollar by a relatively small margin, but appreciated against the euro and the yen markedly. Many market participants believe a makeup adjustment is thus needed. Second, the Federal Reserve has started to gradually exit from the quantitative easing policy. In December 2015, it raised its key policy interest rate for the first time in many years. Undoubtedly, the Fed's policy actions have an important impact on asset allocation and capital movements worldwide. It is fair to say that although the policy evolution of the Fed in 2013 and 2014 had an impact on many economies, in particular emerging market economies, but the impact on China was not large. However, in 2015, the Fed's policy evolution had a very notable impact on China, in particular the interest rate hike in December. This might be seen as sort of a makeup adjustment. Third, speculative forces have been targeting China. Speculative forces are always looking to bet on something. They saw the slowdown of economic growth and financial market volatility in China. The problem is that the previously weak speculative forces have gathered astonishingly large amount of liquidity after several rounds of QE by the major economies. How is the Chinese economy performing? We have confidence and patience to wait for further data releases to speak for the state of the Chinese economy. Of course, for those who have taken their bet, this is less relevant. What they want is immediate results, and they have tried hard to create hype. Fourth, in the conditions created by QE policies, financial assets worldwide have accumulated bubbles and adjustment pressures, though to varying degrees. Following accommodative monetary policies adopted in 2008 in response to the global financial crisis, the prices of many assets have increased for an extended period of time and accumulated internal pressures for adjustment. The question is what will trigger such an adjustment. Adjustment is always painful, so everyone wants to have someone to blame.
Some people are concerned that China will allow the yuan to depreciate in a bid to boost exports and GDP growth, which might intensify the so-called currency war. If one has a closer look at China's current account balance, he will find that in 2015 goods trade surplus was close to US$ 600 billion and net exports' contribution to GDP was fairly high. Therefore, there is not a motivation for depreciation to boost net exports. Premier Li Keqiang also reiterated this point on many occasions. Of course, a significant portion of the trade surplus in 2015 was due to the slump in commodity prices. China's imports of many of the commodities in volume terms registered positive growth, especially crude oil, but the value of imports dropped. Therefore, China's slowdown should not be the culprit for the decline in commodity prices. As such, in order to explain the depreciation pressures on the yuan against the U.S. dollar, one has to examine major factors such as the rapid appreciation of the U.S. dollar against other currencies, domestic and external events, and short-term market sentiment.
Does the central bank have an estimate of the magnitude of hot money?
Hot money does not have an explicit definition. Speculations are not the major forces influencing the balance of payments. Major speculative forces are in offshore markets, whereas cross-border flows under Qualified Domestic Institutional Investors and Qualified Foreign Institutional Investors schemes are limited in volume, and the size and pace of such flows are subject to management. Of course, shorting China in offshore markets can affect the sentiments of onshore markets.
We have observed that some export enterprises, affected by expectations, make decisions accordingly with regard to whether and where to convert foreign exchanges into the yuan and whether to delay such a conversion, conduct forwards transactions to mitigate forex risks, adjust the time of investment and bring forward the purchase of foreign exchange. These actions influence supply and demand in the foreign exchange market. A large number of domestic enterprises that have overseas subsidiaries can choose to put their money either at home or offshore more easily than before. But export enterprises need yuan funds to pay for wages, utilities, raw materials and spare parts. Such adjustment strategy thus has an ending. This also applies to import enterprises.
Another factor is that domestic enterprises (including foreign-invested enterprises), influenced by certain expectations, make adjustments in their liabilities, reducing or paying off U.S. dollar-denominated debts and borrowing in yuan instead in order to mitigate the impact of the U.S. dollar appreciation. China, as a major economy, has a fairly large amount of external debt, or over US$ 800 billion in 2014. To make adjustment, a massive purchase of foreign exchange from the central bank is needed. Shifting to yuan-denominated debt is made easier due to the availability and favorable prices of yuan loans. This means that if the expectations are right, adjustment of liabilities is rational, and enterprises have autonomy to make such decisions. As soon as external debt is paid off, such adjustment will come to an end. Many foreign-invested enterprises need their parent companies to use U.S. dollars for trade finance. This portion of demand is fairly large and unlikely to be reduced to zero.
As such, it is necessary to distinguish capital outflows from capital flight. It is normal for export-oriented enterprises to choose their foreign exchange conversion strategies and adjust their liability structures after weighing benefits and costs. Such an adjustment will not be endless. Such behaviors do influence capital flows and foreign exchange reserves, but they do not necessarily constitute capital flight.
As uncertainties have recently been abounded in the global financial market, some speculative forces are targeting China. Under normal circumstances, China is not the target of international speculators because it is not easy to make money due to the sheer size of the economy and abundant resources. As a matter of fact, China experienced mainly capital inflows for many years, some of which might be hot money. It is nothing strange that such money withdraws from China when opportunities are good.
You analyzed two of the major fundamental factors that affect the exchange rate, namely balance of payments and inflation. But, apart from these two, changes in the capital account also can have a large impact on the exchange rate.
Yes. Here is a summary of the capital account. First, direct investment items are basically stable, and foreign-direct investment, though experiencing some fluctuations, has remained basically stable. Second, Chinese enterprises make more outbound investments than before as they "go global." This is a natural outcome of policy opening and a better understanding of the international market by Chinese entrepreneurs. Outbound investments have been growing rather rapidly, which is a good thing.
Of course, as we have noticed, some people are pursuing emigration and investing in overseas real estate due to concerns with confidence, property protection and original sins. Some businessmen are investing overseas through acquisitions, not due to comparative advantages or to expand into new markets, but to keep a way open for an exit in the context of incomplete bankruptcy law in China.
Given the size of the Chinese economy and the high degree of opening up, capital outflows do exist side by side with normal investments and there is room for improvement. However, the amount is not large compared to China's trade volume of US$ 4 trillion per annum and several trillion dollars of foreign exchange reserves. It is necessary to differentiate the magnitude of various flows when making estimations. Furthermore, problems will be gradually addressed as the legal system in China continues to improve.
The direction of the reform of yuan exchange rate regime
What will be the direction and pace of the yuan exchange rate regime reform in the next stage?
The exchange rate regime reform will be carried out unwaveringly. We are patient. We hope to see substantial progress in the exchange rate regime reform during the 13th Five-year Plan period, moving toward greater reliance on market forces and a more flexible exchange rate.
The direction of yuan exchange rate regime reform remains unchanged, that is, a managed floating exchange rate regime based on market supply and demand and with reference to a basket of currencies. First, market supply and demand are emphasized. The market is to be respected despite the existence of short-term speculative forces. In the mind of the central bank, there is not an optimal, model-produced exchange rate level. The reference to a basket of currencies is a natural choice for China as a country with diversified trade partners and investment in multiple regions. The reference to a basket of currencies was not emphasized in the past with our focus on the U.S. dollar. In the next step, we will strengthen the reference to a basket of currencies. We have always held the view that the efficient market hypothesis cannot be relied upon 100 percent. A market deficiency may demonstrate itself from time to time when the market is dominated by speculative forces, short-term sentiments or herding behaviors, and therefore certain management is necessary for a floating exchange rate. Our aim is to have the exchange rate "broadly stable at an adaptive and equilibrium level," and there are interactions between the two. Although the equilibrium level defies an accurate assessment, a broadly stable exchange rate level can only be achieved when it is around the equilibrium level. Stability is impossible when the exchange rate is at a wrong level or in disequilibrium. Meanwhile, the pursuit of an equilibrium level can only be facilitated by the presence of general stability. Few will heed fundamentals or equilibrium analysis in times of turbulence and turmoil.
For a country as big as China, to achieve the reform goal may require a considerable period of time. To press ahead with reform, one should take decisive actions when windows of opportunities open up, but refrain from reckless moves in the absence of such windows. We can wait a bit and create more favorable conditions for reform. We emphasize balancing reform, development and stability for the Chinese economy. The international economy is recovering from the crisis. This emphasis is still relevant. We are pragmatic, patient and determined with our goals, but do not target to move in a straight line toward reform goals. We will continue with reform efforts, and will also continue to be a responsible big economy.
The yuan exchange rate regime reform is making headway in the context of another round of global financial market adjustment. There has been much talk on the spillovers of China's financial markets. Do you think this is fair?
A lot of volatility in the financial market is driven by events. Between the Fed's announcement of QE tapering and its first rate hike, many trading opportunities were created. Meanwhile, event-driven transactions are amplifiers. Heightened volatilities may easily get on people's nerves and induce finger-pointing. The launch of important policy measures should take these new factors into account.
In the past, the weight of China's economy in the global economy was not big, and we were not accustomed to the possible spillover effects of our actions on the global economy and markets. Nowadays, the Chinese economy does have spillover effects. When the volatility of financial markets is intensified by market events amid heightened uncertainties worldwide, the international community pays greater attention to such spillovers. We will promote the yuan exchange rate regime reform prudently, choose appropriate opportunities and windows, and minimize negative spillovers, especially to avoid adverse interactions of various effects.
There have also been spillovers among the domestic stock market, the bond market, the foreign exchange market and the money market, which reflect by nature interactions among price distortion, soundness, bubble and resilience. As required by the Central Economic Work Conference, cross-contagion and adverse feedback among domestic financial markets should be avoided to prevent systemic risks. We've learned from the global financial crisis, which started from the 2008 subprime crisis in the U.S., that cross-contagion between the real estate market, the subprime market and shadow banking system in the United States produced disastrous impacts. There is also the soil for such contagion in China. Therefore, advancing reform should pick good windows of opportunities and requires art in timing, cooperation and skills of execution. Some reforms will lose momentum if suspended and the "once bitten, twice shy" mentality should be avoided. Certainly, another extreme should also be heeded, as international experiences have shown that caution should be exercised to avoid "transition trap" and "reform fatigue."
Since the second half of 2014, the U.S. dollar strengthened significantly while the euro and yen depreciated by a large margin. The yuan basically followed the trend of the U.S. dollar, weakening against the dollar but not much. Therefore, the yuan has accumulated some depreciating pressure against other currencies. These are endogenous adjustment pressures. In the past few years, the yuan exchange rate was very stable compared with other currencies, with almost the smallest volatility globally. This has created unrealistic expectations in the domestic and international market that the yuan should remain very stable all the time. In this context, even a tiny move in the yuan exchange rate may trigger very strong external responses with regard to potential spillovers. In reality, in comparison with the yen and euro, the volatility of the yuan exchange rate is much smaller, not to mention the currencies of emerging markets such as Russia, Brazil and South Africa. However, people's thinking is easily subject to inertia and needs time to adapt. Therefore, playing up the spillovers of China is unfair indeed in some way.
Does the central bank pay more attention to the yuan's exchange rate relative to a basket of currencies after the release of three yuan exchange rate indices on December 11?
Currently the yuan exchange rate regime is neither pegging to U.S. dollar nor a free floating system. In the foreseeable future, to enhance the reference to a basket of currencies, namely keeping the basket exchange rate at a broadly stable level will be the keynote for the yuan exchange rate regime reform. A more mature reference mechanism to a basket of currencies will involve a series of arrangements, including guiding market estimation of the exchange rate level that remains stable relative to a basket of currencies and requiring market makers to consider the need for a stable basket rate when making quotations for the central parity, as well as the central bank's policy to keep the basket rate stable when making exchange rate adjustments. As a result, the stability of the yuan to a basket of currencies will be strengthened and the two-way volatility of yuan to U.S. dollar enhanced.
During the reform of the exchange rate regime, we will significantly enhance the reference to a basket of currencies. But this does not mean pegging to a basket, as there are many other factors influencing the exchange rate. Though pegging to a basket of currencies would better guide market expectation and market understanding of exchange rate movements, there will also be difficulties. First, there is an issue of how to incorporate the impact of macroeconomic data releases. Second, how to demonstrate that market supply and demand is the basis, as the force of market supply and demand should be given more consideration if it points to a different direction from that shown by a basket of currencies. Third, how to choose the weight of a basket of currencies, as there is no consensus. It can be a trade-weighted basket, an SDR basket, or baskets with other weighting methods. Different baskets result in different indices. It will be a gradual process to enhance the reference to a basket of currencies. Now three yuan exchange rate indices have been released, and the future design of the regime will be adjusted according to macroeconomic developments and market supply and demand.
A mature and transparent regime will come out of explorations and implementations. Currently, a consensus has been achieved to enhance the reference to a basket of currencies, and the pricing mechanism of central parity has incorporated factors to stabilize the basket exchange rate. In operation, keeping the stability of the yuan exchange rate to a basket of currencies is the major goal, and intra-day yuan volatility against U.S. dollar will be managed in an appropriate manner. In the future, a mechanism for macroeconomic data to influence the exchange rate will be introduced. The central bank will enhance market communications and strengthen the role of yuan exchange rate indices so that the market could judge the effectiveness of the mechanism with reference to a basket of currencies.
Economic policies of every nation can have some spillover effects. In this respect, can we expect international coordination mechanisms to play a bigger role?
I would say that such an international coordination mechanism is yet to be established, but efforts related to the SDR are aiming at building one. At present, there're discussions with the hope of sharing burdens and safeguarding stability through coordination. Those discussions are helpful, but years of hard work are still ahead of us.
There's a view in the market that the rules for the yuan exchange rate regime are not transparent enough, which gives rise to the need to guess the reasons behind central bank decisions. How could the central bank improve its communications with the market?
First of all, the central bank definitely has a clear and strong willingness to improve communications with the public and the market. And we did have some very successful communications in the past. However, good communication is never an easy thing.
Currently, there are many uncertainties in the global financial market, which have led to the divergence of opinions and many debates. In these days of stress, everybody hopes for a person of foresight or an authoritative voice that could turn uncertainties into certainties. But uncertainties do exist in the market, which cannot be simply eliminated by some words of assurance. The central bank is neither God nor magician that could just wipe the uncertainties out. Therefore, sometimes the central bank has to say, "Excuse us, but we have to wait for new data inputs."
With respect to forward guidance, there're a few questions to consider. The first is about guiding the market. Could central banks outsmart the market in the quality of personnel or in terms of information collection? Are central banks' theoretical basis or forecast models necessarily better than those of the market? The second is the relationship between forward guidance and traditional monetary policy tools. When there is no more space for tools like policy interest rates and open market operations, we have no other way but to discuss the future. Thirdly, we can learn from international experiences that debates are unavoidable at times, and even within central banks there is sometimes internal divergence of viewpoints. At these particular times, the signals sent by forward guidance cannot give the market much relief.
The yuan strengthened for many years in the past, and China's foreign exchange reserves have kept building up. This cannot be an open-ended process. There must be a peak or turning point eventually. Before the turning point appears, overshooting in appreciation is unavoidable and requires adjustment. After the turning point, overshooting in depreciation is also possible. After that, there will be a trend of appreciation again, as the economic fundamentals point to a stronger yuan. The overall trend is for the yuan to gradually move toward stability through stages of adjustments and fluctuations, which is a dynamic feature of the system that objectively exists. China's foreign exchange market is still not a fully competitive and sophisticated market. The central bank has different communication strategies for different market participants. To the general public, the central bank focuses on communications in knowledge and institutional frameworks. For institutions that use foreign exchange, such as importers and exporters, it is important for the central bank to guide and stabilize their expectations. For speculators, however, the central bank views them as rivals in a game, and it is unimaginable for the central bank to reveal its operational strategies to them. This is like a player who will never reveal his next moves to the opponent in a game of chess.
Managing Capital Flows
Many people are worried about the declines of foreign exchange reserves. How does the central bank view and manage speculation?
Speculation is not rare in the market, and it is sometimes hard to distinguish speculation from risk management operations. China has the largest volume of foreign exchange reserves in the world, and we will not let speculative forces dominate market sentiment. The scope of usage for foreign exchange reserves covers not only international payments, but also financial stability. China's foreign exchange reserves are more than enough for international payments, and its role in safeguarding financial stability is a key function. China's capability in this regard is beyond question. As capital flows in and out, the foreign exchange reserves may decline now and increase later. As long as there's no problem in the economic fundamentals, rises and falls of reserves are perfectly normal.
Nevertheless, not letting speculative forces dominate market sentiment doesn't mean we will engage in a head-on fight as long as there is a sign of speculation. We also need to consider effective use of ammunitions to minimize costs. Further reforming the exchange rate regime itself will give us more flexibility in responding to market speculation. If the fixed exchange rate in the past was considered an unmovable steel shield, the more flexible exchange rate could be considered a sponge shield, with which we could better manage excessive speculation.
Recently the central bank has tightened yuan supply in the offshore market, which has a relatively large impact on yuan internationalization. How do you strike a balance between the two targets?
We certainly hope to see smooth progress of yuan internationalization. It is impossible to wish that all the good things will happen in economic performance. The process of yuan internationalization will move forward like waves do. If speculation becomes the key problem in the foreign exchange market, we'll emphasize dealing with speculation. However, when the market gradually goes back to a relatively normal state, yuan internationalization will keep on.
Will capital controls be strengthened in the face of speculation and cross-border arbitrage?
We will make overall arrangements and take into consideration both the ease of cross-border transactions and risk prevention. We will continue to facilitate trade and investment aggressively, while at the same time strengthening risk prevention, emphasizing anti-money laundering, fighting against tax evasion, tax base erosion and profit shifting, and illegal financial activities. We will continue to stress the fulfillment of application and declaration obligations in international payments and the requirement of authenticity and full compliance, and crack down on activities that are illegal or against regulations. But all the regular demands for foreign exchange will be met and remain undisturbed.
Recently, there are people saying that China will adopt this or that capital control measure. Some are apparently spreading rumors to create panic among households and trade enterprises to the benefit of the speculators' bets. There are even rumors about controls against current account transactions. For example, some rumors claim that the State Administration of Foreign Exchange (SAFE) will restrict repatriation of profits by foreign-funded enterprises. This belongs to current account transactions and has been allowed all the time, and SAFE has never imposed any limit on it. With respect to capital account transactions, enterprises can obtain foreign exchange to fund acquisition and establishment of subsidiaries and representative offices overseas through normal procedures. The financial market is different from the real economy in that in many situations confidence is more important for the stability of financial market.
International experiences have demonstrated that controls over capital account transactions work for a closed economy, but are usually not effective for those relatively open economies. In addition, capital control is more effective in preventing excessive inflows than outflows. As a large and open economy, China depends more heavily on trade than many other large countries, with trade volume exceeding US$ 4 trillion per annum and involving millions of import and export enterprises; it also has more than 100 million cross-border travelers each year and 50 million citizens living overseas. The capital stock of foreign-funded enterprises is more than US$ 1 trillion. They are all stakeholders of the yuan exchange rate and exchange system. Any inappropriate control will cause inconvenience and disturbance to the real economy and trade, potentially undermining confidence and international payments. Moreover, due to the high degree of openness, market participants can usually circumvent controls. We will carefully strike an appropriate and feasible balance between enforcing laws and regulations and managing and maintaining trade and investment facilitation and the degree of opening-up.
The proposals for the 13th Five-year Plan state that the building of a macro-prudential policy framework will be strengthened, and there will be reforms to improve the financial regulatory framework to adapt to the development of modern financial markets. Why is macro-prudential policy framework so important?
In fact, macro-prudential policy framework is not a new concept. It was discussed and proposed for development at the G-20 Summit in 2009, and was already in use in the late 1970s. Many economies have also adopted measures to the similar effects. However, more focus was on micro-financial regulation prior to the global financial crisis, while the importance of macro-prudential policy was neglected. Tremendous changes have taken place since the outbreak of global financial crisis in 2008. Central banks could not single-mindedly regard keeping inflation low as their only mandate, but instead should also be responsible for maintaining the health and stability of the financial system to prevent crisis. Improving the macro-prudential policy framework has already become a major trend and a key element in global financial sector reform.
After the crisis, it has been gradually recognized that the pro-cyclicality of financial system and cross-market risk contagion may cause shocks to macro economy and financial stability, and even trigger systemic risks. Adopting macro-prudential policy is mainly aimed at addressing this issue.
Currently, macro-prudential Policy is a widely used term around the world, which is a general term that covers policy objectives, assessments, tools, transmission mechanisms and governance structures for macro-prudential management and runs parallel to monetary policy.
The PBOC has been promoting and improving macro-prudential policy framework since 2009. How has been that undertaking going?
We have talked on several occasions about and adopted a macro-prudential policy framework since the outbreak of global financial crisis. Research was first conducted around July and August 2009 when different assessments about situations at that time gave rise to diverging views on who should lead the efforts in developing a macro-prudential policy framework. The term, macro-prudential policy framework, was officially introduced at the Central Economic Work Conference at the end of 2010. From early 2011, the PBOC began to calculate desirability loans in a countercyclical manner by largely relying on capital adequacy self-regulation and reasonable need of economic growth, and to build incentives and constraints via such tools as differentiated reserve requirement ratios. These are the major elements of the last round of macro-prudential policy framework.
In this process, some tried to equate a macro-prudential policy framework with old-fashioned, quantity-based management, regarding it as an administrative measure. In fact, this is not right. As an institution responsible for macro adjustment, the PBOC only put in place the differentiated reserve requirement ratios in 2004, with no other incentives or constraint mechanisms targeting the credit expansion by financial institutions. Calculation of the desirability of loans based on capital self-discipline was introduced later, which is still based on capital, but with a countercyclical factor. Therefore, it is consistent with a macro-prudential policy framework, but not exactly the same as the one used internationally, as it takes into consideration China's circumstances.
The macro-prudential policy framework has played an important role. Otherwise, simultaneously dealing with the slowdown in economic growth, making difficult structural adjustments and absorbing the effects of previous economic stimulus policies might have exerted a more pronounced negative effect. As a result, it is natural to upgrade the framework now.
China has made a lot of innovations in theory and practice in macro-prudential policies and later the macro-prudential assessment framework. Why is China at the forefront of this issue?
After the global financial crisis, the PBOC voiced its viewpoints during different international events. In particular, we submitted a report on correcting pro-cyclicality at the annual meeting of Bank for International Settlements (BIS) in Sao Paulo in November 2008, noting that there are many pro-cyclical factors in the economy, namely, there are too many positive feedback loops while negative feedback is inadequate. The term macro-prudential was not used in an explicit manner at that time. After debate, the BIS said macro-prudential was used once and could be used again. At the same time, such concepts as positive feedback, negative feedback, oscillation, bubbles, pro-cyclicality and counter-cyclicality were all included in the macro-prudential policy framework, which was submitted to the G-20 London summit for deliberation in April 2009.
At that time, countries were divided on the judgment of economic situations. China was the first to recover from the crisis, and thus was in need of some countercyclical adjustment. So the PBOC developed the macro-prudential policy framework by taking into account China's specific circumstances. Most of the macro-prudential policy measures adopted around the world were introduced afterwards. For instance, Basel III was introduced in 2010, including countercyclical capital buffer, which was then further developed by expanding to leverage ratio, liquidity coverage ratio and net stable funding ratio. As China was the first to recover, it may enter a period of excessive stimulus. Therefore, we need to act earlier.
There was another term at that time, which was macro-prudential regulatory framework, but it was changed into macro-prudential policy framework. Why was the change made?
During discussions in April 2009, it was proposed that central banks should be responsible for making judgments about macro-prudential policy and cyclical issues, as regulatory authorities were not good at making macroeconomic assessments. Policy design should be consistent with implementation. Problems would arise if policy design and implementation were separated. However, coordination should also be emphasized. After discussion, the term was finally changed into macro-prudential policy framework. Based on country-specific circumstances, the Basel Committee suggested that macro elements like capital buffer should be added to the Basel III to make adjustments in line with economic cycles. This has appropriately distinguished macro-prudential from micro-prudential policies.
The macro-prudential Assessment framework released by the PBOC in late 2015 contains indicators for seven aspects, including capital and leverage, assets and liabilities, liquidity, implementation of credit policy and the like. For the time being, can these macro-prudential management measures meet the needs of safeguarding financial stability and preventing financial risks?
It has covered major existing concerns, but may prove inadequate for future development. Macro-prudential management measures still face many challenges, such as regulatory coordination and lack of necessary information and statistics, which are the very foundation for macro-prudential assessment and policymaking.
On the other hand, we need to emphasize the synergy between macro-prudential policy and financial regulation to prevent lack of communication, policy overlapping or deviation, which may undermine the effect of adjustment. Macro-prudential policy also requires effective implementation mechanism to avoid costly coordination.
There is another issue, i.e., innovation and development of macro-prudential policy tools has lagged behind. The lack of new tools has reduced to some extent the effectiveness of measures for macroeconomic regulation and safeguarding financial stability.
So it follows that only with good coordination with financial regulatory reforms can macro-prudential policy yield twice the result with half the effort right?
In general, macro-prudential policy can compensate for existing weaknesses of the financial management system. Under traditional arrangements, monetary policy mainly targets price stability, but financial markets and asset price may still undergo large volatility despite a basically stable CPI. Financial regulation focuses on the health of individual institutions, but the health of individual institutions does not equal to soundness of the whole financial system. Pro-cyclicality of financial rules and the contagion of risks among individual institutions may also amplify instability of the entire system, triggering systemic risks and even financial crises.
In the past, there was a gap in how to prevent systemic risks between macro monetary policies and micro-prudential regulation. Therefore, one of the objectives of this round of financial regulatory reform should be to strengthen the macro-prudential policy framework.
The digital yuan
The PBOC held a seminar on digital currency on January 20, saying that the central bank will try to launch its own digital currency as soon as possible. What are the considerations behind this?
The PBOC has studied digital currencies for a long time. History shows that currency has evolved abreast of technological advances and development of economic activities. The evolution from early-stage physical currency and commodity currency to the later credit currency was a result adapting to the development of commercial society. Paper money, as the last generation currency, lacks high-tech support, and it is an irresistible trend that paper money will be replaced by new products and new technologies with greater security and lower costs. With the rapid development of the Internet and the significant changes in the global payment systems, it is necessary to establish the issuance and circulation system of digital currency, which will help build the financial infrastructure and improve the quality and efficiency of the economy.
How can a digital currency replace paper money? There are several ideas. One is to make digital currency anonymous, like paper money which is transacted anonymously, and this anonymity will determine the technology. But paper money is not designed to be anonymous. It is anonymous because no real-name technology can ensure the convenience of a large amount of small-value transactions. Some people assume that it would be better for digital currency to be transacted anonymously in the future because the government may fail to protect people's privacy regarding wealth and the use of wealth, which should definitely be protected.
From the central bank's perspective, a digital currency should be designed in a way that can best protect people's privacy, but we also need to pay attention to social security and social order. We need to keep some necessary investigative instruments readily available to deal with criminal activities. A balance needs to be struck between protecting privacy and cracking down on illegal activities. Different preferences between these two motives will lead to different technological orientations for digital currency.
What is the central bank's thinking on the issuance and management of a digital currency? Will it be different from the digital currency in the market right now?
Many countries around the world acknowledge that the digital or electronic currency issuance framework led by central banks might be different from the current private sector practice.
There are several principles underlying the central bank digital currency issuance framework. The first is convenience and security. Second, as mentioned earlier, a balance needs to be struck between protecting privacy and maintaining social order and cracking down on illegal activities, especially preserving necessary tools to fight money laundering and terrorism financing activities. Third, it should be conducive to the efficient operation and transmission of monetary policies. Fourth, the control over monetary sovereignty should be maintained. Digital currency can be converted freely but its convertibility will also be controlled. We think, therefore, as a legal tender, digital currency must be issued by the central bank. The issuance, circulation and transaction of digital currency will follow the same management principles of traditional currency.
Is there any timetable for the launch of digital currency? Will a digital currency replace paper money?
We do not have a timetable yet. China has the world's largest population and is a huge economy. It will only take several months for a small country to replace an old version of paper money with a new one. But it has taken about 10 years for China to do the same thing. So a digital currency will co-exist with cash for quite a long time before it finally replaces cash. The cost for cash transactions will gradually increase in the later stages. For instance, banks do not charge any fees for counting large amounts of coins now, but in the future they may charge their clients for the service. With the transaction costs of paper money rising, people will be motivated to opt more for digital money. But digital currency and cash will coexist for a long time.
Do we still need monetary policies once we have digital currency? How will monetary policies be implemented against such a background?
We think we still need to adjust the money creation mechanism and money supply. At the current stage, the central bank's major goal of issuing digital currency is to replace the physical cash so as to lower the costs of issuing and circulating traditional paper money and to improve the convenience. The central bank will fully consider the current monetary policy framework, money supply and creation mechanism and monetary policy transmission channels in designing digital currency.
The current practice of cash issuance and withdrawal is based on the "central bank-commercial banks" binary system. The issuance and operation of digital currency should still be based on such a system, but delivery and storage methods will change: money will be delivered electronically instead of physically, and money will be stored in cloud computation space instead of the central bank's treasuries and commercial banks' vaults. The security and efficiency of issuing and withdrawing digital currency will be significantly improved in the end.
What anti-forgery measures will be taken for the digital currency? For example, how to avoid the "51-percent attack" security loophole in bitcoins?
From a practical perspective, we should make the anti-counterfeiting knowledge of paper money easy to understand for the consumers. But fundamentally these key anti-forgery technologies are national secrets. It is the same thing with digital currency issued by the central bank. We will use many information technologies including cryptographic algorithms to make sure that the digital currency cannot be counterfeited. Technologies will be upgraded in the future. We will take that into consideration and bring in the development idea of long-term evolution from the beginning.
As for the hotly debated "51-percent attack," it is more about bitcoins. Bitcoins do not involve a central bank. For a digital currency controlled by the central bank, a combination of technological measures, institutional design as well as laws and regulations will be applied to ensure the security of its operation system. This differs from bitcoins at the very start.
Block chain technology has recently attracted lots of attention. Has the central bank considered using block chain technology for its digital currency?
The technologies of a digital currency can be divided into two types: account-based and non-account-based. These two technologies can coexist by being applied to different layers. Block chain is one option. It is non-account-based and non-counterfeiting, and features distributed ledgers. If a digital currency wants to emphasize privacy protection, block chain technology is a good choice. The PBOC has spent a lot of time and energy researching on the application of block chain technology. But so far block chains have consumed too many resources, including both computation and storage resources, and cannot handle the current transaction volume. We need to wait and see whether this problem can be solved in the future.
Besides block chain technology, the PBOC's digital currency research team has made in-depth studies on digital currency related technologies such as mobile payment, trusted and controllable cloud computation, cryptographic algorithm and secure chip. We will cooperate with the financial industry and science and technology community to continue researches on all kinds of innovative technologies, to improve the technical framework for issuing and circulating digital currency, and to fully predict, timely react to and effectively address risks that may emerge during the application. To that end, the PBOC welcomes the support, participation and contribution from all related parties so that the research can bear fruits.
Source: EnglishCaixin