Fmr Central Bank Governor Zhou on Digital Currency & Electronic Payment (DC/EP)

Not to challenge the USD or sideline Chinese Big Tech

Zhou Xiaochuan, the former governor of the People’s Bank of China from 2002 to 2018, gave a detailed speech on China’s DC/EP (Digital Currency Electronic Payment) on Saturday, May 22, at the 2021 Tsinghua PBCSF Global Finance Forum.

Bloomberg, Global Times, and CGTN ran brief reports of his speech, but your Pekingnologist thinks it deserves more attention, not only because Zhou is highly respected both domestically and internationally (Scott Kennedy, CSIS), but also because he responded specifically to the various points featured in international media - in Zhou’s own words:


With all the media and discussions and voices, we still need to enhance communication and discussions in this area, so that society, including the global community, can have a clearer understanding of the progress and development of digital currencies and a better understanding of China's DE/CP and e-CNY.

If you haven’t been familiar with the prevailing Anglophone narrative on DC/EP, read James T. Areddy’s impactful piece on the Wall Street Journal in April, which stands out among numerous similar reports.

There are not many “analyses” in this particular newsletter - Zhou was mostly very clear, and your Pekingnologist isn’t exactly an expert on DC/EP - or anything else. So this is largely just a translation, based on the transcript published (Mandarin) on the website of Phoenix TV.

To make the sharing easier, the English translation of Zhou’s speech in a PDF has been uploaded to Google Drive.

There is another 269-page PDF containing all the speeches - mostly in Mandarin - made by guests to the 2021 Tsinghua PBCSF Global Finance Forum. Zhou’s speech is from Page 95 to 108. The guests are influential Chinese and international figures in finance and economics so you may want to take a look at them, also uploaded to Google Drive.


Summary by your Pekingnologist:

1) DC/EP is not designed to replace the U.S. dollar as the reserve currency or the international payment currency, to begin with.

2) DC/EP helps RMB internationalization somewhat, but not a big help. RMB internationalization has much more to do with China’s reform and opening up and institutional arrangements.

3) DC/EP is not intended to sideline existing third-party payment channels (Alipay, WeChat Pay, etc.)

4) China’s R&D and pilot of DC/EP is shall NOT aim unrealistically high, i.e. solving a lot of problems all at once.

5) Controlled anonymity, a principle of China’s DC/EP, is to strike a balance between privacy protection and anti-money laundering.

6) China’s DC/EP should prioritize the improvement of the retail part of the payment system, not other parts of the system. Some payments, such as international trade and cross-border remittance, cannot be significantly improved by DC/EP alone.




Today, I would like to talk about an academic issue, "digital currency and electronic payment system."

This topic has been discussed a lot for a period of time, and it is indeed a clear issue of the Communist Party of China Central Committee and the State Council and has been included in the 14th Five-Year Plan. DC/EP is to be actively explored, developed, piloted, and promoted. However, after reading many media reports and comments in this area, I found that there are still many concepts that need to be further clarified and some issues on the direction of DC/EP still need to be explored. Although China has already entered the R&D and pilot phase of DC/EP, there is still much to discuss in terms of understanding this issue, so I take this opportunity to share (my opinions) with you. At the same time, I feel that it is also of international interest. Of course, I am now in this position as an observer, and I am actually at a certain distance from some specific issues in the R&D and pilot process, and my observation may not be very accurate, but I would like to discuss this topic with you.


First of all, the media, especially the foreign media, had some discussions on this issue which caused certain misunderstandings. As I said earlier, we have actually had a lot of discussions on these basic concepts in the past few years, but it is not that we have all gained a consensus or have a deep understanding of this issue.


To cite a few examples, one of the more common statements in the foreign media now is that China's DC/EP or e-CNY cannot replace the dominant position of the US dollar in the international arena, no matter how much it develops. I think this is not a correct proposition, to begin with, because the development of DC/EP is mainly targeted on the modernization of the domestic payment system, keeping pace with the digital economy and the Internet era, improving efficiency, and reducing costs, especially for the retail payment system, which is not designed to replace the U.S. dollar as the reserve currency or the international payment currency.


There is another argument, which is also more talked about by foreign media, that the development and piloting of the DC/EP is closely linked to the internationalization of RMB, and that the DC/EP is not very helpful to the internationalization of RMB, or that it will not achieve the internationalization of RMB. I think this issue, the modernization, and digitization of the RMB payment system will help to a certain extent to improve the status of the RMB and to improve the cross-border use of the RMB, but it is not a big help. The internationalization of the RMB depends more on institutional and policy choices, and more on the progress of China's reform and opening up, rather than on technical factors.


There is also the discussion that the DC/EP or e-CNY promoted by the People’s Bank of China is trying to replace the current role of third-party payments, which I think is also false. The PBoC clearly said that the DC/EP plan is a two-tier system, and the whole R&D team is organized by the People's Bank of China, with the participation of major commercial banks, including the ICBC, Agriculture Bank of China, Bank of China, China Construction Bank and others, as well as telecom operators and a few major third-party payment institutions, all aiming at upgrading to a new stage based on their previous work. Everyone is in the same boat. Granted, people in the same boat sometimes have different views, and sometimes there may be controversy on some issues, but after all, it is the same boat. It is not what some people say as if it is a kind of infighting, or who will replace who.


I happened to watch a movie the other day about playing volleyball. I wanted to use this as an example. How volleyball players train (themselves)? Playing volleyball, one wants to increase the strength of the offense and smash, so the athletes need to train muscles. Then some people on the side see this training and then start to say things like "your muscle training is good, but however you train, you’ll have no hope in winning any weightlifting competition." The (volleyball) team would say we have no intention to participate in weightlifting competitions (at all), so don't talk about such irrelevant things.


I cite this example to say that some unwarranted concepts or references actually originate in a lack of understanding of the R&D program and the pilot (of the DC/EP). At the same time, these misconceptions are prone to causing the thinking “that mountain is always higher than this one”/the grass is always greener on the other side of the hill. The plan has already been proposed, and it is already in the process of system building and piloting - do not play volleyball and at the same time wanting to win in other sports, which could be a problem.

These highlighted sentences appear to be a warning to some of the domestic audience: the ongoing DC/EP program shall stick to its set cause and not be induced by all the exaggerations to aim for unrealistically overblown targets that Zhou “debunked.”


Then there is the debate about “controlled anonymity.” In fact, payment systems necessarily have to strike a balance between protecting privacy and anti-money laundering, anti-terrorism, anti-drug, and anti-cross border gambling. On the one hand, privacy should be guaranteed; at the same time, the necessary monitoring of certain activities has to be implemented. So if you look at this from two perspectives, there are people on the left who say you're not protecting privacy enough, and there are people on the right who say you're condoning money laundering and drug dealing. So necessarily a balance is somewhere in the middle, but that balance can also be a little to the left or a little to the right. The concept of controlled anonymity, as explicitly proposed by China's DE/CP, is not a mathematically precise point in terms of controlled anonymity itself, but it expresses the idea of finding a balance between privacy protection and anti-money laundering and anti-drug dealing. We can look deeper into where this point of balance is, but we should not intentionally or deliberately use this issue to belittle or attack the DE/CP process.


There is also the issue of whether the power to issue digital currencies should be subject to special legislation and so on. and I will say a few words about this later when I have the opportunity, and there may be a lot of conceptual aspects that need to be discussed in the middle of this.


All in all, with all the media and discussions and voices, we still need to enhance communication and discussions in this area, so that society, including the global community, can have a clearer understanding of the progress and development of digital currencies and a better understanding of China's DE/CP and e-CNY.

Zhou’s speech gets quite technical and theoretical from now on.


Secondly, I'd like to talk about modernizing the payment system. What should we focus on in modernization? First of all, we say that digital currencies can have many different priorities from a global perspective - some focus on improving the effectiveness of the retail system, some focus on wholesale transactions, and some focus on the possibility of adopting a new payment and settlement system for transactions on exchanges and financial markets. Some say there is so much global trade, including trade in goods and services, so can trade in goods and services can be more convenient (?) When Facebook first launched Libra, it felt that cross-border remittances were inconvenient and could it be made more convenient (?) Some people also mentioned the convenience of cross-border investment. So it is possible that there are prospects for development (of DC/EP) in several areas. I would like to talk about what we should focus on. On the whole, the modernization of the payment system is taking one step after one period of time, and this step generally speaking needs to be a relatively large step, so people have enough motivation (to do it).

For example, it’s like the upgrading of a smartphone. Some manufacturers published an update every few months, but from the customer's point of view, he or she just spent money to buy the smartphone not long ago, and the smartphone was still good enough, and the upgrade might not have brought large progress. (So the customer might refrain from buying the upgraded phone instantly.)

So, we would only think about upgrading the system only if this step is relatively large. After that, we would think about upgrading. Very small steps and tiny improvements offer insufficient incentives to change the system. So we gotta use the gap (before and after the upgrading) to measure how big the step should be, to decide what direction we should choose.

怎么看这个台阶呢,一个是看系统的功能,它的效能怎么样,它的表现怎么样。第二个看成本,是不是成本能够降低,效能跟成本一比就是性价比。此外还要看看这个系统出错的可能性,因为金融系统涉及到稳定,涉及到信心,对出错的概率是非常关注的。还有一个就是很难避免百分之百不出错,小概率会出错,出错以后究竟能不能纠正这个错误。比如说支付错了,能不能退款,能不能止损,信用卡里也有一个叫charge back,就是能把这个钱找回来。再有一个从性能上风险控制的能力,这个系统有多强的风险控制能力。有时候一些技术从技术开发的角度来说,非常希望能用他的技术,但是从金融系统的角度来说,对于稳定性、风险控制、出错概率以及纠错能力的重视,可能比从技术角度来讲要求更高一些。

How to look at this step? One is to look at the function of the system, how effective it is, how it performs. The second is to look at the cost, whether the cost can be reduced, the efficiency, and whether it is cost-effective. In addition, we should also look at the possibility of errors in the system, because the financial system involves stability and confidence, the probability of errors is a huge concern. Another angle is that since it is difficult to be 100% error-free, there always remains a small probability of error, so can we correct the error after it happens? For example, if there is a wrong payment, can you refund, can you control the damage? There is a function in the credit card system called “charge back.” That is, to get the money back. Then there is the ability to control the risk in the performance, how strong the system is in its ability to control the risk. Sometimes, from the (narrow) viewpoint of technology development, it is highly expected to use that technology (because it is advanced). But from the point of view of the financial system, stability, risk control, the probability of error, and the emphasis on the ability to correct errors may take a higher priority than just the technology.


From these perspectives, China attaches more importance to the retail system, which can take a bigger step. China is a society that uses more cash, but its cash use is not particularly prominent from a global perspective. I estimate that even in developed countries where credit cards are more popular, it is still worthwhile to take this step up (in the retail system) with the emergence of the Internet, especially the mobile Internet. In addition, this is also the demand of customers, who do not want to have too complicated, too many different payment methods. They, with smartphones, would like to see the emergence of a mainstream retail payment method via mobile internet. The cost savings of this step is great, so the impetus to move forward is relatively large.


From the wholesale point of view, there are now some countries looking to engage in CBDC (Central Bank Digital Currency). From my personal observation, China’s e-CNY is not exactly CBDC, but of course, it can also be included in the big topic of CBDC discussion. However, China’s e-CNY also has its own characteristics. There is a kind of CBDC that’s mainly on the wholesale payment. Most of the commoners and people outside the financial do not know much about the wholesale part of the payment system, they do not know the clearing system behind it, they do not know how the bank clearing and settlement behind it works. They don’t know how the clearing system behind it works, how the bank behind it clears and settles, etc. They don’t know if the system is currently less effective, if it makes mistakes, if it costs too much, if it overcharges the bank, and if the fees charged are indirectly passed on to other bank customers. With the development of technology, there is a great potential to further improve the wholesale system. But at present, there is not a lot of room for improvement in cost-effectiveness; even if there is an improvement, it is not very obvious, and society will not feel too much about the improvement. In general, we feel that the wholesale (part of the payment) system should also be given attention, but it seems that the step/potential here is not too big now, and even if we take a step here, it would be a rather small step - that’s the approach.

Your Pekingnologist doesn’t know much here, as Zhou rightly observed. But what’s clear is Zhou was saying China’s DC/EP won’t change the wholesale part of the existing payment system - whatever it means :(


And the exchange. In the exchange, now all systems are still in very good operation, except for individual cases, especially due to high-frequency trading, such as the flash crash in the United Kingdom. In general, the operation is still relatively good. Although the entire system of the exchange, including the so-called price-first, time-first queuing automatic aggregation system, as well as the back of the securities registration and delivery system also has a lot of costs. But the call in this regard is not high, if we hope to reduce transaction costs, it may be more to reduce the stamp duty, stamp duty than the cost of technical systems are more concerned.


Also, it’s not the faster the transaction settlement, the better. For so many years everyone has been discussing whether the technology system in the exchanges has the ability to provide T+0, to provide same-day swing trading, and to provide more high-frequency trading. But in fact, the discussion of market participants, also raised certain doubts and challenges - it is not the faster, the better. It’s possible for the whole payment system, including the system in the exchanges, to implement a real-time, full trading system, but a real-time, full trading system is not a good choice for every segment.. That's why the International Swaps and Derivatives Association repeatedly advocates that you need to engage in cash settlement, which is more beneficial to the risk control of market participants while reducing the economic capital and the so-called risk measurement required for real-time physical settlement. In terms of the system in the exchanges, it's not that the faster the full, real-time trading, the better. Therefore, it also involves the question of how much room there is for this step to take.

Possible translation errors in the paragraph above :(


Let’s look at international trade. International trade is actually the main content of cross-border payments, including trade in goods and services. But for outsiders, they are prone to imagining that, can international trade be conducted just going to a store to buy things? When one sees something good, he or she pays the money and gets the product - as easy as that? In fact, the vast majority of international trade involves a certain volume and consequently a more complex system than this. First of all, the majority of goods - other than bulk goods - are in containers. A container contains a lot of things, involving many varieties, specifications, and other information which need to be specified in the contract, and there has to be a lot of communication in advance. More importantly, it involves transportation, warehousing, and insurance. What happens in transportation? Will there be risks? Will there be losses? How about the storage? Will things in the warehouse go bad? All these things lead to a series of further services, and will involve finance.


From the perspective of payment, cross-border payment involves exchange rate and currency selection. In addition to this, exporters also need to have trade financing - when the goods sent to the other party were received and inspected, get paid. [One sentence is missing because the Mandarin wasn’t understood.] So there is the need for trade financing. A typical tool in trade financing is the letter of credit financing when enables financing and the next round of production by borrowing from banks. This financial service must also be included in [the payment system?] as an important component.


In addition, there are many small and medium-sized enterprises in the international trade, they (do business) across the countries and sometimes cross the continents, and do not know each other very well. They know some counterparties, but do not trust each other well, so it is necessary to find a bank. They find a bank in Country A, a bank they are familiar with and probably they opened an account with, and they find a bank they are familiar in Country B. The banks established a correspondent bank relationship - in addition to making payments, it is in fact to establish a relationship of trust. It is to help establish a human relationship between different companies. Although the whole system is very complex, and some people complain that it may not be efficient and can be improved, but it’s not as some people imagine that it could be just like going to a store and buy stuff - not that easy. You have to think about it. The transformation of the system is not easy, it’s not easily replaceable by imagined digital currency. This step may need to take into consideration more functions, and then (let’s) see what kind of opportunities there are to do an upgrade as the next step.

Zhou appears to be saying DC/EP cannot easily replace the existing payment system in international trade as imagined by some.


Then there is the remittance. Cross-border remittance is indeed expensive, and some banks’ charge in cross-border remittance are indeed too high. But the main obstacle of cross-border remittance is - Facebook caught the spot of cross-border remittance, so proposed to use Libra to do cross-border remittance, and in order to make more countries accept Libra, Facebook knew that many countries will worry about dollarization, so Facebook proposed a basket of currencies. However, Facebook did not understand that a basket of currencies had been discussed internationally for many years, and everyone tried to find ways to see how to get the international monetary system from all angle - it was not a simple thing. After trying for a year, Facebook found that it was difficult to do a basket of currencies, so Facebook changed from Libra to Diem, focusing only on the U.S. dollar. Cross-border remittances are not only difficult in terms of technology, but also in terms of policy formulation, especially when it comes to cross-border labor remittances to home, involving developed and developing countries. For mutual remittances between developed countries, although there are the U.S. dollar, the yen and the euro, which are relatively efficient and not too costly. Developing countries face higher costs and more delays. So this could allow for a step forward, but it cannot be solved by the technology system alone. It depends on the solution of the financial system and national policy, especially when it comes to the exchange rate system, foreign exchange management. There are some countries that have foreign exchange control. Many young people may not know that before China's reform and opening up, there were so many overseas Chinese and they sent money home in US dollars and yen, but at home you can not get the US dollars and yen, which must be exchanged for RMB. The exchange rate at the time was very unreasonable, so what to do when the recevier would be losing money? (The Chinese state) would give you some additional foreign exchange certificates. Although China has long passed these stages through reform and opening up, many other developing countries are still facing similar problems, and they are also worried about the risks associated with dollarization. Therefore, when we choose to use digitalization, use the Internet to improve the modernization of the payment system, and to take a step forward, I think we need to consider our choice: in which direction can this step be bigger and achieve more obvious results?


At the same time, do not dream of becoming fat with one bite - that I got a system now, I can beat the chest bragging in solving retail payment, the wholesale system, the exchange system, trade settlement, remittances and everything. I think this is unrealistic, so if the choice is already made in R&D and pilot, we have to have the determination of not thinking “that mountain is always higher than this one”/the grass is always greener on the other side of the hill.

Zhou appears to be advising China’s DC/EP should be realistic and practical.


Let me conclude by talking about the internationalization of the RMB. I think the internationalization of the RMB is a good topic. As the world's second-largest economy and the world's largest trading country, China's currency status should rise, and it does have the potential, and the technology system mentioned earlier will have an impact on this. So there's been a lot of development and a lot of support on the technology side over the years, such as the Cross-Border Interbank Payment System (CIPS) and so on. So is it possible to use something like the digital currency - the CBDC - to take the international status of RMB to a greater level? I think we should not overestimate the technological aspects, but more the institutional and policy factors. It is (ultimately) a choice of reform and opening up and the question of how big the next step should be taken.


First of all, whether a currency can be widely accepted may depend on your economic volume, trade volume, the degree of openness to the outside world, but you cannot force the international users to make that choice. (Customers) have the right to make their own choice. So this is not just about technicals. One of the main elements is the degree of free use of the currency. One of the factors that led to the International Monetary Fund, in 2016, adding the RMB in the Special Drawing Rights (SDR) basket is that the degree of free use of the RMB has improved a lot. But it is a continuous process and there is a lot of room for further improvement. However, no matter how free the degree of use the RMB becomes, it is still important to pay attention to preventing money laundering, tax havens, tax evasion, drug transactions, etc. This is one aspect.


Then there is the ability of a currency to resist shocks. We all know that various countries around the world, at various stages, would see a financial crisis every once in a while. What we all know now is the global financial crisis in 2008. But in fact, if you really look at each country, there is a financial crisis every decade or several decades. So the ability to resist shocks is also very important. So we think there is also the factor of the system, China may further increase the strength in the future of its reform and opening up, and may also make a more distinct choice. And this choice is also dependent on the path of development, the path of reform and opening up, depending on the balance of views. In fact, this view is also a balance, like the one I talked about just now - between the privacy of the currency and anti-money laundering. Some people will think that the free and convertible RMB is a very good thing, and needs to be pushed forward as soon as possible. Others may think this is a very bad thing, very risky, and try not to do it. It may end up being a normal/Gaussian distribution, with more views in the middle, and it will be moving with the reform and opening up, so we are saying that the changes in the opening up process may have more to do with the internationalization of the RMB, and the technical aspects are just the basis, which can be done relatively easily. When China’s financial system develops CIPS, for example, the Bank of China, the banks used to play a big role in cross-border payments in the past. For them, when the policy and the system is clear, using the existing technology to develop a system is not something too difficult. Certainly we should not underestimate this effort.


At the same time I would like to say here that I have always emphasized the internationalization of the RMB. From the central bank's point of view, the currency issued is your liability. Many people think it's your (the central bank’s) asset, and I remember at the dinner table of a very important international conference, there was a very prominent guest commenting on the internationalization of the RMB, who said that in the future you can issue RMB around the world and you have a big asset. I said on this you are not right, from the balance sheet point of view, issuing currency is a liability of the central bank, you have to make your liability part cashable, with purchasing power, and stable. And it's the central bank that has to provide that convenience and assurance to people when a country is going to promote the currency to achieve a certain function. So from this point of view, it is a liability, which means that you should not look at the internationalization of the RMB too much as if I can create an asset out of thin air, but you should think more about the commitments you have to make, the obligations you have to undertake, and consider it from the balance sheet point of view.


So the modernization of the payment system, DC/EP and E-CNY will first and foremost bring an enhanced experience for cross-border retail use, including use in business visits by travelers, and also retail online shopping, which is more fashionable now, and will also benefit the RMB. From a broader perspective, wholesale financial transactions, trade, remittances, and other aspects, to achieve the internationalization of the RMB, we still need to make continuous progress in the policy and institutional aspects, and we believe that progress in these aspects will be the major step to make substantial progress in the internationalization of the RMB.


At the same time, I also stressed on different occasions that it is also a relative thing - several major international currencies are competing for a share between one another - in total, not one currency can get more than 100 percent. If one gets more, others get fewer. So, in addition to doing good or bad in oneself, it also depends on how well others do.


I would like to take this opportunity to report to you on such a topic, and also to make a small input to the Graduate School of People's Bank of China and this Global Finance Forum. Please correct me if I am wrong. Thank you.