Recently there has been an increased interest in digital currencies. Bitcoin has been leading the way, and now central banks are also planning to issue their own ‘cryptocurrencies’. How would they change the financial landscape?
In this blog, we will detail the specifics of the Central Bank Digital Currencies, or “CBDCs”, and the way they are likely to change the financial system, as we first outlined in the December 2020 issue of our Q-Review series. While the original idea of some sort of a ‘deposit safe haven’ for households and corporations may seem reasonable at first glance in a time of generalized currency debasement, CBDCs could easily grow to threaten our economic freedoms.
Let’s examine this further.
What are central bank digital currencies?
The idea of a central bank digital currency is simple. The central bank issues a digital currency, thereby creating the possibility for consumer and corporate deposits at the central bank. Additionally, CBDCs could be restricted to the use of financial institutions only.
Currently, only commercial banks offer consumer deposit accounts, and the central bank acts as a liquidity provider, or the ‘lender of last resort’ for them. The central bank also sets the interest rates on the reserves which banks are required to hold at the central bank. In this way it affects the interest rates set by banks.
If the CBDCs would be issued to retail, that is, to the general populace, things would change drastically.
What would happen with issuance of a CBDC to consumers?
First, as a central bank cannot go bankrupt—at least technically—deposits at a central bank are considered the safest of all deposit-bearing institutions. So, those households and corporations looking for safety would be likely to transfer their deposits to the central bank. ‘
Commercial banks could naturally compete by offering higher interest rates for deposits, but this would mean that interest rates at commercial banks would be higher than those on the reserves they are required to hold at the central bank. This creates a perplexing situation, because bank interest rates might not follow the rate set by the central bank.
This could create a situation where interbank rates would be likely to rise, possibly much higher than the overnight lending rate (interest rate on reserves) at the central bank. Usually, if interbank rates rise higher than the overnight rate, this would be a sign of a stress in the banking system. Now it would be an opportunity to arbitrage the rates set by the commercial bank and the central bank. Restrictions could possibly be put in place to alleviate this.
Notably, a much more problematic situation emerges when we notice that by making CBDCs available to all, a central bank would become a competitor of the commercial banks. Thus, the central bank would function in the role of national banking supervisor, the ‘lender of last resort’ and as a competitor in the commercial banking sector. It is clear these obvious conflicts of interest could quite readily lead to the further corruption of any such central banking system.
Issues would multiply in a banking crisis
The massive corruption the central bank digital currencies could unleash upon the financial system becomes evident when we consider a banking crisis. In a banking crisis it is the responsibility of a central bank to
- provide emergency liquidity support (money, and lots of it) to the banking sector, and
- organize and oversee the restructuring of the banking sector.
It is plain when a central bank is also a competitor of ailing commercial banks, the situation would become completely untenable. In a banking crisis, deposits would flee to the safety of the central bank, aggravating the crisis.
Moreover, why would a central bank support its competitors? It could easily announce the closure of all unstable banks and the transfer of deposits to the central bank, with the tacit approval of apprehensive politicians.
In the worst case, the whole banking sector would be nationalized. Some may even consider this to be a positive good, but they fail to consider the scenario this creates as a result.
CBDCs put a choke hold on our economic system
Throughout human history, if there has been one iron law when analyzing a range of future scenarios, it is the need to fearlessly consider the worst one. Humanity has learned this the hard way. So, what is the worst scenario resulting from the nationalization of the banking sector?
First, our economic freedoms would come under serious threat. When a central bank controls our deposits using CBDCs (having banned the withdrawal of, or eliminated physical cash first, of course!) it can set an arbitrary interest rate of, let’s say, a negative 10% at will. This could be done to “stimulate” demand in the economy in a severe recession by forcing consumers and corporations to spend: “use it or lose it” to bolster activity.
Additionally, banning cash for CBDCs means that one of the unquestionable advantages of cash disappears as well: anonymity, also known as “privacy.” All transactions could be traced, one way or another, legal or illegal. And even though a set of transactions could be legal, commercial or government agencies monitoring them would be able to build economic and psychological profiles of practically all consumers. In the most mundane case, such information would simply be used for marketing, as Google or Facebook do now. In the worst imaginable scenario, such data could be used to coerce or intimidate people, as we will discuss below.
The only thing sparing us from the imposition of CDBCs and their ensuing abuse would be the fortitude of politicians, but how likely it is that they would have the wisdom and conviction to stand against the central bank in a recession or a crisis, when faced with soaring unemployment and political unrest, and when “emergency” measures are being deployed to “rescue” an economy in collapse?
Into the Global Economic Dystopia?
Most worryingly, since central banks are only quasi-independent organs of government, they could eventually become vehicles of economic coercion. Recently, for example, China froze the accounts of critics of China’s Communist Party.
With CBDCs this step would be simple. Moreover, if countries enact something similar to China’s ‘social credit system’, government sanction of citizens could easily be linked to access to their own bank deposits. “Sorry, you have jay-walked and littered too many times, so your withdrawal limit has been reduced to 5 euros per day” or “Sorry, you have criticized the government on social media, so your account has been frozen” could become the norm.
This would lead us well down the path to an unrecognizable Global Dystopia, where our present freedoms could be sharply limited, if not completely taken away.
We should not be naive
Those skeptical of the above-mentioned scenario need only familiarize themselves with the history of mankind—and especially the development of government oppression—to appreciate the tendency towards tyranny. Moreover, while the first stage on the issuance of the CBDCs could be to make them available to financial institutions only, there’s no way guarantee that their availability would not be extended to consumers in a banking crisis. We consider this to be almost certain.
Practically all the major central banks are currently looking into digital currencies. At the same time, the International Monetary Fund has issued vague statements about something called “Bretton Woods 2.0”, which might result in a new global reserve currency, perhaps to include a basket of cryptocurrencies. However, the details of any proposed plan have not yet been made public. In any case, these developments, worryingly, point in the direction of a Global Dystopia driven by the imperatives of leading economic institutions.
Moreover, as Professors Daron Acemoglu and James Robinson note in their insightful book, The Narrow Corridor: How Nations Struggle for Liberty, freedom is something that has been our privilege for a relatively short time, and it is by no means guaranteed to exist in the future. We could very well end up losing it, and if we do, central bank digital currencies could easily be one modern, convenient, innocent-sounding factor in the overall process ending in Global Dystopia.
Freedom as a choice
Giving over-reaching power to governments over our civil and economic freedoms has never led to anything good. We cannot assume modern central banks are benevolent entities, but rather the opposite.
Central banks have been ‘running amok’ since the financial crisis of 2007-2008 and the results have been nothing short of disastrous. They have managed to nullify price discovery in the capital markets, drive the European banking sector to the brink of collapse, punish savers and retirees with low rates, pummell the returns of pension funds and insurance companies, encourage vast over-leveraging by corporations and governments and zombify our economies. In a word, they have become a menace!
Giving central banks the power to further encroach upon our economies through CBDCs would subject us to punitive interest rates (in a recession) and, in the worst case, to arbitrary sanctions and bans on deposit withdrawals and loans. It would lead ever closer to the expropriation and subsequent destruction of the free market economy by the central banks.
We need to ask ourselves if we cherish our freedoms, or if we will permit central banks to lead us into a modern variety of economic totalitarianism? We dearly hope that the answer to this question is obvious.