The dystopian science fiction novel 1984 by George Orwell is a cautionary tale of what can happen when a government exerts too much control over its citizens. It’s a lesson in totalitarianism, surveillance, and repression, and it’s often used to analogize legislation that risks eroding our freedom.
The Federal Reserve recently announced its intention to pilot a Central Bank Digital Currency (CBDC), and given the outcry, it is as if this decision came directly from the Ministry of Truth. But before we label CBDC as “1984 on steroids,” let’s first explain the concept, why the Fed is considering using one, and the potential ramifications if the Fed were to adopt it.
The Federal Reserve Bank (Fed) is a bank for banks. J.P. Morgan and Bank of America work with the Federal Reserve Bank, similar to how we work with them. Banks have accounts at the Fed, and we have checking and brokerage accounts at banks. Using banks as “intermediaries” between the Fed and consumers and businesses is customary in most free countries.
But the system isn’t perfect. An estimated 4.5 percent of U.S. households were “unbanked” in 20211. That means they can’t buy stuff online, get a mortgage, save for retirement, etc.
Intermediaries also add cost to the financial system. Banks need to earn a profit, so they charge fees for services like moving money around and underwriting loans. Furthermore, roughly 13% of U.S. adults with bank accounts still use costly alternative services like money orders, payday loans, and check-cashing services2.
Banks also slow things down. For example, moving money between banks can take days and is often cumbersome. When the Fed wanted to distribute money during the lockdowns in 2020, they had to first dispense the money to the banks, who then had to place the cash in our accounts. That didn’t happen with the click of a button.
Let’s also address the elephant in the room. Banks occasionally fail, and when they do, their tentacles can create problems that aren’t known until it’s too late. The federal government does provide insurance up to $250,000 per account, but there appears to be more than enough uninsured deposits out there to ignite a crisis (look no further than March of this year for evidence).
Despite these shortcomings, the current system works relatively well and hasn’t changed much over the last century. But what has changed is how we pay for stuff. In 2020, the United Kingdom recorded a 35% drop in payments made via cash and coins, and today, only one in six payments are made in cash3. Over 75% of Americans shop online at least once a month4. Simply put, physical cash usage is plummeting.
Central bank digital currency was designed for a world where digital cash is preferred to paper currency. It doesn’t look or feel much different than how we use currency today, but it uses similar technology to what Bitcoin and other cryptocurrencies are built on to disintermediate the financial system.
Meaning, a CBDC could theoretically remove the need for banks along with their associated costs and risks. Americans would no longer need a bank account at J.P. Morgan because they would have one directly with the Fed. Bank runs would go the way of the dodo bird.
If the government wanted to send a tax refund, rather than mail it or wait a few days for an electronic transfer to clear, the Treasury Department could click a button and fund the account immediately. Home buyers could wire money to sellers using iPhones with no wire fees or title insurance.
Furthermore, consumers that don’t have banking relationships today because they don’t meet the minimum account requirements would no longer need to stuff money under the mattress and rely on loan sharks to cash checks. Americans in all socioeconomic brackets would have equal access to banking.
What’s the catch?
So far, this may sound like a home run. Costs come down, all financial transactions happen instantaneously, and we never have to deal with a bank again. Given the advantages, why the Orwellian concern?
The main fear is that having an account directly with the government is giving Uncle Sam too much power over personal finances. The digitized nature of CBDC allows for complete oversight over all transactions. The Feds would know everything about every dollar moved in and out of every account it held. They could see how many times any American bought toothpaste or lent money to friends.
Giving up this much privacy will likely be unpalatable to more than just thieves. Millions of law-abiding Americans would almost certainly reject any system that gave the government that much control. Full-scale adoption is possible only through legislation, and there are officials in both political parties that have voiced opposition to a CBDC.
Aside from privacy concerns, there are operational hurdles. Disintermediating banks from global payments would be massively disruptive and risk destabilizing a system that’s become too big and critically important to the global economy.
It's more than just moving money around faster and building new technology. Basic services like call centers to help people recover passwords need to be replicated. It also replaces the private sector, which must compete for business through productivity and innovation, with the monopolistic public sector. Are we better off if the same incentive structure and efficiencies that run the DMV were brought to banking?
Simply put, a CBDC would solve problems but also create new ones. It’s unclear whether the net result would be positive.
The bottom line
Our house was built in 1910 and designed for life then. We recently considered tearing down a wall to open the floor plan and make it more livable for how we operate. But our general contractor explained that it would require a new support beam to be installed, the floors replaced, the ceiling trim repaired, electrical and plumbing moved, securing permits from the city that could take a year, and moving into a rental for a few months.
He also warned us that success wasn’t guaranteed and that he wouldn’t know for sure until the project started. This meant no assurances on cost. Ultimately, we decided that while an open concept would be better, what we have today is fine.
This feels analogous to what the Fed is doing with CBDC. Even if they determine that a CBDC is better than what they’ve got today, the odds they break ground are infinitesimally small because the potential benefit isn’t worth the disruption and risk. It’s an academic exercise, similar to a car company testing a prototype that will never make it to the showroom floor. They want to see what’s possible, not probable.
Besides, the U.S. already has a digital currency. It’s called the U.S. dollar. Most people don’t get paid in physical cash anymore, nor do they close on a new house with a bag full of cash. The current dollar may not be built on a blockchain with digital wallets held by the Fed, but it’s still 1’s and 0’s sitting on a hard drive somewhere.
Meaning, a lot of those Orwellian fears are already a reality. Fail to pay your taxes or child support, and the government can and will liquidate your bank account. Move more than $10,000, and your bank must legally report this to the government5. If Congress doesn’t want us to buy something, they can pass laws to make it illegal. New York officials will even check credit card purchases, cellphone records, social media feeds, and veterinary and dentist records to prove residency for those trying to evade state income taxes6.
The bottom line is that a CBDC would make money trails better paved, but it’s not like the current system operates on unmarked dirt roads. However, given the extreme operational hurdles, any future adoption of a CBDC would almost certainly be a supplement rather than a replacement to the current U.S. dollar system.
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