Tuesday, June 20, 2017

The road to sound digital money

No, I'm not talking about sound money in the sense of having a stable value. I'm talking about money that is sound because it can survive natural disasters, human error, terrorist attacks, and invasions.

Kermit Schoenholtz & Stephen Cecchetti, Tony Yates, and Michael Bordo & Andrew Levin (pdf) have all recently written about the idea of CBDC, or central bank digital currency, a new type of central bank-issued money for use by the public that may eventually displace banknotes and coin. Unlike private cryptocoins such as bitcoin, the value of CBDC would be fixed in nominal terms, so it would be very stable—much like a banknote.*

It's interesting to read how these macroeconomists envision the design of a potential CBDC. According to Schoenholtz & Cecchetti, central banks would provide "universal, unlimited access to deposit accounts." For Yates this means offering "existing digital account services to a wider group of entities." As for Levin and Bordo, they mention a similar format:
"Any individual, firm, or organization may hold funds electronically in a digital currency account at the central bank. This digital currency will be legal tender for all payment transactions, public and private. The central bank will process such payments by debiting the payer’s account and crediting the payee’s account; consequently, such payments can be practically instantaneous and costless as well as completely secure."
I don't want to pick on them too much, but all these authors are describing a particular implementation of central bank digital money: account-based digital money. There's an entirely different way to design a CBDC, as digital bearer tokens. My guess is that the authors omit this distinction because macroeconomists tend to abstract away from the differences between various types of money. Cash, coins, deposits, and cheques are all just a form of M in their equations. But if you get into the nitty gritty, bearer tokens and accounts two are very different beasts. Some thought needs to go into the relative merits and demerits of each implementation, especially if this new product is to replace banknotes at some hazy point in the future.

Let's first deal with account money. An owner of account-based money needs to establish a connection with the central issuer every time they want to make a payment. This connection allows vital information to flow, including instructions about how much money to transfer and to whom, confirmation that there is sufficient funds in the owner's account, and a password to confirm identity. Only then can the issuer dock the payor's account and credit the payee.

Bearer money, the best examples of which are banknotes and coins, never requires a connection between user and issuer. As I described in last week's post, courts have extended to banknotes the special status of having"currency." What this means is that if you are a shopkeeper, and someone uses stolen banknotes to buy something from you, even if the victim can prove the notes are stolen you do not have to give them back. The advantage of this is that there is never any need for a shopkeeper to call up the issuer in order to double check that the buyer is not a thief.** As for the issuer, say a central bank, they are not responsible for the debiting and crediting of banknote balances, effectively outsourcing this task to buyer and sellers who settle payments by moving banknotes from one person's hand to the other. The upshot of all this is that since users and issuers of bearer money don't need to exchange the sorts of information that are necessary for an account-based transaction to proceed, there is no need to ever link up.

This makes bearer money an incredibly robust form of money. If for any reason a connection can't be established between user and issuer, say because of a disaster or a malfunction, account-based money will be rendered useless. Examples of this include the recent two-day outage of Zimbabwe's account-based real-time gross settlement system due to excess usage, or the famous 2014 breakdown of the UK's CHAPS, its wholesale payments system, which limited the system to manual payments. M-Pesa, Kenya's mobile money service, has periodic outages, and last month my grocery store, Loblaw, suffered from a malfunction in its debit card system. Banknotes—which don't require constant communication with the mothership—worked fine throughout.

The private sector used to be heavily engaged in providing bearer money, both in the form of banknotes and bills of exchange. However, bills of exchange-as-money went extinct by the early 1900s. As for banknotes, the government thoroughly monopolized this activity by the mid-1900s. Which means the government has—perhaps inadvertently—taken on the mantle of being the sole issuer of stable, disaster-proof money. So any plan to slowly phase out government paper money is simultaneously a plan to phase out society's only truly robust payments option.

Going forward, it's always possible that governments once again allow the private sector to  issue bearer money. With the government's bearer money monopoly brought to an end, the public would be well-supplied with the stuff and central banks could safely exit the business of providing a robust payments option. But I can't see governments agreeing to relinquish this much control to private bankers. Which means that for society's sake, whatever digital replacement central banks choose to adopt in place of banknotes and coins should probably have bearer-like capabilities in order to replicate cash's robustness. Account-based money won't cut it. Nor will volatile private tokens like bitcoin.

One way to design a digital bearer money system is to have a central bank issue tokens onto a distributed ledger and peg their value, say like the Fedcoin idea. The task of verifying transactions and updating token balances would be outsourced to thousands of nodes located all over the world. So if all the nodes in the U.S. have been knocked out, there will still be nodes in Europe that can operate the payments system. This would restore a key feature of banknotes, that they have no central point of failure, thereby allowing central banks to get rid of cash. I'm sure there are other ways of creating robust money than using a distributed ledger, feel free to tell me about them in the comments section.

* CBDC would be redeemable on a 1:1 basis for traditional central bank money (and vice versa), so the two would have the same value and be interchangeable. Consumer prices, which are already expressed in terms of traditional central bank money, would now also be expressed in terms of CBDC. Since consumer prices tend to be sticky for around four months, CBDC holdings would have a long shelf-life. If CBDC was designed like bitcoin--i.e. its quantity was fixed and there was no peg to existing central bank money--then its value would diverge from traditional central bank money. Price would continue to be expressed in terms of traditional central bank money, and would be sticky, but there would be a distinct CBDC price that would no longer be sticky. So CBDC would no longer have a long-shelf life; indeed, CBDC prices could become quite volatile. See here.
** The caveat here is that while banknotes have long since been granted currency, CBDC—which does not exist—has not. Nor have cryptocurrencies like bitcoin been granted currency status. But if a central bank were to issue a bearer form of CBDC, it's hard to imagine the courts not declaring it to be currency fairly early on, unlike say bitcoin.

PS: I just stumbled on a 2006 paper from Charles Kahn and William Roberds which nicely captures these two types of money:


  1. Even digital bearer money is not quite as robust as paper and coin since it won't work without devices or power. Device loss may or may not be equivalent to paper and coin loss, but if not, it would still need cloud access and that may not be more robust than distributed central accounts.

    1. Yep, the need for power means that digital bearer money isn't as stable as good old paper money.

  2. All digital money is bearer cash because all cash devices can implement honest double entry accounting not requiring a third part ledger service.

    1. Can you explain that? I don't follow.

    2. Digital money requires the user have a local processor in hand. Since the local processor must be secure enough to hold a digital crypro coin, it thus has enough security to execute tamper proof honest accounting such that it never double spends. Put in other words.

      Right now I can double spend bitcoin, spending it a second time before the first goes through the ledger. But the new hardware wallets prevent that.

      For example, In China when the PBOC prohibited withdrawals for a time, traders simple passed the e codes for bitcoin between themselves with messaging software, which works fine as long as the two parties are trusted. But if the users have digital devices that have secure operating code,then any device can become trusted, just like a hundred dollar bill is generally trusted.

      Making trusted hardware wallets is now standard.

    3. "All digital money is bearer cash because all cash devices can implement honest double entry accounting not requiring a third part ledger service."

      What about mobile money, say something like M-Pesa?

    4. If you put the secure element inside the smart phone then M-Pesa can do direct wallet to wallet without using the M-Pesa central exchange. This van be done directly, card to card, person toperson using NFC, or it van be tunneled through the internet for direct wallet to wallet transfer. In this case, the actual M-Pesa exchange is used as a ledger service, only when needed,. Or the M-Pesa service can specify a limit on direct peer to peer exchanges before one call to he central service is needed.

    5. Interesting. But no one is actually doing this, are they?

    6. Since bitcoiners already pass ecodes over the email for direct person to person transfer, then I have a difficult time understanding how a secure bitcoin wallet would avoid offering the same capability. The user need only read out the bit coin code from the wallet, then send it along to another person who inserts it into their wallet. In other words, it would be an actual denial of the obvious.

    7. Also, I should mention that some hardware wallets are nodes on he block chain. Hence, there is no exchange service, the wallet submits the transaction, and the other wallet finds confirms the result. The intermediate block chain simply serving as a network. But, overall, the idea that two hardware wallets cannot pass crypto coins directly between them is absurd and defies all logic about what real cash and real wallets are all about.

  3. Here's my take:


    For context:



    1. Thanks for the links, Rohan, especially the second one which I hadn't seen before. Would you say that a central bank could deploy eCurrency Mint's product as either an account-based solution or a bearer solution, depending on their needs? Or is there a better way to think about eCurrency?

    2. I would say eCurrency Mint's product is definitely a bearer instrument first and foremost, but that you could set up an accounts-based payments intermediary layer on top that uses the DFC system as its underlying rails, either by serving as as a proxy wallet-manager for consumers, or as a genuine payments intermediary by holding DFC balances as collateral against account balances on a 1:1 basis, similar to how MMFs do with treasury securities, or how mobile money systems use ring-fenced deposit (or CB) accounts or trusts to ensure safety of their mobile money liabilities, without incurring significant intermediary risk (depending on the settlement technology, etc).

      The former approach, which I think is cleaner/simpler, is similar to if you delegated to your bank the authority to open your private safety deposit box, and make transfers of the contents to other safety deposit boxes in the approved banking network. The customer, as opposed to the intermediary, still "owns" the property/file in the box, but all transmission signals are intermediated via the intermediary, with whom the individual is required to have an account.

    3. This exchange, between eCurrency CEO Jonathan Dharmapalan and a representative from US Treasury, may shine a bit more light (beginning around 22:10):

      "“Q: Hi, Loretta Michaels, U.S. Treasury. I have to say, we are very excited by what Jonathan is up to. It's been very clear to those of us at Treasury watching this space that there are two areas that we feel strongly about. One is that digital is clearly the future, but we want currencies to be regulated, and not a wild west of unregulated currencies. And so it was quite timely for us to meet Jonathan and hear his thoughts. So we've been very excited by that.

      And so I had a couple of questions for you. One is – how easy is it for the marketplace to adjust itself to accept digital currency? So i'm thinking merchant acceptance, POS systems, ATMs, et cetera, because even if the regulator could turn it on overnight, there needs to be a marketplace use for it. [...]

      A: This ties a little bit to Victor's question – what is different now to when there was Digicash? What is different now is that we have mobile money, and that the marketplace and the public have accepted this capability, and they are using it in tremendous amounts. They are using it for remittances, they are sending it to their villlages, they are using it to buy bananas. It is being transacted already. So electronic money is working, and working incredibly well.

      What we have done is enabled the central bank to create a digital currency, and do a one-time swap of digital currency for mobile money. By doing that one-time swap, they will insert their legal sovereign currency into the mobile money system. Once it's in there, there is no more privately issued e-tokens flying around. There are only currency units issued by the central bank. So from a public perspective, that are already used to transacting on Paypal, on M-Pesa, on Airtel money, the use case doesn't change. They still do the same things they do. The only difference is the ultimate trust of the instrument they are using comes to them from the central bank.

      So it was a combination of putting this philosophy together with technology that can actually do that one-time swap in the system.”


    4. Thanks Rohan, that answers my question. It definitely qualifies as a robust form of money.

  4. JP how would you incentivize the 'thousands' of nodes worldwide to maintain these ledgers? With the existing known examples, such as Bitcoin, the incentives are 'mining' fees and/or transaction fees. In your case, the mining fees are not feasible, since that amounts to outsourcing money creation to unknown third parties unrelated to the central bank. That leaves the transaction fees. There, again, the existing examples such as Bitcoin demonstrate that this is a tricky balance. If you don't have the mining fees, you have to either see constant price appreciation to make prior fees look bigger or you have to make transaction fees bigger to make the process worthwhile. Price appreciation goes contrary to the 'peg' while transaction fees won't stand agains the current debit swipe fees that we even have now.

    1. I think mining fees are feasible. Each block would result in an automatic generation of a few new Fedcoins for the miner. There are other ways to do it too. Rather than a successfully-mined block providing a reward of new Fedcoins, the central bank could pay the miner directly from its own stock of existing Fedcoins.

    2. JP,

      Thanks again for a great post! (I have noticed you've become recognized as an expert on CBDC, and rightly so.)

      This particular comment of yours left me unsure about how you see Fedcoin. Like currency, it should be recorded on the RHS of CB balance sheet, right? But only while it's in circulation. Any "own stock of Fedcoins", just like in case of currency, would be off balance sheet.

      Putting Fedcoin (new or existing; I don't really see much difference, just like notes can be re-used or destroyed & replaced) into circulation means a credit to the account "Fedcoin in circulation" (or similar). Right?

      My question: Which account will be debited?

    3. Hi Antti,

      The Fedcoin mechanism would work exactly like cash currently does. Central banks don't push cash directly into circulation; they use commercial banks as their distribution agents, the public pulling cash into circulation. When a client requests cash from his/her banker (and say the banker doesn't have any on hand), the banker has to go to the central bank and ask for banknotes. The central bank provides the cash while at the same time debiting the banker's account at the central bank. So in the end allthat is occurring is a reduction in one item on the right hand side of the central bank's balance sheet, the liability side, and an increase in another item on the RHS.

      Same with Fedcoins.

    4. I get that, JP.

      I was referring to this: "Rather than a successfully-mined block providing a reward of new Fedcoins, the central bank could pay the miner directly from its own stock of existing Fedcoins."

      If the central bank will pay the "miner" in this way, it will ultimately be a debit to its equity, through P&L. Or that's how I understand it. Of course, there's no need to pay in Fedcoin should the miner prefer to get his checking account credited instead ("I don't want cash, or e-cash -- just credit my account").

      So I would say it's not comparable to Bitcoin, and I don't see how it would matter whether the CB creates new Fedcoins or uses ones it has created earlier and is in possession of (unless the existing ones contain some kind of memory and so should be re-used?).

      I don't know if you get what I mean. I just feel that we are, and have always been, giving too much attention to money as an object. And that you continue on that path if you differentiate between newly created Fedcoins and existing Fedcoins in the hands of the central bank. What if the central bank destroys all Fedcoins it receives and issues new ones as needed? I don't see any difference.

    5. "...and I don't see how it would matter whether the CB creates new Fedcoins or uses ones it has created earlier and is in possession of."

      Yes, you're right. I had a certain model of Fedcoin in mind, where all the coins are created at once at the outset, i.e. premined. Say like 20 trillion of them. The central bank keeps all of these in its account and never creates new ones, only putting them into circulation as required. But the model could also involve the central bank creating new Fedcoins on an as-required basis.

  5. I'll continue a bit, to give you some background.

    I believe that Bitcoin is money misunderstood. When new Bitcoins are created, it's like making a credit entry without a debit entry. Not so in the case of Fedcoins.

    With currency, central bank reserves or Fedcoins, there always exists a debit balance, a debt, of same magnitude on the LHS of the balance sheet. These debit balances consist mostly of what the Fed calls "Collateral Held against Federal Reserve Notes":


    So, Fedcoin is a credit balance. There exists collateral, debit balances, against it. There's no collateral held against Bitcoins.

    I've discussed this in my comment to Tony Yates here:


    I don't think I'm saying anything you didn't already know. I just don't get why Bitcoin is considered similar to "fiat money". It's not, and the most significant way it differs from it has nothing to do with Bitcoin being more scarce. Bitcoin is a credit without a debit. That makes Bitcoin unsound, at least to an accountant like me.

    1. I agree - there is no ongoing debit obligation to take bitcoins in the future, unlike bank deposits that are created by bank borrowers who are obliged to provide something to deposit holders in the future.

    2. Antti, I agree with pretty much everything you say in your comment.

    3. Good to hear, JP and Dinero! Would you say that there's a general agreement among economists on this matter?

    4. I would say not, there is not general agreement amongst economists as to why and how loan contracts give the corresponding liabilities that are written against them in the monetary system value, what you call here sound vs unsound.

    5. That's what I thought.

      If I read you correctly, you call the credit balances 'liabilities'? Like in "liability of the bank"? That's the conventional way to put it, so I don't blame you. Nevertheless, I have found it useful to adopt the opposite view and the language that goes with it (not least because central bank liabilities are often not recognized as real liabilities; perhaps rightly so).

      An example:

      Let's imagine that the LHS of the Fed's balance sheet consists of an MBS worth 100 and gold stock worth 100 (at market price). On the RHS of the B/S there's "FR notes in circulation" with face value of 200. No equity.

      The MBS is a liability of the mortgagors. The gold is a liability of the Fed. Isn't the gold an asset of the Fed, you might ask? Well, who is the Fed? The Fed doesn't really own anything. If we wind it down, everything in its possession goes to the parties holding credit balances -- in this case the FR note holders. We could say the Fed is liable to look after the gold that ultimately belongs to someone else. (This view finds also support in the birth story of double-entry bookkeeping in Genoa, but I save that story for some other time.)

      So, the LHS of the Fed B/S consists of liabilities/debt/debit balances. The RHS consists of credit balances which can be viewed as their holders' rights to receive something. Naturally, that kind of right has value if its holder can expect to receive something.

      So, let's wind down the Fed.

      To make it easy, it just so happens that someone holding FR notes worth 100 happens to buy the houses of the people behind the MBS (assume loan-to-value 100 %). The note-holder got the houses worth 100; he was holding a right to receive something worth 100, and did receive it. The mortgagors had a liability to give up something worth 100, and so they did. After the deal they sent the notes they had received to the Fed, which wrote off the MBS and burned the notes.

      Next, another person holding the rest of the FR notes walks to the Fed and takes possession of the gold. He had the right (credit balance) to receive something worth 100, and he did. The Fed had the liability (debit balance; gold stock) to give up the gold in its possession should the bank be wound down, and so it did.

      For the system to be sound, the amount of liabilities, or obligations, should match the amount of rights. People shouldn't be entitled to receive more than others are obliged to give. To me that sounds like the most natural thing.

      What do you think?

    6. There is an expense to storing gold but that expense does not make it a liability , it is still an asset.

      Other than that I agree. The main point is that the source of value in the banking system is on the LHS of the balance sheet. The assets. The RHS ,the deposits, are a record of who are the the beneficiaries of the assets.
      And I take the accounting a step further, in the honouring of the loans, the deposit holders don't receive the house they receive the economic resources sold to them by the mortgagors in paying the mortgage.
      The point is in the modern banking monetary system , money, bank deposits or Fed deposits are not some nebulous token used as a means of exchange only by accepted custom, the money is a real economic contract of rights and obligations.

    7. Dinero, exactly. They don't need to sell their houses, if they sell their labor, or products of their labor. I only had them sell their houses for simplicity's sake; focus was on the note-holders.

      You said: "There is an expense to storing gold but that expense does not make it a liability , it is still an asset."

      Yes, but whose asset it really is? Who ultimately owns it? The beneficiaries on the RHS, as you call them. And the Fed, to me, is someone who is liable to take care of the gold, but doesn't own it. It keeps accounts exactly because -- as a trustee -- it's under the scrutiny of parties on the RHS (public at large in the case of a central bank).

    8. Dinero, can I find some kind of exposition of your view somewhere? It sounds it's not too far from how, for instance, Mike Sproul puts things in his version of Real Bills Doctrine?

    9. I explain where I come from here:


      I'm currently working on a longer post where I go through how my view compares to others' views on how the monetary system works. In it I will also go through an example of public spending and taxation. (I aim to post it during July.)

    10. My view of the relationship between bank deposits and assets does start with the 1800s Real bills Doctrine but NOT as Mike Sprouls version as he references everything to silver coins, which I think is unnecessary and missing the point that the relationship between borrowers and deposit holders recorded on a bank Balance sheet T account endogenously provides currency.

      There is no one site that provides an exposition as far as I know. I also share the view with Monetary Realism often discussed here , http://www.pragcap.com/ama/, that the prime source of money in the economy is commercial bank deposits, Central Bank deposits being somewhat a distraction.

      Your post about Andy, Betty and bananas uses a record keeping that is actually used in practice on community trading sites like community-exchange.org but I have not read up on them for a while.

    11. I agree. Including gold or silver, especially in form of coins, is at best a distraction. I only chose to include gold in my example because the Fed actually does have a gold stock, but it could have been replaced by any real or nominal assets.

      Commercial bank "deposits" (I avoid that word and prefer to talk about different kinds of credit balances; nothing is deposited) are important, as you say. But if we first explain how central bank credit balances work (for instance, that they themselves are no debt/liability to anyone), then we can see that commercial bank credit balances can be viewed in the same way: the bank is keeping records of (mostly other agents') liabilities (LHS) and rights (RHS). The only difference is that in the case of a commercial bank, there happens to be a rule which allows a credit-holder in the bank to demand for a credit balance in another bank's (incl. the central bank) books instead; that is, he can change his record-keeper. Note that this does not mean that the bank owes the "depositor" money; within this framework that kind of language is not valid.

      Yes, the record-keeping in my "world" is probably very similar to community trading sites. But how do you see that our actual monetary system differs from that kind of record-keeping?

      My aim is to show how from these simple premises we can build up our actual monetary system, and once we adopt the viewpoint I suggest, and the language that goes with it, we never need to talk about "money being created by banks" or "out of nothing". All that is going on is simple accounting.

    12. I agree , the bank is keeping records of obligations and rights. You can make it even more self evident by removing the bank and replacing it with a paper transferable IOU written by the issuer.

      I think the Trading site record keeping does give an insight into our actual monetary system. That is why I think the actual economic transaction between people occurs on commercial bank ledgers.

    13. I don't think we can remove the bank. That would lead to bilateral debt relations, where the holder of the IOU could walk to the debtor and demand payment in goods (incl. services). The whole point about the banking system is that there's no I in the IOU. It's more like "you are owed" (credit balance) and "you owe" (debit balance), but the counterparty is the society as a whole. I as a mortgagor can work for any company I choose and in this way pay my debt to others (the society). You as a "deposit-holder" can buy goods from anyone and in this way you get paid.

      I would say the actual (economic) transaction is usually recorded on commercial bank ledger. Not that it occurs there. For instance, nothing is transferred from the buyer's account to the seller's account. It is just recorded by the bank that (a) the seller has given up goods of certain value (measured in an abstract unit-of-account) without receiving anything in return, and that (b) the buyer has received goods of certain value without giving anything in return.

      Do you see what I mean?

    14. A transferable IOU can be used to buy goods from anyone who positively rates the credibility of the issuer. Its not equivalent to a bank its a scenario that is illustrative of contractual arrangements that are similar to the raw material of a bank.
      Bank ledger, yes that is what I had in mind, the transactions are recorded on the commercial banks ledger.

      Cheers for the chat Antti Jokinen !

    15. Cheers to you, Dinero! I don't think we are yet fully on the same page, but mostly so. (If we were, I'd have nothing new to say, and I believe I have. We'll see.)

  6. Antti! You're alive! ;-)
    You wrote: The only difference is that in the case of a commercial bank, there happens to be a rule which allows a credit-holder in the bank to demand for a credit balance in another bank's (incl. the central bank) books instead; that is, he can change his record-keeper.
    I would say that it is the existence of a central bank that allows for that rule to exist. That 'rule' is the raison d'être of a central bank. Without it, one bank's bills could not be guaranteed to convert at a fixed exchange rate with another's. That would make freely changing record keepers a lot more difficult, if not impossible, imo. No CB = no common standard.

    1. Oliver, not only am I alive, but I'll be in Zürich on Nov 12. I'm ready to claim the beer you once offered, if you're in town ;-)

      The central bank surely helps in establishing a standard, as you suggest. You might be right.

      Of course, changing the record-keeper is not different from what we are used to call "making a payment", when the account to be debited is in one bank's ledger and the account to be credited is another bank's ledger. At least in theory the banks should be able to sort it out between themselves, in the absence of a central bank, so that parity is maintained? Of course, there would then probably be fewer and more robust banks -- and less debt.

    2. Beer is on! I'll try to drop you my coordinates in an inconspicuous place on your blog.
      My question is, does the 'bank of agriculture dollar' necessarily follow the same path in value as say that of the 'mortgage bank'? Is it really one and the same dollar in absence of standard enforcer of first and lender of last resort? And is really society as a whole the counter party to each dolar or is the counter party restricted to the users / clients of each bank? I think you may be idealising the value of the Skilo. But I fear this has gone way off topic.

    3. Great!

      Good questions. I think all records refer to the same abstract dollar; what varies is how willing people are to have their dollar-denominated credits recorded in a certain bank's books. But in practice this might lead to a situation you have in mind, where we can say that a 10 dollar credit in one bank's books is worth more than a similar credit in another bank.

      I would say the whole society is the counterpart if the bank's customer can transact with practically anyone in the society. And the goal of authorities is to ensure that this is the case. Once the range of counterparties is severely restricted, then we can't anymore speak of 'money' (MOE; that stuff which others still seem to see ;-)), can we?

    4. To continue a bit: One or more of the banks would, I think, necessarily become a de facto central bank when it comes to the standard. Sellers would demand that their accounts in the strong bank(s) should be credited with the exact price of the goods they sell.

    5. re: I'll try to drop you my coordinates

      I have done so. I expect an avalanche of spam...

      Re your other points. A bit of historical fiction:

      - Consider a country with a number of banks. One, the largest, is very profitable, offers good conditions on loans and deposits, has a large network of local branches, broad base of customers, friendy service while another, much smaller, has close ties to the crown. Which of the two is likelier to have a more stable 'standard' in relation to, say a precious metal or foreign currency? And which is likelier to become the central bank?

      - Maybe bank A's notes start out stable but, being highly invested in agriculture, become less so after a series of natural desasters?

      - Maybe a central beaurocracy seated e.g. in Brussels suddenly decides to create a new standard, ex nihilo so to speak?

      How do you define society? I'm not sure one can use a political definition of the term (say, a country) for making a logical, economic argument. Imo one has to start with the smallest logical element, in this case the record keeper, aka a bank, and aggregate from there. Society in this particular sense is thus merely the customer base of one single bank. From there it is logically feasible, and I'm sure also historically verifiable, to have a situation in which there is more than one monetary standard within a political / legal entity. Likewise one can have a group of political / legal entities that share a standard (say, the Euro or CFA franc). That isn't to say that the fact that in most cases national borders coincide with monetary standards is a coincidence. But, rather than being a logical necessity, I would interpret that as being an artefact of the synergy between the legal sphere and the nature of accoutning money (e.g. in enforcing contracts).

    6. You're raising important points, and I'm not sure if I'm yet ready to tackle all of them.

      What is the 'standard' we are talking about? I'd approach it like this:

      If a seller quotes a price of 10 dollars for his wares, what does it mean? If it means he is happy to part with his wares should he get his account in a certain bank credited with 10, then can we say that this bank sets the standard at least when it comes to this particular seller. But it might be that another seller would demand a credit of 11 in that bank, whereas a credit of 10 in his local bank, which he happens to trust the most, is enough for him (it's perhaps easiest to think of private banknotes, familiar from JP's posts).

      Do you see what I mean? Of course, the central bank usually sets a common standard, where all the sellers are happy to receive a 10 dollar credit in its books for wares they price at 10 dollars.

    7. Oliver said: "Imo one has to start with the smallest logical element, in this case the record keeper, aka a bank, and aggregate from there. Society in this particular sense is thus merely the customer base of one single bank."

      Yes and no. If there's a group of people who transact mostly with each other and all have accounts at the same bank, then yes. But if people are using multiple banks, then what matters is that the seller's account at his own bank gets credited. All that is required for the goods transaction to be settled is that the buyer is able to make that happen.

      It's hard to think of a situation where buyers were looking specifically for sellers with accounts at the same bank as the buyer. It's not wholly inconcievable, but to say that logically that should be the starting point sounds like a stretch.

      Yet, I do see your point. In theory you might even be right. But practice shows that once there are multiple banks, the society (consisting of any number of people who cooperate, whether we are talking about multiple towns or even multiple nations -- I'm not trying to define society here) tries to make it, and keep it, so that people can transact with one another as smoothly as possible regardless of which bank they happen to use. One single bank as a starting point, as you suggest, is (in a larger society with multiple banks) practically conceivable only in the case where that particular bank fails. Isn't it?

    8. I think the most basic case is one in which 10 units underwritten by one bank are not necessarily comparable with 10 units underwritten by another. One bank may have an apple standard, the other an orange standard.

      A second step is then to have unified units / and or fixed exchange rates across various banks by means of a common, universal reference standard (a gold standard or whatever). This can and has happened with or without a central bank. Each bank will try to maintain its own standard but may fail.

      The third step is then complete homogenisation into a 'real currency' by means of modern central banking. The banking system becomes like a franchise system in which entries may survive the demise of individual banks. I.e. it doesn't really matter where you bank within a currency area.

      I'll grant you that case I is not particularly practical and would most likely be found, if anywhere, in closed trading circles with a common clearing house. I still maintain that this is a type of money, though - indeed the simplest type. Albeit not one that lends itself naturally to 'decentralised' types of exchange, e.g. with coinage or bills.

      The reason I bring this up is that I find it exemplifies the role of the central bank and how it differs from that of 'ordinary' banks and from the notion of a standard. Neither in case I nor II is there a need for a central bank as such. All three cases, however, are perfectly compatible with the book keeping view of money and some sort of common or not so common standard. I would keep institutions (or what they do), methods (book keeping) and social phenomena (a shared notion / standard) separated.

      Nit picking, I suppose...

      I also don't understand what you mean by your last sentence.

    9. clarification:
      Each bank will try to maintain parity with the common standard but may fail.

    10. Sorry for late answer, Oliver!

      I think where we differ is that I don't view these as cases of different standards. For me the 'standard' is the abstract dollar; that's what the entries in all banks' books refer to.

      What you mean is probably easiest to explain by using an example of commercial bank notes (paper money). If we have two seller's, both selling the same good at $10 price, then one of them might accept a $10 note from a certain bank at full face value and the other didn't. That alone wouldn't testify for two different standards; there's no standard if individuals acting alone are responsible for the valuation. Do you have in mind an exchange rate set on a market? Say, how bank notes from Texas would be priced in the Californian market?

      We probably just use different meanings for 'standard' :-)


    11. I think where we differ is that I don't view these as cases of different standards. For me the 'standard' is the abstract dollar; that's what the entries in all banks' books refer to

      And this is where I would repeat my 'accusation' that you are idealising the abstract dollar. Let me try with a hopefully more realistic example.

      Start with two countries that have one bank each. Lets call them USA & Mexico.

      Now zoom in to neighbouring border towns of El Paso and Ciudad Juarez. Basically , they make up one, albeit segregated, economy. Assuming for a moment that there are no transaction costs for cross the border trade (no taxes, trade restrictions etc.), one could well imagine that the inhabitants of both towns adhere to the same abstract 'money' standard. They always think in terms of both currencies and are very apt at translating peso prices into dollar prices. The two are separated simply by a factor of multiplication. A bun is always worth about 1/10th of an hour's work, rent will cost approx. 1/3 monthly wages etc., no matter which currency you choose. Nad if there is a shift, it happens in both currencies simultaneously. One could consider this to be one standard with two different names.

      Unfortunately for these residents, though, the US and Mexican economies consist of more than only the El Paso and Ciudad Juarez economies. And so, the currencies tend to change in value relative to another. Banking and trade thus become speculative activities and with each transaction one will have to consider which currency / bank to bank with. The set of abstract but stable relative prices that residents of both cities have internalised are disturbed by factors that lie beyond the realm of their respective economies. They have to deal with two distinct standards.

      My claim, now, is that such differing standards can exist within a single jurisdiction. Namely in the case where you have various commercial banks that do not commit to any mutual standard. Free floating bank 'notes', if you like it tangible. Where the value of each is determined not by a shared set of abstract, relative values, but rather by the relative commercial success of the banks themselves. Your claim seems to be that market forces would make such a system naturally gravitate towards the standard of one bank (the most successful one, I suppose), unless they are somehow fenced off by national borders. I can see that, but I say that if the banks specialise in certain types of transactions, (or regions, or services, customer groups etc.) that a system with different 'standards' can exist with a certain amount of stability within one and the same jurisdiction. I am not claiming that such a system is suprerior to having a common standard. But it can be imagined.

      And again, the reason I bring up such a theoretical example, is to tease out the respective roles of a: trading partners, b: banks and c: the central bank and how each relate to the abstract standard.

      I hope that was understandable.

    12. addendum:

      Even if one concluded that multiple standards within the same jurisdictions could not survive due to the gravitational forces of the omnipotent market, one would still have to explain by which mechanism the law / national borders interfere with the minds of people so as to perturb that otherwise immaculate, universal standard.

  7. There's an interesting post touching this subject at the Bank Underground:


    I tried to leave a comment there, but it doesn't seem to get even into moderation (although I'm quite sure it will somehow show up one day). I'll anyway re-post it here:


    Great post! Thanks.

    You said: "However, assuming the rise in CBDC isn’t matched by a fall in the issuance of banknotes, the issuance of any meaningful quantity would lead to a significant increase in liabilities for the central bank, requiring them to buy more assets."

    I'm struggling to understand how this would lead to increase in CB liabilities.

    Members of the public willing to hold CBDC would most likely instruct their bank to debit their checking account and credit their CBDC account at the central bank (if no individual accounts, but a e-token system, this would nevertheless lead to a credit on "CBDC in circulation" account at the CB). This would mean that the CB would debit the instructing bank's reserve account, so there would be no increase in CB liabilities/balance sheet. There's plenty of excess reserves, so there should be no need to further increase the CB liabilities.

    CBDC issuance is comparable to issuance of new banknotes, and as you well know, in the modern world that doesn't increase CB liabilities -- new notes replace either bank reserves or old banknotes.

    Did you have in mind some other way the CBDC would be issued? Of course it could be issued when the CB does purchase new assets, but those purchases would not need to be made to deliberately issue CBDC.

    1. Yep, you're right. That paragraph is weak.

      "This would mean that the CB would debit the instructing bank's reserve account, so there would be no increase in CB liabilities/balance sheet. There's plenty of excess reserves, so there should be no need to further increase the CB liabilities."

      When all excess reserves are used up, banks will have nothing to debit in order to get CBDC. They will have to sell or repo an asset to the central bank in order to get new reserves, and then convert these reserves into CBDC.

      So maybe it is this that has the writer concerned. If we take things to the extreme, and every deposit in the U.S. is brought in for conversion into CBDC because of massive public demand, then the central bank will have to take the entire banking system's assets onto its books in order to facilitate the demand for CBDC. That's a big expansion of its balance sheet.

      Once banks have submitted all their assets to the central bank, then banks will have effectively ceased to exist. At this point, to get new CBDC the public will have to directly provide some sort of asset of their own to the central bank. One wonders what assets would be acceptable.

    2. JP said: "So maybe it is this that has the writer concerned."

      Could be, but I doubt it. They talk about "any meaningful quantity", which in the absence of a fall in the issuance (they probably mean stock? Issuance to me sounds like flow, not stock) of banknotes would lead to significant increase in liabilities. Whereas your case is an extreme, and thus we can't really talk about "any meaningful quantity" in that case, can we?

      I really like the way you try to follow lines of thought into their logical conclusion! I'd like to do some serious brainstorming with you on this subject, but right now I'm a bit short of time. A couple of ideas/questions related to your extreme scenario:

      1. Let's say commercial banks would offer a higher (than CBDC) interest rate on a checking/savings account. Could we still assume that those accounts are risk-free, even if they weren't explicitly insured? If yes (and I can think of a couple of reasons why this would be so), there would remain significant demand for checking account balances.

      2. You said: "At this point, to get new CBDC the public will have to directly provide some sort of asset of their own to the central bank."

      I think this is partly related to a wider problem in thinking about "money demand". How do we get our hands on money? We sell something to a non-bank. By posing this problem, you implicitly assume that in a world where most of us are already using CBDC -- and CBDC only -- in our daily business, there would be no one willing to buy goods/services/assets offered for sale. Right? That's an extreme assumption, and to get even close to this would require the mother of all deflations.

      Perhaps where you're getting at is that the CB should start extending credit (also unsecured) to non-banks for the system to work, or at least extend credit to commercial banks while non-banks would continue to go to commercial banks for their credit needs?