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Why the U.S. Government Should Digitize the Dollar

The entire world is looking into currency digitization right now. Countries everywhere are launching central bank digital currencies (CBDCs) and switching.

The move towards this new development primarily started with China. Xi Jinping’s administration had seen CBDCs as a means of transforming its economy. So, in 2019, it began work on a CBDC.

Since China started its mission, several other countries have joined in. Many of them have been looking to optimize their currencies and make them more effective. So, digitization seemed like the right choice.

Many estimate that countries representing 90% of the world’s GDP will launch CBDCs by the next decade. But, the largest economy remains on hold. Moreover, the United States has yet to join the CBDC race, despite calls from allies to do so. While there have been talks here and there, nothing concrete has shown up yet. So, it begs the question – what does the United States stand to gain by joining the CBDC race?

Stopping the Rise of China

Perhaps the most crucial benefit of a CBDC for the United States will be the prospect of keeping its position. Today, China is the most significant economic threat to the United States. Its GDP is on the rise, and estimates say that China will eventually beat the United States economy.

One crucial area where China holds a significant gambit is a trade. China is highly interconnected, and many countries around the world depend on it for work. With a digital version of its yuan, China could make transactions easier using its currency. The government could also leverage its position in global trade and ensure that more people demand the yuan.

Since it will be in digital form, the yuan will be more attractive. People will use it for trade and cross-border transactions, meaning less reliance on the dollar.

The United States has so far maintained its superpower status because of the global demand for the dollar. Once that goes away, it will lose significant leverage on other countries.

The only way to stop China itself is to get on the same playing field. Norihiro Nakamaya, a Japanese government official, said as much last year.

Efficiency and Monetary Policy Reasons

Besides improving the United States’ ability to compete globally, a digital dollar could also help internally.

One practical reason to issue this asset will be to reduce resource wastage. According to reports, the Federal Reserve has budgeted over $1 billion this year for the Bureau of Engraving and Printing to print money. Besides that, the use of cash brings implications for safekeeping, handling, and preventing counterfeits. All of these tasks will take a financial toll as well. By moving to a digital dollar, the government can cut these costs.

The use of a CBDC will also entail new costs. For example, the government will have to pay for cybersecurity and hack prevention, system maintenance, etc. But, the benefits outweigh the costs for sure.

Then, there is the monetary policy benefit. In theory, the use of physical cash imposes a zero lower bound on interest rates. Replacing it with a CBDC will help eradicate this issue and optimize monetary policy efficiency.

The problem with this is that it’s not so feasible. The government can’t just phase out cash in a single day, as we all know. Also, if market participants believe that a CBDC will have a negative interest rate, they might not adopt it.

Some central banks have even broken through the zero lower bound. But, the cost of holding cash discourages moving to cash when negative interest rates are the order of the day.

Improving Payments

Lastly, there is the standard benefit we all know. CBDCs can serve as a safe and viable means of making payments and storing value. This means that they can have benefits for financial stability.

One of the many criticisms of traditional cryptocurrencies is their volatility. But, stablecoins present a better alternative; CBDCs will merge the benefits of these two. They will make money transfers quick and efficient, and their values will also be stable.

CBDCs can also improve the “durability” of financial markets. Market participants can withdraw bank deposits in times of stress and run to CBDCs. In the current market system, it is much more expensive to convert your holdings to cash. So, there’s no incentive for market participants to do this. But, with a CBDC, that process is much easier.

Are We Making Progress?

As stated earlier, the Federal Reserve isn’t doing much work on a CBDC. The agency has been examining the potential of a digital dollar, however. First, there is the Digital Dollar Project, Led by Christopher Giancarlo. Giancarlo is the former chairman of the Commodity Futures Trading Commission (CFTC). Also, he’s looking to get a proper CBDC framework.

The Digital Dollar Project proposes a two-tiered banking system. This will focus on preserving the current banking infrastructure and innovating at the same time. Under this system, the Federal Reserve will issue digital dollars to commercial banks. On the other hand, users will store their money in bank accounts or hold the CBDCs in digital wallets.

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With the two-tiered system, banks will be able to lend against the funds in their accounts. So, everyone can monitor the circulation of funds. For now, however, this system is still in the proposal stage.

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