There’s No Such Thing As An ‘American-Style’ Central Bank Digital Currency

Central bank digital currencies, or CBDCs, have come under withering criticism for the way they enable authoritarian governments to control their citizens. And yet, a number of leading figures in American financial regulation continue to advocate for what they call an “American-style” CBDC. But it is hard to reconcile the surveillance and censorship capabilities of a CBDC with classic American notions of civil liberties.

By way of background, CBDCs are the new hotness among central bankers around the world. Japan, which currently chairs the Group of Seven, has announced that that the coalition of advanced economies is moving forward with plans to introduce CBDCs around the world.

CBDCs represent governments’ answer to crypto: they graft the technology undergirding bitcoin with the monetary policies of traditional fiat currencies like the dollar, the euro, and the renminbi. But unlike traditional digital currencies like bitcoin or even dollar-pegged stablecoins like Tether
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or USDC
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, CBDCs give governments visibility into, and control over, every single economic transaction.

If you hand a $5 bill to a street vendor selling a taco in New York City, there is no government record anywhere that records your identity nor what you bought. CBDCs are the polar opposite of traditional paper cash. The Chinese CBDC, called the e-CNY, enables the government to not only instantly know who bought what, where, and when, but also to censor any transaction that the government deems undesirable.

As Saule Omarova—President Biden’s ill-fated nominee for the Office of the Comptroller of the Currency—has written, CBDCs also enable governments to do many other things: replace private-sector checking and savings accounts with government accounts; replace Congress’ power of the purse with the Federal Reserve’s unlimited ability to print and allocate money; and not only add, but subtract money from individuals’ bank accounts. To Omarova, these features are the attraction of a CBDC.

Republican support for CBDCs

But it isn’t only figures on the left who support a CBDC. Last November, Kevin Warsh, the former Republican appointee to the Federal Reserve Board of Governors now at Stanford’s Hoover Institution, wrote an essay for the American Enterprise Institute in which he argued that China’s CBDC leadership “represents a consequential threat to the extant American-led financial architecture,” one which requires the U.S. to develop its own, “American-style, narrow CBDC.”

Warsh believes that an “American-style” CBDC could avoid Chinese characteristics by limiting itself to “wholesale” transactions between the Fed and private-sector depository institutions. Warsh argues that consumer privacy would “not just be maintained, but strengthened, under the new regime,” because the use of the CBDC would be limited to banks and the Fed.

But this makes no sense. Warsh’s “guardrail” protecting consumers from CBDC surveillance and censorship is about as strong as a sheet of Kleenex. Once an American CBDC is live, all it would take is a flick of a legal switch to bring it to every user of the U.S. dollar.

Warsh isn’t the only prominent Republican advocate of a CBDC. Christopher Giancarlo, who ran the Commodity Futures Trading Commission under President Trump, has gone even further. In 2020, at the World Economic Forum in Davos, Switzerland, Giancarlo and David Treat of Accenture
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announced the formation of the Digital Dollar Project, an initiative seeking to “catalyze a digital, tokenized U.S. currency that would coexist with other Federal Reserve liabilities.”

Like Warsh, Giancarlo says that he opposes Chinese-style CBDCs, while believing that it is urgent for the U.S. to build one lest America fall behind China. But unlike Warsh, Giancarlo seeks to craft “a well-designed, durable, and universal US CBDC” that would also be used by consumers. Giancarlo, in a 2019 op-ed for the Wall Street Journal, argued that a retail CBDC can incorporate privacy protections because consumers could use “trusted, regulated intermediaries to maintain digital wallets” that the government wouldn’t directly control.

In 2022, Giancarlo published a book entitled Crypto Dad: The Fight for the Future of Money. He is very familiar with how blockchain-based currencies work. So it is puzzling that he could believe that digital wallets maintained by intermediaries will protect consumers’ privacy. Ultimately, if a consumer engages in a transaction using a CBDC, that transaction will be recorded on the government’s ledger, whether or not the consumer uses third-party wallet. Indeed, in Crypto Dad, Giancarlo praises the fact that the U.S. today balances consumer privacy with the government’s ability to “abridge that privacy in pursuit of legitimate law enforcement, national defense, or other overriding objectives.”

Stablecoins are superior to CBDCs

What’s particularly strange about the Warsh-Giancarlo position on CBDCs is that we already have blockchain-based versions of the U.S. dollar that do all the things Warsh and Giancarlo want a CBDC to do, but with far more robust privacy protections. These “stablecoins” vary widely in their structure, but the best of them, like Circle and Coinbase’s USDC, work in almost exactly the same way as money-market mutual funds. Just as one dollar in a money-market mutual fund is backed by near-cash instruments like Treasury bonds and commercial paper, so too is $1 of USDC.

Warsh and Giancarlo argue that a CBDC is necessary because “many stablecoins are backstopped by ambiguous or insufficient collateral,” in the words of Warsh, and because there are “no requirements for audits or reporting” in the words of Giancarlo. But these are easy problems to fix. All that the feds need to do is bring stablecoins into the well-established regulatory framework that already exists for the $4.8 trillion money-market mutual fund system. These mutual funds, provided by brand names like Fidelity, Vanguard, and TD Ameritrade, have been regulated by the Securities and Exchange Commission for decades. MMMFs have rarely faced solvency problems, and regulators are constantly refining their experienced oversight over these products.

Some stablecoin providers, like Tether, may seek to remain offshore, and outside the U.S. regulatory system. But regulated stablecoins can provide American consumers and financial institutions with the speed and reliability of 21st-century technology, with all the safeguards against authoritarianism that Americans require.

Legislative efforts to ban U.S. CBDCs

Congress has begun to take notice of increased government interest in CBDCs. In March of 2022, Republican senators Ted Cruz (Tex.), Mike Braun (Ind.), and Chuck Grassley (Iowa) introduced legislation to amend the Federal Reserve Act to ensure that “no Federal reserve bank may offer products or services directly to an individual, maintain an account on behalf of an individual, or issue a central bank digital currency directly to an individual.”

The Cruz bill, however, has a bunch of loopholes. It would not preclude a Warsh-style “wholesale” CBDC, because depository banks are not individuals. Nor would it prevent non-Federal Reserve agencies, such as the Treasury Department, from introducing a CBDC.

Hence, in September of 2022, Sen. Mike Lee (R., Utah) introduced far more robust legislation that bars all federal agencies, including any “Federal reserve bank, the Board, the Secretary of the Treasury, any other agency, or any entity directed to act on behalf of the Federal reserve bank, the Board, the Secretary, or other agency” from issuing a CBDC individuals or institutions, from providing CBDC-related banking services, and from holding CBDCs on their balance sheets.

Lee’s bill could be paired with the Responsible Financial Innovation Act from Sen. Cynthia Lummis (R., Wyo.) and Kirsten Gillibrand (D., N.Y.) to align stablecoin regulation with that of money-market mutual funds.

The U.S. can leapfrog China on digital assets

There are plenty of ways in which China is effectively competing with the United States. But digital assets isn’t one of them. The People’s Republic has little regard for American-style civil liberties. And that is to China’s detriment. Innovation and entrepreneurship flourish most in areas of the economy where people are free to do things without first asking permission from authorities.

Warsh and Giancarlo fear that China’s CBDC will eventually replace the U.S. dollar as the world’s premier currency. But while the dollar has many problems—particularly because of America’s skyrocketing federal debt—it is inconceivable that, all else being equal, global markets will prefer e-CNY based on surveillance and censorship to a universe of dollar-backed stablecoins with built-in privacy protections.

Indeed, the opposite is more likely true. U.S. dollar-denominated stablecoins represent the vast majority of the global market. The largest non-dollar-based stablecoin is the Stasis Euro, with $134 million in circulation at time of publication. That represents one one-thousandth of the $132 billion stablecoin market. Dollar-denominated stablecoins like Tether ($81 billion) and USD Coin ($32 billion) represent nearly all of the rest.

The stablecoin market, in turn, represents less than 3 percent of the $4.8 trillion market for money-market mutual funds. In the coming multi-trillion-dollar market for digital assets, stablecoin-based dollars will handily defeat surveillance-based yuan. All the U.S. has to do is get out of the way.