In part 1 of this post, I wrote about how — similar to the medicine men of old who used to prescribe poisons like Mercury as cures — central banks around the world are trapped in a hamster wheel of their own making. Low interest keep causing economic disruption that is addressed with even lower rates. But unfortunately for them, there’s a natural barrier to how far they can push things, and it is known as “the zero-bound problem.”
The idea behind Negative Interest Rate Policy (NIRP) is to force people to spend or invest the money they would otherwise save by effectively imposing a tax on savings accounts at banks. But unfortunately for economists, the average citizen didn’t go to Harvard, so he or she doesn’t realize that buying things they don’t need or investing in things they don’t like is good for them. Ignorant as they are, the average person likes to save to build a buffer against future setbacks. In a NIRPy environment, the best way to do that is to hoard cash. So long as doing so is an option, taking interest rates significantly below zero is not effective, putting a zero bound on just how much poison the medicine man can force upon his patient.
As we also discussed in part 1, economic models, like the ones that have fallen flat since the economic crisis, are never wrong. It’s always the humans who don’t do what the Excel spreadsheet predicted they would who are at fault. If the natural reaction to NIRP (an idea that is relatively new) is to hoard cash (an idea that is thousands of years old) then the smart move is to eliminate cash altogether. How? By having a central bank issue digital legal tender, colloquially referred to as Central Bank Digital Currency, or CBDC.
CBDCs are the hottest new idea in policy circles, in part because they give policymakers total control over the currency. There are different implementations, and a few include the use of blockchain tech. The original Bitcoin white paper, after all, was titled “Peer to Peer Electronic Cash,” and the technology is an eloquent solution for creating digital bearer assets that can be used as money.
For consumers, the appeal of a CDBC is the elimination of the expensive or fragmented electronic payment solutions of today. Just imagine if your smartphone held your digital dollars, and you could instantly send them to anyone, anywhere, possibly for free. A CDBC could also better incorporate the poor and unbanked into the digital economy.
For Central Banks, having every single payment occur on a ledger they control is the ultimate source of power. The imposition of negative interest rates would now be absolute as users’ digital dollars would literally have nowhere to hide. Even inflation targeting would theoretically become trivial. Want to create instant 2% inflation? Just program every blockchain addresses balance to increase by 2%.
There are many different challenges to building out such infrastructure, starting with the fact that no blockchain today can even remotely handle the volume such a system would require. Even if the technical issues were solved, there would still be systemic challenges, like what happens to the commercial banking industry, a big part of the value proposition for which is payments and cash management.
We are still years, if not decades, from such a solution being viable, but that’s not what matters to policymakers. What matters is that there is a solution to the zero-bound problem on the horizon. Twenty years ago, the idea of deeply negative interest rates would have had to be dismissed due to consumers’ ability to hoard cash. But now, “there’s a blockchain for that.”
The potential for the development of a CBDC is yet another reason why NIRP is bound to get NIRPier. People are already talking about this with the ascent of Christine Lagarde — current head of the IMF and big fan of the digitization of cash — to replace Mario Draghi as head of the European Central Bank. Dozens of other central banks are already researching how they would deploy digital cash into the economy. Many pay lip service to the practical benefits of such a system, but it’s safe to assume an underlying motivation is the elimination of the zero-bound barrier.
So once again we are back to the conclusion of my original post that NIRP will keep getting NIRPier, and that gold and crypto will be the biggest beneficiaries. Gold is ancient, easy to understand and familiar, but also difficult to acquire, store and transact. Crypto is new and confusing, but easy to store and transfer.
Ironically, the fact that one potential design of a CDBC is to use blockchain tech will further enhance the bullish thesis behind crypto. If Central Bankers — the people whose very existence is anathema to the notion of decentralized money — bless the technology that empowers the likes of Bitcoin and Ether, how bad could those assets really be?