David Andolfatto, senior vice president at the Federal Reserve Bank of St. Louis, gives his thoughts on Facebook’s Li
bra, 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.
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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/
Transcript:
Laura Shin:
Hi everyone. Welcome to Unchained. 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 that you’d be interested in a 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 end of every Unconfirmed. So, if you’re not yet subscribed to Unconfirmed, go do that now and find out what I think are the biggest news stories of the week.
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Laura Shin:
My guest today is David Andolfatto, Senior Vice President at the Federal Reserve Bank of St. Louis. Welcome David.
David Andolfatto:
Hey Laura. How you doing?
Laura Shin:
I’m interested to hear your background because you obviously work at the federal reserve, but you are quite a prolific author and speaker on blockchain and cryptocurrency, so tell us how you came to be in this role.
David Andolfatto:
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, etcetera, and so, when this new phenomena 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 one 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 in history and also, whether or not any of this emergent technology has any, you know, monetary policy implications going forward.
Laura Shin:
So, how did you hear about defi and blockchain, and also, why do you think that they really caught your interest other than, you know, the fact that it, you know, it’s sort of in your professional sphere?
David Andolfatto:
Yeah. Well, you know, I was a bit of a historian of monetary policy and monetary developments, you know, I was aware that there’ve been 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 about it kind of referred to as, you know, kind of people are very, very skeptical at the time, you know, calling it a scam, I mean, I think Paul Krugman famously wrote something on it that intrigued me, and so, I think, if I recall correctly, I mean, that’s, you know, 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 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.
Laura Shin:
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?
David Andolfatto:
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, it’s a very unique kind of creature, it’s 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, the Fed was basically designed to basically be there as a backstop and to server as kind of a lender of last resort to provide an elastic currency, as the phrase that 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 us the powers that it has to fulfill its congressional mandates of price stability and 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 representative of the Board of Governors, and most of your listeners are probably aware of that, part of the fed where the FOMC, the Federal Open Market Committee, makes decision about the path of interest rates in the economy to help regulate inflation and economic activity according to the congressional mandates that it has.
Laura Shin:
Can you also elaborate on the role that commercial banks play in the banking system?
David Andolfatto:
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 commercial banks use to clear payments with each other. So, this is kind of interesting in and of itself in the context of the talk today because was 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 the payment that are occurring in the private sector. So, when you go and you make a payment to the Starbuck’s merchant, you know, your account is debited, the account of the merchant is credited, there’s got to be a flow of fund between the two accounts, what’s happening in the background is that federal Reserve funds are flowing from your bank to Starbuck’s bank and it happens through these backchannels in the payment system.
Laura Shin:
All right. So, this sets enough of a stature 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 worlds 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?
David Andolfatto:
It’s intriguing, I mean there’s been a lot, I mean, 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 that, although it has limited access, there have been many proposals in the past to do what is, well, pre-internet days. What’s different about this is, of course, we are now in the internet era one, and also, Facebook is a social media giant that has over two billion users, so, it already has a really fast network in place already. So, people can talk to each other through Facebook, and that’s at the end of the day what money transfer is all about, is talking to different accounts, it’s information transfer, and so, what makes Libra interesting is, is you’ve got this large private entity with just 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 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 processes around the world. On a scale, you know, like I said, these types of proposals have been around in the past, but just the massive scale that Facebook brinks the barrier on this possibility is what makes it really interesting.
Laura Shin:
So, when you say it would have a massive effect on payment processes, like, I guess you mean from the sheer aspect of people might prefer to use the Facebook system simple 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 regional banks, on maybe weaker economies or just, aside from payment processes, what are some of the other impacts on existing players?
David Andolfatto:
Well, I don’t see what other impact it would have other than payment processing, the, 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 serve as a competitor to other types of monetary instruments, so there’s that, but you know,…
Laura Shin:
Like what are some examples of some of the others?
David Andolfatto:
Oh, I just mean Euro’s and Yuen and US 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 be concerned about currency competition. Usually, you’re concerned about currency competition of other types of currencies for example, and in many emerging economies, you know, people like the US dollar for example, that competes against the domestic currency. In principle, private currency issuance like Libra might compete against the US dollar for example, these are just kind of the potentials. I don’t necessarily see that happening.
Laura Shin:
Oh, you don’t? 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.
David Andolfatto:
Well, it’s a complicated issue. 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 how Libra would be restricted by basically domestic regulations. I just think that, I mean, they’re going to have to be compliant to the underlying regulation of every country, and I just think that 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 they spoke, of course, can be accessed globally and very easily relative to say a US money fund, you know, I don’t know. SO, you know, I see a lot of regulatory hurdles that I think that would make it very difficult for Libra to kind of displace such a dominant world currency like the US dollar, at least any time soon. We should never say never of course, but I don’t see it in the foreseeable horizon.
Laura Shin:
What about for weaker economies? That probably doesn’t apply, like if you were, you know, a Turkish central banker or Argentine or something, what would you be thinking about the advent of Libra?
David Andolfatto:
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, 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 say from bitcoin for example that has no designated CEO or corporate structure, so this a very, very different, you know, competing against bitcoin is a completely different animal then competing against say Libra. So, even there, I think that, you know, it kind of depends on how open the jurisdiction is to permitting its citizens to process payments using some private provider like Facebook, it just kind of at the end of the day just depends.
Laura Shin:
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 this 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 know even if Libra will launch, but 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 STR’s 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 designed a global stablecoin, 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?
David Andolfatto:
Well, I mean, the idea is in terms of like creating a stablecoin, I can kind of see the logic of the approach they took and indeed I think they might have very well have been inspired by the approach that the IMF took. When the IMF, the International Monetary Fund created the special drawing rate, when the special drawing rate, however, was create, 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 rates, that it was basically displace all national currencies as 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 new market, their unit of account, I don’t know. I mean, I just think it was a big hurdle to kind of climb. I think may equally well have approached it, but just saying look, I mean, we’re just going to create these things called Facebook dollars, you know, just the way a lot of games create their own credits inside, you know, their environment, you know, Facebook just can create its own money, could be airlines create airmiles, you know, various companies create coupons redeemable in money that they issue themselves, little credits, so, Facebook credits…
Laura Shin:
Okay, but what will the value have those been? Like, would it have been pegged to the US dollar then, if your saying that they should have just created, you know, Facebook dollars? Are you saying it should have been pegged to the US dollar?
David Andolfatto:
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 US dollar, but I mean, you know, I mean, I don’t know. I guess you could’ve chosen that model too, the US dollar is the dominant currency, but I guess for a variety of reasons, you might want to move away from having the US 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 US dollar. So, 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, and…
Laura Shin:
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…?
David Andolfatto:
Yeah, I’d float it.
Laura Shin:
Oh, I see. Okay.
David Andolfatto:
Yeah, just a floating exchange rate. I mean, so, you know, one way to envision what this currency…because I guess that you have to distinguish between this currency as a store of value and as a kind of a what I think some economists have called it, a vehicle currency. So, most people perhaps might not even hold this floating currency, this Facebook currency, what they might use if for is just to affect a transfer of funds. So, they 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 risks associated with it. So, that would have been a kind of alternative model, it’s not entirely clear what would be the best way to go.
Laura Shin:
Okay. Well, since we’ve been talking about the US 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 US 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 US dollar, how it plans to respond to competing digital fiat currencies, what the Fed would need from congress for the development of a dollar, etcetera, what did you think of the letter and do you think they’re right to be concerned about the long-term primacy of the USD?
David Andolfatto:
No, I don’t think they should be concerned about it. I mean, the US 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 III for example, that have solidified role of the US dollar as a regulatory object. So, I don’t think I’d be too concerned about that, but I have to say this, even if it was true, I mean, who cares really. I mean, most countries don’t have a world where they preserve 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 seem like a very nice place to visit, 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 US dollar is the world’s global currency is actually kind of just peripheral, it’s kind of like an exuberant 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 wellbeing 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, 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, 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 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, you know, in the old days, you know, if I wanted to travel to Europe I’d have to take travelers checks, you know, 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…
Laura Shin:
This is how I first traveled to Europe.
David Andolfatto:
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 go back, pick them up, you’d fly to Europe, you’d have to go take a taxi to a, you know, a American Express or Thomas Cook office, it’s 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 need to make a big cashing of Lyra, if you’re in Italy for example, and then you’d have to carry around a wad full of Lyra in a country were, you know, maybe you wouldn’t. I mean, today you travel to Europe and I take my credit card, I mean, it’s great. So, there’s…
Laura Shin:
Yeah. Well, so if you were to design like a US dollar CBDC, how would you do that? Like, 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 that 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 US digital dollar.
David Andolfatto:
Right. Well, I’d be very careful about that last statement you said about Fed coin. There’re 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, 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, you permit everybody to have accounts directly with the Fed or you could kind of have it disintermediate 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 banks 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 you know, I’m not sure that…
Laura Shin:
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 a better way?
David Andolfatto:
Yeah. So, I’m sorry, I got a little off track there in terms of the KYC thing there. You know, another model of this showing the Fed digital currency is to have it basically as kind of the anonymous Swiss bank account model as well, as kind of a token-based model, and so, there’s a wide variety of model in which you could issue this 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 US Postal Savings Bank did for many years, from 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’d be no other services provided, no overdraft privileges for example, and that this type of service is kind of like a public option that should appeal to people who might otherwise find it difficult to open up bank accounts in the commercial banking sector. It could co-exist with banks, it’s not like it would drive banks out of business because banks of course off their clients all sorts of services that they bundle together with payments, so, yeah, I think I’ve been proponent of the idea that the Fed could issue just a very basic, plain vanilla kind of a central bank digital currency which the way I’m describing it, it’s not a Fed coin but it’s just basically permitting people to open up bank accounts directly with the Fed. Very much in the way Americans can already open up bank accounts directly with the US Treasury. You can go to www.treasurydirect.gov and you can open up an interest bearing account there at the US Treasury, you’re not allowed to make payments with this 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 the central bank digital currency could take is in fact in terms of treasury money where people could make online payments directly with their www.treasurydirect.gov accounts. Many other models are possible of course, but that’s kind of the basic one I see.
Laura Shin:
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.
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Laura Shin:
Back to my conversation with David Andolfatto of the St. Louis Federal Reserve. Is it one thing, you know, earlier when you talked about how you didn’t think it was super important that US dollar be the, you know, 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 effect the US 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?
David Andolfatto:
Yeah. Am I concerned? You know, I’m a central banker so I’m paid to get concerned about everything I guess, but 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 US dollar, I mean, you know, you just have to ask yourself, I mean, how would you rather be holding your wealth? In US dollars, or you know, in Chinese Yuan? 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 US 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, debiting 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 the ball about what truly it is that create the wealth and material wellbeing 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 US dollar. It’s happened before in history, and you know, countries and people just continue to live a prosper.
Laura Shin:
So, in the crypto world, many people see the emergence of central bank digital currencies as practically inevitable, and I was wondering, in your world of federal reserve bankers, how much are these ideas being discussed and how seriously?
David Andolfatto:
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 G20s is likely inevitable now. He didn’t believe the US would be a leader on that front, but he sees it as inevitable.
Laura Shin:
What did you think of the Bank of England Governor Mark Carney suggestion to have, you know, a global digital reserve currency?
David Andolfatto:
You’re right. So, that’s an interesting idea, right, that’s again trying to get away from the special status that the US 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, that’s an interesting idea, but that kind of from a practical perspective, I just don’t see how countries are going to agree on how to manage such an object, so, I could be wrong and there might be a way to do it, but I actually don’t think that politically it would happen, and so, for the time being, I mean, I guess that were basically stuck with the US dollars as far as I’m concerned.
Laura Shin:
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 there by bypassing the commercial banks and you didn’t seem to really 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, JP Morgan, 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?
David Andolfatto:
Oh. Well, you know, I think that they should be worried all right, but primarily in the sense that they should be worried only to the extent that they would be worried and quite naturally about the emergence of any competitor, right? So, any new competitor on the scene should have them worry about how they’re 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 intermediated, and having these accounts they pay maybe a more competitive deposit rate for example, which certainly increase the cost of maintaining deposits in the commercial banking sector. So, it might have some impact on how 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 envisioned is just a very plain vanilla payment processor that may appeal to kind of a very limited constituency, most likely most people will continue to have both commercial bank accounts and fed accounts for example in the world I’m envisioning, so, yeah, I think that they’d have to be concerned, but it’s not like a threat to their business model, they just have to be concerned about competing more vigorously for, you know, the payment services.
Laura Shin:
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 and if so what do you think those effects would be?
David Andolfatto:
Wow, 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, banking’s are in the business of creating money when they extend loans against good business prospects or good collateral, and they issues their deposit liabilities to 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 the fractional reserve 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 interbank market or borrowing reserves as a 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 debiting and crediting of accounts. How do we keep the accounts safe, secure? How do we transfer information rapidly at little cost? How do we keep the ledger secure? There 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? To me that a very different question that I don’t really see how it directly bears on this question of processing payments.
Laura Shin:
Right. It’s more about where people are keeping their money, you know, in order to then later make a payment. So, if they’re keeping it in a commercial bank versus at the central bank versus…
David Andolfatto:
Well, like I said though, but I mean, the private banks can compete for those deposits, you know, they might actually have to pay a higher deposit rate to redeem those deposits or they can then borrow the reserves on the interbank 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 how are these banks going to have to up their game so to speak to kind of retain these deposits.
Laura Shin:
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.
David Andolfatto:
Well, right, so, as many people have commented in terms of on 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 then at the proof of work that underlies the clearing of payments in bitcoin is kind of the cost one has to bear to make it 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, the 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 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 promote 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.
Laura Shin:
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 if you 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?
David Andolfatto:
Well, I think that inherently it’s very difficult 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 monthly rental payment is denominated in dollars, and so, if, you know, if your 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 has depreciated 20% relative to the US 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’ve 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, means that 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 wealth as kind of a long-run store of value. So, kind of that’s what kind of motivated my comment that I can see it as kind of a, you know, flight to safety security or is it kind of a long-run store of value, kind of something, the digital equivalent of say some sort of commodity like gold, but that has kind of an everyday monetary payment instrument it’s probably not likely to be taken up any time soon.
Laura Shin:
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 really hasn’t taken off yet?
David Andolfatto:
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 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 debiting one 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 debiting and crediting. You have to worry about security of course, you have to worry about resilience, you have to worry about keeping a backup copy, you have to worry about a whole bunch of stuff, but this 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 block chain base 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, and in the case of bitcoin you’re opening it up to anybody in the community that wants to become a, 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 in difficult to achieve the consensus the larger the group is, and it’s not impossible, and I tip my hat 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 through a trusted intermediary like Coin Base 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 banks, some people like permissionless system for 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, 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 by enlarge, 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 corresponding banking system worldwide, the answer to that is not bitcoin, the answer to that is just to 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, right, my broad view on things.
Laura Shin:
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 stablecoins on public blockchains that are pegged to USD, which would you prefer to hold, and I know there’s different models of stablecoins, so which model of stablecoin would you put most faith in? Like one that is backed by reserves, one that’s crypto collateralized like MakerDAO, or like a seigniorage shares model of stablecoin? So, it’s a two-part question.
David Andolfatto:
Well, for under 250 thousand dollars, I would hold it in a US bank, there’s no stablecoin in the world that can beat that. I mean, there’s federal deposit insurance coverage that 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 thousand dollars and in indeed in a crisis that probably insurance is going to go up. So, there’s no stablecoin in the world, private stablecoin in the world that can match that stability already, but I think that the point you’re trying to make is that the stablecoins do not need to rely on any government insurance regime, there value is guaranteed by kind of a verifiable set of assets that they hold, and you asked me the question which of these would I find kind of more desirable, safer? It’s not entirely clear to me 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 US dollar on a unilateral basis, and the way it does that is by accumulating sufficient US dollar reserves or US treasuries to back up the promises of meeting the redemptions at the par 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 stablecoins that are emerging. 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 funds. So, I’m not exactly sure what’s new here except I suppose possibly that they 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 stablecoins.
Laura Shin:
A lot of people expose the potential for blockchain technology to bank the unbanked, but at least I think so far, it’s really barely made any inroads in that effort, so, why not? Why do you think that hasn’t happened and what do you think needs to happen for us to get there?
David Andolfatto:
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 on banks, you know, don’t have those problems, they’re perfectly willing to have permissioned accounts and they’re perfectly willing for a banker to do the debiting and crediting of their checking accounts. So, it’s not like one can wave the magic blockchain and expect the unbanked problem to go away, and indeed like I said, blockchain is inherently more inefficient way to conduct information transfer relative to a centralized system.
Laura Shin:
I think the idea is that a lot of banks don’t find the unbanked population kind of desirable as customers whereas, you know, 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.
David Andolfatto:
No, that’s a good point actually. That is a good point. So, I think that apart 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, you know, 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 basically your address, you know, you have to identify yourself, so, there’s that information requirement. I guess what you’re suggesting is imagine you have access to a payment system where you could really just open up an account with no need to identify who you are, the equivalent I guess of holding cash for example. I guess that would 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 that 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 and just kind of hinging my hopes on kind of some blockchain sort of solution that like I said, is probably not a solution.
Laura Shin:
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?
David Andolfatto:
Oh yeah. Well, of course naturally we’ve got Google and you can Google the St. Louis Fed, go 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 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.
Laura Shin:
All right. Great. Well, thanks so much for coming on Unchained.
David Andolfatto:
Well, thank you very much. It’s been a lot of fun.
Laura Shin:
Yeah. Yeah. I agree. 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 signing up for my email newsletter at unchainedpodcast.com. Unchained is produced by me Laura Shin with help from Factual Recording, Anthony Yoon, Daniel Nuss, and Josh Durham. Thanks for listening.
