Cbank digital currencies and the path to Gosbankification
Central banks issuing their own digital currencies (on blockchains, naturally) is an idea currying ever more favour in high-brow economic and banking circles.
Fedcoin. BoEcoin. ECBcoin. They’re all (allegedly) at it — or at the very least contemplating the idea as a work-around to the zero lower bound and other niggling monetary problems.
This month the BoE issued a paper on the topic entitled “The macroeconomics of central bank issued digital currencies. A related blog “Central bank digital currency: the end of monetary policy as we know it?” was published this week. But if you Google “central bank blockchain” you’ll find a gazillion references or more from all over the world talking about the subject.
The arguments for are predictable. Official emoney would give central banks more power and control over the money supply. They’d be able to introduce negative rates or expand and contract the base money pool as and when the economy required it, especially if physical cash was suspended at the same time. Official emoney would also solve the safe asset problem (because the BoE’s balance sheet would now be available to anyone). And everyday people would be given the chance to limit their exposure to the banking sector without having to compromise on the convenience of digital banking services.
Last and not least — something most popular with hard money enthusiasts — official emoney would open the door to an effective full-reserve system wherein bank funding would have no choice but be sourced from the existing loanable funds universe, eradicating the money creation power of the banks. (An appealing prospect for the likes of Positive Money, who have long been lobbying for the centralisation of money creation power.)
Now it’s true that for a long time FT Alphaville expressed some sympathy for all these arguments (do see the back-catalogue links below). But, in the spirit of contrarianism, we’ve recently changed our minds (links to flip-flop posts also available below).
There are three core factors which have changed our perspective.
It’s worth noting the BoE’s Marilyne Tolle has already hinted of how the setup could end-up complicating the monetary policy channel:
Forcing banks to pre-fund every loan with central bank money, meanwhile, could constrain the monetary growth needed to deliver the monetary returns promised. As a result, the arrangement would put a lot of trust in a single authority’s ability to determine just how much money supply is enough at any given time. It would also shift most of the balancing risk over to the government balance sheet and away from the private sector. In short, the temptation to imprudently create money could hypothetically be shifted away from the private sector and over to the government sector instead.
And it’s not like the annals of centralised money systems past haven’t already provided us with some poor examples of these models in play.
The first and foremost which comes to mind is that of the Gosbank system of the Soviet Union. To wit, here are a few extracts from Patrick Conway’s 1995 Princeton research paper entitled “Currency Proliferation: The monetary legacy of the Soviet Union”:
But you can see where we’re going with this. Once you centralise the money-creation function you inadvertently create a captured market for a single type of monetary instrument. This removes the checks and balances associated with a competitive monetary system and leads directly to the second problematic issue we’ve identified: a single monetary authority’s ability to competently manage and re-invest the monetary float in a way which will defend its par value.
If and when the central bank fails to do that — something ultimately determined by the quality of the assets or claims which back the reserves — then private sector alternatives, foreign national currencies or commodities will begin to circulate as money anyway (and will do so even if they’re less convenient).
Fedcoin. BoEcoin. ECBcoin. They’re all (allegedly) at it — or at the very least contemplating the idea as a work-around to the zero lower bound and other niggling monetary problems.
This month the BoE issued a paper on the topic entitled “The macroeconomics of central bank issued digital currencies. A related blog “Central bank digital currency: the end of monetary policy as we know it?” was published this week. But if you Google “central bank blockchain” you’ll find a gazillion references or more from all over the world talking about the subject.
The arguments for are predictable. Official emoney would give central banks more power and control over the money supply. They’d be able to introduce negative rates or expand and contract the base money pool as and when the economy required it, especially if physical cash was suspended at the same time. Official emoney would also solve the safe asset problem (because the BoE’s balance sheet would now be available to anyone). And everyday people would be given the chance to limit their exposure to the banking sector without having to compromise on the convenience of digital banking services.
Last and not least — something most popular with hard money enthusiasts — official emoney would open the door to an effective full-reserve system wherein bank funding would have no choice but be sourced from the existing loanable funds universe, eradicating the money creation power of the banks. (An appealing prospect for the likes of Positive Money, who have long been lobbying for the centralisation of money creation power.)
Now it’s true that for a long time FT Alphaville expressed some sympathy for all these arguments (do see the back-catalogue links below). But, in the spirit of contrarianism, we’ve recently changed our minds (links to flip-flop posts also available below).
There are three core factors which have changed our perspective.
- Centralised money’s tendency to ossify the economy.
- The fact that float/reserve management is really hard, especially for a central operator.
- The fact alternative money systems will always find a way to co-exist with official money, especially if the official money turns bad.
It’s worth noting the BoE’s Marilyne Tolle has already hinted of how the setup could end-up complicating the monetary policy channel:
If households and firms were given access to CBcoin accounts at the CB, banks’ dominant role as providers of payment services would be called into question. As a risk-free, interest-bearing asset, CBcoin would be preferable to bank deposits (and even paper currency, presuming anonymity concerns were addressed), encouraging households and firms to convert their bank deposits into CBcoin deposits. The appeal of CBcoin vis-à-vis deposits would likely depend on the relative interest rate payable.Under this scenario, banks would no longer be able to depend on deposits for funding. Their money creation power would be dissolved, but so too would their capacity to take competitive risks with respect to lending decisions. If banks wanted to make loans they would be forced to source funds from the population’s central bank deposits (which, of course, might not be forthcoming) or to seek liquidity directly from the central bank. Funding for lending would become the norm, with the central bank determining which loans were worth making and which were note. This might not seem so bad, until you realise banks would turn into simple branch agents of the central bank.
In effect, retail payments (and securities transactions) would no longer have to be mediated by banks, as the funds would be transferred directly from one party’s CBcoin account to another’s. A disintermediated payment system could gradually replace the current centralised system and its associated credit and liquidity risks (see BIS (2003)). The main benefit to CBcoin account holders would be access to cheap and fast peer-to-peer transactions.
Forcing banks to pre-fund every loan with central bank money, meanwhile, could constrain the monetary growth needed to deliver the monetary returns promised. As a result, the arrangement would put a lot of trust in a single authority’s ability to determine just how much money supply is enough at any given time. It would also shift most of the balancing risk over to the government balance sheet and away from the private sector. In short, the temptation to imprudently create money could hypothetically be shifted away from the private sector and over to the government sector instead.
And it’s not like the annals of centralised money systems past haven’t already provided us with some poor examples of these models in play.
The first and foremost which comes to mind is that of the Gosbank system of the Soviet Union. To wit, here are a few extracts from Patrick Conway’s 1995 Princeton research paper entitled “Currency Proliferation: The monetary legacy of the Soviet Union”:
The Gosbank was the monetary authority for the Soviet Union. Its policy of ruble-banknote emission was essentially passive. If the demand for currency to meet necessary wage and pension payments exceeded the stock of currency available through the financial system, the Gosbank issued additional currency against the liabilities of the central government.Now, we’ll admit it’s not an absolute equivalent situation. With Gosbank came Gosplan, a people’s political authority and a helluva lot of welfare.
———
… the Gosbank was the only bank for the entire economy; even after 1987, when it was broken into pieces, the activities of the pieces remained under the control of Gosbank leadership. Second, the use of currency and credit for making payments occurred in two largely separate channels. Third, government liabilities were the chief assets for the entire financial system.
————
This monobank system of accounts produced a dichotomy between banknote and accounting transactions in the flow of funds. Households received wages from enterprises and transfers from the government. They then used these to purchase goods and to save through deposits at the Gosbank. These flows took place in banknotes or “cash rubles,” using the Soviet terminology. Financial flows among enterprises and between enterprises and the government occurred through accounting entires at the Gosbank and were thus in non-cash rubles. The cash and non-cash circuits were not completely self-contained or self-balancing, however, because the enterprise and banking sector received and made paymetns in both cash and non-cash rubles. The convertibility of cash and non-cash flows was ensured by the Gosbank, which exchanged banknotes and accounting rubles at par.
————
The Soviet government had large fiscal responsibilities. Most notably, it was directly responsible for numerous vast industrial operations, including those in the defense and aerospace sectors. In the absence of adequate tax revenues, the government sought to sustain these operations by deficit spending through credit creation by the Gosbank. The outcome of these activities was a large buildup of inflationary pressure in the final years of the Soviet Union.
But you can see where we’re going with this. Once you centralise the money-creation function you inadvertently create a captured market for a single type of monetary instrument. This removes the checks and balances associated with a competitive monetary system and leads directly to the second problematic issue we’ve identified: a single monetary authority’s ability to competently manage and re-invest the monetary float in a way which will defend its par value.
If and when the central bank fails to do that — something ultimately determined by the quality of the assets or claims which back the reserves — then private sector alternatives, foreign national currencies or commodities will begin to circulate as money anyway (and will do so even if they’re less convenient).
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