Authors: Ross Buckley and Mia Trzecinski, UNSW
For almost 80 years, the US dollar has dominated the global financial system. Its pre-eminence survived the collapse of the Bretton Woods system in the early 1970s and has even risen since the COVID-19 pandemic.
The United States has long enjoyed the many benefits that flow from this privileged position — continuous capital inflows, lower foreign borrowing costs and the power to sanction other nations. But with the development of new monetary technologies and the sanctions imposed on Russia’s central bank in 2022, this could be set to change.
Central Bank Digital Currencies (CBDCs) have the potential to disrupt dollar dominance and transform the mechanics of the global financial system by providing faster and cheaper ways to settle international trade and financial transactions. CBDCs are a form of digital currency issued by the central bank, either for use by the general public (retail) or by businesses (wholesale). Wholesale CBDCs will be used in substantial transactions and are designed to improve the efficiency of interbank, trade and financial settlements.
Retail CBDCs will make central bank-backed digital money available to the general public. Customers will likely still be dealing with commercial banks, but with the terms and conditions set by the central bank rather than the commercial bank. While the customer experience may be largely unchanged, the infrastructure supporting it will be.
In 2021, the Bank for International Settlements conducted a survey and found that 90 per cent of central banks that responded are exploring CBDCs, with 54 per cent considering issuing one in the next six years. China is leading the world in these efforts, with its CBDC — the digital renminbi (e-CNY) — expected to be the first issued by a major economy. The e-CNY has already been trialled in over 20 cities and used in over 100 billion RMB (US$14 billion) worth of transactions, giving China a massive first-mover advantage.
Wholesale CBDCs, which have attracted far less attention than their retail counterparts, pose a real challenge to the US dollar dominance and have the potential to deliver massive gains in cross-border payments. The development of CBDCs has occurred alongside growing efforts by states to build alternatives to the dollar — largely pioneered by the BRICS (Brazil, Russia, India, China and South Africa) coalition. The coalition was formed in 2009–10 to increase their role in global governance.
CBDCs are the most promising development for states looking to develop alternatives to the dollar — a quest that has been accelerated by the unprecedented sanctions imposed on Russia in 2022. In recognition of this risk, the United States has now expedited the development of a digital dollar. But it is still far behind China in this development.
Smaller economies are motivated to implement CBDCs to promote financial inclusion. The Bahamas and Cambodia have introduced their own CBDCs. These measures are aimed at improving financial inclusion for the unbanked and promoting financial stability. They address gaps in existing payment infrastructure. This is distinguishable from wholesale CBDCs in major economies that aim to improve trust in wholesale financial and international trade markets, improve efficiency and implement fiscal and monetary policy.
While CBDCs are potentially financially and technically transformative, they could also be geopolitically disruptive. A digital dollar could maintain or strengthen US dollar dominance, even with alternatives developed by rival states, because a digital dollar will be cheaper and easier to use than dollars today.
But the United States could also lose its dominant position in the global financial system as rival states develop CBDC-based alternatives, fragmenting the global economy into two or more competing blocs. There could also be a transition toward a multipolar system characterised by cooperation rather than competition, though this is the least likely outcome in the current geopolitical climate.
Each of these possibilities will pose opportunities and risks for Australia and the global financial system. But the second outcome — a global economy fragmented into two or more competing blocs, likely led by the United States and China — would be very difficult for Australia. Given Australia’s historic security ties to the United States and its economic ties to China, Australia will likely attempt to engage with the CBDC networks of both blocs.
Balancing these relationships have become more difficult, but this could be further complicated if the China-led bloc imposes political or security requirements for membership. Given the importance of exports to the Chinese economy, China may be slow to mandate use of e-CNY. But the United States has shown a willingness to use financial sanctions to address global conflicts and China is playing a long and strategic game.
Australian policymakers must begin preparing for these challenges. The Reserve Bank of Australia is already working to identify the uses for a digital Australian dollar. While the issuance of CBDCs is likely to significantly impact the global financial system and Australia will have very limited influence over the outcome of this disruption, our policymakers need to think of approaches and strategies that will mitigate the risks and realise potential benefits.
Ross P Buckley is Scientia Professor in the School of Private and Commercial Law at the University of New South Whales.
Mia Trzecinski is Research Fellow at the University of New South Whales.