Digital Euro: We Need Facts, Not Propaganda (Part 2)

The closer we get to the introduction of digital currency, the more politicians and bankers want to allay our concerns with simple arguments. We take four of these arguments and supplement them with additional facts and aspects. In Part 1, we took a closer look at the subject of cash. Today, we're going to ask whether the digital euro is really suitable as a safe-haven investment - after all, it shouldn't be an investment asset, and it shouldn't earn interest. 

In the first part of our mini-series[1] , we talked about the fact that the value of cash is linked to confidence in this means of payment. If the public has doubts about the solvency of banks, it will seek to recover its deposits as quickly as possible. In extreme cases, there will be a run on the banks.

Lobbyists like to point out that the digital euro - unlike cash - offers greater guarantees and could therefore be particularly suitable as a safe-haven investment.[2] At this point, we pick up the thread and turn to another argument from the digital euro lobby: the digital euro will not generate any interest, either positive or negative. It will be a means of payment, not a fixed asset!

Who wins, who loses?

Denis Beau, Senior Deputy Governor of the Banque de France, recently said: "As economies go digital, cash is used less and less for payment purposes. However, cash has unique characteristics that are not present in the digital space. That's why we see the digital euro first and foremost as a 'digital banknote', which preserves the characteristics of cash in the digital space". [3]

From a purely economic point of view, one advantage of cash is that it protects us from state control, for example through excessive taxation or negative interest rates.

This advantage is also a disadvantage: the central bank cannot pay interest on cash in the form of banknotes. Those who store cash under their mattress (or elsewhere) do not receive any interest. However, they are not protected against inflation.

So if the digital euro is to be a "banknote with the characteristics of fiat money", we don't get any interest on our stocks, but we can't expand them at will either. This is also complemented by an ECB argument that we should always bear in mind: "The ECB will minimise any potential threat that a digital euro could pose to the financial system. For example, the amount of digital euros that users could hold in their accounts would be limited to prevent outflows of bank deposits, even in times of crisis."[4]

We are getting a little closer to the heart of the problem: we know that the quantity of central bank money has to be increased in the event of a bank run. We know that central banks - and the ECB is a central bank - cannot become illiquid or go bankrupt (because they have a monopoly on money creation and can print money).

But if central banks are over-leveraged (and the banknotes issued are recorded as debt), they lose their ability to act in terms of monetary policy and confidence in money disappears. This is because the purchase of "debts" in the form of "money" must be covered by central bank assets. But these assets are often insufficient.

If the digital euro is held by the central bank, it is no longer necessary to buy back debt in the form of money, which means that it is no longer necessary to cover it with central bank assets.

This is the context in which the current statement by the President of the German National Bank should be understood: "If someone had asked me 20 years ago whether the central bank's business model was destructible or not, I would have said no. Today, I'm not so sure - we need to work on our business model". Today, I'm not so sure - we need to work on our business model".[5]

To sum up:

- The digital euro as a form of central bank money similar to cash must first and foremost serve to stabilise political financial systems.

- It should prevent large outflows of bank deposits in times of crisis, which is useful for the State and the banking system.

- It must guarantee the central role of central banks, which are seeing their monopoly threatened, particularly by the considerable growth of crypto-currencies.

The ECB argues that the digital euro makes life easier, that it is risk-free, widely available and user-friendly. Let us not be blinded by such arguments. In fact, the technological component of a central bank's digital currency involves risks that we definitely don't have with physical cash. This point will be addressed in the third part of our mini-series.

This article was forst published in Courrier des Stratèges on May 15th, 2024.

[1] http://2f9bb33b.easyname.website/blog/the-digital-euro-we-need-facts-not-propaganda-part-1

[2] https://www.bundesbank.de/resource/blob/931090/be2be8b2c5324245e4147d6306689312/mL/2024-04-29-dkp-15...

[3] https://www.bis.org/review/r240430a.htm

[4] https://www.ecb.europa.eu/euro/digital_euro/faqs/html/ecb.faq_digital_euro.fr.html

[5] https://www.handelszeitung.ch/banking/nagel-zentralbank-relevanz-hangt-an-digitalen-wahrungen-709682