by Bill O’Grady | PDF

This week, we conclude our series on CBDC with market ramifications.

Ramifications
Money is a seminal good.  As our metaphysical discussion examined, economics has tended to avoid forays into the being of money.[1]  Accordingly, for the past 150 years, there have been steady changes to the use of money, from a gold standard, to a dollar standard, to full fiat currencies, and floating exchange rates.  We have seen credit money dwarf state and commodity money.  There have been discrete changes; the failure of the gold standard to hold in the interwar years was one, while Nixon’s closing of the gold window, effectively ending the Bretton Woods Agreement, was another.  Most of the other changes were less dramatic.  The development of the Eurodollar market undermined the Great Depression regulatory regime, as did the creation of the money market fund.  The steady expansion of derivatives and the non-bank financial system played a role as well.

CBDC would also be a significant event on a global scale.  And, any time there is a change in how money works, the potential for unexpected outcomes is high.

One way to develop a framework about CBDC and the challenges it brings is to use a Johari Window.  A Johari Window is a psychological concept to compare what we know to what is known by others.  We adapt it for our use by not having two “players” and instead use it to describe the risks of introducing CBDC.[2]

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[1] For a deeper dive into this topic, we recommend: Bjerg, Ole. (2014). Making Money: The Philosophy of Crisis Capitalism. London, U.K.: Verso Publishers.

[2] The Johari Window is the basis for Donald Rumsfeld’s famous “known/unknown” comment.

by Bill O’Grady | PDF

(Due to the Easter holiday, the next report will be published on April 12.)

This week, we continue our series with an examination of the geopolitics of CBDC.

The Geopolitics
As we noted in Part I, there has been strong interest among the central banks to introduce digital currencies.  We would expect each country that decides to establish a CBDC regime will do so based on its domestic situation.  But these new currencies won’t exist in a vacuum; the establishment of CBDC in one country will likely affect what occurs in other nations as well.

Therefore, this week’s report examines the likely structure of CBDC in the U.S., China, and the Eurozone.  We will project what a CBDC will look like in each region by establishing the priorities of each one, a likely CBDC structure based on those priorities, and current progress.  Obviously, the world is more than these three entities, but for our purposes, the introduction of CBDC by these three powers will tend to determine what other nations decide on this issue.

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by Bill O’Grady | PDF

In Part I, we discussed the metaphysics of money.  This week, we will examine the current structure of money and the potentially complicated impact of CBDC.

The Current Structure
Here is a Venn diagram of the current structure of money in most developed markets.

First, there are two forms of money that are electronic only—reserve money and bank account money.  Reserve money is part of the monetary base and it is money that banks “hold” at the central bank.  Only banks can access reserve money, or, put another way, only banks have direct access to the balance sheet of the central bank.

Bank account money is money held in household or firm bank accounts.  It is mostly created by banks through the lending process.  The central bank issues two forms of money—cash, which is an anonymous bearer instrument, and reserve money.  Finally, cash and bank account money are held by anyone, therefore they are universally accessible.

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by Bill O’Grady | PDF

There has been a surge in interest in digital currencies among the world’s central banks.  The triggering event was probably Facebook’s (FB, USD, 264.28) unveiling of the LIBRA project in June 2019.  Digital currencies of various stripes have been around for some time; bitcoin (BTR, USD, 49,989.80), introduced in 2009, is one of the oldest.  For the most part, central banks have not felt threatened by bitcoin because the cryptocurrency fails to meet the standards of a currency (which we will discuss in greater detail below).  First, it is difficult to use in transactions.  Because bitcoin does not have a central repository for executing transactions, it relies on “miners” who receive bitcoins for verifying the accounts in a transaction.  Miners earn the right to execute the verification by cracking puzzles that use large and growing amounts of electricity.  In fact, the energy consumption has reached the point where China has halted mining in Inner Mongolia, an area of cheap electricity.  In addition, the price volatility of bitcoin makes it difficult to use as a store of value.  If bitcoin were your only currency, you would be facing rapid changes in prices and, for the most part, persistent deflation.  Finally, it may not be safe; the blockchain is vulnerable to being corrupted and its impermanent nature could lead to governments ending its existence.

However, when Facebook entered the cryptocurrency realm, central banks took notice.  Not only could the tech firm have the resources to manage a payment system, it has a widely adopted platform in place.  Therefore, interest began to grow among central banks who wanted to determine if they should begin offering a digital form of currency.

This chart shows central bank speeches on the topic of CBDC.  They started in earnest after 2016; initially, the tone was negative, but it has steadily turned more positive beginning in 2018 and went net positive early last year.

Another factor that has fostered the interest in CBDC is the pandemic.  Social distancing and the goal of reducing virus transmission encouraged cashless payments which were not always available, especially to the less affluent.  In addition, the distribution of fiscal aid was hampered by the lack of financial services among the same groups.  It is thought that a digital currency may have helped resolve these two issues.

So, why is CBDC a geopolitical topic?  It is estimated that around 80% of the world’s central banks are considering and investigating the introduction of CBDC.  As we will detail in this report, central banks will have choices in how they structure their CBDC.  But these digital currencies won’t exist in a vacuum; firms and individual countries will likely use these currencies as well, so there will be an international impact to their issuances.

Part I of this series is an examination of what money is.  Part II will begin with a discussion of the current state of money and show how CBDC can act as money in multiple ways.  We will also examine how the digital currency’s structure could have significant effects on financial systems, fiscal policy, privacy, and data collection.  Part III will analyze the geopolitics of the introduction of CBDC, and Part IV will discuss potential market ramifications.

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