Tag Archives: Electronic money

CBDC-Skepticism-Skepticism

On their blog, Stephen Cecchetti and Kermit Schoenholtz voice doubts regarding the usefulness of universal central bank digital currency (U-CBDC). They argue:

… in an effort to retain their deposit base, commercial banks would surely raise the interest rate they offer to their customers relative to the rate on U-CBDC. … the introduction of U-CBDC would cause a substantial fraction of deposits to shift to the central bank, with the remainder prone to exit in a period of financial stress.

… if the Federal Reserve were to issue U-CBDC, we expect that this would not only hollow out the U.S. commercial banking system, but also destabilize the financial system in a range of countries.

… what would the central bank become? As its U-CBDC liabilities grow, its assets will need to expand as well. And, since commercial banking will have shrunk, so will the sources of private credit. At this point, the central bank turns into a commercial lender. It will become the state bank. In the allocation of funds, it will substitute increasingly for the discipline of private suppliers and markets, inviting political interference in the allocation of capital, slowing economic growth.

The problem with this argument is twofold: First, it disregards the possibility of liability substitution: Deposits may be replaced by other forms of bank debt. Second, bank balance sheet length is equated with lending capacity. But empirically, one is far from a perfect predictor of the other. For example, some countries rely much more heavily on bank credit than others, without obvious implications for intermediation and investment.

… we are compelled to ask what problem it is that U-CBDC is designed to solve. There seem to be three possibilities: the inability of monetary policymakers to set interest rates much below zero; the fact that paper currency is a vehicle for criminality; and the need to broaden financial access. On the first, we currently see little political support for interest rates that go meaningfully below zero. … As for criminal use of paper currency, as we argued in a recent post, there is a strong case for eliminating anything bigger than the equivalent of a U.S. 20-dollar note, but doing so does not imply a need for U-CBDC. Finally, there is financial access. Here, we see technology as providing solutions outside of the central bank [e.g., India’s program of providing costless, no-frills accounts].

Indeed, none of these arguments makes a convincing case for CBDC (especially since only the first one directly relates to the monetary system). But there are two more convincing arguments. First, it is preposterous to have governments prohibit citizens from using cash—the legal tender—for large transactions, and to force them into using privately issued money instead. Opening the central bank’s balance sheet to the public is a more liberal approach than restricting access to financial institutions.

Second, private money creation puts the central bank at a second mover disadvantage, effectively forcing it to serve as lender of last resort during liquidity crises or even as provider of bailout funds. Since the central bank is obliged to safeguard the payment system it cannot escape this disadvantage; regulatory measures—to the extent that they work and do not cause more harm—may alleviate moral hazard but cannot solve the time consistency problem completely. The more payments are conducted using CBDC the less can the banking sector and its customers dictate monetary policy.

To conclude, we see very little upside for central banks to issue retail digital currency. Instead, we see an enormous risk to the commercial banking system and political challenges for central banks. In the end, we wonder: would capitalism survive the introduction of U-CBDC? It may, but we are not at all sure.

As argued above, threats to capitalism also lurk in other corners.

“Die Vollgeld-Initiative und eine Alternative (The Swiss Sovereign Money Initiative, and an Alternative),” SNB, 2017

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.

Fintech Regulation in Switzerland: Open Questions

In the NZZ, Jürg Müller 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.

Money, Banking, and Dreams

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.

Money without a Government

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 …

eKrona

In the FT, Richard Milne reports about the Riksbank pondering to issue a digital currency.

There are considerable questions for Sweden’s central bank to answer about how a digital currency would work. Would individuals have an account at the Riksbank? Would transactions be traceable, unlike with cash? Would emoney earn interest?

Ms Skingsley said: “Personally I would like to design it in a way that is most like notes and coins.” That would mean no interest would be paid on it. But she added that the state had no interest in helping illegal activity, suggesting some form of traceability.

The Riksbank would also need to consider financial stability issues such as whether they would or should compete with commercial banks’ deposit base. Ms Skingsley said she was concerned that in times of financial instability citizens could transfer money to a state-backed electronic system, potentially increasing instability.

CAD-Coin

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.

But:

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.”