As the US government begins setting up the regulatory guardrails for a digital dollar, the EU forms a consortium to develop a prototype for a digital euro. Its members include Amazon and dozens of large EU banks.
It is a rare experience to find oneself in more or less full agreement with a senior central banker, particularly these days. Yet that is what happened to me just over a month ago. In early August, Neel Kashkari, ex Goldman, ex Pimco employee, currently the President of the Minneapolis Fed, lambasted the idea of creating a digital dollar, arguing that US consumers already had access to instant digital payments through private-sector platforms.* Speaking at the 2022 Journal of Financial Regulation conference at Columbia University, he also flagged concerns about the threat central bank digital currencies (CBDCs) could pose to privacy, anonymity and other basic freedoms.
“I can see why China would do it,” Kashkari said. “If they want to monitor every one of your transactions, you could do that with a central bank digital currency. You can’t do that with Venmo. If you want to impose negative interest rates, you could do that with a central bank digital currency. You can’t do that with Venmo. And if you want to directly tax customer accounts, you could do that with a central bank digital currency. You can’t do that with Venmo. I get why China would be interested. Why would the American people be for that?”
Kaskari is right, of course: they probably wouldn’t. But they’re not being consulted on the matter. In fact, in most cases they’re not even aware it is happening.
White House Recommends Creating a Digital Dollar
Today, the digital dollar is closer to becoming a reality than ever before. On Friday (Sept. 16), the Biden Administration released a framework for the responsible development of digital assets, including cryptocurrency, CBDCs and other items of value that exist only in digital form. An alphabet soup of government agencies, including the US Treasury, the Justice Department, the Consumer Finance Protection Bureau and the Securities and Exchange Commission, have been tasked with contributing to reports that will explore the risks, development possibilities and usage of digital assets.
All of this was put into motion just over six months ago by Joe Biden’s Executive Order 14067, officially dubbed “Ensuring Responsible Development of Digital Assets.” Signed on March 9, it represented the first ever “whole of government approach” to regulating digital assets. Among the executive order’s many goals is to make the handling of digital assets easier and more secure; to safeguard US global leadership in digital asset innovation; and, as laid out in section 4, to lay the groundwork for the creation of a digital dollar:
Sovereign money is at the core of a well-functioning financial system, macroeconomic stabilization policies, and economic growth. My Administration places the highest urgency on research and development efforts into the potential design and deployment options of a United States CBDC. These efforts should include assessments of possible benefits and risks for consumers, investors, and businesses; financial stability and systemic risk; payment systems; national security; the ability to exercise human rights; financial inclusion and equity; and the actions required to launch a United States CBDC if doing so is deemed to be in the national interest.
On Friday, US Treasury Secretary Janet Yellen posited two reasons for developing a digital dollar: first, because “some aspects of the current payment system are too slow and too expensive”; and second, “to reinforce the US’ role as a leader in the world financial system”.
This is seen as increasingly necessary as China forges ahead with its digital yuan. China’s central bank has been exploring the possibilities offered by digital currencies since 2014. The digital currency is now being piloted in more than 20 regions and cities and was also widely showcased in this year’s Beijing Winter Olympics. As British technology news website The Register reported last week, the Chinese government is now looking to integrate the digital yuan with China’s private digital payment systems — most notably Alibaba’s AliPay and Tencent’s WeChat Pay, which dominate China’s payments landscape and which already have millions of payment terminals outside China.
Simpler, Cheaper, More Direct
In theory, CBDCs will allow for the creation of a simpler, cheaper, more direct payment system, by cutting out most, if not all, financial intermediaries, as the Washington-based analyst NS Lyons notes in his brilliant article, Just Say No to CBDCs:
A customer would open an account directly with a country’s central bank, and the central bank would issue (create) digital money in the account. Crucially, this makes the money a direct liability of the Fed, rather than of a private bank. Using a simple smartphone app or other tools, the customer can then initiate direct transactions between Fed accounts. The digital money is deleted in one account and recreated in another instantaneously.
However, in its Future of Money and Payments report, the US Treasury envisages a two-tiered model under which the Fed would issue and redeem digital dollars but the distribution of those digital dollars would be handled by intermediaries eligible for an account at the Federal Reserve. Payment services would also be managed by banks and other private sector players:
This would be similar to how paper currency is distributed through commercial banks. It also shares similarities to responsibilities surrounding noncash retail payments today: the intermediaries onboard, provide customer support, and manage payments. In addition, intermediaries would likely implement AML/CFT obligations, while relevant supervisors would monitor compliance with those obligations.
In other words, a select group of banks and non-banks chosen by the Fed would continue to play a role in the new financial system, while most financial institutions — including the small local lenders and credit unions that serve local communities — would presumably get disintermediated. As the European Central Bank recently warned, a broadly adopted CBDC is likely to lead many people and businesses to pull their money out of commercial banks at the first whiff of a financial crisis and put it into the supposedly safer accounts held with the central bank.
Playing Catch Up
Currently, just over 100 jurisdictions representing 95% of global gross domestic product are exploring or have already created a central bank digital currency, according to the Atlantic Council. They include the US, the Euro Area, China, India, Russia, the UK, Australia, Canada, Brazil and Mexico. Here’s an infographic, courtesy of Visual Capitalist, depicting the global state of play in the CBDC space:
Naturally, the Atlantic Council — a Washington DC-based US think tank that aspires to “shape the global future” — believes the US should lead the way in the global rollout of CBDCS, but that will be easier said than done given the head start China has on it (and most other large economies):
The Treasury Department says it wants to talk more with other countries, share knowledge on digital currencies, and help set international standards. Treasury recognizes that it is in the national interest to create a digital dollar and that there are national-security concerns connected to it.
What does that mean? It means that, as China is creating its own digital currency, the United States wants to make sure the model that proliferates around the world is one that respects democratic values—for example, privacy. But in order to do that, the United States needs to bring its own model to the table. Treasury is saying today that the United States is going to do that and that it’s a whole-of-government priority. The issue is urgent.
The US has not exactly been sitting on its hands all this time. The Digital Currency Initiative at MIT has been working with the Boston Federal Reserve to explore the steps necessary to create a safe and effective central bank digital currency, “applying the learnings from a decade of cryptocurrencies toward designing CBDCs and integrating them into our increasingly digital lives.” In February, the Deposit Trust and Clearing Corporation (DTCC) launched a prototype, known as Project Lithium, to explore how a CBDC might operate in the U.S clearing and settlement infrastructure leveraging distributed ledger technology.
Amazon to Test-Run a Digital Euro
The EU seems to be somewhat further along the path toward creating a digital euro. On Saturday (Sept 17), the European Central Bank (ECB) announced it had handpicked a team of five companies — Amazon, Spain’s CaixaBank, France’s Worldline SA, Italy’s Nexi S.p.A. and the European Payments Initiative, a consortium of 31 large Euro Area banks and third-party acquirers — to develop a prototype for a digital euro, with each firm exploring a specific digital use for the euro-area currency.
“The aim of this prototyping exercise is to test how well the technology behind a digital euro integrates with prototypes developed by companies,” the Frankfurt-based institution said. This follows an announcement from the ECB in July that work on a digital euro has entered its second development phase, which will involve testing the CBDC for retail use cases in preparation for a 2023 rollout.
So, while the US government is in the process of setting up the regulatory guardrails for a CBDC, the EU is in the two-year “investigation phase” of the digital euro project. Although the ECB claims that no formal decision on whether to launch a digital euro has been taken (what else would it say?), the most likely outcome, as Bloomberg reports, is that the ECB will be among the first advanced-economy central banks to issue a digital form of its currency, with officials pointing to the middle of this decade for a possible rollout.
A research paper recently published by the ECB, titled “The Economics of Central Bank Digital Currency,” concludes that CBDCs are the only possible means of safeguarding sovereign money in an age of declining cash use and proliferating private digital currencies such as cryptocurrencies and stable coins. It also posits that cash, whose volume in circulation in the Euro Area has almost doubled in the last decade even as usage has fallen, does not meet the needs of the digital age:
“Since cash is only available in physical form, it is by construction not ‘fit’ for the digital age… Accordingly, the introduction of digital cash in the form of a CBDC appears to be the only solution to guarantee a smooth continuation of the current monetary system.”
Of course, the ECB disclaims that the research paper paper only reflects the opinions of its authors. It has also repeatedly stated that a digital euro would coexist alongside physical cash. But the ECB has a habit of saying all sorts of things it ends up not doing.
The paper’s authors also note that although repeated surveys have shown that consumers place a high value on privacy, they are usually willing to give up their data for free or in exchange for small rewards or gains in convenience. But what about those who aren’t? As I’ve warned before, if central banks and governments were to do away with cash or to vastly accelerate its demise by penalizing its use (while incentivizing the use of CBDCs), we would probably see a huge increase in financial exclusion
The creation of a CBDC would not just require consumers to hand over their data. As Kashkari noted in his speech, it would mean giving up what remains of your privacy and anonymity. It would mean handing even more power — a lot more power, arguably total power — to the governments, central banks and select tech companies and large commercial banks that will end up running this new monetary system.
That power could be used, among other things, to take interest rates into far deeper negative territory. If there is no cash, there is no means for people to escape negative rates no matter how negative they go. In a CBDC world central banks will not only know exactly what we spend our money on; they will also be able to determine what we can and cannot spend our money on.
CDBCs could also be used to strongly encourage “desirable” social and political behavior while penalizing those who do not toe the line, as recently happened in Canada. As Lyons points out, “The most dangerous individuals or organizations could simply have their digital assets temporarily deleted or their accounts’ ability to transact frozen with the push of a button, locking them out of the commercial system and greatly mitigating the threat they pose. No use of emergency powers or compulsion of intermediary financial institutions would be required: the United States has no constitutional right enshrining the freedom to transact.”
The fact that the US dollar and the euro are currently the world’s two preeminent reserve currencies and are used globally makes this an even more important issue. Other risks associated with CBDCs include cyber security and system resilience. As even the World Economic Forum noted in its 2020 report, Central Bank Digital Currency Policy-Maker Toolkit, “compared to physical cash, risks from counterfeiting, theft and network failure for digital money entail more catastrophic consequences.”
As I noted in a previous article (Unbeknown to Most, A Financial Revolution Is Coming That Threatens to Change Everything), CBDCs and the digital IDs that will come hand-in-hand with them are among the most important questions today’s societies could possibly grapple with — not only from a financial or business perspective but also from an ethical and legal standpoint. They promise to totally transform the societies we live in and the economies we depend on. As such, they should be under discussion in every parliament of every land, and at every dinner table in every country in the world.