When Is a Dollar Not a Dollar?


A digital currency issued by the Federal Reserve would revolutionize the U.S. financial industry. Yet while economic and financial digitization is crucial, as Fed Chairman Jerome Powell says, it cannot also be universal. The result is that major economies are going to end up with at least two different kinds of money.

The most common worry is that a central bank digital currency, or CBDC, would lead to disintermediation, with individuals or wholesalers putting their money into a CBDC system rather than commercial banks. The result would be fewer loans and less private-sector economic activity.

CBDC proponents typically say regulation can fix this problem. They favor some combination of issuance limits on CBDC units, CBDC access for wholesalers and major players only, or penalty interest rates or fees on CBDC holdings.

Yet all of these ideas create barriers — you might even call them “capital controls” — between ordinary dollars and CBDC dollars. If there are limits or barriers to dollar-to-CBDC conversion, dollars and CBDC units will not sell for the same price. Why should they? They perform different functions for different clienteles. Of course if the Fed allows unrestricted conversions, a one-to-one price would be enforced by arbitrage. But such open and unfettered privileges are precisely what policy advocates are seeking to limit.

The result would be a bit like the Chinese system. The yuan has for a long time had one value within China and another in world markets, with the difference being enforced by capital controls. And with a Chinese digital currency on the way, China may soon have (at least) three different currency prices.

In this new world, people will ask whether the U.S. dollar unit of account refers to “ordinary dollars” or to CBDC dollars. There might be two competing “dollar units of account” — or, more plausibly, retail prices would continue to be denominated in terms of ordinary dollars and the CBDC would have a floating exchange rate with respect to these “retail dollars.”

Given the sophistication of U.S. business and the widespread distribution of smart phones, which can enable ready calculation, I don’t find this scenario troubling. Nonetheless it would be a revolution of sorts. In particular, the price of the CBDC dollar would become both a major policy variable and a major indicator of where central bank policy is headed. To what extent does the Fed wish to allow transactions, intermediation and resources to flow into the CBDC-linked sector? Current debates about open-market operations or interest on reserves will become arcane and outdated. The regulations roping off the CBDC sector from the retail-dollar sector would become truly significant, and would give the Fed (and other regulatory parties) much greater influence over sectoral allocation.

Over time, the CBDC financial sector would become much larger, as more of the economy digitizes and demands the hypermodern CBDC payment and settlement system. That would mean that the dominant U.S. currency — the CBDC dollar —would be fully separate from the mainstream accounting unit, namely the retail dollar.

Whether some other currency might replace the U.S. dollar as the world’s reserve currency is a perennial debate. Maybe the real alternative to the dollar is … the CBDC dollar.

Another question is whether privately supplied digitized currencies can coexist with a Fed-issued CBDC. The likely answer is yes. A Fed-issued CBDC, no matter how well run, will not serve all purposes. Market participants might also desire digital currencies with greater privacy and anonymity, digital currencies subject to different regulations, or digital currencies designed to transact with foreigners, including countries with illiquid, non-convertible currencies. After all, it is unlikely that the Fed will allow all foreigners to partake in the new CBDC system, in part because of regulatory requirements, and in part because of fear of global runs. There might also be a “basket” of CBDCs at the global level.

It might also be the case that only “wholesalers” are allowed to partake in the CBDC, but banks issue stablecoins to give their depositors indirect access to the Fed’s underlying CBDC system. Banks might try to peg those stablecoins at one-to-one to either retail dollars or CBDC dollars, just as money market funds peg their shareholdings. In either case, there would be yet more monies and additional floating prices.

There is also the possibility, of course, that the Fed will take no action toward a CBDC. In that case, other central banks will. So no matter where the policy lands, it is time to fasten your seatbelts.

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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