Bitcoin, Ethereum and other cryptocurrencies have attracted widespread media attention. Interestingly, their advent has also triggered reflection among central bankers. Their first reaction was, unsurprisingly, to warn consumers against the dangers of unregulated private money. However, almost ten years after the creation of Bitcoin, central bankers now see the huge potential of these currencies for monetary policy and the control of payments. Is this enthusiasm justified? Should central banks create their own digital currency?
In an early report in 2012, the European Central Bank warned that the unregulated nature of virtual currencies could “expose users to credit, liquidity, operational and legal risks.” Several years later, central bankers now acknowledge their potential for monetary policy. The Bank of England and the Swedish National Bank, among others, are intensely studying the possibility for central banks to issue their own digital currency (hereafter called Central Bank Digital Currency, or CBDC).
Nowadays, money takes either the form of cash (coins and notes) or, for the largest part, of bank deposits. The introduction of CBDC would mean that people could, in addition, hold money in the form of deposits held at the central bank. For now, only banks and certain financial institutions have access to the central bank’s reserves. According to the most ambitious scenario, that proposal would open that possibility to all, firms and citizens alike. This post will leave technical issues aside, and focus instead on the social and ethical implications of CBDC. Should central banks create their own digital currency? What reasons could they have for doing so?
One first set of reasons relate to the huge powers that private banks have acquired over the economy, and to the dependence of central banks on the financial system.
In our financialized economy, private bank deposits constitute the largest part of the money supply. Under the current system of fractional reserve banking, only a small fraction of these deposits needs to be backed in cash or central bank reserves. This means that private banks can grow exponentially by increasing the amount of private money in circulation and, thereby, acquire a structurally dominant position within the financial system. That position gives them an insane privilege. The economy needs banks for lending to the productive sector and for managing payments between firms and individuals. In principle, one individual bank is of no importance. However, in practice, most banks have grown to the point that the state cannot let them down in the case of financial difficulties, for, as the Lehman Brothers story illustrates, letting them fail might have dramatic consequences for the financial and economic systems. Banks know this, and this creates an incentive for them to grow to the point of becoming “Too-Big-To-Fail”.
Modern central banking practices have given private banks the opportunity to gain another form of power, namely infrastructural power over the channels of transmission of monetary policy. In other words, central bankers are increasingly dependent on bankers to steer the economy. Why? To put it simply, the modern financial system is based on a (more or less) strict division of labour between private banks, which are in charge of lending money to the productive sector, and central banks, which supervise the former and attempt to impact the economy through interventions on the financial markets. This means that central banks have only a (very) indirect influence on the productive economy and are dependent on private banks for channelling monetary policy.
Banks (and bankers) have gained considerable benefits from these two powers. Their dominant structural position means that they can go on with huge bonuses and rewards, without having to pay the costs of their misconduct. The infrastructural power of private banks led central banks to pump trillions of euros and dollars into financial markets, in the hope that banks would use that money for productive investments. In practice, though, this has resulted in huge profits for banks, in a (still more) unequal distribution of wealth (at the benefit of bondholders), and in a very weak stimulus for the economy (if any).
The implementation of CBDC on a large scale has the potential to dramatically alter this situation. CBDC would offer an alternative payment system that is not managed by the private banking sector. Citizens could also choose to hold their savings on central banks’ accounts, which, by definition, would be much safer than commercial banks’ accounts. This would help alleviate the structural power problem, by making private banks less vital for the economy. Moreover, the introduction of CBDC would decrease banks’ infrastructural power by allowing central banks to credit citizens’ accounts directly, without necessarily resorting to banking intermediaries. Therefore, the introduction of CBDC could make monetary policy more direct or straightforward.
But are all these effects good? At first sight, we might rejoice about the possibility to tame the powers of banks, to limit the excessive accumulation of wealth in the hands of a few, and to undermine the arrogance of money-makers. However, if central banks use CBDC to credit people’s accounts, and if citizens start considering their central bank as their purveyor of banking services, don’t we risk making private banks obsolete and superfluous? Neither citizens nor central banks would be in need of any financial intermediaries. Private banks would, therefore, lack a proper source of funding (customers’ deposits) and a proper business (lending) and the size of financial markets would shrink dramatically. Is that really desirable?
An important point here is that financial power would not disappear, it would just change hands: from private bankers in London or New York to unelected bureaucrats in Washington or Frankfurt. Following the financial crisis, central banks have already gained huge powers: the ECB has taken part in the Troika in Greece and other European Southern countries, deliberately imposing structural economic reforms in these countries; the US Federal Reserve, the ECB and the bank of England have gained additional supervisory tasks over the banking system; and they all have massively intervened into financial markets, through the massive purchase of bonds and securities. CBDC would strengthen their hold on financial markets, and the economy, by giving them direct access to citizens and firms’ accounts, and by allowing them to circumvent private financial actors. The risk is that we are inflating a Frankenstein monster.
The behaviour of private banks, at least to a certain extent, is tamed by competition. But what about central banks, whose independence from political entities is guaranteed by law, and which have a monopoly over money creation? Perhaps, we could increase democratic control over central banks: national (or European) parliaments could have a more stringent supervisory role over central banks, they could restrict or enlarge the central bank’s mandate, or, even, have a direct influence over the central bank’s decision process. In essence, CBDC (with proper democratic controls) could put the power over monetary affairs in the hands of the people (through their representatives), something that many have dreamed about for years.
Still, even if the introduction of CBDC is accompanied by proper representative procedures, there are at least one epistemic and two democratic arguments against that proposal.
- First, the concentration of the provision of credit into the hands of a small number of technocrats might increase the risks of mis-allocating credit in the economy. Markets may be better at gathering information and distributing it to the relevant economic agents, than a centralized and bureaucratic agency. In the case of the provision of credit, this suggests that commercial bankers at the local level are better situated to evaluate their customers in terms of both productivity and solvency than central bankers ever can be. That argument might not be conclusive, though, for existing private banks have increasingly become detached from their local roots and have opted for international financial markets instead. The Too-Big-To-Fail problem also means that private banks have an incentive to lend too much, without any real need to care about the economic rationale of their investments.
- Second, central banks, if they are led to provide banking services and to fuel the productive economy with credit, could be drawn into severe conflicts of interests. For central banks would become their own regulator.
- Third, increased democratic scrutiny also means that central banks would no longer be independent from the political realm. Why is independence important? The usual justification of central bank independence is that, by abandoning monetary policy to independent central bankers, governments make their pledge to maintain price stability credible to financial markets. For independent central banks do not risk manipulating monetary policy in times of elections to please voters.
How independent (or dependent) central bankers would become after the introduction of CBDC and of parliaments’ oversight over its implementation is an open question. We can guess their independence would be seriously reduced, and that this could impact their reputation and the efficiency of monetary policy negatively. What should we think of CBDC, then?
The challenge behind CBDC is that it might be impossible to have both a democratic central bank and a central bank that strives for the common good at the same time. On the one hand, a highly independent and powerful central bank may circumvent the hold of the financial system over the economy and deliver a really progressive monetary policy, for instance thanks to the implementation of CBDC. Its independence would guarantee its credibility to financial markets but also help create a gigantic Frankenstein monster. On the other hand, a highly democratic central bank may be legitimate, but its dependence on political entities might undermine the confidence of markets while increasing the risk of mismanagement and misuse of monetary policy.
For sure, CBDC points at the right problems: excessive powers of private banks, dependence of central banks on financial markets, and lack of legitimacy. But it may not constitute an adequate solution to these problems, as it might lead to a dilemma between efficiency and legitimacy.