Greg Medcraft, the Chair of the Australian Securities and Investment Commission, recently said that “traditional” bank current accounts may disappear in the next decade because central banks will create digital currencies and provide payment accounts to customers directly (Australian Financial Review, 3rd September 2017). This is a topic that I examined in some detail in my recent book, Before Babylon, Beyond Bitcoin. Did I mention that I have a new book out, by the way? This is what the noted British magazine Prospect said about it:
When a book comes along with glowing praise on its sleeve from Kenneth Rogoff and an introduction by Andrew Haldane, Chief Economist at the Bank of England, you know you’ve got something hot on your hands. This analysis of money by one of the world’s leading experts on the subject does not disappoint…
Birch is brilliant at bringing together these disparate historical strands, through the birth of the great European trading centres, up to the present day. The central insight of all this is that money is essentially a technology, just like any other and that technologies change—and improve—over time. In other words, money is not fixed. And it is certainly not just coins and notes.
And what of the future of money—will it be characterised by a drive towards a small number of unified currencies, or towards a multitude? Birch opts for the latter. In future, communities will develop their own stores of value, Birch says, independent of governments and central banks. The growing popularity of crypto-currencies such as Bitcoin suggests that he may have as good a handle on the future as he does on the past.
From What actually is money? A new book examines early civilisations to find out | Prospect Magazine
As you will deduce from this, I think that the way that money works now is, essentially, a blip. It’s a temporary institutional arrangement and it must necessity change as technology, business and society change. These sentiments are not restricted to technological determinists of my ilk. As the former governor of the Bank Of England, Mervyn King, wrote in his book The End of Alchemy”, although central banks have matured, they have not yet reached old age. But their extinction cannot be ruled out altogether. Societies were managed without central banks in the past”. I was reminded of this when I listened to the excellent London FinTech Podcast series produced by my good friend Mike Baliman. In Episode 85 “The Nature of Money, Economic Imbalances & will Central Bank Digital Cash alleviate them?” which Mike made with David Clarke of Positive Money, the idea of central bank digital currency is discussed in some detail. While I understand the reasons why a digital currency is attractive to a central bank (and there are many of them) I’m not convinced that in the long run central banks will retain any sort of monopoly over digital currency. And if they don’t have a monopoly, what can they do to keep the value of their money up and therefore attractive as a store of value?
I had to think about this sort of thing in some detail when the kind people from Amsterdam Institute of Finance (AIF) and the Dutch central bank (Die Nederlandsche Bank, DNB) invited me to Amsterdam to launch my book in their fair city, so I took the opportunity to run through the “5Cs” model of money issuing from the book and take questions from a very well-informed audience.
One of the points that I made was that technology is no longer a barrier. The idea of the DNB running something like M-PESA but for Dutch residents is hardly far fetched. There are 26 million M-PESA users in Kenya (as of 2Q17) and Facebook can manage a couple of billion accounts, so I’m sure that DNB could download an app from somewhere to run a few million accounts for the Netherlands. There is a middle way though. The central bank could create the digital currency but it could still distribute it through commercial banks. The commercial banks would not be able to create money as they do now (only the central bank would be able to do this) but they would use their existing systems to manage it. Yao Qian, from the technology department of People’s Bank of China, wrote about this earlier this year.
“To offset the shock to the current banking system imposed by an independent digital currency system (and to protect the investment made by commercial banks on infrastructure), it is possible to incorporate digital currency wallet attributes into the existing commercial bank account system so that electronic currency and digital currency are managed under the same account.”
PBOC Researcher: Can Cryptocurrency & Central Banks Coexist? – Bitcoin Magnates
We had a go at this sort of thing a couple of decades ago with Mondex and its ilk in the first attempts to get bank-issued electronic cash into the mass market. Those efforts failed for a number of reasons but primarily because of a lack of acceptance. It was easy to give people cards but hard to give people terminals. That’s all changed now. M-PESA doesn’t use cards and terminals, it uses mobile phones. I’m sure that when future historians write about the evolution of money, they will see that the mobile phone, not the plastic card, was the nail in the coffin of cash. But back to the point, which is… why bother? What if the Chair of the Australian Securities and Investment Commission is right? Why bother with the commercial banks in this context? Now we are clear about the differences between cryptocurrency and a digital currency, let’s review a few of the key issues:
A monetary regime with central bank-issued national digital currency (i.e., digital fiat) has never existed anywhere, a major reason being that the technology to make it feasible and resilient has until now not been available. But now technology is available, and we should use it.
The monetary aspects of private digital currencies (a competing currency with an exogenous predetermined money supply) may be seen as undesirable from the perspective of policymakers. Also, as I have mentioned before, the phrase “digital currency” is perhaps a regrettable one as it may invite a number of misunderstandings among casual readers.
Digital fiat means a central bank granting universal, electronic, 24 x 7, national currency denominated and interest-bearing access to its balance sheet.
The cheapest alternative for running such a system would clearly be a fully centralised architecture like M-PESA but there may be other reasons for want to use some form of shared ledger implementation instead (e.g., resilience).
A feature of such a shared ledger system is that the entire history of transactions is available to all verifiers and potentially to the public at large in real time. It would therefore provide vastly more data to policymakers including the ability to observe the response of the economy to shock sort of policy changes almost immediately.
Were we to decide to create a new central bank digital currency issued and managed by commercial banks (let’s call it Brit-PESA) now, of course, we wouldn’t use the basic SIM toolkit and SMS technology of M-PESA. We’d use chat bots and AI and biometrics and voice recognition and all that jazz. I don’t think it would that difficult or that complicated: there would be a system shared by the commercial banks with the funds held in a central account.
There’s a very good reason for doing so. I’m sure you’re all familiar with the Bank of England Staff Working Paper No. 605 by John Barrdear and Michael Kumhof, “The macroeconomics of central bank issued digital currencies”. It says (amongst other things) that
…we find that CBDC issuance of 30% of GDP, against government bonds, could permanently raise GDP by as much as 3%, due to reductions in real interest rates, distortionary taxes, and monetary transaction costs. Countercyclical CBDC price or quantity rules, as a second monetary policy instrument, could substantially improve the central bank’s ability to stabilise the business cycle.
Did you see that? Permanently raise GDP by as much as 3%. Scatchamagowza. Permanently raise GDP by as much as 3%. Why aren’t we doing it right now! Let’s draw a line under the money of the past and focus on the money of the future. Talking of which, back to my presentation at DNB.
Whether digital fiat is the long term future of money or not (and I think it isn’t), let’s get on with it, whether Brit-PESA or Brit-Ledger or Brit-Dex, and give everyone access to payment accounts without credit risk. And there’s another reason, beyond GDP growth, for doing so. Writing in the Bank of England’s “Bank Underground” blog, Simon Scorer from the Digital Currencies Division makes a number of very interesting points about the requirement for some form of digital fiat. He remarks on the transition from dumb money to smart money, and the consequent potential for the implementation of digital fiat to become a platform for innovation (something I strongly agree with), saying that:
Other possible areas of innovation relate to the potential programmability of payments; for instance, it might be possible to automate some tax payments (e.g. when buying a coffee, the net amount could be paid directly to the coffee shop, with a 20% VAT payment routed directly to HMRC), or parents may be able to set limits on their children’s spending or restrict them to trusted stores or websites.
From Beyond blockchain: what are the technology requirements for a Central Bank Digital Currency? – Bank Underground
If digital fiat were to be managed via some form of shared ledger, then Simon’s insight here suggests that it is not the shared ledger but the shared ledger applications (what some people still, annoyingly, insist on calling “smart contracts”) that will become the nexus for radical innovation.