A Digital Dollar?

Previously published on May 5, 2023 in

By Milton Ezrati, Chief Economist at Vested

Talk of a digital dollar has resurfaced. It first emerged in 2019 when the People’s Bank of China (PBOC) launched its digital yuan. Then, pointless speculation arose, about how the digital yuan would soon surpass the dollar as the world’s premier reserve currency. Those who wrote and talked that way missed how much more is involved in a reserve currency than a convenient digital exchange mechanism. The renewed chatter has come in response to Washington’s recent announcement that it will investigate the creation of a digital dollar. Advocates claim much good will come from it. Others see dangers. Still others hold that the effort is pointless, that the dollar is already effectively digital for all practical purposes.

The main impetus now comes from presidential Executive Order 14067, entitled “Ensuring Responsible Development of Digital Assets.” According to a White House summary, the investigation will receive a full “interagency effort” to consider “18 technical design choices.”

Nor is the White House the only source of interest. In Congress Rep. Stephen Lynch (D-Mass.) has introduced the eCash Act, calling on the Treasury to implement a digital currency. Also, the Federal Reserve Bank of New York has launched a 12-week pilot program to test the use of a digital dollar.

With so many options, it is hard to tell what if anything might eventually emerge from Washington. Presumably, the structure, if one is ever established, would have the Federal Reserve (Fed), like the PBOC and its digital yuan, create dollar accounts for everyone and digitally administer their transactions. Today, the Fed creates reserves for banks, which create and administer the accounts. Some of the 18 choices to which the White House summary alludes would keep the banks as intermediaries. Either way, all these digital transactions would presumably appear on a single Fed ledger.

Aside from offering the United States an answer to the PBOC, digital dollar advocates stress three additional virtues. A digital dollar would first enable people and businesses to transfer money cheaper and easier than they can today. Second, the arrangements would offer access to financial services to the 4.5% of Americans who today are “unbanked,” as the popular descriptor goes. Third, it would allow Washington an easy way to reapportion cash benefits to citizens, directly and securely simply by debiting and crediting their accounts.

It is hard to argue with points one and three. They are obvious technical advantages. As for the “unbanked,” it is not apparent that the digital dollar would make much difference to them. Modern e-banking apps have all but eliminated the trouble and minimums that once kept people from using financial services. A cheaper and easier answer for this need might lie in educating people and perhaps providing access to cheap or free smartphones.

Whatever the digital dollar’s virtues, it would also bring problems. Chief among them is the matter of privacy. If transactions all appear on a government computer, the authorities will have easy access to information on each person’s purchases and sales and accordingly, the ability to use that information against them. No doubt such an unparalleled surveillance capability is why China has led in this area. True, Washington can access such information through credit and debit cards, but the authorities must get a court order from an independent judiciary to access those records. A digital system might offer similar safeguards, but the existence of everything on one government-administered computer certainly makes the access easier, quicker, and more prone to abuse.

A digital dollar arrangement could also muddle the allocation of capital. Presently bank lending and the flow of information in financial markets directs financing to what are presumably the most promising investment prospects. But if digital deposits lie with the Fed, then it will direct much investment financing. Such an arrangement could be too easily open investment decisions to political direction and away from economic considerations. Though politicians and bureaucrats always think they know better, but if the past is a guide, the increased political influence would tend to slow the growth of income and wealth.

Nor is it apparent that the effort is at all necessary. Whatever China’s needs, it should be obvious to all that the dollar, as well as most other major currencies, have long been digitized. Most people today are paid through direct deposits. Tax refunds arrive that way as well, and tax payments are automatically withdrawn, as are many bills. Transactions occur easily and conveniently through credit cards, debit cards, Apple watches, PayPal, and a host of similar schemes. Even foreign currency transactions occur automatically through one or another of such devices. Perhaps a digital dollar would facilitate all this cheaper and more conveniently, but it is neither essentially different from what exists now, nor is it worth risking other drawbacks.