January 21, 2022
FAST THINKING: The race is on for a digital dollar
GET UP TO SPEED
Ready for UncleSamCoin? It’s official: The Federal Reserve’s new report on central bank digital currencies (CBDCs) has opened the door for the first time to the United States issuing its own digital currency. That marks an evolution from Fed Chairman Jerome Powell’s previous skepticism about a US digital currency, and it comes at a moment in which nearly ninety countries are at least exploring the idea of issuing a CBDC. Experts from our GeoEconomics Center, which helped shape this debate with its Central Bank Digital Currency Tracker and all the research on global trends that goes into it, break down the next moves for the Fed.
TODAY’S EXPERT REACTION COURTESY OF
- Josh Lipsky (@joshualipsky): Director of the GeoEconomics Center and former International Monetary Fund official
- Hung Tran: Nonresident senior fellow at the GeoEconomics Center and former IMF official
The (new) great game
- The US dollar has long been the world’s reserve currency, which is an immense source of economic might and geopolitical leverage for the United States. But with nine countries having already launched a CBDC, and China expected to make a splash with its digital yuan in the coming days at the Beijing Olympics, Josh argues that position could weaken.
- “Imagine a world where Russia invades Ukraine, Russian banks are shut off from the SWIFT banking system [the widely used platform for global financial transactions], but they switch over to a wholesale CBDC exchange between Russia and China,” Josh says. “That’s all possible with digital currencies.”
- The Fed hasn’t committed to a CBDC, but its report nonetheless sends an important signal about its desire to help develop international standards for these digital currencies. “This is a message from the Fed to the world that we are working on our own model, but in the meantime we want to make sure that what everyone else does is going to protect privacy, be safe from cybersecurity threats, and not become a vehicle for illicit finance,” Josh tells us. “This is what central banks have been asking for—a Fed that says they are ready to get in the game.”
- “Even if a US CBDC takes years to come online, its very possibility can shape the decisions being made today” by other governments experimenting with CBDCs, Josh adds.
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Not just pocket change
- US Treasury Secretary Janet Yellen has said a CBDC “could result in faster, safer, and cheaper payments.” So how would it work? Hung says it would be “the digital form of physical cash.” You would get it through a financial institution, not directly from the Fed, and it would be “privacy-protected.” But unlike cash, it would be “identity-verified” to help guard against criminal activity.
- That leaves numerous unanswered questions about implementation. Would a CBDC work like a bank account? Then it would lose the anonymity of cash. Would these coins come in digital wallets that allow direct transfers among users outside the purview of banks? This would provide more privacy, but as Hung notes, “the wallets can be designed to give the Fed information about the movement of tokens among wallets” as a crime-fighting measure.
- The Fed also raised the prospect of attaching interest rates to a new CBDC, though Hung warns that “paying interest on a CBDC would have more downside risks,” such as higher costs and financial instability. He argues that allowing consumers to earn interest on the new digital currency would put it in competition with Treasuries or other bonds, which could raise borrowing costs and damage the economy. Meanwhile, a negative rate, which the Fed could use to encourage spending by making the currency lose value over time, “could be viewed by many Americans as an unauthorized confiscation of their wealth.”
Reading between the lines
- The Fed will not go it alone on a CBDC. A key message in its report is that the institution needs authorization from Congress to put one in place. And Congress is not known for speed. “This cautious stand risks putting the US behind in the race to issue CBDCs,” Hung tells us.
- But despite the equivocation, Josh sees hope, particularly in the report’s assertion that a CBDC could protect the dollar’s reserve-currency status. “The Fed wants to find a way to yes,” he says. “What yes means in terms of public-private partnerships, protecting anonymity, and dozens of other technology choices is what the months and perhaps years ahead will be about.”
Further reading
Image: Federal Reserve Board building on Constitution Avenue is pictured in Washington, U.S., March 19, 2019. Photo via REUTERS/Leah Millis.