Good intentions and digital currencies

| February 17th, 2022

Is a Northern Rock lurking below the surface?

Why I think that not only Central Bankers WILL push hard for CBDC, but also why their coy pretending that “we won’t access data” or “we’ll protect people’s right to use their money as they please”  as matters stand now  looks like pure hogwash.

Central Bank Digital Currencies, or CBDC for short, are  a liability of the sovereign, quite similar in their main characteristics to physical cash, as stated by the Federal reserve on their Website:

There are significant differences though, that would be some kind of “sovereign bitcoin”,  which aren’t readily apparent from a cursory reading.

Physical cash,  as the name implies, is something that has to be transferred physically between two parties, leaving no trace of who the previous owners were or of the actual transaction. In that, it is quite different from any kind of digital money extant or coming, since a “fully physical” digital money would incur the same problems: counterparties would have to meet in order to exchange whatever physical container of the digital cash was, since it is safe to assume that whatever long distance electronic mean  of transmitting said money is either compromised now, or it will be.  “Carta canta e villan dorme”, says an Italian proverb.

There is another characteristic which proponents of the “cashless” and/or CBDC approach usually state that I find quite questionable: at times, I hear it said that “the cost to the system of supporting physical cash is quite high”. That might be true in the abstract, but once I am out of the ATM machine booth, the physical cash can (and will) change hands a number of times at a zero transaction cost before going back on an electronic platform, be it a bank account or a credit card etc.  To say that a cashless society incurs less costs (and risks) than a society using it in quantity, like Germany or the US, without pointing that out requires a disregard for thorough analysis, or an axe to  grind, or both. Moreover, as stated above, privacy  in that case is gone and doesn’t come back, to the extent that my Italian bank reports individual credit card transactions on my bank statement instead of massing them as “card payment” and reporting them separately.  That also means that I have a bank that has tried to sell me bycicles, computers, phones, you name it.

So, should anyone think that “serious” players in the Crypto money space should use the internet to transfer bitcoins, queue up over there, I have a number of bridges to sell you. Well, NFTs of one bridge, but let’s not quibble over trifles.

Actually one of the reasons of the movements in the Bitcoin price space has nothing to do with any pretense of secrecy. The original white paper authored allegedly by a Satoshi Nakamoto  is clear in that it states “In this paper, we propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions.” That implies that every bitcoin must “contain” the ENTIRE history of the various exchanges it has been a party of, and that being connected is a condition sine qua non for any transaction. No more sidling up to someone on a sailing ship in mid Atlantic saying “may I have a cig, I will pay you.”

Yet, one of the charachteristics of the Bitcoin is that supply has an upper limit, hence it is even LESS flexible going forward than Gold was in the old system. So, if it’s not a  currency whose total issuance can be increased or decreased at will, and it’s not in bearer form, my question is… why?

One of the issues has been acutely and painfully evidenced in these past few days in Canada.  Canada’s Premier, Justin Trudeau, has announced he would declare the establishment of war emergency power in order to stop the trucker protests and blocks across highways and bridges. But relevant to this article is the fact that he plans to put Crowdfunding and Bitcoin platforms under legislation mandating that all those platforms be put under Canadian financial regulatory authority, report all “large and suspicious transactions” and  refuse according to their own suspicion to provide services, without any judiciary or government input, safe in the knowledge that the government has endorsed that they won’t incur civil liabilities for any action. Now, limiting the thoughts to the subject matter, this means that no, Virginia, “digital currencies” are not a surrogate of physical cash, which obviously could not and would not be stopped unless something is done directly to the various holders. These are at best a surrogate of credit card transactions, since they share with them one main characteristics: no transaction is valid if only the two counterparties are involved, necessarily  the transaction must be authorised / disseminated. Your privacy is NOT the same as it is with hard  physical cash, and neither is your money really yours, as Trudeau vividly showed the world (that is, the parts of the world where the media duly disseminated both the news and its implications). You don’t toe the party line, someone else will toe it for you, with what you mistakenly thought was your money all along.

Yet, that is neither good nor bad by itself: modern society has digested that there are transactions that are really possible ony if this freedom and privacy sacrifice is voluntarily entered – think Credit cards, bank transfers etc. So, given that the above would tell that central banks have no interest one way or another in  introducing yet another payment procedure, why are all of them fervently working on introducing one of their own?

If anything, as the Swedes periodically tell each citizen with a state published brochure, in case of any significant crisis, it’s a personal reserve of physical cash which might save the day, NOT CBDC, as indicated on page 11 of said brochure: “Cash in small denomination” is a must even in one of the most cash free economies in the world.

Let’s examine the BoE position as  Dario Perkins suggested, and let’s say that they actually mean what they say, especially since in the foreword they state “We do this by issuing money in the form of banknotes and central bank reserves. We ensure the safety of the other main form of money used in any modern economy – bank deposits held by households and businesses, also known as ‘commercial bank money’ “.

Let’s disregard  for now the differing opinions on “safety” as in “banks don’t go bust so much that even deposits get bailed in” as opposed to “As a depositor, the bank or payment processor will duly follow whatever instruction I  give him provided that it is legal, without question or breach of privacy, unless a relevant Court orders otherwise after having duly followed a process that has informed me of the fact”.

Why should central bankers actually want to issue a Central Bank Digital Currency, in short CBDC ?? Obviously not for “electronic payment” purposes, this is not the Middle Ages. You can barely find a card holder with less than six slots on Amazon. And I want to expand on the “Middle Ages” concept a bit, if I may, since it’s NOT  the first time that monetary authorities have SUCCESSFULLY transitioned the international monetary system from an open market, self regulating system to one that was more amenable to the Sovereign need, but few people have thought about it.

For that it’s necessary to remember that for millennia, we had a metallic monetary system under various guises, gold, gold /silver/copper and the like. That itself was an improvement on a simple accounting system in which barter was used, and which practically gave us the modern accounting, language, and poetry. After humanity switched to a metal standard, for all intent and purposes we had ONE or two currencies for millennia: from the depths of ancient myth like that of the Argonauts, up until States transitioned fully from gold convertibility to paper money. Pat O’Brian, the writer of the “Master and Commander” series of books and a serious researcher of the Napoleonic period, has an interesting passage in which a treasure conquered by the protagonists is publicly counted on the ship and of the various, FUNGIBLE types of gold coins still current at times that are not so far from us. Where I live, there are still majestic bank branches which in bronze letters on the facade report “Cambio – Exchange – Wechsel”, and money changers were still a business in the 70ies.

From that, we transitioned to a new and more restricted era of “coin of the realm”, in which one of the very few authentic “fintech” moments happened: within a political border, only ONE currency was officially in use instead of ALL of them at the same time. Imagine whispering in Anti Money Laundering authorities of today that yes, they can limit cash transactions to 1.000 Euros (today’s limit for Italian residents) , but every other currencies can be freely used with no one being the wiser.

So we had the first big limitation for citizens, which is “each nation has its own currency”. After that, we started to have more and more stringent limits on cash payments, and now we are staring at full “Electronic currency”, which is the new governments’ wet dream. But why do that?

All western banks offer ( in a rather pushy way, I might add) credit cards, Debit cards, electronic payments et cetera. In part they are egged on by governments craving tax compliance, but anyway the offshoot is that you already have tracing on every electronic payment.

So why should central bankers not say clearly that “digital currency” is already there? because there is IMHO one difference between CBDC, “normal” electronic payments and physical cash, which is quite different from the possibility for authorities not only to trace all transactions, but to limit those ex-ante, a threat never experienced by any previous civilization in the world, not even in Communist countries at their heyday.

That involves one of the dark wraiths of the recent past: Bank defaults.

In 2015, during the implementation of the Bank Recovery and Resolution Directive, a number of banking crisis damages were offloaded here to final savers, direct subordinated bond holders, and especially in Italy that was a significant item of news. Yet, that abhorrent piece of legislation is  only  a two-trick pony, even if that fact is not readily apparent. 

The first is when you retroactively “tax” subordinated bondholder without putting the banks into liquidation. I know , that’s what the BRRD is meant to avoid, but the kind of legal shenanigans that happened in Italy would set anyone’s nose hair on fire, to the point that a passing reference had been uttered by Banca d’Italia during a parliamentary hearing , see page 12: “  On the other hand regarding the aforementioned desired consequences, a bail-in may intensify – instead of smooth – the risks of systemic instability provoked by the crisis of individual banks. It could undermine trust, which is the basis of banking activity; end up in a mere cost transfer of the crisis from the bigger arena of taxpayers to a cathegory of subject no less deserving of protection – small savers, pensioners – who directly or indirectly have invested in bank instruments.” [translation and Bold added by me].

Those words, spoken by Carmelo Barbagallo, then heading banking supervision, have been remarkably prescient: while in fact now in Italy individuals are to all intent and purposes are banned from directly buying and owning banking subordinated instruments (thay are fully entrusted to buy  as many bank equities they want  of course), They are no less exposed as a category than they were at the time, they are merely paying an additional yearly fee to whatever money  manager is exposing them to those same instruments. Hence my saying a TWO-trick pony: trick one was changing the rules on the fly ( and on a Sunday, no less), trick two would be undergoing a bail-in now of any bank: final savers would STILL lose money, but less per individual given the wider dispersion inherent in pooled money, but there would still be risks on the senior bonds, and of course on bank deposits.

Here is where CBDC comes in: the BRRD did away with the coupling between government and bank liabilities known as “Doom Loop”, which the vast majorities of pundits said was a weakness while I even at the time thought it was a FEATURE of the banking architecture that would give more latitude to banks and authorities to smooth over a bank restructuring, keeping sacred the objective of maintaining said bank in continuing operations. Yet, the link hasn’t been completely severed due to the deposit guarantees that governments have enshrined into law, amounting now to 100.000 EUR per bank per depositor.

So imagine a scheme like this: in a central bank owned ledger,  each EU saver would be authorised to hold through banks  up to 100.000 EUR (or less) in Central Bank Digital Currency, a solely electronic currency which would be irrevocably guaranteed by governments through central Banks, and immediately transferrable in case of a fail of the institution where the individual had held said amount. BUT, any and all other guarantees would not have legal recourse to any government financial help. Of course, while those CBDC denominated reserves would NOT be transferrable between individuals, in order to “maintain a stable financing of economic activities by the banking sector” they would have a NEGATIVE yield (apparently the word “cost” has been removed from the dictionaries issued to central bankers). Do you see the elegance?

Of course that would work best in Europe (where negative rates have been enshrined into law and custom) than in the US, which by law and design hasn’t seen or envisaged going below freezing (for you American heathens, 0° Celsius is freezing point. Farhaneit was a dope).

For one, money held through pooled investment would be told to go pound sand. That’s not different from now but people are kept unaware of that, they are such children anyway.

Second, in this zero interest era, there ARE affluent people who still get a good protection by the government by holding cash in different banks. Since today the 100k guarantee is “per bank”, five banks not belonging to the same group afford you an half a million backstop. In the new system, not only that falls to 100k, but it has a running cost.

Also, Central Bankers could justify that fact under a macro prudential framework: the difference between their set price negative interest rate and whatever interest banks either ASKED or paid to clients on cash balances would be a good indicator of their financial health assessment by depositors. And I put ASKED in capital since there would be another  hidden gift to banks: they are now finding problems in imposing negative rates on balances and/or flogging competitors into line thereby losing deposits when they try, but if the Central Banks makes every saver experience “negative rates”, then  they are destroying that psycological barrier for you. Also, while now even in the EU negative rates are hard to push lower, in that system it would only take an overzealous politician to forbid paper money altogether, and then the Marianas trench is the lower limit. Yet…

Politicians would then ask for their pound of flesh. Like #ESG has been a price paid by central banks to the political masters, total ex ante control of any spending by individuals would in my opinion only be a matter of time. Control infrastructure is a one-way route, like a nuclear bomb: once the first is set off, that genie will not go back in his bottle no matter how hard people try. Then, all the other objections to CBDC would come forth: no economic freedom, hence less growth, hence lax central bank policy to compensate, hence even more negative rates (which is a tax on wealth) until that turns into a social problem that might turn into a state control of an unruly population problem, hence deplatforming/debanking of the unwashed trying to oppose that fact.

But there are more immediate problems, thanks to the rash decision by Canadian authorities:  protestation of  pledges to maintain the right to own physical cash ring hollow now that a government claimed war emergency powers in order to deprive political opposition of any savings they had. Add the “Modi maneuver” to the mix, where a standing government could render existing banknotes it had issued worthless overnight, and the eyes of the shrewder observers move immediately from Canada to… The United States of America. That’s because the obvious answer to an inchoate domineering government closing the vise on citizens is not only capital flight, but removing cash from domestic banks…. demanding to be paid in USD denominated cash. If that happens, of course that wouldn’t make the USD legal tender in Canada, but it WOULD negate the power of the central bank to “devalue” to zero only the opponents, leaving the supporters of the established order unscathed.

Some inkling may already be appearing, with five big Canadian banks reporting a surge in outages since the news came out.

So, thanks to Canada, the central banks of the WORLD, and especially the Federal Reserve, are at a crossroad: they were established to protect the very concept of money, which is so elusive that if you ask and hundred very smart people of business, politics or philosophy, you would get a hundred different answers. If they get drawn into use that concept for political purpose ( and my personal opinion is that their involvment with “climate change green financing” has already been a huge mistake), they risk debasing ALL currencies and ALL banking systems at the same time, in a cascading failure with incalculable risks.

For  a political assesment of that, I asked my friend Albert Marko, my go-to source on the internal workings of US politics, about the fact that Republicans abstained from confirming officially Jay Powell as FED chair, a place he now holds pro tempore with full power, but still waiting for what he agrees will be a certain confirmation:

GOP vs Biden Fed nominees

The GOP has been recently emboldened to hold up Fed nominees by Biden. Most will look at Powell which is obviously the biggest name on the Senate confirmation list, however, the biggest problem Democrats have is getting their people into more operational positions at the Fed to enact progressive policies under the Fed charter. Namely, Lisa Cook and Sarah Bloom Raskin. The Republicans led by Rubio understand that this is a pressure point that could subtly undermine the market by adding uncertainty to Jerome Powell’s confirmation process.

Powell will undoubtedly be confirmed at some point, but timing is now on the Republicans side as midterm campaign seasons ramps up and the Democrats have Lujan still out recovering from a stroke, giving them one less key vote to pass issues.”

Now, all people familiar with the situation are in agreement that Powell is in his full power at the FED even while awaiting these political footballs to sort themselves out (perversely, these might help him as Fed chair), yet seen from a trucker seat in Oklahoma, or a McDonald Franchise in Texas, this and other bit of news might bring a bit of disquiet in dealing with the banking system at large. Some time has elapsed,  yet apparently no central bank is willing to come forward with an unambiguous statement in favor of “money neutrality”.

That by itself could induce some people, especially in low or negative rates jurisdictions, like Europe, to pull some money home. And by “home” I mean the physical place of abode.

Is that a likely outcome? No, its a low probability risk. But so is driving your car ten inches closer to a precipice with a foot to spare. Why??