Don’t listen to me, listen to Christine Lagarde

Now, you may think that all this talk about digital currencies is just unhinged techno-determinism when it comes from me, and you can safely ignore it, but when it comes from Christine Lagarde, the head of the International Monetary Fund (IMF) and pillar of the Washington Consensus, you have to take it seriously. In a talk given to the Bank of England conference on “Central Banking and Fintech” (29th September 2017), she said that virtual currencies [by which she means digital currencies in my taxonomy] could actually become more stable than fiat currencies. She says “for instance, they could be issued one-for-one for dollars, or a stable basket of currencies”. This idea of creating a what is strictly speaking a digital currency board is not new and I was interested to see Ms. Lagarde’s mention of a basket of currencies as a viable option. In my recent book “Before Babylon, Beyond Bitcoin” I discuss this as one of the potential futures for money, with reference to the vision of a former Chancellor of the Exchequer. Many years ago, John Major proposed just such an extremely sensible alternative to the euro, which at the time was labelled the “hard ECU”.

The idea of the hard ECU was to have a pan-European digital currency (it would never exist in physical form) but still be accepted in all member states. I am not alone in thinking that this was a missed opportunity. Keith Hart, author of the brilliant “The Memory Bank“, a book about money from an anthropological perspective, wrote that it was a big mistake to replace national currencies with the euro. He further pointed out that the hard ECU would have meant politically-managed fiat currencies alongside a low-inflation alternative, a plural option enjoyed by countries that didn’t join the euro, like Britain and Switzerland. I couldn’t agree with Keith more.

The hard ECU, or as I used to like calling it, the e-ecu was always a better idea than the Euro but when John Major proposed it, he was ignored. He envisaged a cross-border currency for businesses and tourists to use. Thus, businesses could keep accounts in hard ECUs and trade them cross-border with minimal transaction costs and no foreign exchange risk and tourists could have hard ECU payment cards that they could use across the continent. But each state would continue with its own national currency — you would still be able to use Sterling notes and coins and Sterling-denominated cards — and the cost of replacing them would have been saved.

 Global money

Real Money.

When researching the hard ECU concept for my book, I discovered that the proposal goes back well before Ms. Lagarde and Mr. Major and back into the early days of Margaret Thatcher’s government, in a 1983 report of the European Parliament on the European Monetary System. The proposal was at that time supported across the political and national groups in the parliament, including by the Germans so long as the central bank only concerned itself with stability of the currency (as subsequently transpired). It was taken up by Mrs. Thatcher’s government as a practical single currency for Europe, a means to expand the UK’s financial services industry across a European single market. But it never made it and the later political drive for the euro sidelined it. 

The point is, though, that it was a feasible option and that a digital currency that is backed by a reserve (whether of dollars or some basket of currencies or, indeed, commodities) is a sensible idea. In fact, it’s already being tried in a couple of places. In Kenya, where M-PESA is a private currency backed 1-1 by Kenyan shillings. And in Ecuador, where the government has been trying to launch a Central Bank digital currency. Any Ecuadorian over the age of 18 can open an account for free and transfer money to other people for free. 

An interesting aspect of this otherwise fairly straightforward value transfer system is that is denominated in US Dollars. The US Dollar has been legal tender in Ecuador since 2000, when the post-gold standard “Sucre” was abandoned although, apparently, the “centavo” coins are still in use. This is a practical solution to the big problem of small change under “dollarisation” and most countries that use the dollar still mint local coins: thus, Ecuador uses the dollar as legal tender but mints centavo coins. The government guarantees that anyone who wants to exchange 100 Ecuadorean centavos for a genuine United States dollar can do so. As the economist John Kay noted when he reflected on the coins in his pocket in Ecuador, is in itself an interesting comment on the subject of money. He also pointed out that there is a 50 cent coin minted for the government of Ecuador while the US does not issue 50 cent coins. So “while everyone in the Galápagos or the national capital Quito would accept my 50 cent coin, no one in Washington would”. He went on to note the curiosity that “genuine dollar coins, minted for the US Treasury, have not proved popular in the US but are widely circulated in Ecuador”. It is important to understand that the US Federal Reserve banknotes that are in circulation in Ecuador, stuffed under mattresses in Ecuador and fuelling the less-formal sections of the Ecuadorian economy are in essence an interest-free loan to Uncle Sam. By replacing these with digital currency, the Ecuadorian central bank can reclaim the seigniorage for itself.

All well and good and the ability to transact electronically will also be of the great benefit to the citizens and should cut transaction costs across the economy. If the central bank were to ask the advice of people with knowledge of the creation of a national non-bank mobile payment system (e.g., my colleagues at Consult Hyperion) I am sure that they would be advised to make the system a platform for innovation to encourage entrepreneurs to build local solutions on top of it. The lack of APIs in the initial roll-out of M-PESA was, in hindsight, a mistake and Ecuador could clearly learn from this to capture even more benefits from its transition to digital currency.

Ecuador Demo


Unreal Money.

The Ecuadorian Digital Dollar has, I have to say, not been universally well-received. A suggestion for governments thinking of introducing such a system in the future is that it  would benefit greatly from transparent auditing as citizens will not hold the electronic currency unless they are sure that it will remain redeemable at par for US dollars (or other basket of currencies or commodities) themselves. Any suspicion of fractional reserve is disastrous. If the government were to fall prey to the temptation to put more of the digital dollars in circulation than they have (or have the equivalent of) in reserve then, as the Wall Street Journal observed at the time of launch, they will simply be creating doomed electronic assignats that will never obtain traction in the wider economy and Ecuador will be unable to reap the many benefits of its transition away from cash. Christine makes this point herself, saying that the issuing of such a digital currency could be “fully transparent, governed by a credible, pre-defined rule, an algorithm that can be monitored…or even a ‘smart rule’ that might reflect changing macroeconomic circumstances”. I agree strongly: the use of shared ledgers and other such technology may be of maximum benefit in delivering the robustness and availability that a national cash replacement system and the radical transparency that it is required to give people faith in the system.

P.S. In case you see any tweets, newspaper comment or learned articles that refer to the Ecuadorean digital experiment in monetary futures as a “cryptocurrency” please bear in mind that it isn’t.

Central bank digital currency again

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.

dnb slide

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.