Enough with the “Britcoin” already!

Yesterday we were chatting about the Governor of the Bank of England’s comments about central bank digital currency. I said I thought this was a good thing. Other people think the same.

The new Positive Money report on Digital Cash recommends that central banks should issue digital cash for six main reasons: it widens the range of options for monetary policy, it can make the financial system safer, it can encourage innovation in the payment system, it can recapture a portion of seigniorage, it can help to develop alternative finance businesses and it can improve financial inclusion.

From Are central banks a relic of the Industrial Revolution? | Consult Hyperion

As it happens, Dr. Ben Broadbent, who deputy governor of monetary policy at the BofE, appeared before the Lords economic affairs committee today. He was scheduled to

“explore the prospect of a central bank digital currency and the effect it could have on commercial banks”.

From House of Lords asks BofE deputy governor: Time for ‘Britcoin’?

This was part of a session that also included evidence from my good friend Simon Taylor, formerly of Barclays Bank, and the noted financier Blythe Masters who is in charge of Digital Asset Holdings (DAH) and you can see it all online here.

Houseoflords

 

 

 

 

 

 

OK, so far so good. I’ve written about this topic in exhausting detail before, and the truth is I’m rather a fan of a strategic and planned shift towards digital currency. But the article goes on to say…

Earlier this year Broadbent floated the idea of using distributed ledger technology to enable individuals to hold digital currency accounts with the central bank.

From House of Lords asks BofE deputy governor: Time for ‘Britcoin’?

Surely use or otherwise of distributed ledgers is tangential and irrelevant to the issue of digital currency. The payment mechanism has nothing to do with the currency. So, if Dr. Broadbent means that the Bank is thinking of using a shared ledger to manage personal accounts for individuals, where account transfers are settled instantly in central bank balances, then all to the well and good.

I simply do not see the efficiency of “a digital form of legal tender” as being evidence that the government might issue a UK cryptocurrency as some in the Bitcoin world have said.

From Britcoin or Brit-PESA? | Consult Hyperion

On the other hand, if Dr. Broadbent means that the Bank his going to set up a shared ledger that will be implemented using a blockchain that incentivises consensus-forming work with an on-chain asset (i.e., a Bitcoin-like Britcoin) then I think he must have been inadequately briefed. Why on Earth would a central bank abandon its money supply management duties to a cryptographic algorithm? That makes no sense at all.

Since the latter explanation is implausible — and if you listen to his evidence to the Lords you will notice that deputy governors of the Bank of England are very well-briefed indeed — the only explanation for the “Britcoin” tag is journalists confusing digital currency and cryptography and jumbling up the use of double-permissionless shared ledgers with double-permissioned shared ledgers. I suppose it’s an easy mistake to make, so let’s put it to bed once and for all. Here is  a handy cut-out-n-keep guide:

Birch-Brown-Parulava Colour

 

Would the Bank of England get behind a Sterling-backed Bitcoin? I think not. In fact, I think I’m coming round to Robert Sam’s thinking about the role of Bitcoin in the greater scheme of things with respect to the co-evolution of money and technology. Robert wrote a very good note about this called “Some crypto quibbles with Threadneedle Street” in response to one of the early Bank of England research notes about Bitcoin back in 2014, suggesting that, as he put it, “digital currency with a deterministic money supply function” is not a feature but a limitation of early cryptocurrency designs (and that a capped supply function such as Bitcoin’s is a “bug” on economic grounds).  

As to the key question of whether a central bank or someone else should provide money, Robert alludes to the problem with the marginal cost of the production of competing private monies, what I often refer to in blog posts and talks as the big problem of small change. The problem is this. If privately produced money is successful as a means of exchange and earns a profit for its producer in the form of seigniorage (it is hard to see how cash replacement can earn transaction fees so in the long term I imagine these to be asymptotic to zero) then it will invite competitors and those competitors, provided the monies they produce are reasonable substitutes for each other, will drive down the cost of the private money to its marginal cost of production. In our digital world, however, the marginal cost of production is to all intents and purposes zero and so that private companies will bail and only the state can deliver the a sustainable money as a means of exchange (remember, this has nothing to do with it being a currency or not).  

Hence it is very difficult to imagine how competing private currencies that are nothing more than direct substitutes for national fiat currencies can obtain any traction at all. This nudges me further towards thinking that if the imperfections of fiat currency are to be addressed in the free market it will be by currencies that are more closely linked to the communities that use them and that embody some values of those communities. I often use the example of a gold-backed interest-free electronic currency for the Islamic diaspora as a simple thought experiment, a sort of hard ECU for the new millennium, a currency that will be widely used but never exist in physical form.  But that’s for another time.

Suppose, however, that we stay with fiat currency and central banks. Now, if Bitcoin is to be used in that role (i.e. as a medium of exchange) it’s volatility is undesirable but that does not mean that it needs to display the long-term stability that is required of a store of value. That’s a different function of money and can be implemented in a different way. It does however mean that Gresham’s Law will come in to play and drive Bitcoins out of the marketplace (to speculators, at least in the short term) and that no-one will hold them for transaction purposes. As far as I can tell, this is where we are now anyway.  

So what does all of this mean? Well I’m not sure I have any more insight into this than any other commentators but my take on it is that while the marginal cost of production of Bitcoin is undeniably higher than the marginal cost of production of other kinds of private money, that doesn’t really mean anything because Bitcoin will never be used as money in the same way. On the other hand it does mean that it is hard to imagine why anyone who wants to produce private money, and in particular a digital version of a fiat currency, will use it even if they want to use a shared ledger for other reasons (something I personally favour). On the contrary, since we have no reason to suspect that the proof-of-work and blockchain structure is the best consensus mechanism, it seems more likely that if (say) the Bank of England were to decide to implement a digital sterling, then it is highly likely that they would use some other mechanism that relies on validators (e.g., commercial banks) rather than miners. Let’s come back to this in a minute.

I don’t think there’s ever going to be a Britcoin. Central-bank digital currency is about balances and an appropriately private protocol for moving value between accounts. My prediction is that this would look more like the bastard child of Ripple and M-PESA than a blockchain cryptocurrency with a 1-1 reserve in Sterling. And guess what…

As I was sitting down to finish off this post, what should flow in through the internet tubes but  Bank of England Staff Working Paper No. 605 by John Barrdear and Michael Kumhof, “The macroeconomics of central bank issued digital currencies”. This is referred to in Dr. Broadbent’s evidence to the House of Lords. It says that (amongst other things) that 

We study the macroeconomic consequences of issuing central bank digital currency (CBDC) — a universally accessible and interest-bearing central bank liability, implemented via distributed ledgers, that competes with bank deposits as medium of exchange. In a DSGE model calibrated to match the pre-crisis United States, we find that CBDC issuance of 30% of GDP, against government bonds, could permanently raise GDP by as much as 3%, due to reductions in real interest rates, distortionary taxes, and monetary transaction costs. Countercyclical CBDC price or quantity rules, as a second monetary policy instrument, could substantially improve the central bank’s ability to stabilise the business cycle.

Did you see that? Permanently raise GDP by as much as 3%. Scatchamagowza. Permanently raise GDP by as much as 3%. Why aren’t we doing it right now! Let’s draw a line under the money of the past and focus on the money of the future.

Money Typology v2

 

I’ve read the working paper and while I don’t understand the economic model at the heart of it (I have no idea what “credit cycle shocks policy rate corridors” are) I do understand the implications and the observations of the authors. I have come to similar conclusions but from the technological direction. Since the observations of the Bank from an economic perspective correlate so closely with my observations from the technological perspective (I think I may have mentioned that I’m writing a book about this at the moment) I think I’ll finish here just by highlighting a few key points that I have mentioned on the blog before.

  1. A monetary regime with central bank-issued national digital currency (i.e., digital fiat) has never existed anywhere, a major reason being that the technology to make it feasible and resilient has until now not been available. 

  2. The monetary aspects of private digital currencies (a competing currency with an exogenous predetermined money supply) are undesirable from the perspective of policymakers. Also the phrase “digital currency” is perhaps a regrettable one as it may invite a number of misunderstandings among casual readers.

  3. Digital fiat means a central bank granting universal, electronic, 24 x 7, national currency denominated and interest-bearing access to its balance sheet. The Bank says that they envisage the majority of transaction balances will continue to be held as deposits with commercial banks and observes as I did above that digital currency has nothing to do with shared ledgers, distributed ledgers or blockchains.

  4. The cheapest alternative for running such a system would clearly be a fully centralised architecture (M-PESA in Keyna is the obvious example) but as the Bank notes this will come with increased resiliency risks that are likely to be deemed unacceptable. However, options that are distributed but permissioned would provide an improvement in the efficiency of settlement and serve to improve resiliency relative to the status quo, both of which would represent a reduction in cost the real economy.

  5. The key feature of such a  permissionless shared ledger system is that the entire history of transactions is available to all verifiers and potentially to the public at large in real time. It would therefore provide vastly more data to policymakers including the ability to observe the response of the economy to shock sort of policy changes almost immediately.

There is no sane argument against digital fiat. Let’s get on with it. And let’s have no limit on the number of different currencies that the ledger might hold.

Cashless as Count Zero

Speaking at this year’s World Economic Forum in Davos, John Cryan (the co-CEO of Deutsche Bank AG), said that cash could become history “within a decade”, going on to note that it is terribly inefficient. Mr. Cryan also focused on the way in which cash supports the underground economy.

Cash should be dematerialised, he said in a panel on the future of finance – and governments should be interested in this process because it would make transitions more traceable and would help to combat illegal financing or money laundry.

[From Bank chief: The end of cash could happen within a decade EurActiv]

Yes, all good reasons for getting rid of it. Hence it seems to reasonable to ask, and were I to have been present in Davos I would certainly have asked, why it is that central banks keep pumping the stuff out? On Deutsche Bank’s home turf, for example, cash is already undermining the law-abiding majority.

As even the most cursory examination of the statistics shows, virtually none of this cash is used to support the needs of commerce (the Bundesbank estimated that only 10-15% was used for this) and the rest of it is unexplained , as they say.

[From Behind enemy lines Consult Hyperion]

This tallies with the Bank of England’s estimates that perhaps a quarter of the cash in circulation in the United Kingdom is for what they call “transactional purposes”. So in two of the world’s largest economies, at most a quarter of the cash out there is actually used as a medium of exchange. And this fraction is, as you might imagine, steadily falling as cash is replaced at POS and, increasingly, in inter-personal transactions. I just paid Vic Keegan the money I owed him for the football on Saturday using my bank’s app and I can’t imagine how I might be persuaded to go to an ATM and draw out money to post to him instead.

Nevertheless, as cash is falling out of favour as a means of exchange, the amount of the stuff “in circulation” continues to grow. Here are the Bank of England’s figures for the UK over the last forty years.

Value of Bank of England Notes

So. Cash on the road to extinction? Well, as the chart above shows, there is now more cash than ever in circulation in the UK and the amount of cash as a fraction of GDP is trending up, not down. What on Earth is going on? More £50 notes than ever out there and I never see one from one year’s end to the next. Cash increasing as a proportion of GDP but falling as a share of retailer payments so, as we discussed here recently, who is using it and what for?

Look, I think Mr. Cryan is right, although probably not in the way that he means it. I mean that we will be effectively cashless in the timescale he discusses. Cashless in the Count Zero sense: cash will still be around and it will still be legal tender (although I don’t think people understand what a limited concept this is), but cash will disappear from polite society and from the daily lives of most people. The middle classes will never see the stuff. Although, to be frank, they pretty much don’t see it now as we are a debit card society.

He had his cash money, but you couldn’t pay for food with that. It wasn’t actually illegal to have the stuff, it was just that nobody ever did anything legitimate with it.

[From Count Zero – By William Gibson]

Assuming there still is a European Union in a decade then there will still be Euro banknotes and there will still be Eurocoins coins. But they won’t matter for business or for the economy. If this is the cashlessness that the Deutsche Bank co-CEO is imagining, then I’d say he is spot on. It’s a cashlessness that is too conservative to reap the benefits of a truly cashless economy, too disorganised to reign in the criminal exploitation of cash and too wedded to the symbolism of physical money to switch it off (just as we switched off analogue TV not that long ago).

Thus by “cashless”, I mean that cash has ceased to be relevant to monetary policy, become irrelevant to most individuals and vanished from most businesses. As we look to the future, we can begin to ask, quite reasonably, whether developments in digital payment technology and changes in payments and banking regulation will bring us to the point of this kind of cashlessness within, say, a generation as Mr. Cryan and I expect? The answer is probably yes, but that doesn’t mean we can’t take action to make sure!

That M0 rump cash (and I exclude various categories of post-functional cash from this definition) should be actively managed out of existence. Europe needs politicians to take this seriously and put forward concrete and reasonable plans to achieve effective cashlessness. In order to help them in this endeavour, I am gathering input from a group of colleagues to assemble a “Manifesto for Cashlessness” to put forward with my good friend Geronimo Emili from Cashlessway at Money2020 Europe in Copenhagen. Way back at the 1997 World Economic Forum in Davos there was a discussion about the electronic cash that attempted to cover all of the relevant topics and I’ve used it a few times because it provides a useful starting point for discussions. I’ve updated that list of issues and brought them together in a structure that I think rather helpfully identifies four key areas that I’m going to use to structure the manifesto (any more than four key points and no-one will remember them!) over the next couple of weeks.

Electronic Money Issues grey

So… if you have any comments on any of these issues please don’t be show and post them as comments on this post. I am genuinely interested to see what you think.

Where is the aggregate demand for cash coming from?

A few days ago, I happened to be at an event where the Chief Cashier of the Bank of England gave an interesting speech about the trajectory of banknotes. These are important to the Bank of England, because the note issuing department of the bank is the most profitable nationalised industry in history. And demand for their product continues to grow.

Aggregate demand for Bank of England notes has grown quickly, increasing by around three-quarters over the past decade, and has outpaced the growth in GDP since the 1990s. Today there are nearly three-and-a-half billion notes in circulation, totalling over £60bn.

[From Working together to deliver banknotes for the modern economy – speech by Victoria Cleland | Bank of England]

But what was most interesting to me about the speech, since I don’t care about plastic banknotes and Victoria seemed most unenthusiastic about my campaign to have Sir Thomas Gresham replace the Queen on all British banknotes when I told her about it afterwards, was that she gave up heads up on today’s Bank of England Quarterly Review (3Q15), in which the Bank looks at cash usage. In the same speech, Victoria said that while “demand for cash as a medium of exchange appears broadly stable, its use as a store of value appears to have grown… We estimate that around 20% to 30% of total UK cash was in, what we refer to as, the ‘transactional cycle’ – cash held by banks, consumers, and retailers for the purposes of facilitating everyday transactions”.

In essence she said that their latest figures show that only about a quarter of the cash that they put into circulation is for transactional purposes (i.e., used). The rest of it is either shipped overseas (i.e., exported), which we will put to one side for the moment, kept outside of the banking system (i.e., hoarded) or used to support the shadow economy (i.e., stashed). In other words, not in circulation at all but stuffed under mattresses.

UK banknotes GDP:ATM

If you look at the trend growth of that cash “in circulation” over the last few years it has accelerated well ahead of trend GDP growth as well as past trend ATM withdrawal growth. And we also know that the use of cash in retailing has continued to fall steadily so the “cash gap” between the small amount of cash that is used to support the needs of commerce and the large amounts of cash that are used for other purposes has been growing. The interesting question that the Quarterly Bulletin article by Tom Fish and Roy Whymark stimulates is straightforward: “if the majority of Bank of England notes are not being used for everyday transactions in the domestic economy, what are they being used for?”

I was invited to write a comment piece on this for The Guardian, so having looked at the high level picture I thought it would be interesting to look at each category and what the key drivers in each of them might be. The first, cash that is used, is easy. We know that the driver is technology but that the impact is weak. In other words, new technology does reduce the amount of cash in circulation, but very slowly.

Moving on to the next category, I know it’s a rather simplistic analysis, but if the amount of cash that is being hoarded has been growing then that would tend to indicate that people have lost confidence in formal financial services or are happy to have loss, theft and inflation eat away their store of value while forgoing the safety and security of bank deposits irrespective of the value of the interest paid. The Bank say that “a small number of individuals hoard large amounts of cash” (Ken Dodd, rather famously, had £336,000 in suitcases in his attic) and so might account of a lot of the notes.

If, on the other hand the amount of cash that is being stashed has been growing then the Bank of England is facilitating an increasing tax gap that the rest of us are having to pay for. In this context cash is a mechanism for greatly reducing the cost of criminality while it remains a penalty on the poor who have to shoulder an unfair proportion of the cost of cash. In this case, we should expect to see a strategy to change this obviously suboptimal element of policy.

The amount of cash that is being exported is hard to calculate, although the Bank itself does comment that the £50 note (which makes up a fifth of the cash out there by value) is “primarily demanded by foreign exchange wholesalers abroad”. I suppose some of this may be transactional use for tourists and business people coming to the UK, and I suppose some of it may be hoarded, but surely the strong suspicion must be that these notes are going into stashes.

The Bank notes that “given the untraceable nature of cash” they cannot tell where cash is going. That’s true. I’m not suggesting we adopt the Chinese policy of having ATMs record the serial numbers of notes that they dispense and having cash recycling centres record the serial numbers of notes coming in to rectify this lack of data, but clearly we can look at some proxies to help us establish the rough proportions of used and hoarded, stashed and exported. The Bank says that it thinks around 25% is used and around 25% is hoarded, the rest stashed and exported. If most of the exported cash is stashed, then heading towards half of the cash out there is for, not to put to fine a point on it. criminals. 

So where is the demand coming from? The Bank says that “no single source of demand is likely to have been behind the sustained growth” but I’m not so sure, because I think stashes have grown at the expense of hoards. In a fascinating paper that I looked at last year by Prof. Charles Goodhart (London School of Economics) and Jonathan Ashworth (UK economist at Morgan Stanley), they note that the ratio of currency to GDP in the UK has been rising and argue that the rapid growth in the shadow economy has been a key cause. If you look at the detailed figures, you can see that there was a jump in cash held outside of banks around about the time of the Northern Rock affair, but as public confidence in the banks was restored fairly quickly and the impact of low interest rates on hoarding behaviour seems pretty marginal, there must be some other explanation as to why the amount of cash out there kept rising. Two rather obvious factors that do seem to support the shape of the curve are the increase in VAT to 20% and the continuing rise in self-employment (this came up a couple of times in comments to The Guardian piece), both of which serve to reinforce the contribution of cash to the shadow economy. The Bank say that there is “limited research to confirm the extent of cash held for use in the shadow economy”, but Charles and Jonathan make a reasonable estimate that the shadow economy in the UK could have expanded by around 3% of UK GDP since the beginning of the current financial crisis.

While the BoE paper notes that academic evidence does not suggest the black economy is expanding in the UK

[From UK savers hoard at least £3bn of cash at home – FT.com]

According to Tax Justice UK, there were £100 billion in sales not declared to UK tax authorities that meant a tax loss of £40 billion in 2011/12 and that will rise to £47 billion this year. That sounds like expansion to me. The IMF have noted that while Her Majesty’s Revenue and Customs (HMRC) is not good at estimating losses outside the declared tax system, which is why their latest estimates for the tax gap are low at £33 billion for 2011/12. And while we all read about Starbucks and Google and other large corporates engaging in (entirely legal) tax avoidance, half of all tax evasion is down to SMEs and a further quarter down to individuals (according to HMRC).  There are a awful lot of people not paying tax and simple calculations will show that the tax gap that can be attributed to cash is vastly greater than the seigniorage earned by the Bank on the note issue. Cash makes the government (i.e. us) considerably worse off.

In summary, I think think that the Bank’s view on hoarding is generous and that it is the shadow economy fuelling the growth in cash “in circulation”. There’s something wrong about this, especially when we know that the cost of cash falls unfairly on the poor. It is time for Bank of England to develop an active strategy to start reducing the amount of cash in circulation. For a start they could take a look at what’s been going on in Sweden where a broad alliance between the government, banks, trade unions (it is their members who get beaten up and stabbed in cash robberies) and Bjorn from ABBA has made it the first country in the world where the amount of cash “in circulation” is falling.

Next week we’ll take a look at the second part of the Quarterly Bulletin article about what might influence the demand for cash in the future.


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