I recently attended the #CBDC #CentralBank #Digital #Currency Summit in Washington, DC in collaboration with the #IMF and George Washington University. Here are my thoughts.
According to John Kiff, former Senior Financial Sector Expert at the IMF, retail CBDC are currently being explored in more than 90 jurisdictions:
Source: John Kiff (www.Kiffmeister.com)
Central Banks are spending a lot of effort on exploring CBDC’s, and it seems just a question of time until their introduction. Some of the smartest minds in monetary innovation are committed to advancing this potentially revolutionary technology. But the question must be allowed if this is really the best use of their time and effort.
The value proposition of CBDC from a retail point of view might differ from countries with stable (relatively speaking) currencies to those with perennial problems of inflation / devaluation. Why would I hold a wallet with something that quickly loses value; there is no point of having a digital Venezuelan Bolivar.
The issuance of CBDC from the view point of the central bank should not increase its balance sheet as it is a liabilities swap. An end-user acquires CBDC against his (commercial) bank deposit. The commercial bank (= intermediary) purchases CBDC from its central bank against its deposit with the latter. Central bank liabilities to banks decrease, liabilities of CBDC outstanding increase. Monetary aggregates would be unchanged, hence no inflationary potential should arise from the issuance of CBDC.
This opens a different and admittedly experimental thought: in our current monetary fiat system it is impossible to create money without the simultaneous creation of debt (it doesn’t matter if by central bank or private sector institution). One person’s savings are always somebody else’s debt. This creates an inherent instability, especially in the long run, given that the interest function is an exponential one, which, in a world of finite resources, will eventually hit a wall.
According to the International Institute of Finance (IIF), the global debt-to-GDP ratio currently stands at 350 per cent. This implies that an average interest rate on said debt of only 3 per cent would siphon off ten per cent of GDP just for interest payments – annually.
This obviously exceeds the debt-bearing capabilities of all but the fastest growing economies. Increased financial instability will lead to financial crisis, banking crisis, and, potentially, debt defaults. Default either by non-payment (as is often the case in emerging markets) or inflation. Both outcomes are basically rug-pulls on entire generations of savers, which, via social unrest, is a risk to democracy.
The fate of CBDC in its current design is ultimately linked to fate of its underlying fiat currency. One could describe the relationship as a 1:1 peg. How would it be possible to break this (potentially fatal) link? Bitcoin broke this link, as a Bitcoin is nobody else’s debt (like a gold coin). So would it be possible to issue a CBDC which is not a liability of the CB (or any other institution)? There is no particular reason why it must be a liability. Users have no benefit from the fact that a dollar bill is a liability on the Federal Reserve Bank system’s balance sheet. Liability-free CBDC would also have the benefit of creating seigniorage (profits generated from issuing currency). Seigniorage does not exist in the current system as each currency unit sent into circulation by the central bank becomes an asset and a liability at the same time. Seigniorage profits could potentially replace the dwindling ability of governments to debt-finance deficits. A certain amount of CBDC could even be ‘air-dropped’ to all residents/citizens to include a social element.
How to break the link to fiat money? In the beginning, a CBDC would have to be pegged 1:1. But one could imagine a defined plan of limited issuance, similar to Bitcoin, where the amount of CBDC issued would be determined by a formula, and not at the discretion of the government or central bank. Changes to the formula could be made subject to a public referendum.
Over time, the CBDC would be allowed to trade at a premium to its fiat sister, making it advantageous to hold as a store of value. To avoid a bank run, where people rush to exchange their fiat into CBDC, the annual appreciation should be kept in check, allowing additional issuance in case appreciation exceeded a certain threshold.