Following on from my previous article on what central bank currencies (CBDCs) are and their potential effects on your money, this article deals with a white paper recently published by the major central banks and the Bank of International Settlements (BIS). In the document, they discuss the positive and negative consequences of central banks implementing CBDCs. While I refer to negative interest rates in the title of this piece, it is, in fact, only a footnote to the actual paper.
The crux of the matter is that the central banks would, in essence, be implementing a different form of money or currency. We’ll leave a discussion on the distinctions between these two concepts for another time though.
Interest Bearing CBDC (Maybe Even Negative Interest Rates)
The central banks are considering the CBDC as a form of an interest-bearing note, much in the same vein as a treasury note.
Treasury notes bear interest of varying amounts and are issued in 2, 3, 5, 7, and 10-year maturities. Interest on these securities is paid on a semi-annual basis. In effect, the CBDC will be a government liability that produces interest.
So, the money itself bears interest in a similar way that deposits do and there would be CBDCs that produce interest and CBDCs that act more like cash that don’t produce interest. This lends itself to the idea that monetary policy could be influenced via the CBDC route.
While this is not the stated aim, rather than having to rely on the banking system to adjust to changes in the Federal Reserve interest rates, a direct change to the interest rate applicable to the CBDC is a more direct route with very little time lag.
Now, one of the problems with this is that CBDCs potentially pass on negative interest rates directly to the public. It is noteworthy that this paper is a part of a series written in collaboration of the central banks of some of the world’s top developed countries, and in papers written later in the series the discussion on negative interest rates is not just a footnote. It is actually discussed more in depth and as a way to fulfill their monetary policy objectives.
One solution is to hold cash, thereby avoiding these interest rates.
Could Cash Possibly Be Banned?
However, they allude to the possibility of no cash being available, in which case it might encourage the use of foreign currencies or so-called crypto-currencies.
It makes sense to store your value somewhere that is safe from having it stolen directly from your bank account. While positive interest rates add to your bank balance, negative interest rates will result in funds leaving your bank account.
So, in essence, the implementation of a CBDC will force you to stay within the system with no way to escape the negative consequences.
That is not to say that it will be implemented in this way.
The white paper is structured in such a way as to discuss various options to implement this type of currency and to better understand the idea of central bank digital currencies as a concept.
Stimulate Demand, Bring in the Helicopters!
Beyond the discussion around interest rates, there has also been much public discussion on the use of a CBDC to stimulate aggregate demand through direct transfers to the public.
You may recognize this mechanism of monetary policy by its more common name, “Quantitative Easing”. The paper refers to this as the so-called Helicopter Drop. Now, there is a lot of nuances with quantitative easing. QE is not a form of government transfer payment as the stimulus packages in 2020 were. Quantitative easing is a way for the central banks to monetize the government debt which then in turn may be used for fiscal transfer payments. However, they do not have to be.
To increase liquidity and combat deflation, Ben Bernanke was simply parroting Milton Friedman when he referred to stimulating the local economy by dropping money from a helicopter directly into the hands of eager citizens.
This stimulus package approach can be actioned far more efficiently through a CBDC than making payments by cheque and waiting for the deposit into one’s bank account. The writers of the white paper are at pains to point out though, that monetary policy is not the primary motivator for issuing a CBDC.
One would be naive to accept this disclaimer at face value, given the politicization of something like that. Given the psychology of money, it makes sense that the adoption of a CBDC could be motivated to some extent by its ability to control the implementation of monetary policies.
The Disintermediation of Banks
Another risk, which is discussed at length, is the potential for consumers to bypass commercial banks.
This speaks directly to the financial stability of the banking system, as the CBDC would have a side effect of making it more difficult for a bank to profit from its reduced operations.
This is not dissimilar to the situation in which the state banks found themselves following the passing of the National Banking Act of 1863. You can find my dissection of this period in our financial history here.
As a reaction to losing deposits to CBDCs, the banks may rely more on wholesale funding and consequently restrict credit supply. The knock-on effect will see a contraction in economic growth as money becomes scarce.
From the report, the major central banks see this as a threat to the stability of the financial system, with people running to the central bank’s CBDCs for more money as opposed to the typical commercial bank deposits. By removing their deposits, they argue that there is a risk of a run on the banks or some other financially destabilizing event.
I do question this line of argument, given that the commercial banks don’t really require your deposits to function.
However, the nuances of reserve requirements may have a bearing on this. Nevertheless, an interest-bearing CBDC would attract people to it, rather than them keeping their money in interest-bearing accounts at commercial banks.
The Protection of Monetary Sovereignty
A further risk revolves around the protection of the national currency.
Large amounts of money that are not denominated in the sovereign currency will limit the impact of monetary policy, and the ability of the government to influence financial stability. This leads to a loss of control over the country’s monetary system.
The ultimate effect is that domestic consumers move to stable coins or so-called cryptocurrencies and foreign CBDCs. When this happens, the sovereign currency dwindles and, in the case of the US, we may lose our reserve currency status.
Basically, people could cease to use US dollars, choosing instead to move their funds into other currencies and CBDCs because of differences in the implementation of each country’s digital currency.
Therefore, the central banks are discussing the challenges of dealing with the cooperation and interoperability of many countries having CBDCs. The whole system must work at scale on an international level, giving rise to the possibility of a global base CBDC.
What the BIS and the rest of the major central banks want, is an efficient and convenient CBDC to reduce the risk of alternative units of account dominating. For the Fed, this means having the best CBDC to maintain the Dollar’s reserve currency status while at the same time supporting its public policy objectives.
This is the “greater good” argument which you’ll need to evaluate on its merits by viewing the report Central Bank Digital Currencies: Foundational Principles and Core Features, for yourselves.
