The Federal Reserve CBDC Report
The long anticipated report by the Federal Reserve regarding CBDCs was released yesterday and it contains a lot of informative tidbits. It is something that is much anticipated since the US Dollar is the most widely used currency. Hence, everyone is wondering what the Fed will do in this regard. Many fear the issues of CBDCs by other countries, especially China, could be a problem.
For that reason, let us go through the highlights of the report and compare where things stand now.
The Constraints On The Federal Reserve
Contrary to what most believe, the Federal Reserve (Fed) is rather constrained. It does not have as much power as many believe. In fact, this will be shocking to many, but the Fed cannot increase the money supply (USD). It can affect the monetary base but that is all.
The Federal Reserve Act does not authorize direct Federal Reserve accounts for individuals, and such accounts would represent a significant expansion of the Federal Reserve’s role in the financial system and the economy.
We do not bank at the Fed. Depositing member banks have accounts there and we, in turn, bank in the commercial banking system. This draws a line between what the Fed can do and its impact upon the economy. There is no way for the Fed to get "money" into the hands of any individual. When it engages upon Quantitative Easing (QE), it does so by "printing" up bank instruments that are swapped with depositing banks for Treasury or Mortgage-Backed Securities.
A CBDC would change that. The way the present thinking is going, this line would be eliminated. CBDCs money would be directly deposited to individual accounts, thus expanding the Fed's potential within the economy.
The Federal Reserve does not intend to proceed with issuance of a CBDC without clear support from the executive branch and from Congress, ideally in the form of a specific authorizing law.
This is a rather unnecessary statement since it is prohibited, by law, from engaging in this activity. It is going to take an Act of Congress to reverse the Federal Reserve Act of 1913 which prohibits the Fed's liabilities from being legal tender.
Here is where we can see some of the changings that would take place if all this happens.
For the purpose of this paper, a CBDC is defined as a digital liability of the Federal Reserve that is widely available to the general public.
This is where the change becomes clear. What the Fed produces now is not available to the general public. Instead, we operate with the currency the commercial banking system produces, i.e. dollars. The Fed has nothing directly to do with that.
As stated, a CBDC would interact with the public. Thus, the expansion of the Fed liabilities would enter the general economy. Some might think this a good thing. Certainly, elasticity of money is a required. However, with the track record of the Fed in not "getting it right", we can presume they will make sizeable blunders, cause detrimental impact to the economy.
a CBDC would differ from existing digital money available to the general public because a CBDC would be a liability of the Federal Reserve, not of a commercial bank.
This is an important point. Cash is an asset to all individuals and businesses. The sole exception to that is depositing banks. When money is loaned out and redeposited it, it becomes a liability to that bank. We know this because people expect to be paid back, usually with interest. This means the commercial bank is on the hook for the money.
A CBDC would eliminate this. It would move the liability from the commercial banking system to the Fed. This could eliminate the need for FDIC since a central bank does not carry the same risk as the commercial banking system. As we can see, it is a revamping the system completely.
CBDC transactions would need to be final and completed in real time, allowing users to make payments to one another using a risk-free asset. Individuals, businesses, and governments could potentially use a CBDC to make basic purchases of goods and services or pay bills, and governments could use a CBDC to collect taxes or make benefit payments directly to citizens. Additionally, a CBDC could potentially be programmed to, for example, deliver payments at certain times.
It is at this point that things can take a couple different turns. The Fed, while looking at some of the downside risk, is doing some from the health of the financial system standpoint. There is a greater risk proposed here that is not being discussed.
The last line, about programming the money, is what gets people worried. In the report, the Fed presented the CBDC as being within their control. That is one possibility. The other to consider is where the power-hungry politicians stand on this. It is unlikely that they will not want to be able to influence the control over the newly created money.
This is where we see the programmability of the money turning political. What happens if the politicians decide they do not want to allow people to spend money on certain things? Of course, it will be framed as if it is for our benefit.
Another major issues is using the money supply to destroy one's political opposition. What if one party decided the CBDC could not be used to support the other party. All donations would be blocked.
There are numerous instances throughout history where governments used all means necessary to destroy anyone who dared question them. Handing control over money to them is not a wise move.
The Fed tries to answer this in a general away:
..., would best serve the needs of the United States by being privacy-protected, intermediated, widely transferable, and identity-verified.
What is being presented is a hybrid-model. Powell and some others at the Fed are well aware of the impact of this move. It would really hinder the commercial banking system. For this reason, the report tries to walk the line whereby the existing banking structure would still have some relevance. Unfortunately, it is easy to be skeptical of this idea, especially in an environment where tyranny among government officials is expanding.
The Fed is well aware that is needs to upgrade technologically. That is already taking place. It is also understands there is a lot already invested in how things are done.
For example, cash is still a rather large part of the economy. While it is diminishing, a significant number of transactions are done using this method.
Cash is currently the only central bank money that is available to the general public, and it remains an important and popular means of payment. According to a 2020 survey, U.S. consumers used cash for 19 percent of total transactions (6 percent by value). The Federal Reserve is committed to ensuring the continued safety and availability of cash and is considering a CBDC as a means to expand safe payment options, not to reduce or replace them.
Of course, there is "only" about $2 trillion in physical USD out there. This is a smidgeon of the total when we consider all the USD that is generated through lending and the Eurodollar system. Plus, physical dollars are only put into circulation, outside replacing damaged ones, when commercial banks request them. Hence, the central bank money is still driven by the commercial banks.
One of the key aspects to all of this is as a payment system. Over the last 100 years, a domestic and international payment system evolved, moving money all over the world. Some of this was designed under the Fed, other aspects, like the Eurodollar system, completely outside its realm. However, we do have a system that moves money around, mostly without issue.
The Fed is aware of this. It also understands some of the limitations at present.
While the existing U.S. payment system is generally effective and efficient, certain challenges remain. In particular, a significant number of Americans currently lack access to digital banking and payment services. Additionally, some payments—especially cross-border payments—remain slow and costly. Digital financial services and commercial bank money have become more accessible over time, and increasing numbers of Americans have opened and maintain bank accounts. Nonetheless, more than 7 million—or over 5 percent of U.S. households—remain unbanked. Nearly 20 percent more have bank accounts, but still rely on more costly financial services such as money orders, check-cashing services, and payday loans.
We have to be careful because the "poor" are going to be used to "sell" the idea of a CBDC to the general public. The focus will be upon the idea of giving them money in a direct manner. Of course, anyone in cryptocurrency knows that anyone with an Internet connect and a mobile phone could quickly leave the ranks of the "unbanked". Nevertheless, this is a target as we can see.
The report also mentioned, not cited here, how there are already public-private partnerships underway in the United States to alleviate this problem. It is focusing upon those areas where poverty rates are higher and people are having to turn to alternative, yet extortionary, entities.
In addition, it is not as if the Fed was sitting around doing nothing technologically over the last few years. There are already upgrades in the works that will come online soon.
The Clearing House has developed the RTP network, which is a real-time interbank payment system for lower-value payments. The Federal Reserve is also building a new interbank settlement service for instant payments, the FedNow Service, scheduled to debut in 2023. These instant payment services will enable commercial banks to provide payment services to households and businesses around the clock, every day of the year, with recipients gaining immediate access to transferred funds. The growth of these instant payment services also could reduce the costs and fees associated with certain types of payments.
Here we see how the Fed is already getting ahead of the curve (or playing catchup) and is going to offer instant access to money. No more waiting 3 days (or overnight) for clearance as settlement takes place.
Request For Feedback
This report was meant to get the discussion going. The Fed came to no decisions and certainly has not proposed anything to Congress. It is nothing more than an information source explaining its view on things.
The challenge with this is that a CBDC is still a solution looking for a problem. Does it speed things up and reduce costs? Most likely. However, as we can see, upgrading things via technology can provide the same results without revamping what is being done.
Obviously, a CBDC is going to be controlled. This is something that will allow the "we need to stop terrorism" and monitoring of all that takes place. Here is where the idea of a CBDC taking over loses traction.
Money and trade is about confidence. For all the discussion about replacing the USD with something else, the bottom line is the confidence of the international community. It is also the point where most of the other options are laughable.
First, some feel the Chinese Yuan is a threat. Nobody trusts the Chinese. Do you think a company in Japan, Germany, or the US will want to use a currency that not only can the CCP monitor, but can stop? That currency will be a screaming success within China yet a failure outside.
When we look at the central banks in Europe, who trusts them? The European banking system is to the point where it is on the brink of collapse. Foreign banks are no longer taking their debt as collateral. Also, before the EU, every decade one country or another nuked their currency. We see the ECB turned the bond market into a swamp.
The Japanese went hundreds of years without dealing on the international scale with their money.
Which leaves the United States. For all the talk about the end of the USD, the options are limited. Even cryptocurrency is adopting the idea of stablecoins being tied to it. This provides the stability that is not associated with other tokens.
Of course, the same question applies as to the Chinese Yuan. Is there a company in Japan, Europe, or the US that wants use a currency where the US Government can not only see every transaction but also stop it? At any time, an account could be frozen. The situation is turned bleaker if the politicians get their hands on this, which we can presume they will fight for.
It is worth reading the report to get an idea about where this is heading.
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