Dialing for Dollars: Solving CBDC’s Equality Conundrum

By Karen Petrou

• CBDC advocates tout its inclusiveness, but the digital divide is a profoundly exclusionary impediment to CBDC access for LMI, disabled, older, and rural households. 
• Centralized deposit-taking and payments via the Post Office and/or Fed pose challenges to personal privacy and even freedom of expression that, if not averted in initial design, could come to pose significant political and governance risk.  Lack of private competition also presents discrimination risk based on pricing or other terms not subject to outside scrutiny.
• If CBDC succeeds as some envision it, then lending will come either from the federal government – Big Brother problems of still more concern – or capital-markets sources outside the perimeter of safety-and-soundness and often also consumer-protection regulation and enforcement.
• A CBDC in which the Fed acts as an open-source utility corrects for many current inclusion, governance, and intermediation obstacles to payment-system speed and efficiency. 

At a recent Senate Banking hearing and several other Congressional sessions, advocates of central-bank digital currency (CBDC) rightly pointed to the payment-system failings that did so much damage to federal and state efforts quickly to distribute COVID-related financial assistance earlier this spring.  A solution such as CBDC is essential, but only if it is built with upfront awareness of and fixes for three inescapable facts:  1) millions and millions of Americans are not like the highly-educated, high-skilled millennials advocating sweeping CBDC; 2) a government-based financial system poses unique threats impossible from any private provider, no matter how detestable; and 3) a financial system without private, competitive, and innovative intermediation cannot generate macroeconomic growth on anything other than the federal government’s terms and maybe not even then.  This post considers each of these immutable facts in turn and then suggest a CBDC design that doesn’t supplant cash and serves as a supplement to – not replacement of – regulated, competitive, and innovative providers of financial-intermediation and payment services.

The Grand Canyon

During the COVID crisis, the digital divide proved at least as deep in the U.S. as other inequality chasms.  When distance learning was suddenly forced on the U.S. educational system, private schools generally transitioned without a glitch, but public-school districts found that many students lacked smart phones or tablets with the functionality needed for instructional delivery.  Many students also lived in homes or even entire areas without sufficient broadband capacity.  Teachers, especially those in rural areas, had similar challenges, with some forced to drive miles into town to prepare lesson plans in library parking lots.  It took the District of Columbia over six weeks even to find all of its students, let alone reliably reach them, after classrooms were forced to close. 

Over time, better smart phones and a more equitable digital infrastructure might solve for some of these delivery challenges, but a banking system launched before that time will prove a profoundly unequal financial system, throwing more millions into the un- or under-banked world at still more hazard.  It’s one thing if entertainment is hard to get, quite another when children are excluded from education, and even more devastating if the basic construct of everyday economic life is off-limits due to the digital divide.

22 percent of the U.S. population in 2019 was un- or under-banked, and millions more use their banks in very limited ways due to cost, inconvenience, distrust, or disability.  It’s not at all clear that any of these households would go to a bank or even to the Post Office, as some CBDC advocates prefer.  Many may well stay off the grid because they prefer cash to digital money regardless of whether it’s the digits in a bank account or those housed at the Fed.  Even if they have a bank account, households with incomes below $25,000 – approximately 26 percent of the U.S. population – prefer cash over other payment instruments by very large margins.  In 2018, 29 percent of households with incomes of less than $30,000 used cash for some or most of their transactions; only seven percent of households with incomes over $75,000 did the same. 

Big Brother’s Bank

Commercial interests already use our personally-identifiable information for purposes many of us dislike, distrust, and might well abhor if we knew more about them.  However, commercial interests use our personal data only (I hope) to promote their own commercial interests.  These may impoverish or deceive us, but they may not purposefully advantage one candidate over another, provide government agencies with enemies lists beyond tight limits of certain law-enforcement disclosures, or monitor transactions to determine the extent to which we are good citizens behaving ourselves in adherence to government edicts. 

We know these risks to be of prime importance in nations such as China that are racing to deploy CBDC to add one more arrow in the central government’s formidable quiver.  Are we so confident that the Fed or a Post Office controlled by adherents of an unscrupulous President would be more nice-minded? 

Statutory controls on government access might mitigate some of these central-government problems with CBDC.  However, CBDC that provides only infrastructure services with only limited and transitory access to personally-identifiable information is better.  Divide and conquer is a cliché with clout.

Looking for Loans

If the Fed takes over deposit-taking as pending legislation would have it, funds in the banking system  directly supporting $15 trillion of loans and hundreds of billions of more in indirect support via nonbank lending channels would have to come from the Fed or all these loans might be no more.

Some advocates of this CBDC “Fed Account” construct suggest that the central bank could just recycle them back into the banking system.  However, no one has yet stated clearly how this is to be done and at what cost, which loans would be permissible, and whether the Fed could pick the banks and even the nonbanks it likes the most.  Almost certainly, Congress will demand that only virtuous banks get loans for virtuous purposes and, even if it doesn’t, the Fed will be treading on such thin political ice that it will surely do so.

Which brings us back to Big Brother’s Bank.  Many may like this idea when it comes to climate-change policy.  Would we like it as well if a conservative government demanded loans to expand Arctic drilling as many Republicans now do?

Solution:  Open-Source CBDC

In an equality-focused CBDC, private providers would work with the Fed to create a new system in which a token-based form of digital money moves through established, regulated banks and money transmitters along with, as it evolves, new, blockchain-based infrastructure within and without the central bank.  A “token-based” CBDC means one in which the digital dollar is not based on access to a Fed or bank account, but is instead a digital representation of physical dollars and coins.  This form of CBDC does not supplant the cash on which millions of lower-income Americans and small merchants still rely.  Instead, perhaps powered by digital ledger technology, it supplements cash by being both the functional equivalent of fiat currency and an easy equivalent to it that those who wish to bank by electronic device can deploy as desired, not demanded.

As sketched out in one proposal, this CBDC system would parallel and thus complement regulated providers, ensuring that they – not only the Fed – continue to have the deposit wherewithal with which to make loans.  At the same time, this system would be far better adapted for electronic commerce and ready and able to take on benefit payments across the country under both ordinary and high-stress circumstances. 

Under this construct, reserves held at the central bank combined with tough rules and, going forward, reserve requirements for nonbank system participants would ensure payment-system certainty and stability as well as the ability of deposit-holders to get their money back in hard-currency, token, or account-based form when and how desired.  Banks would still likely be the depository of choice since only banks carry the FDIC insurance necessary for household financial security, but an array of options that interact seamlessly with household wage payments and government benefits would sharply reduce the cost of day-to-day transactions, especially for those unwilling or unable to open bank accounts.

In short, this digital-dollar system would combine the benefits of regulated banking, deposit-insurance protection, and payment-system certainty with those proffered by electronic commerce.  This new construct would work even better if nonbank e-commerce providers such as the bigtech companies are allowed access to the new system on condition of offsetting sterile reserves (i.e., deposits backing their payment exposures).  Bigtech would also need to ensure compliance with a new body of law and rule protecting transaction integrity and consumer privacy. This system would enhance equality by virtue of its speed and inclusiveness, ending the roadblocks and risks all too evident when the Treasury and states couldn’t figure out how to send urgently-needed payments to the millions of American eligible for them at the start of the 2020 pandemic.  It would be considerably more inclusive than the current banking system not just because of efficiency and speed, but also because of ease of access by anyone with or without electronic devices or the broadband capacity needed to enable real-time payments.  And, importantly, it would avoid top-down takeover of the national economic financial system by the Fed.  For all its virtues, such omnipotence in the hands of one ultimately-political central bank is a very, very bad idea.