‘Sovereign money’: a bad idea, part deux
Last week, right after I wrote my previous post on ‘sovereign money’, the BIS published a whole report on this very concept (and more precisely, on the idea of using cryptocurrencies or blockchain-based systems to give anyone the ability to deposit cash/hold assets at the central bank). It is a very good report. Do read the whole thing.
The BIS differentiates between wholesale digital currencies, primarily used for clearing and settlement and available to financial market participants, and ‘general purpose’ ones, which allow the general public to effectively ‘acquire’ digital cash at the central bank rather than hold deposits at a commercial bank or hold central bank physical cash. The BIS acknowledges that this could have some repercussions on the conduct of monetary policy and of its transmission mechanism (as such digital currency would become a potentially widely-held asset and a liability on the central bank’s balance sheet).
The report is pretty detailed about the potential benefits and issues of such digital sovereign money (from minor Know-Your-Customer issues to more critical cross-border deposit flows and siloed high-quality collateral), and essentially agrees with and elaborates on many of Jordan’s – and my – arguments. But crucially (and this is the main focus of this post), it also looks at what could happened should a full-on financial crisis strike. In my previous post, one of my main concerns was commercial banks’ funding depletion due to deposits ‘leaking’ towards that new low risk, very liquid and convenient, central bank legal tender (Tolle, in a BoE blog post, went as far as saying that this could end fractional reserve banking). The BIS takes this reasonning further, pointing at the worsening impacts of such instruments on financial instability risk:
A general purpose CBDC could give rise to higher instability of commercial bank deposit funding. Even if designed primarily with payment purposes in mind, in periods of stress a flight towards the central bank may occur on a fast and large scale, challenging commercial banks and the central bank to manage such situations.
Digital sovereign money would therefore facilitate bank runs, which could occur with “unprecedented speed and scale”, and increase the probability and severity of a crisis. Of course, as history teaches us, in such situation regulators would probably blame ‘inherently unstable’ banks – or capitalism – for not holding enough liquidity and not having a stable-enough deposit base in the first place. Which would be another opportunity to further regulate banks and grant regulators more power. But that’s another story.
Another very interesting point raised by the BIS, and which was also present among my top concerns, is political interference and less effective capital allocation. While the BIS doesn’t elaborate much on political interference in its piece, it does acknoledge the limitations of central planning (and even refers to Hayek’s The Use of Knowledge in Society!):
Introducing a CBDC could result in a wider presence of central banks in financial systems. This, in turn, could mean a greater role for central banks in allocating economic resources, which could entail overall economic losses should such entities be less efficient than the private sector in allocating resources. It could move central banks into uncharted territory and could also lead to greater political interference.
It looks like, for once, many leading central bankers, the central banks’ central bank (i.e. the BIS) and I are on the same line. Champagne?