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CBDCs — The good, the bad, the ugly

Feb 23, 2023 · Alasdair Macleod

There has been much comment over the likelihood that central bank digital currencies will be introduced. I
conclude they are unnecessary — a red herring. But it does allow us to discuss their possible relevance to a
new Asian super-currency.

Earlier this month, the Bank of England in partnership with the UK Treasury produced a white paper on the
subject, which waters down the objectives identified by the Bank for International Settlements considerably.
The British proposal is a bad idea because it is pointless and I explain why. 

In this article, I describe how a new gold-backed currency can do away with the US dollar for trade
settlements and commodity purchases entirely between participating nations in the Russia China axis. Some
informed commentary on the topic suggests that a blockchain will be involved, and Sberbank, the Russian
state-owned lender has already issued a gold-linked fund designed to be available to the public by being
compatible with ethereum. Perhaps it is front-running developments…

The ugly side in our title is found in the BIS’s dystopian proposals, which sees CBDCs as an opportunity to
allow central banks to double down on their attempts to manage economic outcomes while restricting
personal freedom. 

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Messing about with fiat currency alternatives such as CBDCs could end up revealing the formers’ fragility. 
CBDCs will take years to implement in any major currency anyway, during which fiat currencies led by the
dollar are likely to fail anyway.

Introduction

It is not clear what encouraged central banks to think about introducing their own digital
currencies, other than possibly a feeling that if they didn’t do something, then private sector
money could threaten their monopoly. 

Initially, bitcoin was touted as sound money with a hard stop of 21,000,000 coins and proof of
ownership recorded on a blockchain. Bitcoin’s strength was to be the opposite of fiat currency
weakness, whose expansion is the primary means by which a central bank stimulates an economy.
But if central banks think that bitcoin could overturn fiat currencies, they merely exposed their
own ignorance about the nature of money and credit.

Bitcoin is not legal money. As opposed to credit where there is a counterparty risk, the only lawful
money is gold (and silver for small amounts), usually in coin, acting as an anchor for a gold
substitute in the form of credit. Therefore, if bitcoin is to be regarded as money by its users, they
must accept that they do not enjoy the protection of the law. In day-to-day transactions this might
not matter to the parties involved. After all, they are free to exchange goods or services for
anything — in the past family doctors have even been paid by their patients in cigars and whiskey. 

Money and credit have a legal status which differs from other forms of property. Some things can
only be acquired through legal tender, and bitcoin is not legal tender. But there is a further
distinction which kills bitcoin and any copycat cryptocurrency stone dead: when ownership of
legal money and credit transfers, it transfers absolutely, but this is not true for bitcoin. 
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Consider the situation if someone steals your wallet containing banknotes. There is no doubt that
the thief has committed a crime. But if he spends the stolen banknotes in a shop, and the
shopkeeper was not a party to the theft, then the banknotes become the shopkeeper’s property,
and you have no claim against the shopkeeper. This is equally true if you had coins stolen, or the
thief transferred credit from your bank account. This happens all the time today, and you may
have wondered why your bank cannot recall the funds.

A bank can recall funds if an error has occurred, and the error can be established in reconciliation
differences between banks, such as a misposting. If the bank has made a mistake in the
management of your deposit account, you may have a claim against the bank, but once funds have
left your account the bank usually cannot reclaim them so the bank must bear the loss. But if the
bank received valid instructions to transfer funds from your account, then on the transfer there can
be no reclaim, even if your account was hacked. The basis was established in Roman law, which
differentiated between money and credit in the normal course of banking, and a bank’s legal
obligations to items, including money, held in custody. The former being mutuum, in modern
accounting being a bank’s balance sheet liability or obligation in favour of the customer. And the
latter is a depositum (not to be confused with the term bank deposit), whereby the property in the
money remains with the customer.

The difference between mutuum and depositum is not strictly limited to money and credit but
extends to some other asset classes which can be transferred. For example, debts can be freely
bought and sold, without the debtor’s agreement. After all, this happens when a bank’s customer
transfers a bank’s obligation to him to another party by writing a cheque or tapping a debit card
on a payment machine. 

An interesting case occurred when Richard Cantillon, having acted as a banker, was sued by
customers to whom he had loaned funds to acquire shares in John Law’s Mississippi venture. On
taking in the shares as collateral, he immediately sold them. Technically, he remained liable for the
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return of the shares’ value.

But Cantillon collected twice: the first time from the sale of the shares into the market which
subsequently collapsed, and the second time when he sued the debtors for repayment of their
loans. The Court of Chancery in London decided he was legally entitled to sue because the shares
were in bearer form and not numbered, and therefore were not identified specifically as the
debtors’ property. In other words, they were classed as mutuum.

But bitcoin does not have the legal status that permitted Cantillon to claim that Mississippi shares
were in effect mutuum and taken in onto his balance sheet, and not identifiable as a depositum. With
its blockchain, Bitcoin is specifically identified property, just the same as ownership of a painting,
or any tangible asset. Its downfall as a currency is that the blockchain identifies it as having been
someone else’s property in the past. This may not matter to a current owner. But if the authorities
have evidence that your bitcoin was previously stolen, used in money laundering, or purchased
with the proceeds of crime, they can trace the bitcoin to you and seize them legally without
compensation. Any protestation that they need the wallet key to regain possession counts for
nothing: legally they may not be your property and if you refuse to allow access, you will be guilty
of obstructing the law.

Obviously, with cryptocurrencies being a relatively new development, this needs further testing in
law and confirmation in multiple jurisdictions. But recent actions by various authorities and
agencies to perfect recovery appear to be moving in this direction. Clearly, without the protection
offered to legal money and credit, bitcoin cannot be used as a settlement medium except for ad hoc
transactions.

That is the first point. Even more important perhaps is its unsuitability for use as money, and a
misunderstanding of the relationship between money and credit. Ever since Rome’s Twelve Tables
setting out the original basis of Roman law dating from about 450BC and at the time when,
according to Gaius in his Commentaries (on the Twelve Tables) Roman coins were first introduced,
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credit rather than coin has provided capital for merchants and businesses. 

Credit has always been the principal means of financing ventures and trade. The Phoenicians
trading in the Mediterranean and further afield will have needed credit a thousand years before
Rome’s Twelve Tables became the basis of Roman law. And when credit became based on money
as opposed to an obligation to deliver specific goods in Phoenician times, it required a certainty of
value. Being inherently volatile, bitcoin is not suited for this role. And the hard stop on its quantity
means that if it was to act as money ubiquitously, the continually increasing purchasing power that
would likely ensue would kill off demand for credit based upon it. Fans of bitcoin might argue that
that is the point, in which case they merely expose their ignorance of the relevance of credit to all
economic development.

Therefore, to the extent that central bankers are worried that bitcoin or other private sector monies
pose a threat to their status as controllers of the currency, they are themselves ignorant of their
trade. However, the idea of central bank equivalents in their own digital currencies has taken hold.
The Bank for International Settlements took it upon itself to coordinate research into CBDCs, for
which they have determined two separate roles. The first is when a central bank issues a CBDC
purely for domestic circulation. It is presumed that citizens and foreigners, such as tourists, can
use a CBDC so long as they are in jurisdiction. But they will become worthless outside the
country. The second is collaborative CBDCs, when two or more central banks settle on a CBDC to
be used to settle trade between their jurisdictions.

This gives rise to the title of this essay: the good, the bad, and the ugly. The good may come from
collaborative efforts to do without the fiat dollar, ensuring cross border trade can continue in the
event that the dollar collapses, or if the US continues to weaponise it. The bad is considering the
introduction of a CBDC for no good reason. And the ugly is when a CBDC is devised to give the
state greater control to manipulate its citizens’ behaviour.

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The good

On the information available, it appears likely that under the aegis of both Russia and China, a
new currency will be issued for the purpose of replacing the dollar for commodity purchases and
cross-border trade. This project centres on the Eurasian Economic Union (EAEU), which is the
political vehicle which hosts the committee considering the matter. Already, on 26 December
Russia’s state-owned Sberbank issued tokenised gold on the Sber blockchain, having launched its
first digital asset some time ago based on factored invoices. Furthermore, having made its
blockchain compatible with Ethereum, Sberbank intends to make it widely available to consumers.

Given that Sberbank is state-owned, this project can be regarded as not just licenced by the state
(digital financial assets require permission from the Central Bank of Russia) but perhaps as a
testbed for the state’s own monetary intentions. And Sergey Glazyev, the senior Russian economist
who is leading the EAEU committee clearly sees gold replacing the dollar as the monetary
standard for cross-border settlement. In an article for Vedomosti on 27 December (the day after
Sberbank announced its gold-linked digital asset), he said as much.[i]

There are other gold related developments in Asia. Notably, this week it transpired that the
Central Bank of Iran is in talks with Russia to create a stablecoin backed by gold for settling trade
through the Astrakhan special economic zone, through which goods from Europe transit to the
Middle East and south Asia.

But when it came to central banks trying to come up with roles for CBDCs, none thought a CBDC
would be deployed to facilitate a return to sound money. If they weren’t just trying to fend off
private sector currencies, they were thinking up new ways to deploy fiat either to stimulate
economic activity selectively, replace bank notes, or exercise greater control over individual users
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of currency. We do not know if Sergey Glazyev is considering using a CBDC to keep track of a new
trade currency, but in the plans outlined below, it is unnecessary. Normal accounting conventions
will suffice, and gold will provide the standard.

Glazyev is also the moving light behind a new, enhanced Moscow gold exchange. And now, all the
signals are pointing in the direction of cross-border transactions being settled in gold, or gold
substitutes. One condition which will need to be in place is for a value for gold measured in fiat
currencies to ensure there is sufficient available valued in goods to back inter-Asian trade. Despite
the accumulation of gold by the central banks of the Shanghai Cooperation Organisation
membership (SCO), some of them may not have sufficient official gold reserves to cover their trade
deficits except for limited times, requiring a higher gold value in order to do so. And other
members, such as Russia, could see continual accumulation of physical gold because of her net
energy and commodity exports. Ideally therefore, instead of trade settlements being entirely in
physical gold, they should be facilitated by a banking system based on gold which is properly
valued.

What is required is an entirely new currency backed by gold specifically created for cross-border
trade. Presumably, this is what Glazyev is trying to achieve. But it is relatively simple and does not
require blockchains and the paraphernalia of a CBDC. However, being a revolutionary concept, it
might be established as a CBDC to provide extra credibility to satisfy those whose understanding
of money and credit falls short.

The bulleted list that follows is a brief outline of how a new trade settlement currency based on
gold can be established to replace the fiat dollar in all transactions between member nations. It is
designed to be politically acceptable to all involved, as well as a long-term practical solution to
facilitate the Russian Chinese axis’s ambitions for an Asian industrial revolution free from
interference by America and her allies. The essential elements are as follows:

• The announcement of the creation of a new central bank (NCB) and a new gold-based
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currency on the lines below will be made in advance of implementation to allow bullion
markets to adjust to the new regime before it comes into existence. 

• A new central bank is then established, whose function is to issue a new digital currency
backed by physical gold, available only to participating central banks. It will be designed to be
a fully trusted gold substitute, fully independent of fiat currency values.

• The new currency will only be redeemable for gold by participating central banks. They are
also free to add to their NCB currency reserves by submitting additional gold to the NCB at
any time.

• The NCB’s eligible participants will be the central banks of participating nations, broadly
limited to member nations of the EAEU, SCO, and BRICS+. The NCB’s currency is issued to
the national central banks against their provision of a minimum 40% gold backing for it. For
example, currency representing one million gold grammes secures an allocation of 2,500,000
currency units denominated in gold grammes. The gold does not have to be delivered to a
central storage point but can be earmarked[ii] from within a central bank’s gold reserves, on
condition that they are securely stored in Asian vaults on a list approved by the NCB.

• Commercial banks trading in member nations and elsewhere will be free to create and deal in
credit denominated in the NCB’s new currency. Issuers and users of this credit are always free
to acquire physical gold in the markets, should they wish to back credit created in the new
currency with gold itself. 

• All taxes and restrictions on gold ownership must be fully rescinded by participating nations.

• An efficient central clearing system for commercial banks dealing in credit based on the new
currency will need to be established.

• Accompanied by the major energy producers setting price benchmarks, Asian commodity
exchanges will price all products in the new NCB currency, replacing pricing in US dollars
completely for trade between participating member nations.
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The purpose of the new currency is to provide the basis for trade finance and other cross border
financial settlements on a sound money basis. It is also likely to lead to participating nations
placing a greater emphasis on their own currencies’ stability while providing a safe haven from a
fiat currency system collapse, to which the establishment of gold backing for payment systems is
likely to contribute in its consequences.

All empirical experience informs us that when gold becomes the means by which credit is valued,
credit’s own value becomes tied to that of gold and is not dependent on stability in credit’s
quantity. This stability imparts pricing certainty to trade and investment, necessary conditions for
maximising economic development.

Constructed on the lines above, remarkably little physical gold would be required to underwrite
cross-border payment values for trade in Asia and beyond. It should be simple and quick to
establish. It must be free from interference from members of the western alliance trying to
preserve their own fiat currency systems. And the 40% gold backing rhymes with the basic
requirement for a metallic monetary standard set by Sir Isaac Newton, when he was Master of the
Royal Mint.

For participating central banks, the replacement of gold in their reserves for allocations of the new
currency would represent a significant increase in their reserves. As confidence in the scheme
builds, it could be argued that only minimal gold reserves need to be retained by participating
central banks, with the balance swapped for the new currency. For example, the Reserve Bank of
India officially possesses 787.4 tonnes of gold. Converted into the new gold currency, its value in
reserves is uplifted to 1,968.5 tonnes equivalent. 

One difficulty which will need to be considered is the repatriation of gold held in western central
bank vaults. Between the Bank of England and the New York Fed, earmarked gold totals 10,693
tonnes. The bulk of gold held at the NY Fed appears to be earmarked for the IMF, Bundesbank,
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and Banca D’Italia. Very little Asian gold would appear to be stored there. More Asian gold is
likely to be stored at the Bank of England. This could be a concern, because the Bank of England
on instructions from the US Government refused to repatriate Venezuela’s gold when requested. If
in losing its dollar hegemony the Americans become obstructive to Asian monetary plans, it could
become a problem for nations with gold earmarked at the Bank of England.

Presumably, the consequences for gold would be to drive the price up measured in dollars, euros,
etc. Foreign central banks in the Asian camp would be selling down currency reserves to acquire
gold. Furthermore, it would suit the new central bank to see a higher stable gold price as a starting
point, which is the reason to let the market find a level between announcing plans for the NCB and
implementing them. And it is worth making the point that if the price of oil adjusted by the price
of gold is to be returned to its post war dollar value, the dollar price of gold should be $3,360.

It could be argued that it’s not in China’s interests to undermine the dollar so dramatically, given
her dependency on exports to the US and elsewhere. Undoubtedly, while being open about her
desire to replace the dollar for cross-border transactions as much as possible, China has preferred
to let the change be evolutionary. But the time for caution has ended, and unless China joins in
with Russia’s plans, Russia will make all the running. 

The bad and the ugly

It should be noted that, to date, there are just two live retail CBDCs (the Sand Dollar in The
Bahamas and DCash in the Eastern Caribbean). For a major jurisdiction to introduce a CBDC there
are significant bureaucratic and technical issues to be addressed, which inevitably means that lead
times are substantial. The first step is to come up with a discussion paper, which is what the Bank
of England in conjunction with the UK Treasury did earlier this month.

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According to the Bank of England and the Treasury, there are two basic reasons for issuing a
digital pound: people are not using cash as much as they used to, with digital payments becoming
more common. And “there are new forms of money on the horizon, some of these could pose risks
to the UK’s financial stability.”

Let us address these two issues. Digital payments are indeed becoming more common. Credit
cards have been around for decades, so there is nothing new there. The Bank is referring to debit
cards, which authorise the transfer of a bank’s obligation a customer in accordance with the
customer’s instructions. This form of payment has become progressively more efficient, leading to
a public choice for paying with debit cards. A separate wallet for a CBDC, as proposed by the
Bank, is unnecessary. That leaves us dealing with fear of the unknown — the new forms of money
on the horizon, and the risk to financial stability.

This is a straw man fallacy. There is no threat from private sector currencies. As pointed out earlier
in this article, they lack the legal status of money and credit, and are entirely unsuitable. But what
the bitcoin revolution has done is create a lot of excitement amongst the progressives, who feel a
response is necessary. And reading the Britcoin’s consultation paper, we see that the intention is
for a CBDC which is limited in its scope compared with some of the ideas coming out of the Bank
for International Settlements’ own consultation documents.

The UK’s proposed CBDC will use digital wallets and not require individual bank accounts with
the Bank of England. Retail and business accounts at a central bank was one of the BIS’s ideas. But
this cuts across the role of commercial banking and faces enormous technological challenges. If the
Bank wishes to introduce a CBDC, then private sector wallets make more sense for this reason.
They should allow payments to be made between individuals and businesses as if they are made
in bank notes, and without these transactions being recorded at the Bank, they should retain their
anonymity.

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The intention is that there will be no difference between a CBDC pound and a one-pound coin.
The consultation paper argues that it is not intended to be a cash replacement, but an additional
equivalent of cash payment. A CBDC pound will not earn interest, but there will be a limit on the
quantity held in a wallet which is yet to be decided or how it is to be implemented.
Implementation rings warning bells with respect to privacy.

But the exercise appears to be pointless. At least in its scope it is not as ugly as some of the
objectives coming out of the BIS. In an official video recorded by the BIS, Augustin Carstens, its
General Manger, said the following:

“The key difference with a CBDC is that the central bank will have absolute control on the
rules and regulations that will determine the use of that expression of central bank liability.
And also, we will have the technology to enforce that. Those two issues are extremely
important and make a huge difference with respect to what cash is.”

Carstens is describing a system where central banks intrude upon the use of their CBDCs,
presumably through requiring individuals and businesses to maintain accounts at or under the
control of a central bank, or by central banks having access to individual wallets. Absolute control
determining their use is a dystopian vision of the future of currencies.

It seems unlikely that the fullest ambitions for CBDCs revealed by Carstens will find support from
commercial bankers, because it treads on their toes. This is important in the US’s political context
because commercial banks bankroll congressmen and senators. One can envisage commercial
banks supporting a CBDC as proposed by the Bank of England, because it is clearly a supplement
to bank notes and not commercial bank credit. However, it is difficult to see how a CBDC-lite
model will find much public favour, because current payment systems are so efficient that they are
unlikely to be bettered by a CBDC.

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There is a risk that tinkering with a fiat monetary system by adopting CBDCs will end up eroding
confidence in fiat currencies generally. This outcome may seem unlikely to the planners, but if the
Russian Chinese partnership does move towards gold-backed trade settlements, for fiat currencies
the retention of public confidence  in them should be their highest priority. 

In any event, even without the Asian hegemons backing a new trade currency with gold, the
western alliance’s fiat currencies face enormous challenges. The days when interest rates could be
contained at, below, or marginally above the zero bound are over. Entire banking systems from
central banks downwards are threatened with liquidity issues which can only be defrayed by yet
more credit expansion, which ends up making things even worse.

The whole CBDC story is a red herring. The plan outlined above for a new Asian trade settlement
currency does not require a CBDC. It can be progressed within current banking systems. And as
for the time taken to implement CBDCs in the western alliance’s fiat currencies, it is highly likely
that they will have collapsed into worthlessness long before CBDCs can be adopted. 

[i] For a summary of Glazyev’s Vedomosti article, see https://www.goldmoney.com/research

/russia-s-intentions-are-clarifying

[ii] Earmarking is the technical term whereby one central bank acts as custodian for another
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central bank’s bullion.

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