SIMON POTTER: Bitcoin is, as we said at the start, it's a slightly different class to the Facebook Libra. Remember as I said, it's a decentralized system. It doesn't have any central authority. It's growing in a way not related to any government. There are a number of people who are attracted to an asset class like that, because there's no government involved. That means particularly because the supply of Bitcoin is limited, it is likely to have some value as an alternative asset class.
ROBERTO PERLI: Hi, I'm Roberto Perli, and I'm one of the founding partners of Cornerstone Macro, together with Nancy Lazar and Andrew Laperriere. I'm also the head of global policy for the firm.
Today, I'm here with Simon Potter to talk about cryptocurrencies and the attitude of central banks or governments in general towards this new asset class. Simon is currently a senior fellow at the Peterson Institute for International Economics and formerly until last spring, Simon was the head of the markets group for the Federal Reserve Bank of New York and the manager of the system, open market portfolio of the Federal Reserve, which is the portfolio of the Federal Reserve, which at its peak was about 4.5 trillion, not billion, trillion with a T, so pretty large, pretty respectable size.
Simon, thank you very much for joining us, much appreciated. We're going to talk about digital currency, cryptocurrencies. Let's start with the very basics, so for the people that are not very well versed with this, what is a cryptocurrency?
SIMON POTTER: Let's think about the US dollar that all of us have. That's a piece of paper we can exchange between each other and no one has to be involved in that. We could have a bank account and that bank account, someone has to check the we're the rightful owner of that. A cryptocurrency is somewhere in between that bank account and that piece of paper. The most common cryptocurrency people know about is Bitcoin.
Bitcoin solved for a difficult problem. If I have a bank account and someone's checking whether I spent the money, there's one record of that, and so you can see. If I want to pay for a burger, and I use my bank account, they deduct it from that. How could you decentralize that process so it looks a little bit like cash but there is a record that's available not just between the two of us, but for everyone to see? Bitcoin solved that problem to prevent double spending and produce this quite elegant way of maintaining trust in a monetary system without a central authority having a rule.
ROBERTO PERLI: Sounds like a very good thing. It sounds like it's serving a good purpose. Yet, regulators seem to be a little bit weary of this of this new idea. Can you give us an idea what [indiscernible]?
SIMON POTTER: I think part of it was that one of the reasons that we want a national currency and we want the government to have control and regulators is to monitor and prevent certain types of behavior. When Bitcoin started out, it was very much associated with behavior that was on the fringes and not legal. There was a concern that the main use of Bitcoin would be to facilitate that behavior.
There are people who say that cash does that as well, so cash has some big pluses. There's some minuses because it allows certain types of behavior like that. Bitcoin had that feature and people were worried because it had this advantage over cash. I have to be next to you to send you cash. For Bitcoin, I just have to be able to connect to the internet to do a transaction. That could happen anywhere in the world and regulators were concerned it would facilitate this bad behavior across borders.
ROBERTO PERLI: Yeah. That's one of the concerns. We talked, you talked about Bitcoin, which is, I think just one of the several thousands, I think of various different currencies that are out there. Now, one currency in particular that got a lot of attention recently, just this past summer, was Libra. Facebook came up, make a very high profile announcement that they're planning an international, this new digital currency. Yet, I would say the reaction on the part of Federal Reserve, Congress, other central banks, other governmental authorities around the world was probably not what Facebook was hoping for, was very, I would say hostile. Why is that? Why are regulators so concerned?
SIMON POTTER: I think there's the crypto aspect and the Facebook aspect. Let's just focus on the crypto aspect, but there's clearly issues with Facebook and the large tech firms and there was some reaction to the fact it's a large tech firm pushing that. Facebook has, say 2.4 billion users, and they have already a network in place that would facilitate a medium of transaction like Libra. That medium of transaction is not a national currency. It's a Facebook currency.
If you believe that there are important advantages to governments and to the government's control a national currency for people who live in those countries, there was this concern that the goals that Facebook would have for their international currency wouldn't necessarily match the goals that you would have for societies as a whole, because Facebook is a private sector and they will be interested in making money. Facebook did point out that the inclusion will be greater because of all the people who didn't receive good financial services who are on their network, and they could do peer to peer transactions. I do think there is a role for something like Facebook's Libra currency in terms of the social value that it might add, but some aspects of the design suggested it wasn't going to be as efficient as that.
ROBERTO PERLI: It seems to be that perhaps precisely because of the association with Facebook, Libra faces fairly uphill battle. Do you think it will come to fruition in the near term?
SIMON POTTER: I think it's unlikely the version was promoted in the summer, that we'll see that version of Libra. That was what's called a stable coin. That's different to Bitcoin. A stable coin take some other asset to back the currency. The assets that they were going to take for Facebook were a basket of currencies. That was a feature that I think diluted a little bit the goal there, which was to use this large network effect on the Facebook platform, and as we were discussing earlier, would have been easier to back that just with the US dollar.
ROBERTO PERLI: Now, there are crypto currencies and then central banks or governments have come up with their own versions, if you want to call it that way. It's called central bank digital currencies or national currencies. Can you tell us a little bit the difference between the two? How do public authorities think about this digital culture? What would they like to introduce rather than Libra or Bitcoin?
SIMON POTTER: We're all used to digital currency. We have credit cards, we have bank accounts. There is a digital record. One thing we don't have as citizens is a direct account, say with the Federal Reserve. There's a lot of belief from the Federal Reserve that that is not the most efficient way of organizing the financial system. What they want to keep in place is this two-tier system, where we bank with a private bank, who then has a digital account with the Fed.
What we've seen over the last few years is growing acceptance of different types of institutions having accounts with the Fed or with say, a central bank in another country. It could be a FinTech company. It could be something called a narrow bank that we saw an application for in in the US, where the bank keeps an account at the Fed, but all it does is hold Federal Reserve assets, reserves. That would be one way to have a national digital currency.
Another way, and this is something which I do think we'll see is for central banks like the Fed to issue a token. A token is like paper currency, but instead of existing in a physical form, it's going to exist in a digital form and use some of the proof of who owns it and prevent double spending that is behind Bitcoin and the other private cryptocurrencies.
ROBERTO PERLI: You talked about a regulator's desire to keep this so-called two-tiered banking system. Basically, it sounds like regulators have that set on keeping this intermediated financial system. They don't want a direct consumer, or a business having direct access to Central Bank cash. It is an important point that and probably is not something that people generally understand very well. Can you explain why? Why is that?
SIMON POTTER: The banks in the US provide a lot of services. People might not realize it, but they provide a lot of services. They provide loans, they provide risk transfer, for insurance companies provide other products, they help with mergers. They give advice over a whole range of things. They do that off a base of deposits from households and firms.
That's a set of skills that central banks don't have. If central banks were the only bank around, they'd have to learn that set of skills, there's no reason to think that the public sector will be as efficient as the private sector in producing that range of financial services. Clearly, there's some issue with how efficiently financial services have been produced in the US over the last few years, but that's the role of regulation the private sector.
I don't think many of us we want to be in the situation that the Chinese people fell wherein for many years, there was one bank which was the central bank, the People's Bank and you've had no other choice. It was the People's Bank job to allocate capital, do the risk transfer, advise on mergers, things like that. I don't think we would want that in the United States or in those countries.
ROBERTO PERLI: Yeah, I agree, actually. It's a situation where the central bank says, look, I'm good at doing certain things, but I don't have the skills to do everything that private banks do. There is a comparative advantage for private banks to continue to do what they're doing, so we should preserve--
SIMON POTTER: I don't give it as an absolute as well, comparative, yes.
ROBERTO PERLI: Yeah. Okay, so talking about central banks again, one argument that you hear frequently as to why central banks would want their own version of a digital currency is, well, we live in a world where interest rates have lowed and unfortunately, we cannot cut rates all that much. If only we could cut rate very deep into negative territory, that would solve all the world's problems. Unfortunately, we cannot cap rates too deep into negative territory because there is cash out, there's dollar bills and people who don't want to pay negative interest, all they have to do just hold cash and they pay zero.
Too deep negative rates don't work and so the idea would be well, what if we eliminate cash as we know it, and instead we substitute it with the digital currencies, then we can force everybody to pay as negative interest rates as we want and the world would be a much better place? I say this tongue in cheek but has this attitude changed recently or what do you think.
SIMON POTTER: Clearly, one of the attractions behind a digital currency for people who studied the theory of monetary policy was if you had a digital currency and you remove physical cash, then you could, and this is just a theory now, you could set very negative nominal rates. As you pointed out, if you have physical cash, people will stop using digital accounts and just use cash to transact. That would not be an efficient place to be, they would store value in cash.
But if you didn't have cash, they will be forced-- and I'm using forced here, to hold this currency, which was losing value each day on purpose. In the models, people don't get upset with that. In fact, what they do is they spend a lot of money today, which gets you out of the slump that you've been in. We haven't tested this yet, because you would have to rewrite the whole financial system.
Think of a world where we had minus 5% rates and you want to issue some debt with a coupon. Then that coupon, as the person who borrowed the money going to the lender to collect the coupon, that's an upside down world. Another version of it. We all like to pay our taxes as late as possible. In this world, you'll be paid.
I'd like to pay taxes for the next five years idea. There's something wacky about that world, more importantly, I think taking away cash, which has a lot of virtues, and even in this digital world we're talking about will still need cash because of power outages or because of cyber-attacks, that would be a very costly thing to do for society.
ROBERTO PERLI: Yeah. It seems to me that this idea is basically, I would say, anti-democratic, a central bank, even a non-elected official pushing, forcing citizens to--
SIMON POTTER: I wouldn't like to be walking down the street at 2 p.m. on a FOMC day and I've got my digital wallet, and I'm walking. It has $100 and then at two or one, it has slightly less than that but under the theory, that would be a better, more efficient world to be in.
ROBERTO PERLI: Hopefully, central banks realize that the theory is one thing, probably an impractical solution and they're not pushing potion actively for that anymore, I would say.
SIMON POTTER: Unaware of anything people who are senior at Central Bank's pushing actively for that. There are many papers which are elegant, which shows some of the great benefits of this, those papers do not tend to have a financial system in them. We don't know how disruptive it would be. Mildly negative rates, which the euro area and Japan have used, they might have some benefits in that case. I don't believe mildly negative rates have that much benefit in the US.
ROBERTO PERLI: Right, we can all agree with that. Then also, I think the idea of negative rates came up originally say, hey you, we push rates negative for a short period of times, just a few months, maybe a year tops, and we solve the problems and we're back to normal but in Europe, it's been, what, five years? More than five years, and there is no end in sight. I think the problem has changed a little bit. I think the appetite for central bank for negative rates has diminished considerably.
SIMON POTTER: I believe that's correct. Yes.
ROBERTO PERLI: Back to our digital cryptocurrency, let's talk a little bit about the global view on geopolitical implications of this. Suppose there is a world-- there will be a world eventually where a lot of countries adopt their own digital dollar, digital Euro, digital everything out. What does this do to the global financial system? Does it make it easier for example, for the dollar to maintain its prominent role, or does it make it easier for other currencies to take over the current dollar role? Does it help dollarization of the world economy or not?
SIMON POTTER: As you pointed out, the global financial system basically transacts in US dollars. If you look at foreign exchange, there's 6 trillion transacted each day, about 90% of that is in US dollars. Most of the invoicing in international sense is done in US dollars. It's the biggest reserve asset. Performance is very important function for people all over the world as a reserve currency reserve asset.
There are some costs to that. Many countries would like to be more independent from the US dollar. One version of issuing a digital currency similar to the Facebook Libra idea that Governor Mark Carney from the Bank of England spoke about a Jackson Hole is an international asset that is basically linked to a basket of currencies. This is a very old idea going back to Keynes. You could argue that that would be a more efficient system.
The problem is how do you get to that new system? How do you maintain all the benefits of the US dollar, of it being widely accepted, people understanding it, the deep capital markets we have in the US and also allow for this basket of currencies? That is something that's not been proven. We've never seen that worked to maintain the benefits of a reserve currency amongst a basket. I'd argue that that was unproven, and it seems more sensible to think about ways of improving the role of the dollar, you would have to be careful.
In many countries, citizens use the dollar as a store of value. They'll use it in the paper form that we've been talking about. If there was a digital version of the dollar, which you didn't put limits on, they would want to use that as a store of value, which would lead to a big increase in dollars held overseas and will affect the monetary policy in those countries.
ROBERTO PERLI: It probably would affect, could affect the monetary policy in the US as well. In other words, the Federal Reserve would become even more than it is today, the strength "central bank of the world".
SIMON POTTER: The exchange value of the dollar would probably go up in that world a lot and the Fed would have to react to it. I think the first order effect again, for a small country, would be from the fact that citizens could access this digital dollar. Remember, the US is very big. The GDP is big compared to some of the smaller countries. The larger countries, which might have this impact on the US, their currencies tend to be more stable, less of a demand for it. For example, the euro area, if you had a situation where it looked like the euro might break again, and there was a digital dollar, that could cause some disruption that would not be positive.
ROBERTO PERLI: Yeah. Talking about global here, I don't think any discussion of global issues would be complete without talking about China these days. China with respect to digital currency seems to have taken a little bit more, I would say, what, proactive stance as opposed to other countries. You want to tell us a little bit what's happening there?
SIMON POTTER: China's a great example. As you know, they've grown a lot in the last few years. What they've done is they've looked at all the latest versions of how to make payments, how the financial system should work. They don't have checks in China. They don't use cash that much anymore. They use their mobile phones through Alipay and WeChat Pay to do a lot of the transactions there.
The People's Bank has been monitoring that quite carefully. It's also interested in issuing its own central bank digital currency. I'd expect them to be the first major central bank to do something like that. Some of the details of the design aren't out yet, but