S9 Ep32: The digital money supply

Episode Summary

Executive Summary: The episode argues that modern money is mostly private bank money, but its reliability depends on central bank backing and institutions that ensure uniformity, transferability, and final settlement. It compares CBDCs, tokenized deposits, and stablecoins, concluding that stablecoins likely cannot function at scale without some form of public support and that international coordination is needed to regulate global digital money.

Main Topics: Where money comes from (Priority: 5/5): Explains the split between public money (central bank currency and reserves) and private money (bank deposits), emphasizing that most spending today uses privately created bank money. Why private money works (Priority: 5/5): Details the institutional conditions that make bank deposits accepted at par: uniformity, low-cost transfer, final settlement, and elastic supply under stress. Historical evolution of banking money (Priority: 3/5): Traces modern bank-money creation back to 17th-century goldsmith banking and fractional reserve practices, showing that the basic logic is old even if the technology is digital. Three forms of digital money (Priority: 5/5): Compares retail CBDCs, tokenized deposits, and stablecoins, distinguishing their legal status, design, and how they interact with the banking system. CBDC effects and crowding out (Priority: 4/5): Assesses whether retail CBDCs displace bank deposits and argues the effect depends on what the central bank does with the funds and collateral requirements. Stablecoin regulation and systemic risk (Priority: 5/5): Argues that stablecoins are not money creation in the banking sense and need central bank backing to function at scale, with regulatory approaches differing across the US, EU, and UK. Crisis management and lender of last resort (Priority: 4/5): Shows that when confidence falters, central banks prevent money supply collapse through lender-of-last-resort actions, as seen in the SVB episode and money-market-fund support.

Key Arguments: Most money used in daily transactions is created by commercial banks, not central banks, even though public institutions underpin trust in it. Banks do not create unlimited money because lending is constrained by prudence, liquidity needs, capital rules, and the risk that deposits will leave the bank. The acceptability of private bank money depends on monetary uniformity, easy transfer across institutions, and final settlement without residual risk. The money system must be able to expand in crises; without central bank support, demand shocks can trigger deflation, recession, and destabilizing runs. Retail CBDCs are public money, but whether they crowd out bank deposits depends on how central bank liabilities are offset on the asset side. Tokenized deposits are mainly a technical upgrade to existing bank deposits, adding programmability and potentially easier cross-border or time-based payments. Stablecoins are not equivalent to bank money creation because issuers do not make loans; they mainly recycle funds into securities or bank deposits. Stablecoins can only function as money at scale if users believe they will be supported in stress; the promise of no backing may not be credible. Regulation differs by jurisdiction, but no local regime alone can supervise globally issued, held, and traded stablecoins effectively. International standards and coordination are necessary because digital money creates cross-border externalities and systemic spillovers.

Data Points: Share of everyday money that is banknotes: about 10% at most - Estimate given for money used to purchase goods like a car or refrigerator; most is private bank money. Timeline for banking-like money creation: mid-17th century - Origin story of goldsmiths issuing claims against stored gold and evolving into fractional reserve banking. Digital finance prevalence: 50-60 years - Speaker says finance has been database/code-based for at least half a century. Share of money that is digital: 90% - Claim that roughly 90% of what we think of as money is already electronic ledger money. EU stablecoin reserve requirement: 30% to 60% - MiCA approach requiring stablecoin issuers to hold part of reserves in bank deposits. Circle reserves at SVB: $3.3 billion - Example cited to argue stablecoin issuers were effectively supported during bank stress. SVB failure date: March 10, 2023 - Referenced as the Friday when Silicon Valley Bank failed during a run. CBDC holding limit example: 3,000 euros - Illustrative proposed limit for digital euro holdings for individuals.

Pivotal Quotes: "the private liability of the stable coin is not going to operate or function as money at scale without central bank backing" — Steve Cikchetti: Core thesis of the episode on stablecoins and public backing. "all of finance is a database code and a set of agreed-upon protocols for who can make changes to what" — Steve Cikchetti: Explains that modern finance is already digital in structure, with innovation mainly changing protocols and architecture. "lend freely against good collateral at a penalty rate" — Steve Cikchetti: Cites Walter Bagehot’s classic lender-of-last-resort principle for crisis lending.

Implications: Digital money innovation will not replace central bank support; it will likely reshape how backing is delivered. Regulators need cross-border coordination, or stablecoin and CBDC risks could amplify runs, contagion, and policy conflicts.