EWEN STEWART

CENTRAL Bank Digital Currencies are coming, whether we like it or not. What I set out to do here is to explain what they are, examine them in the context of our existing currencies, and ask if we should be afraid of them. There is much hyperbole, so this essay is designed as an introduction looking at both sides of the argument.

It’s sensible to start with a disclaimer on our present currency system. The UK and indeed global central banks have not been much good at preserving either confidence in and or the store of value of their currencies in recent decades. Since the start of the 20^th century a degree of price stability which had lasted centuries collapsed.

With the obvious caveat that measuring historical inflation is somewhat subjective, we can observe sterling’s performance from the chart above as a store of value over the last 700 years.

In ‘real’ terms, had Medieval Man, born in 1325, come back 400 years later, he might have complained at the price of a flagon of ale. It would have been four times more expensive. Not great for him but recognisable. On the eve of the Great War our Medieval Man would have been reduced to drinking very weak ale as prices had doubled again. So, with the caveats given, over the 589 years between 1325 and 1914 prices increased roughly eightfold. Since the cataclysm of 1914 inflation has eroded the value of sterling a staggering 129 times. Logic would dictate that all things being equal, in a society of untold technological advance, prices should be falling, not rising. This is plainly not the case.

In recent history, sterling been a very poor store of value though relative to most others, USD and Swiss Franc excepted, the UK has been a relative out-performer. The Weimar German mark, Third and Fourth Republic French franc, Argentinian peso, Italian lira and more were all disasters. So when we address the question of CBDC we need to understand that the current situation is not all that great – the combined effect of politicians’ assumption of command over the economy and a currency with no physical tie has proved a recipe for instability. The dying days of traditional fiat currency are not exactly ones of stability.  It is in this context that we need to consider this new form of money, CBDC which is moving from the theoretical to the real.

But what exactly is CBDC and how is it different from our historic fiat currency and also crypto currency?

Fiat currency is ultimately backed, in theory at least, by central banks. It is largely commercial banks which create money by lending within their capital structure and regulatory and monetary constraints determined largely by the State. Individual accounts are subsets of this and the ultimate property of the account holder assuming cleared funds, within agreed overdraft limits, which can be used for any legal purpose.

Private digital currency, like Bitcoin, is quite different and is not backed by any central bank. Instead, Bitcoin currency is generated by a competitive decentralised process called mining, with individuals rewarded with new currency if successful in the mining process. Mining is difficult and takes time and resources.

Unlike fiat currency which can be and is created at the whim of the central or commercial bank, Bitcoin is designed in such a way that bitcoins can be created only at a fixed rate which is predictable and decreases over time with the number of new bitcoins being created automatically halving each year until a maximum of 22million are in existence. Bitcoin is in theory at least limited in its quantum – fiat or conventional currency is not and in the latter case has been highly elastic in its issuance.

This elasticity is the great flaw of fiat currencies in terms of preserving the value of money. Thus Bitcoin, so long as there is trust in the process, has a great advantage in its fixed supply. In this sense theoretically it has some of the characteristics of gold clearly without the physical benefits or literally centuries of trust that gold has developed.

Another key difference is Bitcoin uses blockchain databases that are shared across the computer network, providing a secure and decentralised record of transactions. This guarantees fidelity and security and is designed to generate trust without the need of a third party. The traditional central bank or commercial bank is thus redundant in the private crypto world.

Private digital currency is still embryonic and is a speculative asset class. Bitcoin, the market leader by a margin, has a market capitalisation of outstanding ‘coin’ at the time of writing of around $1.7trillion with a long tail of competitors whose combined worth is probably around the same again. This sounds a lot but compared with an approximate $62trillion market cap of the US stock market it remains niche, despite the column inches.

The European Central Bank (ECB) have been investigating the feasibility of CBDC for five and a half years, but ECB President Christine Lagarde has just confirmed that, subject to approval from ‘stakeholders’, they expect to gain clearance to launch a Euro CBDC within a few months.  Make no mistake, they will get that legal approval.

While the timeline to proposed legal approval might be shorter than some expected, the direction of travel is not. This is a wakeup call for, like it or not, CBDC is going to happen because (a) elites want it and technology makes it possible and (b) the temptation of elites to proceed is just too great given the potential scope for increased centralised power and observance. Let’s consider these in turn.

Indeed, two countries have operated such a scheme already, Nigeria and Zimbabwe, with very different results. In the latter case the abolition of the near-worthless Zimbabwean dollar for a new gold backed ‘ZiG’ currency has almost certainly been a force for good resulting in an attempt at fiscal discipline from a country ravaged by hyperinflation. Inflation is still high but there are some signs that stability is being restored from a position of extreme dislocation.

In the Nigerian case, the eNaira has not been successful. Nigeria banned private crypto-currency claiming the new CBDC would usher in a ‘new stability’. Unfortunately, the opposite happened with central government control increasing with great volatility and strict limits on daily withdrawals enforced. Worse, while physical cash was still accepted old banknotes became near-worthless, leaving the poorest even worse off.

Clearly Nigeria and Zimbabwe’s characteristics are rather different from advanced Western nations but the warning is clear. If any currency is to succeed, and by success I mean hold a strong store of value, it should be scarce, limited in supply, enjoy very low transaction costs, be widely accepted, unencumbered (i.e. citizens free to use it as they legally see fit without restriction or favour) and critically be trusted. Current fiat currency meets some of these requirements but critically not the scarce and limited in supply with no underlying asset base to support it.

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This article (The unstoppable rise of digital currency – Part One) was created and published by Conservative Woman and is republished here under “Fair Use” with attribution to the author Ewen Stewart

See Part Two Below

The unstoppable rise of digital currency, Part Two: Centralised power

EWEN STEWART

THE move to CBDC is likely to be global: 134 nations are currently exploring the feasibility of CBDC with every OECD nation in the advanced technical appraisal stage. I would suggest that by the end of the decade it will be the primary financial tool in developed economies.

We are told there is nothing to worry about, that there are safeguards, that no decision has been made yet and that in any case it won’t be functional until the second half of decade at the earliest. Parliament will decide so there will be full democratic control. Indeed! Moreover we will still be able to use cash, so what’s the concern? The Bank of England’s cuddly video on the digital pound is anodyne enough with a friendly northern accent to reassure.

On the other side of the argument a quick search of X suggests it will lead to total governmental financial control, the end of financial privacy, ‘programmable money’ (which I explain later), digital IDs and a social credit system with ever increasing centralisation of power. So who is right? A grave threat to freedom or a natural technological evolution that will make transactions cheaper and more ‘transparent’?

The reality is we don’t yet know as the architecture of the proposed CBDC has not been agreed or made public.

There are a range of options which countries could adopt, from the relatively benign at one unlikely extreme to complete surveillance and control at the other. Where we will lie on the curve, and just as importantly might end up in time, is unknown because no direct detail has yet been published either by the European Central Bank or the Bank of England.

One might imagine it is welcome that a major central bank should be ‘forward thinking’ by examining the various options for sterling in an increasingly digital world; however there are major grounds for concern. Ultimately, confidence in currency is perhaps the most paramount lever a state has and a free people enjoy. If trust is breached the impact could be devastating. While I think some of the more polemic ‘control’ arguments are over the top, CBDC does potentially offer a grave threat to liberty without very strict, timeless and enforceable safeguards which, even if in place at the off, risk erosion over time.

It is likely in the initial iteration, in the UK anyway, there would be safeguards and CBDC probably will run in parallel with both cash and traditional banking, but it is naïve to believe that such safeguards will be foolproof. What is certain is the UK and Euro versions will not be linked to any hard commodity/gold.

There is a grave risk of mission creep. We only have to see how politicians responded to the alleged covid crisis as an example. In extremis all options are on the table and a digital centralised currency materially increases the potential power options for Governments.

What the UK central bank seems to have in mind is a very far cry from private digital currency with the central bank core ledger at the heart of it, enabling regulated entities authorised access. These ‘payment interface providers’ are ‘the user friendly interface’ with the individual or company, as the Bank of England inelegantly puts it. This new Government-backed CBDC would thus potentially be quite different from its private equivalents in three primary spheres.

First, Government envisages that the central bank sits at the core, not a decentralised process of controlled currency expansion as with private currencies. While it is likely that individual accounts will still be held with financial intermediaries, or possibly traditional banks, it potentially gives far greater central oversight of transactions and loan growth.

Second, with a shorter direct transmission mechanism than is currently the case, it theoretically makes it easier for central banks to micromanage. It might be argued that as things stand controls in the recent world of monetary extremism are pretty limited anyway. The record since the global financial crisis has shown just how willing central banks are to create money via quantitative easing. A CBDC would theoretically enable that process to be taken a stage further, simply creating or withdrawing credits as centralised policy makers dictate, with a potentially much more direct transmission mechanism than the current QE and Asset Purchase programmes.

Third, politicians must decide whether this government-backed digital currency is ‘programmable’ or not. This sounds innocuous, but it is anything but. CBDC-world would enable an immediate transmission process and would potentially allow for the temptation of even more activist monetary policy as the central authorities deemed appropriate. While in parts of the eurozone, under conventional money, rates were strongly negative for quite long periods, CBDC could allow this to be taken a stage further with a much greater potential for materially negative rates, with clear implications for savers and indeed personal choice and liberty.

A second aspect of programmability means that in effect the state could have control over how you spend your money and not just the quantum of it. Theoretically it could be tied into behavioural incentives and penalties built into the system at a theoretical touch of a button. This needs very careful watching and clarification, for without very strong safeguards CBDC would result in the greatest power grab of the state over the individual yet.

With current money held in one’s account one is free to do with it as one pleases (within understood and accepted laws). It’s yours to spend or invest as you like. A ‘programmable’ CBDC currency could theoretically override that freedom based not just on the sum in the account but also other variables at the whim of the central bank or politicians.

Unless a CBDC was set up entirely neutrally, it could be used to block expenditure on items deemed ‘socially harmful’. Carbon-intensive purchases are an obvious example (diesel or indeed any fossil fuel). The direction of spending of state benefits (no sugar, salt, fat, alcohol or tobacco products) is another area that might attract attention.

The point is that under the current monetary system there is no direct check on what you do with your money so long as it is legal – be it to buy red meat or go vegan – and rightly so: that is what a free society is all about. But unless explicitly excluded it would not be hard to imagine a CBDC tax or credit system introduced simply at the whim of government to suit whatever short-term target it might have. This has to be a legal red line, for if lockdown has shown us anything, it is how easy it is for the state to control our thoughts, words and deeds.

Sure, central banks have caused serious damage to fiat currency with their interference and constant desire to micromanage and debase. The CBDC, unlike the private equivalent, potentially opens a whole new avenue of state power to direct, control, helicopter in and withdraw at the flick of a switch. We need to watch these developments very carefully.

Any attempt to make this ‘programmable’, even if the authorities generously allow this digital currency initially to run in tandem with traditional currency, would effectively mark a major breach of an individual’s or corporate freedom to buy legally what they like.

The Man from the Ministry already demands a state of almost half the size of entire economy but to nudge, direct and dictate how the remainder might be spent goes well beyond any reasonable definition of a free society. Break the link between currency and productivity/production in all its forms and you play with fire; breaking the link with personal choice and preference of what to buy and you cease to have a free society.

So ultimately it comes down to how much you trust the government. Trust is being eroded for sure and we have witnessed a huge transfer of power from the private to the public sphere over the last 100 years, with the pace picking up.

It would be wrong to write polemically about this just yet as the details are unknown but read the small print very carefully, look at how it is backed (almost certainly on trust in government alone) and look at the liberty safeguards, central bank objectives and potential programmability. I am deeply sceptical – watch this space.

This article (The unstoppable rise of digital currency, Part Two: Centralised power) was created and published by Conservative Woman and is republished here under “Fair Use” with attribution to the author Ewen Stewart