The Malcolm Wiener Lecture in International Political Economy delivered by: The Right Honourable Gor
If the world’s central bank digital currencies (CBDC) quickly replace banknotes, the trillion dollar shadow economy could become even more opaque.
The big problem for governments and central banks is that this process is already happening to some extent – for example, the recent explosive growth the value of the cryptocurrency anticipates its inevitable appearance.
Global monetary institutions from Beijing to Frankfurt have accelerated plans to release legal tender digitally over the past year, in part to keep pace with the explosive growth of private sector cryptocurrencies and online payment systems in recent years. Many projects and concepts, many of which are still being discussed, make it difficult to get a clear picture of what will come in the future..
It is clear that the digital currency transition sounds like the death knell for physical banknotes and coins as we know them – there is still a slow decline in their use, which is catalyzed by social distancing due to the pandemic. And that could be happening soon – China is already testing its versions of the digital yuan, and the European Central Bank expects to see the digital euro within the next four years..
But if the end of the cash era is approaching, then the people or activities most dependent on tangible banknotes that effectively ensure the anonymity of the holders of funds and transactions with them will have to adapt to new conditions or find another way of doing business..
Those who use cash most often – as opposed to electronic money that is redirected between bank accounts within the existing banking system – are employed in the sector that the International Monetary Fund (IMF) calls «shadow economy».
For the most part, this ecosystem is designed to avoid taxation, regulation and supervision, and can include everything from households using banknotes to pay cleaners or construction workers to avoid taxes, to organized crime and drug trafficking or even terrorist financing..
The scale of this shadow economy is enormous.
In a working paper published shortly before the crisis COVID-19, IMF economists estimate that the shadow economy in the largest European countries, for example, can reach 20% of gross domestic product (GDP) and up to 35% in some emerging market economies.
For the eurozone alone, this could be more than 2 trillion euros – almost double the 1.2 trillion euro banknotes in circulation and, curiously, still more than the market capitalization of all known cryptocurrencies at $ 1.5 trillion..
Cash certainly won’t disappear overnight, even when the CBDCs are launched. And, probably, not all of the shadow economy will move to the nooks and crannies of the cryptocurrency world. Moreover, the IMF refers to a study according to which the wider use of simple electronic payments significantly reduces the shadow economy..
But assuming that governments are reluctant to encourage underground activity – not least because of the loss of much-needed tax revenues in the coming years – this could have a significant impact on the development of new CBDCs..
Currently in Europe, much attention is paid to the digital euro as a zero-yield deposit directly with the ECB – the direct responsibility for the central bank is exactly the same as in the case of banknotes. Thus, using the digital euro, depositors will be able to avoid risks as opposed to deposits of commercial banks..
To counter this, ECB board member Fabio panetta and ECB Director General for Market Infrastructure and Payments Ulrich bindsale proposed to limit these first-tier deposits to households only and to no more than € 1,000, effectively punishing holdings in excess of this amount and those owned by companies or investors with deeply negative interest rates.
Moreover, Panetta said last week that in the event of a banking crisis, negative tier two rates may need to exceed 2% or 3% to avoid excess commercial bank deposits in CBDC..
But it is unlikely that anyone operating in the shadow economy seeking to avoid taxes and / or law enforcement scrutiny will want to open a visible and traceable central bank account..
This is why some economists believe that CBDCs should only be issued as digital tokens, mimicking banknotes in digital form, but privately in digital wallets, the way cryptocurrencies work now..
However, even as with the main cryptocurrency Bitcoin (BTC), this movement of tokens from wallet to wallet can be tracked to some extent. And it’s hard to imagine legal tender tokens to be 100% anonymous.
Discussing CBDC’s plans to date, arguing that there is a risk «giant failure», economists Peter bofinger and Thomas haas questioned both the ideas of deposits and tokens, in favor of the unit «store of value», which could integrate private online payment systems like Facebook with its Libra / Diem with legal tender and prevent them from going from permanent to crypto and vice versa.
They also argue that the idea of unlimited and completely anonymous CBDC tokens simply won’t comply with anti-money laundering regulations..
Metlife Investment Management Strategists Alexander villacampa and Jun Jiang believe that while central banks now need CBDCs to fight control of monetary systems by the cryptocurrency world and big tech. For central banks, token is the only logical path.
«Without a CBDC token, central banks could actually push people to use cryptocurrencies, which is unlikely», – experts say.