Vincient Arnold is a researcher at the Yale Program on Financial Stability and publishes research notes on his blog, Discursive Etc. The views expressed herein are his own.
The United States would seriously like to maintain the supremacy of the US dollar as an international reserve currency, and BRICS coin — unseriously — would like to replace it.
Whatever the (lack of) merits of a BRICS coin, there are real, lurking challenges to the dollar’s role abroad. A forward-looking response to the dollar threats of tomorrow, not just today, would be to lead the pack in the development of a cross-border wholesale central bank digital currency (wCBDC): ie, the offshore digital dollar. However, President Trump just signed an executive order banning the development of all CBDCs in the US, while supporting the development of stablecoins.
Now, I have no qualms with the value of stablecoins in supporting the dollar system, as I’ve written elsewhere. But, as experiences in the Eurodollar market have shown, privately-created money — while a great complement to central bank money — is no perfect replacement. A CBDC is still worthy of consideration, and Mr. Trump’s order is, on that front, shortsighted.
I’m not convinced, though, that the executive order is really targeting wCBDCs in the first place? In it, CBDCs are defined as “a form of digital money or monetary value, denominated in the national unit of account, that is a direct liability of the central bank.” As many FT Alphaville readers are very likely aware, we already have digital money that is a direct liability of the Fed: reserves. Surely Mr. Trump is not suggesting that we get rid of the Fed’s balance sheet?
Given previous Republican opposition to CBDCs, it’s pretty clear that their issue is retail CBDCs — in other words, a digital form of cash — over privacy concerns. What I humbly suggest should still be on the table (and may still be, given the vague wording of the EO) is simply the crypto-ification of existing central bank reserves. It would be far from straightforward and would come with costs as well as benefits. But it seems the possibility should at least be considered, particularly given that it would be complementary to offshore dollar stablecoin issuance.
How would that differ from today’s reserves? Currently, reserves are limited to US commercial banks and exist in ledger form. Unlike traditional central bank reserves, policymakers could design a wCBDC to be tokenised, meaning that the liability on the central bank balance sheet would be to whomever holds a token representing some quantum of reserves.
Similar to the distinction between checking accounts and cash, the distinction between current digital reserves and a wCBDC is that the former is account-based, whereas the latter is token-based. More radically, this wCBDC would be cross-border, with foreign banks able to hold the tokens.
Such a leap holds great appeal. The Eurodollar market — including, crucially, stablecoins — would operate on firmer ground and, given the nature of fractional reserve banking, the quantity of dollar deposits abroad would balloon, strengthening and entrenching the appeal of the dollar. More dollars abroad under a system of programmable tokens would mean more offshore transaction information — fortifying American sanctioning capacity and restricting the financing of terrorism. Broadened access to dollar accounts abroad might even help the world digest spates of ever-expanding Treasury issuance. And reasoning defensively, China already has a first-mover advantage on a cross-border wCBDC, putting the US at risk of being left behind.
How would the offshore digital dollar work? Start with the obvious design decision: access. You’d probably have a tiered system, such that commercial banks in higher-risk (in an AML/CFT sense) countries with under-developed financial systems and poor bank regulation would have very limited access; moderate-risk nations would have moderate access; and so on, on a sliding scale. With tokenisation, the digital tokens would be programmed with various parameters (“this can’t go to accounts in North Korea”), which would aid in risk control. It would almost certainly be limited to depository institutions.
The Eurodollar market — that is, dollars created/intermediated outside of the US (including offshore stablecoins), or the offshore dollar market — has operated for decades with no official backstop from the US. Foreign commercial banks promise dollars on demand to their customers (in the form of deposits), with dollar assets backing them. But if they ran out of dollar assets? They don’t have access to the Fed. There’s no FDIC for the offshore dollar market. Even so, partially out of self-interest and partially in the interest of broader global stability, the Fed has episodically intervened in the Eurodollar market to provide backstop liquidity. That would very quickly need to become official.
Would foreign commercial banks have access to the discount window? Almost certainly not. But there would need to be some kind of parallel system, even if it were intermediated by foreign central banks (like an expanded network of swap lines or repo facilities). If stablecoins are meant to support the dollar offshore, the need for such a formalised backstop would only grow.
Precisely because of the above, American commercial banks holding Fed reserves are supervised by the Fed. The Fed can’t, and wouldn’t, supervise offshore banks, so co-operation with foreign bank supervisory authorities would be crucial. The tiered system would help limit the complication, but multilateralism, in short supply these days, would be a must.
Direct claims on the Fed already circulate widely around the world: crisp green cash. But that cash doesn’t earn interest. In an interest-on-reserves policy world, the Fed’s hand would probably be forced in remunerating all its reserves, inclusive of a tokenised wCBDC.
In practice, the Fed already in effect maintains an offshore dollar monetary policy: the floor is set by the rate on the FIMA reverse repo pool and the ceiling by the FIMA repo facility. With stablecoins offering higher rates, such an offshore wCBDC deployment would in effect create an offshore parallel to the onshore dollar hierarchy between official money and private money, interest rates and all.
The risk of volatile capital flows would pose a regulatory challenge to both stablecoins and any offshore wCBDC. If I’m an emerging market central bank, and I’ve sorted out capital flow regulations (and gotten the IMF off my back about it), I probably don’t want a bunch of digital dollar wallets sprouting up all over the place.
What could be worse for capital flows/foreign exchange stability than the ability for citizens to run out of their native currency into dollar accounts in their own country? Here, wCBDCs have an advantage over stablecoins and, developed in careful co-operation with foreign authorities (in potentially bespoke nature, given their programmability), could calm the nerves of host country policymakers.
The offshore digital dollar is pretty radical — more radical, perhaps, than it initially sounds. Many benefits would likely await the US, but, like everything in economics, there’s no free lunch here. The peril of becoming lender of last resort to functionally the whole world, political indigestion from paying interest on the reserves, and bureaucratic complexity.
Yet, it’s also less radical than it sounds. Direct offshore claims on the Fed already exist in the form of cash, a much dirtier dollar. And a wCBDC wouldn’t be creating the offshore dollar market; it already exists. To the extent the Fed would have to provide emergency liquidity, it’s unclear that’s something it’s not already doing.
If the plan is to have stablecoins around the world, better to pair them with an official version: the offshore digital dollar. While Washington tinkers, Beijing toils. Food for thought.