It’s been said that inflation is a “hidden tax”, as an increase in the circulating money supply causes the value of our currency to drop. Consumers dislike inflation when it causes grocery prices to increase, but this same force also has the ability to increase asset prices such as homes and investments, just as we’re seeing today.
Human beings strive for efficiency, and combined with technology, the result is deflationary. However because the debts of nations are significant, central banks such as the Fed seek inflation — as it causes the future payback value of governmental debts to decrease. As civilization is entering a time of exponentially increasing technological innovation, the tools of the Fed have lost much of their power to trigger inflation.
Typically low interest rates stimulate borrowing and aid in inflation, but this is no longer working as the US interest rate has been low, even zero, for quite some time now. But the Fed has another trick up its sleeve: negative interest rates.
Negative interest rates at the central bank level are not a new idea. In October 2015, the International Monetary Fund (IMF) published a working paper titled “Breaking Through the Zero Lower Bound” which starts out quite boldly:
“There has been much discussion about eliminating the “zero lower bound” by eliminating paper currency.”
The zero lower bound, of course, is referring to central banks’ ability to take interest rates below zero. Appendix I (pg. 38) of this paper is titled “Potential steps in the transition from paper currency standard to digital currency”.
Negative rates are already in use in some countries today. The Bank of Japan (BoJ) instituted negative interest rates in January 2016, and since then Germany and several other European countries have followed suit. Recently, the Bank of England (BoE) instructed banks in the UK to prepare for implementation of negative rates from an accounting perspective.
The Federal Reserve (the Fed) actually has a fairly limited toolset with which to influence the US economy today. Aside from setting the Federal Funds Rate (i.e., the interest rate for bank borrowing), and performing open market operations via the FOMC (the Federal Open Market Committee), such as with QE (Quantitative Easing), there’s not a hell of a lot the Fed can actually do to stimulate the economy.
When the Fed “creates money”, what they are essentially doing is providing a larger credit line to commercial banks. However, when we are in a higher risk environment such as the current economic downturn, banks’ appetite for risk is greatly diminished, and thus only businesses and organizations with the highest quality credit are able to actually borrow for any economic stimulation.
Typically when the Fed’s interest rate is lower, the purpose is to increase borrowing and stimulate the economy with the hope of causing inflation. But because the Fed’s actions still count on the commercial banks to lend, and because it takes approximately 18 months for this new “money“ to filter down to the real economy, their influence is often subpar.
There are a few things you may have seen in the headlines in recent months, one is that the Fed has been struggling to cause the desired inflation (PCE measure), and another is the fact that they have been working on a central bank digital currency (CBDC).
In reality, the Fed can’t effectively cause economic growth and inflation because they can’t control how often regular consumers are willing to spend, and they can’t control whether people will save money or spend it. If they could do so, they believe they *could* in fact stimulate economic growth and inflation.
In a world where economic growth is threatened — such as was happening long before the pandemic, these tools — as well as QE and other buying programs, have been shown to be inadequate to stimulate the ‘official’ PCE inflation measure. These interventions prop up parts of the market — but that’s about it.
And so, the Fed and the economists want you to spend, they want you to avoid saving, and they desperately want you to go into more and more debt, because that means an increase in the circulating money supply, and more economic activity in hopes to trigger inflation.
But what is a central bank to do when interest rates are already at zero, after a long period of being at record-low interest rates?
As mentioned, several countries have already moved to negative rates but with limited success. The problem is that a $20 bill appears to be worth $20 even if it has been devalued behind the scenes by inflation. If this face/par value could be bypassed, then the value of the money itself would physically change instead of consumers seeing an increase in consumer prices.
So the Fed and the IMF believe that moving to a digital currency would eliminate that hindrance. And they are correct. However as long as physical money with its bothersome face value exists, their efforts would still be limited.
So the Fed will move to a CBDC, and get rid of physical cash, which is exactly what they are planning to do. Some of the coronavirus stimulus bills, such as the Banking For All Act mentioned the idea of paying stimulus directly from the Fed as a “Digital Dollar” and opening bank accounts for all US citizens directly with the Federal Reserve.
Aside from not yet addressing the issue of obtaining consumer credit in the future, a move toward consumers banking directly with the Fed places commercial banks in jeopardy. This is referred to as “bank disintermediation”, and leading up to CBDC’s, this concern has been widely discussed in many papers from the Fed, the IMF, and other economic institutions.
The implementation of a CBDC/Digital Dollar, and having consumers bank directly with the Fed should raise questions. For example, If you hold CBDC in your Fed-based digital wallet account instead of physical dollars (or today’s digital US dollars), what happens when the Fed declares a move to a negative interest rate?
I’ll tell you what it means:
The money in your Fed digital wallet will go down in value completely outside of your control — like a pickpocket snagging some of your money. We will have real-time inflation via real-time currency devaluation.
If you own crypto or shares of stocks, you’re familiar with the concept that checking your investment account or crypto wallet will show you the value of what your assets are worth right at that moment.
So how do you feel about that happening with the hard-earned money in your wallet?
The Fed may sugarcoat it, they may offer us discounts for paying with CBDC instead of USD until cash is completely phased out — but it is coming. The Fed’s goal is to increase monetary velocity by getting you to spend, and disinhibiting your desire to save.
Will this make you spend it more quickly, they are wondering? Yes, that is exactly what they are hoping — that you will acknowledge your $1,000 is going to magically become $993 by the end of the week, and so you’d rather spend it sooner than later.
Understand — there will be no way to withdraw CBDC, just as you cannot withdraw bitcoin. You can only spend CBDC or save it — it cannot live outside of the financial system. You can’t grab it from an ATM, and you can’t hide it under your mattress (where it would at least seem to keep its face value!)
If interest rates go negative, part of your money will go with it, with no escape.
And so we start to see how the Fed is hoping to control monetary velocity — the number of times a given dollar changes hands. If your digital dollar is going to become worth less and less over time, you become incentivized to retain as much purchasing power as possible by spending that money as quickly as possible.
They will be able to do this because CBDC is programmable currency, not unlike Ethereum smart contracts.
So you’re thinking, I won’t use CBDC, I’ll use the existing money we already have. That will be fine, until CBDC is the only game in town. Not long from now, you’ll start hearing about plans to get rid of the $100 bill, and the $50 bill. Ultimately we’ll be down to coins and maybe one dollar bills — if we’re lucky.
80% of the world’s central banks are already working on CBDC, and countries like China and Sweden have already made great strides toward reducing the use of physical cash. This trend of more and more digital payments will only increase from here on out.
There are other concerns we should have over moving to a national digital currency. Because CBDC is programmable, there are more aspects beyond the aforementioned devaluation that central banks will have much more control over. I’ve written several articles about CBDC already, but a basic list of capabilities we should be concerned about with CBDC is as follows
As you can surmise, all of the above are designed to place controls on spending and to give the Fed the ability to influence monetary velocity and prevent you from saving. I think they will find that ultimately their efforts do not work nearly as well as they hope, but nonetheless it is a significant level of control that we will not be able to avoid.
Heading into the future, we are given hope with the advent of bitcoin and other cryptocurrencies, as they provide a way to break out of what will soon be a closed-loop financial system.
In the meantime, consumers should pay special attention to any legislation that appears to indicate movement toward CBDC, or any removal of physical bills, and we should raise our voices to our legislators with all we have left of democracy.