The guest commentary below was written by written by Daniel Lacalle. This piece does not necessarily reflect the opinions of Hedgeye.
In recent weeks Jerome Powell at the Federal Reserve and Christine Lagarde at the European Central Bank have commented on the likelihood of implementing digital currencies in the next years.
The positives have been well explained. More transparency, ease of use and lower cost.
The European Central Bank has stated that “a digital euro would guarantee that citizens in the euro area can maintain costless access to a simple, universally accepted, safe and trusted means of payment.
The digital euro would still be a euro: like banknotes but digital. It would be an electronic form of money issued by the Eurosystem (the ECB and national central banks) and accessible to all citizens and firms. A digital euro would not replace cash, but rather complement it. The Eurosystem will continue to ensure that you have access to euro cash across the euro area.
A digital euro would give you an additional choice about how to pay and make it easier to do so, contributing to financial inclusion alongside cash”.
In the United States, many voices call for a digital dollar to compete with China’s yuan. However, the US dollar is already the world reserve currency, it is used in more than 80% of global transactions while the yuan is used in less than 4%, according to the Bank of International Settlements (the total is 200% as each transaction involves two currencies), and most payments and transfers are already electronic. The euro is the second most used currency and is also mostly through electronic transfers. One can say that the US Dollar and the euro are already “digital”.
All this sounds good. So, why should we worry about a central bank “digital currency”?
There are important risk factors to consider.
The first one is privacy. The central bank would control almost all transactions in a currency and have all the information of how deposits and savings are kept. The gradual implementation of the central bank digital currency would involve important risks of privacy but also concerns about the central bank controlling the amount of savings and their form. A central bank that controls all transactions and how savings are kept is also able to act against those savings by “dissolving” them with monetary policy.
The most important risk of a digital currency is that it would provide unlimited power to central banks to increase the money supply and direct it where governments want it.
The digital currency would eliminate the banks as intermediaries in the transmission mechanism of monetary policy. These “brakes” are and have been essential to contain inflation and excessive government control of money creation. In quantitative easing the credit system works as a tool to prevent the inflationary pressures of money supply.
When central banks increase their balance sheet it does not immediately translate to inflation because we, citizens, and businesses, limit the money supply risk of destroying purchasing power of the currency by taking less credit than the increase in money supply. If citizens and businesses do not demand more credit, the transmission mechanism of monetary policy has enough back-stops that prevent excess of money from creating massive inflationary pressures in goods and services.
Yes, quantitative easing does generate massive inflation in asset prices by making the most secure asset -sovereign bonds- very expensive, but it certainly works well as a brake on inflationary risks. Governments are also limited in their borrowing desires by their budgets and internal financial controls.
Money creation is never neutral, and disproportionately benefits the first recipients of new money created, governments, while hurting massively the last recipients, savers and real wages.
The digital currency would not only open the flood gates of much higher money supply growth, but destroy all the mechanisms that prevent new money from being absorbed entirely by political spending and eroding the purchasing power of salaries and wages. In essence, a central bank digital currency can be the dream of a central planner as the ultimate tool for the expropriation of wealth and taking control of an economy to put it entirely in the hands of governments.
A digital currency could open the risk of eliminating all controls on government spending, as politicians would be the first recipients of all newly created money and able to do so without budget control. As such, a digital currency could be a dangerous tool used for the nationalization of the economy
When banks and the credit mechanism are erased from the transmission of monetary policy, the risk of inflation and destruction of the purchasing power of the currency rises massively. It would eliminate the demand part of the credit mechanism as a brake on inflation.
The reader may think that the above is too negative and that this would not necessarily happen. However, the reader must think of the following question: If governments are given a tool that allows them to spend all they want and take control of the economy, do you really believe they will not use it?
The reader may say that central banks are independent, and that this independence prevents governments from crowding out all money supply and take unlimited risk. Unfortunately, the independence of central banks is increasingly questioned, and monetary policy has gone from being a tool to help make structural reforms to a tool to avoid them.
The fact that central banks are almost in all occasions taking actions to facilitate more crowding out of the public sector and more government control and spending does not help either.
A digital currency can only be a good idea if central banks had no power in the increase of money supply, if they had clear and unbreakable rules -such as a Taylor rule- regarding their policy, and discretionary measures were impossible. Keep dreaming.
The only way in which a digital currency would work for savers and real wages is if there was clear evidence that it would not be controlled by central banks, curbing the ever-increasing government control of the economy. Unfortunately, that is not the case. When neo-Keynesians talk about “innovation” in central banking and digital currency what they are talking is simply Argentina-style money printing to advance government control of the economy.
A central bank digital currency would eliminate all the remaining limits to government control of the economy.
The risks of a digital currency is enormous. Privacy could disappear and the limits to government spending would be eliminated. Even worse, the power of governments to decide who and why receives new tokens of this money would be unchallenged.
In today’s world, we should not even discuss any tool that can open the gate of giving even more power and control of the economy, wages, and savings to governments.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor note by economist Daniel Lacalle. He previously worked at PIMCO and was a portfolio manager at Ecofin Global Oil & Gas Fund and Citadel. Lacalle is CIO of Tressis Gestion and author of Life In The Financial Markets, The Energy World Is Flat and the most recent Escape from the Central Bank Trap. This piece does not necessarily reflect the opinions of Hedgeye.
