I can see one scenario where we will end up with CBDC as the only form of digital money. And that does NOT require a totalitarian government to impose its will on the population.
Central banks worldwide are experimenting with Central Bank Digital Currencies (CBDC). Among the central banks, the People’s Bank of China is the furthest ahead in this experiment. As reported by Reuters, the Chinese have an actual working trial of a CBDC. In Australia, the CBDC is in the research phase.
First, let’s understand what a CBDC is.
Currently, ordinary people cannot have an account with the central bank. Only banks and governments can have an account with the central bank. Essentially, a central bank is a bank for commercial banks and governments.
In the past, without ubiquitous information technology, it was highly impractical for everyone to have an account with any bank, let alone the central bank. The amount of administrative paperwork would be impossible to handle. It was simply not possible for the banking system to handle every financial transaction. That is the reason why there were much more cash transactions than bank transactions.
Today, with ubiquitous information technology, everyone has a bank account. Not only that, every transaction in the economy can go through a bank. When you pay for bread in the local supermarket with a wave of your debit or credit card, a bank is involved. We are essentially living in a cashless society already. We have credit cards, debit cards, Apple Pay, Google Pay, WeChat Pay, AliPay, PayPal, Cash app, Internet banking apps, etc. Money is already digital today.
So, that begs the question: what is the point of CBDC anyway? Is it just another form of digital money?
From the point of view of the end user, there is no difference in terms of user experience between CBDC and other forms of digital money. For example, China’s AliPay is in direct competition with the digital yuan CBDC. If left to the free market to choose a form of digital money, CBDC is so late in the game that no one will bother to switch to it. There are simply no compelling reasons to use CBDC when there are plenty of incumbent choices out in the free market.
But you have to understand this crucial point: From the perspective of the government, there is a world of a difference between CBDC and other forms of digital money. The difference is like the difference between night and day.
How?
In current forms of digital money, there are simply too many intermediaries from the central bank to the end user. For example, when you pay for something with a credit card, the money has to flow through multiple intermediaries: from your bank account to your bank, then through the payment network, then to your merchant’s bank, and finally to your merchant’s bank account. If you use other financial technology like Apple Pay, there is yet another layer of financial intermediary. In this example, the central bank is not even in the picture. Ultimately, all your transactions are aggregated along with everyone else’s transactions into giant transactions between banks, which is facilitated by the central bank.
With too many intermediaries, the central bank cannot see or control anything. All they see is giant aggregated and netted-out transactions between banks. They are too far removed to control anything that is happening in the economy.
A CBDC cuts out all these financial intermediaries. When you pay for something with a CBDC app, the central bank facilitates the transaction between you and the merchant. Now, the central bank can see and control everything. It can see who transacts with who. It can even approve or deny any financial transactions it wants. Or impose any programmable conditions on any transactions. It can even impose negative interest rates on the money in your central bank account, which was impractical before when there were too many financial intermediaries.
So, a CBDC will concentrate too much power into the hands of the government. Naturally, most people in countries with strong democratic and freedom traditions will abhor it if they truly understand what it is. Even if the majority of the population does not understand the implications of CBDC, they have no incentive to take it up, given that there are already so many incumbent forms of digital money that already work very well. Therefore, it is unlikely for CBDC to get into the actual implementation phase in most Western countries.
However, I can see some scenarios where people will finally accept CBDC. What is it?
Systemic banking crisis
Recently, I watched this YouTube video about the security of your cash at the bank.
Due to how the financial system works, every dollar deposited in your commercial bank account does not correspond to a dollar deposited by your bank in its central bank account. Your cash at the bank is a form of IOU.
Therefore, in a banking crisis, your cash at the bank can disappear and be converted into bank stocks. In a systemic banking crisis, there may not be enough cash in the national deposit insurance scheme to ensure the security of everyone’s ‘cash’ at the bank. In a systemic banking crisis, when cash disappears into thin air, financial transactions will not happen. The economy will grind to a halt. Buying and selling will not happen. ATMs will shut down.
This will be the opportunity for the government to introduce CBDC as the solution to your problem. If given the choice of losing access to your cash at your bank or having it converted into CBDC, what will you choose? Of course, you will choose the latter. CBDC is still cash. The difference is that instead of cash at an untrustworthy bank, you have cash at a ‘trustworthy’ central bank that can never go bankrupt.
CBDC will be the only form of digital money that will work
Also, notice another thing. In a systemic banking crisis, all current forms of digital money will stop working. Apple Pay, Google Pay, credit cards, debit cards, PayPal, Cash app, Internet bank transfer, etc will stop working. Given that we are already living in a largely cashless society, if the incumbent forms of digital money stop working, then we will be unable to buy and sell anything. Life will grind to a halt. But CBDC will be the only form of digital money that will work. It will not have any competition!
In a cashless society where most people have hardly any physical cash, CBDC is the only alternative. People, whether they like CBDC or not, will be forced to adopt CBDC because they need to eat, drink and pay bills.
What about cryptocurrencies?
For cryptocurrency fans, everyone will ideally already have their cryptocurrency portfolio, such that in a systemic banking crisis, the free market will switch to cryptocurrencies.
But cryptocurrencies have a multitude of issues. And like it or not, it is not mainstream. Too many people have too much at stake in form of cash at the bank. Cryptocurrencies can never replace disappearing cash at the bank because it is only a tiny proportion of the entire world’s wealth.
Summary
If you believe that another systemic banking crisis is coming our way, be prepared for it to pave the way for the ascendency of CBDC.