Digital Euro: We Need Facts, Not Propaganda (Part 1)
Let's start with an argument we hear very often: The digital euro will not replace cash! Beau said in Montpellier: "We will continue to ensure that freedom of choice is preserved by ensuring that cash remains widely available and accepted".[1]
According to Beau, the Banque de France has announced plans to build a new banknote printing works in the Puy-de-Dôme region of France. At a cost of €250 million, this plant would be the most modern, efficient and environmentally-friendly banknote production centre in Europe, and is due to be phased in by 2026.
Cash: a threat to banks?
Let's add a few facts and aspects here. Let's remember that in most countries - and therefore also in the eurozone - the monetary system is two-tiered: central banks create "central bank money", while commercial banks supplement it with so-called "credit money". This credit money (also known as public deposits) is generally not fully covered by liquidity reserves. Banks can never disburse all public deposits at once. They live with the constant risk of a bank run. This is part of the commercial calculation and is covered by the central bank's "last resort", often in the form of partial deposit guarantees.
Another thing to bear in mind: As we have already mentioned[2] , until the financial crisis of 2007/2008, the monetary base consisted mainly of banknotes and only a small proportion of sight deposits. Thanks to the ECB's monetary and interest rate policy, central banks have greatly expanded their holdings of giro accounts in order to maintain liquidity in the financial system. However, this means that the fewer liquidity reserves banks hold in credit money, the greater the risk of slipping into illiquidity if the number of deposits withdrawn exceeds the number of liquidity reserves available.
Conversely, this means that if the public holds less liquidity, there is more monetary base left for the banks. This gives them room to manoeuvre for new business. If the public hoards cash, it reduces the money creation multiplier - which is bad for banking.
The digital euro as a safe-haven currency?
So the issue of cash is not whether we set up printing works somewhere to print coloured paper. Mr Beau's argument cannot and should not reassure us.
The value of cash depends on confidence in this means of payment. If the public have doubts about the solvency of banks, they will try to get their deposits back as quickly as possible. If too many people do so at the same time, the amount of monetary base needs to be increased to prevent the economy from contracting.
But we know from the banking crises of recent years that even generous state liquidity support and deposit guarantees from central banks cannot prevent people from losing confidence in cash and trying to save what can still be saved.
This scenario was also highlighted in a recent study by the Deutsche Bundesbank (German National Bank).[3] It concludes that many banks could switch to digital euros in times of crisis.
Should we therefore expect the digital euro to make a bank run in a crisis even more likely? Can we be sure that the central bank's digital currency, unlike cash, offers greater guarantees? That the digital euro is therefore particularly suitable as a safe-haven investment?
On the subject of safe-haven investments: we know, however, that the digital euro must be a simple means of payment and not an investment asset. Nor should it earn interest, whether positive or negative. This argument was also raised by Denis Beau in Montpellier. It will be addressed in the second part of the mini-series.
This article was fist published in Courrier des Stratèges on May 10th, 2024
[1] https://www.bis.org/review/r240430a.htm
[2] http://2f9bb33b.easyname.website/blog/digital-euro-why-our-cash-is-coming-under-pressure
[3] https://www.bundesbank.de/resource/blob/931090/be2be8b2c5324245e4147d6306689312/mL/2024-04-29-dkp-15...