State digital currencies: defence of the realm


You thought cryptocurrencies were disruptive? Wholesale adoption of digital euros issued by the European Central Bank could force it to step in to bolster banks in an extreme scenario wargamed by analysts at Mediobanca.

Managing retail flows of money has historically been fiddly. Central bankers largely outsourced the job to banks owned by stockholders. As the use of cash declines and technology advances, digital currencies could enable central banks to dispense with some of these middlemen.

The EU would be more likely to press ahead with a digital euro, which it is in the early stages of considering, for strategic reasons. One of these would be to challenge what a French politician described as the US dollar’s “exorbitant privilege”. Another would be to forestall substitution of euros by cryptocurrencies or rival central bank digital currencies (CBDCs).

The People’s Bank of China has taken an early lead. Payments of digital renminbi are already being made in selected cities via smartphones. After next year’s planned launch for retail payments, the next step would be cross-border trade payments.

Current plans for the digital euro would limit its use to retail payments. If interest rates stayed negative or very low, digital euros held directly with the ECB could drain the deposit accounts that help fund lending. Mediobanca analysts led by Andrea Filtri estimate that if eurozone households and non-financial corporations each held a capped amount of €3,000, almost €1tn would switch.

This would increase funding costs only modestly. But if households and businesses moved the bulk of their deposits in a crisis, costs would balloon. The prospect of market disruption and a collapse in profits would force the ECB to step in to support banks.

Conspiracy theorists may find validation for fears of a European superstate in such wargaming. In reality, central bankers must be equally scared of scenarios that lumber them with such responsibility. But if cryptocurrencies show any signs of supplanting fiat money, you can be sure that CBDCs will be widely touted as an alternative.

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