Twenty twenty is a year dominated by bad news. While governments around the world have imposed extremely destructive restrictions on economic life and promise a “Great Reset” that amounts to a great leap forward into the socialist future, central bankers have advanced plans for implementing central bank digital currencies (CBDCs). These may arrive as early as next year. Yet what is the motivation behind this innovation? Reports recently published by the Bank for International Settlements 1 and the European Central Bank 2 provide part of the answer. These publications provide fascinating insight into the theories and ideologies driving central bankers in their pursuit of CBDCs.
Monetary Policy? Moi?
One perhaps surprising theme in both reports is the disavowal of any monetary policy behind plans for introducing CBDCs. The BIS report claims that “monetary policy will not be the primary motivation for issuing CBDC” (p. 8) and the ECB report notes that a “possible role for the digital euro as a tool to strengthen monetary policy is not identified in this report” (p. 3). One might first of all suppose that introducing a new form of money would by definition amount to monetary policy, at least in a broad sense, and secondly perhaps find it a tiny bit weird that institutions dedicated to researching and implementing monetary policy would not have considered the potential effects of a new form of money in light of its effects on policy. But what is really striking is that both reports—and especially the one issued by the ECB—at great length detail the implications for monetary policy of CBDC. True, they say they don’t, but looking beyond the executive summary and paying attention to what is written in the report itself puts the lie to that claim.
In order to see this, we only need to look at the key features the central bankers identify as desirable in a CBDC: it should be interest bearing, and it should be possible to cap how much each individual can hold. Both measures are clearly aimed at supporting monetary policy. The cap on holdings forces people to spend their money, driving either price inflation or investment in financial assets, and by making the CBDC interest bearing (or remunerated, in the language of the ECB) it becomes a tool of setting and passing on policy rate changes, including negative interest rates.
The ECB’s Report on a Digital Euro in particular goes on at great length about the need to limit or disincentivize “the large-scale use of a digital euro as an investment” (p. 28). The reasoning behind this position is crystal clear: since monetary policy has driven interest rates into negative territory, the ECB should not allow large-scale holding of digital euros, since investors would then, quite sensibly, chuck their holdings of negative-yielding bonds and seek a safe haven in digital euros—that is, if they can hold them at no cost. Similarly, the ECB is averse to letting people convert their bank deposits into digital euros (p. 16), which would reside in their individual wallets rather than in a bank account. Indeed, the horror of what the BIS and ECB reports call “financial disintermediation” looms large in the minds of central bankers: if people keep their money outside of banks, these will have less money to lend out, thereby increasing borrowing costs. In the words of the BIS report, they are concerned that
a widely available CBDC could make such events [i.e., bank runs] more frequent by enabling “digital runs” toward the central bank with unprecedented speed and scale. More generally, if banks begin to lose deposits to CBDC over time they may come to rely more on wholesale funding, and possibly restrict credit supply in the economy with potential impacts on economic growth. (p. 8)
Of course, Austrian economists since Ludwig von Mises 3 understand that “financial disintermediation” can really be a blessing. In the context of digital euros, all it means is that people would hold the amount of cash they deemed desirable outside the banks. They would only make true savings deposits in banks, i.e., they would only surrender money that they did not want instant access to. Under such circumstances, banks would be incapable of expanding credit by issuing unbacked claims to money; they could only make loans out of the funds their customers had explicitly made available for that purpose. This would not only result in a leaner or sounder financial system, it would also avoid the problems of the perennially recurring business cycle. And contrary to what the central bankers fear, the supply of credit would not be restricted, it would simply be forced to correspond to the supply of real savings in the economy. This, unfortunately, is an understanding of economics completely alien to central bankers.
Negative Interest Rates
One aim in introducing CBDCs that is only hinted at is the possibility of imposing even lower negative interest rates. In recent years monetary economists 4 have increasingly discussed the problem of the “zero lower bound” on interest rates: the fact that it is impossible to set a negative interest since depositors in that case would simply shift into holding physical cash. When manipulating the interest rate is the main policy tool of central banks this is obviously a problem: How can they work their alchemy and secure an acceptable spread between the main policy rates and the market rate of interest when interest rates are already very low? Allowing for the cost of holding physical cash, –0.5 percent seems to be about as low as they can go.
With a centrally controlled digital currency this problem would disappear. The central bank could set a limit on how much each person and company could hold cost free, and above this limit, they would have to pay whatever negative interest rate (or “remuneration,” as the ECB insists on calling it) is consonant with central bank policy. In this way, holding cash would not obstruct monetary policy, as the cash holdings would be fully under the control of the central bank.
There is just one problem with using CBDC in this way: it only works if physical cash is outlawed. Otherwise, physical cash would still simply play the role it does today, i.e., as the most basic and least risky way of holding one’s wealth and of avoiding negative interest rates. The BIS report clearly identifies this problem (p. 8n7), as does the ECB (p. 12n18): a CBDC could help eliminate the zero lower bound on interest rates, but only if physical cash disappeared. So long as physical cash remains in use, the zero lower bound cannot be breached.
But the People Demand It!
However, people might of their own accord come to the rescue of the world’s central banks, sorely beset as they are by the zero lower bound. At least according to Benoît Coeuré, head of the BIS Innovation Hub (the group tasked with researching CBDC), plenty of people want a central bank digital currency. The ECB also sees the decline in the use of physical cash in favor of other means of payment as one of the main scenarios that would require the issue of a digital euro (p. 10).
Now, while some people might like CBDC, there is really no reason to believe, notwithstanding monsieur Coeuré’s anecdotal evidence, that there is widespread demand for central bank digital currency. The ECB admits as much when they write that physical cash is still the dominant means of payment in the euro area, accounting for over half the value of all payments at the retail level (p. 7). But Coeuré does not need to go far to see the continuing relevance of cash: in 2018 researchers at the BIS itself concluded that cash, far from declining in importance, was still the dominant form of payment. 5 More recently, a study in the International Journal of Central Banking showed that cash usage is not only not declining, but even increasing in importance. 6
Be that as it may, the central bankers are certainly right that there is an increased demand for digital payment solutions and for cryptocurrencies. However, it is erroneous to conclude from this that therefore a central bank digital currency is demanded. Demand for a payment solution is not the same as demand for a new kind of money. It simply means that people demand payment services that allow them to more cheaply transact with each other. Such services are plentifully provided by companies such as Visa, Mastercard, Paypal, banks, and so on and so forth. There is no reason to believe that central banks need to provide this service nor that they could do it better than private companies and banks, and it is simply a mistake to equate demand for such services with demand for a money.
The mistake in the case of cryptocurrencies is even more egregious. When people hold bitcoin or another cryptocurrency, it is not because their heartfelt demand for a CBDC has to go unfulfilled and this is their closest alternative. On the contrary, people want to own bitcoin precisely so they can avoid the negative interests imposed on the established banking system and the risks of holding inflationary fiat money. Introducing a CBDC would not mitigate those risks, but rather add to them, as the central bank would assume total control of the money supply through it and the attendant abolition of physical cash. The felt need for inflation hedges and the desire to escape central bank control, including as it does negative interest rates and caps on how much cash one could hold, would only increase.
It’s All about Control
At the end of the day, central bank digital currencies are all about control, not meeting consumer demand. The ECB admits as much at several points in their report. Here is just one instance: If people are really demanding a digital euro, why would it have to be assigned legal tender status in order for it to be accepted, as the authors of the report clearly state would be necessary (p. 33)? The only scenario where introducing a CBDC makes sense is in order to phase out the use of physical cash in order to be able to impose whatever negative interest rate regime the central bankers in charge judge necessary. Helicopter money, restrictions on cash holding, and negative interest rates are all part of the bundle of desirable policies that can only—or most easily—be achieved with digital currencies fully controlled by the issuing central banks.
Ironically, far from buttressing the role of central banks and government fiat money, imposing a CBDC may have the completely opposite effect. Replacing physical cash with a CBDC would only strengthen the undesirable qualities of fiat money and further hamper a free market in money and financial services, increasing the demand for alternatives to government money, such as gold and bitcoin.