This speech (reproduced here with his permission) is entitled “The public digital money revolution (CBDC)–A different vision of money and banking.”
The speech was given on 31st Aug 2020 at the Universidad Internacional Menendez Pelayo.
As you will see, he very much veers in the direction of Vollgeld / full reserve banking. But don’t take my word for it: read his material and decide for yourself where he stands on the fractional reserve / full reserve debate.
Many thanks to Miguel Angel Noceda, Carlos Torres and the Universidad Internacional Menéndez Pelayo for inviting me to this course.
These last years I have dedicated myself to study, write articles, give some classes and conferences, keep a blog and write a book about the problems of the current financial/banking system and how to avoid them with the introduction of the digital public money (CBDC). It is a privilege for me to share with you what I have learned.
What effects is Covid-19 having on the financial system?
Let me summarize my speech: this crisis is having a significant effect on ideas, on the vision we have of how the financial system works, but, in addition, in the future, it will also have a transformative effect on reality, on the policies of the authorities and on the behavior of private agents, which will be the beginning of a structural change in the financial system.
THE CONVENTIONAL VISION AND THE DISTINCTION
Let's start with the change in ideas, with the vision of our financial system.
And we could sum up by saying that "Of all the banking systems one can imagine, the one we have now is the worst of all. The phrase is not mine, it is from Mervyn King, a colleague and friend who suffered the years of the Great Crisis as governor of the Bank of England.
The problems of the current system are caused by the use of risky assets created by private banks as money. These are the so-called "deposits", which are not really deposits. And they are not money either, but "promises" to return money. This problem was once experienced by banknotes issued by private banks but, at the end of the 19th century, banknotes were issued exclusively by central banks. Now the cash is public and safe but not the deposits, which are private and fragile.
The negative effects of this system based on bank deposits have become increasingly serious. In less than a century this system has produced hundreds of national banking crises and two major global crises, and we have suffered from the gigantic increases in debt, the explosion of credit bubbles, the inefficiency of monetary policy and the lack of innovation and competition in payment services. These problems in the financial system have deteriorated economic growth and the welfare of most of the world's citizens.
Nevertheless, there is a certain consensus regarding the problems of the current financial system. All economists agree that the current system is very fragile and admit the tendency of commercial banks to enter into crisis, but where there is no consensus is in diagnosing the causes of these problems.
Most of the profession has persistently maintained the belief that by increasing prudential regulation and state protection of banks, these problems could be mitigated. This has long been the conventional and majority view and this explains why, after each banking crisis, the reactions of the authorities have always been to approve more regulation and more protection of banks.
This also happened after the great crisis of 2008. Let us remember how, at the end of that year, practically all economists and those responsible for governments, central banks and international organizations agreed on the diagnosis of the crisis. "The market has failed," we all said. No Only leftist economists but even inveterate liberals like Alan Greenspan confessed the error of having believed too much in the market.
But the diagnosis that the market was to blame for the Great Crisis was wrong. On the contrary, the problems are the consequence of a monetary/banking system in which the state, for many years, decades, even centuries, and in order to avoid bankruptcies and leaks of deposits, has increasingly protected the banks with all sorts of privileges and regulations so that citizens could use bank deposits as if they were public money without fear.
This misdiagnosis led to the prescription of very harmful remedies in the long run. The result was, once again, more state interventionism and protectionism. Intrusive regulations increased again with Basel III, new resolution models and new supervisory bodies were created, deposit guarantees were increased and central banks increased the volume and variety of their instruments, reaching levels of interventionism in the markets that would have been inconceivable years ago.
But in those same years a different vision of the problems of money and banking began to emerge and what the solutions to these problems should be, which should not be those of increasing state interventionism and state protection but of liberalizing banking activities and opening them up to competition and not continuing to use the fragile money of bank deposits but switching to using safe money, which could not enter into crisis, that is, public money, the money issued by the central banks .
In reality, this vision was not so new. For many years, many prestigious economists (David Ricardo, Henry Simons, Irving Fisher, Milton Friedman, one of the Hayek's, Von Mises, Maurice Allais, etc.) had denounced the dangers of using deposits in private banks as if they were money.
WHAT IS THIS DIFFERENT VIEW?
The first thing is to realize that the most serious problems of the financial system are exclusively in the money and in the banks and not in the rest of the system. From the point of view of regulation, the financial system can be divided into three sub-sectors: money, banks (in their function of creating deposits) and the rest of the financial system, that is, the stock market, investment funds, insurance, hedge funds, venture capital funds, derivatives markets, etc. These sub-sectors also have problems that require regulation, but are very different from the problems of banks that are heavily intervened and protected by the state.
This rest of the financial system (which, by the way, in the US cannot be said to be a "rest" since it already accounts for 85% of the financial system) functions absolutely by the rule of the market, and its problems can become important, but do not have serious systemic consequences. The problems of fragility, inefficient monetary policy and lack of innovation in payment services do not appear in the rest of the financial system; they are a consequence of our money and banking system.
And if the problems are concentrated in money and banking, it is because the determining characteristic of the current system is that money and banking are indissolubly linked. This explains why no progress can be made in strengthening money security without affecting banking, and why banking cannot be liberalized if there is no money to replace the fragile deposits in private banks.
This close relationship between money and banking does not only explain the problems of instability. Since private banks are not only intermediaries, but fundamentally are the creators of money, they also generate problems in the management of monetary policy. Likewise, the lack of innovation, low quality and high cost of payment services is due to the fact that these services are today practically oligopolized by the banks without having yet been opened to competition from other non-banking providers.
THE SOLUTION TO THE PROBLEMS
According to this vision -different from the conventional one-the solution to our problems should come from two actions: On the one hand, by replacing the fragile money that is bank deposits with a public and secure money, the one issued by the central banks, which today we call CBDC, which stands for Central Bank Digital Currency. And on the other hand, by the liberalization of banking activities, that is, by the elimination of all the protections and privileges that banks have and also the elimination of a very voluminous and complex prudential regulation with which regulators believe they can prevent bank failures from occurring.
The effects of a reform of the financial system that would introduce digital public money and liberalize banking activities would be very important. On the one hand, it would mean forgetting about banking crises (not financial crises) and increasing the efficiency of monetary policy. On the other hand, it would initiate a process of innovation and competition in payment services.
There are more problems of the current system, such as the huge public aid that is necessary to save the banks, the subsidies that, even when there is no crisis, are necessary to avoid them, the loss of seigniorage, etc., problems that I will not comment on today because we have little time. For those interested in knowing more, I encourage you to read the book Goodbye to the Banks. A different vision of money and banking, which I have just published and where, with a simple language, all these problems are exposed, as well as the benefits that would be obtained with the introduction of public money and the liberalization of banking activities.
EVOLUTION SINCE 2014
From 2014 onwards this different vision, which until then had been defended by a very small group of scholars, began to appear in articles, documents and activities of greater diffusion. The Bank of England published two documents that radically changed the idea we had about how money is created in our economies. Some parliaments began to discuss proposals to open up access to public money for all citizens, and The Economist and Martin Wolf of the FT supported a referendum in Switzerland that proposed to allow all citizens to have accounts in the Central Bank.
But discussions about these reforms were still taking place in minority circles. And this has been the case until the idea of introducing public money became a seemingly less ambitious proposal, that of introducing the CBDC, not as a global solution to the problems of the current system, but with a very specific objective, to make available to all citizens what we could call a "digital cash". Unlike what would be a complete structural reform, this public digital money would not replace but, in principle, would continue to coexist with the fragile deposits in private banks.
It is curious that the idea of introducing public money has not jumped from theoretical reflection to reality because the authorities would have wanted to solve the serious stability problems or overcome the difficulties of managing monetary policy, but rather it has arisen because of the inefficiency and lack of innovation in payment services.
It has been the slowness, the cost of payment services, the exorbitant commissions charged especially in cross-border services, the exclusion of millions of people who do not have accounts in private banks and the lack of innovation in these services that has led this idea to jump from theory to practice.In fact, at first the central banks were very reluctant, not to say absolutely opposed, to the idea of introducing CBDCs. With the exception of the Bank of Sweden and the Bank of England, most central banks were very negative.
The orgy of regulations, protections and the creation of new public entities that were established after Lehman, has somewhat improved stability but the banks continued to suffer other disruptions and the market began to distrust their future.
Those "cracks" that have been emerging in the current system have been resolved with different patches without any authority having considered making structural reforms to the financial system that would improve the stability and efficiency of monetary policy. But, as I have pointed out, in recent years proposals have appeared for the introduction of public digital money that will It represents a disruption in a business that has historically been monopolized by banks: payment services.
And it has not been the authorities, it has been the market, the private initiative, that is forcing the authorities to consider the need for such a reform. And they are rushing it. Right now, the world's main central banks are already studying, designing and even experimenting with the possibility of introducing public and secure money (CBDC).
THE EFFECTS OF COVID-19
Has it been the virus, with its effects on the economy, that has accelerated this interest in the introduction of public and secure digital money into our financial systems?
Detecting causality is always difficult but the correlation is evident. It is a fact, a verifiable fact, that during these months there has been an explosion of work and studies on the CBDC, secure digital money, which had not been seen before. It has been during these months that the Bank of England has published one of the best reports on the subject (CBDC: Opportunities, Challenges and Design) and the International Monetary Fund has continued to produce documents of great interest for the design of CBDCs.
The Bank for International Settlements in Basel, the BIS, which only 15 months ago had shown its reticence about this idea and warned about its risks, has published during the confinement the second part of its report on cross-border payments, a consultation on the regulation of "stablecoins", a valuable article by Ralph Auer in its quarterly newsletter and is playing a very important role in the indispensable task of coordinating the work of national central banks.
There is not a single institution (Brookings, Group of Thirty, Davos, ) that has not published an extensive document on CBDCs in recent months. And many private initiatives have also been posted on Youtube, such as "Digital Dollar" prepared by one of the major international consulting firms.
But without a doubt, the most relevant event was the publication last April of the second Libra "White Paper" by a consortium led by Facebook. As you probably know, last year Facebook launched the idea of a private currency, called Libra, which could allow 1.7 billion people in the world who do not have a bank account to make transactions. And the evolution of this private project explains the change in attitude of the most important central banks towards proposals to introduce public digital money into our systems.
In the first White Paper, Libra proposed to back up its currency with bank deposits and other risky securities. If this proposal had been accepted without further ado, it would have increased and aggravated the problems we already have with banks, of fragility and risk of financial crises and also of lack of control of monetary policy.
The regulators reacted correctly against this proposal but the acceptance by Facebook in April of not backing their currency with private assets but with public money has reassured the authorities which could facilitate its approval. And itis clear that, if one of the objectives of introducing public digital money is to open up payment systems to competition, this will be much more intense if the large Bigtechs can participate than if the banks had to compete only with small Fintechs.
WHAT ISSUES ARE BEING DISCUSSED?
And what issues are being discussed in this extensive and intense debate among experts on the introduction of public digital money (PDCM)? Many. I will only mention a few.
In terms of volume of work and documents, the issue that is filling more pages is the issue of the different technologies that could be used. I am not going to describe them because, being the technologies very important, since without them we could not have CBDC, from an economic/financial point of view we do not we need both to know in detail how they work and to know what they are for.
Another of the most debated issues is whether or not public digital money will be anonymous. This is of great interest because although most of the money we use now, private bank deposits, are not anonymous, it is true that the bills, the only public money that citizens can now use, are anonymous.
Another important element of the design is the role that commercial banks and central banks should have. The majority option is for the Central Bank to have a reduced role, focused exclusively on ensuring the registration and security of money and for private entities to provide payment services. However, it is possible that central banks may need to play an important role in some infrastructures.
There are also discussions about cyber security, antitrust regulations or the use of user data, issues that are also being raised in other businesses.
But perhaps the most worrying aspect of this debate is the possible disruptive effects on private banks of the introduction of public money (CBDC). And this is not surprising, because if citizens were allowed access to public money without any limit, this would mean the end of private banks.
Many people do not realize that, unlike other companies, private banks survive exclusively on state protections, subsidies and privileges. And the rule that prohibits citizens and other financial and non-financial companies from accessing public digital money is one of those many privileges that allow them to exist.
If citizens were allowed unlimited access to this public money, the business of private banks could be rapidly reduced, which is why it is very reasonable that the authorities are thinking of protecting commercial banks from sudden disruption. Initially, the absurd idea was proposed to penalize public digital money (CDB) with a remuneration that would always be lower than that offered by banks in order to encourage the use of private deposits. This would now mean that public digital money would lose value over time which is not the case now with banknotes. Lately another, more reasonable, idea is being imposed, that of limiting the volume of digital money that citizens and companies can safely use in the first phase of introducing public money.
There are more issues being analysed that explain the numerous studies that are being produced in this great debate in which, so far, only experts are participating. Some are very technical, such as identity verification, scalability, cost, speed, or energy consumption, but there are also other general issues, such as financial inclusion, or guarantees that all the money used to provide payment services is backed by public money, or ways of ensuring competition (for example, the possibility that payments can be made between users of different payment service entities), which are very interesting and which we could discuss at the symposium.
Let me finish by commenting on how I see the future of the financial system.
Despite the limitations imposed to protect banks, the moment public money payment services (CBDC) are liberalized, banks will start to feel their disruptive effects. These disruptions will have the positive effect of alerting the banks that in the not too distant future theywill not be able to maintain the privileges and protections of the State that they enjoy today, and this should encourage them to transform themselves into entities that can function perfectly in a world that is totally subjected to competition.
Today banks have a high quality human capital because they have been able to offer high salaries to the best professionals. And it is to be hoped that their managers will be right in how they should transform their institutions so that, without State aid, they can offer what users want. Because citizens and companies will no longer be captive, they will no longer be forced to go through the banks to make their payments.
Some banks now see the danger of letting citizens have access to safe public money. But I am convinced that, at some point, many banks will realize that, by giving up their deposit business, they will be able to develop other financial activities that are more profitable than their traditional business and without having to comply with heavy and burdensome regulations that would no longer have any justification.
Banks that do not adapt, as happened with companies like Kodak, will disappear. But normally, as it happened with other photographic companies, some entities will transform and subsist. This has also happened in other sectors -air transport or telecommunications, for example -where technology and liberalisation have radically altered the business climate.
The improvement in payment services will be the most visible effect and, as has happened with telecommunications, the result will not only be that new payment service providers will continue to do what banks used to do, but cheaper and of higher quality, but above all that new services will emerge that we cannot even imagine today. Innovation is the most important effect of competition.
In the longer term, the introduction of public money and competition will be the spark that will shed light on the problems of the current system. Today, citizens are not aware of these problems because the protection of the State has an "anaesthetic" effect, which prevents them from seeing them because the objective of subsidies and protections is precisely that, to reassure depositors, that they do not perceive the problems of private money.
The introduction, although very limited, of public digital money will be a Pandora's box that will generate a growing and unstoppable movement so that all the money stops being fragile and the unnecessary protections and regulations of banking activities are suppressed. We will not need resolution agencies, deposit insurance, or prudential oversight agencies. And monetary policy will not require massive interventions in the financial markets because the central banks will stop directly manipulating interest rates.
Certainly there will still be problems in the financial system, but we will no longer have problems that we have created, due to the many regulations and protections of the state. The communist countries made the mistake of believing that the state knew better than free interaction between individuals and companies and subjected the production of goods and services to strong interventionism.
And for decades the productive system had many problems that its inhabitants had to suffer.
Well, now, in almost every country in the world, both the production of goods and services and the activities of most of the financial system are already subject to the rules of the market, but still the discipline of the market does not rule in that part of the financial system which are the banks.
When the introduction of public digital money is complete, there will no longer be any reason to justify state intervention in the banks, and we will see, as the communist countries saw, the enormous improvements that innovation and competition bring about in the welfare of all citizens.
The path to that future, like everything in history and life, will not be linear. It will most likely be, as we are seeing it begin, an unpredictable mix of disruption and reform.
Thank you very much.
I hope and desire to hear your questions.