Now central banks are weary of private digital money: How history is being repeated the other way round..

Before central banks became monopolies of currency issuance, private banks started issuing their own notes. These notes were backed by gold/silver. However, some banks could overissue currency leading to mismatch between currency and metal base.

It so happened that a Swede bank – Stockholms Banco- over issued its banknotes. This led to a kind of run on the bank leading to all kinds of crisis. The bank was shut leading to jailing of its founder  Johan Palmstruch. But the seeds had been sown and the King established another bank called Bank of the Estates of the Realm in 1668. This bank eventually became Riksbank, known as the first central bank of the world. (Much more here)

So basically, early central banks were formed for two purposes. Prevent this overissuance of private bank money (as in Riksbank) or financing wars (as in Bank of England and Banque de France). They were not really central banks right at the beginning. The Central bank we know today came via evolution over multiple years as Governments realised the power of money and concentrated most powers under a central bank financed by them.  Though early central banks were private banks which were eventually nationalised.

Fast forwarding to today. With digital money, it is becoming possible for private players to once again enter the money space. And not surprisingly central bankers are worried as a monopoly would be.

Norway’s central bank  Deputy Governor Jon Nicolaisen gives a speech cautioning against these private money. He gives an example:

There are perhaps some who believe that deposit money will ultimately become the sole means of payment. Because Norwegian banks are well-run and well-capitalised, and because customer deposits are covered by the deposit guarantee scheme, we trust deposit money. As long as this is the case, using deposit money will be cheap and efficient for the consumer. But is it entirely unproblematic?

Imagine an ordinary consumer, let’s call him Ola, in a future when cash is no longer in frequent use. Ola hasn’t been to a bank for many years. He hasn’t used cash for a long time. He pays for everything digitally. But now he’s worried. Over the past few weeks, there have been several major cyberattacks against the bank he uses. The bank’s systems have been down for hours at a time, and staff are working overtime to fix the problem.

Ola decides he wants his money.

He logs on to his online bank, which for the time being is still open. He considers his options: he could transfer his money to an account in another bank. Or he could transfer money to a pre-paid card. But Ola does not trust either option. Who is really behind these solutions? How safe are they now?

Ola decides he wants cash and contacts his bank. But the bank cannot meet his request as it is currently unable to provide Norwegian banknotes. Ola faces the same options as before: use an account in another bank? or a payment card? The only option that does not involve using another bank account is to buy bitcoins. Ola does not want to do this. Perhaps he is a little stubborn. He wants cash.

The bank clerk is patient. He tells Ola that the bank can offer dollar or euro banknotes. Ola sees no alternative and withdraws euro banknotes. But he soon encounters another problem. In order to use this currency to make purchases in Norway, the shop has to accept payment in euros. If not, Ola will have to deposit the euro banknotes in his bank account in order to make the payment – bringing him back to square one.

What has been lost here?

First, Ola has become completely dependent on a third party – the bank: payments can no longer be made directly between two parties, but must be channelled through a bank, a card company or an app. Today, you can settle a payment at a shop or with a neighbour in cash, without involving anyone else.

Second, Ola has become dependent on the technology functioning as it should. Technology is not needed to settle payments in cash – as long as cash is available.

Third, Ola is no longer anonymous when he makes a payment. All payment transactions using deposit money can be recorded. Anonymous payments are often associated with something negative, such as tax evasion or other criminal activity. But there is another side to anonymity – privacy. We may not be entirely comfortable with the thought that every purchase we make is recorded. It may be too reminiscent of the society described in George Orwell’s 70-year-old novel 1984.

Fourth, Ola no longer has access to money directly backed by Norwegian authorities. We no longer have functional legal tender. The monetary system has been turned over to private entities. Alternatively, Ola has to use another country’s currency – in our hypothetical case, the euro.

We have to ask ourselves: should we allow private solutions to compete freely in developing means of payment, or must the authorities play a role?

The crucial factor is whether solutions based on private money deliver the characteristics the payment system should have. The system must be able to channel payments swiftly, safely, at low cost and in a user-friendly manner. The means of payment itself – our money – must be universal, because money is only useful if it is widely used. This requires trust.

Deposit guarantee schemes and banking regulation promote trust. The objective of monetary policy is to maintain stability in the value of the currency. Norges Bank assists private operators in implementing faster and safer payments. We cooperate with other authorities to oversee and supervise the payment infrastructure to ensure robustness and efficiency. Privacy rules prevent unauthorised access to payment information.

But there are some characteristics deposit money lacks. It cannot offer anonymous payments. The system is vulnerable to advanced attacks. Having more money on deposit than is covered by the deposit guarantee scheme involves risk. Nor is direct and immediate settlement between two parties, without the involvement of a third party, possible without cash.

Two things. First countries like Norway which have much better internet and other securities are worried about digital money. But India is going all guns blazing with not even half of these facilities.

Second, how all these things can be questioned at central bank front as well which overtime issued fiat money. Earlier one could get some metal against the notes one held. Overtime all you get for surrendering one banknote is another banknote! So it is not as if this is anything new. If private banks cannot give banknotes against digital money even central banks stopped giving gold/silver against the notes. It was just a paper, just as digital money is just a few digits.

So how do central banks preserve their monopoly? First is to use the old way of central banks issuing digital money and only this digital money can be used to pay taxes. Second is central banks becoming like commercial banks asking customers to open accounts with them:

In the future, new payment solutions may be able to offer these possibilities. Private digital currencies providing anonymity are already on the market. These currencies can also be used even if banks’ systems fail – as long as the Internet is still functioning. The same applies to platform currencies and e-money. However, there are other crucial characteristics missing from these solutions – they are not backed by any authority and the level of foreign exchange and credit risk can be high.

One alternative currently being discussed is the introduction of electronic central bank money. There are several ways of achieving this: consumers can have an account either at the central bank itself or in a system controlled by the central bank. Another possible solution is for Norges Bank to issue a payment card or develop an app for consumers to use for anonymous payments.

Which brings us to another question: which means of payment should be the statutory form of legal tender in Norway if we introduce electronic central bank money? Should it be banknotes and coins, or Norges Bank’s electronic money, or both?

We must also ask ourselves what the consequences will be for the banking system. For many consumers, electronic central bank money could provide an alternative to deposit money in a bank, as cash does today. Banks can attract deposits through the interest rates they offer. But their ability to create money and extend credit could nonetheless be affected, especially if this new form of electronic money enters into widespread use.

Norges Bank has begun the work of assessing what the future form of money should be. This is a long-term process. Whatever the conclusion, we can be fairly certain that banknotes and coins will be with us for many years yet. Deposit money in banks will most likely continue to be the dominant means of payment, even if electronic central bank money is introduced. Nevertheless, the very fact that these questions are being raised heralds a new era for our monetary system.

Apart from these issues, the speech is fascinating as it gives a lot of history behind central banking and money..


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