In recent weeks, Jerome Powell of the Federal Reserve and Christine Lagarde of the European Central Bank have both expressed their views on the possibility of implementing digital currencies in the coming years.
The positive aspects of digital currencies have been thoroughly explained: more transparency, ease of use and lower costs.
The ECB said that “the digital euro will ensure that citizens of the euro area have free access to simple, universally accepted, secure and reliable payment methods. It describes the digital euro as “a form of electronic money issued by the Eurosystem (the ECB and national central banks) that can be used by all citizens and companies”.
The ECB believes that the digital euro will not replace cash: “The Eurosystem will continue to ensure that people can use euro cash throughout the euro area. The digital euro will give the population more choice in terms of payment methods, make payments more convenient and contribute to financial compatibility alongside cash.”
In the U.S., many are calling for a digital dollar to compete with China’s yuan. However, the U.S. dollar is already the global reserve currency; according to the Bank for International Settlements, the dollar is used in more than 80 percent of global transactions, while the yuan is used in less than 4 percent (200 percent total since every transaction involves both currencies), and most payments and transfers are already electronic.
The euro is the second most common currency in the world and is also mostly used through electronic transfers. You could say that the dollar and the euro have gone “digital”.
All of this sounds good. So, why should we worry about central bank “digital currencies”?
There are some important risk factors to consider.
The first is the issue of privacy.
Central banks will control almost all currency transactions and have all the information about where deposits and savings are going. While the gradual implementation of a central bank digital currency will consider important privacy risks, it will also raise public concerns about the amount and form of savings that the central bank will control. Once the central bank has all the information on transactions and savings holdings, it will be able to “dissolve” these savings and act on them through monetary policy.
The most important risk of digital currency is that it will provide central banks with unlimited power to increase the money supply and direct it to the size the government wants.
Digital currencies would eliminate the banks’ function as regulators in the transmission mechanism of monetary policy. These “brakes” were and still are essential to curb excessive government control of Inflation and money creation.
In quantitative easing, the credit system functions as a tool to prevent inflationary pressures on the money supply. When central banks lift their financial statements, it does not immediately translate into inflation because people and businesses limit the risk of the money supply destroying the purchasing power of money by taking less credit than the money supply increases. If the population and businesses do not demand more credit, then the transmission mechanism of monetary policy has enough backstops to prevent a monetary glut from causing massive inflationary pressures in goods and services.
Yes, quantitative easing does generate massive asset price inflation by making the safest asset – sovereign bonds – very expensive, but it naturally works well as a brake on inflation risk. Government borrowing programs are also constrained by budgetary and internal financial controls, among other things.
Money creation is never neutral, and it disproportionately benefits the initial audience for newly created money – the government – while greatly hurting the end audience – savers and ordinary the working class.
Not only would digital money open the floodgates to higher money supply growth, but it would undermine all the mechanisms that prevent the new money from being fully absorbed by political spending and erode the purchasing power of payrolls.
By its very nature, a central bank digital currency could make central planners’ Dreams come true as the ultimate means of expropriating wealth and controlling the economy, keeping it completely under government control.
Digital currencies could pose the risk of eliminating control over government spending, as politicians would be the initial audience for all newly created currencies, and they would also be able to spend without budgetary control. As a result, digital currencies could become a dangerous tool in the service of nationalizing the economy.
When banking and credit mechanisms are erased from the transmission of monetary policy, the risk of inflation and the destruction of the purchasing power of money rises dramatically. This would eliminate the demand component of the credit mechanism as a disincentive to inflation.
Readers may argue that the above statement is too negative and that these risks may not really happen. However, you must consider the following question: If governments were given a tool that allowed them to spend at will and control the economy, do you really believe they would not use it?
Readers may also argue that central banks are independent and that this independence prevents governments from crowding out all of the money supply and taking endless risks. Unfortunately, central bank independence is increasingly being questioned, and monetary policy has been reduced from a tool to help implement structural reforms to a stumbling block to them. On almost all occasions, the central bank has taken steps to reinforce the crowding out of public resources, government control and government spending, but to no avail.
A digital currency is only a good idea if the central bank does not have the power to increase the money supply, if it has clear, unbreakable rules for its policy, such as Taylor’s Law, and if it cannot take discretionary measures. Keep the fantasy going.
The only prerequisite for a digital currency to be saver and average working class friendly is that there is solid evidence that it will not be controlled by the central bank to curb the increasing government control of the economy. Unfortunately, this is not the case. When the New Keynesians talk about central banking and the “innovative” function of digital currencies, they are looking only at Argentinean-style money printing that advances government control of the economy.
The risks of digital currencies are enormous. Privacy could disappear, and restrictions on government spending could be dissolved. Worse, the government’s power to determine the subject and rationale for receiving new tokens would be unchallenged.
In today’s society, we shouldn’t even be discussing any means of opening the floodgates that would give the government more power over the economy, payroll, and savings.
Author Bio.
Author Daniel Lacalle, Ph.D., is chief economist at hedge fund Tressis and author of Freedom or Equality, Escaping the Central Bank Trap, and Life in Financial Markets.
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