Mark Carney’s Trojan Unicorn — Are Central Banks Considering Stealth Nationalization in Sovereign Digital Currencies?

Naked Capitalism | Clive | Oct 1, 2019

digital currencies and sovereignty - Mark Carney’s Trojan Unicorn — Are Central Banks Considering Stealth Nationalization in Sovereign Digital Currencies?Whether or not the purported explanation that the plot and characters of Wizard of Oz being an allegory for the Federal Reserve and the Gold Standard is correct, for anyone in finance the notion that central banks operate on a basis of smoke and mirrors certainly rings true. It’s not only that it’s all smoke and mirrors with the central banks. It’s that behind the smoke and mirrors, there’s just more smoke and mirrors. Usually, clues surface when central banks start opining on something that is so fundamentally a bad idea that it really ought to be left to shuffle off into a dark corner and die a quiet, unmourned, death. Something like sovereign digital currencies, for example.

The FT has been trying (more on this later) to work out what central bank governors, like the Bank of England’s Mark Carney, meant when he came down from Mount Parnassus, to tell us all how central banks and governments will increasingly be required to consider the move to a digital reserve currency in a “multi polar world”.

Carney was, here, entirely correct in principle. The US manages the US dollar primarily for the US’ interests. Certainly in terms of interest rates, the US Federal Reserve takes the needs of the US economy — as it perceives them — as the basis for how it operates monetary policy and who can use the US dollar, for what purposes. Reading between Carney’s lines, you can also intuit a political frustration that, on more than one occasion, the US will also operate the US dollar in pursuit of US geopolitical policy objectives. Even at some economic cost — and not just to the rest of the world, but potentially to the US itself, too. Carney didn’t mention in his speech about another problem, which is how central banks end up having to step in to support the commercial banks in times of financial stress — the FT spotted this angle, we’ll return to this more fully below.

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But firstly – and most importantly – whether a sovereign digital currency ever gets implemented is ultimately going to be a political choice. It is a political – not something that is subject to any economic or technical constraints or influences – decision, if The Powers That Be did decide to introduce a sovereign digital currency. We would have to ask ourselves why it was they made that choice to solve the problems they are confronted with, rather than an equally valid (and considerably simpler) alternative, which was nationalisation of the existing system.

Apart from hard-line free-market ideology, there is another, more subtle, impediment to any ideas about the implicit nationalisation of the payment system through a government-backed digital currency, which the banks could only access through an interface the central banks would have to provide to the currency’s (presumable) distributed ledger. Note that this is a key element of the digital sovereign currency idea – and why a digital sovereign currency would be defacto nationalisation of the payment system.

Today, it is the commercial banks which control their individual ledgers which when taken in aggregate form what is in effect a single distributed ledger. They – and add-on’s like the credit card schemes and interlopers such as PayPal – then create bespoke competing and overlapping interfaces. A digital sovereign currency could only have one distributed ledger (which the central bank would maintain) and one interface to it (which again, the central bank would specify and control).

But given that this would entail the central banks and governments taking a far more hands-on role in the provision of what are currently operated solely on a strictly private-sector commercial basis, like money transmission services – a role they are determinedly eschewing — how will the cakeism inherent in what is being mooted be resolved? If central banks — and, by proxy, governments – want to be in control, they’ll need to be willing to to shoulder responsibilities of operating, monitoring and controlling any digital sovereign currency. Responsibilities which they can presently and often conveniently shirk through a “because markets” shrug of the shoulder.

See:  Canada’s Central Bank Issues White Paper on Government-Backed Digital Currency

If the system were to be in effect nationalised by migration to a digital sovereign currency, then governments would provide – in response to public, or consumer, demand — the services which societies needed. This would be on a utility basis — there’d be no drive for marketing and adding special bells and whistles onto what would be a generic, core, product of sending money from person (or business) A to person (or business) B. But much of the complexity in the current payments ecosystem is artificial, driven by needless product differentiation. Bank accounts which will clear checks for value on paying-in (rather than having to wait for them to pass to the issuer bank and get a confirmation that the check wasn’t bad). “Instant” transmission of funds whereby there’s no time-lag between, say, using your Debit card in a store and the store getting your money into its account. Some of this was driven by a call, legitimate at the time, to avoid banks being able to profit on the funds held up while payments were being cleared.

But that was only a true statement in the days of high positive returns on cash (or positive liquidity). Now holding cash – having a positive balance in funds awaiting release through clearing — can be a cost to the banks.

We can forgive, then, the Financial Times for doing its part in keeping a flame burning under the meagre gruel being cooked up by purveyors of digital currencies, such as Facebook’s Libra, because the central banks have not stopped muttering on about it for months. The FT does its best in their article to puzzle out why central banks are even entertaining the possibility of implementing a digital currency. To be fair, if you read the piece closely, you can see that it expands on a key difference between something like, say, Libra – which is entirely a private sector owned and operated system – and a sovereign digital currency which would be, notionally, run in the public interest by governments.

I think the FT’s writer stumbled across the truth of the matter, but didn’t realise it. Certainly, they could have simply printed their last paragraph and be done with it. It’s the only thing that tells us what’s going on here, in the entire article. Because the FT stopped at that point – just where it was getting interesting — rather than using that as their introduction, we’ll need to pick up that baton from there and explain what’s really afoot.

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To understand what’s piqued central banks’ interest in digital currencies, we need to remind ourselves about a feature of the banking system which is hidden in plain sight. If, as a suggestion, you decide to make a donation to the Naked Capitalism fundraiser and you, wisely, don’t want to risk putting cash in the mail, you can use the PayPal option or post a check. These are money transmission, or remittance, products. They move money from the sender of the funds to the recipient of them.

But what happens in the – highly likely – event that several different financial institutions are involved in the flow-of-funds chain? To return to the fundraiser donation example, unless you and Yves have the same bank, there’s your bank (the one which maintains your account) and Yves bank (where her account is held). And that’s just the most straightforward of scenarios. If I send a donation, there’s my bank in London (HSBC in my case), HSBC’s office overseas (in NY), a currency conversion from £ to $ (potentially done via HSBC’s NY branch and the NY Fed, should HSBC need to access a fresh supply of dollars for the dollar clearing) then finally Yves’ bank as she doesn’t have a bank account with HSBC.

In normal circumstances, none of this is a problem. The central bank which looks after UK banks (the Bank of England) is happy to provide HSBC in London with whatever GBP (£) liquidity it needs to send the money to its NY branch, the NY Fed is happy to let HSBC’s NY branch have whatever USD ($) liquidity it needs to convert the GBPs to USDs and then the regional fed which supervises Yves bank is happy to let Yves have her money knowing that it can get it back from HSBC in NY.

But in times of financial stress, especially systemic ones like those which occurred in the Global Financial Crisis (GFC) 10 years ago? It was in those circumstances where the (unwitting) generosity of the central banks to support all that nice “provision of industry and payment services” came back to bite them on the bum. By making all those $’s and £’s (and other currencies, like ¥ from the Bank of Japan, or € from the European Central Bank) available on demand (subject to the proffering of high quality collateral, or what was supposed to be high quality), the central banks prop up the whole show. This is known in the industry as intraday liquidity.

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To say that the central banks are vexed by this shotgun marriage between public funds and private capital is an understatement. Since the GFC — so we are talking a decade or more now — central banks have been ruminating over how to extricate themselves from this role — while at the same time save the money transmission system from complete collapse in times of upheaval.

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