We've all heard about Bitcoin and other crypto-currencies, which are all the rage right now. But did you know that central banks around the world have been looking to create their own versions of crypto-currencies called central bank digital currencies?
This entire process kicked off in mid 2019 when social media giant Facebook announced ambitious plans to create a blockchain-based digital stable-coin called Libra. This new crypto-currency was going to be backed by vast pools of safe, short-term debt instruments denominated in U.S. dollars, euros, British pounds, Japanese yen and Singapore dollars - much like a money-market fund. The resulting digital currency would be relatively low-volatility - hence the name "stable-coin" - and could easily be traded across international borders via Facebook's digital Calibra wallet.
However as 2020 dawned, it quickly became apparent that Facebook's Libra digital currency would be stillborn. Politicians and central bankers across the political spectrum strenuously objected to the bold plan. Although the official skepticism towards Libra was ostensibly because of concerns over money laundering, in reality the idea was scuttled because it had the potential to permanently disempower existing national fiat currencies and their political beneficiaries.
But this idea did make it apparent to central bankers all over the world that digital currencies were here to stay and that if they wanted to remain relevant, they needed to adapt. Facebook's failed Libra initiative became the motivation behind the idea of replacing existing national fiat currencies with central bank digital currencies.
There are a lot of very rational reasons for the adoption of central bank digital currencies. Probably the biggest benefit is that it can simplify and expedite global payment systems.
Most people aren't aware of this fact, but the world's financial system is laboring under a disorganized patchwork of different payment systems that have haphazardly accumulated over the last several centuries.
We have cash, consisting of paper money and coins which originated in the 17th century or earlier. There are checks, which are a late 18th century invention. The first credit card was the Diners Club card, which was first issued in 1950. The ACH (Automated Clearing House) system was deployed in Great Britain in 1968 and the U.S. in 1972. Finally, we have the SWIFT (Society for Worldwide Interbank Financial Telecommunication) system which came into being in the mid 1970s.
Unfortunately, these payment systems are slow by modern standards and often don't communicate well with each other. Enter central bank digital currencies. Under this new system the dollar (or euro or pound or yen) would utilize blockchain technology to allow for near-instantaneous transfers of money from person to person, institution to institution, or any combination thereof. So for example, a digital U.S. dollar would be nearly identical to the existing dollar other than its purely digital nature and built-in payment system.
The coming advent of central bank digital currencies isn't just idle speculation either. The Swedish Riksbank began testing its digital e-Krona in February 2020. The United Kingdom's Bank of England is actively researching its own digital currency. And the Reserve Bank of Australia announced in November 2020 that it will explore the concept of a sovereign digital currency.
But the Bahamas has beaten them all by launching its very own (domestic use only) digital currency called the Sand Dollar in October 2020!
The United States Federal Reserve has signaled that it will not be left behind in the rush for central bank digital currencies by preparing its own FedNow Service. FedNow is slated for release in 2023 or 2024 and will include core functionality necessary to any successful digital currency including fast clearing and settlement capabilities and balance inquiry/reconciliation features. Although FedNow isn't a digital currency in its own right, it could very easily be used as the foundation for a future U.S. digital dollar once it has been perfected.
Now this is all well and good, but what I'm really interested in is the future implications of fully functional central bank digital currencies. And due to the U.S. dollar's importance in global trade and finance, I'm going to focus my analysis on the effects of a possible Federal Reserve digital dollar.
My thinking was really sharpened on this matter by a YouTube video I recently watched featuring Raoul Pal, the CEO and co-founder of Real Vision Finance. It is an incredibly thought-provoking video that I highly recommend you watch. I would even go so far as to say that Raoul Pal is almost prophetic in his musings. I've embedded the video below for you convenience.
Let's see if we can intelligently speculate about the future ramifications of a fully-digital, Federal Reserve dollar (which we will nickname "FedCoin").
First it is apparent that upon the launch of FedCoin every citizen will receive a free online account (or digital wallet) capable of storing, sending and receiving the Fed's new digital currency. This will almost certainly be coupled with enticements for individuals to use the new system. These could include higher interest rates on balances held in FedCoin (versus dollars held in the traditional banking system), faster receipt of government mandated stimulus payments, lower prices for goods and services (because there would be no credit card vendor fees for retailers to pay) and the possibility of bonus stimulus payments not sent out to people who don't use FedCoin.
The savvy observer will immediately note that a Federal Reserve digital currency would permanently disintermediate a large segment of the financial services sector almost immediately. The importance of this development cannot be overstated. If FedCoin is rolled out successfully, the demand for credit cards, bank deposit accounts or other transactional, retail-facing banking services (think PayPal or Venmo) would decline dramatically nearly overnight. FedCoin would simply do what these companies' services already do, except faster, cheaper and better.
However once successfully established, the financial authorities would have unprecedented control over the financial system. They could almost instantaneously credit or debit any FedCoin digital wallet for any amount with little oversight. It would be difficult - bordering on impossible - for any central bank to resist the raw power that this scenario would bestow on them.
And while it could be used relatively responsibly - for the fast payment of stimulus funds or UBI (Universal Basic Income) to citizens in need - it is more likely that our central bank overlords will ultimately abuse their newfound financial power.
I imagine this would be a gradual, creeping process.
For example, if the economy were to take another nosedive (a distinct possibility in a world of rolling lockdowns due to COVID) the Fed might feel compelled to step in to provide fiscal stimulus if the legislative branches of government were unable to come to a speedy agreement among themselves.
In fact, the Federal Reserve has already floated a trial balloon for this idea via what it calls "insurance recession bonds". These would be contingent, zero-coupon bonds that would only be "activated" when GDP declines below a certain threshold. Once activated, the Fed would automatically issue checks to every American household using the bonds as collateral. It is important to note that the bonds would simply be a book-balancing accounting exercise - in reality it would be naked money-printing.
Insurance recession bonds are important because they would allow the Fed to usurp congress' traditional role of allocating government spending. Suddenly, the Fed would be the real fiscal power behind the throne. I expect this outcome, if for no other reason than because the U.S. Republican and Democrat parties are unable to collaborate in any meaningful way anymore.
And if a Fed issued central bank digital currency already exists, then this entire process would become even more irresistible. After all, it would be convenient for both U.S. political parties if they were to grandstand for the cameras, each refusing to give an inch to the other side, while the central bank did the real heavy lifting of making sure tens of millions of people got the necessary funds to put food on the table or avoid eviction.
One dark side to this system is that there will be tremendous political pressure to make FedCoin the only game in town. Right now the Federal Reserve (along with most other central banks) is bumping up against the limits of monetary policy due to the zero-bound problem. When interest rates are at 0%, it is almost impossible to stimulate the economy via traditional monetary policy. It is also very difficult to institute negative interest rates because people can always flee to physical cash (which is exempt from such a policy).
But once FedCoin has been properly rolled out and scaled-up, there isn't any reason why the U.S. Treasury couldn't phase out the use of cash (and non-FedCoin bank accounts). The justifications for such a move could be numerous: cash is dirty and unsanitary in an age of pandemics; cash is antiquated and unnecessary; only criminals and tax-cheats use cash, etc.
The point is that once Fedcoin has been firmly established as a universal, convenient and low-cost alternative, the financial authorities might well move to ban cash. This could be done via a carrot and stick approach, with small bonuses for those who use the new FedCoin (extra one-time payments or higher interest rates) and punishments for those who fail to adopt the new digital currency (slower stimulus payments or additional financial scrutiny from the authorities). It is even possible that citizens may eventually be forced into using FedCoin or face the prospect of not receiving their stimulus or UBI payments at all!
Once the Fed has transitioned everybody to FedCoin and phased out cash, it will find a wonderland of new monetary policy tools at its fingertips.
For instance, the central bank could easily implement negative interest rates without having to worry about people hoarding cash. It could (electronically) print and instantly distribute massive sums of money to systematically-important financial institutions or favored industries. It could engage in targeted interest rates where some groups (like college students) would receive high interest rates on their FedCoin (to encourage them to save) while other groups (like retirees) might receive negative interest rates on their savings (to encourage them to spend).
It is even conceivable that the Fed could deposit stimulus funds into peoples' digital wallets, but then declare that if the money is not spent within a certain time frame it will disappear! And all of this could be done with little to no oversight from elected officials.
There are other downsides to central bank digital currencies for the average citizen besides delightfully cruel new monetary policies. Once FedCoin is the exclusive money of the realm, the government would be able to track every single purchase or financial transaction that you make. The central bank would even have the ability to block transactions that they feel are suspicious or that they don't like.
So when might we realistically see FedCoin come into existence? That isn't exactly clear. The Federal Reserve states that their FedNow Service won't be ready until 2023 at the earliest. This technology could serve as the backbone of a FedCoin rollout. But in my opinion, it would still take a minimum of 18 to 24 months after the introduction of the FedNow Service for an official U.S. dollar-based digital currency to be ready.
That would put the first realistic date for the release of FedCoin at 2025 or 2026 at the earliest. In all probability it would take substantially longer than this given the technical hurdles inherent in such an ambitious project. In other words, the late 2020s or early 2030s seem like a far more viable date for the release of FedCoin.
But let's not lose sight of what is important here.
Although central bank digital currencies may be the future of fiat money, they'll only serve as a trap for the average person. This is why I advocate buying portable tangible assets as a way to protect yourself from the possibility (maybe even inevitability) of FedCoin and other central bank digital currencies. This could be as simple as purchasing a $1,000 face value bag of U.S. 90% junk silver coins or as complex as assembling a fine collection of vintage Patek Philippe wristwatches. Bullion, fine art, gemstones and antiques are all feasible alternatives to a locked-down, FedCoin-dominated financial ecosystem.
Central bank digital currencies are coming, maybe not this year and maybe not next year, but they are coming. Invest accordingly.
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