This week Fed Chair Powell was on a panel hosted by the IMF that discussed digital currencies in the context of cross-border payments. Powell noted that the Fed was looking into this, but didn’t offer much else. This is probably because CBDCs don’t really have any applications in the U.S. In this post I’ll talk about what problems CBDCs could solve, how it could be helpful for other jurisdictions, and why it doesn’t seem to make sense in the U.S.
What is a CBDC?
CBDCs are digital currencies issued by governments directly to the public. This is different from our current system, where all the digital money we use is issued by commercial banks. Our current monetary system is a two-tiered system where central banks issue digital currencies (reserves) that can only be used by commercial banks, and commercial banks issue digital currencies (bank deposits) to the broader public. A CBDC essentially sidesteps the banking sector and allows us to directly interact with the central bank. Note that a CBDC does not require blockchain technology; in fact China’s recent trial of a digital Yuan does not use blockchain technology.
In theory, a CBDC could offer safer and faster payments. This is because deposits would be directly held with the government (no bank credit risk) and payments would be made directly between people who both have accounts at the central bank (no more inter-bank settlement). In practice, neither are real concerns in a modern banking system. The public already enjoys deposit insurance and instant electronic payments.
The real purpose of a CDBC system is that gives the government significantly more control over the monetary system. The government will be able to directly send and take money from the public, more accurately track movement of money, and directly apply interest rates to our balances. At the moment all these powers belong to the private banking sector, beyond the direct control of the government.
Suppose you bank with JPM. JPM knows exactly how much money you have in your checking account, who your send it to, imposes interest rates on those balances, and can deduct or credit balances to your account. The U.S. government does not have access to that data and cannot unilaterally take deposits out of your account unless it has a legal order.
CBDC is a new tool kit that opens up a whole new frontier of policy that is particularly attractive to jurisdictions where the transmission of monetary policy is impaired.
CBDCs Could Help the Eurozone (and others)
Broadly speaking, financing can come from commercial banks or the capital markets. The U.S. has a healthy banking system and deep capital markets, while the Eurozone has smaller capital markets and a banking system that is in deep trouble. This means Eurozone borrowers have trouble getting the money that they need.
According to the IMF, U.S. public equities and private debt are 170% and 100% of GDP, respectively. In contrast, the same numbers for the Eurozone are 68% and 85%. There are structural reasons for this difference. The Eurozone is a collection of different jurisdictions each with their own tax laws and bankruptcy laws. This makes it difficult to develop deep capital markets (although the they are trying hard with a Capital Markets Union initiative). Until that comes to fruition, Eurozone borrowers will have to continue their tradition of relying on bank loans. Eurozone banking sector assets are 300% of GDP, while the U.S. banking sector assets are only 85% of GDP. Unfortunately, Eurozone banks are in bad shape with many trading below their 2008 financial crises lows. Years of negative interest rates have bled them dry. This impedes their ability to provide credit.
In addition to weak banks and underdeveloped capital markets, the Eurozone has fragmented fiscal policy. There is not enough political unity to undertake fiscal stimulus the way the U.S. Treasury can. In times of stress, the only actor that can do something is the ECB. This is where CBDC comes in.
A CBDC would give the ECB the power to side step the banking sector and give money directly to the people. It could even impose negative interest rates directly on them. Unsurprisingly, the ECB has already hinted at a digital Euro. Note that China, who also has a deeply troubled banking sector and underdeveloped capital markets, is another major jurisdiction experimenting with CBDC.
CBDC Doesn’t Make Sense for the U.S.
There really isn’t much of a role for CDBCs to play in the U.S. Our capital markets and banking sector are both healthy and continue to provide credit to the public. When the Treasury wanted to send stimulus check payments to Americans, they were able to easily do so via the banking system.
In addition, there is a mountain of dollar paper currency outstanding in the world. As Powell noted, a substantial amount of the currency is held abroad. It would be difficult to implement a digital currency when so much paper currency exists.
All that being said, the clear trend over the past decades is for more centralized government power. I would not be surprised if CBDCs eventually reach the U.S. under some flimsy pretext just so the bureaucracy could have more power.