Investment Officer, once in a while, has a conversation with investment expert Jan Longeval to discuss his views on economic and financial developments. This time, he warns about the risks of Central Bank Digital Currencies, or CBDCs.
«Many central banks around the world are currently in a pilot phase to launch CBDCs,» explains Jan Longeval. «In the current monetary system, private individuals and businesses never have a bank account with the central bank. Private entities hold accounts with commercial banks, which in turn hold accounts with the central bank. This system has its advantages and disadvantages.»
To make a loan
«One of the downsides is that when you deposit money into a commercial bank, it is exactly the same as if you were lending that bank money. Deposits from customers are not listed as assets of the bank but are on the liabilities side. Essentially, you are providing a form of capital to that commercial bank. This also means that a deposit can disappear if a commercial bank goes bankrupt.»
«Commercial banks are responsible for 95 percent of all money creation,» Longeval continues. «They do this by issuing loans. They don’t use deposits for this. If you take out a €300,000 mortgage, your commercial bank creates €300,000. In English, this is well described as ‹to make a loan.› When you borrow €300,000, the bank makes a €300,000 loan, which it records as an asset on its balance sheet. At the same time, it creates a €300,000 deposit, credited to the account of the person taking out the loan.»
Oxygen
«The commercial banking model has structurally high leverage,» Longeval notes. «Typically, the total balance sheet of a commercial bank is many times its equity. This model is therefore inherently fragile. But it’s necessary because it allows commercial banks to create enough money in the form of credit, which is the oxygen for economic growth alongside innovation.»
«To strengthen the fragile commercial banking model, central banks were established. A central bank’s role is to prevent currency devaluation and avoid chaos in the monetary system, which is synonymous with the banking system.»
«When a commercial bank is on the verge of collapse, the central bank steps in as a saviour. To provide even more security to depositors, the deposit guarantee scheme was also introduced. You can have your reservations about this system, as it cannot fully prevent financial crises. But overall, if you look at the economic growth and wealth creation over the past few hundred years, we have made incredible progress, partly thanks to this system.»
Even safer (?)
«In some political and technocratic circles, the idea is gaining ground to make the system even safer by allowing the non-financial private sector to hold bank accounts with the central bank,» says a frowning Longeval.
«According to them, this is the miracle solution. A central bank in a monetarily sovereign country or region cannot go bankrupt, as it can always create more of its own currency without limitation—what is called ‹the power of the purse.› And all people worldwide who have a smartphone but no bank account could then have an account, albeit with the central bank.»
Longeval is, to say the least, not enthusiastic about these plans. «Firstly, the ‹D› in CBDC is misleading. Our current accounts with commercial banks are already digital, so a CBDC doesn’t add anything new in that regard. Moreover, I think CBDCs are a terrible idea for several reasons. If it’s not broken, don’t fix it. As mentioned, this system, despite its flaws and periodic crises, has worked very well over the centuries.»
«You can see a tendency toward centralisation at the European government level. In Europe, the ECB is actively working on CBDCs. The regulation from the European Commission is becoming increasingly coercive. CBDCs are effectively the next step towards a planned economy with extensive control over citizens’ lives. It’s no surprise that the Chinese government is a big fan of CBDCs.»
Power to the government
«There is talk of certain hybrid forms, where the commercial bank would still be involved. But even if that happens, the entire architecture is being built today so that, one day, your account will be directly on the balance sheet of the central bank.»
Longeval believes there should be a public debate about CBDCs in Europe. «If this path is continued, I may have to reconsider my opinion on crypto.»