Everything is digitizing, and our currency and payment systems are no exception. Regular readers will know that official ecash, or central bank digital currency (CBDC), is one of our favorite topics—so complex that it needs to be unpacked, developed rapidly, and has the potential to fundamentally change the way our economy works.

So let’s highlight a series of recent developments.A new CBDC emerges, with Cambodia following the Bahamas Issuance of official electronic moneyThe upcoming Winter Olympics have long been expected to be where China will showcase the digital yuan it has been experimenting with.

In developed countries, official agencies are increasingly investigating CBDCs.A few weeks ago, the British House of Lords issued a Report. The Federal Reserve then issued a discussion paper The pros and cons of digital currencies.Two experts, Markus Brunnermeier and Jean-Pierre Landau, have just written a Digital Euro Report for the European Parliament.The BIS is an intellectual leader in the field and doesn’t delay too long between each speech or article about it, most recently by its managing director Agustín Carstens. Digital currency and the “soul of money”.

Anyone interested should take a look at all these reports as they give a good indication of the range of attitudes towards CBDC. The House of Lords report embodies the instinctive skepticism of many: it dismissively suggests that CBDCs are “solutions to problems.” The Fed comes across as open-minded—compelled not to get too far behind other central banks’ explorations, but to hope the challenges go away. The Bank for International Settlements and the Digital Euro report represent the vanguard of official thinking, as they both see a CBDC as a necessary response to the inevitable digitization of money.

I hope everyone gets there eventually. There are many possible answers to the question that the House of Lords claims is unable to determine what a CBDC should address. For example, everyone agrees that cross-border transfers such as remittances are too expensive, and a CBDC can help solve this problem. Most believe that innovation in payment services is happening rapidly, and that in the absence of an official digital currency, private currencies can replace not only official currencies, but commercial bank deposits as well. After all, it was the prospect of a “Facebook coin” that scared central bankers into taking a serious look at CBDCs.

Brunnermeier and Landau put it most clearly:

“The main rationale for developing a digital euro is therefore to preserve the role of public funds in the digital economy.”

This awareness has been growing in official circles – especially in emerging economies, as Duvvuri Subbarao, former central bank governor of India point out — but it came reluctantly. It is often matched with a straightforward assumption that private financial actors can at least meet the challenge like central banks. What follows closely is what impact it will have on the private financial sector if central banks step in to provide digital currencies.

In my opinion, this is the main reason for the hesitation of policymakers. The concern is that an easily accessible CBDC would be so attractive that customers would prefer it to bank deposits, either as transaction funds or as a safe store of value, disrupting commercial banks’ business models: using Deposits fund loans, support our primary form of trading currency, and ultimately, illiquid investments.

But there’s a problem with this argument—aside from the odd notion that the product’s appeal is the reason for banning it. One is that, as all central bank reports acknowledge, there are ways CBDCs could be designed to eliminate their threat to private banks. Another reason is that even though CBDCs are more attractive than bank deposits, interest rates on digital cash can be set so low (even negative) that the cost of funding for banks is as low as before.

But the deepest question is that our current monetary system driven by private banks is a fundamental premise worth preserving, and threats to it must be resisted or disarmed. We should at least dare to ask the question whether CBDC’s disintermediation of private banks might not reduce risk, but the most important answer to the House of Lords’ arrogant question about what a CBDC should achieve.

think about it. Much of the currency in circulation today is bank deposits—that is, debts of private commercial banks to their customers. The fact that all governments think they have to guarantee a significant portion of these private debts first hints at how strange this actually is. Even stranger is how the total amount of this money is determined.

Deposit currency is created when a (private) bank makes a loan, when it credits a borrower with a deposit in an account in exchange for a promise to repay. That is, banks don’t lend out money that customers deposit into the bank; they just create new deposits when they make new loans and cancel existing funds when they repay them. (The Bank of England Quarterly Bulletin a great explainer years ago. )

As a result, the total size of the broad money supply in our economy is a discordant by-product of commercial banks’ decisions on how to issue and allocate credit. Now, the amount of money in circulation, and especially how fast it expands or contracts, clearly has some effect on economic activity (otherwise why would central banks try to manage monetary conditions?). However, there is absolutely no reason to believe that private banks’ best individual choices in their lending decisions should be aligned with the monetary aggregates that make the economy the most productive and safest.

In fact, it’s worse. The way private banks expand or contract the amount of money is destabilizing. This is because when money grows fast, so does economic growth, and the resulting optimism and high returns encourage banks to lend, thereby creating more money. Conversely, when people default on their loans or pay them off, there are fewer jobs, less economic growth, and less reason for banks to lend.

What a CBDC can do is separate the process of determining the total amount of money in circulation from the process of allocating credit. In such a system, banks would have to do what we tend to naively think (before we read the BoE explainer linked above) that they are already doing: bid for customers to deposit their existing currency balances in the bank, and Deposit these balances in the bank. Get the most out of them by lending them to borrowers they deem reputable. All the while, democratically controlled decision makers would directly determine the total amount of money in circulation without participating in the allocation of credit. With that said, disintermediation sounds like a good thing.

other readings

• This Fed press conference This week made some market watchers Expect faster tightening US monetary policy.

• However New Economic Research provides a novel argument for keeping monetary policy accommodative in an “unbalanced global recovery” like ours today. Luca Fornaro and Federica Romei point out that while central banks face the full cost of domestic inflation from stimulus, the benefits will cross borders — by stimulating the production of goods whose supply shortages are driving global inflationary pressures.

digital news