Abandoning traditional caution, the U.S. Federal Reserve and other nations’ central banks are likely to introduce CBDCs (central bank digital currencies) in the near future. Supported by the Bank of International Settlements, 105 countries representing more than 95% of global GDP, including the U.S., the European Union and China, are testing or actively considering digital currencies.
While details remain sketchy, CBDCs will probably be based on similar technology to bitcoin
and other cryptocurrencies, but with important differences, such as:
- CBDCs would be a liability of the central bank, in effect, digital cash fully backed by the state.
- Its value would be pegged to the national currency, unlike true cryptocurrencies whose price is determined purely by demand and supply.
- It would function identically to existing fiat money and allow making normal payments and meeting financial or commercial obligations.
The only difference from cash would be the lack of bills and physical transferability as transactions would be electronic, similar to existing funds transfers through banks. Although initially voluntary, it could easily be made mandatory.
The case for CBDCs, as for banning cash itself, is always couched in terms of enhancing efficiency. However, given that most advanced economies have efficient funds transfer systems and most payments are now electronic in any case, it is unclear what additional benefits would accrue. To the extent that payment systems, especially cross-border, are expensive or slow, improved inter-operability and clearing systems would provide effective solutions.
Other benefits cited include deterring criminality or terrorism, increasing the legal economy by reducing the scope of the underground economy, eliminating tax avoidance, reducing the cost of printing money and even preventing contact with bacteria and virus-harboring notes. There is scant supporting evidence for any of these claims.
CBDCs create new problems. If savers switch from bank deposits, funding for the banking system could be reduced, disrupting the flow of credit. It might increase the chance of runs on banks (with investors shifting from deposits to CBDCs) during periods of financial uncertainty. These risks would require complex workarounds; for example, implementing permanent or temporary limits on transfers into central bank accounts and deposit withdrawals. This would detract from the essential idea and fragment the payment system.
Central banks also risk losing seigniorage revenue (the earnings from issuing currency at a cost below their nominal face value or earnings on holdings of securities funded by money creation). Annual U.S. seigniorage revenue, for example, is estimated at about $20- to $25 billion (0.1% of GDP).
Power to the state
In reality, like all restrictions on cash use, CBDCs are designed to increase the state’s power:
- CBDCs would reduce privacy and anonymity allowing surveillance of spending habits and indirectly behaviors of citizens, as CBDCs are completely traceable.
- Negative rates (which have been used widely in Europe and Japan over the last decade) can be avoided by holding cash. Replacing money with CBDCs allows central banks to trace holdings and charge a negative interest rate for their digital currencies.
- Central banks could promote consumption by placing a time limit on digital currencies within which it must be spent or lost forever. It can channel the spending into specific areas through incentives or penalties.
As with electronic transactions generally, there are familiar issues of cybersecurity and disruptions to operations due to technology or power supply failures.
“There is concern that cryptocurrencies could threaten the U.S. dollar’s dominance.”
The real motivations behind CBDCs are complex. Governments fear loss of the state monopoly on currency creation, monetary control and falling behind the demands of evolving marketplaces de facto ceding control to private interests. Central bankers are also conscious of not being seen to impede “innovation.”
For the Federal Reserve, there is additional concern that in the long run cryptocurrencies could threaten the U.S. dollar’s
dominant status as a reserve currency. But introduction of CBDCs by major economies risks creating instability as it would erode the monetary sovereignty of smaller countries and facilitate capital flight in times of instability. For international adoption, collaboration on technical standards and legal frameworks would be necessary.
CBDCs make little sense. Currency remains an important medium of exchange and provides a payment option for legitimate transactions. Despite increasing reliance on electronic payments, cash is still extensively used especially for small value transactions. Cash use globally remains significant among the poor and older people as well as large parts of the world where fast Internet coverage is not ubiquitous. Elimination of currency would worsen not improve social and financial exclusion.
Instead of pandering to fashionable fintech, central banks would be better to focus on their core objectives — ensuring sound money and enhancing cheap access to essential financial services for their country’s citizens, especially the disadvantaged.
Russian novelist Fyodor Dostoevsky considered money, which in his day was purely cash, “coined liberty.” It would be ironic if crypto-technology, intended by its inventors as a mechanism for increasing liberty, became the basis for increasing state control over individual lives and decisions.
More: Hear from Ray Dalio at the Best New Ideas in Money Festival on Sept. 21 and Sept. 22 in New York. The hedge-fund pioneer has strong views on where the economy is headed.