Financial Times, February 1, 2016 11:31 am

Free Lunch: Time for a digital government mint

Martin Sandbu

Phase out cash, phase in official digital money 

http://www.ft.com/intl/cms/s/3/eab39a48-c860-11e5-be0b-b7ece4e953a0.html

E-cash for the people

  Two profound changes are under way in our attitudes towards money, both of which could in short order transform how most of us deal with the banking system, and indeed how the system itself works. The first trend is a growing preference for electronic means of payment over cash. The other is the growing push for central banks themselves to issue electronic money for use by individuals.

It’s easy to conflate these two trends. Bloomberg View, in an otherwise nail-on-the-head editorial calling for the abolition of cash, seems to take the phasing out of cash as synonymous with the phasing in of state-backed digital money. But, by itself, the phasing out of cash would just leave the field open to the private digital payment systems, largely based on current account deposits in private banks, that already exist or are rapidly being developed.

The shift away from cash is something we have commented on before, and is the subject of a new report from Imperial College with Citi. It argues that hundreds of billions of dollars could be saved globally by digitising even just a fraction of current cash transactions. Even so, the take-up varies a lot around the world, and only a few Nordic countries have passed “peak cash”.

Currently, coins and paper notes are the only state-issued money available for use by you and me; the vast bulk of what we normally call “money” is a deposit with a bank. Up to a limit (currently €100,000 in Europe), this is state-backed in the sense that the government guarantees that it will be available for spending no matter what happens with the bank. Even this is surprisingly recent. On the eve of the financial crisis, the pan-European limit was much lower and EU law explicitly prohibited deposit insurance schemes from being backed by the state (they had to be industry-funded schemes).

So a shift away from cash towards electronic money as it currently exists is a migration of “money” away from state-issued currency. The second idea — creating a digital version of cash, with its full state-backed characteristics — is a push for just the opposite. Wrapping one’s head around the difference between official versus private money is a lot harder than understanding the distinction between physical and electronic money — but it is also essential for making informed judgments about financial and monetary policy (we have previously explained why). Well done, therefore, to Positive Money, which has just published a report arguing how and why official digital currency should be introduced in the UK. The thoughtful and thorough report qualifies as essential reading.

The general idea is for the Bank of England (or other central banks; the ideas are general) to offer deposit accounts directly to the public, or alternatively, for private banks to offer accounts fully backed by central bank reserves. The authors go through the mechanics of how this would work, and address the main objections. We only discuss the most important of these here (but do read the whole report), which is that the system may work too well.

Too well, that is, in that people would convert a very large share of their current bank deposits into official digital money, in effect taking them out of the private banking system. Why might this be a problem? If it’s an acute rush for safety in a crisis, the risk is that private banks may not have enough reserves to honour all the withdrawals. But that is exactly the same risk as with physical cash: it’s often forgotten that it’s central bank reserves, not the much larger quantity of deposits, that banks can convert into cash with the central bank. Both with cash and official e-cash, the way to meet a more severe bank run is for the bank to borrow more reserves from the central bank, posting its various assets as security. In effect, this would mean the central bank taking over the funding of the broader economy in a panic — but that’s just what central banks should do.

A more chronic challenge is that people may prefer the safety of central bank accounts even in normal times. That would destroy private banks’ current deposit-funded model. Is that a bad thing? They would still have a role as direct intermediators between savers and borrowers, by offering investment products sufficiently attractive for people to get out of the safety of e-cash. Meanwhile, the broad money supply would be more directly under the control of the central bank, whereas now it’s a product of the vagaries of private lending decisions. The more of the broad money supply that was in the form of official digital cash, the easier it would be, for example, for the central bank to use tools such as negative interest rates or helicopter drops. Both could be indispensable in the years ahead.

Other readables

• The OECD surveys Israel, one of the rich-country club’s newest members. It’s a study in contrasts. The country has grown much faster than the OECD average every year for more than a decade, but is riddled with spiking inequality, deepening poverty and a system of market power and protection that makes these problems worse.
  
  
• Tim Harford revisits his previous optimism that economic growth was reducing pollution in China — based on the concept of the “environmental Kuznets curve” — and then revisits his contemplated correction.

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• On Iowa caucus day, the numbers journalists at fivethirtyeight.com cover the state’s best pollster and explain how good Ann Selzer’s performance has been over the years.

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