The Fed Has a Chance to Boost Equality With Digital Currency

(Bloomberg Opinion) -- On Aug. 15, the U.S. marked the 50th anniversary of the birth of fiat currency, or a currency that depends on faith in the Federal Reserve and not in the gold standard. Like most 50th anniversaries, this one shows the celebrant worse for wear.

The "almighty dollar" is facing a raft of challenges from other supra-national currency powerhouses such as China and from giant technology companies that understand they would exercise even more market clout if they controlled not just what we buy and sell, but also how we pay for it. If the Fed doesn't quickly redefine the dollar to reflect its rapid digitalization by other hands, central banks will join shopping malls on the long list of complacent category killers felled by agile competitors.

When the Fed designs the U.S. central bank digital currency (CBDC), it must focus not only on its own concerns, including how it would impact the transmission of monetary policy, but also on ensuring that CBDC is money that materially improves economic opportunity. This does not and must not mean manipulating a digital dollar's value to advantage one group or another; it means that digital dollars need to be a truly neutral transmitter of value just like physical dollars.

Although Fed Chair Jerome Powell disputes any of the risks digitalization poses to the dollar as both fiat and the primary global reserve currency, the U.S. central bank is preparing for a possible assault. And while work is under way, nothing said by Fed officials so far indicates any awareness about the importance of a CBDC's design beyond just the Fed and the banking system. There are four design features essential for equitable CBDC.

First, the CBDC must complement cash, not replace it. The Fed already knows this for its own purposes, but it also needs to understand that cash is critical to low-income households and digital dollars remain inaccessible to many elderly and disabled Americans. And, while the new infrastructure bill will shrink the "digital divide" if it's enacted, cash is still crucial to many rural communities cut off from fast, safe and efficient broadband connectivity.

Second, accessibility should be incorporated from the start in CBDC design. Any vision-impaired computer user knows the difference between using screen-reading software that is only tenuously attached to an operating system as an afterthought and already built-in accessibility features.  Important though cash is, it's fast disappearing from the day-to-day financial system. Ready access to digital dollars is thus at least as important to equality as preserving a role for cash.

Third, the Fed's digital dollars need to flow through sound, safe and regulated financial institutions. Anyone with its hands on a consumer's money should have no commercial conflicts of interest that might divert digital dollars for its own purposes. Sure, the current payment system is inefficient in ways that adversely affect the most vulnerable, but speed that gives an advantage principally to retailers or social-media companies would destroy the neutrality fundamental to fairness.

Finally, the Fed must not take deposits out of the national financial system. Instead, the CBDC should only, but importantly, facilitate the payment system's accessibility, efficiency and speed. If the Fed instead becomes the nation's deposit-taker, then it will also need to be the nation's loan-maker. It would need to make decisions not only about each individual’s creditworthiness, but also about who deserves a loan to advance what type of economic activity.

When the Fed in March 2020 restarted buying trillions of dollars of financial assets, it saved financial markets, up to and including junk-bond exchange-traded funds, not the millions of households struggling with a liquidity crisis. The financial system stood firm and key sectors in it -- junk bonds again coming immediately to mind -- even did better than before. But millions of households still face years of lost opportunity due to layoffs and the bills coming due as loan forbearances come to an end.

When the U.S. finally established the dollar's dominance in 1971, the gold standard it replaced was anything but golden or standard. Failure to recognize this and ensure a gradual transition to a new currency regime led to macroeconomic and financial-system disruptions that lasted well into the late 1980s, sowing the seeds of today's economic inequality. In 1971, the U.S. was a middle-class nation; by 1990, it was anything but. A digital dollar is as inevitable as the gold standard's demise, but a CBDC designed with equality as an afterthought will be a CBDC that comes at an unduly high cost not just to the economy and financial system, but also to the greater good. 

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

Karen Petrou is the managing partner of Federal Financial Analytics Inc., a financial services consulting firm. She is the author of "Engine of Inequality: The Fed and the Future of Wealth in America."

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