Should We Fear the Replacement of Cash with Digital Currency (CBDC)?

Most Americans believe in the rule of law. They assume that most of the time our laws will be enforced as written and applied in a fair and judicial manner. I don’t mind if the police spy on me, as long as I get to spy on the police (through police body cameras). But what about eliminating cash and making all the details of my transactions available to the government through the introduction of a central bank digital currency (CBDC)?

A while back, economists at The Bank of England asked me to present my paper on “A New Digital Currency (CBDC) Monetary Policy Tool to Stop Inflation Without Causing a Recession” in their session at the American Economic Association annual meeting.  Lately a lot of people have expressed concern about the privacy issue associated with the creation of a central bank digital currency (CBDC) and how to keep the government from misusing the account information.  In my paper I noted that it would be easy to keep the transactions information separate from the account ownership information, connected only through alpha-numeric codes as done for the cryptocurrencies such as Bitcoin, Litecoin, Ethereum, et cetera. A judge could decide whether suspicious ( illegal ) transaction activity (drug dealing, money laundering, etc.) in a particular account was sufficient to warrant allowing government officials access to the account’s ownership information.

Most people think that a bank just loans out the money that people deposit in that bank. This is a complete misconception of how our banking system works. The bank does not loan out the money you deposit, but instead uses that money to loan out as much as ten times the amount of money you deposited. Where does your bank get all that money? It just creates it out of thin air. The banks creates a loan by creating an account for the person or business that is to receive that loan and then typing in the amount of the loan as the account balance. That is it. The bank creates that loan money out of thin air! Your deposit just provides your bank with the authorization under our fractional reserve banking system to create and loan out ten times as much as you have deposited.

It is important to know that at least 90 percent of currency in the United States is already digital and has been created by the private banking system under our fractional reserve banking system.  Most money is in checking accounts, savings accounts and credit cards, which the private banking system monitors.  The Federal Reserve Bank can adjust the amount of money in our economy on the margin to fight inflation (raise interest rates and reduce available money) or to stimulate the economy (lower interest rates and increase available money). But most of the money in our economy has been created by private banks.

Wells Fargo took advantage of people by giving them features or accounts they didn’t ask for and charging them for those features or accounts.  The law eventually caught up with Well Fargo.  Several of its leaders were forced to resign and the bank was heavily fined.  The rule of law must be adhered to to prevent private banks and government autocrats (mainly politicians) from violating our rights under the law.

Many young people don’t even bother carrying cash now that even vending machines accept credit card payments.  I was in NYC at a Times Square hotel to present my paper at the Eastern Economics Association meeting when I noticed a sign in the hotel lobby near the hotel restaurant that said: “We do not accept cash.”  I thought that this was just the hotel, but I went to a nearby Starbucks and saw the same sign: “We do not accept cash.”  Eliminating cash avoids wasting time making change and the occasional robbery. The bus is going nowhere and the passengers all have to wait patiently while the bus driver is busy with cash transactions. Why bother with it. Some newer vending machines don’t accept cash. Some of the older vending machines accept cash in theory but not in practice. Sending workers around to all the vending machines to add or remove cash is such a waste of time. Credit card transactions can be sent electronically to the vendor. Cash is (becoming) trash! Well, actually you may want to hold on to some of these strange pieces of paper and coins to show your grandchildren and great grandchildren. In reality, money is going digital one way or another whether we like it or not.

The fear of government access to our transaction information by replacing cash with a Federal Reserve issued digital currency is part of a broader concern about the potential use of government power to violate our privacy to control and manipulate people. Politicians clearly have an interest in rewarding their followers and undermining their opponents in order to ensure their re-election. But why would so-called government “bureaucrats” have any interest in manipulating people? What would be their motivation?

Many of my students were willing to forgo making the big bucks on Wall Street to instead take a job as public servants with an oath to abide by the rule of law and the Constitution.  They have worked for the IRS, the CIA, and many other key agencies in the government. They are all good people serving our country by following the rule of law and the Constitution of the United States.  If you believe in the rule of law, you will want to keep decisions about arresting and prosecuting people out of the hands of the politicians and only in the hands of dedicated public servants including police officers, judges and juries who are committed to the fair and impartial application of the rule of law.

Politicians like Donald J. Trump hate my former students and call them the “The Deep State” because they refuse to violate the law in favor of acting to promote Donald J. Trump.  Don’t hate the government and the public servants who have dedicated their lives to serving us. Just stop the politicians who want us to violate the rule of law and the Constitution. It is not the dedicated government public servants who have served America over the years who are motivated to use our information to take advantage of us, but rather it is the politicians who want to gain access to our private information in order to manipulate us for political gain.

Instead of disparaging “The Deep State“, we should be celebrating them and thanking them for following the law and the Constitution instead of following some politician who wants to violate the law to promote themselves.  The transition from cash to a digital currency that lacked adequate privacy protection could enable a rogue politician such as Donald Trump to identify and abuse his or her opponents and their followers. Strengthening “The Deep State” is the best way to keep any president from abusing his or her power. We should be honoring, not disparaging, our friends and neighbors in “The Deep State.”

One would think that conservatives would want to correct any deviations from the rule of law and the Constitution. If the Biden or previous administrations have used government power inappropriately, you would expect conservatives to propose ways to re-establish the rule of law under our Constitution. But the Trump supporters at The Heritage Foundation are proposing the opposite strategy in their Project 2025 plan entitled “Mandate for Leadership: A Conservative Promise.” The Project 2025 plan calls for Trump to dismantle any and all barriers to a president who wishes to violate the law and the Constitution to turn the presidency into a means to promote the president’s agenda of personal gain for himself.

On December 18, 2020 Trump lawyer Sidney Powell met with Trump and several of his advisers to go over the draft executive order dated December 16, 2020 which would order the defense secretary to seize all the voting machines in an effort to overturn the November 2020 election results. Ultimately the draft executive order was never carried out with Attorney General Bill Barr resigning and many others in key positions in the Justice Department threatening to resign. The lies told on Fox News claiming voting machine fraud resulted in Fox News being sued and settling out of court with Dominion voting machines for $787.5 million dollars. Trump now understands that he must replace all senior Justice Department officials and military leaders with hard-core, dedicated Trump loyalists in order to follow President Putin’s example in adjusting election results to his liking.

Trump is running to permanently take control of the government and establish an authoritarian dictatorship that might make Putin’s regime in Russia look mild and timid in comparison. One of the first laws that Trump will have the Congress pass will be to protect the presidency for those who “love our country” and from “unpatriotic, anti-American, traitors” who disparage the presidency. As in Russia, anyone criticizing the president or the policies promoted by the president will be prosecuted.

Let’s face it.  Trump had no intention of leaving the presidency at the end of the four years in his first term.  He only failed because he failed to replace the top Justice Department officials, the top military commanders, the top Capitol police commanders, and the top Secret Service commanders with people who would do whatever he said regardless of having taken an oath to abide by the rule of law and the Constitution. But now Trump’s followers know that as president he will pardon them if they violate the law on his behalf.

Trump is not running for four-more-years. He will just follow Putin’s example and have Congress change the law.  Last time he attempted to stay in power regardless of the popular vote.  He urged his followers to stop the certification of the vote. He knew that that some had guns. They made their intentions clear when they chanted “Hang Mike Pence,” overpowered the police to push through the police barricades, and smashed windows to force their way into the Capitol building. Nine people died, several police were injured trying to defend the Capitol from the insurrectionists, and several million dollars of damage was done to our Capitol Building. Trump has made clear his intention to pardon many of these “patriots.”

Trump failed to stop the certification of the vote because he didn’t replace the Justice Department, military, police and Secret Service leaders with his own loyal surrogates.  He will not make that mistake again. Trump is not running for four more years as president. Trump clearly intends to replace the rule of law and adherence to the Constitution with his own permanent personal dictatorship.

If Donald J. Trump gets back into the White House and proceeds to correct his mistake in his first term of failing to replace the Justice Department officials, the military leaders, the Capitol police leaders, and the Secret Service leaders with his own sycophants and, thereby, eliminates the rule of law and the Constitution and replaces our democratic republic with a permanent Trump dictatorship, you will have to ask yourself:  “What could I have done a year ago to prevent this tragedy from happening?”   How much money would you have given?  How much time and effort would you have put in to prevent replacing the rule of law and adherence to the Constitution with the permanent Trump dictatorship?  Should I have posted more on Facebook? Should I have taken the time to talk with my neighbors, friends, and family members? Think about this now before it is too late. There is a lot more at stake here than the privacy of your digital transactions.

Use Central Bank Digital Currency to Stabilize US Economy

The question as to whether the government should be allowed to issue a Central Bank Digital Currency (CBDC) really boils down to whether government should be allowed to issue a currency to begin with. Should we say “no” and go back to only allowing private banks to issue bank notes in order to preserve and enhance private bank profits? It is also the case that many online private currencies such at Bitcoin and stablecoins along with the planned introduction of Facebook’s Diem and many other stores of value and payment systems are going to disrupt the traditional private commercial banking system in any case.

However, it is still reasonable to avoid unnecessary disruption of the banking system by introducing a situation where depositors immediately sought to switch all their money from private bank deposits to a new CBDC upon its creation. Furthermore, a CBDC would offer a safer, more secure place to store wealth than that provided by any private bank. A US CBDC may be useful for international transactions as US dollars are today. Consequently, a US CBDC could charge a fee (i.e., negative interest rate) that rose as the size of the deposit increased, which would advantage those with smaller deposits.    In times of inflation, it may be especially useful to provide a positive return on savings in the form of interest payments for small deposits by individuals to encourage saving by people with a high marginal propensity to consume (e.g., low- and middle-class Americans) rather than spending money when too much money was chasing too few goods.

Banks often refuse to accept small amounts of money from potential depositors. Some banks require minimum amounts for individual deposit accounts or certificates of deposit sometimes at least $1,000 or even a minimum of $5,000. It would appear rather hypocritical for banks to complain about a CBDC offering interest on small deposits when they refuse to consider working with such small amounts of money themselves. Ironically, banks may be better off with a well-functioning financial system that is able to avoid swings of inflation and recession, or, worse yet, stagflation, than trying to squeeze pennies out of the system by using their political influence to block a more effective monetary policy system that uses interest rates on small savings accounts as a return-on-savings tool to draw money away from spending when excessive demand is driving up prices and causing excessive inflation. In times of weak demand and a threatening recession, the central bank could inject money directly into these accounts for everyone with a US Social Security number. 

US Treasury I-bonds already compete for deposits

Moreover, the United States government already offers already offers a high interest rate savings vehicle in the form of US Treasury Series-I bonds. Most people don’t even know about these government I-bonds because there is no secondary market for I-bonds, which must be purchased directly from the U.S. Treasury. However, no money can be withdrawn from these 30-year bonds during the first year and there is a three-month interest penalty for withdrawing money from the second through fifth year. These restrictions on early withdrawal make these I-bonds unsuitable for most Americans who need immediate access to their money in the event of an automobile accident, a medical emergency, a cut in work hours, a job loss, a sudden rent increase, or some other unexpected financial difficulty. However, the existence of U.S. Treasury I-bonds establishes government sponsored savings as a legitimate activity of the federal government in competition with private banks.

One thing about CBDC savings accounts and U.S. Treasury I-bonds needs to be made crystal clear. No matter how high the interest rate offered, if the people with the highest marginal propensities to consume don’t know about them, such accounts or bonds will be useless in stopping inflation. Just as War Bonds had to be vigorously promoted during World War II, these high interest rate accounts and bonds must be advertised in all the media accessed by those with the highest marginal propensities to consume. Ultimately over 50 percent of Americans purchased World War II War Bonds as a result of the widespread promotional activities which included celebrity performances and advertising during athletic contests in addition to billboard and media advertisements.

If we are serious about getting people to save money and cut back on their spending to reduce the inflationary pressure that is driving up prices, while at the same time avoiding a recession, we need to provide an equally vigorous promotional campaign to get especially lower-income Americans who are the ones with the highest marginal propensities to consume less and to invest money in CBDC accounts instead of using that money to increase consumer demand and further drive up prices during periods of excessive inflation. These CBDC savings accounts will not only provide individuals with a source of funds for emergencies but will also in aggregate provide the nation as a whole with greater economic stability by providing an automatic stabilizer.

Central Bank Digital Currency as a Monetary Policy Tool

While the Federal Reserve is trying to decide whether to recommend that Congress authorize creating a central bank digital currency (CBDC) for the United States, many other countries have already committed to creating their own CBDCs to avoid having their currencies replaced by Facebook’s Diem or some other stablecoin that has established or will establish strong financial networks. Dubbed “FedAccounts,” a Federal Reserve CBDC would provide a basis for a new return-on-savings monetary policy tool.

To serve as a tool for monetary policy, a Federal Reserve CBDC would need to be account-based (“FedAccounts”) as opposed to token-based. To protect individual privacy, while still deterring criminal behavior, the names and identifying information of account holders (including some personal transactions) would be kept in a separate file from their general transaction histories. The two files would be linked by a 60-digit alphanumeric code. If authorities observed suspicious activity in the general transaction histories, they would need a judge’s permission to access the corresponding identifying information file.

In addition to the 60-digit alphanumeric code, the transaction histories file would contain a single-digit yes-or-no dummy variable indicating whether this account had an associated Social Security number. This would be important, because only accounts with an associated Social Security number could earn a high positive interest rate during an inflation and that positive interest rate would only apply to a base amount of no more than $10,000. If $12,000 were in an account with a Social Security number, only the first $10,000 would earn the high positive interest rate, while the remaining $2,000 would be subject to a negative interest rate, as would all the money in accounts without a Social Security number. Anyone in the world could use US dollars to create their own US Federal Reserve “FedAccount.” People in Zimbabwe or Venezuela experiencing very high inflation in their local currency may be glad to pay a small or modest negative interest rate for the security and safety of holding their money as US dollars in FedAccounts.

To stop inflation the Federal Reserve has been raising the cost of borrowing, which suppresses supply as well as demand. Businesses that can’t afford the higher cost of borrowing may have to cut hours, lay off employees, or close outlets. Lower income people are generally the ones with the most debt so they get hit the hardest when the cost of borrowing goes up. If the economy slows because of the rate increase, it is the lower income people who are most likely to be unable to make their mortgage payments and lose their homes to foreclosure.

The current world-wide inflation is due in large part to the COVID-19 supply disruptions which are continuing. We have forgotten when we had to absorb excess demand to fend off inflation in the face of the mother of all supply disruptions at the beginning of World War II. We suddenly had to transition from civilian cars and trucks to tanks, armored personal carriers, warplanes, and warships. We also had to send a lot of our young, male workforce overseas to fight the Nazis in Europe and Imperial Japan in Asia. We needed a way to absorb a lot of money that would otherwise go to consumer demand to ward off inflation. We did it with “Liberty Bonds.” Celebrities were singing and dancing in promoting “Liberty Bonds.” Billboards and radio broadcasts were intensely advertising “Liberty Bonds.” By the end of he war, about 50 percent of American families had purchased “Liberty Bonds.”

It would be great if we could do the same with U.S. Treasury Direct Series-I bonds. For six months ending October 31, 2022, the 30-year I-bonds were paying 9.62 percent interest. Beginning on November 1, 2022, I-bonds are now paying 6.89 percent interest. A major problem preventing I-bonds from absorbing excess demand to stop inflation is the severe withdrawal restrictions that I-bonds currently enforce. No withdrawals are allowed for the first year, and there is no secondary market for I-bonds. Withdrawals after the first year are heavily penalized up until the end of the fifth year. This does not work for marginal savers who need immediate access to their money in case of an automobile accident, a medical emergency, an unexpected increase in rent, or a job loss. Yet it is the marginal savers with relatively high marginal propensities to consume who can stop inflation by saving their money to reduce excess consumer demand.

An alternative approach would have been the postal savings accounts that existed under “The Postal Savings Act of 1910” where for 56 years from 1911 to 1966 anyone could go to any post office in the United States and set up a savings account. The amount of money allowed in these accounts was severely restricted so it was aimed at people with only small amounts of money to save. But, again, the marginal savers with relatively high marginal propensities to consume are the very ones we want to influence to save more and spend less. If these postal savings accounts still existed, they could be used to absorb excess demand to stop inflation without causing a recession by offering a very high interest rate and heavily advertising them.

To make these accounts as attractive as possible to lower-income people, any interest earned in the new CBDC “FedAccounts” should be tax free. Every baby born in the United States should be assigned a Social Security number and a FedAccount at birth with $1,000 put in it, which could not be withdrawn until age 70. However, any interest in the account could be withdrawn at any time along with any additional money put into the account. This would make these CBDC accounts as attractive as possible. With everyone having a FedAccount, whenever someone cut your grass, mowed your lawn, or shoveled your snow, you could pay them instantly with a smartphone to smartphone transfer from your FedAccount to their FedAccount.

Finally, when an economic downturn comes, the Federal Reserve can use the FedAccounts with Social Security numbers to offer small low-interest-rate loans and give stimulus money directly to the people on Main Street to stimulate the economy as necessary instead of going through the New York financial markets on Wall Street. This new monetary policy CBDC tool would provide the Fed with more bang for the buck in controlling our economy more efficiently and more effectively in avoiding both recessions and excessive inflation.

( Note: Economists at the Bank of England have asked me to present my paper entitled: “New Central Bank Digital Currency (CBDC) Monetary Policy Tool” in their Bank of England session at the American Economics Association Conference in New Orleans on January 8, 2023. If you would like to see the abstract (“View Abstract”), the PowerPoint slides (“Presentation”), or the paper itself (“Preview”), you can find them at this link: )

Larry => be sure to go into html mode in MailChimp to hyperlink both this tinyurl and the link to this ND Economist commentary.

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