Dornbusch, who taught some of the great economists of the modern era, including Paul Krugman and Kenneth Rogoff, may have been riffing off Lenin’s famous “there are decades where nothing happens; and there are weeks where decades happen” but his observation is starkly true.
"The necessity for central banks to come to grips with digital and cryptocurrencies is … profound as currency will play a crucial role in the reshaping of global economic relations.”
It’s true too for those institutions Dornbusch spent much time observing: central banks.
These bastions of monetary policy – interest rates – have been forced to cede preeminence to fiscal policy – taxing and spending – as global interest rates have cratered and COVID-19 recessions have metastasised.
Now central banks are being forced to re-evaluate their role in currency and money creation.
As digital currencies emerged followed by cryptocurrencies, central banks were happy to sit on the sidelines. Now, as COVID has accelerated the shift to the digital world (and to be fair, even before), those banks are re-evaluating their roles.
Christine Lagarde, the President of the European Central Bank, said at a recent conference “we have a duty to play an active role in balancing the risks and benefits of innovation in payments”.
She went on: “more importantly – but so far unlikely – if the bulk of payments are made using digital wallets rather than bank deposits and are denominated in private digital currency with weak links to sovereign currency, monetary sovereignty could be weakened. In a digital world, consumers must have the possibility to pay with sovereign money.”
But the necessity for central banks to come to grips with digital and crypto currencies is actually even more profound than that, as currency will play a crucial role in the reshaping of global economic relations and globalisation generally.
This is particularly true of China – and China-US relations – given China is among the most advanced economies when it comes to digital payments and central bank digital currencies.
As ANZ economists Raymond Yeung and Xing Zhaopeng explain in a new research paper, the People’s Bank of China’s DC/EP or “digital yuan” is like an electronic form of M0 money (essentially cash).
“It is not a cryptocurrency because it does not rely on blockchain payment technology. It also differs from Alipay and WeChat Pay as the latter are private payment platforms backed by the banking system,” they say.
However “the introduction of DC/EP will usher in a structural change in China’s money supply. China’s M0, which includes cash in circulation, is currently at CNY8trn or 3.7 per cent of M2, will likely be turned into household deposits.
“As a result, the money multiplier could rise to 10 from the current 7.15. This will move China much closer to its goal of a ‘cash-lite’ society (although) whether it will facilitate the RMB’s internationalisation or not depends on the evolution of global politics and China’s level of participation in Central Bank Digital Currency (CBDC) forum discussions.”
Central banks and digital currencies
A recent paper published by the Bank for International Settlements, known as the central banks’ central bank, surveyed the field of CBDCs.
The paper, “Rise of the central bank digital currencies: drivers, approaches and technologies” by Raphael Auer, Giulio Cornelli and Jon Frost, finds most projects originate in digitised and innovative economies.
“Retail CBDC work is more advanced where the informal economy is larger. None of the projects surveyed seeks to replace cash - all aim to offer a digital complement,” they note.
“While central banks are considering various technical infrastructures, current proofs-of-concept tend to be based on distributed ledger technology rather than a conventional infrastructure. Access frameworks tend to be based on account identification rather than allowing for token-based anonymity. Most retail CBDC projects have a domestic focus.”
In Australia, as a developed economy with an established, efficient payment system, the imperative for a CBDC is not as pronounced as in China or emerging economies.
The Reserve Bank of Australia recently noted “consistent with previous discussions, members considered that at present there is not a strong public-policy case for issuance in Australia (for a CBDC or e-AUD), given that the electronic payments system in Australia compares very favourably with those in many other countries and access to cash remains good”.
“Nonetheless, the Board will continue to closely watch the experience of other jurisdictions,” the bank wrote in its bulletin. “The Bank is continuing to research the technological and policy implications of a wholesale form of CBDC and is working to develop a proof-of-concept with external parties to explore aspects of wholesale CBDC, building on research the Bank did in its Innovation Lab last year.”
There is much greater urgency in China and it is not just because of a need to modernise the payments system.
ANZ’s Yeung, as a side project, has just published a book opening a discussion on the implications of a Chinese digital currency, China's Trump Card: Cryptocurrency and its Game-Changing Role in Sino-US Trade.
Yeung looks at the emergence of central bank digital currencies from the perspective of deglobalisation, the China-US trade wars, America’s trade deficit and unconventional policies, and the international preeminence of the US currency, the greenback.
Since the middle of the last century, the greenback’s position – and the “exorbitant privilege” it bestows on the US - has been unshakeable.
But Yeung argues that privilege can be shaken as globalisation recedes and more countries – especially China – seek to “de-dollarise”. With China, the impetus comes from the country’s move towards digital leadership. Indeed, he says the digital focus is China’s best hope of avoiding a middle income trap.
Yeung doesn’t argue China will replace the greenback but he highlights the implications of digital and particularly cryptocurrencies.
“Based on blockchain, cryptocurrency is technically capable of being a secured form of payment,” he says. “In contrast to our money-and-banking system, distributed ledger technology is dis-intermediating. The architecture is completely different from sovereign money, be it the yuan or the US dollar. However, distributing the trust across participating members does not disqualify its legitimacy as a form of money.”
Yeung makes no claims to be forecasting a likely future but his analysis highlights the implications of CBDCs. Indeed, he sketches the possibility of a new global e-currency.
“The digital currencies issued by different central banks are largely an electronic version of M0. They are still fiat money,” he says. “To preserve the spirit of blockchain, global policymakers should develop an official cryptocurrency that can also overcome some of the operational issues of private coins, such as governance of reserve or AML/CTF (anti-money laundering/counter-terrorism financing.”
Yeung suggests a name: the World Crypto Currency (WCC). He argues it would be a global world currency palatable to all economies – including China.
While his book is intentionally speculative and a WCC perhaps a step too far for many to consider, Yeung’s cogent argument and analysis makes clear central banks will very quickly have to step back from centuries of tradition as things start to happen faster than any economist thought they could.
Andrew Cornell is managing editor of bluenotes