It seems the Federal Reserve (Fed) and the European Central Bank (ECB) have decided to follow the lead set by the Peoples Bank of China (PBOC). They aim to develop digital currencies. Media outlets have given these moves a lot of attention, as they did a little over a year ago when China announced the launch of its digital yuan. For all the fanfare, such currencies will develop neither as fast nor as easily as much reporting suggests. Nor are they as revolutionary. Before the Fed or the ECB can go ahead, they will need to answer a number of complex questions on matters of privacy, for instance, and more fundamentally how their economies will allocate financial capital for growth. Matters are much more complex than they seem on the surface.
On the surface, an American or European digital currency hardly seems necessary. After all, people in the developed world certainly have no lack of digital means to get paid and to make payments. Most are paid through direct deposit. Tax refunds arrive that way, too. Tax payments and many other transactions occur through automatic withdrawals from bank accounts. Meanwhile, credit cards, debit cards, Apple watches, PayPal, and a long list of comparable arrangements allow people to transact digitally. Through ATMs, people can use a digital device to get paper currency just about anywhere in the world. Even if central banks were to refuse to develop digital currency, most people would have little trouble adjusting if coins and bills disappeared entirely tomorrow. To be sure, the arrangements would not be with a government or a central bank, but they would be as convenient for the general population as a digital currency.
If the introduction of a digital dollar by the Fed or a digital euro by the ECB offers the residents of their respective jurisdictions little more than they already have in abundance, it is fair to ask why these central banks look to develop digital currency at all. The answer lies in the same place that has motivated the PBOC: surveillance. If all payments run through the central bank, the government will know every person’s income as well as where he or she spends it and on what. Government will also know when each transaction occurs, and in real time. Especially if the system managed to abolish coin and currency, few transactions could occur anonymously. The authorities would have much less trouble ferreting out tax fraud or money laundering. They would in short have a much easier time tracking everyone for any purpose. The dubious people who want to engage in fraud and the like, or remain anonymous on principle, would still have Bitcoin and other cyber currencies to provide services much more convenient than suitcases full of $100 bills, if, that is, such currency remains available.
As should already be clear, privacy is of concern. To be sure, privacy is an issue with credit and debit cards as well as all other electronic transactions. But as yet that information is not centralized in a government computer, as it would be with a digital currency. The government can, of course, access transaction information through banks, PayPal, and the like, but now it needs a subpoena to do so, a route that is more time consuming and less certain than simply accessing a record that already exists in the government’s system. The question of privacy has even come up with China’s digital yuan, and the PBOC has responded with what it calls “controllable anonymity.” That promise of privacy, however, only protects people against intrusions from other individuals and businesses. The PBOC still has access to all, which, of course, is what China’s authoritarian state wants most of its digital currency.
Then there is the question of equity. Underprivileged people do not necessarily own the smart phones, Apple watches, and other devices needed to use a digital currency. Especially if the new system were to replace bills and coins, these people would find themselves at a distinct disadvantage to others. It would also be unconscionably expensive to give such equipment. Perhaps a solution would use a chip card that could access a digital account at the the Fed, where people’s pay and/or public assistance could be channeled. While such a system might promise to solve the technical problem, it would also stigmatize those using the card.
At a more fundamental economic level lies the question of the economy’s allocation of capital. At present, this occurs through the banking system and financial markets. Those involved lend and otherwise direct financial resources to new projects that offer the best return at the least risk. In this way, the present channels resources to the projects that also offer the greatest prospect of promoting secure economic growth. To be sure, these arrangements occasionally make egregious mistakes, but the general consensus is that having literally tens of thousands of people independently making such decisions produces the most efficient and effective allocation of capital. Because a digital currency would obviate the need for many checking accounts, it would transfer to the Fed a good part of resources in today’s system, especially from the smaller regional banks that are the primary lender to small business. The Fed, of course, would then have the means to make these loans, but the decision making on where the funds go would become much more concentrated than it presently is. The Fed would have a hard time equaling the efficacy of today’s diverse approach, especially since, under government pressure, it would tend to respond more to political interests than to economic considerations.
There is every reason to expect that future years will see a greater move toward digital currencies in the United States and in the developed West generally. Given the questions and doubts that accompany such developments, it seems likely that the digital answer will develop as something parallel to coins and bills rather than as an absolute substitute.