We address five key concerns that are frequently put forward:
1. Aren’t digital currencies just a hype, now that crypto ‘currencies’ like Bitcoin have proved too volatile and expensive to serve as reliable stores of value or mediums of exchange? This confuses things. A central bank digital currency (CBDC) is like cash, only digital; Alipay, Apple Pay, WeChat Pay, and so on are like deposits, only handier; and crypto currencies are not in any way linked to typical currencies, but they live on the blockchain.
2. Doesn’t a CBDC or ‘Reserves for All’ choke investment by cutting into bank deposits? No, because new central bank liabilities (namely, a CBDC) would fund new investments, and this would not in any way imply socialism or a stronger role of government in investment decisions.
3. Wouldn’t a CBDC cut into the profits that banks generate by creating deposits? Less money creation by banks would certainly affect their profits. But if this were deemed undesirable (by the public, not by shareholders and management) then banks could be compensated.
4. Wouldn’t ‘Reserves for All’ render bank runs more likely, undermining financial stability? We argue that, in fact, the opposite seems more plausible.
5. Aren’t deposit insurance, a CBDC, Vollgeld/sovereign money, and the Chicago Plan all alike? There are indeed close parallels between the different monetary regimes. In a sense, “money is changing and yet, it stays the same”.
The slides (PDF) of a recent presentation of mine at a round table on the future of finance.
Central bankers often argue that CBDC would increase the risk of bank runs. On his blog, JP Koning rejects this notion. After all, he retorts, during a confidence crisis bank customers would no longer have to queue to withdraw cash; lender of last resort support would be provided much more quickly; and “large” cash holders would continue to shift funds into treasury bills, not into CBDC.
The general criticism here is that during a crisis, households and businesses will desperately shift their deposits into the ultimate risk-free asset: central bank money. Presumably when deposits were only redeemable in banknotes (as is currently the case) and one had to trudge to an ATM to get them, this afforded people time for sober contemplation, thus rendering runs less damaging. But if small depositors can withdraw money from their accounts while in their pajamas, this makes banks more susceptible to sudden shifts in sentiment, goes the Carney critique.
I don’t buy it. … even in jurisdictions without deposit insurance, I still don’t think that shifts into digital currency in times of stress would exceed shifts into banknotes. A bank will quickly run out of banknotes during a panic as it meets client redemption requests, and will have to make arrangements with the central bank to get more cash. Thanks to the logistics of shipping cash, refilling the ATMs and tellers will take time. In the meantime a highly visible lineup will grow in front of the bank, exacerbating the original panic. Now imagine a world with digital currency. In the event of a panic, customer redemption requests will be instantaneously granted by the bank facing the run. But that same speed also works in favor of the bank, since a request to the central bank for a top-up of digital currency could be filled in just a few seconds. Since all depositors gets what they want when they want, no lineups are created. And so the viral nature of the panic is reduced.
But what about large depositors like corporations and the rich … ? During a crisis, won’t these sophisticated actors be more likely to pull uninsured funds from a bank, which have a small possibility of failure, and put them into risk-free central bank digital currency?
I disagree. In a traditional economy where banknotes circulate, CFOs and the rich don’t generally flee into paper money during a crisis, but into short-term t-bills. Paper money and t-bills are government-issued and thus have the same risk profile, t-bills having the advantage of paying positive interest whereas banknotes are barren. The rush out of deposits into t-bills is a digital one, since it only requires a few clicks of the button to effect. Likewise, in an economy where digital currency circulates, CFOs are unlikely to convert deposits into barren digital currency during stress, but will shift into t-bills. The upshot is that banks are not more susceptible to large deposit shifts thanks to the introduction of digital currency—they always were susceptible to digital bank runs thanks to the presence of short-term government debt.
Of course, depending on the type of CBDC, central banks might also choose to pay negative interest on CBDC in order to depress demand for it.
- CBDC is not the same as krypto currencies.
- The case against CBDC is not at all obvious; CBDC has costs and benefits.
- Switzerland should not dismiss CBDC too quickly.
- (The title of the article is misleading, it is not mine. I argued for openness in the discussion rather than for adoption.)
On VoxEU, Clemens Jobst and Helmut Stix argue that
… cash balances for transactions comprise only a modest share of overall cash demand (a rough estimate of 15% might be a good guess across richer economies). … changes in currency in circulation are dominated by motives like hoarding. While transaction demand is reasonably well researched … still too little is known about non-transaction demand in general, and recent increases in particular.
In a BIS Quarterly Review article, Morten Bech and Rodney Garratt offer a taxonomy of money, with special emphasis given to central bank issued digital and crypto currency. They stress four dimensions:
issuer (central bank or other); form (electronic or physical); accessibility (universal or limited); and transfer mechanism (centralised or decentralised). The taxonomy defines a CBCC as an electronic form of central bank money that can be exchanged in a decentralised manner known as peer-to-peer, meaning that transactions occur directly between the payer and the payee without the need for a central intermediary. This distinguishes CBCCs from other existing forms of electronic central bank money, such as reserves, which are exchanged in a centralised fashion across accounts at the central bank.
On his blog, JP Koning discusses “dictionary money” and the ancient practice of simply redefining what “pound,” say, means.
People have historically advertised prices for wares using a word, or unit of account, the LSD unit being the most prevalent. … from the Latin librae/solidi/denarii. The monarch was responsible for declaring what these words meant. … something to the effect that a pound, or £, was worth, say … silver coin[s]. This definition was subject to change. …
Dictionary systems came to an end when the symbol for money was finally fused directly with the instrument itself. … coins never used to have denominations, or units of account, on their face. …
In the 1700s monarchs began to adopt the practice of inscribing the actual unit of account directly on the coin’s face …
In the Trustlines Network
every user is acting as a bank by granting credit lines to friends they trust. This allows to issue people powered money between friends and facilitate secure payments between strangers, by sending payments along a chain of trusting friends.
Think of IOUs or cheques and netting in the blockchain.
On his blog, JP Koning discusses the versatility of cheques:
- A cheque instructs a bank to transfer deposits.
- It is a derivative on bank deposits.
- A post dated cheque serves as debt instrument, e.g., vis-a-vis pay day lenders.
- An uncashed cheque may serve as money if marked “to bearer” or endorsed by the recipient. Laws grant cheques currency status.
- A cheque may be used for payments even if other payment mechanisms break down. During the Irish banking strike of 1970, “for six months post-dated cheques circulated as the main form of money.”
- A cheque can be used by the unbanked.
This combination of negotiability, robustness, openness, and decentralization means that long before bitcoin and the cryptocoin revolution, we already had a decentralized payments system that allowed pretty much everyone to participate and, indeed, fabricate their own personal money instruments! …
… a whole language of cheques has emerged, allowing for significant customization. By putting crossings on cheques, like this the cheque writer is indicating that the only way to redeem it is by depositing it, not cashing it. This means that the final user of the cheque will be easy to trace, since they will be associated with a bank account. Affix the words non-negotiable within the cross on the front of the cheque and it loses its special status as currency. Should it be stolen and passed off to an innocent third-party, the victim can now directly pursue the third-party for restitution. To even further limit the power of subsequent users to use the cheque as money, the writer can indicate the account to which the cheque must be deposited. This language of checks can be used not only by those that have originated the cheque, but also by those that receive it in payment. On the back of any check, any number of endorsements can be written, effectively allowing for the conversion of someone else’s payment instructions into your own unique medium of exchange.
… laws that … grant … currency status. … Say that person A is carrying some sort of financial instrument in their pocket and it is stolen. The thief uses it to buy something from person B, who accepts it without knowing it to be stolen property. If the financial instrument has not been granted currency status by the law, then person B will be liable to give it back to person A. If, however, the instrument is currency, then even if the police are able to locate the stolen instrument in person B’s possession, person B does not have to give up the stolen [instrument] to person A. We call these special instruments negotiable instruments.
On VoxEU, Luca Benati, Robert Lucas, Juan Pablo Nicolini, and Warren Weber argue that long-run money demand in many countries is rather stable.
… using a specific, narrow monetary aggregate, M1, we study a dataset comprising 32 countries since the mid-19th century (Benati et al. 2016). The main finding of this large-scale investigation is that, contrary to conventional wisdom, in most cases statistical tests do identify with high confidence a long-run equilibrium relationship between either M1 velocity and a short-term interest rate, or M1, GDP, and a short rate – that is, a long-run money demand.
In another excellent post on Moneyness, J P Koning likens the monetary system to the plot in the movie Inception, featuring
a dream piled on a dream piled on a dream piled on a dream.
Koning explains that
[l]ike Inception, our monetary system is a layer upon a layer upon a layer. Anyone who withdraws cash at an ATM is ‘kicking’ back into the underlying central bank layer from the banking layer; depositing cash is like sedating oneself back into the overlying banking layer.
Monetary history a story of how these layers have evolved over time. The original bottom layer was comprised of gold and silver coins. On top this base, banks erected the banknote layer; bits of paper which could be redeemed with gold coin. The next layer to develop was the deposit layer; non-tangible book entries that could be transferred by order from one person to another.
The foundation layer has changed over time:
One of the defining themes of modern monetary history has been the death of the original foundation layer; precious metals. … as central banks chased private banks from the banknote layer … and then gradually severed the banknote layer from the gold layer. By 1971, … [b]anknotes issued by the central bank had become the foundation layer. The trend towards a cashless world is a repeat of this script, except instead of the gold layer being slowly removed it is the banknote layer.
Fintech improves the efficiency of the layer arrangement and its connections. It also adds new layers: For instance, some payments made via mobile phone effectively transfer claims on deposits. And it may circumvent layers:
In U.K., the Bank of England is considering allowing fintech companies to bypass the banking layer by offering them direct access to the bottom-most central banking layer.
In contrast, a krypto currency like bitcoin establishes a new foundation layer, on which new layers may be built:
Even now there is talk of a new layer being developed on top of the original bitcoin foundation, the Lightning network. The idea here is that the majority of payments will occur in the Lightning layer with final settlement occurring some time later in the slower Bitcoin layer.
I fully agree with this characterization. In addition to the theme emphasized by Koning—adding layers—I would also stress the theme of untying higher-level layers from lower ones: Central bank money typically is no longer backed by gold; deposits typically are not fully backed by notes; and mobile phone credits may no longer be backed by deposits. The process of untying layers relies on social conventions and trust, and it is fragile. Important questions concern the cost of such fragility, and its necessity. Fragility is not necessary when the social cost of liquidity provision at the foundation layer is negligible.
In the FT, David Pilling reports about Somalia which has managed without central bank issued money for decades.
… up to 98 per cent of local banknotes are fake … With the help of the International Monetary Fund, Mogadishu plans to print official banknotes for the first time in more than a quarter of a century … No official Somali currency has left the presses since the Horn of Africa nation descended into clan warfare after the collapse of the government in 1991.
… warlords, businessmen and breakaway regions printed counterfeit notes or shipped them in from abroad. … several important issues, including what the government would use to back its new currency, were still being discussed. So was the question of what the conversion rate would be of fake Somali shillings for the new official ones. Use of Somali shillings, largely limited to the less well-off rural population, comes a poor third to US dollars and electronic money in what is a mostly dollarised economy. … Some dollars in circulation are also fake …
On Moneyness, JP Koning argues that India’s demonetization experiment could have proceeded more smoothly if bank notes had been overstamped rather than immediately withdrawn.
In the Journal of Economic Literature, William Roberds reviews Christine Desan’s “Making Money: Coin, Currency, and the Coming of Capitalism” and he provides his own perspective on European monetary history.
… the transition of the Bank of England’s notes from the status of experimental debt securities (in 1694) to “as good as gold” (1833) required more than a century of legal accommodation and business comfort with their use.
Desan emphasizes England’s traditions of nominalism (as opposed to metallism) and monetary restraint as well as early experiments in monetary substitution in laying the foundations for the Bank of England’s success. Lobbying played its role, too.
Roberds discusses the experience of note issuing institutions in other countries.
At the time of the Bank’s founding, there were about twenty-five publicly owned or sponsored banks operating in Europe. These institutions are largely forgotten today; most were dissolved by the early nineteenth century and only one continues in existence, Sweden’s Riksbank. …
These banks were run by and for the merchant communities in their respective cities [Amsterdam, Genoa, Hamburg, and Venice] … The existence of the early municipal banks depended on a form of nominalism more extreme than what prevailed in contemporary England. Merchants in these “banking cities” were required by law and by custom to settle all bills of exchange (the dominant form of commercial credit) with transfers of money on the ledgers of the local public bank. The practical advantage of such a restriction was that it reduced or eliminated the possibility of settlement in the debased coins … the municipal banks’ ledger money was often seen as more reliable than the typical coin in circulation …
Most of these banks failed after getting involved in speculative episodes, hyperinflation, or political turmoil. The Bank of England was lucky.
On Alt-M, Larry White discusses three aspects of the Indian “demonetization” experiment.
The transition from old notes blocks “honest” currency transactions, reduces income, and harms the poor who don’t have access to alternative means of payment. Because not all old notes will be redeemed, the transition into new notes will generate seignorage revenue for the government on the order of USD 40 billion, according to White’s estimates. Not all groups or industries get access to the new notes at the same time; this changes the terms of trade (Cantillon effects).
At the recent Karl Brunner Centenary event, Ernst Baltensperger characterized Monetarism as a set of five convictions:
- Money matters (as accepted in the neoclassical synthesis)
- Rules are preferred over discretion (in contrast to the views of Modigliani, Samuelson or Klein), but some flexibility is accepted
- Inflation and inflation expectations are key (in contrast to traditional Keynesian views)—adaptive expectation formation, parallels to Phelps
- Money growth targeting is useful—Brunner and Meltzer favored the monetary base, Friedman M1
- Money, credit and the “details” of financial markets matter for the monetary transmission mechanism—Brunner and Meltzer pushed the credit view, parallels to Tobin
Baltensperger concluded that the macroeconomic mainstream has absorbed many of these convictions, as it has absorbed many pillars of Keynesian thought.
Jonathan McMillan proposes a systemic solvency rule which stipulates that
[t]he value of the real assets of a company has to be greater than or equal to the value of the company’s liabilities in the worst financial state. (p. 147)
That is, the financial assets of a company have to be financed by equity. This reminds of Kotlikoff’s limited purpose banking, see here and here. McMillan (who is actually two persons, a banker and a journalist) argues that Kotlikoff’s proposal
is a step in the right direction to address the boundary problem, [but] it creates an overwhelming public authority [that monopolizes monitoring]. Moreover, it does not solve the boundary problem. Limited purpose banking requires the regulator to differentiate between financial and nonfinancial companies. … Finding clear legal criteria to categorize a company as financial is impossible. (p. 140)
In the FT, Philip Stafford reports about a digital currency initiative by the Bank of Canada and commercial banks. It
will involve issuing, transferring and settling central bank assets on a distributed ledger via a token named CAD-Coin.
The Bank of Canada said the experiment was a proof-of-concept and confined to interbank payment systems. … “None of our experiments are to develop central-bank issued e-money for use by the general public.”
In his recent book Geld aus dem Nichts (Money out of Nothing), Mathias Binswanger discusses the role of banks in creating money, and money’s role in affecting the macro economy. The book is written for a non specialist audience and the arguments are often quite loose.
In the first part of the book, Binswanger describes how money mostly is created by commercial rather than central banks.
Part II provides a nice historical overview. Binswanger describes the origins of modern banking with goldsmiths first storing gold for their merchant clients, then lending some of the stored gold to third parties, and finally issuing more “receipts” than what corresponds to the gold deposits they actually accepted. From there, he argues, it was a small step to state licensed national banks like the Bank of England. On p. 120 Binswanger describes how minimum reserve requirements got out of fashion, not least because they suffered from circumvention when they were binding.
Part III lacks precision and is misguided (see also pp. 30 or 66). It covers the link between money creation and growth but confuses national accounting concepts and their relation to money and credit. Clearly, growth can occur without credit (think of an economy with just one agent to see this most directly) but Binswanger seems to dispute this point, in line with earlier writings by his father. A “model” on p. 144 does not help to clarify his views because it is orthogonal to the argument. Binswanger criticizes mainstream economics for refusing to accept the presence of long-run links between money and growth but this critique remains vain. Part IV deals with money creation and its effect on financial markets.
Part V, on reform, is sensible. Binswanger rejects proposals to move (back) to the gold standard or a 100%-money regime (or, essentially equivalent, “positive money”). His arguments against the Swiss “Vollgeld” initiative resonate with points I made here and elsewhere, including the point that it would be difficult to enforce a “Vollgeld” regime (see also p. 122). Binswanger criticizes the “Vollgeld” initiative’s vagueness concerning actual implementation of monetary policy. He ends with more limited, rather standard proposals (relating to regulation, monetary policy objectives and capital requirements) to address problems in financial markets.
In jusletter.ch, Corinne Zellweger-Gutknecht argues that the legal status of central bank reserves is more equity- than debt-like—at least as far as the Swiss National Bank (SNB) is concerned. According to Zellweger-Gutknecht, reserves constitute debt only if the SNB is legally obliged to redeem them in exchange for central bank assets.
If the SNB purchases dollars against Swiss Francs in an open market operation, it creates reserves which are equity-like. But if it acquires dollars against Swiss Francs and is committed to engage in a reverse transaction in the future (a swap), then it (temporarily) creates reserves which are debt-like.