Central Bank Digital Currencies – coming to a wallet near you.

Finance & Fury Podcast

Welcome to Finance and Fury. This episode is to look at Central bank digital currencies - Central banks releasing digital currencies is an inevitability at this stage - proof-of-concept programmes are currently in the works across the globe - with more than 80% of central banks looking at digital currencies – The RBA is one of them

There is a lot of cover in this topic – we will define a central bank digital currency and go through why central banks are looking at pure digital currencies as an option – We will also look at what is happening in China with their plans for the distribution of the digital yuan – but also look at the alternatives the RBA is looking at

Defining the different forms of currencies in the modern monetary economy – physical and digital

1. Physical money is easy - Think of cash in your wallet – either in notes or coins – this is physical money – when you log into your bank account and see digits on a screen – this could be considered a digital currency – but you can still convert these digits into physical money
2. Digital currency is the name given to the electronic equivalent of physical money or cash when it is issued in a purely digital form
   1. Digital currency is managed, stored or exchanged on digital computer systems over the internet.
      1. Types of digital currencies include cryptocurrency, virtual currencyand central bank digital currency
      2. Under current legislation – you can still convert your digital currency into fiat currency, hence physical – you can withdraw digital forms of money – i.e. exchange BTC for AUD, then withdraw this AUD
   2. Currently – the digital representation of your physical money can be used via payments technologies such as online banking and electronic financial transaction point of sale – EFTPOS for short
      1. These payment methods are linked to commercial bank accounts in your own name, as well as deposit-taking mobile wallets, and gift, credit or debit cards – most people listening would have most likely used this form of payment – transferring the right to a physical currency digitally
   3. A CBDC is different to cryptocurrency – or cryptoassets based around the terminology used in legislative frameworks
   4. these are government sanctioned and centralised in their production – exactly like physical money - a cryptocurrency such as BTC or ETH does not – it is decentralised
   5. A CBDC would still have a ledger – but this would be centrally controlled and fully integrated into the financial payments system
   6. Currently - Every single day - Central banks are issuing conventional digital money to commercial banks that can then be exchanged with cash at par value – you go to an ATM to withdraw digital representations of your dollars for physical ones – the internet revolutionised this in the financial system
      1. banks used to have to store more physical currency – or at least a paper entitlement to this – to meet the demand of consumer payments - digital was never a consideration – with the decline in physical currency demand – less economic activity is conducted in this manner – so banks need to hold less physical cash - I remember going to Coles with my grandparents when I was a kid – they would take out cash for their weekly spending and pay in cash for everything – because this was how things were done in their day – today – credit and debit cards have mostly replaced cash payments
   7. In the current monetary economy - the RBA actually does issue digital currency to commercial banks through the provision of money into each bank’s account within the exchange settlement account (ESA) system — However – there is no major central bank that purely issues digital currency directly to the public
      • Whilst most currency that exists is digitised – it can still be transferred into physical currency

1. Plus – you don’t get your digital cash from a central bank – you get it through commercial banks

4. The transfer of the monetary system from a physical currency to a digital one would be a form of a monetary reset - Let’s take a step back and look at the previous monetary reset that occurred –
   1. Under the gold backed currencies – you could convert your paper money for gold at the equivalent pegged value – until this was banned by Governments on the population – in the US from 1933 – but other Central banks could still convert currency for gold under the Brenton woods system – until 1971 when any form of gold standard was abandoned
   2. Think of a Central Bank Digital Currency as a similar process of reducing your financial freedoms – you can currently convert your digital money into physical money – but when the nation adopts a pure digital currency policy, this is no longer possible – no more physical cash – everything is digitised – the same as when the population was no longer allowed to convert the currency for the asset backing it – i.e. gold
5. This brings us to a core component of this episode – the People’s Bank of China (PBoC) – which is one of the most prominent central banks globally, aims to be the first major central bank to issue digital currency for use by the general public and business – replacing physical cash
   1. This digital yuan will be fully produced and backed directly by the Chinese central government
   2. The underlying technology for this is different to the blockchain ledger, and will be controlled by the Chinese government and not distributed across the Chinese financial system - or any other nodes – like a decentralised ledger that crypto operates on

Why do Central Banks – particularly China’s want a digital currency?

1. Based around the released papers - it is suggested that the Digital Currency electronic payment system will alleviate the risks to the financial system that are present with both physical money or cryptocurrency transactions – these are anonymous counterfeiting, money laundering and illegal financing
2. This sounds like a great argument if you are a monetary official – on the surface - because under a purely digital currency, monetary regulators can completely monitor digital currency transactions – for them this is a major plus as they will greatly increase their financial and monetary supervision capabilities – but what about for the individual in the economy – who makes up the economy
   1. So, Governments and Central Banks want to track every transaction that someone makes – this is firstly in an aim to reduce the black market economy
      1. Black market economies emerge to fill in the gaps of an imperfectly legislated economic environment – with tradies in Australia – the 10% discount to pay in cash to avoid GST
      2. In other nations that are highly regulated through central planning – black markets emerge to provide goods as well as currencies to fill in a gap – because of limitations of government controls – these sorts of economies exist mostly in communist/socialist economies like Venezuela and North Korea
         1. Where there is demand – people will find a way to fill this through providing the supply – whether it be food or drugs – if people want it and the government wont allow it – it will likely find its way onto a black market

• The black market fills a hole to reduce the inefficiency of the government – allows the economy to function at a greater capacity than it would under a complete governmental control – hence, the introduction of a pure digital CB currency removes this natural phenomenon to help right any wrongs that central planning creates
  1. This is particularly relevant in nations which complete central planning – socialist/communist countries like Venezuela and North Korea, or the USSR, China and Cuba in the past – the only way for people to get an allocation of food was often through the black market – but at imperfect prices due to market disruption

1. All of these operate on cash – which cannot be tracked and measured by the government - It actually creates a completely centralised and controlled economy – the monetary authorities may view this as a win – but for the every day individual, this limits their ability to maximise their economic output – the greater limitations occur in situations where economic transactions are limited by government – countries like Australia are relatively free – but in countries like China – this could really reduce the individuals living standards if they are both cut off from cash payments and restricted in the digital payments –

1. The most alarming factor of all of this – especially for China – this relates to their social credit score system – monitoring what you spend your money on – allows them to allocate you a score
   1. If you spend too much on alcohol, or if you are hoarding too much cash and not being a productive member of society through investing or spending this, well – you will see your score lower – even if you are friends with an alcoholic – your score will lower – then you save, spending money, cannot travel, find accommodation to live and you become homeless quickly as you are completely cut off – you can also not beg for money
   2. This digital Cb currency from China has the added element of being able to piggy back onto what is already an incredibly authoritarian system of control of its population – where if you score is also too low – now you no longer have the right to access this currency and you are shut off – with no method of redemption
2. From an Economic perspective – monetary officials want to create the perfect world – where they can measure spending down to the exact dollar and manipulate the economy through making adjustments to the money supply and interest rates – they can also get a measure on inflation
   1. They have been trying to do this for decades but with little effect – think about monetary policy for a minute – the control over interest rates is aiming to control behaviours of individuals that make up the economy – if there are lower interest rates, this based on the rational models that entities like the RBA have, which theorises that a lower interest rate should decrease the incentive to save cash and instead people will spend it – this should then increase inflation and then interest rates can increase over time – but these models aren’t perfect – as unintended consequences occur – what happened in practicality is that the lowering of interest rates to help increase inflation resulted in credit growth – i.e. mortgage sizes – where people were borrowing more money – whilst interest rate payments were lower per dollar borrowed, people now had more borrowed dollars – so total interest rates did decrease, but loan repayments for principal increased – resulting in more money flowing into debt repayment – hence less being spent in the economy – therefore the inflation never materialised as hoped
      1. Monetary officials think that these models aren’t perfect because they don’t have complete data – they don’t know how much exactly each individual is spending and where they are spending this – plus, inflation is currently measured by around 0.8% of households keeping a manual diary and reporting this back to the ABS – would be much easier to have a direct line to every transaction you make and measure the relative price increases – this equals a completely centralised and controlled monetary system
      2. What they never understand is that there I no way to control a complex system like the economy – any model is never going to work as the economy is non-linear – i.e. if you put in $100 to the economy expecting a multiplier of 2 under a linear system – you would get $200 – under a non-linear system you could get $20, -$50, $100 – who knows – inputs do not equal outputs
   2. In addition – thin about Welfare payment that governments and central banks can make – a recent proposal was made in limiting spending and transactions to a card where it could only be spent on food or other essential goods – no alcohol or withdrawn as cash to spend on who knows what – this would fulfill this if CB digital currencies came into existence
      1. But also – Digital currencies in their pure form are only from CBs to commercial banks – the invention of digital CB currencies allows for the expansion of helicopter monetary policies
      2. The payment directly from a CB to your bank account – this is the basis for economic policies such as UBI based around modern monetary theory – MMT
      3. So these CB digital currencies allows for a circumvention of fiscal policy – no longer goes a government decide on welfare payments – CBs can directly pay individuals as the commercial banks would no longer be required as a financial intermediary
   3. The end result of this is Central Banks increasing their Control over the economy –
      1. We already do don’t have a free market economy – money is the life blood of any economy – it is what facilitates the exchange system of the economy – but the control of the supply of money and the interest rate control affecting incentives to save or spend has completely destroyed the natural state of the economic and business cycle
         1. What is even more telling about the potential implications for us – is when looking at a speech given by the Bank of England’s chief economist in 2015 – where CBDC would be the ideal mechanism to implement negative interest rate policies – if you get charged to save, then you would withdraw your cash savings and put it under your mattress – but if this is not possible, you would have no options to either spend or invest the cash
      2. Increase spending – from both the population but from a central bank through just issuing more digital currency – as well as economic transfer payments directly to the population – if this doesn’t come from a government, and from the creation of the money supply – it isn’t technically debt represented on a balance sheet anywhere
         1. Under the current economic environment – for governments to spend money they don’t have, they get into a deficit and fund this through issuing a bond – with digital currencies directly issued from a CB – no government debt
      3. From a central bank’s point of view – a digital currency can also reduce the costs involved in handling, maintaining and recycling banknotes and coins throughout financial systems and economies
         1. It is true that it does cost money to print dollars and produce coins – There can also be currency shortages - Coin shortage in the US at the moment – the costs go up over time to produce these assets, whilst inflation reduces the real value of the currency
         2. I did some maths for Australia – looking at the 20c coin – it weighs 11.3g – and constitutes 75% copper and 25% nickel – well at current market prices this represents around 7c of nickel and 11c of copper – so even the raw materials are worth around 18c – let alone the manufacturing costs – so in producing a 20c coin, the RBA may actually be losing money if commodity prices continue to rise

China is serious about this – they are rolling it out -

1. It will initially be distributed to all commercial banks affiliated with the Chinese central bank such as the Agricultural Bank of China
   1. First phase - it is designed as a replacement for China’s Reserve Money (M0) – this is the monetary reference to central bank notes and coins – it is essentially the base money supply on which banks can extend the money supply to commercial banks
   2. Second Phase - it will be distributed to large fintech companies such as China’s Tencent and Alibaba to be used alongside their WeChat Pay and Alipay inhouse payments respectively
2. The first public testing is already going on - in October 2020 - China's central bank issued 10 million yuan ($2 million AUD) of digital currency to 50,000 randomly selected consumers
   1. This digital currency is available for transactions across 3,389 retail outlets in Shenzhen
3. Next phases of testing - 4 key cities are going to be the first cities to test the use of the DCEP
   1. These cities will be closed economies – where pilot tests and this is testament of digital currencies - Beyond this first stage of domestic integration – China is thinking of internationalising the RMB by offshoring the yuan into Hong Kong and Singapore
4. Multinational foreign firms – companies such as McDonalds and Starbucks will also take part in the DCEP testing alongside local hotels, supermarkets, postal lockers, bakeries, bookstores, gyms

Does this relate to Australia and why would cash disappear?

1. Studies by the Reserve Bank of New Zealand (RBNZ) suggest there are two main reasons why cash could disappear
   1. Cost - The relative cost of its use of physical cash compared to digital methods – as we went through earlier in the episode – the major reason to get rid of a fiat cash is if it is worth more than what the value you attribute to it is – i.e. why spend 0.21c to produce a 0.2c coin?
   2. Undesirable outcomes – Central banks think that physical cash has a socially undesirable outcome – i.e. the attractiveness for tax evasion, money laundering and illegal transactions
      1. In Australia - large-scale cash transactions have been deemed such a social risk that in 2019 the Currency (Restrictions on the Use of Cash) Bill 2019 was introduced in Federal Parliament to ban cash transactions over $10,000 – this is a step to limit cash
   3. How the RBA views this topic on alternative digital payment methods
      1. Australia’s digital version of the Australian dollar (AUD) will be some way off
      2. In 2020 - The Reserve Bank today announced that it is partnering with Commonwealth Bank, National Australia Bank, Perpetual and ConsenSys Software, a blockchain technology company, on a collaborative project to explore the potential use and implications of a wholesale form of central bank digital currency (CBDC) using distributed ledger technology (DLT). This is part of ongoing research at the Reserve Bank on wholesale CBDC.
   4. From a central bank/governmental perspective - The benefits have been acknowledged to include
      1. improved financial tracking
      2. cost reductions from reduced production and general handling of coins and banknotes.
      3. In China, Australia and elsewhere, the cashless trend is seen to be strong with both business and consumer habits seen as key drivers in the likely seamless adoption of a DCEP.
   5. China is the first mover – where they are cracking down on crypto assets – as they are implementing their own digital currency - China wants complete control – any nation that implements this also likely wants complete control
   6. Be prepared for the next decade of change – as central banks adopt digital money – replacing physical currency

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