The Federal Reserve risks being left behind in the battle to determine the future of money. Central banks elsewhere, notably China and Europe, as well as the social networking company formerly known as Facebook, have all taken decisive steps towards creating their own digital currencies. The Fed, for its part, belatedly released a discussion paper last week, outlining both the risks and benefits of a digital currency. If the almighty dollar is to extend its dominance, the Fed cannot be so sanguine about the risks.
That the Fed chose to release the paper without taking any firm conclusions reveals either a diligent willingness to consult, or a degree of scepticism towards the advantages of taking the US dollar digital. Such scepticism is well-founded. Central bank digital currencies risk destabilising the financial sector by providing a superior alternative to the bank deposits that form the bedrock of the monetary system. A digital currency could become a tool of surveillance too — a chilling possibility whether in the hands of Facebook or the Chinese government.
None of these problems is insurmountable. Account-based central bank digital currencies, in which private banks continue to manage most of the consumer-facing part of the financial system, would leave private information at arms length from government bureaucrats. A digital dollar, however, could help improve the payment system behind the scenes. While elsewhere such central bank digital currencies can appear “a solution in search of a problem”, America’s lacklustre retail banking system and the importance of the dollar in cross-border money flows make an obvious case for reform.
Either way, if the Fed does not address them itself it risks having to live with whatever solution either tech groups or foreign powers come up with. A mooted “first-mover advantage” for early adopters of digital currencies could see the dollar’s role as the international reserve currency — used for trade invoices as well as global finance — diminished.
Even with the Fed’s slow start, however, threats to dollar supremacy are overblown: US Treasuries remain the safe asset of choice around the world and the Federal Reserve is trusted as the de facto global reserve bank — its international lending during both the 2008 and 2020 crises played a key role in supporting credit markets across the globe. America’s financial permissiveness contrasts favourably with China’s attitude towards offshore renminbi trading, damping a digital renminbi’s pitch to become the global reserve currency issue.
The domestic problems posed by private stablecoins, such as the Facebook proposal, should be more important to the Fed than the dollar’s global role. It was the prospect of “libra” that spurred many of the Fed’s peers to push ahead with their own digital currency plans. Supposedly pegged to fiat currencies and backed by stores of high quality assets, stablecoins resemble the shadow banks that contributed to the 2008 financial crisis.
Regulatory pressure — with the Fed partnering with other agencies — may keep stablecoins at bay, but the attractiveness of Facebook’s plan was to lower transaction costs for US consumers and make cross-border transactions cheaper. Those are laudable goals that could be aided by the development of a digital dollar. It is precisely because of the strength of the dollar’s global position that the Fed should engage further with efforts to reform the creaking and expensive system of international payments. The Fed is right to take its time to consider the future of money, but the world’s most important central bank cannot remain a laggard forever.
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