Originally published at Project-Syndicate | March 9, 2021
Recently, the idea of a digital greenback elicited support from US Treasury Secretary Janet Yellen and Federal Reserve Chair Jay Powell. Ultimately, the advantages of a digital dollar will need to be weighed against the potentially high costs and significant risks to the financial system that come with it.
BERKELEY – The idea of a digital dollar has been in the air for some time now. Recently, it descended from the ether to the lips of US Treasury Secretary Janet Yellen and Federal Reserve Chair Jay Powell. At an event in February, Yellen flagged the idea as “absolutely worth looking at,” adding that the Federal Reserve Bank of Boston, in conjunction with academics at MIT, was already doing so. In Congressional testimony the following day, Powell called a digital dollar “a high priority project for us.”
Some see this as another front in the technological cold war between the United States and China. The People’s Bank of China (PBOC) will almost certainly be the first major central bank to roll out a digital currency, in 2022 at the latest. If the US doesn’t move quickly, it will fall behind. America’s financial system will remain stuck in the twentieth century, damaging US competitiveness. The dollar’s position as the dominant international currency will be eroded by the ease of using China’s digital unit in cross-border transactions, and the US will squander a singular source of monetary and financial leverage.
In fact, such concerns are either overblown or flat-out wrong. The PBOC’s main motivation for issuing a digital renminbi is to create a government-controlled alternative to two very large and loosely regulated digital payment platforms, Alipay and WeChat Pay.1
The ubiquity of Alipay and WeChat Pay raises the specter of the Chinese authorities losing control of payment flows through the economy. And because they use information on payments to inform their lending activities, their pervasiveness points to the possibility of the authorities losing control of financial flows and credit allocation more generally. Thus, the PBOC’s determination to issue a digital currency is part and parcel of the Chinese government’s decision last November to quash the initial public offering of Ant Group, Alipay’s corporate parent.
The American government has no analogous worries. In the US, scores of different platforms, such as PayPal, Stripe, and Square carry out digital payments, which are ultimately settled by banks, and hence through Fedwire, the Federal Reserve’s in-house system for clearing interbank transactions. Visa, Mastercard, Discover, and American Express process the lion’s share of card-based payments, but their actual cards are issued by banks, which are regulated, limiting risks to the payments and financial system. Here, too, settlement occurs through Fedwire.
Similarly, it is important to bear in mind how far the renminbi lags behind the greenback as an international currency. Currently, China’s currency accounts for a mere 2% of global cross-border payments, a negligible share compared to the dollar’s 38%.
To be sure, the convenience of a digital renminbi would hasten its uptake in cross-border transactions. But that digital currency might also have a hidden backdoor, enabling Chinese authorities to track transactions and identify those undertaking them, discouraging use by third parties. Given this, it’s hard to see China’s digital currency as a game changer internationally.
So, the decision to create a digital dollar would have to be justified on other grounds. The soundest justification is financial inclusion. Americans without credit cards and bank accounts, who rely entirely on cash, are denied not just financial services but other services as well. Rideshare companies ask you to link your app to your credit or debit card; no card, no pick-up. And no bank account, no card.
In this context, recall the difficulty the US Treasury had in getting pandemic relief checks to the unbanked. If everyone had a Federal Reserve-issued electronic wallet into which digital dollars could be deposited, this problem would be solved.
Digital dollars could also address the exorbitant cost of cross-border money transfers. But foreign governments might be reluctant to permit their nationals to install the Fed’s digital wallet, because that would leave them and their central banks unable to enforce their capital controls, which they value as macroprudential tools.
Alternatively, the Fed’s digital wallet could be made interoperable with foreign digital wallets. But interoperability would require close cooperation between central banks on the details of technology and security. While there are efforts in this direction, making it work would be a daunting task, to say the least.
Ultimately, such advantages should be weighed against the costs and risks of digitizing the dollar. If people shift their savings from banks to digital wallets, banks’ ability to lend will be hamstrung. Some banks will close, and small businesses that rely on banks for credit will have to look elsewhere.
Moreover, a Fed-run network of retail payments would be a rich target for hackers and digital terrorists. Security and financial stability are of the essence, and it is not obvious that they can be guaranteed. All this is to say that while the case for a digital dollar may be worthy of examination by Yellen and Powell, it is hardly a slam-dunk.
Barry Eichengreen: Is a Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His latest book is The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era.
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