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Central Bank Digital Currencies

“We are still in an age where paper money has primacy.”

The value of bank notes in circulation in the UK are measured by the Bank of England (BoE) each year on the last day in February. The broad trend over time has been ever upward but recently the increase has slowed.

Whether we have now reached “Peak Paper” is yet to be seen, but the expansion of both cashless payments (debit cards, etc.) and crypto-assets (i.e. tokens) are eroding the use of cash for everyday transactions.

Central banks are monitoring this trend towards a cashless future with keen interest. The Bank of Japan (BoJ), in a recent report, considers whether “central banks should issue digital currencies that can be used by ordinary people instead of paper-based banknotes.”  This is indeed a question that has also been taxing Research Advisors at the BoE: back in May 2018, the BoE released a working paper that constructed different models for Central Bank Digital Currencies (CBDC).

As the BoJ report points out, there are essentially two types of CBDC: wholesale (i.e. financial institutions only) and retail (i.e. with access for consumers/households).

Under the latter scheme, a central bank would grant access to all sectors of the economy, including the general public.  In other words, the CBDC would be made available by the central bank to everyone with bank accounts held directly with the central bank.  A slight variation on this scheme is called “narrow-banking” whereby an intermediary administrates the central accounts held by consumers.

One of the main benefits of such an approach would be financial inclusion, certainly a laudable goal. But there is also another aspect of CBDC that is arguably just as important: a CBDC would be able to overcome what is known as the “Zero Lower Bound (ZLB)” of interest rates. Whilst the connection between Japan and ZLB couldn’t be clearer (Japan flirted with negative interest rates in 2016), the connection between ZLB and Bristol Pound perhaps requires a little more explanation.

We are still in an age where paper money has primacy. By this, I mean that we still have the prerogative to store paper pounds safely (or otherwise i.e. under a mattress!) in the event that real interest rates turn negative. For example, this happened in Japan in 2016 when sales of metal safes rose in response to the negative interest rates introduced by the central bank. Any paper currency thus “hoarded” would keep  value better than digital pounds (as subject to negative interest).

Ergo: paper money has primacy.  With negative interest rates they would be easily hoardable for value-keeping purposes. Thus the move to abolish paper currency would be an unpopular (and radical) step, yet one with many advantages (especially to first-mover nations, as explained elsewhere), especially with regards to the “economic lever” of interest rates.

What if?…

What if there were no paper pounds in circulation? This would “defeat” the ZLB since the hoarding of physical cash would no longer be a possibility and interest rates could ‘tick’ down below zero. High interest rates make it expensive to spend now compared with waiting until later, while low interest rates encourage people to spend in the now.  People would either spend, or hoard in another non-monetary form e.g. gold (or foreign stocks).

The idea of money earning a negative return is not a new one. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money as a possible way of avoiding financial crises.  Gesell was concerned that during times of monetary tightening, people hoard money rather than lend it (think: austerity) and as such, his ideas shaped the approaches of other economists such as John Maynard Keynes and, more recently, Charles Eisenstein. 

A negative interest rate is therefore a strong incentive to spend now rather than later (as is high inflation, or rising prices) and a strong disincentive to hoarding behaviour.

In the closed system economy of Bristol Pound, we concern ourselves with liquidity (i.e. how much money is in the system) and velocity (i.e. how fast the money in the system is circulating).

If we could find a way to make the Bristol Pounds in the system circulate more fluidly, whilst penalising hoarding behaviour, then it would be quite a compelling model for an operation geared towards spending in a local economy.

In contrast to a central bank, we have the luxury of abolishing our paper pounds by simply not printing more when the current editions expire (i.e. in 2021).  Either that or replace the paper pounds with some kind of depreciating note technology (which is likely more complicated than simply removing the paper pounds from circulation).

In effect, since the Bristol Pound is a closed system in which the CIC entity acts as a “mini-me central bank”, we have the luxury to redefine the scheme using the upsides of a demurrage (i.e. negative interest bearing) currency. By doing so, we may well open the door to a brand new model that promotes spending behaviour (over hoarding) for local economic benefit.

Peak Paper

Whether we have seen our own Bristol-based “Peak Paper” is still yet to be determined. However, perhaps the trend we see on a local level concerning the rise of cashless payments is being played out more broadly (and perhaps also more slowly) across the whole UK.  The data each February will tell a chapter of this unfolding (and possibly cash-free) story.

Nicholas Hemley, CTO

February 2019

If you are interested in learning more about the Bristol Pound and our vision of a cashless society, please do get in touch.

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