Central bank digital currencies (CBDCs) have often been deemed a solution in search of a problem. But US President Donald Trump appears to have provided a rationale for CBDCs, even as he has banned the development of a digital dollar.
A CBDC, as its name suggests, is a digital version of an existing fiat currency that would be issued and controlled by a central bank and have the same guarantees.
A study by the Atlantic Council, published shortly before Mr Trump’s election win last year, found that 134 nations — including the US at the time — representing 98% of the global economy, were exploring digital versions of their currencies, with almost half at an advanced stage.
But Mr Trump then issued an executive order in January prohibiting US agencies from establishing, issuing or promoting a digital dollar, seemingly as part of a drive to promote private cryptocurrencies and stablecoins instead.
That may leave the door open for other countries to set the rules for CBDCs and other forms of digital money as they evolve.
The arguments for and against CBDCs are various. They could lower the cost and complexity of financial transactions, while potentially bringing more people into the digital economy. Critics counter that existing technology can offer the same benefits, and some warn that CBDCs could threaten individual privacy and become a tool for government snooping and control.
From a central bank perspective, if private stablecoins — or cryptocurrencies backed by a hard currency — come to dominate the digital currency space, they would have to be closely regulated. So the simpler option may be to issue their own digital currency instead.
But the most compelling reason may be that we appear to be entering a new era of economic nationalism in which the US dollar may no longer be relied upon, meaning state-run digital currencies could thus become a matter of national financial security.
This risk of getting left behind in the digital payments race is particularly acute in Europe.
Non-European payments firms process about two-thirds of euro zone credit card transactions. On top of that, US tech applications process almost 10% of euro retail payments, and usage is growing fast.
Additionally, most existing stablecoins are linked to the dollar, so if their use increases, the primacy of the euro within Europe’s currency bloc could be undermined.
This was spelt out powerfully in a recent speech by European Central Bank Chief Economist Philip Lane.
“The digital euro is not just about making sure our monetary system adapts to the digital age. It is about ensuring that Europe controls its monetary and financial destiny, against a backdrop of increasing geopolitical fragmentation,” he said.
The Bank of England has sounded more agnostic about a digital pound but has nonetheless been planning and studying the matter for years.
BoE Governor Andrew Bailey has voiced concern that commercial banks are not stepping up to innovate in the digital currency space, leaving the field open to less-regulated tech firms. If that persists, the bank may need to create its own CBDC.
At the same time, China is racing ahead. Usage of the digital yuan — or e-yuan — is accelerating, with transactions more than tripling between June 2023 and June 2024.
The US administration has indicated that it wants a weaker dollar, but not a world that can operate around the greenback. The latter would have profound consequences for US economic power and its ability to service its mountain of debt, which last year amounted to more than 120% of GDP or some US$35 trillion.
The greenback accounts for almost 60% of global foreign exchange reserves, so a major shift away from the US currency would take years, maybe decades. But given the growing trade tensions between Washington and Beijing, it is possible that China could seek to use CBDCs as a tool in a long-term battle to unseat the US dollar as the foundation of global finance.
And if the US is the only major economy not to offer a CBDC, it risks becoming far less dominant in the global monetary system, especially if CBDCs become widely used in cross-border payments, terrain currently dominated by the dollar via the SWIFT global payments network.
The Bank for International Settlements has noted that mutually compatible CBDCs could lead to more efficient cross-currency and cross-border payments, reducing costs and delays in the payments process.
Already, the central banks of China, Hong Kong, Thailand, the UAE and Saudi Arabia are collaborating on a cross-border payments platform dubbed “Project mBridge” using wholesale CBDCs. And Moscow wants the Brics nations — Brazil, Russia, India, China and South Africa — to create a “Brics Bridge” international payment system, though experts see little chance of the latter coming to pass.
Mr Trump has reacted negatively to any suggestion of a rival to the dollar. In January, on his Truth Social platform, he warned the Brics against attempts to create a new currency or back any alternative to “the mighty dollar”, at the risk of seeing their exports to the US face 100% tariffs.
But Washington has already let the financial security genie out of the bottle by upending established international trading norms, spurring other countries to rethink their dependency on a dollar-based and US-led global economic order. It is not clear if that can be rebottled. Reuters