Central Banks Don’t Need Their Own Digital Currencies

(Bloomberg Opinion) -- Whether central banks should issue their own digital currencies may sound like an arcane debate. But allowing them to do so could have a profound impact on a nation’s economic and financial landscape — and not for the better.

The various proposals are works in progress, but share one basic feature: Central banks would issue electronic deposits. These deposits would be available to eligible citizens or businesses, allowing a greater number of parties direct access to the accounting and payments mechanisms of the central bank. One simple version of the proposal would let individuals hold an account at the Federal Reserve, just as they can hold an account at Bank of America. It would be like a “public option” for banking, albeit with an electronic focus and direct access to the Fed.

One question is whether the Fed, or other central banks, is ready to deal with temperamental retail customers demanding better service. Probably not, but that’s not even the biggest problem with these proposals.

To understand the import of the digital currency idea, consider how the system works now. U.S. banks have a special relationship with the Federal Reserve system — they have direct access to its payment services and in return receive lender-of-last-resort privileges. If you are not a legally defined bank, you usually have to work through one to get access to the Fed’s payments system. In the meantime, that bank can use the deposits you place with it to make loans.

Now consider how this all changes if you can put your deposit directly with the central bank instead. What happens to lending? Under one scenario, the central bank might simply sit on your digital deposit, much as a cloakroom at a restaurant holds on to your coat. In that case the quantity of lending would go down, to the likely detriment of the economy. In addition, depositors might not find these accounts so remunerative or attractive.

An alternative scenario is that the central bank decides to enter the commercial lending business, much as your current bank does. Will the central bank be a better lender than the private banks? Probably not. Central banks are conservative by nature, and have few “roots in the community” as the phrase is commonly understood. The end result would be more funds used to buy Treasury bonds and mortgage securities — highly institutionalized investments — and fewer loans to small and mid-sized local businesses.

That’s a bad trade-off, especially given that Treasuries already can be funded at low rates and new business creation has been sluggish. There is also the danger that central bank lending could become politicized. Imagine, for instance, Trump-appointed regulators deciding that more lending to troubled swing states was needed, and that the Fed would do it.

The problems run deeper yet. Financial regulation makes a relatively tight distinction between banks and non-banks. Banks have access to the payments system directly and enjoy other privileges, and in return their risk-taking is regulated more heavily (by not only the Fed but also other federal agencies and states). A fintech startup, in contrast, avoids most bank regulations, but it must work through banks to make payments. This division of responsibilities is imperfect, but it has allowed many parts of the U.S. economy to grow and innovate without facing all of the regulations imposed on banks.

This leads to my primary objection to an official government e-currency: It would, in effect, make many more economic institutions more like banks. Over time, those institutions would probably be regulated more like banks, too. For instance, if the Fed is directly transmitting payments made by a private company, it might be wary of credit risk and impose capital and reserve requirements on that company, much as it does on banks. Banks also might complain that they are facing unfair competition, and ask that consistent regulations be imposed. In any case, more of the economy likely will be subject to financial regulation, not just the relatively narrow core of the banking system.

Consider China, which is perhaps the furthest along of any government in this field with its plan for a digital yuan. The Chinese banking and payments system is already so state-run and state-controlled, so this will prove one of the easier transitions.

That China is in the lead here should give you pause. Most banking and financial systems are an uneasy blend of centralized and decentralized elements, with the balance changing as technologies evolve. If countries institute central bank digital currencies, it will in effect be an end run around the private sector. Too much commercial activity will be subject to centralized regulatory control.

Is that the system that the U.S. and other capitalist democracies want? The status quo is not perfect. But it is not on the verge of implosion or catastrophe. Digital currencies from central banks are a solution in search of a problem.

To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include "Big Business: A Love Letter to an American Anti-Hero."

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