March 14, 2023

Digital Pounds - Part 2: The Case For Innovation

Why We Need Public Money 

The paper is strongest when arguing that there needs to be some form of public money in circulation. Put simply, the state monopoly over issuing currency is non-negotiable. This authority allows the government to borrow risk free and, through monetary policy, respond to economic shocks. Official currency conversions, with the exception of joining the Eurozone, are rare. However, the effective switch amongst individuals to a foreign currency is all too common — often referred to as dollarisation as the USD is invariably the alternative. In many Latin American countries dollar bills circulate as freely as local tender whilst governments, losing the confidence of financial markets, are forced to borrow in hard currencies. For these countries both benefits of a domestic currency are lost. 

Whilst the paper acknowledges that such a switch is unlikely in the UK, the rise of digital currencies which are more convenient and adaptable increases the risk of the pound being replaced, whether by a digital dollar or a store of value not issued by any state entity, like Bitcoin or Ether. Such a threat to the UK, is intolerable. The Digital Pound, in providing many of the same benefits, would head off this threat. 

The need for the public to feel that their pounds are state backed is also critical. Nobody questions the value of their bank accounts because the balances are convertible between account providers into physical cash, which both is and feels safe. All pounds, whether public or private, are near enough equivalent. This is not always the case, however. In the Eurozone crisis, insolvency fears at Italian and Greek banks made a Euro in some banks less desirable than an equivalent value deposit at a German firm. Furthermore, a Euro at a failing bank is never going to be worth more than one in a strong institution, so why not switch just in case — whilst you still can. Unlike in Europe, all UK banks are backed by the same central bank guarantee, as well as the FSCS, which all but avoids these risks. However, in a world where all circulating money was private, and not necessarily convertible to a government issued form, the risk of divergence between different private pounds grows. Is £10 in a current account worth as much as in a bank note? What about on a corporate gift card? Or as a stable coin? They are only equally valuable until they are not. Once again, this would provide an intolerable threat to UK financial stability and the Digital Pound seemingly heads these off by maintaining a government issued currency which everything else would be pegged to. 

Innovation

Finally comes the case from innovation, the outline of which could well be copied several other recent government proposals. All new policies, it seems, will lead to innovation and growth so long as you are not too precise about how. The strongest version of this argument runs something like this: the current payments infrastructure is run by an oligopoly (Visa and Mastercard foremost among them) who do the hard work of integrating with myriad banks, card providers and other financial services and, in return, extract a rent of several hundreds of million pounds. Stripe has made a fortune disrupting some of these incumbents, but they remain powerful. A CBDC would provide a single endpoint which could be accessible in an open manner to provide financial services. New and existing firms alike could circumvent existing barriers to entry and growth will result. 

There are plenty of examples of government platforms leading to innovation which was not imagined at the outset: GPS, real time public transport data and even roads make strong cases. The argument is similar here; a fair, stable and open platform will let others build. Our currency is a critical public good, and so a platform should be built for it that is suitable for the digital age. 

Given the apparent preferences of the authors, these arguments are well made, albeit at times rather hidden through the text. In contrast, the major pitfalls posed by such a scheme are scarcely mentioned. Below, I discuss four of them. 

This is Part 2 of a submission in response to HMT’s and BoE’s public consultation. To continue reading Part 3 click here. The further parts are available here.

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