A few months ago, Izabella Kaminska and I arranged to talk to each other on Skype and had a very interesting discussion. Izabella has written a wonderful column on the Financial Times’s blog Alphaville based on that discussion: “The time for official e-money is NOW!” I was delighted when Izabella told me it was fine to mirror that column in full here. In relation to what follows, let me say that my two-year timeline for a government to get all the legal wrinkles figured out for electronic money is for a government that is making a concerted bureaucratic effort. But I think it will not be too many years before some government does exactly that.
Now, more than ever, is the time for central banks to launch their own official e-money. We’ve campaigned for this before. But in light of further Bitcoin and altcoin developments, as well as secular stagnation observations by Larry Summers, it’s worth reiterating the argument for an unconventional policy of this sort.
First, it’s important to stress why this wouldn’t in any way be a panicked response to the supposedly destabilising “threat” of Bitcoin.
Central bankers, after all, have had an explicit interest in introducing e-money from the moment the global financial crisis began.
What’s more, the Bitcoin asset bubble is much more likely to be doing the stagnating dollar economy a favour at the moment than a disservice.
For one thing, it’s directing what would otherwise be de-stabilising flows into an entirely synthetic market rather than into real world goods and resources, like houses, art or commodities — in so doing stopping at least some actual consumable goods and resources from being bid up to prohibitively high levels for regular folk. Second, it’s expanding the overall money supply — useful in a disinflationary world which lacks compensatory bank lending. Third, it’s potentially improving the velocity of money. And fourth, it’s created a parallel currency that looks hugely overvalued relative to the dollar, by definition causing Gresham’s law type effects that end up rewarding the dollar with greater use, velocity and competitive advantage.
Most important of all, however, Bitcoin has helped to de-stigmatise the concept of a cashless society by generating the perception that digital cash can be as private and anonymous as good old fashioned banknotes. It’s also provided a useful test-run of a digital system that can now be adopted universally by almost any pre-existing value system.
This is important because, in the current economic climate, the introduction of a cashless society empowers central banks greatly. A cashless society, after all, not only makes things like negative interest rates possible, it transfers absolute control of the money supply to the central bank, mostly by turning it into a universal banker that competes directly with private banks for public deposits. All digital deposits become base money.
Consequently, anyone who believes Bitcoin is a threat to fiat currency misunderstands the economic context. Above all, they fail to understand that had central banks had the means to deploy e-money earlier on, the crisis could have been much more successfully dealt with.
Among the key factors that prevented them from doing so were very probable public hostility to any attempt to ban outright cash, the difficulty of implementing and explaining such a transition to the public, the inability to test-run the system before it was deployed.
Last and not least, they would have been concerned about displacing conventional banks from their traditional deposit-taking role, and in so doing inadvertently worsening the liquidity crisis and financial panic before improving it.
Given the disruptive consequences of such an irreversible move for the banking sector — effectively transforming banking into fund management — the central bank would not have been keen to deploy the strategy until it was sure that secular stagnation was really the result of the crisis and that the conventional banking model was beyond saving.
Almost of all of these prohibitive factors have, however, by now been overcome:
1) Digital currency now follows in the footsteps of a “disruptive” anti-establishment digital movement perceived to be highly accommodating to the black market and all those who would ordinarily have feared an outright cash ban. This makes it exponentially easier to roll out. Bitcoin has done the bulk of the educating.
2) What was once viewed as a potentially oppressive government conspiracy to rid the public of its privacy can be communicated as being progressive and innovative as a result.
3) Banks have been given more than five years to prove their economic worth and have failed to do so. If they haven’t done so by now, they probably never will, meaning there’s unlikely to be a huge economic penalty associated with undermining them on the deposit front or in transforming them slowly into fully-funded fund managers.
4) The open-ledger system which solves the digital double-spending problem has been robustly tested. Flaws, weaknesses and bugs have been understood, accounted for, and resolved.
All that is left is to develop an economically efficient deployment plan! Lucky for us Miles Kimball, professor of economics and survey research at the University of Michigan, has exactly such a plan.
Very loosely it involves a central bank centrally issuing e-money and allowing it to trade side by side with paper money for a period of time. Use of e-money could be incentivised by a favourable rate environment for e-money, or by an enticing exchange rate for swapping out of paper money for e-money. In that sense it would be similar to the parallel Rollad system envisioned by Willem Buiter in 2009. Its use could be further encouraged by a general campaign to stigmatise the use of paper cash.
We were originally unconvinced that a transitory dual framework period would be needed. We worried in fact that it might come across as too confusing. The success of Bitcoin, however, shows that the public is more than capable of understanding and adopting a parallel value system which provides it with an explicit interest rate or exchange rate advantage.
Kimball noted to us, however, that before any such system could be deployed the legal status of electronic money would have to be defined by government. But he is optimistic that all the preparations could be completed within two years or so.
And there’s no reason at all why a central e-money system couldn’t replicate many components of the Bitcoin open-ledger system in a way that ensures a similar level of privacy, as well as equally competitive transaction costs (or lower) because the computational costs end up being borne by the central bank directly rather than by miners.
Once everyone was captured by the system, it would then be possible to manage the exchange or interest rates on e-money (relative to cash) in such a way that an implicit negative rate was achieved.
Kimball is confident that it’s a question of when rather than if the system is deployed. He also believes if the US government doesn’t act first some other central bank will instead.
What it would effectively mean is that everyone would via the process be able to bank directly with the central bank if they wished, and only invest in bank deposits if they were prepared to bear the associated risks in exchange for potentially greater payoffs.
If and when an official e-money currency of this sort was launched it’s fair to state it would probably prove a major competitor of Bitcoin or other altcoin systems, offering as it does price stability, trust, liquidity, ubiquity, reputation, mutual interest, a government guarantee system, not to mention protection from overbearing wealth concentration or debasement. All features that happen to depend on the presence of a central planner, who acts in the interests of the people because it is accountable to them.
That’s not to say the incentive to hold or use alternative currencies would be eliminated entirely. It would, however, be linked entirely to those coins’ speculative value rather than their superior functionality, and in that sense be influenced as much by central bank interest rates policy as any other speculative asset class is currently influenced today.
Though, of course, the greater the negative interest rate, the greater the incentive to hold alternative coins. The greater the incentive to hold alternative coins ,the greater the incentive to produce them. The greater the incentive to produce them, the greater the chances of oversupply and collapse. The more sizeable the collapse, the more desirable the managed official e-money system ultimately becomes in comparison.
Either way, the key point with official e-money is that the hoarding incentives which would be generated by a negative interest rate policy can in this way be directed to private asset markets (which are not state guaranteed, and thus not safe for investors) rather than to state-guaranteed banknotes, which are guaranteed and preferable to anything negative yielding or risky (in a way that undermines the stimulative effects of negative interest rate policy).