The Chinese are credited with the invention of paper money. And now, 1200 years later, they may be leading the way in another money innovation – digital cash.
Around 800 A.D., during the Tang dynasty, Chinese businessmen had a problem: To trade in distant regions, they had to carry large amounts of heavy metal coins. This wore out the horses and increased the risk of attacks by bandits. So bankers came up with the idea of using the recently invented printing press to print paper notes with official seals, which could be exchanged for coin money. They called this paper “flying cash” because it could blow away in the wind.
In the present day, the head of the People’s Bank of China (PBOC) recently confirmed that China is developing a bitcoin-like “cryptocurrency” that would be controlled by the central bank. This would give the PBOC more control over its economy.
Bitcoin is digital money that is created and held electronically. At the core of bitcoin technology is a kind of super database called the “blockchain.” The blockchain is public and accessible to anyone, just like the internet.
The blockchain contains every transaction in the history of bitcoin, and is constantly growing. When you use bitcoins to buy something, a global network of computers checks the blockchain database, verifying that you own the bitcoins. It’s like thousands of computerized notaries instantly checking, authenticating and guaranteeing every transaction.
This is different from using a credit or debit card. When you buy something with a credit card, a financial middleman, like a bank, verifies every transaction. This takes time, and they charge you a fee for the “service.”
In a bitcoin transaction, the verification and transfer is performed instantly by the blockchain. There is no middleman. Many believe that as bitcoin-like technology matures, it will be used to process everything from stock trades to voting. These more efficient, less costly transactions could end up saving individuals and corporations billions of dollars.
Just as the internet gave everyone more access to information, many predict that blockchain technology will revolutionize the world of financial transactions. As much as 75 percent of the world’s population currently can’t buy anything online, because they don’t have a bank account or credit card that allows them to do this.
The blockchain allows anyone in the world with a phone to make transactions directly, skipping the middleman. This could be a huge boon to retailers and to global business in general.
A growing number of governments, like China, the U.K., Canada, the Philippines and Ecuador, are taking a serious look at developing their own digital currency. However, when they introduce their own digital currency, they may ban alternatives, like bitcoin.
And this is where the conspiracy theories come in. Countries may have more on their minds than just helping their citizens eliminate transaction fees. Certainly, there would be more financial surveillance with fewer cash transactions – something not all citizens would welcome.
Many think governments are waging a war on cash. For instance, there is talk of the European Central Bank scrapping the 500 euro note. And in the U.S., some academics are calling for the end of the US$100 bill. The reasons given are to reduce crime and terrorism, because large bills make it too easy to move dirty money around.
But, with less cash, and a digital currency, central banks would find it easier to control the money supply. As we discussed, when there is deflation, that is, when prices are falling, businesses and individuals hoard cash, whether in bank accounts or under their mattresses.
Central banks try to fight deflation by lowering interest rates, hoping to make bank-held cash less attractive – and motivate people to withdraw, spend and invest more to stimulate the economy.
The problem many central banks have is that a decade of low interest rates hasn’t helped grow their economies. And with rates near zero, central banks can’t go any lower.
So, many central banks have instituted negative interest rates, whereby banks have to pay to hold cash. The hope is this will motivate banks to lend more money, that will then be spent and the economy will be stimulated. At the very least, people would tire of earning no interest on their savings and decide to spend or invest it.
However, with paper cash as an alternative, rather than earn zero interest on bank deposits, and pay bank fees for the privilege, people can simply withdraw their money and put it under the mattress. The central banks don’t want this—they want cash hoarders to use their savings to stimulate growth.
If an economy was completely cashless, and all deposits were digital currency, a central bank could in theory “tax” all deposits and force people to spend or invest, without worrying they’ll just stash the cash. In fact, prominent economists have argued that the world would benefit from the “end of cash.”
And China may have other motives for setting up its own digital currency. China is the largest market for bitcoin users. Four of the five largest bitcoin exchanges are based in China, and the yuan is the most traded currency on bitcoin exchanges.
Plus, according to Bloomberg, an estimated US$843 billion of money left China in the 11 months through November 2015.
So, is the Chinese government looking for a way to control the digital currency market and stem the flow of money leaving the country?
Paper money and coins have been used for centuries and are not going to disappear. There is something very human about exchanging paper bills for goods or services. It remains to be seen if digital money will ever completely replace good old cash. Or, why governments and central banks are looking into their own digital currencies.