In Central Banks We Trust – Why Not Central Bank Digital Currencies?

In Central Banks We Trust – Why Not Central Bank Digital Currencies?

Well, not all of us trust the central banks either… But I'll get to that in a minute….

We know that the New World's move toward CBDCs is gaining momentum, driven by the Central Banks.

All told, around 100 countries are exploring CBDCs at one level or another. Some research, some testing, and a few already distributing CBDC to the public.

In the Bahamas, the Sand Dollar—the local CBDC—has been in circulation for more than a year.

Sweden’s Riksbank has developed a proof of concept and is exploring the technology and policy implications of CBDC.

In China, the digital renminbi [called e-CNY,] continues to progress, with more than a hundred million individual users and billions of yuan in transactions.

And in January 2022, the Federal Reserve issued a report that noted that “a CBDC could fundamentally change the structure of the U.S. financial system.”

It’s happening. And, the day's discussion revolves mostly around the costs, benefits, and major implications for economic systems. We are much more concerned about the major implications for mere humans. The people whose lives will be controlled beyond anything we’ve seen before if CBDCs become the norm.

The soul of money is trust. So the question becomes: which institution is best placed to generate trust?

The President who didn’t believe…

In 1828, Andrew Jackson, hero of the Battle of New Orleans and a determined foe of banks in general and the Second Bank of the United States, was elected president.

Why was Jackson so opposed to the Bank? On a personal level, Jackson brought with him to Washington a strong distrust of banks in general, stemming, at least in part, from a land deal that had gone sour more than two decades before. In that deal, Jackson had accepted paper notes — essentially paper money — as payment for some land he had sold. When the buyers who had issued the notes went bankrupt, the paper he held became worthless. Although Jackson saved himself from financial ruin, he never trusted paper notes again. In Jackson’s opinion, only specie — silver or gold coins — qualified as an acceptable medium for transactions. Since banks issued paper notes, Jackson found banking practices suspicious. Jackson also distrusted credit — another function of banks — believing people should not borrow money to pay for what they wanted.

Jackson’s distrust of the Bank was also political, based on a belief that a federal institution such as the Bank trampled on states’ rights. In addition, he felt that the Bank put too much power in the hands of too few private citizens — power that could be used to the detriment of the government. The Bank also lacked an effective system of regulation. In other words, it was too far outside the jurisdiction of Congress, the president… and voters…

Jackson saw his 1832 win as validation of antibank sentiment. Shortly after the election, Jackson ordered that federal deposits be removed from the second National Bank and put into state banks. Although Jackson’s order met with heavy criticism from members of his administration, most of the government’s money had been moved out of the Bank by late 1833. The loss of the federal government’s deposits caused the Bank to shrink in both size and influence.

Meanwhile, in Philadelphia, Biddle responded to Jackson’s action by announcing that the Bank would (or could) not respond to the loss of government deposits by attracting new private deposits or raising new capital. Instead, the Bank would limit credit and call in loans. This contraction of credit, he believed, might create a backlash against Jackson and force the president to relent and redeposit government funds in the Bank, perhaps even renewing the charter. But Biddle’s move backfired: in the end, it helped to support Jackson’s claim that the Bank had been created to serve the interests of the wealthy, not to meet the nation’s financial needs.

It would be more than seventy-five years before the United States made another attempt to establish a central bank. During that period, the U.S. economy experienced several banking crises. But after the Panic of 1907, which triggered a nationwide suspension of payments and a deep recession, Congress established a commission to look into ways to improve how the banking system responded to the shocks. The commission’s findings led to the creation of the Federal Reserve System in 1913.

And the beginning of the end for the US dollar.

Common Narrative Of “Trust”

As an IMF analysis explains,

“If CBDCs are designed prudently, they can offer more resilience, safety, availability, and lower costs than private forms of digital money. That is clearly the case when compared to unbacked crypto assets that are inherently volatile. And even the better managed and regulated stablecoins may not be quite a match against a stable and well‑designed central bank digital currency.”

But also,

“Launching a CBDC is a multidimensional undertaking that extends beyond the central bank’s normal information technology project management frameworks….  The new currency could lead to major disruptions affecting monetary policy transmission, financial stability, financial sector intermediation, the exchange rate channel, and the operation of the payment system.”

As more central banks begin researching the possibilities of issuing a central bank digital currency (CBDC), there is a common concern about the impact this will have on privacy. Of the 8,200 comments the European Central Bank (ECB) received during its consultation period on the potential for a Euro-denominated CBDC, 41% of all replies centered around privacy.

CBDC acceptance will therefore depend partly on users’ trust in the privacy offered by CBDC. However, the notion of privacy is not consistent across the globe, and privacy preferences, policies, and laws vary significantly by culture and region. Privacy is not a binary choice – there is a spectrum of configurations to enable varying levels of privacy. In many jurisdictions, privacy rights need to be considered in light of the disclosure requirements of policies aimed at combatting money laundering or terrorism.

We feel so reassured…

Taking a cue from an article by the late Nobel Prize-winning economist James M. Buchanan, “Politics Without Romance”, a central bank is necessary as long as an economy is wedded to a fiat currency. It may sometimes behave independently, but not in the face of large-scale budget deficits, as we have today.

Walter Bagehot, the eminent 19th-century British economic journalist, coined the phrase “lender of last resort” in his classic book, “Lombard Street.” He said:

“a ‘natural’ competitive banking system without a ‘central’ bank would be better…. ‘nothing can be more surely established by a larger experience than that a Government which interferes with any trade injuries that trade. The best thing undeniably that a Government can do with the Money Market is to let it take care of itself.’”

Bagehot did not believe that a central bank was inevitable or desirable. For Bagehot, “the natural system” was the one “which would have sprung up if Government had let banking alone.” There would have been “many banks of equal or not altogether unequal size.” He described this as “the many reserve system,” in which each bank held reserves for itself, which he believed would have meant a stronger banking system. In modern parlance, Bagehot’s celebrated “lender of last resort” is the second-best solution – second to a world of competitive banks and no central bank.

We second that.