And the Social Nature of Money

You’ve probably heard some of the fuss around central bank digital currencies (CBDCs). This article is neither a fiery condemnation (that would be too easy) nor a technical explanation, nor anything in between. I will briefly explain what they are, describe their attractions and dangers, and then explore some seldom-discussed foundational questions.

What is a central bank currency—digital or otherwise? It is money issued by a central bank such as the Federal Reserve that either circulates as cash or is held in accounts at the central bank. Today, the only entities that have accounts at the Fed are banks and other financial institutions. Private citizens and businesses can’t open an account at the Fed. I tried, but they put me on hold.

Here is a simplified version of how it works, accurate enough for the present purpose. Acme Bank has reserves of $100 million at the Fed. During the course of the day, it makes loans and takes deposits. The loans end up as deposits in other banks. At the end of the day, all these transfers are “cleared,” meaning that if Acme lent a total of $20 million and received a total of $15 million, its account balance at the Fed would fall by $5 million, and other banks in the system would see their balance rise by a total of $5 million also.

I hope you didn’t tune out as soon as you saw numbers. Basically what is happening is that central bank money moves from one bank’s account to another to settle accounts with other banks.

Obviously, these bank reserves at the Fed do not take the form of piles of hundred-dollar bills. They are digital already. So what is new about CBDCs?

The novelty stems from the fact that the money you and I spend (with the exception of cash) is not central bank money at all. It exists only in the ledger of your commercial bank or other institution. If I Paypal you $1000, my Paypal balance and your Paypal balance change, but nothing happens in the central bank. Same is true if Alice, who banks at Acme, writes a $1000 check to Bob, who deposits it in XYZ Bank, and then Carol, who also banks at XYZ, writes a $1000 check to Dave who deposits it in Acme. These individuals’ account balances go up and down, but their banks are even with each other and the Fed is not involved at all.

A central bank digital currency essentially allows private individuals and businesses to have accounts at the central bank. It would function just like (and ultimately replace) cash, requiring no intermediary, no bank, no credit card company, and no transaction fee. If I buy a coffee at your cafe, an app or card reader sends a message to automatically credit your account and debit mine. The user experience would be the same as today, but there would be no fee and no lag time. Normally, paying by debit or credit card involves a 3% fee and a day or two for the funds to become available to the seller.