Quo Vadis: Big Central Bank is Watching You

Green light

Last year, the European Central Bank was given the green light to launch a project around the launch of the ‘digital euro’ in the form of a Central Bank Digital Currency (‘CBDC’), a currency issued in digital form by a central bank. The official intentions around this initiative sound very noble. Europe wants to increase the efficiency of payments and monetary policy, improve financial inclusion and, above all, strengthen the banking system.

The current banking system is indeed intrinsically fragile. To understand this, you need to understand what money actually is and who creates it. Since the invention of the modern banking system in the 17th century, 95% of all money in circulation has been created by commercial banks. This does not involve a money press hidden in the basement. Commercial banks create digital money by granting credits. This magical power consists of a simple accounting trick that only a bank is allowed to perform. It books the new credit on the asset side of its balance sheet and - Huub huub, Bancatrick! - simultaneously credits the borrower's account with an equally large deposit, which is booked on the liability side of its balance sheet. In other words, credits create deposits and not vice versa. Thus, a bank that grants a credit should not draw on its customers' deposits to do so. If credits merely recycled existing deposits, then the money supply could not grow and neither could the economy, which, by the way, is why the economy hardly grew in the entire history of mankind before the 17th century. So, the common idea that banks should ‘put deposits to work’ to support the economy is totally wrong. Banks should put credit to work by literally ‘making loans’. You may not like to read it, but all money is credit. After all, from the customer's point of view, a deposit is a credit to the bank. You may not like to read it either, but the money in your bank account is not ‘public’ money issued by the government. It is private money issued by a commercial bank. Your money (the deposit) is therefore at risk when the bank is at risk.

Annoying habit

Commercial banks have a nasty habit of occasionally teetering on the verge of bankruptcy, but this is inevitably linked to their existential economic role of creating far more money than they have in shareholders’ equity on their balance sheet and because they are structurally illiquid. To solve the latter problem, we created central banks. Central banks can create digital interbank money (called ‘bank reserves’ that can only be used between banks) - through the same accounting trick - to help commercial banks with extra liquidity. Central banks also supervise commercial banks to keep them in line. This system is not perfect, but it is partly behind the huge wealth creation since the 18th century. Unlike the digital money in your bank account, CBDCs are digital public money, i.e. issued by the government, made available directly to citizens and businesses for the first time. Since a central bank cannot fail, this would improve the security of the banking system.

Banknotes and coins make up the remaining 5% of money in circulation (95% is therefore the private money of commercial banks) and are public money, issued by the central bank. CBDCs will become the digital equivalent of banknotes and coins and will be held in ‘digital wallets’ rather than in your physical wallet.

DARK SIDE

In these modern times, anything called digitisation sounds good a priori, but CBDCs have a very dark side. To understand this, we need to understand how a CBDC works in practice. Most CBDCs would use blockchain technology. All transactions would thus be stored in a digital ‘ledger’. A digital ledger can best be compared to a large Excel sheet. But that's where the similarity ends. In the case of a crypto currency, the ledger is public and decentralised. Copies of the ledger are held simultaneously on thousands of computers (‘nodes’) connected to each other via the internet. All network participants can see the ledger but cannot ‘edit’ it. The transactions and ownership are, as it were, forever cemented in the public ledger; no one can manipulate them. However, the ledger behind CBDCs is private in nature, in the sense that only the central bank can see the ledger. Moreover, unlike a public ledger, the central bank can edit the ledger. And this is where things get shady. A citizen with an account at the central bank not only gives access to his entire financial affairs, but also gives a power of attorney on his account to the central bank. In other words, you give up your privacy and put your financial fate in the hands of the central bank. And whoever says central bank might as well say central government. Central banks are supposed to operate independently of the government, but that is very relative. Central bank chairmen are politically appointed. The Federal Reserve chairman is appointed by the POTUS and the ECB chairman by the Council of Europe. The past has also shown more than once that in case of emergency, the government does not hesitate to take power out of the central bank's hands at its convenience. For example, the Federal Reserve was formally placed under the authority of the US Treasury for years out of discord with the Federal Reserve's mishandling of the 1930s depression. The central banks' promise to erect a Chinese wall between the CBDC and the government therefore rings very hollow.

Chinese wall

Central banks may initially launch only interbank CBDCs (‘wholesale CBDCs’, CBDCs that can be used by citizens are called ‘retail CBDCs’ and there is also a hybrid form) and use commercial banks and payment institutions as a partition in the distribution of retail CBDCs, but history shows that in times of crisis, whether they are budgetary in nature or linked to war or climate, the government breaks down every Chinese wall or partition without hesitation. The bottom line is that we are building the infrastructure that can eventually be used by the government to gain absolute control over its citizens. Not surprisingly, China is a forerunner in the realm of CBDCs. As in camera surveillance with facial recognition.

Sancta Barbara

CBDCs may also take the form of programmable money, giving the government seemingly endless policy options. Take a not-so-imaginary example that ties in with current events. In the Netherlands, some, like Rabobank economist Barbara Baarsma, are coquetting with the idea of imposing a maximum CO2 emissions budget on every citizen. The government can then track your spending patterns and corresponding CO2 emissions via your CBDC account. If you then threaten to exceed your CO2 budget, the government can, if it so wishes, debit CO2 levies directly from your account or block some types of expenses, such as the purchase of a plane ticket or a tender steak and brown beans. Barbara Baarsma - to whom the inside of an aeroplane holds no secrets - does not care. Luckily, she envisages making citizens' CO2 emission rights tradable. Those who have little money and cannot travel anyway can then sell their unused CO2 allowances to a more affluent citizen, like Barbara, who can. In her own words, this is a real WIN-WIN: ‘Someone who doesn't want to travel, because they don't have money to do so, for example, they sell emissions rights to me. And therefore gets a bit more money. So, people with a ‘narrow’ (sic) wallet can also earn something from green policies.’ If the government wants to encourage citizens to consume more, it can, for example, programme your money so that a certain amount of money will evaporate if you do not spend it within a certain period or charge a negative interest rate, which amounts to the same thing. It can programme your money so that you cannot buy stuff on certian (foreign) websites and so on. ?

Cash no longer accepted

Those who control all money have total control over society. ‘All’ money is also closer to the truth than you might think. After all, CBDCs threaten to suck all deposits away from the commercial banking system towards the central bank in times of crisis because citizens and corporations then want to move their money to safety. In the most extreme scenario, only one bank remains: the central bank, just like in the past in some communist countries. To go full circle, the government can at the same time abolish cash. It looks like CBDCs, like banknotes, will pay no (positive) interest. This should allow commercial banks to compete with the CBDCS at the central bank via offering interest on customer deposits, but there are also other motives at play. After all, a CBDC without an interest rate is, like a bank note, a free loan from the citizen to the government.

Experiment

The ECB and China's central bank are not alone in their interest in CBDCs. No fewer than 134 countries, including all G20 members, are experimenting with CBDCs. Together, they account for 98% of global GDP. Three countries have launched a CBDC (Bahamas, Jamaica and Nigeria), 44 countries are in pilot phase and 20 in development phase:

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?Pandora's Digibox

In the United States, like almost everything else, CBDCs are the subject of intense political controversy. On the initiative of Senator Ted Cruz, a Republican of course, a bill known as the ‘CBDC Anti-Surveillance State Act’ was introduced in May this year. This bill seeks to amend the Federal Reserve Act - which regulates the activities of the US central bank - to prohibit the Federal Reserve from offering products and services to individual citizens, from holding accounts for individual citizens and from launching CBDCs. Some see the lack of a US CBDC as a threat to the international status of the dollar, but they could be wrong. If other countries adopt CBDCs, the dollar's attractiveness as a safe haven will only increase. And if desired, in a new form of private-public cooperation, the US can promote so-called ‘stablecoins’ (a type of crypto coins like Tether) backed by dollars as an alternative to CBDCs. And the US would not be alone in their aversion to retail CBDCs. Canada and Australia, for instance, have recently pulled their tails around the launch of retail CBDCs. In Europe, we look smugly at American political wrangling and polarisation, but CBDCs deserve public debate. CBDCs are the Trojan horse of the European Superstate in the making, wrapped in Pandora's digibox. If CBDCs are not managed properly, they create a potentially dystopian future. A future with no privacy, no freedom and no commercial banks. And it is sad to see that there is not a glimmer of public attention to this important issue in the Old Continent.

Jan Longeval, November 2024

Kounselor Consulting (www.kounselor.be)

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