The Economist has an excellent article discussing the gradual extension of government into the business of banking. With the recent bailout of Silicon Valley Bank depositors, authorities have signaled that virtually all deposits are implicitly backed by the US government. When you deposit money in your local bank, you are essentially lending the funds to the US Treasury, which then re-lends the money at the exact same interest rate to the commercial bank. We’ve already socialized a big portion of our banking system.
Here’s how The Economist concludes its essay:
Another looming change is the issuance of central-bank digital currencies, which could give the public another alternative to bank deposits. In recent years economists have worried about the risk of such currencies becoming de facto narrow banks that drain the legacy system. But some argue banks would work fine if the public switched their deposits for central-bank digital currencies, so long as the central bank stepped in to replace the lost funding. “The issuance of [such currencies] would simply render the central bank’s implicit lender-of-last-resort guarantee explicit,” wrote Markus Brunnermeier and Dirk Niepelt in 2019. This scenario seems to have partly materialised since the failure of SVB, as deposits have fled small banks for money-market funds which can park cash at the Fed, while the Fed makes loans to banks.
The prospect of banks becoming de facto government-funded should alarm anyone who values the role of the private sector in judging risk. Yet the difference between deposit financing underwritten by multiple layers of the state and funding that is provided directly by the state itself is getting harder to distinguish. A more explicit role for governments in the banking system may be the logical endpoint of the road down which regulators have been travelling for some time.
Many people are concerned that a central bank digital currency (CBDC) could increase the role of the government in our financial system. Unfortunately, that ship has already sailed.
There are good reasons to oppose a CBDC, but in my view they relate more to issues of privacy. It is unlikely that a government issued digital currency would allow the sort of privacy associated with paper currency. As they like to say on one of David Henderson’s favorite TV shows: “For that reason, I’m out.”
READER COMMENTS
vince
Sep 20 2023 at 11:59pm
Besides privacy, my concern is imposition of negative interest rates as a means of stimulus.
Trina Halppe
Sep 21 2023 at 2:25am
How about both paper currency for use where privacy matters and CBDCs for use where it doesn’t.
If CBDCs become widely used, why does the central bank have to replace lost funding? Why can’t a commercial bank get funding by issuing bonds or selling their assets to Fannie Mae?
Suppose I have more paper currency that I need, I can trade it for CBDC and maybe a commercial bank would be one of the places to do that and they would charge me a fee and when I need paper currency I can use their ATM for a fee. That could be the limit of my relationship with that commercial bank. I wouldn’t be exposed to the risk of their investments and I wouldn’t be able to participate in any bank run. Immediately upon converting cash to a CBDC amount I could send it to my broker and buy stocks or mortgage securities issued by Fannie Mae. Thus we have no bank runs and banks have funding. The CBDC could pay no interest because it’s up to me to do something useful with it which can be very soon if I have the use of a phone or computer.
Commercial banks are an anachronism. There should be companies that are just an pure interface to CBDCs and I might seldom use their brick-and-mortar facilities.
Scott Sumner
Sep 21 2023 at 12:14pm
One problem is that cash use is already heavily restricted by the government, and likely to become even more restricted in the future. A CBDC might speed up that process.
Grant Gould
Sep 21 2023 at 8:42pm
A central part of privacy is privacy in the question of whether privacy matters to you. For instance, I use an encrypted messaging channel with my family not because we’re discussing nuclear secrets but because nobody really has any business knowing whether we are or not.
If all non-privacy-sensitive traffic moved to one medium then even using the other, privacy-sensitive medium at all would be enough evidence of wrongdoing for the government to invade that same privacy. It is only by using private means for ordinary transactions that we retain the concept of privacy at all.
Thomas L Hutcheson
Sep 21 2023 at 7:45am
And the anchor was pulled up in 2008-09 when instead of lettings lots of financial institutions fail and their franchises bought up by new equity holders (as is called for by Bagehot), we bailed them out. the Fed could still have (and should have) flooded markets with enough liquidity to prevent the ban failures from themselves being a negative shock. It would have even been good politics, maybe headed off some Tea Party ire.
Scott Sumner
Sep 21 2023 at 12:12pm
Yes, that’s also my view.
Thomas L Hutcheson
Sep 21 2023 at 8:23am
Given where we are, prudential regulators (which should not be in the Fed), should at least insist that banks not use the implicit guarantee to do term transformation. They should not permit funding long-term fixed rate assets with sight and short-term liabilities.
spencer
Sep 21 2023 at 10:47am
Unlike the Great Depression, today’s bank runs, e.g., SVB, just represent a redistribution of deposits within the confines of the payment’s system.
There’s not an economist on the planet that understands money and central banking. Banks began buying their liquidity in 1961 instead of following the old-fashioned practice of storing their liquidity, thereby reducing their profits.
spencer
Sep 21 2023 at 11:01am
The banks should be nationalized because the banks simply pay for the deposits that the system collectively already owns. Banks can’t attract deposits other than those that already exist. Deposits are the result of monetary policy, not the public’s savings. Savings aren’t synonymous with the money supply.
Jose Pablo
Sep 23 2023 at 2:27pm
Why is “privacy” so relevant regarding payments?
Which kind of payments are you worried about becoming “traceable”? by whom?
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