Below is a recent article of mine for the FT on a subject dear to my heart.
Think of CBDC as the digital equivalent of banknotes. In the early 19th-century, private banknotes were used in shops. With numerous banks issuing different notes, it was complex and confusing — and bank failure could render your notes worthless.
But, since the 1844 Bank Charter Act, things have been streamlined by the Bank of England issuing its own retail banknotes. That also levelled the playing field. The banks had always had access to a risk-free payments system between themselves via their own Bank of England accounts. But with banknotes — Bank of England IOUs — something similar was available to all.
However, the Bank of England retained its “wholesaler only” role in other services with commercial banks “retailing” cheque payment services via their local networks.
But, by the turn of this century, the internet made it technically straightforward for everyone to have an online Bank of England account. After all, wholesalers everywhere were disintermediating their own retailers over the internet — so you can buy your flight from a travel agent or online direct from the airline.
However, central banking for all online would have been classic “disruptive innovation” and that’s not usually prosecuted by large incumbent systems, to say nothing of the political obstacles it would have encountered. Now, with private digital currencies nibbling at the payments system, the CBDC sits smiling up at us from the in-tray, raising all these issues again.
A Bank of England issued digital currency would enable anyone to hold the Bank’s IOUs in their digital wallet for transfer to anyone else as easily as we transfer credit from our credit cards and phones. But, being central bank money, it would be cheaper, and risk free.
Moreover, Bank of England notes generate so-called seigniorage profits — the difference between the amount central banks receive on issuing money and the much lower cost of printing it. As owner of the Bank of England, this ultimately goes to the government.
A CBDC would do something similar but on a much grander scale — handily for a Covid-ravaged Budget. Currently, 97 per cent of the money in circulation is created by commercial banks when they lend. It’s nice work if you can get it, generating them large rents.
With money being the core economic public good, governments muscling in on the banks’ near monopoly on money creation would see banks’ profits fall just as telecoms companies had to find the cash to purchase spectrum at auction that had previously been gifted to them.
This raises two further questions. First, CBDC in your digital wallet can substitute for your deposit in a bank. To prevent a wholesale run from bank deposits into CBDC in a panic, the issuance of the digital currency could be capped.
Modelling by Bank of England research staff looked at issuance equivalent to 30 per cent of GDP. This would make a major contribution to government coffers, displace costlier taxation and improve the efficiency of payments. All this would expand the economy by a hefty £90bn.
Second, falling bank deposits could reduce bank credit creation. In addition to the usual economic adjustments — for instance involving deleveraging and the expansion of equity funding — the central bank could lend back to banks or, as I’ve previously suggested, it could lend to others pledging super-safe collateral.
Of course, one might argue that, if it ain’t broke don’t fix it. But the more money creation is tied to bank debt, the more broke and unstable it is. As Mervyn King said as Bank of England Governor in 2010, “of all the many ways of organising banking, the worst is the one we have today”.
Of course, adopting a CBDC would be “courageous”. Then again, these are not normal times. At another extraordinary time — 1943 — John Maynard Keynes was advising his government and reflected to a colleague on how things had changed since he’d done the same in the first world war.
“Here I am back in the Treasury like a recurring decimal,” he said. But where previously “most people’s only idea was to get back to pre-1914. No one today feels like that about 1939. That will make an enormous difference when we get down to it.” And so it did. But that was a pandemic, a depression and another world war later.
So far, we’ve had the depression and the pandemic. How many more crises might it take to face our demons? How many might we avert by facing them now?
The writer is chief executive of Lateral Economics and visiting professor at King’s College London’s Policy Institute