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The Urgent Case for a Digital Dollar

And why it has more to do with dogecoin than China.

By , the chief global strategist at Barings and the head of the Barings Investment Institute.
Photo illustration showing visual representations of dogecoin and bitcoin.
Photo illustration showing visual representations of dogecoin and bitcoin.
Photo illustration showing visual representations of dogecoin and bitcoin. Yuriko Nakao/Getty Images

Washington worries about everything related to China—from its expanding military might to its rapid technological gains to its deeper engagement with developing countries. U.S. officials, not to mention an army of pundits, also point with rising alarm to the Chinese central bank’s launch of the digital yuan this year as the latest sign that the United States is falling behind. In the U.S. Congress, Republican and Democratic legislators, who agree on very little else, are united on the pressing need for new legislation to ensure the U.S. dollar doesn’t fall further behind in a “digital assets space race.”

Creating a digital dollar is the right goal, but doing it to counter China is the wrong reason. The real challenge to the United States’ central role in the global financial system comes less from Beijing than from dogecoin and other homegrown, unregulated cryptocurrencies. A plan to create a digital dollar that focuses only on beating China risks overlooking the strengths that make the dollar so attractive today and the opportunities for new technologies to magnify those strengths.

An individual asset like dogecoin, the most famous of the cryptocurrency memes, may not itself pose a threat. But the rapidly expanding array of alternative digital assets and “stablecoins”—cryptocurrencies backed by a major currency or precious metal—is about to shake the foundations of the global financial system, with important consequences for market stability, economic growth, and U.S. foreign policy. Even if there were no Chinese alternative already rolled out, Washington should be pushing hard to develop a digital dollar that takes advantage of the dollar’s status as a global reserve currency and the technological revolution at hand.

Washington worries about everything related to China—from its expanding military might to its rapid technological gains to its deeper engagement with developing countries. U.S. officials, not to mention an army of pundits, also point with rising alarm to the Chinese central bank’s launch of the digital yuan this year as the latest sign that the United States is falling behind. In the U.S. Congress, Republican and Democratic legislators, who agree on very little else, are united on the pressing need for new legislation to ensure the U.S. dollar doesn’t fall further behind in a “digital assets space race.”

Creating a digital dollar is the right goal, but doing it to counter China is the wrong reason. The real challenge to the United States’ central role in the global financial system comes less from Beijing than from dogecoin and other homegrown, unregulated cryptocurrencies. A plan to create a digital dollar that focuses only on beating China risks overlooking the strengths that make the dollar so attractive today and the opportunities for new technologies to magnify those strengths.

An individual asset like dogecoin, the most famous of the cryptocurrency memes, may not itself pose a threat. But the rapidly expanding array of alternative digital assets and “stablecoins”—cryptocurrencies backed by a major currency or precious metal—is about to shake the foundations of the global financial system, with important consequences for market stability, economic growth, and U.S. foreign policy. Even if there were no Chinese alternative already rolled out, Washington should be pushing hard to develop a digital dollar that takes advantage of the dollar’s status as a global reserve currency and the technological revolution at hand.

What is a digital dollar? No, it’s not the money you already see online in your bank account, which is in fact a record of your bank’s obligations to you. Rather, a digital dollar is a cryptographic representation of the money the U.S. Federal Reserve issues today in the form of cash and bank reserves.

The dawning age of blockchain innovation allows this digital money to move as quickly and cheaply as an email but with the privacy and security of a bank transfer. In effect, a digital dollar would be a version of cash in your pocket that you could transfer directly to someone halfway around the world at virtually no cost and without involving any intermediary, such as a bank.

With rising alarm, Washington officials and an army of pundits point to China’s digital yuan as the latest sign that America is falling behind.

Critics claim cryptocurrencies solve a problem that doesn’t really exist. Money moves just fine, thank you very much. (Naturally, banks tend to say this.) There are lots of ways to transfer money on your phone. But the phone in your purse or pocket may be the best analogy to crypto innovation: There were lots of convenient ways to make calls when the first mobile devices appeared, but by now, voice calls are the least useful thing about them. Mobile telephony has reimagined whole swaths of human activity—from news delivery and ride-hailing to entertainment and company meetings.

Even though privately issued currencies have worked in narrow historical circumstances, the United States’ tumultuous free banking era in the 19th century underlined the importance of government-issued alternatives. A world with thousands of alternative methods of payment sounds good to the political libertarian and the free market zealot. But it’s hardly clear how monetary policy, payment flows, and law enforcement operate smoothly in this environment. Crypto innovation that will transform money as a unit of account, store of value, and means of payment also requires rules to maintain confidence. It’s no surprise that cryptocurrencies imploded even faster than the stock market during the recent market crash.

Sweden’s central bank—the Riksbank—has moved rapidly to issue an e-krona because its officials were alarmed by the rapid disappearance of cash as consumers embraced—and banks encouraged—the convenience of cards swipes. China’s government has lots of reasons to roll out a digital yuan, but high on the list is a payments system that was dominated by two private sector giants, creating potential systemic risks. More than 100 other countries are also working on designs for their own official alternatives.

Why does the United States need a digital dollar? One simple argument is that it’s hard to imagine the dollar remaining a reserve currency while standing aside from the next major wave of financial modernization. The list of governments already incrementally shifting their reserves into other currencies because they fear the long reach of U.S. sanctions would surely accelerate if the dollar didn’t retain its indispensable global role during the coming era of distributed finance.

The United States derives enormous benefits from the dollar’s dominant status. Economically, these include revenues from seigniorage—the Fed’s profits from issuing dollars to meet widespread global demand for U.S. currency—and reduced borrowing costs for the U.S. government. Politically, the ability to sanction criminals, terrorists, and rogue governments has obviously become an important policy tool, as the financial sanctions against Russia show.

The global financial system, too, would benefit from a digital dollar. Issuers of stablecoins argue that they can offer better service and faster innovation in payments mechanisms than any central bank. But it chills the spine to contemplate a crisis on the scale of the Lehman Brothers collapse or COVID-19 without the Fed being able to inject huge amounts of the store of value that everyone trusts. And it’s hard to imagine dollars as that store of value in a future financial world defined by blockchain technology without a modern digital dollar issued directly by the Fed.

A third argument for moving quickly is less about preserving the advantages of the current system and more about advancing the values that the United States and its allies hold dear. Ultimately, the dollar’s attractiveness, as that of any currency, reflects the strengths of its political and economic system. People choose to hold dollars, ultimately, because the United States has a durable democratic system with a credible track record of protecting individual rights and property. While far from perfect, the world’s deepest financial markets are only possible because independent courts and regulators set the market rules regardless of political winds.

A digital currency offers the prospect of amplifying those values. China’s digital yuan has triggered questions about how it may tighten political control by tracking payments. A worthy digital dollar, by contrast, would actually emphasize privacy protections (especially for small private payments), financial inclusion (especially for the poorest households), and innovation (especially for creative fintech start-ups). A new digital dollar could, for example, better protect privacy as it enforces laws against money laundering. Rather than providing unsecured sensitive personal information to a financial services provider with every new account, proof of identity could be immutably stored in the blockchain, where it could be verified securely. A digital dollar would also improve financial inclusion, not least because it wouldn’t require a bank account for making non-cash payments.

The Fed’s experts are working hard on potential designs for a digital dollar, but Chair Jerome Powell suggested last week that he is not close to making a decision. He is undoubtedly right that it’s better “to get it right than be first,” but the United States is already far from first. It would be an enormous loss if it were actually last.

Christopher Smart is the chief global strategist at Barings and the head of the Barings Investment Institute. Twitter: @csmart

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