The US lawmakers who grilled Facebook boss Mark Zuckerberg for six hours last week appeared to speak from a position of power.
But the tough talk could disguise fundamental weakness. The stark reality may be that national governments and central banks are already losing control of the global monetary system.
National governments are in a bind, say the economists
That’s the apparent conclusion of a recent research paper, ‘the Digitalisation of Money’, from Markus Brunnermeier and Harold James of Princeton University and Jean-Pierre Landau of Sciences Po.
The monetary future outlined by Brunnermeier, James and Landau is one of upheaval and revolutionary change, in which even powerful countries no longer have the upper hand.
National governments are in a bind, say the economists. Those that fail to keep up with the global trend towards digitalisation may see their own currencies fall from use altogether.
“Countries that are socially or digitally integrated with their neighbours may face digital dollarisation,” say Brunnermeier, James and Landau.
Dollarisation has occurred in the past when citizens of countries with unstable currencies have ditched them wholesale in favour of a more reliable unit—such as the US dollar—issued abroad.
At the same time, we can expect successful digital currencies to operate increasingly outside the control of individual nations, Brunnermeier, James and Landau predict.
“The prevalence of systemically important platforms could lead to the emergence of digital currency areas that transcend national borders,” the economists say.
Splitting the functions of money
Why is national control of monetary systems proving so unstable?
The answer lies in new digital currencies’ ability to split the traditional functions of money: store of value, medium of exchange, and unit of account.
In future, digital money may specialise in providing particular services, say Brunnermeier, James and Landau.
“Digital currencies feature innovations that will unbundle the functions served by money, rendering the competition among currencies much fiercer,” they say.
Up to now, government-issued national currencies, such as the dollar, yen, euro or pound, have tended to provide all three functions of money simultaneously. But this is unlikely to be the case with new digital money, predict the economists.
“Digital currencies may specialise and compete exclusively as exchange media or exclusively as stores of value,” they predict.
And this unbundling will leave the operators of large-scale internet platforms in a powerful competitive position, the economists say.
These firms will be able to reintegrate certain traditional functions of money, such as providing a means of payment, with other services, such as data gathering and social networking, say the economists.
“In a digital economy, cash may effectively disappear”
China, for example, is already showing the rest of the world how mobile apps can offer a variety of services, such as messaging, taxis, food, shopping and dating, in addition to payments.
The rapidly growing trend towards mobile-based digital money is likely to lead to the establishment of ‘digital currency areas’ that operate cross-border, say Brunnermeier, James and Landau, while outside the control of national governments.
National governments and central banks may be wrongfooted in other ways too, say the economists.
One immediate challenge for policymakers is consumers’ and merchants’ flight from the use of cash. Another is central banks’ likely loss of a key steering wheel—their ability to manage the economy via credit supply and interest rates.
“In a digital economy, cash may effectively disappear, and payments may centre around social and economic platforms rather than banks’ credit provision, weakening the traditional transmission channels of monetary policy,” the economists say.
CBDC—not a risk but a necessity
In such circumstances central banks should view the introduction of their own digital currencies (central bank digital currency, or ‘CBDC’ for short) as a necessity, rather than as a risk, say Brunnermeier, James and Landau.
Up to now, many central banks have shown reluctance to distribute digital versions of their national currencies amongst the general public for fear of destabilising the banking system.
However, say Brunnermeier, James and Landau, introducing a CBDC may now be national governments’ only option if they wish to retain some control over their own monetary systems.
“The introduction of CBDC may restore some power to the monetary authority without requiring the direct regulation of new currencies,” say the economists.
However, if national governments and central banks fail to proceed with their CBDC plans, we may see a fracturing of money in more ways than one.
For example, say Brunnemeier, James and Landau, we may be heading for a future where the moneys of different private issuers are no longer anchored and fluctuate freely in competition with each other.
This would place an additional burden on the users of money when it comes to payment, for example, say the economists.
“The creditworthiness of each issuer would have to be continually re-assessed in order to value monetary instruments,” they say.
“Payments could become segmented into different categories of instruments according to the reliability of the issuer.”
This would bring the world back to the ‘free banking’ era seen in the past in the US, Scotland and other countries.
Under free banking, deposits at different banks with the same nominal value have different market values, there is no lender of last resort and there is no state insurance of deposits.
And a more fundamental shift would take place if people started using new digital currencies, rather than national moneys, as their long-term units of account, say Brunnermeier, James and Landau.
“The unit of account permits agents to communicate value in an easily understandable way. It is, in a sense, like a common language,” they say.
If national currencies lost their unit of account role, “the power of monetary policy may be severely impaired,” say the three economists.
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