A speech given by Governor Christopher J. Waller in August of 2021 seems to put a huge question mark on the feasibility and use of CBDCs.
The speech was titled “CBDCs: A solution in Search of a Problem” and using the discussion papers produced by the BIS in 2020 and 2021, dismantle every argument put forward supporting the need for CBDCs.
In effect, the speech repudiates the arguments put forward by the central banks from all over the world of major developed countries like Switzerland, England, Canada, the United States, and also Sweden.
The Federal Reserve received calls for the implementation of CBDCs as a matter of urgency and the FED’s chairman, Powell, announced that the bank would publish discussion papers on the benefits and costs of creating a CBDC. Using these papers, Waller, who has studied and researched monetary theory for the past 20 years and has written extensively about alternative forms of money, disagrees with just about everything that has been put forward by the Central banks of the major countries and BIS.
Is There a Compelling Need For a CBDC?
Waller is highly skeptical of the need for a CBDC and asks the question, what problem does the CBDC solve?
Alternatively, what market failure or inefficiency, demands this specific type of intervention? After careful consideration, he isn’t convinced as of yet, that a CBDC would solve any existing problem that is not being addressed more promptly and efficiently by other initiatives.
He focuses on account-based forms of a CBDC and not necessarily a general purpose CBDC such as a cash-like token. His critique appears to be based more on individuals having an account at the Fed.
He makes the important distinction between Central Bank and Commercial Bank money because a lot of people don’t make that distinction, which is a topic that has been discussed at length previously.
On the basis that reserve accounts provide a risk-free settlement asset for trillions of dollars of daily inter-bank payments, and importantly, the use of central bank money to settle interbank payments, promotes financial stability. It does this by eliminating credit and liquidity risk.
The Commercial Banking system is just an intermediary between the Central Bank and the general population.
The funds in commercial bank accounts are digital and can be used to make digital payments to households and businesses. But commercial banks also promise to redeem a dollar in one’s bank account into one dollar of U.S currency. So, in short, banks peg the exchange rate between Commercial Bank money and the US dollar at one-to-one. Due to the substantial regulatory and supervisory oversight of the Federal Deposit Insurance, households and firms reasonably view the fixed exchange rate as perfectly credible. Its exchange rate is deemed credible because you never have to think about it.
The important distinction is that your deposits in your checking account at a Commercial Bank are not a liability of the Federal Reserve.
There is a distinction between money and currency and the credibility of this fixed exchange rate between commercial and central bank money is what allows our payment system to remain stable and efficient.
The Markets Operate Efficiently in Their Current Form
The division of functions between the Federal Reserve and commercial banks reflects an economic truth that markets operate efficiently when private sector firms compete to provide the highest quality products to consumers and businesses at the lowest possible cost.
This is the crux of Waller’s argument, which he comes back to multiple times as he picks apart the CBDC argument.
Government Should Intervene Only If There is a Failure
In general, the government should compete with the private sector only to address market failures.
If the only time the government should intervene is when there is some failure, then Waller doesn’t believe that a CBDC should be an example of that intervention in the current scenario.
The next point he makes is that if the government implements a CBDC, then physical money will disappear. In that case, how will commercial banks make good on their promise to convert a dollar of digital money into a dollar’s worth of physical currency?
By going cashless, the government disintermediates the commercial banks and essentially makes them useless.
The existing interbank payment services have nationwide reach, meaning that an account holder at one Commercial Bank can make a payment to an account holder at any other U.S bank. Similarly, this applies to international payments as well.
The question is whether or not the whole cross-border payments process and implementing a CBDC would increase the reach of the U.S payment system. Waller’s argument is no, it would not. He says, “a lack of connectedness and geographic breadth in the U.S payment system is not a good reason to introduce the CBDC”.
FedNow is Being Rolled Out in 2023
If existing payment services are too slow, then this is being negated by FedNow, which will be rolling out in mid-2023. The private sector has done something similar with its RTP service, which is a real-time-payment service.
These services will move funds between account holders at U.S commercial banks immediately after payment is initiated. Even though cross-border payments are typically less efficient than domestic payments, efforts are underway to improve cross-border payments. These innovations are all moving forward in the absence of the CBDC.
A CBDC is therefore not needed for that kind of efficiency to be remedied.
The traditional payment system is doing it anyway and having a type of parallel CBDC or redundant system, doesn’t really add anything to the argument supporting its implementation.
The United States’ Unbanked Population
According to a recent Federal Deposit Insurance Corporation (FDIC) survey, approximately 5.4 percent of U.S households were unbanked in 2019. The FDIC survey also found that approximately 75 percent of this unbanked population were not at all interested or not very interested in having a bank account.
The point is, that the percentage of the unbanked population who have no desire to open a bank account is a small percentage and of those, only an insignificant percentage would be served by having access to a CBDC. It is implausible to Waller that developing a CBDC is the simplest, least costly way to reach this one percent of households.
He questions whether there is not some other form of initiative or something they could do better. He refers to financial empowerment, “Bank on Project”, which is something that is currently not common knowledge.
Can The Federal Reserve Provide Services Cheaper Than Commercial Banks?
A CBDC needs to make existing payment services cheaper if they are unreasonably expensive. In economics, the price of a service is typically composed of two parts; the marginal cost of providing the service and a markup that reflects the market power of the seller.
The marginal cost of processing a payment depends on the nature of the payment. For example, paper check versus electronic transfer, and the technology used, for example, batch payments versus real-time payments, and the other services provided in processing the payment, like risk and fraud and other such services.
Since these factors are primarily technological and there is no reason to think that the Federal Reserve can develop cheaper technology than private firms, it seems unlikely that the Federal Reserve would be able to process CBDC payments at a materially lower marginal cost than existing private sector services.
The Federal Reserve doesn’t appear to have a robust customer service department, at least not for the general public, or on that scale. This is something that was explicitly discussed in the BIS discussion papers.
Introducing a CBDC would create additional competition in the market for payment services.
How then would a Federal Reserve CBDC affect this competition in this kind of payment system?
The general public could use CBDC accounts to make payments directly through the Federal Reserve. Thus, allowing the general public to bypass the commercial banking system. Deposits would flow from commercial banks into the Fed’s CBDC accounts, which would put pressure on banks to lower their fees or raise the interest rates paid on deposits to prevent additional deposit outflows.
This sounds great for the consumer, as they may get more interest as an incentive for holding deposits at a bank. Private sector innovations might reduce the markup charged by banks more effectively than a CBDC would. The argument is that private sector competition would be better for the consumer overall than the FED coming in and being a competitor.
If commercial banks are earning rents on their market power, this reflects their level of competition.
There is then a profit opportunity for non-banks to enter the payments business and provide the general public with cheaper payment services. This is indeed what we are currently seeing, as a surge of non-banks getting into payments.
Waller cites stablecoins for the most part and specifically the ones that are pegged one-to-one with the dollar.
If one or more stable coin arrangements can develop a significant user base, they could become a major challenger to banks for processing payments. More importantly, payments using such stablecoins might be free in the sense that there would not be a fee required to initiate or receive payment. Accordingly, one could easily imagine that competition from stablecoins could pressure banks to reduce their markup for payment services.
This, therefore, negates the use of a CBDC or at least the proposed benefits of such a CBDC.
Waller points out that “the private sector is already developing payment alternatives to compete with the banking system; hence it seems unnecessary for the Fed to create a CBDC to drive down these payment rents”.
To Waller, it appears that the private sector is already innovating quite rapidly, in fact, faster than regulators can process. Therefore, spurring innovation is not a compelling reason to introduce a CBDC.
Is Privacy a Consideration?
The traditional banking system already has pro-individual privacy kinds of uses. The introduction of a CBDC would negate those and reduce privacy is Waller’s argument.
He feels that the government has sought to balance the individual’s right to privacy with the need to prevent illicit financial transactions such as money laundering. The balance between individual privacy and preventing money laundering is a common theme in the discussion documents.
While the government does not receive all transaction data regarding account holders at commercial banks, the Bank Secrecy Act requires that commercial banks report suspicious activity to the government.
Depending on its design, CBDC accounts could give the Federal Reserve access to a vast amount of information regarding the financial transactions and trading patterns of CBDC account holders.
The introduction of a CBDC in China, for example, will likely allow the Chinese government to monitor the economic activity of its citizens more closely. Should the Federal Reserve create a CBDC for the same reason? Waller thinks not.
Additionally, Wallace fails to see how allowing U.S households to pay their electric bills via a Fed coin instead of a commercial bank account would help to maintain global dollar supremacy.
Of course, the Federal Reserve CBDC accounts that are available to persons outside the United States might promote the use of the dollar, but the global availability of this Fed coin would also raise acute problems related to money laundering. Prompting the need for a cost-benefit analysis to understand whether or not the implementation of a CBDC would be a net benefit to the United States.
Many commentators have suggested that new private monies will diminish the impact of the Federal reserve’s policy actions since they will act as competing monetary systems. It is well established that in international economics, any country that pegs its exchange rate to the US dollar surrenders its domestic monetary policy to the U.S and imports U.S monetary policy. Thus, their currency is essentially just a derivative of the USD.
The same logic applies to private money as well, where if you have a private stable coin that is pegged to the US dollar for whatever fixed exchange rate, you’re essentially having the same thing happen for the stablecoin as for a foreign currency.
Waller believes that having such a thing, especially with private stable coins, actually broadens the reach of U.S monetary policy rather than diminishing it.
So, all in all, Waller believes a central bank digital currency is a solution that’s searching for a problem to fix.
