Fedcoin! Ever since the rise of cryptocurrencies in the mid-2010s, some pundits have theorized that the Fed is secretly working on its own cryptocurrency to rival bitcoin and Facebook’s nonexistent Libra. Fed members themselves have occasionally fanned the flames, too, fueling mounting speculation a digital dollar (or thereabouts) awaits us. The chatter escalated once again in mid-August, when Fed Governor Lael Brainard said, “the Federal Reserve is active in conducting research and experimentation related to distributed ledger technologies and the potential use cases for digital currencies.”[i] Since then, we have seen a litany of newsletters warn this is the end of the dollar as we know it, with everyone’s savings eventually coming under government control (and subject to confiscation). Even on the less hyperbolic, more reputable side of the financial commentary world, pundits are ruminating over “Fedcoin” potentially disrupting digital payments and altering the currency landscape. A theoretical paper on central bank digital currencies released by seven central banks and the Bank for International Settlements this week added even more fuel to the fire. But whatever the Fed eventually does, we rather doubt any of these spectacular scenarios come to pass. It all actually seems pretty dull to us.
The way most commentary explains the situation, the rise of bitcoin and other cryptocurrencies revealed a huge global appetite for digital money, incentivizing central banks to create their own digital coins to ensure money creation stays under centralized control. At the same time, central banks throughout the developed world have adopted or flirted with negative interest rates, raising the question of how effective a negative rate can really be if people can avoid it simply by stashing paper bills under the mattress? Academics and newsletter writers theorized official digital coins could solve this dilemma, as they would replace cash and central banks would control their value. This, as best as we can tell, is the genesis of all the “Fedcoin will destroy savings” warnings we have seen.
As is typical of most fearful frenzies, however, there is little grounding in reality. Lost in 99.9% of coverage we have seen on the matter is the simple fact that the US already has a digital currency, and it is called the dollar.[ii] Chances are, you own it and transact with it regularly! Any money in your bank account isn’t stashed in a vault—it is a digital accounting entry. Whenever you shop online, you are paying with digital dollars. When you use your credit or debit card at brick-and-mortar stores, you are paying with digital dollars. The Fed doesn’t even need to create systems to enable these digital payments, because they already exist. Your bank and credit card companies administer them. So do PayPal, Square, Apple and Venmo—not to mention Starbucks’ smartphone app, which stores so many digital dollars in the form of gift cards that we have occasionally wondered if it should be regulated as a bank. All of these were born in the free market, without central banks guiding them, as many innovations are.
As we read the entirety of Brainard’s speech, it became clear to us that the Fed’s real area of interest likely isn’t in creating a token, but rather in adopting blockchain or a similar digital ledger to make tracing transactions easier. This seems to us not like an effort to dethrone the dollar, but to solve the issue of bitcoin transactions being permanent and private, which has enabled theft and fraud, not to mention rampant use of the digital currency on the black market. Addressing this is a noble goal, but we doubt it makes a difference, as people who use bitcoin for privacy purposes aren’t exactly going to come running to a government-administered system that traces the movement of every last digital penny.
We aren’t arguing the digital payments system is perfect. There is plenty of room for improvement, as various reports of fraud in some electronic payment systems allude to. A better interbank system for transferring money among depositors would probably be beneficial. Perhaps Fed scholars have something to contribute on this front. But that seems less about dollar replacement and more like a typical public-private collaboration that ultimately benefits existing systems and users.
To us, Fedcoin fears are the latest in a long, long line of fearmongering (most prevalent in the newsletter world) about the dollar’s demise. Other iterations include fears of the dollar’s dethroning as the world’s reserve currency that have lingered for more than a decade and, perhaps most bizarrely, a mythical “global currency reset” involving the Iraqi dinar, of all things. In our view, investors benefit most from thoughtfully separating fact from fiction, weighing what actual central bank people are saying against what distant third parties are theorizing, thinking critically about probabilities, and remembering the simplest, most boring explanation is usually correct.
[i] “An Update on Digital Currencies,” Lael Brainard, Speech at the Federal Reserve Board and Federal Reserve Bank of San Francisco’s Innovation Office Hours, 8/13/2020.
[ii] Kudos to Jon Sindreu making this point in Monday’s Wall Street Journal.
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