One reason it took us all so long to recognize climate-change risk is that many scientists focused on specific plants and wondered what might be amiss with each of them. Deforestation went little noticed until it’s almost too late. So it goes with financial-system structural realignment. Day-to-day battles over regulatory details and quarter-over-quarter earnings preoccupations obscure the clear fact that profitable, regulated financial intermediation is becoming as hard to find as a dry street corner in Miami Beach. However, two forces could well ensure that U.S. finance will forever more be irreversibly a business only for the unregulated and then mostly for only the prosperous. Negative rates up-end financial intermediation. The solution increasingly sought by global central bankers – central-bank digital currencies (CBDCs) – might resurrect financial intermediation, but only because central banks – not the private sector – would do it.
What is a CBDC? Variations matter, but the general construct is well described in a recent, high-level paper from the IMF. In broad terms, all CBDCs are “central-bank money,” serving largely as a “unit of account” on and off a central-bank balance sheet much as fiat currency does now. Instead of being valued in relation to a currency, CBDC is the currency.
Although talk has swirled around CBDCs at central-bank cocktail parties for the last year or so, the question took on real urgency with Libra’s launch. French Finance Minister Bruno Le Maire suggested Thursday that Libra threatens the ability of central banks to control the money supply and the ability of sovereign nations to set financial policy. To his mind, CBDCs are the solution. He will thus press the IMF to craft a CBDC construct at its annual meeting next month.
Mr. Le Maire is not the only global central banker with a hankering for CBDC. Although the idea gives FRB Chairman Powell considerable pause, Bank of England Governor Carney used his 2019 Jackson Hole speech to propose one as a solution to President Trump’s increased warlike use of the dollar’s power as a reserve currency. The Chinese central bank reportedly also plans a CBDC, possibly also with an eye on the dollar as well as a way to gain even more control over that nation’s financial system. Just this morning, the European Central Bank announced its own plan to launch a CBDC.
Regardless of why they are established, CBDCs redefine banking in fundamental ways based on how a CBDC is designed. One approach essentially creates a “tokenized” form of fiat currency that could end the need to conduct payments through “private money” – i.e., bank reserves. This opens the system to anyone with whom a central bank is willing to deal. The Federal Reserve plans for a faster payment system limited only to banks to preserve the interbank nature of the U.S. framework, but Amazon, Google, Facebook, and other tech companies are certain that a Fed-controlled system is a Fed system that offers considerable competitive advantage.
They’re right. CBDC could well move payments farther and faster in a Fed system providing liquidity backstops and other protections once imaginable only at the considerable cost of extensive regulation. With CBDC, nonbanks could place their float in the payment system not in central-bank reserves but in Treasury obligations or other low-risk assets. This would essentially replace fractional banking with narrow banking to the extent money flowed out of bank deposits and into the payment system through nonbank payment-system participants.
In this system, the IMF expects that transaction deposits would flow outside banks and savings might well migrate to mutual funds or other non-bank intermediaries. Banks would still presumably get wholesale money, but for how long and at what cost to long-term lending?
A second CBDC model has the central bank also serving as an account holder for CBDC – essentially becoming the retail bank at which idle CBDC are housed just as idle cash now is converted into private money in the form of bank deposits. This is not a fantastical CBDC outcome – Swiss voters were so enamored of the idea that they forced a referendum on it in 2018 and supporters of Sen. Warren have also suggested it. The more we focus on “helicopter money” – or “the people’s quantitative easing” as progressives prefer – the more central banks become intermediating banks. They could of course do so even without CBDC just by opening themselves to retail depositors and then lending funds out for what the central bank or a politician thinks is a socially-desirable purpose – infrastructure, the green new deal.
Thus, one approach to CBDC has the central bank’s currency serve as the medium of exchange for payment-system transactions without the need ever to touch a central-bank reserve held at cost by a regulated bank. The other CBDC option has the central bank take over retail bank deposit-taking along with any lending it thinks behooves the nation. These aren’t mutually exclusive – any way one looks at it, banking would be very, very different.