Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a former professor of economics and senior adviser at the Bank of England
The private sector crypto world might be imploding in flames, but around the world central banks are pushing on with their own digital asset projects.
China has rolled out its central bank digital currency (CBDC) to several cities and it was available for use at the Winter Olympics. Many other central banks — including the Bank of England — are thinking about it and seem well disposed. The list of other enthusiast banks includes those of the eurozone, US, Sweden and Canada. India has already launched a pilot scheme, while Mexico has confirmed the launch of a digital peso by 2024.
It is a road that central banks should not be going down. A CBDC is, as the name suggests, the digital equivalent to central bank currency, or cash — notes and coins. Strictly speaking, almost every country already has one. The old name is “electronic or central bank reserves”. These are the digital things — entries in the central bank equivalent of a spreadsheet — that central banks lend to or borrow from their counterparties, the retail banks that have you and I as customers.
So introducing CBDCs really means “making central bank reserves more widely available than just to counterparties”. This naturally raises the question: “Who else should get them?” Non-bank intermediaries? Households? All companies? Residents only or foreigners too?
Many of the motivations for doing it are suspect. I detect that some are doing it for a vague notion that CBDCs are the future. Others worry that central banks that don’t do a CBDC will lose out in global currency usage. This is pretty much irrelevant unless you are either the US Federal Reserve, the European Central Bank or the People’s Bank of China.
And even then, the race has a current victor — the dollar, clearly. The things pivotal to that “reserve currency” status in the future are not whether a state has CBDC or not. It is more the institutional health of the sponsoring country and whether they are good for their debt.
One motivation cited is to head off the threat from cryptocurrencies such as bitcoin or similar. This is also not a good reason. Cryptocurrencies are such bad candidates for money. They don’t have money supplies managed by humans to generate steady paths for inflation and are hugely expensive and time consuming to use in transactions. They can also be dealt with through laws and regulations, not cajoling the central bank to provide a wholly new competitor asset.
Advocates discuss the possible benefits of “financial inclusion”, but the most practical way of doing this — contracting out to banks to provide app-based access for CBDCs — entails familiar issues: an association with banks, the need for IT literacy etc.
The most compelling arguments are about payments and settlement efficiency, reducing the percentages of national income that are lost to the providers of payment and settlement services. But here too the debate is mysterious.
It would be a colossal undertaking for the central bank to employ the staff to build and manage the hardware and the software of a new payments system — tens of thousands probably. So this will be contracted out to the private sector — not everyone’s ideal construct. If there are efficiency wonders to be had in terms of systems, what is it about CBDCs that cannot be got through existing ones? If the major players are taking too big a cut in the payments business, why not just tax the excess away?
CBDCs do have other “advantages”. If you allowed interest on the accounts, you could use the interest rate to sharpen the transmission of monetary policy into the economy. If you combined CBDCs with actually abolishing cash, you could charge negative rates so during a really bad recession the economy is stimulated by the spending of savings. In crises, the government could use CBDC accounts to “zap” money to people. But these advantages are not worth such a rise in running costs and reputational risks.
CBDC accounts may drain money from the banks, particularly during a period of heightened financial risk. This would force banks either to find new sources of funds, or shrink their loans. That could amplify tightening in financial conditions when the central bank is trying to loosen them. The central bank could respond by simply reinvesting CBDC deposits back in the banks. But would this leave us in a better place? We’d have moved from a situation where the government stands behind the banks and takes a stake when things go badly; to one where it is on the hook all the time to the tune of the deposits reinvested.
CBDCs are a huge undertaking. Many of the motivations for doing it are very poor and there are a lot of risks. I would urge central banks not to do it.
Letter in response to this article: