Larry White on Brainerd on Stablecoins
By David Henderson
Monetary economist Larry White had an excellent post recently on stablecoins. It’s titled “Should We Fear Stablecoins?” Alt-M, June 24, 2021.
A large part of his discussion is critical of comments made by Leal Brainerd, a Federal Reserve Board governor. I really do recommend that you read the whole White piece, but I’ll give a couple of excellent highlights plus one criticism.
He quotes this statement by Brainerd:
Given the network externalities associated with achieving scale in payments, there is a risk that the widespread use of private monies for consumer payments could fragment parts of the U.S. payment system in ways that impose burdens and raise costs for households and businesses.
In reply, Larry writes:
To clarify, network effects (more users of a common standard make adopting that standard more useful for each user) and economies of scale are distinct phenomena. Network effects in payments are associated with the widespread adoption of a common unit of account. Scale economies (declining marginal production cost) up to a point characterize wholesale clearing and settlement systems, but these economies need to be so extensive that a single national clearinghouse is most efficient. The huge volume of daily transactions in the New York foreign exchange market—nearly equal to the daily volume on Fedwire—continues to be cleared efficiently (to all appearances) by the private consortium The Clearing House (formerly the New York Clearing House Association). No informed observer, to my knowledge, suggests that moving forex clearing to the Fed would better achieve an efficient scale.
The United States already has “the widespread use of private monies for consumer payments,” of course, namely transferable bank account balances. (Brainard’s language wrongly suggests that only stablecoins and cryptocurrencies are private monies.) Bank account monies are digital in the sense of being represented by digits on the banks’ balance sheets, and also in the sense of being transferable electronically. There is no fragmentation of the dollar unit-of-account network from the issue of dollar-denominated checking accounts by thousands of banks.
Likewise, dollar-denominated stablecoins do not fragment the dollar unit-of-account network. They may even extend it, by enabling dollar-denominated payments outside the United States where dollar checking accounts are inaccessible. (In this respect they extend the dollar network much as offshore dollar banking systems do.) Consider the popular use of Zelle, the inter-depositor transfer system provided by a consortium of U.S. banks, for dollar-denominated transactions in Venezuela. The use of dollar stablecoins by traders in cryptoasset markets, or offshore, does not in any evident way impose burdens or raise transaction costs for U.S. households and businesses.
Another Brainerd quote:
A predominance of private monies may introduce consumer protection and financial stability risks because of their potential volatility and the risk of run-like behavior. Indeed, the period in the nineteenth century when there was active competition among issuers of private paper banknotes in the United States is now notorious for inefficiency, fraud, and instability in the payments system.
To which Larry replies:
The view that that private banking systems are inherently or were historically prone to volatility and runs—or that antebellum US banking in particular was dominated by “inefficiency, fraud, and instability”—is sadly uninformed by the scholarship of the last 50 years. I will leave a clarification of the historical record of the antebellum United States to a planned future post on this blog by George Selgin. But I will note that Scotland, Northern Ireland, and Hong Kong today have “a predominance of private monies” in circulation without any ill effects for consumers or financial stability.
I do have one criticism of Larry’s post. He writes:
If asset losses make us [Tether] unable to pay 100 cents per dollar token, in order [Larry means “other”] words, we may scale down the claim to fewer cents. Invoking this clause would turn Tether into a mutual fund that has “broken the buck.” The clause protects the issuer, but does not protect customers by making Tether tokens less run-prone; quite the contrary.
But it’s precisely the fact that it is a mutual fund that can “break the buck” that prevents runs or makes them highly unlikely. The reason for a run on a bank is that depositors fear that when it’s their turn, the cupboard will be bare. But why would you as depositor try to redeem your funds when you know that in doing so, you will take a haircut? Larry’s right that the clause doesn’t protect consumers from losses, but it does reduce their fear of runs.