Participants in the real modern economy have no direct interaction with the central bank save for the use of notes and coins (i.e. commodity money).
But this state of affairs is more a policy choice than an economic inevitability, and the role of the central bank does not need to be so minimalist.
In the opposite scenario, the central bank could prohibit private banking, require that all transactions were settled through its books, and thereby assert complete control over the monetary system.
Nowadays central banks actually consider the disintermediation of the entire banking sector by introduction of central bank digital currency (CBDC).
Five issues to note in this respect:
Design
The design of CBDC would pre-determine its role and functions.
For example, a CBDC can be made accessible to financial institutions only, to the whole economy (financial institutions, firms, and households), or through financial institutions intermediation.
In a nutshell, CBDC proposals range from abolition of money to abolition of private money.
Replacement of private money
Remember the idea of a single central register of payment obligations. Where such register is in place, money is useless — the register enables to keep track and balance exchanges of value with no money involved.
CBDC tries to implement this idea into reality: instead of recruiting private entities as its agents to perform certain functions, the central bank could expand to perform those functions itself.
For this purpose, the central bank would have to acquire all of the private commercial banks operating in its territory so as to enable use of their account management and payment capabilities to manage the flow of payment by itself.
But the result appears to be no more than reorganisation of the system which already exists.
Imagine, the existing private banks are pooled together into a single private legal entity to provide the services CBDC intend to provide. However, the relationship between the central bank and the private legal entity would be identical to the relationship between the central bank and the current private banking system today — save that the private entity would have greater negotiating power.
Full reserve banking
CBDC can be an instrument of control over the commercial bank money. All deposit banks might be required to hold balances with the central bank equal to 100 % of the amount of deposits received.
In such a case, they will no longer be able to create credit beyond the limits of the amount of central bank money to be made available to them by the central bank.
But there is a problem: the central bank does not pay interest on balances maintained with it. Consequently, deposit banks would cease to be able to offer interest on deposit accounts and would have to pass on to customers the full costs of payment services provided to them.
As a result, customer savings and surplus cash balances would be redirected to non-bank (generally unregulated) vehicles which are not obliged to hold their balances in return-free form.
Centralised banking model
CBDC model takes back to Gosbank, the central bank of the Soviet Union.
Routing all transactions through the central bank turns the central bank into an economic planning ministry exercising overall control of the supply and allocation of credit (recall Gosplan and Gossnab).
The tightening of government control over the economy might require the nationalisation of deposits; highly disputable step in the modern economy.
Bad vs good money
Time will tell how would the Gresham’s law effect CBDC.
According to the Gresham’s law, where there are two different payment media in circulation with different perceived values, the more valuable one will tend to be hoarded whilst the less valuable one will be used. Thus, the more valuable unit will disappear from circulation.
CBDC is a higher credit quality than private bank money issued by the banks of the territory for which the CBDC issuer is the central bank.
* This note is based on The Legal Concept Of Money by Simon Gleeson.
Disclaimer: This is my personal blog. This is neither a legal opinion nor a piece of legal advice. The opinions I express in this blog are mine, and do not reflect opinions of any third party, including employers. My blog is not an investment advice. I do not intend to malign or discriminate anyone. I reserve the right to rethink and amend the blog at any time, for any or no reason, without notice.
