On July 19, the top-level President’s Working Group on Financial Markets met to address "the need to act quickly to ensure there is an appropriate U.S. regulatory framework in place" for stablecoins, a form of cryptocurrency backed by assets, often denominated in dollars. The meeting cited "the risks to end-users, the financial system and national security." This is a pretty clear message from a group composed of the Secretary of the Treasury, the Chairs of the Federal Reserve, SEC, CFTC, and FDIC and the Comptroller of the Currency.
Another element of federal policy on this issue was telegraphed by Fed Chair Jerome Powell when he recently discussed the Federal Reserve’s research on issuing its own digital dollar stablecoin. "You wouldn’t need stablecoins, you wouldn’t need cryptocurrencies if you had a digital U.S. currency-- I think that’s one of the stronger arguments in its favor," he said. The impetus towards such central bank digital currencies (CBDCs) in many other countries, coupled with the thought that this might weaken the dollar's global role, added to regulatory concerns about private stablecoins, appear to be pushing the Fed towards the issuance of its own CBDC. The motivation is understandable, but we still think it would be a bad idea.
There are now a number of private stablecoins circulating that are backed in some fashion by U.S. dollar-denominated assets, such as Tether and USD coin. Facebook has announced its intention to launch its own U.S. dollar-backed stablecoin, the "diem," later this year. If used by a meaningful proportion of Facebook’s several billion subscribers, this could enormously increase the stablecoin universe. Government officials, unsurprisingly, are focusing on the lack of any regime for their regulation and the need for one.
At the same time, central banks worldwide are considering their own CBDCs. As of April 2021, more than 60 countries were in some stage of exploring an official digital currency, including many highly developed countries. But it is China’s digital yuan, now being tested in a dozen Chinese cities, that causes the most concern.
China seems to have two goals in establishing a CBDC. The first is more control over its citizens. If the digital yuan became ubiquitous, the Chinese government would have instant knowledge and control over its citizens’ money, potentially allowing it, for example, to confiscate the funds of political dissidents or block their payments and receipts.
The second goal is to challenge the dominance of the U.S. dollar in international transactions. The dollar is the currency used in 88 percent of foreign exchange transactions, while the renminbi was used in only four percent, according to the Bank for International Settlements. Who, located outside of China, would choose to give the Chinese Communist Party control over their money? The answer is those potentially subject to U.S. sanctions. As the issuer of dollars that the world’s banks need to transact business, the United States government has long demanded and received access from banks to information related to international transactions, which it has used to impose sanctions on hostile states and those it considers terrorists and criminals. Some countries (perhaps Iran, Cuba and Venezuela) may choose to use the digital yuan to avoid U.S. sanctions, as may countries participating in China’s Belt and Road program whose large debts to China may provide the Chinese with leverage over their choices.
If the digital yuan and other CBDCs are widely implemented, as seems almost inevitable, proponents of the Fed digital dollar may argue that there would be erosion in the dominance of the U.S. dollar in international trade and less demand for U.S. dollar-denominated assets including U.S. Treasury securities, pushing interest rates on Treasuries up, making it more costly for the United States to fund its historic deficits. The Federal Reserve might also believe it is in the public interest to issue its own stablecoin because it would be safer and less prone to fraud than private cryptocurrencies. In order to preserve the dollar’s dominance and to constrain the use of private cryptocurrencies, it appears likely that the Federal Reserve will decide this fall, when it is scheduled to report on its consideration of a digital dollar, to move forward with its own CBDC. Is this desirable?
Regulation of private stablecoins is on the way in any case, regardless of whether the Fed issues a stablecoin. More importantly, a digital dollar would further centralize and provide vastly more authority to the already powerful Federal Reserve. The negative impact of a Fed CBDC, both on citizens’ privacy rights and by shifting the power to allocate credit from the private sector to the government, would be enormous.
A Fed CBDC would make it hard for private citizens to avoid financial snooping by the government in every aspect of their financial lives. Moreover, suppose, as one would expect, that that the Fed’s CBDC siphoned large deposit volumes from private banks. The Fed would have to invest in financial assets to match these deposit liabilities, which would centralize credit allocation in the Federal Reserve, politicizing credit decisions and turning the Fed into a government lending bank. The global record of government banks with politicized lending has been dismal. A digital dollar could therefore undo more than a century of central bank evolution, which has usefully divided the issuer of money from private credit decisions. In the process, a digital dollar would subject private banks to vastly unequal and inevitably losing competition with the government’s central bank. Finally, a CBDC would make it easier for the central bank to expropriate the people's savings through negative interest rates. For these reasons, a CBDC may fit an authoritarian country like China, but not the United States.
The delicious irony in the CBDC saga is that cryptocurrency was created because people were afraid of government control and wished to insulate their financial lives from monetary manipulation by central banks. With CBDCs, their ideas would be used to increase exactly the type of government interference and control that the crypto-creators sought to escape.