The Digital Pound

I read the recent papers the BoE released about their digital pound/retail CBDC and thought it worth commenting on the bits I found interesting.

The 1797 cartoon by James Gillray portrays William Pitt the Younger, the Prime Minister of the era, as a devious and manipulative character. Pitt is seen seducing an elderly lady who represents the Bank of England, but his true intention is to forcefully acquire the Bank’s valuable gold reserves.

Contemporary politicians want to use the BoE to harvest data, though the possibilities don’t end there.

The retail CBDC – what you didn’t know you wanted

The retail CBDC, or digital pound, has moved into its next phase of development and though a decision hasn’t been made yet on whether to actually ship it, it will now be developed ready for 2025 at the earliest. It seems unlikely all this work will go to waste. But then all this is funded by the Cash Ratio Deposit scheme, which has an ICO/pre-mine feel about it.

The angle the BoE takes on its retail CBDC development is this:

Cash is being used less and less in a digital economy > we need to keep ‘public money’ an available option > recognises utility of new forms of payment > CBDC allows us to provide this utility ourselves, in our walled garden.

So rather than presented as a new development that provides a step change in control, it is framed as a way of maintaining a state of affairs that is sadly disappearing as fewer transactions happen in cash. And to allay fears, cash is not being removed but complemented by the digital pound. But would a transition not be expected to begin in such a way?

Public money vs. private money

The reason this is a problem, from their perspective, is that there is public money and there is private money. Public money is central bank money – commercial banks’ reserves held at the BoE plus cash/coin. This is often called narrow money or monetary base. Private money is everything issued by the commercial banking sector in form of deposits, usually referred to as broad money.

The first question somebody interested in bitcoin would have is: what is the use in this distinction? Isn’t every claim to a pound public money, because the pound is a gov’t monopoly currency that is currently issued, by gov’t decree, only by the BoE and the commercial banks that agree to adhere to its rules?

This is all true, but the question is begged. None of the above is considered anything but a given for money. So the distinction is made to delineate the difference in financial risk. BoE issued money, public money is described as ‘financially risk free’ because there is no counterparty at risk of default. Commercial banks however can (nominally) go out of business, so deposits are not ‘financially risk free’.

Given the actions of the BoE since 2008, the likelihood that it would allow private money to disappear as the result of bank failure appears slim. For a start, there is deposit insurance up to £85k. Secondly, lender of last resort action tends to lead to the depositors being made whole even if the bank ‘goes out of business’ and its assets are bought by other firms. A reduction in broad money is something that has no positive corollary in the current paradigm of mainstream economics.

The public-private distinction as the BoE would have it is a misnomer. The only autonomy a commercial bank has over the integrity of its deposits is the level of liquidity it has to satisfy redemptions – and this is heavily regulated by the state’s regulatory bodies including the BoE! To characterise a deposit that is a claim on monopoly issued currency as a private money is just not the traditional meaning of the term ‘private money’.

A real private money would be bitcoin. Or something like a bill of exchange issued by a private bank and widely accepted in trade. Or competing currencies in a free banking system. You could argue there is a grey area as something like Tether USD is a more a private money than a bank deposit as it is operated outside the regulatory reach of the Fed – but the price of the unit itself is obviously public if the peg is maintained (which is not guaranteed at all, unlike a deposit).

A public-private partnership

The public/private words are also used in another context in the report. The CBDC project is pitched as a public-private partnership. The digital pound itself, like the cash it will complement, is public money. But the public will interface with it via ‘Private Interface Providers’, which are basically KYC/AML collection apps. My initial thought on these is that they are unnecessary middlemen and have a horrible business model; they are required to harvest user data thanks to the aforementioned regulatory demands (whose effectiveness is terrible but the intention of a policy seems to be the only thing that matters), and of course they will sell this data. That will be their primary revenue stream unless they charge usage fees – judging from social media usage preferences, providers who hide the cost of their service by harvesting and selling data will tend to outcompete those who charge an upfront fee.

The BoE sells the public-private aspect as playing off what the two sectors do best; the state issues highly trusted money and the private sector gets to ‘innovate’ within the area granted it by the state. The former is hardly worthy of comment, but there is clearly a hope that the PIPs develop functionalities that reduce demand for real private monies like bitcoin. Hoped for innovation is basically anything currently being done on the Lightning Network, like micropayments. They use an ugly term for things like this: embedded finance.

It isn’t clear that the BoE understands why there is demand for bitcoin. The desire for money not controlled by politics and ‘policymakers’ and not created at nil opportunity cost with privilege granted to certain parties. They really believe a system using the same ever-increasing units, with gatekeepers required to do the state’s data collection dirty work, is worthy to take the sting out of demand for bitcoin.

Given the demand for money consists of both its exchange and reserve demands, the strategy seems to be to eat into the exchange demand for bitcoin. If they can make a functional and easy to use digital money – and they should be able to given it is fundamentally a centralised database without any of the engineering challenges faced by p2p distributed systems – this will eat into the exchange demand (medium of exchange) for bitcoin. Although LN has greatly increased the flow of sats, most demand for bitcoin remains as reserve demand (e.g. store of value/speculation).

Whether or not this is effective remains to be seen, but the strategy appears to be validation of all the achievements we’ve seen in bitcoin. It would be remiss of the BoE not to try and outcompete challengers on its own turf – but then it has been remiss in meeting its inflation targets. Plus, bitcoin is a global market money whereas the pound is a minor money used exclusively within the borders of the UK.

A limit on digital pound holdings

The paper mentions the limit on holdings, undecided but probably between £10-20k. This is the kind of thing that grabs the attention as it sounds insane. The reason given is that unlimited digital pound holdings would lead to deposits fleeing the banks, which would reduce bank reserves and possibly lead to depressed bank lending as wholesale funding replaces the cheaper deposit funding. The BoE has been writing papers about this ‘bank disintermediation’ and isn’t sure exactly what to think of it. So the limit reflects the potential threat to financial stability that comes with the public being able to very easily acquire central bank liabilities without going to withdraw a load of cash from the ATM, which is daily limited in any case.

Of course, movement between deposits and the digital pound would have no effect on the quantity of money. It would just change the composition between base and broad money, or public and private in the new parlance, which I haven’t heard before outside the context of genuinely privately issued non-state money. I wonder if this is a narrative angle to obfuscate between what it actually means to be a private as opposed a state/gov’t/public money.

I grant that it seems reasonable for the BoE to worry about the economic impact however, as reductio ad absurdum, all deposits could disappear for digital pounds – total bank disintermediation and no bank lending. But this is silly, as there’s no reason to believe that somehow the demand to hold real money balances becomes materially different just because a digital pound exists. Demand for investment would still exist, and in this world prices would be far lower – note this is irreconcilable with the ‘inflation targeting’ regime and Keynesian ideas about deflation spirals etc. But even if demand deposits were replaced by digital pounds, term deposits would still exist to satisfy investment demand, as would peer to peer lending, equity, and bond raises. This is a long way outside the Overton window of mainstream economics and into the fractional vs. full reserve banking argument – not something a central bank is ever going to entertain.

More to come

There is more to comment on, particularly some of the other mentions of bitcoin and ‘distributed ledger technology’, the digital pound as a ‘bridging asset’, bizarre comments on value theory, monetary policy possibilities etc.