Unchained - Fed Economist on the Prospect of the USD Losing Global Reserve Status: 'Who Cares?' - Ep.140

Episode Date: October 8, 2019

David Andolfatto, senior vice president at the Federal Reserve Bank of St. Louis, gives his thoughts on Facebook's Libra, including why regulatory issues will make it hard to compete with the US dollar, and why Bitcoin wouldn't have such issues. He also says, "who cares?" about the US dollar losing global reserve status, pointing out that many prosperous countries have currencies that don't function as global reserves. He tells us how he would design a central bank digital currency, and why, even if central banks enabled citizens to open accounts with them, thus bypassing commercial banks, it wouldn't drive banks out of business. We also cover how that could affect fractional reserve banking and credit creation, the People's Bank of China's soon-to-be-issued digital yuan, and why blockchains haven't yet substantially helped the unbanked, as they were originally touted to do. Thank you to our sponsors!  Kraken: https://www.kraken.com CipherTrace: http://ciphertrace.com/unchained Crypto.com:  https://crypto.com Episode links:  St. Louis Federal Reserve: https://www.stlouisfed.org David Andolfatto: https://research.stlouisfed.org/econ/andolfatto/sel/ David's blog: http://andolfatto.blogspot.com Letter from House Reps to Fed Chair Jerome Powell: https://static.coindesk.com/wp-content/uploads/2019/10/Foster-Hill-US-Crypto.pdf Talk on blockchain, cryptocurrency and central banks: https://www.stlouisfed.org/dialogue-with-the-fed/blockchain https://www.stlouisfed.org/~/media/files/pdfs/dwtf/blockchain_082918.pdf?la=en Blog post on cost efficiency of a centrally managed ledger: http://andolfatto.blogspot.com/2017/12/fedcoin-and-blockchain.html?spref=tw David’s paper on the impact of central bank digital currency private banks: https://s3.amazonaws.com/real.stlouisfed.org/wp/2018/2018-026.pdf Raskin and Yermack paper: https://ccl.yale.edu/sites/default/files/files/Raskin_Max_and_Yermack_David_The%20Future%20of%20Central%20Banking.pdf David on FedCoin: http://andolfatto.blogspot.com/2015/02/fedcoin-on-desirability-of-government.html  Philadelphia Federal Reserve banker Patrick Harker on a G20 CBDC being inevitable: https://www.reuters.com/article/us-usa-fed-harker-digital/feds-harker-digital-central-bank-currency-inevitable-idUSKBN1WH1L4 Related Unchained interview: Dong He and Yan Liu on central bank digital currencies: https://unchainedpodcast.com/the-imf-on-how-to-design-central-bank-digital-currencies/ Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I'm your host, Laura Shin. Heads up, everyone. In case you missed it, last week I rolled out a new feature on Unconfirmed, a weekly news recap. This summer, I conducted a survey to find out what you, the listener, wanted, and a number of you said you'd be interested in weekly news recap on the show. Since I've already been writing up what I think are the top stories every week for my email newsletter, it was natural to extend that to the the end of every unconfirmed. So if you're not yet subscribed to unconfirmed, go do that now and find out what I think were the biggest news stories of the week. Cracken is the best exchange in the world for buying and selling digital assets. It has the tightest security, deep liquidity, and a great fee structure with no minimum or hidden fees. Whether you're looking for a simple

fiat on-ramp or futures trading, Cracken is the place for you. Cipher trace cutting-edge cryptocurrency currency intelligence, powers anti-money laundering, blockchain analytics, and threat intel. Leading exchanges, virtual currency businesses, banks, and regulators themselves use ciphertrace to comply with regulation and to monitor compliance. Crypto.com. Get their app and buy crypto at true cost with no fees or markups. Get a metal MCO visa card with up to 5% back in all your spending. Want more? Download the crypto.com app today. My guest today is David Andalfato, Senior Vice President at the Federal Reserve Bank of St. Louis.

Welcome, David. Hey, Laura. How are you doing? I'm interested to hear your background because you obviously work at the Federal Reserve, but you are also quite a prolific author and speaker on blockchain and cryptocurrency. So tell us how you came to be in this role. Right, sure. So my background is actually as an academic economist. I spent about 20 years in academia and moved to the Federal Reserve Bank of St. Louis in the research division where I got to basically apply the theories that I was studying and I learned as an academic that involved primarily monetary policy, banking, financial stability, payments, etc.

And so when, you know, this new phenomenon emerged, I quite naturally became very interested in this kind of alternative type of money and payment system. So I've been basically keeping an eye on it ever since. It's not part of my official job description here. It's kind of just more of like a hobby, something that I keep an eye on and try to see how it relates to things I've seen happen before. history, and also whether or not any of this emergent technology has any, you know, monetary policy implications going forward. And so how did you hear about Bitcoin and blockchain? And also, why do you think that they really caught your interest other than, you know,

the fact that it, you know, is sort of in your professional sphere? Yeah. Well, you know, I've, as a bit of an historian of monetary policy and monetary developments, you know, I was aware that there have been many, many attempts in the past of, you know, private currency issuance or non-government currency issuance. And that when I first heard about Bitcoin, I think I probably heard it, heard about it, kind of referred to as, you know, kind of people were very, very skeptical at the time, you know, calling it a scam. I think Paul Krugman famously wrote something on it that intrigued me. And so I think, if I recall correctly, I mean, that's five or six years ago now, maybe longer. But I decided to peek under the hood to see what all the fuss was about.

And I quickly, it didn't take me too long to realize that there was actually something quite interesting, something quite novel about this new innovation. And that's just basically how I got started in studying the phenomenon and kind of researching it. And I continue to do that today. So before we get into the meat of our discussion, which is going to be pretty wide-ranging and really interesting, I just want to make sure that the listeners kind of understand essentially like what the Federal Reserve does and also what the different regional Federal Reserve banks do. and also the role of commercial banks. So can you just sort of talk generally about, you know, how all of that works?

Oh, yeah, sure. So the Federal Reserve was founded in 1913. It was founded after the United States had experienced a number of severe panics in the latter part of the 19th century financial panics. And one of the big ones happened in 1907. And what was decided at the time was that, you know, this type of very, very, you know, unstable kind of financial structure needed some sort of backstop, some sort of government-sponsored bank to kind of help stabilize the financial system. There were attempts in the past, two other attempts that the first and second national banks in the United States that failed to get their charters renewed. The Fed was established as kind of very, it's a very unique kind of creatures, kind of like this public, private sector partnership. It's not completely public. It's not completely private. It's kind of this mix.

And, you know, just the Fed was basically designed to basically be there as a backstop and to serve as kind of a lender of last resort to provide an elastic currency as the, phrase was used at the time. And since then, it's evolved over time, you know, to play a major role in facilitating payments in the United States. It played a big role in clearing checks, for example. And also there's that part of the Federal Reserve that is responsible. It has congressional mandates to use the powers that it has to fulfill its congressional. mandates of price stability and in full employment. And so the Federal Open Market Committee is responsible for that. And that committee consists of the 12 regional Fed presidents plus seven representatives at the Board of Governors. And basically this is, you probably, most of your

listeners are probably aware of that part of the Fed, where the FOMC, the Federal Open Market committee makes decisions about the path of interest rates in the economy to help regulate inflation in economic activity according to the congressional mandates that it has. And can you also elaborate on the role that commercial banks play in the banking system? Sure, commercial banks. I mean, there's a lot of them in the United States, you know, thousands of them. And these commercial banks all have accounts with the Federal Reserve Bank. In fact, they are basically digital currency accounts. Fedwire, for example, is a real-time gross settlement system

that the commercial banks use to clear payments with each other. So this is kind of interesting in of itself in the context of the talk today because as we speak, you know, for a long time, we already have had a central bank digital currency, but it's been restricted basically to the commercial banks. So the Fed plays a major role in facilitating payments across banks as they, you know, help facilitate payments that occur in the private sector. So when you go and you make a payment to the Starbucks merchant, you know, your account is debited, the account of the merchant is credited, there's got to be a flow of funds from the two accounts. What's happening in the background is that Federal Reserve funds are flowing from your bank to Starbucks Bank.

And that happens through these back channels in the payment system. All right. So this sets enough of a stage for getting into the meat of the discussion where we're going to talk about all the different ways that developments in the crypto and blockchain world are sort of intersecting with your world. Let's talk first about probably the biggest news of this year, which is Libra. What do you think of the Libra proposal? It's intriguing. I mean, there's been a lot of proposals. This is not new. This is not new by any means. There's been a lot of proposals in the past to create Libra-like objects. The special drawing right at the IMF, the International Money Fund, is an example of this type of Libra, although it has limited access. There have been many proposals in the past to do it as well, pre-Internet days. What's different about, this is, of course, we're now in the internet era, one, and also Facebook is a social media giant. It has over 2 billion users. So it already has a really vast network in place

already. So people can talk to each other through Facebook. And that's at the end of the day, what money is and money transfers all about is talking to different accounts. It's information transfer. And so what makes Libra interesting is you've got this large private entity with this humongous network already established that could potentially, you know, move information around. It already does move information around, you know. You can talk to your friends, for example, but imagine asking, opening up an account at Facebook and asking, you know, whoever's in charge to debit your account of whatever Facebook units or Libra units and crediting the account of somebody else. In principle, you know, Facebook could be involved in this in a way that could have a

major impact on payment processors around the world, on a scale that, you know, like I said, these types of proposals have been around in the past, but just the massive scale that Facebook brings the bear on this possibility is what makes it really interesting. And so when you say it would have a massive effect on payment processors, like, I guess you mean from the sheer aspect of people might prefer to use the Facebook system simply because of its reach. But I'm curious to know also, like, do you think that it would have an impact on central banks? you know, what would the impact be on retail banks, on maybe weaker economies, or just aside from payment processors, what are some of the other impacts on existing players? Well, I actually just, I don't see what other impact it would have other than payment processing.

Well, that's not quite true. I guess there might be some effect to the extent that this monetary object that they create might serve as a competitor to other types of money. instrument so there's that. But, you know. And when you, like, what are some examples of some of the others? Oh, I just mean, uh, euros and yen and U.S. dollar, you know, currency competition has always been very fierce. And, you know, we have Bitcoin. We have many, many competing currencies out there.

And central banks have to constantly, uh, um, be concerned about currency competition. Usually you're concerned about currency competition of other types of currencies, for example, in many emerging economies, you know, people like the U.S. dollar, for example, that competes against the domestic currency. In principle, private currency issuance like Libra might compete against the U.S. dollar, for example. These are just kind of the potentials. I don't necessarily see that happening. Oh, you don't? Well, okay, because what I was going to ask you was, you know, David Marcus, who headed up the group that developed Libra at Facebook, he's come out a few times and said that it's not a threat to these existing fiat currencies. You said it could potentially be, but then you actually just said you didn't think it would be. Why not?

So, yeah, I'm not sure if you agree with David or disagree with him. Well, I could, it's a complicated issue. You can kind of, one could imagine different kind of parameter configurations for how things are set up. But a lot of it depends, for example, on what I think the, how Libra would be restricted by basically domestic regulations. I just think, I mean, they're going to have to be compliant to the underlying regulation of every country. and I just think once these companies are compelled to be compliant, that they're going to be on an equal footing with any regular money market mutual fund, for example. I don't see what the difference is necessarily between Libra and a money fund,

a government money fund, except for the fact that Facebook, of course, can be accessed globally very easily, relative to say, a U.S. money fund. I mean, I don't know. So, yeah, that's kind of, I see a lot of regulatory hurdles, I think, that would make it very difficult for Libra to kind of displace such a dominant world currency like the U.S. dollar, at least any time soon. We should never say never, of course, but I don't see it in the foreseeable horizon. And what about for weaker economies? That probably doesn't apply, like if you or. were, you know, a Turkish central banker or Argentina or something, what would you be thinking about the advent of Libra?

Well, that's a good question, right? For Libra, again, I think for countries like that, they could impose currency controls that would effectively prohibit their citizens from accessing Facebook, for example, on the Internet, that would prevent them. You know, I think that one of the disadvantages of Facebook is it's a registered corporation with a, you know, there's a CEO. There's, they have to be compliant if they want to play nice. And so ultimately they're subject to the regulatory whims of whatever country they're operating in. This is very different, very different, say from Bitcoin, for example, that has no designated. CEO or corporate structure. So it's a very, very different, you know, competing against Bitcoin is completely different animal than competing against, say, Libra.

So even there, I think that, you know, it kind of depends on how open, how open the jurisdiction is to permitting its citizens to process payments using some private provider like Facebook. it's just kind of at the end of the day just depends. Yeah, and even what you were saying about how they could shut off access to Facebook, you know, Facebook claims that it will be the Libra Association that will be in charge of Libra and that there will be other wallet providers that are built on top of this network that's controlled by the Swiss entity.

And so even if people couldn't access Facebook, maybe they could access these other wallets. But we're getting really far ahead of ourselves because we don't even know Libra will launch. But it was also, I was also curious to know you talked about how Libra is not that different from previous attempts to form, well, like you compared it to the STRs that the IMF has created. And I just wondered, in general, what do you think of the way that Facebook approached Libra? Like, you know, if you were to have designed a global stable coin, would you have done it the same way? or do you think, you know, it was a mistake not to just peg it to the dollar or, you know, just on the design of it, what's your take? Well, I mean, the idea is, in terms of like creating a stable coin, I can kind of see the logic of the approach they took.

And indeed, I think that they may very well have been inspired by the approach that the IMF took when the IMF, the International Monetary Fund created the special drawing right. When the special drawing right, however, was created, which of course was many, many, many years before the Internet, nevertheless, there were, you know, I've seen references to people back then proclaiming the end of, you know, domestic currencies that one day everybody was going to be making their payments, receiving their payments, their wages, spending their special drawing rights, that it was going to basically displace all national currencies. well, needless to say that never happened. And so whether or not, you know, the ability of Facebook to leverage up the Internet might make it more amenable for people to want to use kind of a basket of currencies as kind of the numerator, the unit of account, I don't know. I mean, I just think it was a big hurdle to kind of climb. I think they may equally well have approached it by just saying, look, I mean, we're just going to create these things called Facebook dollars. You know, just like just the way any, a lot of games create their own credits inside, you know, their environment. You know, Facebook just can create its own money.

Could be, you know, airlines create air miles, you know, various companies create coupons, redeemable in money that they issue themselves little credits. So Facebook credits. Right, but what would the value have those been? Like would it have been pegged to the U.S. dollar then if you're saying that they should have just created, you know, Facebook dollars? Are you saying it should have been pegged to the U.S. dollar? I guess it depends on what your objective is. I mean, if you wanted to peg it, you could try to peg it to the U.S. dollar. But, I mean, you know, I mean, I don't know. I guess you could have chosen that model, too, that U.S. dollar is the dominant currency.

But I guess for a variety of reasons, right, you might want to move away from having the U.S. dollar being the dominant currency. They probably have in mind that they have a global set of users. And these users may have wanted a currency that was backed more by a basket of currencies rather than just the U.S. dollar. So I can, like I said, I can kind of see the motivation behind that. But I mean, I don't know. They could have alternatively, like I said, just created their own Facebook dollar. Right. But that's why I was asking you, like what would the value of that have been? Like, what would the exchange rate have been? Just a floating. Are you saying then? Oh, I see. Yeah, just a floating exchange rate. I mean, so, you know, one way to envisage what this, what this currency

because I guess you have to distinguish between this currency as a store of value and as a kind of what I think some economists have called a vehicle currency. So most people perhaps might not even hold this floating currency, these Facebook currencies, this Facebook currency. What they might use it for is just to affect a transfer of funds. So they'll just buy it for a very short period of time, transfer the credit from one Facebook user to the other Facebook user to facilitate the payment very quickly that they couldn't otherwise facilitate, say, through the correspondent banking sector in the world.

And then Facebook could just like debit and credit accounts, you know, instantaneously, basically, so you'd bear very, very little exchange rate risk. And then there'd be a separate set of agents or agencies or firms that would be holding this Libra currency as kind of a store of value absorbing all the risk associated with it. So that would have been a kind of an alternative model. It's not entirely clear to be which is the best way to go. Okay. Well, since we've been talking about the U.S. dollar, I did want to bring up this letter that was recently sent by House representatives, French Hill, and Bill Foster to Jerome Powell, the chair of the Federal Reserve.

And they stated, quote, we are concerned that the primacy of the U.S. dollar could be in long-term jeopardy from wide adoption of digital fiat currencies. The letter notes that 40 countries are looking into developing digital currencies. It cites the soon-to-be-released digital yuan in China. And it concludes by asking Chairman Powell if the Fed is looking into a digital U.S. dollar, how it plans to respond to competing digital fiat currencies, what the Fed would need from Congress for the development of a dollar, et cetera. what did you think of the letter? And do you think they're right to be concerned about the long-term primacy of the USDA?

No, I don't think they should be concerned about it. I mean, the U.S. dollar is, if anything, solidified its hold as the primary currency in the world since the 2008 financial crisis. There's been a lot of regulations passed worldwide, Basel 3, for example, that have solidified the role of the U.S. dollar as a regulatory object. So I don't think I'd be too concerned about that. But even, I have to say this, even if it was true, I mean, who cares, really? I mean, most countries don't have a world reserve currency. I mean, it's like Canada, for example, seems to be a perfectly respectable country to live in. And nobody wants to hold Canadian dollars except for Canadians.

And whenever I visit Canada, it seems like a very nice place to visit. that people are prosperous and happy. And, you know, so at the end of the day, I don't even think it's a huge deal in the sense that, you know, the wealth of a nation is determined by its people, its human capital, its productivity, the opportunities it offers. And whether or not the U.S. dollar is the world's global currency is actually kind of just peripheral. It's kind of like an exorbitant privilege, as they say, for the United States because it gets to export dollars for goods and services. and that's kind of a nice benefit to have in some sense. But, I mean, it's not critical for the well-being of a nation. In terms of like a digital currency, you know, I'd argue most people have access to digital currency already.

I mean, through the – they have access to digital bank accounts, for example. So the commercial banking sector is how we make payments, right? We use our debit cards, for example. And most of us, you know, I guess most of the complaints, I guess, are, well, it's kind of interesting. I mean, I'm old enough to remember when even, you know, you didn't have debit cards, you'd actually have to use checks or travelers' checks and things like that. So many young people today kind of take a look at the landscape, the financial landscape out there, and they see inefficiencies everywhere in terms of payments. But one thing you have to realize is that there's been tremendous innovation in money and payments over. the last 20, 30, 40 years. It's not like things are standing still. In the old days, you know, if I

wanted to travel to Europe, I'd have to take travelers checks. I don't even know if many of your listeners know what a traveler's check is anymore. You'd have to go to the Thomas Cook office. Yeah. You'd have to go and buy some travelers checks. You'd have to visit the office, buy the travelers checks. You'd have to have them issued. You'd have to have to go back, pick them up. You'd fly to Europe. You'd have to go. You'd have to go. take a taxi to a, you know, American Express or Thomas Cook office, it'd be closed because it was a bank holiday, so you'd have to go back home and go back the next day. Then you'd go back and visit the office and then, you know, you'd make a big cashing of Lira if you're in Italy, for example,

and then you'd have to carry around a wad full of Lira in a country where, you know, maybe you didn't, I mean, today you travel to Europe and I take my, I take my credit card. I mean, it's great. So if you were to design like a U.S. dollar CBDC, how would you do that? Like would you, because there are a few options here. Like the Fed could issue a digital dollar where it then allows everyday people to have accounts at the central bank. And it could bypass the commercial banks to distribute it. So, you know, would you go that route? I've seen you written, you have written that you believe.

that if the central bank releases a Fed coin, that there shouldn't be KYC restrictions on it. So just describe for me your ideal U.S. digital dollar. Right. Well, I'd be very careful about that last statement you said about Fed coin. There's different models of what one means by central bank digital currency, of course, right? Kind of the old idea is just opening up the Fed's balance sheet to everybody and not just commercial banks. So in a sense, the Fed already does that. We all own a piece of the liabilities of the Federal Reserve to the extent that we hold paper dollars. And so, you know, one might say,

well, if we're allowed to hold paper dollar accounts in our wallets, why can't we hold digital money accounts at the Fed directly? Right now, it's just the commercial banks that are permitted to have digital currency accounts with the Fed. Well, that's fine. I mean, what happens? now is the digital money accounts that you and I have to hold are going to be done through Bank of America, for example, or through a money market fund, perhaps. So, you know, in this model, it's basically indistinguishable from central bank digital currency, except that, in fact, for most people, it's just indistinguishable. You know, it's, you could have the, you could permit everybody to have accounts directly with the Fed, or you could kind of have it disintermediated

a little bit, let the banks intermediate it. That's the model we have now. And the only quibble that people have is really about with respect to the fees that bank charge and whether or not their accounts are insured above some certain minimum level, and whether or not they can make payments overseas efficiently. These are the things that people are complaining about. And And, you know, I'm not sure. So if you were to design it, would you design it, you know, bypassing the commercial banks? Or like you kind of said you could do it either one way or the other, but I'm asking, what do you think is the better way? Yeah.

So I'm sorry, I got a little off track there in terms of the KYC thing there. You know, another model of issuing the Fed digital currencies to have it basically as kind of the Swiss anonymous Swiss bank account model as well as kind of a token-based model. and so there's a wide variety of models in which you could issue the central bank digital currency. For myself, I think that many people have made the case that, you know, it would seem that there might be a role for the Fed to provide a basic utility banking service for people in the economy, very much like, I guess, the U.S. Postal Savings Bank did for many years from 19, I think 1913 to 1965. just a basic plain vanilla payment processing service that, you know, would pay kind of a nice little interest rate on your deposits. It would offer real-time gross settlement. It would charge no fees. Your accounts would be fully insured. And there would be no other services provided, no overdraft privileges,

for example. And that this type of service is kind of like a public office. that should appeal to people who might otherwise find it difficult to open up a bank accounts in the commercial banking sector. It wouldn't attract. It could coexist with banks. It's not like it would drive banks out of business because banks, of course, offer their clients all sorts of services that they bundle together with payments. So, yeah, I think I've been a proponent of the idea that the Fed could issue. just a very basic plain vanilla kind of central bank digital currency, which the way I'm describing it is not a Fed coin, but it's just basically permitting people to open up bank accounts directly with the Fed. Very much, by the ways, in the way that Americans can already open up bank accounts directly with the U.S. Treasury.

You can go to www. treasury direct.gov, and you can open up an interest-bearing account there at the U.S. U.S. Treasury. You're not allowed to make payments with these interest-bearing objects, but that's something that could be overcome. That's not a technical barrier. That's just a policy barrier. So one could imagine a world where you could kind of remove that barrier, and people could, one form that this central bank digital currency could take is, in fact, in terms of treasury money, where people could make online payments directly with their www.w. Treasury.D.D.D.G.G. accounts. Many other models are possible, of course,

but that's kind of the basic one I see. All right. So we're going to discuss how all of this could affect commercial banks, as well as how cryptocurrencies play in all this. But first, a quick word from the sponsors who make this show possible. Crypto.com sees the future of cryptocurrency in every wallet. Have you seen the MCO Visa card? metal card powered by crypto loaded with perks including up to 5% back on all your spending and unlimited airport lounge access. They pay for your Spotify and Netflix too. What's not to love? With crypto.com, not only can you spend your crypto, but you can grow it too.

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That's KRAK-E-N.com. Back to my conversation with David Andalfato of the St. Louis Reserve, Federal Reserve. So one thing, you know, earlier when you talked about how you didn't think it was super important that the U.S. dollar be the, you know, a global reserve status currency. What's your take then on China's PBOC digital currency, which will be released soon, do you think that could kind of affect the U.S. dollar's global reserve status? And does that give you concern, especially as you're watching kind of what's going on in Hong Kong and how maybe a digital yuan could, I guess, increase China's power?

Yeah. Am I concerned? You know, I'm a central banker. I'm paid to get concerned about everything. I guess, but I don't see. I, you know, I mean, I don't know. I take kind of the view that, you know, all the power to them if they want to try to do that. I mean, they might have some success as a regional currency like in Southeast Asia, and I think that would be fine.

I mean, I personally don't see them competing on the global stage with the U.S. with the U.S. dollar. I mean, I just, you know, you just have to ask yourself. I mean, how would you rather be holding your wealth in U.S. dollars or, you know, Chinese one? You just ask yourself that question. A lot of it depends on how the global community trusts, you know, a particular country. And I think right now and probably for the foreseeable future, the U.S. has got it. And China hasn't, although like I said, perhaps China could have some success and especially regionally. And I think that would be fine.

It's not like control over this stuff is going to dictate the trajectory of the wealth of nations. I mean, like I said, it's just what we're talking about here is record keeping, debuting and crediting accounts, information transfer, record keeping, database management. I mean, it's not something that's profound in the sense of like developing human capital, developing entrepreneurial spirit. you know, we have to keep our eye on a ball on the ball about what truly it is that creates the wealth and material well-being in a society. And yes, payments are important. Yes, it is advantageous for a nation to have kind of a favored currency. But it's not something, you know, foreboding that, you know, if suddenly China becomes the world's reserve currency, you know, is the United States economy going to go into a death spiral? I just don't see that.

So we have to be a little bit careful about, you know, being too melodramatic here, about what the ultimate consequences of Bitcoin or some other currency displacing the U.S. dollar. It's happened before. It's happened before in history. And, you know, countries and people just continue to live in probably. prosper. So in the crypto world, many people see the emergence of central bank digital currencies is practically inevitable. And I was wondering, in your world of Federal Reserve bankers, how much are these ideas being discussed and how seriously? Well, they weren't being discussed that much years ago when I started to study the phenomenon.

But increasingly, you know, you see more and more prominent central bankers discussing the idea. And indeed, President Harker of the Philadelphia Fed just recently suggested that a central bank digital currency is among the G20 is likely inevitable now. He didn't believe the U.S. would be a leader on that front, but he sees it as inevitable. And what did you think of the Bank of England, Governor Mark Carney, suggesting to have, you know, a global digital reserve currency? Right. So that's an interesting idea, right? That's, again, trying to get away from the special status that the U.S. dollar has and kind of the issues that it implies for a number of countries that like to peg to the dollar or that issue dollar denominated debt. I think that it's an interesting idea, but that kind of from a practical perspective, I just don't see how countries are going to. agree, agree on how to manage such an object. So at least I could be wrong, there might be a way to do it. But I actually don't think that politically it's, it's a, it's a, it's, it's, it's, it's, it's, it's, it's, it's, it's, for the, for the time being, I mean, I guess we're basically stuck with the US dollars as far as

I'm concerned. And earlier when I asked you about how you would design a central bank digital currency. You did say that you felt that everyday citizens could open accounts at the central bank, thereby bypassing the commercial banks. And you didn't seem to really kind of imply that this would have a huge impact on commercial banks. So do you feel like this is something that they should not be scared of? You know, J.P. Morgan and Wells Fargo are also working on their own versions of digital dollars. And I just wondered how you thought that, you know, they were viewing all these developments and if you were in their place, what would you be doing? Oh, well, you know, I think that they should be worried all right, but the primarily

in the sense that they should be worried only to the extent that they would be worried quite naturally about the emergence of any competitor, right? So any new competitor on the scene should have them worry about how they are going to compete against this new player on the block. And so in that sense, with the Federal Reserve entering into the offering its own accounts directly to citizens instead of having them intermediateed and having these accounts, they pay maybe a more competitive deposit rate, for example, would certainly increase the cost of maintaining deposits in the commercial banking sector. So that will definitely, it might have some impact on how much profit they could extract from deposit accounts. To the extent that the banking system is a monopolistic sector, you know, one could well argue that this might be a good thing, reducing the monopoly profit and providing better services to the depositors. The other thing is that they'd be able to continue to compete as full service banks, right?

I mean, the model I envisage is just a very plain vanilla payment processor that may appeal to kind of a very limited constituency. see. People will, most likely, most people will continue to have both commercial bank accounts and Fed accounts, for example, in the world I'm envisaging. So, yeah, I think that they'd have to be concerned, but I mean, it's not like a threat to their business model. They just have to be concerned about competing more vigorously for, you know, for the payment services. And do you think that this could also have an effect on the fractional reserve banking system? And if so, I have seen some other academic papers that say that if fractional reserve was affected, that that could also, and presumably, you know, if that became less common, that that could have an effect on the creation of credit and even affect monetary policy. Do you think that, you know, do you agree with that?

So what do you think those effects would be? Well, that's a big question. You know, I think that banks would continue to, I mean, the so-called fractional reserve banking model is exactly the business of banking. Bankings are in the business of creating money when they extend loans against good business prospects or good collateral. And they issue their deposit liabilities to be. be redeemable on short notice, on demand, typically for currency. And so it's exactly that

stipulation and the demand deposit liability that makes banks dependent on reserves and currency. The fact that they have fractional reserves is hardly relevant, I don't think, as long as they're running their business model in a responsible manner. The amount of reserves they have on hand is, you know, they always have the option of borrowing reserves from each other on the bank market or borrowing reserves at the last resort at the discount window at the Fed if they're in need of reserves. So I don't see how the business of banking necessarily interacts with what I'm talking about, what we're talking here, which is about the processing of payments. The processing of payments entails the debuting and crediting of accounts. How do we keep the

account safe, secure? How do we transfer information rapidly at little cost? cost. How do we keep the ledger secure? These are the important questions in any database management system. But these questions are very, very different than the question of how should a bank be permitted to extend credit to, say, an entrepreneur? That's, to me, that's a very different question that I don't really see how it directly bears on this question of processing payments. Right. It's more about where people are keeping their money, you know, in order to then later make payments. So if they're keeping it in a commercial bank versus at the central bank versus... Well, like I said, though, but I mean, the private banks can compete for those deposits.

You know, they might have to, they might actually have to pay a higher deposit rate to retain those deposits. Or they can borrow the reserves on the intra-bank market, or they can access the reserves from the Fed at a higher cost. So they're just going to have to compete. So again, it's more like about what sort of, how are these banks going to have to up their game, sort of speak, to kind of retain these deposits? You've written that Bitcoin is essentially what you view as like a promising payment system, but that as money, maybe you view it as less than ideal and also you view it as having a

less than ideal monetary policy. So I was curious just on this payment system aspect, how you view it competing. Well, right. So as many people have commented, in terms of the payment side, I mean, I think that the underlying model is, of course, tremendously inefficient. And it's designed to be inefficient in a way, kind of the proof of work that underlies the clearing of payments in Bitcoin is kind of the cost one has to bear to make a a permissionless system without any central, you know, trusted third party to do the accounting. So, but nevertheless, in spite of that property, that one thing that is true is that given the current structure, given the current infrastructure of the worldwide banking system, the correspondent

banking system in particular, you know, that kind of the quasi-monopoly status, say, of Western Union and making international remittances, that I could see kind of a role for something like Bitcoin to kind of bypass the correspondent banking system or to bypass Western Union as kind of as a relatively efficient way to process payments. So in that sense, I kind of see Bitcoin as being kind of promising and also promising to the extent that it should spur competition in the kind of conventional space to kind of promote competition. competition so that these banks are motivated to do better to kind of use their standard database management systems to extend their lines of communication to make world global banking

kind of operate more seamlessly than it does at present. Something that I find interesting about your take here about how it's more promising as a payment system and has less than ideal money and monetary policy, is that actually I view Bitcoin as succeeding so far primarily on the strength of maybe the monetary policy. You know, most people really are treating it as a digital gold right now rather than as a payment system or digital cash. So why do you think that is? Well, I think that inherently it's very difficult to to displace kind of a local unit of account, right? I mean, when you go pay your rent, it's, you know,

assuming you're in the United States, your rent, your monthly rental payment is denominated in dollars. And so if, you know, if you're selling your services and accepting Bitcoin as payment, you receive the Bitcoin as payment, and you're all happy about that. And then tomorrow you wake up and you notice that Bitcoin is depreciation. 20% relative to the U.S. dollar. And suddenly your rental payment just went up by 20%

overnight. And you're going like, what the heck happened? Of course, the very opposite could have happened. You know, maybe the Bitcoin would have appreciated and you would have been happy. But the whole point is that you are exposed to exchange rate risk. And people do not like exchange rate risk when they're trying to manage their payments. They want something more stable when they're making their everyday payments. They want to make things more predictable. And so the very properties, the monetary properties of Bitcoin, which is to hold the money supply, basically fixed, it means that the demand, as the demand for Bitcoin fluctuates, it's going to cause very, very volatile fluctuations in the Bitcoin exchange rate, making it basically very

unsuitable for making high-frequency payments like paying your workers or paying your rent. On the other hand, its monetary policy is kind of probably arguably very good for as a long run store of value. So if you're willing to live with the volatility, that it might not be a bad place to park a bit of your wealth as kind of a long run store of value. So that's what kind of motivated my comment that I can see it as kind of a flight to safety security or is it kind of a long run store of value, kind of something, the digital equivalent. to say some sort of commodity like gold, but that as kind of an everyday monetary payment instrument, it is probably not likely to be taken up anytime soon. And what do you think of a currency devoted to interbank transfers such as XRP?

Does that make sense? And if so, like why do you think it hasn't really taken off yet? Well, I don't think these things are taking off because fundamentally the system we have in place is ultra efficient in the sense. I know some of your listeners are going to fall off their chairs when I say that, but in the sense that,

again, one really has to sit down and ask, what is this fundamentally all about? And this is all fundamentally about debiting and transferring, debiting and crediting accounts in a ledger. This is not rocket science.

I mean, I can do it on my Excel spreadsheet here on my computer, right? I mean, it's just debuting one account. account and crediting the other. So at a fundamental level, this is not rocket science. And if you can trust an entity to do the bookkeeping, it's very, very, very efficient to have an accountant, just do the debuting and crediting. You have to worry about security. Of course, you have to worry about

resilience. You have to worry about keeping backup copies. You have to worry about a whole bunch of stuff. But this is standard. This is just standard problems that people who manage databases have had to contend with for a very long time. Enter kind of the Bitcoin kind of model, the blockchain-based or kind of something quasi in between like XRP, where you want to replace this designated record keeper with some sort of more communal effort. In the case of XRP, maybe some sort of designated nodes.

In the case of Bitcoin, you're opening it up to anybody in the community that wants to become a minor. They can become basically an accountant and contribute to the accounting effort of maintaining the ledger in Bitcoin. That is a very, very different type of model. This consensus-based model of recording communal information, like the – it could be communal information in general,

like the type of information we keep at a library, at a public library, and this happens to be information in a spreadsheet of digital accounts of money. whenever you bring a community to get involved in managing a database, you introduce all sorts of problems, right? You have to achieve consensus. It's kind of tough to achieve consensus. And it becomes more difficult to achieve consensus the larger the group is. And it's not impossible. And I tip my head to Bitcoin for actually solving this problem.

But what's true at the same time is despite whatever merits this consensus-based approach has, it's inherently more expensive. And so unless you have a pressing need for a consensus-based record-keeping system, like why would you want one anyways? Even people who hold Bitcoin often hold it through a trusted intermediary like Coinbase, for example. So people have demonstrated their willingness. They love to trust their intermediaries. Why would you want to hold something that bypasses that trust?

Well, there might be some reasons. You know, some people just might not trust the government. Some people might not trust the central bank. Some people like permissionless access to payments. Fine. But it's going to cost you. And for most people are just not worried about stuff like that. I'm very happy.

I get my paycheck. I get paid through the banking system. I, you know, sometimes we complain about the fees that banks charge. But, you know, the answer to that is just, you know, let's encourage more competition. But, you know, by and large, the banking system does a pretty good job or can do a pretty good job. And to the extent that it doesn't, like in terms of the corresponding banking system worldwide, the answer to that is not Bitcoin. The answer to that is just to let banks, encourage banks to talk to each other more directly so that I can bypass the correspondent structure.

you know, instead of going through a chain of correspondence, just open up a direct telephone line. What could be easier than Bank A in the United States talking to Bank B in Italy just directly? So that's kind of how I see things stand, my broad view on things. For you as a consumer, let's say that we're, you know, five years, ten years in the future, and there's Central Bank digital dollars as well as, you know, these stable coins on public block chains that are pegged to USD. Which would you prefer to hold? And I know there's different models of stable coins.

So which model of stable coin would you put most faith in? Like one that is backed by reserves, one that's crypto collateralized like MakerDAO or like a senior shares model of a stable coin? So it's a two-part question. Yeah, for under $250,000, I would hold it in a U.S. bank. There's no stable coin in the world that can beat that. I mean, there's federal deposit insurance covers that account. It's completely stable.

I know that when I go to the ATM, I can withdraw my bank account at par and that if the bank ever got in trouble, that my account is fully insured up to $250,000. And indeed, in a crisis, is probably, that insurance is probably going to go up. So there's no stable coin in the world, private stable coin in the world, that can match that stability already. But I think the point you're trying to make is that these stable coins do not need to rely on any government insurance regime.

They are basically their value is guaranteed by kind of a verifiable set of assets that they hold. And you ask me the question, which of these would I find kind of more desirable, safer? It's not entirely clear to me of which ones I would because as a student of monetary history, I'm very familiar with what is called unilateral exchange rate pegs, which is basically where a country tries to peg its currency against, say, the U.S. dollar on a unilateral basis. And the way it does that is by accumulating sufficient U.S. dollar reserves or U.S. treasuries to back up the promises of meeting the redemptions at the part. exchange rate it promises. Almost every attempt to do that in history has basically failed. And I'm not sure why I would expect anything different to happen with these stable coins that are emerging. There's really, it's conceivable, it's possible.

And like I said, the models that I know of that could be run reasonably well, basically already exist today in the form of government money fund. So I'm not exactly sure what's new here, except I suppose possibly that they would enable a user to make, say, cross-border payments more efficiently. I guess that would be the one reason why you might want to use one of these stable coins. A lot of people espouse the potential for blockchain technology to bank the unbanked, but at least I think so far it's really barely made any inroads. that effort. So why not? Or why do you think that hasn't happened and what do you think needs to happen for us to get there? Well, I don't know why people think blockchain is a solution to the unbanked problem. I mean, blockchain, like I said, is a consensus-based record-keeping technology

that might be desirable if you want permissionless access to a database. And if you don't trust a third party to do the accounting. But most people who are unbanked, you know, don't have those problems. They're perfectly willing to have permissioned accounts and then they're perfectly willing for a banker to do the debuting and crediting of their checking accounts. So it's not like one can waive the magic blockchain and expect the unbanking problem to go away. And indeed, like I said, blockchain is inherently more inefficient a way to conduct information transfer relative to a centralized system. I think the idea is that a lot of banks don't find the unbanked population kind of desirable as customers,

whereas if you can just open a blockchain wallet, then you have a way to safely store money where you don't need kind of like the approval of a bank. I think that's sort of the thinking. No, that's a good point, actually. That is a good point. So I think that a part of this depends on what unbanked you're talking about. I'm not sure if you're speaking of the unbanked in the United States or the globally unbanked. I'm not sure that the unbanked in the United States kind of suffer from this.

So for example, compare Canada to the United States, and the unbanked issue in Canada is much less pronounced. It's almost virtually non-existent, in fact. So there is a question of what exactly is driving this phenomenon of unbankedness. in the United States? Is it regulatory? You know, are banks being prevented in some way for regulatory reasons from reaching a particular constituency? I don't know for sure. I think one would have to look into that. But you're right that, I mean, in the sense to the extent that imagine, well, you know, I guess even, you know, opening up a Treasury direct account, what sort of information do you need? You need, you basically your address, you know, you have to identify

by yourself. So there's that information requirement. I guess what you're suggesting is imagine you have access to a payment system where you don't, you could really just open up an account with no, no need to identify who you are, the equivalent, I guess, of holding cash, for example. I guess that that would be encourage people to open up digital accounts. I have to grant you that. And I think that could be desirable along that dimension. But like I said, in many jurisdictions, like in Canada, for example, the population is 100% banked, virtually fully banked. And it's done under a very conventional banking system. So it's not entirely clear to me that the solution to the problem of unbanked is kind of like a blockchain-based payment system.

It could be, it could play a role. I mean, I'm not going to rule it out entirely, but to me, it's like, gee, if we've got a constituency that's unbanked, why is it the case? I mean, is it a regulatory hurdle? Is there something we have to, maybe is it something that a central bank could get in and provide a basic public service? I think that that would be the more natural way to attack this problem of unbankedness than just kind of hinging my hopes on kind of some blockchain sort of solution that, like I said, is probably, not a solution. All right. Well, we have run out of time. There's just so many topics we could have covered. But it's been so great having you on the show. Where can people learn more about you and the St. Louis Fed? Oh, yeah. Well, of course, naturally, we've got Google and you can Google the St. Louis Fed to our

website. And of course, you can Google my name and I have my website up there as well. As you I think alluded to, I have a number of, I have a blog post, a blog, I should say, that I run. It's called Macromania. And I have several posts that relate to cryptocurrency, Bitcoin. And if your listeners are interested, please feel free to email me or to search for that page. It's called My Perspective on the Bitcoin Project. And very happy to hear from your listeners if they have any questions or they'd like to push back against anything that I've said here. All right, great. Well, thanks so much for coming on Unchained.

Well, thank you very much. It's been a lot of fun. Yeah, yeah, I agree. And thanks so much for joining us today. To learn more about David and the St. Louis Federal Reserve, check out the show notes inside your podcast player. If you're not yet subscribed to my other podcast, unconfirmed, go check it out now because now we have a new news recap that ends every show. Also, find out what I think are the top crypto stories each week by setting it from my email newsletter at Unchainedpodcast.com. Unchained is produced by me, Laura Shin, with help from factual recording, Anthony Youne, Daniel Ness, and Josh Durham. Thanks for listening.