The complete digitization of the currency becomes worthless

Digital euro: plans of the ECB

CBDCs, cryptocurrency and stablecoins

The various CBDCs currently being considered and tested differ considerably in their design. CBDCs should not be confused with cryptocurrencies or stablecoins. An example of the latter is Facebook's Diem, also known as Libra. Stablecoins are expressly backed by government currencies or securities, although they are issued and controlled by private networks. Cryptocurrencies such as bitcoins and ethers are not covered. Its proponents see great potential in circumventing government controls and hope that uncovered government money could become worthless for the foreseeable future. In contrast, CBDCs are simply new forms of conventional uncovered government money, as a paper published by the ECB in October shows:

"[...] a digital euro - an electronic form of central bank money that is accessible to all citizens and businesses. A digital euro would be introduced alongside cash, it would not replace it."

Reasons for CBDCs diverse

Although the ECB's paper does not go far beyond this definition, we assume that different central banks are interested in introducing digital versions of their currencies for different reasons. Some openly say they are preparing for a cashless society. Others see the development of a competitive market for faster payments than is currently possible with conventional interbank processing systems. For more authoritarian regimes, the increased ability to monitor activities could be a reason for the introduction of CBDCs.

Light and shadow for consumers

The average consumer will not be bothered by transferring money in supermarkets in the future without using conventional bank accounting systems. On the other hand, he will be concerned if Big Brother refuses to pay with the third beer in the bar with the words "You have already had too much to drink". Commercial banks will be concerned about their profits from payment and settlement businesses. However, you will likely feel that you can influence your central bank enough to favor a CBDC from your central bank, as long as it keeps competitors like PayPal in check.

In other words, the shape of CBDCs and their impact on society can vary greatly depending on the central bank's goal. However, the ECB does not appear to have decided on its objectives yet. A simple comparison between the statements of the ECB and those of the People’s Bank of China (PBOC) makes this clear.

E-Euro should help with digitization

The ECB's thinking seems to be primarily focused on the payment system:

"A digital euro would create synergies with private payment solutions and contribute to a more innovative, competitive and resilient European payment system."

As we are told, an electronic euro would also help with the digitalisation of the European economies that is being sought. After mentioning these advantages, the ECB's paper shows a number of risks and requirements that should be taken into account in the design and implementation. An electronic euro should be able to be used for both online and offline payments. The reference to offline payments implies transactions outside the banking system - for example through prepaid cards onto which central bank money can be loaded.

Little concrete

Other questions remain unanswered. For example, nothing is said about the mechanism by which e-euros should be created and whether or how anonymity should be guaranteed. It also remains open whether the e-euro should have the status of legal tender. More information will likely be announced in summer 2021. Nevertheless, the question arises why the ECB publishes such an unsatisfactory report. There are three possible reasons for this:

First, Facebook's Diem / Libra project has put senior officials within the Eurosystem on high alert. They fear that stablecoins could become competition for the euro. The ECB paper emphasizes several times the importance of the control of the European payments system and monetary policy by the ECB.

Second, China's plans for a CBDC. The ECB paper does not explicitly refer to the project from the Far East, but refers to "foreign central banks".

Third, the ECB wants to demonstrate its competence and demonstrate that its task force has been active for some time.

People’s Bank of China is moving forward

In contrast to the reluctance of the ECB, the PBoC announced in June that, after six years of research and preliminary tests, it was now on the verge of introducing its digital currency as part of the so-called Digital Currency Electronic Payment (DCEP) system. The digital currency is intended to improve the international use and status of the renminbi and expand the control options of the PBoC. In addition, greater independence from the two most important global clearing and settlement platforms for the Renminbi - CHIPS and SWIFT - is being sought, both of which are perceived as being under American influence.

The following details on the DCEP have been released: Trade and retail will have access through the four major state banks as well as non-banks such as Alibaba and Tencent. All merchants currently accepting payments from these non-banks must accept the DCEP.

Another initiative supported by the Chinese government is the development and use of blockchain technologies. The DCEP transaction book will be a fully centralized blockchain that will be overseen by the PBoC and its approved partners. Skeptics wonder why a blockchain should be used when the application is centralized and anything but anonymous? The DCEP will operate entirely outside of the commercial banking and payments system and could be an option for 1.7 billion citizens of the world who, according to World Bank figures, do not have access to the banking system but have cell phones.

Does E-Euro shake banks?

The Chinese authorities appear to have designed a digital currency to divert retail deposits away from the banks. The Chinese, however, are not very concerned about the possible collapse of a major bank.

The problems facing the ECB are different and make one sit up and take notice. The latest research by DZ Bank confirms our fears that the doom loop is accelerating - 100 percent of the new Spanish national debt in 2020 was bought up by the Eurosystem, only a fraction less for Portugal. Both countries would have defaulted on their debts in the past nine years without bailouts. The fact that bond yields in these two countries have fallen from over 1.5 percent two years ago to around 0 percent today shows how market forces are being undermined by the policies of the ECB. The ECB fears that the digital euro could destabilize the market for government bonds. If assets in digital euros were to earn interest at zero percent, there would be less demand for member states' bonds that yield less than 0 percent interest.

Are fees planned?

Not only are the eurozone commercial banks in bad shape themselves, they are critical to the continued existence of the doom loop problem. The ECB cannot move deposits into an electronic euro without exacerbating the problems it is trying to get under control with its expansionary policy.

According to the ECB paper, the risk of bank runs can be addressed in two ways, only the second being feasible. Firstly, by making a digital euro available only through intermediaries, presumably banks. However, as long as e-euros are not in wallets that banks have no access to, customers would not bother to open an e-euro account. Second, about pricing. The ECB is considering a "staggered remuneration system", presumably with a negative remuneration, which weighs more heavily the higher the assets held in e-euros. Investments in the e-euro could be deterred without undermining its function as a means of payment.

Popular cash

Given the non-binding nature of the ECB and the fact that the US Federal Reserve sees a digital dollar as unnecessary and irrelevant, China appears to be the only serious player in the CBDC landscape at the moment.

Although the ECB appears to be constrained by its publicly voiced concerns, it may feel obliged to do something to maintain public confidence in the effectiveness of its current policies and in the stability of the system. If this is the case, we expect a digital offering that is centrally controlled, with negative interest rates for higher portfolios and, above all, is a prestige project. The volume will be manageable and will do little to counteract the decline in the value of banknotes and coins on the liabilities side of the ECB's balance sheet.

There are large differences in the use of cash in the euro zone: in the Netherlands, the share of cash in transactions is relatively low (46 percent), but in nine countries (including Spain, Italy and Germany) it is 80 percent or more . For the time being, this discrepancy rules out any hidden intention on the part of the ECB to abolish cash and make bank runs fundamentally impossible. This naturally raises the question of how the ECB, without replacing cash with an electronic euro, can continue to lower interest rates in the future.

Image: Fabian Kurz
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