Digital Currencies

The Bail-in

Technology has been breaking down barriers on an accelerated basis with the COVID-19 driven government lockdowns. Central banks, globally, are now actively discussing the implementation of Central Bank Digital Currencies (CBDC). China is in the process of implementing one, which will operate in parallel with its existing coins and paper currencies. The European Union is reportedly reviewing the implementation of digital currencies as early as 2021. In the US, Congressional Democrats have proposed the adoption of a digital currency.

There are several advantages for governments and central banks including: forcing existing paper money back into the banking system; taxing black market activities; eliminating bank runs; and enforcing negative interest rates. Major technology companies have been actively supporting the adoption of digital currencies, seeing an opportunity to have a small piece of every transaction and the accompanying data, which they can monetize.

Europe needs digital currencies because of the fundamental weaknesses of their banks caused by failures to write off earlier losses, compounded by the increased losses created by the lockdowns. All major developed countries including Europe, Japan, the UK and US have all adopted bail-in provisions, which provide for the use investor and depositor money in the event of bank failures. However, the first bank to use depositors’ funds as part of a bailout is likely to trigger a depositor run on other weak banks. Central bank digital currencies allow authorities to electronically halt the movement of funds to prevent these runs. Loss of sovereignty is the major shortcoming of digital currencies for depositors.

While Europe might be the next to adopt digital currencies, the US is likely to be the last because $1 to $1.5 trillion of US currency is currently held outside the country and is in widespread use. The US is the only major country where all of the coins and currencies issued by the US Government are still legal tender. The EU countries all canceled their currencies after the adoption of the euro in 1999. India eliminated all currencies with a value of more than 1,000 rupees ($15) in 2018.

There are a number of implications for the introduction of digital currencies in Europe including: increased demand for physical US dollars and deposits in US banks; increased demand for physical gold and gold stocks in countries like France, that require the reporting of all gold transactions in excess of 2,000 euros; and the elimination of cryptocurrencies, which compete with central bank digital currencies. 

The adoption of digital currencies will continue the transformation of the banking system that has been underway over the past decade. An entirely new financial system is evolving. Digital currencies are simply the next step in that transformation.

As always, we welcome your questions and comments.

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