The Federal Reserve and Central Bank Digital Currencies – It’s a Matter of When

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This article was last updated on April 16, 2022

A recent research and analysis document entitled "Money and Payments: The U.S. Dollar in the Age of Digital Transformation" by the Federal Reserve outlines the Fed's potential plans for a central bank digital current (CBDC) and looks at the risks and benefits of a digital currency.

To help us better understand how a central bank digital currency differs from other forms of money, the Fed offers these definitions:

1.) Central bank money is a liability of the central bank. In the United States, central bank money comes in the form of physical currency issued by the Federal Reserve and digital balances held by commercial banks at the Federal Reserve.

2.) Commercial bank money is the digital form of money that is most commonly used by the public. Commercial bank money is held in accounts at commercial banks.

3.) Nonbank money is digital money held as balances at nonbank financial service providers. These firms typically conduct balance transfers on their own books using a range of technolo- gies, including mobile apps.

Central bank and nonbank money are both denominated in the same units (U.S. dollars) and are intended to be convertible into central bank money.

Each of these types of money has different risks with commercial bank and nonbank money having relatively little risk thanks to federal deposit insurance and commercial banks' access to central bank liquidity.  According to the Fed, central bank money carries neither credit nor liquidity risk and is the safest form of money.

Here is an excerpt from the introduction which sets the stage for the Fed's plans and explains the difference between a CBDC and the existing paper money ecosystem:

"The Federal Reserve is exploring the implications of, and options for, issuing a CBDC. For the purpose of this paper, a CBDC is defined as a digital liability of the Federal Reserve that is widely available to the general public. While Americans have long held money predominantly in digital form—for example in bank accounts recorded as computer entries on commercial bank ledgers—a CBDC would differ from existing digital money available to the general public because a CBDC would be a liability of the Federal Reserve, not of a commercial bank…

The introduction of a CBDC would represent a highly significant innovation in American money. Accordingly, broad consultation with the general public and key stakeholders is essential. This paper is the first step in such a conversation. It describes the economic context for a CBDC, key policy considerations, and the potential risks and benefits of a U.S. CBDC. It also solicits feed- back from all interested parties."

The Fed claims that it will not issue a CBDC without clear support (i.e. a specific law authorizing the issuance of CBDCs) from the Executive Branch and Congress and, while they are looking for input, I'm guessing that they really don't care what the public thinks.

According to the Fed, this is what a CBDC should do:

1.) provide benefits to households, businesses, and the overall economy that exceed any costs and risks.

2.) yield such benefits more effectively than alternative methods.

3.) complement, rather than replace, current forms of money and methods for providing financial services.

4.) protect consumer privacy.

5.) protect against criminal activity including money laundering and financing of terrorism.

6.) have broad support from key stakeholders.

CBDCs would also be issued under an intermediated model with the private sector (i.e. commercial banks) offering accounts or digital wallets to manage CDBC holdings and payments and would be seamlessly transferrable from one intermediary to another.  Here is a quote: 

"The Federal Reserve’s initial analysis suggests that a potential U.S. CBDC, if one were created, would best serve the needs of the United States by being privacy-protected, intermediated, widely transferable, and identity-verified. As noted above, however, the paper is not intended to advance a specific policy outcome and takes no position on the ultimate desirability of a U.S. CBDC."

Note that a CBDC intermediary would be responsible for verifying the identity of its customers.  Here's an interesting footnote that appears on page 14:

"In this regard, a CBDC would differ materially from cash, which enables anonymous transactions.  While central banks are unable to fully prevent cash from being used for illicit purposes, a CBDC could potentially be used at much greater scale and velocity than cash, so compliance with laws designed to combat money laundering and funding terrorism is particularly important for CBDC.

And there you have it.  So much for those anonymous, private transactions.  The Fed will know every financial transaction that you undertake.

Let's look at what the Fed believes are the potential benefits of a CBDC:

1.) CBDCs would be free from credit and liquidity risk.  A CBDC could potentially be programmed to deliver payments at specific times and could be used to carry out very small online financial transactions (micropayments).

In my opinion, it is the programable nature of the CBDC (i.e. it can be turned on or off at the whim of the powers that be) that is the most frightening as note on this posting.

2.) Streamline cross-border payments.

3.) Support the international dominance of the United States dollar as quoted here:

"Today, the dollar is widely used across the globe because of the depth and liquidity of U.S. finan- cial markets, the size and openness of the U.S. economy, and international trust in U.S. institu- tions and rule of law. It is important, however, to consider the implications of a potential future state in which many foreign countries and currency unions may have introduced CBDCs. Some have suggested that, if these new CBDCs were more attractive than existing forms of the U.S. dollar, global use of the dollar could decrease—and a U.S. CBDC might help preserve the international role of the dollar."

Basically, if the Fed doesn't adopt a CBDC and other nations do, the U.S. dollar could potentially lose its role as the global currency of choice.

4.) Financial inclusion for vulnerable households and communities by reducing barriers and lowering transaction costs.  CBDCs would enable rapid and cost-effective payment of taxes, wages, tax refunds and other federal payments (think universal basic income) and promote access to credit.

Rather oddly, the Fed seems to be concerned about America's "unbanked", noting that more than 5 percent or 7 million American households have no bank accounts with 20 percent of Americans having bank accounts but relying on payday loans, cheque-cashing services and money orders for their banking needs. Fortunately for all of us, a

 CBDC will solve all of those problems!

5.) Extend public access to safe central bank money.

The Fed notes that digital payments are already rapidly replacing cash with only 19 percent of transactions being made in cash in 2020 compared to 40 percent in 2012.  Nonetheless, almost laughably, the Fed claims the following:

"The Federal Reserve is committed to ensuring the continued safety and availability of cash and is considering a CBDC as a means to expand safe payment options, not to reduce or replace them."

And, if you believe that….

Let's close with a couple of thoughts.  With central banks around the world already test-driving the adoption of central bank digital currencies as shown on this graphic:

The Federal Reserve and Central Bank Digital Currencies - It's a Matter of When

…it's not a matter of if, but rather a matter of when, we experience the rollout of the Federal Reserve's version of a CBDC.  With the growing move to adopt a digital passport as part of the response to the pandemic, it will be sooner rather than later that access to "our money" will be linked to a universal basic income which, in turn is linked to a social credit score which is then linked to our government-mandated digital identification.  

Thanks about it this way – what if the government could control expenditure that you make and gave itself the right to tell you that you cannot buy certain items because they aren't deemed "acceptable".  Given how governments have trampled our rights over the past year as a response to the pandemic, such a move is certainly not out of the realm of possibility/probability.

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