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China Can't Get Enough Bitcoins

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As if Zhou Xiaochuan didn't have enough to worry about, China's central bank governor now has a bitcoin problem on his hands. In a new report, Goldman Sachs says the yuan is now used in 80 percent of transactions into and out of the cyber currency, topping the dollar, yen and euro. Given that the Communist Party's highest priority is stability, and the rampant use of bitcoin represents nothing if not the opposite, it's probably only a matter of time until Beijing tries to crack down.

It wouldn't be the first time. In December 2013 -- at a time when the yuan accounted for about 50 percent of bitcoin transactions -- Zhou clamped down hard on the nascent payment system, citing concerns that it was enabling money laundering and undermining capital controls. On Dec. 5, the People's Bank of China barred financial institutions from handling bitcoin transactions, concluding it isn't a currency with "real meaning." A few months later, in March 2014, the PBOC went further, ordering banks and payment companies to close the trading accounts of more than 10 bitcoin exchanges.

But bitcoin traders continue to show up the PBOC. As Goldman Sachs points out, the trading volume inside China has risen markedly -- even as bitcoins plunge in value (from about $1,100 in late 2013 to around $300) and lose cachet elsewhere. "Bitcoin," writes Goldman Sachs analyst James Schneider, "has momentum in China."

What gives? Some people in China are surely buying bitcoin to engage in relatively innocent forms of financial speculation. But they are probably outnumbered by the people who are using it to move yuan out of the country, while circumventing Beijing's currency controls. That's partly because China's broader economic slowdown provides fewer lucrative investment opportunities. But it's also because of President Xi Jinping's ongoing crackdown on corruption, which has made it harder to launder ill-gotten funds. (Hong Kong money changers used to be the laundering method of choice, but are no longer readily available.) Bitcoin's value gyrates too wildly to be a viable transactional unit, but it's proving to be a nifty way to move money across borders beyond the watchful eye of the government.

Bitcoin's surging popularity in China -- despite the attempts to crack down against it -- underscores how fragile the world's second-biggest economy is at present. Data released yesterday showed industrial output since the beginning of the year was at its slowest pace since 2009, rising just 6.8 percent in January and February. Deflation also seems to be on the horizon.

As growth slows, the risk of a hard landing for the Chinese economy increases. Officially, Beijing is on the hook for about $3 trillion of regional debt. (The Japanese investment bank Mizuho Securities says $4 trillion is closer to the mark.) What's much harder to estimate is what the financial fallout will be from the more than $20 trillion of credit churned out by the shadow banking system between 2008 and 2014. If large numbers of borrowers start defaulting on their debt -- and analysts estimate that's only a matter of time -- Beijing will almost certainly be on the hook for massive bailouts.

With the market thought to be capped at about 21 million bitcoins, it's unlikely the currency will pose an overwhelming challenge to the PBOC. But what about other digital currencies created inside China? In November, Wired magazine explored the rise of darkcoin, which is fast becoming the chosen medium of drug merchants and others active on China's black market. It's not hard to imagine the development of other such cryptocurrencies with Chinese characteristics.

When China has previously faced money laundering problems, it had clearer solutions at its disposal. In 2014, for example, Beijing clamped down hard on  Macau, the former Portuguese enclave whose casinos had become a favored laundromat for ultra-rich Chinese. But now that China's facing a stealthier threat in bitcoin, it's options are more limited. Zhou is undoubtedly aware of the problem posed by bitcoin, but he may not yet know what he should do about it.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Willie Pesek at wpesek@bloomberg.net

To contact the editor on this story:
Cameron Abadi at cabadi2@bloomberg.net