Doubling Down On Failed Policies With Central Bank Digital Currencies

August 21, 2020
Author & Head of Research @ Goldmoney

Many central banks are researching retail digital currencies, which if implemented, would allow them to issue a new currency directly to the public, managed on a centralised ledger bypassing commercial banks. While there is an element of feeling the need to address new private sector currency developments which threaten central bank monopolies, specific objectives are beginning to emerge.

This article does not consider technology issues, confining its comments to the policy objectives identified in an IMF survey of central banks. It points out the dangers to individual freedom and why the application of a monetary policy extended to include central bank digital currencies are bound to fail.


Fiat currencies are failing — let’s try something different. This seems to be the logic partly behind the feverish research by central banks into digital currencies (CBDCs). The central banks of the Bahamas, Ecuador, Ukraine and Uruguay have conducted limited scale pilot projects, and China is also reported to have planned trials through Meituan-Dianping, an on-line food retailer and two further Tencent backed companies, though the status of these projects is at the moment unclear.

These are retail CBDCs. With a retail CBDC, the central bank issues the new CBDC to the public, either through agents, such as commercial banks, or directly to the public, bypassing the current financial system entirely. An advantage claimed over existing fiat is that it is capable of providing access through mobile technology to everyone, including the unbanked. But these advantages are already available through credit and debit cards and e-money, stored in apps such as M-Pesa and AliPay. They work perfectly well, replacing the need for cash where cash is not necessarily available or desired by transacting individuals. Perhaps further development of these facilities could be seen to pose a threat to the fiat monopoly

Alternatively, a central bank might decide to authorise a synthetic CBDC, a privately issued digital money backed by central bank reserves, regulated and supervised by the central bank. In effect the CBDC is contracted out to private sector partners, the full technological capabilities required lacking in a central bank. Furthermore, synthetic CBDCs are potentially cheaper, quicker to market and may be less risky to implement. We shall assume for the purpose of this article that the monopolistic ethos of central banks rules them out and focus on directly-issued CBDCs.

Why central banks want CBDCs

The stated reasons for issuing CBDCs provide initial clarity to observers. According to a recent report from the IMF the following objectives are under consideration:

  1. CBDCs could enhance payment system competition, efficiency, and resilience in the face of increasing concentration in the hands of few very large companies.
  2. CBDCs may be a means to support financial digitization, reduce costs associated with issuing and managing physical cash, and improve financial inclusion, especially in countries with underdeveloped financial systems and many unbanked citizens.
  3. CBDCs could improve monetary policy effectiveness to implement targeted policy, or to tap more granular payment flow data to enhance macroeconomic projections.
  4. An interest-bearing CBDC could enhance the transmission of monetary policy, by increasing the economy’s response to changes in the policy rate. Such a CBDC could be used to break the “zero lower bound” on policy rates.
  5. CBDCs would also help reduce or prevent the adoption of privately issued currencies, which may threaten monetary sovereignty and financial stability, and be difficult to supervise and regulate.
  6. CBDCs could help improve traction of local currency as means of payments in jurisdictions attempting to reduce dollarization.
  7. CBDCs could play a role in distributing fiscal stimulus to unbanked and other recipients.

This list reads like a wish list, rather than one of definite policy objectives, but it is an insight into central bank thinking in its early stages. But given that a synthetic CBDC is almost certainly more efficient when implemented by specialist technology firms in the private sector, we can ditch the first objective whereby a CBDC could offer competition to the private sector as little more than statist flannel. The other objectives are worthy of further discussion, at least from a central banker’s point of view.

Supporting financial digitisation, reducing cash costs and improving financial inclusion

Supporting financial digitisation is little more than irrelevant nonsense and needs no further comment, beyond the observation that in the absence of possessing any entrepreneurial motivation central banks would prefer their fiat monopoly not to be challenged by financial digitisation. And as a means of limiting the expense of issuing cash, other means such as limiting withdrawals or banning cash altogether are more effective.

It is only the last point mentioned in this objective that has a genuine rationale. As well as limiting or banning cash, by including unbanked citizens more of a nation’s GDP is captured, potentially adding to tax revenue, and lifting a nation up global rankings by economic size. By replacing cash with a CBDC distributed to and held by mobile apps, sections of economic activity currently unrecorded become included in the GDP total. Thus, Indonesia, with its scattered communities spread over thousands of islands, could record a larger economy than Australia. This matters to politicians and policy planners.

Improving monetary policy effectiveness

Presumably, the thinking behind this objective is that current monetary policy is failing for lack of control over economic actors while dismissing the possibility that monetary policy itself is flawed. Tapping more “granular payment flow data to enhance macroeconomic projections” is a desire to further monetary control, whereby a small committee of central bank officials can determine not just the quantity of money but how and where it is distributed in the economy. Armed with this power, the economy can be micromanaged through capital allocation directed by the central bank. Some sectors, even individual businesses, will benefit at the expense of others and it is a small step for industry to realise it must not only lobby the politicians but with the politicians in tow also to lobby the central banks.

Lobbying issues aside, for most statists improving monetary policy effectiveness through greater control over free markets is their Holy Grail. It is the ultimate destination of Keynesianism. The reason for its lack of success in banishing the business cycle so far is thought by policy makers to be due to lack of sufficient control over outcomes.

An interest bearing CBDC could enhance the transmission of monetary policy

On the assumption that a CBDC will circulate alongside existing fiat currency, in principal it would have to reflect the same interest rate structure. But if its issuance is restricted to preferred sectors of the economy, it might be possible for interest rate differentials to be maintained. In this case, policy planners could see a CBDC to be an important management tool. But for interest differentials to exist, strict limits would have to be placed on the ability for economic actors to arbitrage interest rates.

Of course, what is meant by interest bearing is almost certainly the imposition of yet greater negative rates with the intention of promoting selected sectors or even individual businesses. The application of the Taylor rule, whereby a central bank sets interest rates with reference to the difference between the GDP deflator and the inflation target is almost certainly behind current thinking.

There appears to be a belief current among monetary policy planners that an economic shock leading to a fall in the consumer price index can be swiftly neutralised by deeply negative rates. If a CBDC circulating alongside fiat is the channel for deeply negative interest rates relative to those of the circulating fiat currency, then a CBDC could become a more effective policy conduit for economic recovery.

The use of a CBDC targeting consumers could probably incorporate another stimulative device by issuing them with a time limited value or an expiry date. The incentive to spend would be enhanced and hoarding all but eliminated. Furthermore, by directly issuing CBDCs to the general public, policy planners might assume they can finetune the effects on prices by varying the quantities and terms of the CBDC.

CBDCs can discourage or prevent the adoption of private currencies

This objective envisages the current monetary arrangement of a state monopoly being undermined by competing currencies in the private sector. Privately issued currencies are not defined, but presumably include centralised e-money tied to fiat. AliPay and WeChat Pay are in this category and their further development might raise problems for state monopolists. Asset-backed stablecoins and crypto assets, such as bitcoin, are seen as a more direct threat to fiat, and their development has informed a millennial tech-savvy generation about monetary policy currency debasement and the relative benefits of limited-issue distributed ledger cryptocurrencies.

It is understandable that central bankers worry about developments in these areas and how they might threaten existing fiat currencies. This threat is possibly twofold; to a central bank’s monopoly over circulating currency, and the potential for any one or combination of these categories to undermine monetary policy to the extent that they encourage fiat to be abandoned.

The monopolist instinct in any state actor demands a policy to address the proliferation of e-money, stablecoins and cryptocurrencies. The simplest response is to ban them all, but that horse has already bolted. Individual currency competitors can be closed down by regulating them out of existence, but to be effective that requires cross-border cooperation, which usually takes years to obtain.

That leaves one alternative, for the state to produce its own CBDC and to ensure as much as possible it circulates as money alongside fiat. But only a statist would think that by issuing a CBDC that economic actors would prefer it to private currencies. Markets decide these things, and the inflationary characteristics of a CBDC would to a large extent determine or undermine its rate of adoption as a circulating medium.

Reducing dollarisation

No doubt all central banks with weak currencies believe that domestic use of the dollar to displace the local fiat currency is the principal cause of policy failure. The reasons for fiat failure and a flight into a more stable foreign currency are not hard to discern, even for central bankers grappling with this problem.

Dollarisation undermines the monopoly power of the central bank. Wherever dollarisation features it is understandable that the monetary authorities will explore the possibility of a CBDC resolving the issues arising from circulation of the dollar in the domestic economy. Furthermore, from Venezuela to Argentina, from India to Zimbabwe, cryptocurrencies present an enormous threat to the state control of money, a threat that central banks naturally believe must be addressed, and a monopoly for a CBDC could be seen to be part of the solution.

CBDC used to distribute fiscal stimulus

Unless the government distributes a digital currency directly which in the IMF paper is assumed not to be the case, the impact on fiscal balances from a CBDC must be through displacement, freeing a government from some of its existing spending commitments. Central banks therefore appear to be exploring variations on helicoptering money and the distribution of fiscal stimulus should be examined in that context.

A CBDC is assumed to be a liability of the central bank, shown as a balance sheet item alongside, but separate from, fiat money cash in circulation. To the extent the quantity of a CBDC is then expanded, balance sheet liabilities increase and have to be matched by an increase in assets.

The current route to a central bank’s balance sheet expansion cannot apply, whereby quantitative easing funds the government (increasing central bank balance sheet assets) and expands the reserves of commercial banks at the same time (increasing balance sheet liabilities). Furthermore, a CBDC bypasses the commercial banks.

If it is banned from funding government spending directly, which is often the case, the central bank would have to find other means of acquiring assets to match the expansion of CBDC on the liability side of its balance sheet. The three-card trick will be to provide stimulus to the targeted individuals and businesses, release the government from that obligation by funding it with a CBDC, and to do so without undermining the fiat currency beyond the price inflation target through excessive monetary inflation.

But monetary inflation is inflation, whether it be by fiat or a CBDC. However, a central bank could decide to keep the issuance of a CBDC off its own balance sheet. A likely innovation would be to use it to fund a sovereign wealth fund under its control. That way, the appearance of inflationary financing would be a step removed from the public arena and directly associated with the state’s creation of wealth for the common good.

The monetary fallacies behind CBDC

So far, we have attempted to debate the benefits of a CBDC from the central banks’ point of view. In doing so, we have generally ignored the fallacies that have led them to consider embracing digital currencies.

Inevitably, critics of macroeconomic monetary policies are cast into the position of the Irishman, who when asked the way to Ballymena by a motoring tourist, advised that he wouldn’t start from here. The fashion for mathematical, state-driven, socialistic macroeconomic theory is so pervasive in the corridors of power, central banks, commercial banks and investment houses that an understanding of the genuine economic philosophy of human action by the establishment hardly exists.

Like the Irishman, we are talking to an establishment that is lost on the wrong road. The multiple errors of macroeconomics, particularly with regard to the treatment of the means of exchange, have driven the establishment towards a collective economic destruction. That is now the overriding issue faced by monetary planners.

The establishment has responded to its policy failures, not through an unbiased examination and reassessment of its errors, but by turning its beliefs into a cult, like an antique religion that appeases its gods by the sacrifice on their alters of human lives. It appears nothing will dissuade them from doubling down with yet more human sacrifices, until all humanity is sacrificed in the name of preserving the establishment’s macroeconomic beliefs.

The establishment is obviously now the enemy of its electorate, destroying private livelihoods and wealth through increasingly rapid debasement of the population’s means of exchange. The very few operators who wield executive power over us and who increasingly discern the errors behind macroeconomic fallacies are now powerless to do anything about it for fear of precipitating the crisis they now fear.

This is why we see sensible men and women when they are given power, conform. They lack the courage, are outvoted or simply despair of changing statist policies. There is no leadership against macroeconomic fallacies, and in any event a brainwashed public wholeheartedly supports inflationism without appreciating the consequences.

CBDCs are merely an extension of embedded inflationism, inflation by additional means. Some of the executive are dimly grasping the reality that their fiat currency will have to be inflated at such a rate that it could lead to its rejection as a means of exchange — unbacked by anything other than faltering confidence in a failing system. But because no one with executive power has the courage and authority to challenge the macroeconomics of aggregates and to rehabilitate economic theories based on the actions of individuals free of government intervention, a solution is being sought in new currencies. Involving CBDCs is one of the possible resets increasingly debated on policy fringes.

Our focus, therefore, must be on the differences that might lead to success of a CBDC where existing fiat has failed. And the first thing we should note is that as proposed, CBDCs are another form of fiat, unless that is, a CBDC is gold-backed. But none of the literature emanating from the establishment suggests or even mentions a sound money objective. We should therefore assume CBDCs will be just another form of inflationary fiat.

With respect to new technologies, the state always moves at a glacial pace. While we have identified trials in the Bahamas, Ecuador, Ukraine and Uruguay with some reports of developments in China, it will be years before CBDCs can possibly become mainstream. The principal weakness will be a centralised ledger, inevitably exposed to outside hackers from cyber-warring states and criminals. The chances of the CBDC movement being stillborn are therefore high, particularly when one considers the urgency of a policy solution to current events. And the most important consideration of the benefits of CBDCs not mentioned anywhere is whether the general public actually wants them, because it will require their cooperation.

For our empirical guidance we can turn to a debate in Germany that took place in the first few years of the twentieth century. The new Austrian school of economics was pitted against the German historical school. The Austrians argued in favour of the general public choosing their medium of exchange, while the historical school, represented by Georg Knapp and the Chartalist movement, argued in favour of the state theory of money. Bismarck seized the opportunity presented by Knapp’s arguments to arm Germany through monetary inflation, which led to the First World War. The continuation of Chartalist policies led to the collapse of the papiermark in November 1923. Predictably, after tolerating it for some time the German public had woken up to the fundamental weakness behind the state theory of money. Give the state the power over money and it will abuse it.

It is an argument that resonates today, with fiat money being inflated as a catchall solution to an economic mess of the establishment’s own making. Let us turn to another example from history which refers to a monetary reset, with or without CBDCs. In December 1789, five months after the storming of the Bastille, France’s National Assembly issued assignat bonds secured on sequestered church lands and bearing a coupon of 5% to pay off national debt. The intention was for the issue to be a one-off, but the temptation to issue more after declaring it as a currency the following year could not be resisted. And when the assignats had lost almost all their purchasing power after successive issues, the government then reset with a new currency in 1796, the mandats territoraux, at the rate of one mandate for thirty assignats. The mandate became worthless within six months.

If the establishment today was not so dismissive of pre-Keynesian classical economics, they might note that the replacement of one fiat currency for another, even bedecked with technological gubbins, is no resolution of the failures of the former.

The implications of CBDCs for economic power

We can describe any modern state’s power as being in three buckets. There is the government itself, managed by a permanent establishment advising the political class. There is the central bank, responsible for managing the currency, ensuring the government is funded, and exercising control over commercial banks. And then there are the commercial banks, licensed by government agents to expand bank credit out of thin air, freed from the charge of doing so fraudulently.

The general public always thinks that the real power is held by the politicians, but that does not account for the control of money, the expansion of which is in the hands of the central bank and its commercial charges, who split the benefits of monetary seigniorage between them. It is assumed in the literature that the introduction of a CBDC will bypass the commercial banks entirely, unlike fiat cash which is always distributed through them.

It is clear from the objectives listed above, which are the result of an IMF survey of central banks concerning their research into CBDCs, that with the possible exception of synthetic CBDCs, there is no intention of retail CDBCs being distributed through the financial system. That being the case, there would be a transfer of power from commercial banks to the central bank, which is likely to be an additional reason for central banks being interested in the possibilities of a CBDC.

Furthermore, central banks are increasingly aware that there are times when commercial banks are reluctant to expand bank credit when risk factors increase, the very moment that central banks believe that monetary expansion is most needed. Consequently, commercial banks become obstructive to the deployment of monetary policies at those crucial times. A CBDC could be seen to be a resolution to this problem. Targeted at stimulating consumption selectively, it could then be used to promote state favoured production and technologies. Not only are central banks contemplating forms of monetary reset, but they may be looking at radical changes in the financial system to enhance their power as well.

Instead, the position of commercial banks could be undermined by the next systemic crisis, which, due to the accelerating rate of bankruptcies rising around the world from covid-19 shutdowns and the banks’ reluctance to lend, is likely to be imminent. Systemic dangers today are without doubt more serious than at the time of the Lehman crisis, and having their origin in the non-financial economy, more far-reaching. Notwithstanding earlier promises of bail-ins for which legislation has been passed by the majority of, if not all G20 member nations, whole banking systems will most probably have to be bailed out by taking them into state ownership.

If this happens, then the benefits of CBDCs to central banks that come from bypassing commercial banks will be nullified, because the effective nationalisation of commercial banks will remove them as a separate power base and obstacle to delivering monetary stimulus. And by holding all the purse strings, central banks could become considerably more powerful than the governments that originally sponsored them.


Central banks researching CBDCs are motivated by finding an additional means of monetary inflation to the existing means of issuing increasing quantities of fiat currencies. By issuing CBDCs directly to the public, commercial banks are by-passed, and central bankers hope to forensically target where the inflation is applied. A successful introduction of a CBDC could eliminate the impediment of contracting bank credit which occurs at the end of every credit cycle.

The further benefit for central banks is it will increase their power as an organ of the state at the expense of commercial banks, potentially becoming more important than the state itself. However, the current economic situation is deteriorating more quickly than a working CBDC can be introduced, so the whole exercise is likely to be too late to have any relevance to monetary policy in the foreseeable future.

Alasdair Macleod


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Alasdair became a stockbroker in 1970 and a Member of the London Stock Exchange in 1974. His experience encompasses equity and bond markets, fund management, corporate finance and investment strategy. After 27 years in the City, Alasdair moved to Guernsey. He worked as a consultant at many offshore institutions and was an Executive Director at an offshore bank in Guernsey and Jersey.

Small amounts of natural gold were found in Spanish caves used by the Paleolithic Man about 40,000 B.C.

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