The European Central Bank, alongside others in the US, China, India, and UK are all exploring new forms of state-backed money that follow the technologies employed by cryptos like Ethereum and Bitcoin. Also referred to as central bank digital currencies (CBDCs), they are based on the imagination of a future where people will be able to run financial services without intermediaries like banks.
The Main Idea Behind CBDCs is Facilitating Direct Financial Transactions
One of the often untold benefits of using CBDCs is that they can help to trim high levels of public debts that have been weighing down on many nations.
The prime idea behind digital central bank currencies is that companies and individuals would be issued with digital wallets that can be used to make payments, buy shares, and pay taxes. In the current traditional model, where people have to work with financial institutions when processing payments, cases of bank runs are not uncommon. Well, this will be a thing of the past with CBDCs.
In today’s retail banks, only a small portion of their deposits is required to be maintained in reserve, though a significant proportion of capital is used as protection in the event that books run into trouble. In the Eurozone, the minimum requirement for banks is 15%, which implies that if a bank has a capital of €1 billion, the lending capacity cannot surpass €6.6 billion.
In the era of CBDCs, the idea is to ensure that the 100% reserve protection in central bank wallets will be extended to retail bank accounts. This would mean that if a person saves 1,000 digital euros, the bank will be willing to multiply the deposit by opening more accounts that can be paid on request. Therefore, banks will be forced to look for other ways to make money.
The Debt Benefit
The high national debt levels in many countries today can be traced back to the 2007-2009 financial crisis, the COVID-19 pandemic, and the Eurozone crisis of the 2010s. Some of the countries with high debt levels as a proportion of GDP include Greece, Turkey, Spain, Portugal, France, and Belgium.
One method of dealing with high debt is creating high inflation that makes the value of debt lower, but this results in impoverishing citizens. Eventually, it can cause civil unrest. By shifting to CBDCs, it is easy to change the rules about retail bank reserves, allowing the governments to take a different route.
The opportunity is available during the transition, where the process of creating money to purchase bonds adds about three times more money to the economy under consideration. Selling bonds for euros would mean that every euro removed results in three getting removed from the economy.
This is an excellent example of how the digital euro should be introduced. Then, the European Central Bank would progressively sell sovereign bonds to remove the old euros from circulation while creating new digital euros to repurchase the bonds. Because the 100% reserve requirement would only apply to digital euros, it means that selling bonds worth €50 million would take €150 million out of the economy.
Because other EU countries would still want to take the same route, it would be very important for smooth coordination between the individual countries and the economic bloc.