- The Vollgeld initiative may point to a problem but it does not propose a viable solution.
- Even with Vollgeld, the time consistency friction with its Too-Big-To-Fail implication would persist.
- A more flexible, liberal approach appears more promising.
- It would give the general public a choice between holding deposits and reserves.
- Financial institutions and central banks around the world are pushing in that direction.
The Bank of England has announced plans to open its central-bank-money settlement system (RTGS) to non-bank payment service providers. This, it hopes, will promote competition, innovation, and financial stability by creating more diverse payment arrangements.
On his blog, Tony Yates raises the question whether the general public has a right to use central bank issued electronic money? Because of inclusion considerations? Or because providing cash and reserves is a central government function?
In: Thomas Moser, Carlos Lenz, Marcel Savioz and Dirk Niepelt, editorial committee, Monetary Economic Issues Today, Festschrift in Honour of Ernst Baltensperger, Swiss National Bank/Orell Füssli, Zürich, June 2017. PDF of draft.
The sovereign money initiative (Vollgeldinitiative) seeks to gain greater control over the money and credit supply, to increase financial stability and to achieve a fairer distribution of seigniorage income. The initiative’s suggested approach – a ban on active money creation – is inefficient and may even prove ineffective, as it fails to address the core problems. A variant of the initiative, which would allow the public access to electronic central bank money on a voluntary basis, would offer greater benefit at lower cost.
In the NZZ, reports about the developing regulatory framework for fintechs in Switzerland. A proposal by the federal finance department drew—reasonable—criticism by various lobbies and industry associations, including the CFA Society Switzerland.
Die CFA Society Switzerland will das systemrelevante Bankensystem von anderen Finanzdienstleistern trennen. Dafür sei eine präzisere Bankendefinition nötig, als sie heute vorgenommen werde. Nur Banken sollen demnach dem Bankengesetz unterstehen. Finanzdienstleister, die kein traditionelles Bankengeschäft betreiben und keine Liquiditätsrisiken eingehen, sollen einem anderen Regulierungsmodell unterstehen. Dabei sollen je nach Tätigkeit unterschiedliche funktionale Lizenzen zum Zuge kommen – dieser letzte Punkt wird von vielen Vernehmlassungsteilnehmern ebenfalls eingefordert.
Schliesslich identifiziert die CFA Society Switzerland auch zentrale Fintech-Themen, die in der Vernehmlassung aussen vor gelassen wurden. Eine dieser Lücken sei der direkte Zugang zur Schweizerischen Nationalbank (SNB). Aus heutiger Sicht sei nicht ersichtlich, weshalb nur Banken elektronisches Zentralbankgeld halten dürften. Auf Anfrage wollte die SNB zu dieser Forderung keine Stellung nehmen. Andere Zentralbanken wie die Bank of England zeigen sich solchen Ideen gegenüber derweil aufgeschlossen. Auch einzelne Schweizer Ökonomen wie beispielsweise Dirk Niepelt stehen allgemein zugänglichem elektronischem Notenbankgeld positiv gegenüber.
Link to my article mentioned above.
On his blog, John Cochrane reports about a Hoover panel including him, Charles Plosser, and John Taylor.
Cochrane focuses on the liability side. He favors a large quantity of (possibly interest bearing) reserves for financial stability reasons. Plosser focuses on the asset side and is worried about credit allocation by the Fed, for political economy reasons. Taylor favors a small balance sheet. Cochrane also talks about reserves for everyone, but issued by the Treasury.
The blockchain technology opens up new possibilities for financial market participants. It allows to get rid of middle men and thus, to save cost, speed up clearing and settlement (possibly lowering capital requirements), protect privacy, avoid operational risks and improve the bargaining position of customers.
Internet based technologies have rendered it cheap to collect information and to network. This lies at the foundation of business models in the “sharing economy.” It also lets fintech companies seize intermediation business from banks and degrade them to utilities, now that the financial crisis has severely damaged banks’ reputation. But both fintech and sharing-economy companies continue to manage information centrally.
The blockchain technology undermines the middle-men business model. It renders cheating in transactions much harder and thereby reduces the value of credibility lent by middle men. The fact that counter parties do not know and trust each other becomes less of an impediment to trade.
The blockchain may lend credibility to a plethora of transactions, including payments denominated in traditional fiat monies like the US dollar or virtual krypto currencies like Bitcoin. An advantage of krypto currencies over traditional currencies concerns the commitment power lent by “smart contracts.” Unlike the money supply of fiat monies that hinges on discretionary decisions by monetary policy makers, the supply of krypto currencies can in principle be insulated against human interference ex post and at the same time conditioned on arbitrary verifiable outcomes (if done properly). This opens the way for resolving commitment problems in monetary economics. (Currently, however, most krypto currencies do not exploit this opportunity; they allow ex post interference by a “monetary policy committee.”) A disadvantage of krypto currencies concerns their limited liquidity and thus, exchange rate variability relative to traditional currencies if only few transactions are conducted using the krypto currency.
Whether blockchain payments are denominated in traditional fiat monies or krypto currencies, they are always of relevance for central banks. Transactions denominated in a krypto currency affect the central bank in similar ways as US dollar transactions, say, affect the monetary authority in a dollarized economy: The central bank looses control over the money supply, and its power to intervene as lender of last resort may be diminished as well. The underlying causes for the crowding out of the legal tender also are familiar from dollarization episodes: Loss of trust in the central bank and the stability of the legal tender, or a desire of the transacting parties to hide their identity if the central bank can monitor payments in the domestic currency but not otherwise.
Blockchain facilitated transactions denominated in domestic currency have the potential to affect central bank operations much more directly. To leverage the efficiency of domestic currency denominated blockchain transactions between financial institutions it is in the interest of banks to have the central bank on board: The domestic currency denominated krypto currency should ideally be base money or a perfect substitute to it, directly exchangeable against central bank reserves. For when perfect substitutability is not guaranteed then the payment associated with the transaction eventually requires clearing through the traditional central bank managed clearing mechanism and as a consequence, the gain in speed and efficiency is relinquished. Of course, building an interface between the blockchain and the central bank’s clearing system could constitute a first step towards completely dismantling the latter and shifting all central bank managed clearing to the former.
Why would central banks want to join forces? If they don’t, they risk being cut out from transactions denominated in domestic currency and to end up monitoring only a fraction of the clearing between market participants. Central banks are under pressure to keep “their” currencies attractive. For the same reason (as well as for others), I propose “Reserves for All”—letting the general public and not only banks access central bank reserves (here, here, here, and here).
In the NZZ, Axel Lehmann offers his views on the prospects of blockchain technologies in banking. Lehmann is Group Chief Operating Officer of UBS Group AG.
- Higher efficiency; lower cost; more robustness and simpler processes; real-time clearing;
- no need for intermediaries; information exchange without risk of interference
- automated “smart contracts;” automated wealth management;
- more control over transactions; better data protection;
- improved possibilities for macro prudential monitoring.
- Speed; scalability; security;
- smart contracts require new contract law;
- interface between traditional payments system and blockchain payment system.
Lehmann favors common standards and he points out that this is what is happening (R3-consortium with UBS, Hyperledger project with Linux foundation).
Related, Martin Arnold reported in the FT in late August that UBS, Deutsche Bank, Santander, BNY Mellon as well as the broker ICAP pursue the project of a “utility settlement coin.” Here is my reading of what this is:
- The aim seems to be to have central banks on board; so USCs might be a form of reserves (base money). The difference to traditional reserves would be that USCs facilitate transactions using distributed ledgers rather than traditional clearing and settlement mechanisms. (This leads to the question of the appropriate interface between the two systems posed by Lehmann.)
But what’s in for central banks? Would this be a test before the whole clearing and settlement system is revamped, based on new blockchain technology? Don’t central banks fear that transactions on distributed ledgers might foster anonymity?
On his blog, Ben Bernanke discusses the merits of the Fed’s strategy to slowly reduce the size of its balance sheet to pre crisis levels. Bernanke (with reference to a paper by Robin Greenwood, Samuel Hanson and Jeremy Stein) suggests that this strategy should be reconsidered:
First, the large balance sheet provides lots of safe and liquid assets for financial markets. This might strengthen financial stability. (DN: In my view, there are also reasons to expect the opposite.)
Second, a larger balance sheet can help improve the workings of the monetary transmission mechanism, in particular if non-banks can deposit funds at the Fed. Currently, the Fed accepts funds from private-sector institutional lenders such as money market funds, through the overnight reverse repurchase program (RRP). (DN: I agree. As I have argued elsewhere, access to central bank balance sheets should be broadened.)
Third, with a large balance sheet and thus, large bank reserve holdings to start with, it could be easier to avoid “stigma” in the next financial crisis when banks need to borrow cash from the Fed but prefer not to in order not to signal weakness. (DN: Like the first, this third argument emphasizes banks’ needs. In my view, monetary policy should not emphasize these needs too much because it is far from clear whether bank incentives are sufficiently aligned with the interests of society at large.)
Bernanke also discusses the reasons why the Fed does want to reduce the balance sheet size.
First, in a financial panic, programs like the RRP could result in market participants depositing more and more funds at the Fed until the interbank market would be drained of liquidity. But these programs could be capped.
Second, a large balance sheet increases the risk of large fiscal losses for the Fed and thus, the public sector. Losses could trigger a legislative response and undermine the Fed’s policy independence. But these risks could be kept in check if the Fed invested in government paper that constitutes a close substitute to cash, such as three year government debt. (DN: But why, then, shouldn’t financial market participants hold three year government debt rather than reserves at the Fed? Because cash is much more liquid than government debt … But what does this mean?)
On a new website, Aleksander Berentsen rejects the Swiss Vollgeld initiative. As an alternative, he suggests the Swiss National Bank should offer transaction accounts for everybody, in line with proposals I have made earlier (see here (2016), here (2015), here (2015)).
- Vollgeld seems attractive because it decouples the supply of money from intermediation. By enabling everyone to use legal tender for electronic payments, electronic base money would satisfy a need.
- Vollgeld would prevent bank runs, at least partly; render deposit insurance unnecessary and reduce moral hazard; could help stabilize the credit cycle; and would redistribute seignorage to the central bank.
- But these objectives can be obtained with less intrusive means.
- Moreover, a Vollgeld system would be hard to enforce. Banks and their clients would establish new means of payment to circumvent the regulation. And in times of crisis, the central bank would feel obliged to provide liquidity assistance and bail outs.
- The central problem is not that private money is used for transactions; it rather is that the money’s users rely on the central bank to guarantee the substitutability of private money and base money. In a democracy, the central bank cannot credibly let large parts of the payment system go under.
- A sudden, forceful change of regime does not offer a credible way out of this trap.
- But letting the general public access central bank reserves without abolishing private money from one day to the other may open a path towards a new arrangement where the public learns to distinguish between private and base money and where only the latter is publicly guaranteed.
The Economist reports about initiatives by commercial and central banks that aim at adopting the blockchain technology.
For commercial banks, distributed ledgers promise various advantages—but they also cause problems:
Instead of having to keep track of their assets in separate databases, as financial firms do now, they can share just one. Trades can be settled almost instantly, without the need for lots of intermediaries. As a result, less capital is tied up during a transaction, reducing risk. Such ledgers also make it easier to comply with anti-money-laundering and other regulations, since they provide a record of all past transactions (which is why regulators are so keen on them).
… Yet … [o]ne stumbling block is what geeks call “scalability”: today’s distributed ledgers cannot handle huge numbers of transactions. Another is confidentiality: encryption techniques that allow distributed ledgers to work while keeping trading patterns, say, private are only now being developed. … Such technical hurdles can be overcome only with a high degree of co-operation …
Meanwhile, central banks plan digital currencies built around the same technology.
Like bitcoin, these would be built around a database listing who owns what. Unlike bitcoin’s, though, these “distributed ledgers” would … be tightly controlled by the issuers of the currency.
The plans involve letting individuals and firms open accounts at the central bank …
Central banks … could save on printing costs if people held more bits and fewer banknotes. Digital currency would be tougher to forge, though a successful cyber-attack would be catastrophic. Digital central-bank money could even, in theory, replace cash. …
Better yet, whereas bundles of banknotes can be moved without trace, electronic payments cannot. … The technology first developed to free money from the grip of central bankers may soon be used to tighten their control.
Source: SNB. The series “in EUR” is based on the author’s calculations.
Note: The exchange rate floor vis-a-vis the Euro was in place from 6 September 2011 until 15 January 2015.
On his blog, Urs Birchler offers different perspectives on the question whether the Swiss National Bank (SNB) is obliged to pay out banks’ reserves in cash.
- One view: Reserves are legal tender. The SNB therefore is not obliged to exchange reserves against cash.
- Another view: According to the law, the SNB is required to provide sufficient cash. Moreover, reserves and cash were meant to be perfect substitutes.
- Yet another view: Lawmakers would have written a different law had they known that the SNB considers it necessary to impose negative interest rates.
In the FT, John Plender reviews Mervyn King’s “The End of Alchemy: Money, Banking and the Future of the Global Economy.” King diagnoses two problems underlying the crisis. First,
Interest rates today, he says, are too high to permit rapid growth of demand in the short run but too low to be consistent with a proper balance between spending and saving in the long run. The disequilibrium persists, as does a misallocation of capital to unproductive investments.
The second problem relates to the financial system and
the alchemy that runs through the financial system, whereby governments pretend that paper money can be turned into gold on demand and banks pretend that the short-term deposits used to finance long-term investments can be returned whenever depositors want their money back. …
King argues that Bagehot’s famous dictum on central bank crisis management — lend freely on good collateral at penalty rates — is out of date because bank balance sheets today are much larger and have fewer liquid assets than in the 19th century. Central banks are thus condemned in a crisis to take bad collateral in the shape of risky, illiquid assets on which they will lend only a proportion of the value, known as a haircut.
King suggests this lender of last resort role should be replaced by … a pawnbroker for all seasons. In effect, he offers an elegant refinement of the concept of “narrow banking”, which seeks to ensure that all deposits are covered by safe, liquid assets. In his system, banks would decide how much of their asset base to lodge in advance at the central bank to be available for use as collateral. For each asset, the central bank would calculate a haircut to decide how much to lend against it. Together with banks’ cash reserves at the central bank, this collateral would be required to exceed total deposits and short-term borrowings.
This central bankerly pawnbroking would facilitate the supply of liquidity, or emergency money, within a framework that eliminates the incentive for bank runs. It amounts to a form of insurance whereby the central bank can lend in a crisis on terms already agreed and paid for upfront …
The system would displace what King regards as a flawed risk-weighted capital regime ill-suited to addressing radical uncertainty. Today’s liquidity regulation would also become redundant. But banks would still need an equity buffer, with King seeing an equity base of 10 per cent of total assets as “a good start”, against the 3-5 per cent common today.
The current shortfall of fully liquid assets against deposits — the alchemical gap — could be eliminated progressively over 20 years, during which time the expectation would grow that banks would no longer be bailed out. The system would apply to all financial intermediaries …
Update: The Economist‘s reviewer writes:
… Lord King wants banks to buy “liquidity insurance”. In normal times banks would pledge collateral to the central bank, which would agree to lend a certain amount against it, if necessary. Banks would thus know in advance precisely how much help they could get in the event of a meltdown, making them behave responsibly when times were good.
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.
In a Federal Reserve Bank of New York staff report, Rodney Garratt, Antoine Martin, James McAndrews and Ed Nosal argue in favor of “Segregated Balance Accounts” (SBAs):
SBAs are accounts that a bank or depository institution (DI) could establish at its Federal Reserve Bank using funds borrowed from a lender. … the funds deposited in an SBA would be fully segregated from the other assets of the bank … only the lender of the funds could initiate a transfer out of an SBA; consequently, the borrowing bank could not use the reserves that fund an SBA for any purpose other than paying back the lender. … the loan made by the lender to the bank would be collateralized by the reserve balances in the SBA account.
The authors argue that SBAs could foster competition in money markets and
help strengthen the floor on overnight interest rates that is created by the payment of interest on excess reserves.
The proposal is related to topics I discussed in previous blog posts:
- Narrow banking proposals.
- Reserves for Everyone—Towards a New Monetary Regime.
- Reserves for Everyone—Towards a New Monetary Regime, Vox.
- Notenbankgeld für Alle?, NZZ.
- Sovereign Money in Iceland?
- Reserves for All.
- Allowing the general public to hold reserves at the central bank could help reduce the risk of bank runs and the negative consequences of deposit insurance.
- It would end the need to accept bank deposits as means of payment although they are not legal tender; this need arises due to prohibitions on cash payments, for tax reasons.
- But it could also have negative consequences: Money and credit creation by banks would be undermined, with social costs and benefits.
- Price stability and financial stability could be threatened during the transition period.
- More technical questions would have to be addressed as well: They concern the payment system or the conduct of monetary policy.
- Proposals to go further and to abolish cash are not convincing. One suggested benefit—more leeway for monetary policy makers—is over estimated: Negative rates can also be engineered (effectively) through fiscal policy, and they can fully be implemented with a flexible exchange rate between reserves and cash.
- Another suggested benefit—better monitoring of tax dodgers and criminals—is also overrated; the fixed cost to circumvent the measure would deter minor illegal activity but not major one.
- But abolishing cash would have severe negative consequences for privacy and could negatively affect financial literacy.
- Enforcing an abolishment of cash would be difficult. In a free society, any reform to the monetary system is constrained by the requirement that money must remain attractive for its users.
VoxEU, January 21, 2015. HTML.
New proposals to phase out cash are set to revive an old debate. Contributions to this debate focus on two related but independent issues: granting the general public access to central bank reserves; and phasing out cash.
Abolishing cash is neither necessary nor sufficient. But allowing the public to hold reserves at the central bank could have substantial benefits. Technical questions need careful consideration.
The Swiss National Bank imposes negative interest rates on sight deposit account balances. The press release explains the details, including the calculation of exemption thresholds.
On June 3, 2014 the Swiss group “Monetäre Modernisierung” (monetary modernisation) started to collect signatures with the aim to force a national referendum on changes to the Swiss constitution. (The group needs to collect 100,000 signatures within an 18 month period in order to succeed.) The referendum would put the “Vollgeldinitiative” (sovereign money initiative) to vote, an initiative that seeks to fundamentally change Switzerland’s monetary system. The group “Monetäre Modernisierung” is part of a broader international movement with partner groups in the UK, the European Union and the US.
According to the proposal, deposit claims vis-a-vis commercial banks would be transformed into claims vis-a-vis the central bank and deposit liabilities of commercial banks would be transformed into liabilities of those banks vis-a-vis the central bank. Within a certain time span, commercial banks would have to repay those liabilities. Moreover, they would be prohibited from ever creating deposits again—that is, all money should be base money. The proposal envisions the Swiss National Bank to bring new base money into circulation by transferring reserves to the treasury, allowing the government to partly finance its expenditures by means of “original seignorage,” or to citizens. The Swiss National Bank could also lend reserves to banks, against interest, to accommodate fluctuations in money demand. (The resulting interest seignorage would add to government revenues as well.) The initiative aims at a complete separation between money and debt; accordingly, base money would be booked as equity in the central bank’s balance sheet rather than debt.
The proposal goes further than Irving Fisher’s 100% money plan and other proposals for full-reserve banking (and narrow banking) where banks are required to keep the full amount of deposited funds in cash/reserves (or very liquid, safe assets). Under the “Vollgeldinitiative,” the amount of deposited funds does not only have to be kept in cash/reserves but deposits are abolished altogether.
Some background information (in German):
- The text of the proposed constitutional amendment, with explanations.
- Background paper by one of the intellectual father’s of the initiative, Joseph Huber. He explains that the name “Vollgeld” is the short form of “voll gültiges gesetzliches Zahlungsmittel,” or legally speaking, “unbeschränktes gesetzliches Zahlungsmittel.”
Some quotes from the Q&A section on the technical implementation of the proposed reform (in German):
Die Girokonten der Kunden werden aus der Bankenbilanz herausgelöst und separat als Vollgeldkonten geführt. Die Guthaben auf den Girokonten bleiben eins zu eins bestehen, werden Vollgeld und somit zu gesetzlichen Zahlungsmitteln gleich Münzen und Banknoten. Ab dann ist nur noch die Nationalbank autorisiert Zahlungsmittel zu schöpfen. Dadurch geschieht mit dem unbaren Giralgeld heute das gleiche wie vor hundert Jahren mit den Banknoten. …
Das bisherige Banken-Giralgeld wird von Gesetzes wegen zu Vollgeld umdeklariert. Liesse man es dabei bewenden, kämen die Banken mit einem Schlag in den Besitz von Vollgeld, obwohl sie nicht das (neue) Vollgeld, sondern nur das (alte) Giralgeld geschaffen haben. Deshalb übernimmt die Nationalbank im Moment der Umstellung alle bisherigen Giralgeld-Verbindlichkeiten der Banken und verpflichtet sich damit, den Bankkunden anstelle von Bankengiralgeld Vollgeld auszuzahlen. Diese Auszahlung erfolgt sofort, damit die umlaufende Geldmenge nicht vermindert wird, und sie erfolgt auf Geldkonten ausserhalb der Bankbilanz, also auf Konten, auf die die Bank keinen Zugriff mehr hat. Für die Bankkunden ist diese Umstellung äusserst relevant: Sie sind jetzt im persönlichen Besitz von gesetzlichem Zahlungsmittel in der Höhe der bisherigen Sichtkonten, die vor der Umstellung blosse Geldversprechen auf Konten der Bank, aber kein Geld waren. …
Nach der Vollgeld-Umstellung gibt es nur noch Nationalbank-Geld. Das elektronische Geld ist genauso vollwertiges Geld wie heute Münzen und Banknoten. Das heisst, die Vollgeld-Zahlungsverkehrskonten der Kunden befinden sich dann nicht mehr in der Bilanz der Banken, sondern diese werden von Banken wie heute Wertpapierdepots verwaltet. Das Geld auf dem Konto gehört nur dem Kunden, wie das Bargeld im Tresor, und ist nicht mehr wie heute, eine Forderung an die Bank. So hat auch der Zahlungsverkehr nichts mehr mit Forderungen und Verpflichtungen zwischen den Banken zu tun, weshalb das heute übliche Banken-Clearing unnötig wird. Wenn ein Kunde eine Überweisung an einen Kunden tätigt, wird einfach Vollgeld von einem Konto auf das andere transferiert. Es passiert dann das, was fast alle Menschen heute meinen, was bei einer Überweisung geschieht.
Diese direkte digitale Übertragung von Vollgeld vereinfacht den Zahlungsverkehr, da die bisherige komplizierte Verrechnung von Forderungen und Verbindlichkeiten zwischen den Banken und eventueller Ausgleich mit Nationalbank-Guthaben entfällt. Statt dessen können Überweisungen sofort ausgeführt und gebucht werden, genauso wie heute der Kauf von Aktien und Wertpapieren. Die bisherige Wartezeit von mehreren Tagen, bis das Geld ankommt, entfällt. Nach wenigen Minuten wird man den Geldeingang auf dem Konto sehen können.
I discuss the initiative here.
- A 100% money regime reduces the risk of credit bubbles, but requires more and better fine-tuning by the central bank.
- Central banks can already implement higher reserve requirements. If the fact that they don’t reflects policy failure, then the 100% money proposal risks handing more power to one source of the problem.
- A 100% money regime increases financial stability, at least temporarily, but it forces banks to find new sources of funding and lowers the interest rate for depositors, which is fine.
- If lender of last resort support by the central bank occurs at too low interest rates then seignorage revenues are privatised and costs socialised under the current regime. Moving to a 100% money regime would help but so would simple Pigouvian taxation.
- How can a 100% money regime be enforced if market participants end up coordinating to use other securities than deposits as means of payment?
- More stable deposits in a 100% money regime do not imply a more stable banking system unless other regulation is imposed that completely prevents “maturity transformation.”
- Aggregate liquidity cannot be created out of nothing, with or without deposit insurance.
- Societies have to take a stand on whether they want to guarantee broader monetary aggregates than base money. If so, the cost of the guarantee should be privatised. Problems arise if societies pretend not to provide such guarantees but central banks nevertheless feel obliged to step in ex post and market participants are aware of that fact ex ante; bad, self-fulfilling equilibria are the consequence.
- Commitment on the part of policy makers is key; it requires independent central bankers and regulators.