CBDCs — The good, the bad, the uglyFeb 23, 2023·Alasdair Macleod
There has been much comment over the likelihood that central bank digital currencies will be introduced. I conclude they are unnecessary — a red herring. But it does allow us to discuss their possible relevance to a new Asian super-currency.
Earlier this month, the Bank of England in partnership with the UK Treasury produced a white paper on the subject, which waters down the objectives identified by the Bank for International Settlements considerably. The British proposal is a bad idea because it is pointless and I explain why.
In this article, I describe how a new gold-backed currency can do away with the US dollar for trade settlements and commodity purchases entirely between participating nations in the Russia China axis. Some informed commentary on the topic suggests that a blockchain will be involved, and Sberbank, the Russian state-owned lender has already issued a gold-linked fund designed to be available to the public by being compatible with ethereum. Perhaps it is front-running developments…
The ugly side in our title is found in the BIS’s dystopian proposals, which sees CBDCs as an opportunity to allow central banks to double down on their attempts to manage economic outcomes while restricting personal freedom.
Messing about with fiat currency alternatives such as CBDCs could end up revealing the formers’ fragility. CBDCs will take years to implement in any major currency anyway, during which fiat currencies led by the dollar are likely to fail anyway.
It is not clear what encouraged central banks to think about introducing their own digital currencies, other than possibly a feeling that if they didn’t do something, then private sector money could threaten their monopoly.
Initially, bitcoin was touted as sound money with a hard stop of 21,000,000 coins and proof of ownership recorded on a blockchain. Bitcoin’s strength was to be the opposite of fiat currency weakness, whose expansion is the primary means by which a central bank stimulates an economy. But if central banks think that bitcoin could overturn fiat currencies, they merely exposed their own ignorance about the nature of money and credit.
Bitcoin is not legal money. As opposed to credit where there is a counterparty risk, the only lawful money is gold (and silver for small amounts), usually in coin, acting as an anchor for a gold substitute in the form of credit. Therefore, if bitcoin is to be regarded as money by its users, they must accept that they do not enjoy the protection of the law. In day-to-day transactions this might not matter to the parties involved. After all, they are free to exchange goods or services for anything — in the past family doctors have even been paid by their patients in cigars and whiskey.
Money and credit have a legal status which differs from other forms of property. Some things can only be acquired through legal tender, and bitcoin is not legal tender. But there is a further distinction which kills bitcoin and any copycat cryptocurrency stone dead: when ownership of legal money and credit transfers, it transfers absolutely, but this is not true for bitcoin.
Consider the situation if someone steals your wallet containing banknotes. There is no doubt that the thief has committed a crime. But if he spends the stolen banknotes in a shop, and the shopkeeper was not a party to the theft, then the banknotes become the shopkeeper’s property, and you have no claim against the shopkeeper. This is equally true if you had coins stolen, or the thief transferred credit from your bank account. This happens all the time today, and you may have wondered why your bank cannot recall the funds.
A bank can recall funds if an error has occurred, and the error can be established in reconciliation differences between banks, such as a misposting. If the bank has made a mistake in the management of your deposit account, you may have a claim against the bank, but once funds have left your account the bank usually cannot reclaim them so the bank must bear the loss. But if the bank received valid instructions to transfer funds from your account, then on the transfer there can be no reclaim, even if your account was hacked. The basis was established in Roman law, which differentiated between money and credit in the normal course of banking, and a bank’s legal obligations to items, including money, held in custody. The former being mutuum, in modern accounting being a bank’s balance sheet liability or obligation in favour of the customer. And the latter is a depositum (not to be confused with the term bank deposit), whereby the property in the money remains with the customer.
The difference between mutuum and depositum is not strictly limited to money and credit but extends to some other asset classes which can be transferred. For example, debts can be freely bought and sold, without the debtor’s agreement. After all, this happens when a bank’s customer transfers a bank’s obligation to him to another party by writing a cheque or tapping a debit card on a payment machine.
An interesting case occurred when Richard Cantillon, having acted as a banker, was sued by customers to whom he had loaned funds to acquire shares in John Law’s Mississippi venture. On taking in the shares as collateral, he immediately sold them. Technically, he remained liable for the return of the shares’ value.
But Cantillon collected twice: the first time from the sale of the shares into the market which subsequently collapsed, and the second time when he sued the debtors for repayment of their loans. The Court of Chancery in London decided he was legally entitled to sue because the shares were in bearer form and not numbered, and therefore were not identified specifically as the debtors’ property. In other words, they were classed as mutuum.
But bitcoin does not have the legal status that permitted Cantillon to claim that Mississippi shares were in effect mutuum and taken in onto his balance sheet, and not identifiable as a depositum. With its blockchain, Bitcoin is specifically identified property, just the same as ownership of a painting, or any tangible asset. Its downfall as a currency is that the blockchain identifies it as having been someone else’s property in the past. This may not matter to a current owner. But if the authorities have evidence that your bitcoin was previously stolen, used in money laundering, or purchased with the proceeds of crime, they can trace the bitcoin to you and seize them legally without compensation. Any protestation that they need the wallet key to regain possession counts for nothing: legally they may not be your property and if you refuse to allow access, you will be guilty of obstructing the law.
Obviously, with cryptocurrencies being a relatively new development, this needs further testing in law and confirmation in multiple jurisdictions. But recent actions by various authorities and agencies to perfect recovery appear to be moving in this direction. Clearly, without the protection offered to legal money and credit, bitcoin cannot be used as a settlement medium except for ad hoc transactions.
That is the first point. Even more important perhaps is its unsuitability for use as money, and a misunderstanding of the relationship between money and credit. Ever since Rome’s Twelve Tables setting out the original basis of Roman law dating from about 450BC and at the time when, according to Gaius in his Commentaries (on the Twelve Tables) Roman coins were first introduced, credit rather than coin has provided capital for merchants and businesses.
Credit has always been the principal means of financing ventures and trade. The Phoenicians trading in the Mediterranean and further afield will have needed credit a thousand years before Rome’s Twelve Tables became the basis of Roman law. And when credit became based on money as opposed to an obligation to deliver specific goods in Phoenician times, it required a certainty of value. Being inherently volatile, bitcoin is not suited for this role. And the hard stop on its quantity means that if it was to act as money ubiquitously, the continually increasing purchasing power that would likely ensue would kill off demand for credit based upon it. Fans of bitcoin might argue that that is the point, in which case they merely expose their ignorance of the relevance of credit to all economic development.
Therefore, to the extent that central bankers are worried that bitcoin or other private sector monies pose a threat to their status as controllers of the currency, they are themselves ignorant of their trade. However, the idea of central bank equivalents in their own digital currencies has taken hold. The Bank for International Settlements took it upon itself to coordinate research into CBDCs, for which they have determined two separate roles. The first is when a central bank issues a CBDC purely for domestic circulation. It is presumed that citizens and foreigners, such as tourists, can use a CBDC so long as they are in jurisdiction. But they will become worthless outside the country. The second is collaborative CBDCs, when two or more central banks settle on a CBDC to be used to settle trade between their jurisdictions.
This gives rise to the title of this essay: the good, the bad, and the ugly. The good may come from collaborative efforts to do without the fiat dollar, ensuring cross border trade can continue in the event that the dollar collapses, or if the US continues to weaponise it. The bad is considering the introduction of a CBDC for no good reason. And the ugly is when a CBDC is devised to give the state greater control to manipulate its citizens’ behaviour.
On the information available, it appears likely that under the aegis of both Russia and China, a new currency will be issued for the purpose of replacing the dollar for commodity purchases and cross-border trade. This project centres on the Eurasian Economic Union (EAEU), which is the political vehicle which hosts the committee considering the matter. Already, on 26 December Russia’s state-owned Sberbank issued tokenised gold on the Sber blockchain, having launched its first digital asset some time ago based on factored invoices. Furthermore, having made its blockchain compatible with Ethereum, Sberbank intends to make it widely available to consumers.
Given that Sberbank is state-owned, this project can be regarded as not just licenced by the state (digital financial assets require permission from the Central Bank of Russia) but perhaps as a testbed for the state’s own monetary intentions. And Sergey Glazyev, the senior Russian economist who is leading the EAEU committee clearly sees gold replacing the dollar as the monetary standard for cross-border settlement. In an article for Vedomosti on 27 December (the day after Sberbank announced its gold-linked digital asset), he said as much.[i]
There are other gold related developments in Asia. Notably, this week it transpired that the Central Bank of Iran is in talks with Russia to create a stablecoin backed by gold for settling trade through the Astrakhan special economic zone, through which goods from Europe transit to the Middle East and south Asia.
But when it came to central banks trying to come up with roles for CBDCs, none thought a CBDC would be deployed to facilitate a return to sound money. If they weren’t just trying to fend off private sector currencies, they were thinking up new ways to deploy fiat either to stimulate economic activity selectively, replace bank notes, or exercise greater control over individual users of currency. We do not know if Sergey Glazyev is considering using a CBDC to keep track of a new trade currency, but in the plans outlined below, it is unnecessary. Normal accounting conventions will suffice, and gold will provide the standard.
Glazyev is also the moving light behind a new, enhanced Moscow gold exchange. And now, all the signals are pointing in the direction of cross-border transactions being settled in gold, or gold substitutes. One condition which will need to be in place is for a value for gold measured in fiat currencies to ensure there is sufficient available valued in goods to back inter-Asian trade. Despite the accumulation of gold by the central banks of the Shanghai Cooperation Organisation membership (SCO), some of them may not have sufficient official gold reserves to cover their trade deficits except for limited times, requiring a higher gold value in order to do so. And other members, such as Russia, could see continual accumulation of physical gold because of her net energy and commodity exports. Ideally therefore, instead of trade settlements being entirely in physical gold, they should be facilitated by a banking system based on gold which is properly valued.
What is required is an entirely new currency backed by gold specifically created for cross-border trade. Presumably, this is what Glazyev is trying to achieve. But it is relatively simple and does not require blockchains and the paraphernalia of a CBDC. However, being a revolutionary concept, it might be established as a CBDC to provide extra credibility to satisfy those whose understanding of money and credit falls short.
The bulleted list that follows is a brief outline of how a new trade settlement currency based on gold can be established to replace the fiat dollar in all transactions between member nations. It is designed to be politically acceptable to all involved, as well as a long-term practical solution to facilitate the Russian Chinese axis’s ambitions for an Asian industrial revolution free from interference by America and her allies. The essential elements are as follows:
- The announcement of the creation of a new central bank (NCB) and a new gold-based currency on the lines below will be made in advance of implementation to allow bullion markets to adjust to the new regime before it comes into existence.
- A new central bank is then established, whose function is to issue a new digital currency backed by physical gold, available only to participating central banks. It will be designed to be a fully trusted gold substitute, fully independent of fiat currency values.
- The new currency will only be redeemable for gold by participating central banks. They are also free to add to their NCB currency reserves by submitting additional gold to the NCB at any time.
- The NCB’s eligible participants will be the central banks of participating nations, broadly limited to member nations of the EAEU, SCO, and BRICS+. The NCB’s currency is issued to the national central banks against their provision of a minimum 40% gold backing for it. For example, currency representing one million gold grammes secures an allocation of 2,500,000 currency units denominated in gold grammes. The gold does not have to be delivered to a central storage point but can be earmarked[ii] from within a central bank’s gold reserves, on condition that they are securely stored in Asian vaults on a list approved by the NCB.
- Commercial banks trading in member nations and elsewhere will be free to create and deal in credit denominated in the NCB’s new currency. Issuers and users of this credit are always free to acquire physical gold in the markets, should they wish to back credit created in the new currency with gold itself.
- All taxes and restrictions on gold ownership must be fully rescinded by participating nations.
- An efficient central clearing system for commercial banks dealing in credit based on the new currency will need to be established.
- Accompanied by the major energy producers setting price benchmarks, Asian commodity exchanges will price all products in the new NCB currency, replacing pricing in US dollars completely for trade between participating member nations.
The purpose of the new currency is to provide the basis for trade finance and other cross border financial settlements on a sound money basis. It is also likely to lead to participating nations placing a greater emphasis on their own currencies’ stability while providing a safe haven from a fiat currency system collapse, to which the establishment of gold backing for payment systems is likely to contribute in its consequences.
All empirical experience informs us that when gold becomes the means by which credit is valued, credit’s own value becomes tied to that of gold and is not dependent on stability in credit’s quantity. This stability imparts pricing certainty to trade and investment, necessary conditions for maximising economic development.
Constructed on the lines above, remarkably little physical gold would be required to underwrite cross-border payment values for trade in Asia and beyond. It should be simple and quick to establish. It must be free from interference from members of the western alliance trying to preserve their own fiat currency systems. And the 40% gold backing rhymes with the basic requirement for a metallic monetary standard set by Sir Isaac Newton, when he was Master of the Royal Mint.
For participating central banks, the replacement of gold in their reserves for allocations of the new currency would represent a significant increase in their reserves. As confidence in the scheme builds, it could be argued that only minimal gold reserves need to be retained by participating central banks, with the balance swapped for the new currency. For example, the Reserve Bank of India officially possesses 787.4 tonnes of gold. Converted into the new gold currency, its value in reserves is uplifted to 1,968.5 tonnes equivalent.
One difficulty which will need to be considered is the repatriation of gold held in western central bank vaults. Between the Bank of England and the New York Fed, earmarked gold totals 10,693 tonnes. The bulk of gold held at the NY Fed appears to be earmarked for the IMF, Bundesbank, and Banca D’Italia. Very little Asian gold would appear to be stored there. More Asian gold is likely to be stored at the Bank of England. This could be a concern, because the Bank of England on instructions from the US Government refused to repatriate Venezuela’s gold when requested. If in losing its dollar hegemony the Americans become obstructive to Asian monetary plans, it could become a problem for nations with gold earmarked at the Bank of England.
Presumably, the consequences for gold would be to drive the price up measured in dollars, euros, etc. Foreign central banks in the Asian camp would be selling down currency reserves to acquire gold. Furthermore, it would suit the new central bank to see a higher stable gold price as a starting point, which is the reason to let the market find a level between announcing plans for the NCB and implementing them. And it is worth making the point that if the price of oil adjusted by the price of gold is to be returned to its post war dollar value, the dollar price of gold should be $3,360.
It could be argued that it’s not in China’s interests to undermine the dollar so dramatically, given her dependency on exports to the US and elsewhere. Undoubtedly, while being open about her desire to replace the dollar for cross-border transactions as much as possible, China has preferred to let the change be evolutionary. But the time for caution has ended, and unless China joins in with Russia’s plans, Russia will make all the running.
The bad and the ugly
It should be noted that, to date, there are just two live retail CBDCs (the Sand Dollar in The Bahamas and DCash in the Eastern Caribbean). For a major jurisdiction to introduce a CBDC there are significant bureaucratic and technical issues to be addressed, which inevitably means that lead times are substantial. The first step is to come up with a discussion paper, which is what the Bank of England in conjunction with the UK Treasury did earlier this month.
According to the Bank of England and the Treasury, there are two basic reasons for issuing a digital pound: people are not using cash as much as they used to, with digital payments becoming more common. And “there are new forms of money on the horizon, some of these could pose risks to the UK’s financial stability.”
Let us address these two issues. Digital payments are indeed becoming more common. Credit cards have been around for decades, so there is nothing new there. The Bank is referring to debit cards, which authorise the transfer of a bank’s obligation a customer in accordance with the customer’s instructions. This form of payment has become progressively more efficient, leading to a public choice for paying with debit cards. A separate wallet for a CBDC, as proposed by the Bank, is unnecessary. That leaves us dealing with fear of the unknown — the new forms of money on the horizon, and the risk to financial stability.
This is a straw man fallacy. There is no threat from private sector currencies. As pointed out earlier in this article, they lack the legal status of money and credit, and are entirely unsuitable. But what the bitcoin revolution has done is create a lot of excitement amongst the progressives, who feel a response is necessary. And reading the Britcoin’s consultation paper, we see that the intention is for a CBDC which is limited in its scope compared with some of the ideas coming out of the Bank for International Settlements’ own consultation documents.
The UK’s proposed CBDC will use digital wallets and not require individual bank accounts with the Bank of England. Retail and business accounts at a central bank was one of the BIS’s ideas. But this cuts across the role of commercial banking and faces enormous technological challenges. If the Bank wishes to introduce a CBDC, then private sector wallets make more sense for this reason. They should allow payments to be made between individuals and businesses as if they are made in bank notes, and without these transactions being recorded at the Bank, they should retain their anonymity.
The intention is that there will be no difference between a CBDC pound and a one-pound coin. The consultation paper argues that it is not intended to be a cash replacement, but an additional equivalent of cash payment. A CBDC pound will not earn interest, but there will be a limit on the quantity held in a wallet which is yet to be decided or how it is to be implemented. Implementation rings warning bells with respect to privacy.
But the exercise appears to be pointless. At least in its scope it is not as ugly as some of the objectives coming out of the BIS. In an official video recorded by the BIS, Augustin Carstens, its General Manger, said the following:
“The key difference with a CBDC is that the central bank will have absolute control on the rules and regulations that will determine the use of that expression of central bank liability. And also, we will have the technology to enforce that. Those two issues are extremely important and make a huge difference with respect to what cash is.”
Carstens is describing a system where central banks intrude upon the use of their CBDCs, presumably through requiring individuals and businesses to maintain accounts at or under the control of a central bank, or by central banks having access to individual wallets. Absolute control determining their use is a dystopian vision of the future of currencies.
It seems unlikely that the fullest ambitions for CBDCs revealed by Carstens will find support from commercial bankers, because it treads on their toes. This is important in the US’s political context because commercial banks bankroll congressmen and senators. One can envisage commercial banks supporting a CBDC as proposed by the Bank of England, because it is clearly a supplement to bank notes and not commercial bank credit. However, it is difficult to see how a CBDC-lite model will find much public favour, because current payment systems are so efficient that they are unlikely to be bettered by a CBDC.
There is a risk that tinkering with a fiat monetary system by adopting CBDCs will end up eroding confidence in fiat currencies generally. This outcome may seem unlikely to the planners, but if the Russian Chinese partnership does move towards gold-backed trade settlements, for fiat currencies the retention of public confidence in them should be their highest priority.
In any event, even without the Asian hegemons backing a new trade currency with gold, the western alliance’s fiat currencies face enormous challenges. The days when interest rates could be contained at, below, or marginally above the zero bound are over. Entire banking systems from central banks downwards are threatened with liquidity issues which can only be defrayed by yet more credit expansion, which ends up making things even worse.
The whole CBDC story is a red herring. The plan outlined above for a new Asian trade settlement currency does not require a CBDC. It can be progressed within current banking systems. And as for the time taken to implement CBDCs in the western alliance’s fiat currencies, it is highly likely that they will have collapsed into worthlessness long before CBDCs can be adopted.
[i] For a summary of Glazyev’s Vedomosti article, see https://www.goldmoney.com/research/russia-s-intentions-are-clarifying
[ii] Earmarking is the technical term whereby one central bank acts as custodian for another central bank’s bullion.
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