In recent weeks, Jerome Powell at the Federal Reserve and Christine Lagarde at the European Central Bank have commented on the likelihood of implementing digital currencies in the next few years.
The positives have been well explained: more transparency, ease of use, and lower cost.
The digital euro wouldn’t replace cash, the ECB says: “The Eurosystem will continue to ensure that you have access to euro cash across the euro area. A digital euro would give you an additional choice about how to pay and make it easier to do so, contributing to financial inclusion alongside cash.”
In the United States, many voices call for a digital dollar to compete with China’s yuan. However, the U.S. dollar is already the world’s reserve currency; it’s used in more than 80 percent of global transactions, while the yuan is used in less than 4 percent, according to the Bank for International Settlements (the total is 200 percent as each transaction involves two currencies), and most payments and transfers are already electronic.
The euro is the second-most-used currency and is also mostly used through electronic transfers. One can say that the U.S. dollar and the euro are already “digital.”
All this sounds good. So, why should we worry about a central bank “digital currency”?
There are important risk factors to consider.
The first one is privacy. The central bank would control almost all transactions in a currency and have all the information on how deposits and savings are kept. The gradual implementation of the central bank digital currency would involve important risks to privacy but also raise concerns about the central bank controlling the amount of savings and their form. A central bank that controls all transactions and how savings are kept is also able to act against those savings by “dissolving” them with monetary policy.
The most important risk of a digital currency is that it would provide unlimited power to central banks to increase money supply and direct it where governments want it.
The digital currency would eliminate the banks as intermediaries in the transmission mechanism of monetary policy. These “brakes” are and have been essential to containing inflation and excessive government control of money creation.
In quantitative easing, the credit system works as a tool to prevent the inflationary pressures of money supply. When central banks increase their balance sheet, it doesn’t immediately translate into inflation because we, citizens and businesses, limit the risk of money supply destroying the purchasing power of the currency by taking less credit than the increase in money supply. If citizens and businesses don’t demand more credit, the transmission mechanism of monetary policy has enough back-stops that prevent an excess of money from creating massive inflationary pressures in goods and services.
Yes, quantitative easing does generate massive inflation in asset prices by making the most secure asset—sovereign bonds—very expensive, but it certainly works well as a brake on inflationary risks. Governments are also limited in their borrowing desires by their budgets and internal financial controls.
Money creation is never neutral, and it disproportionately benefits the first recipients of new money created—governments—while massively hurting the last recipients—savers and real wages.
The digital currency would not only open the flood gates of much higher money supply growth, but also destroy all the mechanisms that prevent new money from being absorbed entirely by political spending and eroding the purchasing power of salaries and wages.
In essence, a central bank digital currency could be a dream come true for a central planner as the ultimate tool for the expropriation of wealth and taking control of an economy to put it entirely in the hands of governments.
A digital currency could open up the risk of eliminating all controls on government spending, as politicians would be the first recipients of all newly created money and able to spend without budget control. As such, a digital currency could be a dangerous tool used for the nationalization of the economy.
When banks and the credit mechanism are erased from the transmission of monetary policy, the risk of inflation and the destruction of the purchasing power of the currency rises massively. It would eliminate the demand part of the credit mechanism as a brake on inflation.
The reader may think that the above is too negative and that this wouldn’t necessarily happen. However, the reader must think of the following question: If governments are given a tool that allows them to spend all they want and take control of the economy, do you really believe they won’t use it?
The reader may say that central banks are independent, and that this independence prevents governments from crowding out all money supply and taking unlimited risk. Unfortunately, the independence of central banks is increasingly questioned, and monetary policy has gone from being a tool to help make structural reforms to a tool to avoid them. The fact that central banks are on almost all occasions taking actions to facilitate more crowding out of the public sector and more government control and spending doesn’t help either.
A digital currency can only be a good idea if central banks had no power over the increase in money supply, if they had clear and unbreakable rules—such as a Taylor rule—regarding their policy, and discretionary measures were impossible. Keep dreaming.
The only way in which a digital currency would work for savers and real wages is if there was clear evidence that it wouldn’t be controlled by central banks, curbing the ever-increasing government control of the economy. Unfortunately, that’s not the case. When neo-Keynesians talk about “innovation” in central banking and digital currency, what they’re talking about is simply Argentina-style money printing to advance government control of the economy.
The risks of a digital currency are enormous. Privacy could disappear and the limits to government spending would be eliminated. Even worse, the power of governments to decide who and why people receive new tokens of this money would be unchallenged.
In today’s world, we shouldn’t even discuss any tool that could open the gate to giving even more power and control over the economy, wages, and savings to governments.
