How central banks are turning to e-money

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JTHE STORY money is littered with scams. In 17th century England, William Chaloner forged coins, banknotes and lottery tickets before being sent to the gallows by Isaac Newton, master of the Royal Mint. During the era of free banking in America in the mid-1800s, Andrew Dexter purchased five banks in New England and began circulating bank notes with very little to back them up. A bank issued $760,000 in notes, backed by only $86 in gold and silver.

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Things got less lively after central banks got legal monopolies on banknotes. Still, there were concerns about it. At the turn of the 20th century, shortly before the Riksbank obtained its banknote monopoly, Pontus Fahlbeck, a Swedish politician, spoke of “fear of serious disruption in the business world” and feared that the bank power plant becomes “much more powerful”. and influential than before for the country’s economy as a whole”.

Today, physical cash has fallen out of favor. Most of the money is digital and created by commercial banks, albeit regulated. A cast of digital money wannabes compete for customers’ e-wallets. And central banks want to stay in the monetary sector by issuing their own digital currencies, which makes the questions raised by Fahlbeck more relevant than ever.

A banknote, as a claim on a central bank, is the most secure form of money. But only commercial banks have access to central bank reserves. A central bank digital currency (CBDC) would extend this to everyone. The public could either hold accounts with the central bank or hold central bank money in private wallets. According to the Atlantic Council, a think tank in Washington, CC89 countries representing 90% of the world GDP explore a CBDC. Bahamian sand dollar, Eastern Caribbean DCash and e-naira from Nigeria are already circulating. China’s trial of its digital currency, e-CNYhas expanded to over 260 million wallets.

the ECB looks at the design and scope of a digital euro. “My preference is to see something in place by 2025,” says Christine Lagarde, its president. In Sweden, a parliamentary inquiry will soon rule on the advisability of an electronic crown. President Biden issued an executive order asking the government and the Fed to explore the idea of ​​a CBDC. In February, researchers from the Boston Fed and the Massachusetts Institute of Technology announced that they had built a system capable of handling up to 1.7 million transactions per second, far exceeding Visa’s throughput.

Central banks want to stay in the monetary business by issuing digital currencies

The consequences of CBDCs in their most radical form would be serious. They could make central banks accountable for how credit is intermediated. Since public money is safer than commercial bank money, deposits could flow from banks to the central bank. In difficult times, this could become a flood, made easier by the fact that money can be transferred between wallets with the click of a mouse. A study in Canada suggests that, depending on the characteristics of a CBDC, households could hold between 4% and 55% of their cash in one. Deposits are a cheap source of funding for banks. If they ran out, lenders would either have to raise funds in more expensive wholesale markets or reduce their lending. And central bank liabilities would increase, says Rickard Eriksson of the Swedish Bankers Association, raising the question of how they should be matched on the asset side. Direct lending to businesses and households would be unlikely, but they may have to lend more to banks.

The danger, according to Princeton’s Markus Brunnermeier, is that lenders’ dependence on central banks would shift the balance of the relationship by giving central banks the power to determine who gets credit. Randal Quarles, the former vice chairman of the Fed, points out that the US distressed asset relief program was supposed to have no conditions, but after going through the political boom, all sorts of conditions were added . Someone should monitor payment data, if only because of anti-money laundering rules. This would turn the central bank into a powerful credit machine and an ubiquitous tool of state surveillance. Eswar Prasad of Cornell University, author of a book on the future of money, believes that the biggest threat to a digital currency is ultimately the independence of central banks.

Yet most central bankers are convinced that a well-designed system CBDC can minimize their intrusiveness, while remaining attractive. Many converge on a set of principles to avoid destabilizing banks. None of the digital coins introduced or tested so far pay interest, so as not to compete with bank deposits. To avoid the risk of a bank run, most CBDCs limit the amount of virtual money customers can hold. A report from BIS and seven major central banks suggest that a system of rising fees could make CBDCs less attractive than commercial bank accounts. The solution to the privacy problem, they say, is to use a two-tier system without dropping dubious transactions. Bahamian Sand Dollar users can hold up to $500 without providing any information to create an account, but those wishing to hold up to $8,000 must pass identity checks. In order to keep central banks at a distance from the public, most countries rely on private providers to offer CBDC wallets, so the wallet providers carry out the anti-money laundering checks.

By design, these amendments would make CBDCIt is an inferior form of money. Cash generally satisfies three functions of money: it is a unit of account, a medium of exchange and a store of value. Caps on virtual money, however, would mean that it would no longer be a store of value. The optimistic view is that it could open the door to innovation and competition. But the pessimistic view is that it could harm the attractiveness of a CBDC.

The result is somewhat paradoxical. Central banks need to make sure currencies succeed, but not too much. In a report to the European Parliament, Mr Brunnermeier and Jean-Pierre Landau of Sciences Po in Paris suggest that a central bank “will have to ensure that the CBDC is present everywhere but important nowhere”.

For some critics, it makes CBDCIt is hardly worth the effort, especially in places where cash is not yet near extinction and existing payment systems are quite fast. The average amount in an e- CNY wallet is three yuan (47 cents), which does not mean it was a smash hit. In Britain, a committee of the House of Lords concluded that CBDCs were a “solution in search of a problem”. But the impetus for CBDCs is building. This makes the political process to agree on them important.

This article appeared in the Special Report section of the print edition under the headline “Monopoly money”

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