This Calling

Sometimes, things start with a simple idea and develop into something very little familiar with the original one but are used by more and more people who cannot happen to master their day without it.

As it is with many things, people who use a new product mainly perceive the positive aspects of it. However, sometimes it happens that over time the public becomes more aware of certain negatives as they get more discussed publicly. A few times, the bad news keeps flowing in until one must ask himself if there are more cons than pros.

In the fall of 2003, 19-year-old Harvard student Mark Zuckerberg programs a new website called Facemash. At this point, no one could know that this would mark the birth of something that would turn into one of the biggest tech companies worldwide. The website is simple, it shows two pictures of female Students from Harvard, and people can vote for the better-looking one. However, it takes only a few days until the university administration takes the site offline. Zuckerberg nearly gets exmatriculated.

Nevertheless, the seed is sawn. In 2004, Zuckerberg launched The Facebook, a social network that collects all social networks from Harvard under one main website. The site quickly grows beyond Harvard and spreads throughout all universities on the North American continent. In 2006 the site, now known as Facebook, was opened for 13-year-olds. Companies recognize the platform's chances to stay in touch with their customers, although Facebook does not make it at that point.

In 2008, Facebook started generating advertising revenues. One year later, the company was profitable for the first time in history. In 2010, the site passed 500 million users; in 2012, it would pass 1 billion. At that point, Facebook was the second most visited website in the US. The company had already moved its headquarters to Silicon Valley, California. The enormous user growth makes the website more and more valuable for consumers and advertisers.

But then, the negatives appear on the surface. To enable advertisers to reach people with a very detailed customer profile, the company saves vast amounts of data, partially also from people who do not even use the platform.

More and more controversies emerge: surveillance of private chats and passing data to third parties, like government agencies or other data corporations who cooperated with Facebook.

A sentence from a Metafilter article from 2010 sums up what many users of Facebook and other free social networks forget:

If you do not pay for it, you are not the customer, you are the product being sold.

In communist East Germany, the ministry of state security (also known as Stasi) collected data about every citizen they considered a potential resister. If a company like Facebook had existed back then, it probably would have done the work for the clerks at the ministry much more effortlessly.

Facebook shows that saved personal data in a central register, with information about so many people, harbors a significant potential for abuse. This becomes even more problematic if the data is not in the hands of a private company but in the hands of the government because everyone is a customer of the state.

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While there is a lot of discussion about additional legislation to make surveillance more manageable, like a central register to save messages from messengers intentionally, the goal of such legislation is to fight fraud. However, it cannot be denied that such policies also threaten freedom.

Centralisation is moving forward, both on the political side and within currency systems. The way we use money might change drastically in the foreseeable future. Central banks worldwide work on projects to issue central bank digital currency, CBDC.

Yet, most payments in our modern economies happen digitally via SWIFT. But in the SWIFT system, the personal data is in the hand of the commercial banks, not the central bank or the state. Interestingly, this is an argument of proposers of CBDCs for improved privacy.

Theoretically, commercial banks can monitor every financial transaction of their customers and create customer profiles. With CBDC, that would not be the case anymore, as the banks do not have access to the data of the payments, which would lie in the hand of the central bank.

Another advantage that proposers point out is that CBDC offers the possibility for fast, direct financial transfer payments for specific households in case of crisis. Further, they argue CBDC could be used to fight racial injustice.

Additionally, central bank digital currencies have another advantage (in the eyes of central bankers): a more active stance in shaping macroeconomic policy. That point was slightly forgotten, as interest rates are significantly higher than a year ago.

CBDC became more widely discussed during the artificially created boom in asset markets and cryptocurrencies during the pandemic. Many people argue that central banks have to offer an alternative to private, in their eyes insecure, cryptocurrencies like Bitcoin.

During that time, many central bankers said negative things about Bitcoin or cryptocurrencies in general and called for more regulation of the sector. For example, ECB’s Christine Lagarde said that Bitcoin has no value and is purely speculative, while a digital euro would be a safe store of value.

In the fall of last year, one of the most significant crypto exchanges worldwide collapsed due to the detection of fraud. FTX has used customer deposits for speculation and lost a bulge of it during the crypto winter last year. Sam Bankman-Fried, the company's founder, was publicly known as a huge supporter of more regulation because he wanted to eliminate competitors.

Back then, Fed chair Jerome Powell argued that it was time to regulate crypto because although the scandal did not spill over into the old financial markets, it could be different in the future.

It can be said that of all central banks, the Federal Reserve is arguably the most critical one when it comes to central bank digital currencies. In November, Minneapolis Fed chair Neil Kashkary said crypto is nonsense, a tool of speculation, and greater fools.

Yet, despite colossal skepticism, the Federal Reserve is also working on CBDC. Yet, it is more probable that the ECB and the Bank of England are closer to implementing one at some point in the future.

There is hardly a country where a CBDC has been tested. Some test runs happened in China, and some of the tests runs still go on. According to Bloomberg, more than 140 million people used the digital Yuan in April 2009.

Only Nigeria has fully rolled out a central bank digital currency. Still, the hope that a vast majority of the population will start to use it evaporated. That might be because citizens connect CBDC with other cryptocurrencies and do not understand why they should use the eNaira when cryptocurrencies are bad.

This week, the Bank of England announced its plans to introduce an ePound for the decade's second half. However, a ban on cash is not planned, said Jeremy Hunt, the UK’s Chancellor of the Exchequer. Worldwide, the use of cash diminished in the United Kingdom, and forecasters expect the trend to continue over the decade.

In Europe, the ECB has already picked five companies to develop a prototype of the digital euro, with US’s Amazon among them. Issuance of a digital euro is also planned in the second half of the decade, similar to what is planned in the UK. Meanwhile, a test run will start in Spain this year.

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Nevertheless, CBDCs are accompanied by a lot of danger, most obviously for the privacy of people who live in the area where they are implemented. However, no central bank has stated that it plans to forbid cash in the future.

Further, the roll-out of CBDC might threaten central bank independence. You may remember the freedom convoy in Canada from last year, where prime minister Justin Trudeau pushed through legislation where the banks were obliged to freeze the bank accounts of people directly or indirectly involved in the protests.

Without paper money, people would have CBDC as the only alternative to SWIFT. However, the last two years should have made it evident that governments do not hesitate to make things as hard as possible for critical voices in times of a potential crisis. In a scenario where cash is banned and CBDC is used instead, it is easy to end the financial existence of people with the click of a mouse. There is no doubt in my mind that governments would use their additional power in such a case again.

While a ban on cash does not seem plausible currently, it could very well be discussed again if we experience another significant financial crisis, where central banks are forced to slash interest rates deeply into negative territory. Although its use is still heavily regulated, a ban on cash would make such policies much more practicable.

If there were negative interest rates, one can assume that the use of cash would increase again to avoid them. Therefore, central bankers and politicians have a big incentive to regulate the use of cash more or even ban cash at all.

The use of central bank digital currency would be very different from cash from a privacy aspect. Jerome Powell said that CBDC would not be anonymous, and BIS’s Augustín Carstens even noted that it would give the central bank total control over payments running through the network. But the more centralized such systems are, the more misuse lies within their nature, and central bank digital currency systems are no exception.

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The aspects I mentioned are the ones that get the most recognition from critical voices on central bank digital currencies. Sadly, that is not the only problem of central bank digital currencies. Interestingly, commercial banks do not have to say anything negative about CBDC, although one may argue that had to be expected because they would not be affected directly. However, central bank digital currencies can lead to significant changes in our economic system as a whole, which also means commercial banks.

Banks play an essential role in our economic system. As intermediaries, they play a significant role in the decision-making process on what real economic projects will be realized because the banks hand out the loans needed to fund the project. The central bank controls the money supply by setting the prime interest rate, hence the number of loans the commercial banks can hand out, while government regulation also plays a role there. In classical banking, the banks borrow short-term and lend long-term, earning the interest rate spread.

During the last decades, the spread became smaller and smaller, while more government regulation led to increasing costs, and the profits of many commercial banks eroded over time. Some used to make up for it via more engagement within financial markets, while others were bought from more prominent competitors.

A brief look into the statistics shows that two-thirds of all banks in the United States disappeared, primarily small banks that either merged or got sold to competitors. In the EU, the banking sector shrank as well: while there were 8,933 credit institutions in 2002, there are now only 5,283. So, we can observe that the banking sector in Europe and the US gets increasingly concentrated.

Now, let us remember the argument that CBDC enables a more active role of central banks for macroeconomic policy, to support specific parts of the population, and to fight inequality.

To fight inequality, central banks could also offer those groups cheaper loans than commercial banks. The result is that central banks would become a competitor of the commercial banking systems while it is also regulating them. In such a scenario, we can assume that the banking sector’s concentration will continue.

Additionally, we can expect that the US and the EU will intensify their aim to pass more regulation legislation, this time regarding ESG. While the Federal Reserve is still unwilling to tie reinvestments to ESG criteria, the EZB announced this month that they would link their potential reinvestments to companies with a good climate performance.

Moreover, there is a discussion in Europe about whether banks should also use ESG scores and tie them to their lending, resulting in more loans for companies and customers with better ESG scores. Such an intention sounds remarkably similar to what happened in the United States in the early 2000s when banks were obliged to hand out credit to people with a bad credit rating to make housing more affordable. That policy set the primary foundation for the 2008 financial crisis.

One can expect that those regulations will favor misallocations of investments and hence slow economic growth, while administrative costs for banks will increase and more credit institutions will disappear from the market.

The ongoing sector concentration with a few big institutions will also drag on future economic growth. Why? Because small banks are more engaged within their geographical environment to lend to companies within the area. A banking sector structure with many small banks, as has been the case in the United States, Germany, Austria, and Switzerland, created a perfect environment for SMEs to become market leaders in niche sectors of the economy, so-called hidden champions.

While such firms do not play a significant role for the big banks, they are essential customers for small community banks. Small banks have a competitive advantage against bigger banks because they concentrate their lending on such SMEs.

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Therefore, we can expect that implementing central bank digital currencies from central banks not only threatens people's privacy but also may be a massive drag for economic growth, not only for the banking sector but in all parts of the economy.

One should shape that small banks understand the potential dangers and will speak out in public because, as we know from Facebook or other historical examples, like the centrally planned communist economies, centralization and concentration of data and power increases the danger of misuse of power and mismanagement.

And I hear this calling, still you don’t seem so far at all,
And I hear this calling, still you don’t seem so far at all

All That Remains - This Calling

I wish you a splendid weekend!

Fabian Wintersberger

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(All posts are my personal opinion only and do not represent those of people, institutions, or organizations that the owner may or may not be associated with in a professional or personal capacity and are no investment advice)