The Bank of England put out an interesting discussion paper yesterday.
No, stop – don’t tune out. I’m serious.
It’s all about the future of currencies. And of all the topics I write about – including inflation – it might be the most important one of all to keep on top of.
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Indeed, the Bank did an admirable job of explaining why.
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Why central banks view stablecoins as a threat
Do you like the idea of being told what you can and cannot spend your money on?
I think it’s worth starting on this point when we talk about digital currencies – and central-bank backed ones in particular – because it’s the main reason users (like you and me) should be against it, and it’s also a big reason why issuers (the government and central bank) might be rather more keen on it.
But before I get to that, we’ll have to cover a bit of background, so we can all start on the same page here.
You might think bitcoin and all the other crypto stuff is a big scam or utopian nonsense. I’d probably have a certain amount of sympathy. However, it’s clear to central banks around the world that there’s something to this digital currency stuff. It’s also clear that they’re starting to circle the wagons on that front.
Central banks aren’t worried so much about bitcoin itself. The big daddy of crypto is useless as a medium of exchange because its value moves around so much. At best (though I might be missing something) it seems most likely to remain a useful digital analogue for gold.
There’s a value to that, but it doesn’t really pose a threat to the existing financial order.
However, other types of digital currencies – “stablecoins” – are viewed as much more of a problem by global central banks. Stablecoins are “pegged” to another asset. Some of them are backed by commodities, but the biggest ones are simply backed by existing government-issued (”fiat”) currencies.
So you get the purported benefits of crypto (mostly rapid movement across borders as far as I can see for now) without the wild swings in value.
That makes these digital currencies viable as a medium of exchange. In other words, stablecoins represent competition to fiat currencies.
And central banks have no intention of letting such competition spring up. You’ll note that they already shot Facebook down in flames when it tried to suggest launching its own currency – Libra – backed by a basket of “fiat” currencies such as euros and dollars.
But there’s only so long that they can continue to hold out. Stablecoins are out there. The biggest – Tether – has a heavily-disputed reputation (to put it lightly), and as yet, is mostly used for trading other cryptocurrencies (it’s “pegged” to the US dollar, so as a trader, you can treat is as cash between trades rather than endure the painful process of going back to fiat).
However, there are many other stablecoins out there. And it’s clear that beyond that an entire “shadow currency” and “shadow banking” system is either springing up or in danger of springing up.
Hence the interest of central banks.
The risks of giving up physical cash
So that’s the background. As with most of these things, some of the concerns are entirely justified. “Shadow” finance – the bits of the financial system that lurk beyond the view of regulators or balance-sheet accounting, particularly involving lending money – is usually the source of systemic trouble.
It was a big part of the problem in 2008, for example (when the entire global financial system turned out to be far more heavily exposed to poorly-written mortgages than anyone had realised).
So you can see why central banks want to keep an eye on this stuff. But there’s also the plain fact that they don’t want the competition.
The idea of competitive currencies might seem odd these days, but there have been plenty of periods in history in which banks have issued their own currencies and competed for usage. There’s plenty of debate over the best way to run such a system but there’s no doubt that they can and have worked in the past (Scotland from 1716 to 1845 is a good example).
You can ban your competition – but that’s a lot harder in a global system. So a better bet is to establish your own digital currency with the full backing of the government. Currencies ultimately rely on confidence, and it’ll be tough for a ragbag of private currencies to compete with a “proper” fiat digital currency.
So, you might think: but we’ve all been basically getting along OK with governments being the monopoly issuer of currency for a while now. Why should we be worried about the same thing happening in the digital realm?
Well, it goes back to what I said at the start of this article “Do you like the idea of being told what you can and cannot spend your money on?”
The basic problem with a monopoly digital currency is that if you get rid of cash and you can’t use any other form of digital currency, then the issuer of said currency has an extraordinary degree of power.
Sir John Cunliffe, deputy governor of the Bank of England, made the point to Sky News yesterday in a slightly more cuddly manner. He noted that digital money could be programmable. You could, for example, make sure that your children’s pocket money “couldn’t be used for sweets”.
Or, when you’re trying to “stimulate” the economy after a recession or a pandemic or a banking crisis, you could programme your population’s wages so that they lose 10% of their value every month, to make sure everyone spends it.
Or, if you’ve decided that the moral panic of the day is fizzy drinks, you could immediately impose a 100% tax on said items. Or you could keep an exact record of who bought them and when, then remove some of their NHS access privileges.
I’m sure there are lots of other dystopian fantasies you can throw into the mix here. But you take my point. Indeed, the one thing that gives me some comfort is that at least the Bank of England isn’t trying to hide the realities of this stuff.
We’ll be discussing this regularly in MoneyWeek as I think that the pace of technology is going to force this issue upon us much sooner than we might be expecting. It’ll have consequences (both positive and negative) for everything from the banking sector to transaction costs.
But I think it’s important to make this point now – if we give up physical cash then we’re running a lot more risks than simply having our bank accounts hacked.
For more on central bank-backed digital currencies, you can read our recent briefing on the topic here.
