Part 3 in the series highlights the role of political rhetoric around CBDCs and why we should always look closer at any appeal for the public interest.
On November 15 2023, the International Monetary Fund (IMF) released the first five chapters of its Central Bank Digital Currency (CBDC) “virtual handbook” series. The handbook outlines a structured framework for managing CBDCs from conceptualization to implementation. The handbook is intended to inform how central banks and finance ministries might approach the “go/no-go” decision at various design stages. The report was preceded by another IMF document titled Central Bank Digital Currency’s Role in Promoting Financial Inclusion. This document and the handbook both pitch CBDCs as a solution to the problem of financial inclusion.
CBDCs reflect a primeval tug of war between extreme ends of macroeconomic thought. Ardent supporters of CBDCs are found in the modern monetary theory and/or welfare-statist camp while free-market and Austrian-school thinkers are in the firm “no, thanks” camp. However, geopolitics is further complicating the go/no-go decision. National security looms large, neo-mercantilist trade logic has become the norm, and sovereign debt is a competition over who gets to hold the third-world shackles. Can an alliance of CBDC-issuing nations become an alternative payment rail that impedes US dollar hegemony? Doubtful, but anything is possible.
As payment systems and capital flows become more volatile and brazenly weaponized, central banks throughout the world are climbing aboard the CBDC train.1 The People’s Bank of China (PBOC) wants to gain a first-mover advantage and build the future payment rails of their offshore financial ecosphere. Others like Nigeria or Jamaica have launched retail versions to support their domestic currencies but are still struggling with adoption two years in. Most BRICS members and even US allies in the Eurozone and South Korea are piloting wholesale and/or retail CBDC prototypes. Wholesale variants, which can be used for settlements between central banks and from central banks to commercial banks, may boost the international appeal of a currency by facilitating bilateral swaps and improving back-office settlement efficiency. Retail versions, which are intended to be used by the general public are essentially tools of domestic monetary control. Regardless of which version central banks opt for, they collectively share a sense that decentralized finance (DeFi) might undermine their control. Increasingly, CBDCs are seen as a way to re-centralize.
Few central banks openly admit that CBDCs’ primary purpose is to protect a central bank’s control. Other social benefits are often claimed. As an example, let’s look at what the IMF and Bank for International Settlement (BIS) are pitching as a problem that CBDCs can solve: financial inclusion.
“Financial Inclusion” and the IMF’s Stance on CBDCs
In its handbook, the IMF staff tried to maintain a non-directive stance. It unpacked deployment scenarios but refrained from offering policy recommendations for individual nation-states. Nevertheless, international bureaucracies like IMF and BIS have the structural power to shape the norms, standards, and expectations within the global financial system, especially through Article IV Consultations. Its reports make it clear that the IMF considers competition from other payment methods for domestic or cross-border transfers as threatening to incumbent national banks. The IMF report considers several risks associated with CBDCs, including those to the banking structure, legal frameworks, and Know-Your-Customer (KYC) compliance. But these risks are couched in a post hoc mentality: the IMF assumes that a CBDC will be launched, and advises on picking the right design to make sure the legal framework, regulation, and oversight work. The question not asked is: why do we need to deploy CBDCs in the first place?
Again, the main concern simply seems to be protecting the interests of central banks. The IMF argues that there is a “risk that central banks will find themselves unprepared in the future and increasingly unable to carry out their basic functions without CBDC.”2
But the IMF does attempt to offer a public interest rationale. CBDCs are portrayed as a way to improve financial inclusion. “Most financially excluded households that lack access to quality and affordable digital payments rely on cash for payments, which marginalizes them from the formal economy (…) someone’s ability to borrow and save formally depends on the availability of quality and affordable products and services for them to do so, as well as on individual factors such as their risk profile.”
What does it mean to be financially included or marginalized?
For the IMF, having access to financial services is what makes homo economicus included in the “formal economy.” That means that if money market funds, interest-bearing savings accounts, broker-dealers, credit card rewards, and so on, are available, the economy is inclusive – a desirable end-state. The IMF regards CBDCs as a gateway to such inclusive financial services.
A highly questionable assumption underlies this position. Is it the medium of exchange – or the actual poverty that marginalizes people? The baked-in assumption is that the availability and choice of a medium of exchange impacts the propensity of its user to amass or store value. This assumption is not plausible on its face. In fact, it ignores two important points that apply for developing and developed world low-income people alike.
The first point being ignored is that financial services like savings accounts or money market funds are a luxury item. They are not very relevant when one’s income is severely limited. The framework of inclusion/exclusion by itself belies the structural status of poverty. Public policy should ensure everyone the ability to lift themselves out of poverty and equal opportunities for advancement. The issue here is not a prohibitive minimum funding threshold for the disenfranchised to be able to own a checking account, it is the lived experience of poverty itself. The IMF makes it seem as if access matters more than risk profile, which any creditor worth their salt would scoff at. If people are lucky enough to be able to lift themselves by their bootstraps, the IMF should note another reason why some low-income people don’t want financial services or bank accounts, which is the second point ignored by the financial inclusion pitch: it’s not a matter of lacking access but a lack of trust in financial institutions in the first place.
IMF staffers should read the Federal Deposit Insurance Corporation (FDIC)’s survey of the underbanked and unbanked households in America. 72% of surveyed population stated they were not interested in having a bank account. The main reason for not wanting a bank account is not having enough money to meet minimum balance requirements. The second reason is that they don’t trust banks and want their privacy, a preference that can apply regardless of income level, but seems particularly poignant with low-income people.
So who are these people on the lower socioeconomic strata? It is worth considering the effects of generational racism and inequality in the US. Compared to a white person of similar income, an African American person may still be less likely to secure a mortgage. Similarly, Asian Americans may be less likely to secure business loans. That is not to say that lower-income whites are not similarly distrustful but that minority constituents are especially distrustful of financial systems given their history. Similarly, first-generation immigrants combine a history of distrust in their home countries due to financial and political instability with the struggle involved with integrating a system with limited financial literacy.
I’m going to make a wild guess that none of those people will willingly opt in to a CBDC. These constituents barely trust private banks, the only real buffer between them and ‘Big Brother’ in the first place.
The IMF and the British Central Bank are also nominally concerned with declining uses for cash as society is increasingly digitized. The claim is “Payments form the foundation of financial services, encompassing deposits, withdrawals, overdraft credit lines, and repayments, which are increasingly becoming digitalized.”
If governments and central banks were going to pitch a highly liquid digital service intended to steadily replace physical bank notes, did they ask themselves, why are marginalized populations using cash in the first place, and how might they react psychologically to a demand to use a CBDC instead? Short answer: people choosing not to buy into those institutions will not trust government-issued hardware; neither will people seeking to shield their income and spending from surveillance and taxation.
We cannot meaningfully assume that digital finance can be universalized for the dispossessed without incenting or compelling adoption. Assuming the Western world does not compel their use and resorts to mere incentives, digital money would have to be mediated by a subsidized digital device.3 CBDCs may also require a universal identity scheme. As the FDIC data shows, the underbanked portion of the population has been steadily decreasing since 2010, which suggests more and more people are able to avail themselves of financial services and fintech for low transaction cost exchanges anyway.4 Those constituents will likely continue making financial choices reflecting their preferences of distrust in government especially as the latter continues to expand and overreach. Therefore, increased digitization is not enough of a valid reason to justify messing with the base money supply.
What about the claim of a credit supply-side market failure due to information asymmetry? The IMF states “Financial service providers have limited information about cash-based households. This information asymmetry arises because the absence of digital records in cash transactions results in a lack of knowledge about the financial activities of cash-based households. This market failure is particularly evident in insurance and credit markets, where financial service providers are forced to group households with varying levels of risk into the same risk pool.”
What looks like a “market failure” to the governments and the IMF is a valued feature for a large part of the economy. This claim assumes struggling people and immigrants manage their finances like a household in Connecticut. Immigrants rely on family for credit or local loan sharks. Many small businesses like local restaurants and hairdressers are very happy to transact in cash, either to under-report taxes, because they don’t trust banks, or both. Good luck pitching a CBDC to them. Many stuff cash under the mattress or hoard gold when they can get it.
What about the Underbanked and Poor at a broader international level?
Hyperinflation hits everyone hard but poor people especially. In the early days of Lebanon’s hyperinflation crisis, the local Lebanese Lira continued being used for basic goods and services despite ongoing devaluation because it minimized transaction costs. As the economy started dollarizing, people continued using the highly liquid and rapidly devaluing Lebanese Pound for basic goods of daily life, and converted whatever they could withdraw from the banks in the harder currency for saving. Many other developing countries have dual-circulation dynamics that will go through similar dynamics in a crisis. For remittances, private sector solutions like TaptapSend and many others are quickly making more expensive Money Transmitter Services like Western Union obsolete. As for gender gaps, there is no reason to believe those cultural-sociological conditions won’t replicate the same in a world with a CBDC compared to one with physical cash. How then can the IMF convince the developing world that CBDCs are not tools for domestic capital controls, taxation and financial surveillance?
CBDCs are more than a solution in search of a problem. All this energy would not be expended on them if they did not align incentive across a coalition of important stakeholders.
If the IMF really cared about financial inclusion, why would their report on Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements not mention stablecoin’s potential for financial inclusion at all? By enabling more efficient remittances and settlement with lower transaction costs and 24-7-365 uptime, stablecoins have the potential to significantly impact financial inclusion, especially in hyperinflationary economies. See part 1 of this series on stablecoins.
The claim that CBDCs are in the public interest because of their contribution to financial inclusion lacks substance. Yes, regulators must balance political demands with serving at least some part of the public interest,5 but it all comes down to a demand for trust in government. Talking about financial inclusion makes you look good, but it is not a pretext for CBDCs. If you want to fix poverty, focus on growth drivers, job creation, workforce development, taming inflation, and so on. In a world of great power competition, where national security is routinely used to trump any other policy objectives, CBDCs can reverse the finality of settlements or even deploy negative interest rates. In other words, your digital money will run out unless you spend it. Thanks, Mr. Keynes. There is plenty of precedent of central bankers going against principles of free market capitalism causing a growing discontent and lack of trust in government policy. This trend was most visible with Canada’s trucker convoy and the US Treasury’s freeze on Russia’s central bank holdings. As Farrell and Newman outlined in their latest book Underground Empire: How America Weaponized the World Economy, once regulators get a taste of power at the push of a button, they will always come back for more. Left unchecked, CBDCs could become the perfect tool for the financial regulator that likes to push buttons and see what happens.
- The IMF handbook was able to mostly ignore the “Fed” elephant in the room even though its policy choices regarding CBDCs will undoubtedly severely impact the rest of the world. The US government is still (somehow) in the legislative process around digital assets as the regulatory overreaches to fill the void. But absent an act of Congress, a US CBDC will not be politically viable, and there would be many frustrating Congressional hearings in the interim. So, we should see it coming.
- What are the basic functions of a typical central bank one may ask? Last I checked, it was price stability and maximal employment, others may add “growth” or highlight “political independence” but definitely not “capital flow management measures.”
- One needs a phone to use M-Pesa, a smartphone to run Venmo and Coinbase, or standalone hardware to run a CBDC-transacting wallet.
- However, the US government is starting to intrude on fintech services like Venmo and others with new tax reporting requirements for fiscal year 2023.
- See Bootleggers and Baptists by Bruce Yandle.