Actively Speaking Podcast
Steve Bleiberg, portfolio manager and thought leader at Epoch Investment Partners, Inc. (TD Epoch) takes on current topics and issues facing today's investor.
Actively Speaking Podcast
Money 3.0: Central Bank Digital Currencies
Central Bank Digital Currencies have progressed from a bold speculative concept to a seeming inevitability and will soon be a core feature of our financial ecosystem. The rollout of CBDCs will further accelerate the digitization of the economy, which is the key defining feature of markets over the past decade. Epoch's Kevin Hebner joins the show to discuss the history of money, the ways digital currencies can work, and the various implications of central bank digital currencies could have on wholesale banking and individual consumers as well as monetary and fiscal policy. (May 27, 2021)
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For institutional investors only. TD Global Investment Solutions represents TD Asset Management Inc. ("TDAM") and Epoch Investment Partners, Inc. ("TD Epoch"). TDAM and TD Epoch are affiliates and wholly owned subsidiaries of The Toronto-Dominion Bank. ®The TD logo and other TD trademarks are the property of The Toronto-Dominion Bank or its subsidiaries. The information contained herein is distributed for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. The information is distributed with the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the proposals and services described herein as well as any risks associated with such proposal or services. Nothing in this presentation constitutes legal, tax, or accounting advice. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Certain information provided herein is based on third-party sources, and although believed to be accurate, has not been independently verified. Except as otherwise specified herein, TD Epoch is the source of all information contained in this document. TD Epoch assumes no liability for errors and omissions in the information contained herein. TD Epoch believes the information contained herein is accurate as of the date produce...
Hello,
Speaker 2:And welcome to Actively Speaking. I'm your host, Steve Bleiberg . Join us each episode as we discuss current issues concerning capital markets and portfolio management from the perspective of an active manager.
Speaker 1:Welcome back, everybody, to another episode of Actively Speaking. We've got a good show today . We're gonna be talking about money, and my guest is Kevin Hebner, Epic's global investment strategist, and I think at this point our uncontested most frequent guest on actively speaking. Welcome, Kevin.
Speaker 3:Oh , thank you Steve.
Speaker 1:So , uh, you and Bill Priest wrote a , a paper a couple months ago that's available on Epic's website. It's called Money 3.0. It's about Central Bank digital currency. So we thought we would talk about that today. Let's start with the title and , and Money 3.0. So that implies that there was a money 1.0 and a Money 2.0. So tell us a little bit about what you, in your mind , uh, what this latest generation of money means and how it compares to previous generations of money .
Speaker 3:Yeah, starting from a historical perspective, the earliest currencies included things like Wales Teeth and Fiji and , and rice in Japan, you know , on the East Coast , uh, in North America, the native tribes used wampum beads, which are made from the shells of clams and seas , nails and things like that. And they're quite skillful to put these things together, but they were used for hundreds and hundreds of years. In fact, they continue to be used for quite a while, even after the first Europeans arrived well into the , the 17th century. So we've had these things, which people often call commodity currencies a bit in jest , but in terms of things that we would recognize as currencies during the Bronze Age, which is the period before 800 bc , people did have pieces of metal, pieces of bronze, which really they weighed, there wasn't much uniformity and shape or purity, but they , they had scales to weigh them and they'd use that to have money. But it wasn't until the seventh century, BCE when we came to something which we'd recognized as money, as standardized coins. And this , this happened in Lydia, which is in , um, modern day sort of Western Turkey and that point, the King crisis . They had made some major innovations and technologies related to metallurgical and , and minting processes, and they came up with standardized gold coins and , and really gold coins. Coins in general haven't changed a whole lot since then and have been used continuously since the seventh century , BCE .
Speaker 1:Okay. So that presumably was money 1.0 . What was Money 2.0 ?
Speaker 3:Well, I think the next big innovation occurred in China and to some extent what we're seeing with the digital world, that innovation also in China initially that happened around seventh Ad called it money because swept though it didn't really take off until the 13th century. And it , it was something that was well reported from by Marco Polo on his visits , you know, recording his visits to Asia. But paper money , which I think would be 2.0 took off initially in China and then spread to Europe. Europe was a couple centuries behind , and it wasn't really until the late 17th century that the Bank of England had paper money in Europe, and it , it's certainly been issuing paper money since then. Initially, the paper money was issued by commercial banks, supervised by the states , and then over time that process has been taken over by the state and , and more recently by central banks to supervise and manage that process.
Speaker 1:So yeah, it , it's an interesting progression. We, we were talking about beforehand that you started with basically physical things, you know, like rice or shells, whatever, and then metals, which seem to, for some reason, humans think they have this intrinsic value, like a lump of gold or a lump of copper or whatever that, that they think it's worth something or they're all willing to believe that it's worth something when they deal with each other. And then the next innovation was this idea that , well, you can just have this piece of paper that says, you know, here, this is worth, this is worth what X but at the beginning, and for a long time, it seems like people only were willing to accept that if they felt that they could convert it into the real stuff, you know, the gold, the copper , whatever. So now we're talking about what what's going on in the modern world is we've moved away from paper money that's backed by something to, you know, what has come to be known as fiat currency, which is just paper <laugh> . You can't really convert it to anything. You can't go to the , to a bank and say, you know, gimme $10 worth of gold for this $10 bill . You can only get, you know, two fives or five and five singles. That's all you can get more paper. You know, it's, it's a fascinating thing, this whole idea of what constitutes money , because it really is just something that we all agree, we will accept as money that we will, you know, if you wanna , if I've made something like a car and you wanna buy it from me , uh, we all have to live in a , a world where we all agree that yes, we will , we will accept these pieces of paper in exchange for real things like, you know, or , or services. So now we're , we seem to be on the verge of, you know, as you say, money 3.0 where we're , we're even doing away with the paper. So talk about, you know, money 3.0.
Speaker 3:Yeah, just , just on what you're saying. So money's definitely a social construct, and money's whatever we agree it to be, you know, the state is behind it, and it used to be , you know , the sword of the state was behind it. Now we have the, the legal system behind it. But to a large extent, I think this just echoes what's happening throughout the economy as the process becomes digitized, as the digital economy swallows up the world. I think say an analog in , in the musical world used to be if you want to listen to music, you know, 150 or 200 years ago, you'd go down the pub, you'd go to a concert hall to listen . Then 150 years ago, Thomas Edison invented the phonograph . Afterwards, Marconi invented the radio, then we had cassette CDs, and now we have streaming Music is digital, the OnRamp is physical because you're still in the recording studio and the off ramp is physical, goes in your ear . But the rest of the music process is digital and we seem to be fine with it. Books to some extent have gone through the same process. And we like our Kindles and our audio books , and that's digital with money is what's happening in so many parts of the economy. Often we have a on-ramp and off ramp that's in the physical world, but the rest of what's happening is in the digital world, the virtual world. And that's not necessarily that new to the, the money economy. Much of the money economy's been digital in some sense for about a hundred years now.
Speaker 1:Well, it's certainly true that, you know , uh, when I think about my day-to-Day life, I I almost never use coins or bills anymore and haven't for years. Uh , you know, when I get paid, it just shows up in my bank account. It's an electronic entry when I, I pay most of my bills, you know, I don't, I don't even write checks anymore, you know , which, which is just another piece of paper, but it's just all electronic transfers from one account to another, my account to somebody else's account. There's very little, you know, we haven't really been using physical cash for quite a while, but now we're talking about something that's , um, things like Bitcoin, you know, the Ethereum people are, are familiar with these digital currencies, but you know, they don't even have there , there is no physical equivalent for any of these things. It's purely digital. But tell us what is, so what is the difference? Like what is really the next, what does that mean the , the next step to go from just, well, you know, I'm transferring dollars from my account to your account to there being an actual quote digital currency, you know , what is the , what is the practical significance of that?
Speaker 3:Yeah, when we're conceptualizing this, I think it's helpful to think about two different economies. The wholesale economy and the, the retail economy, the economy that the consumers and businesses deal with, with the, the wholesale economy or the interbank market. A hundred years ago that was still settled with physical delivery of cash or gold, but actually starting in the 1920s, so a long time ago, the Fed actually set up a digital system. So this system has been digital a long time. Initially it was based on telegraph networks using Morse code over decades it became more modern, particularly from the seventies , um, the system's been upgraded. It now runs on the, the public fedwire system in conjunction with a system that's run by a large group of commercial banks . It's called the clearing house payment system. But now the , the wholesale market, the interbank market entirely digital and is run sort of as a type of public partnership in some sense . I think this is where we're going for the market , which , which is quite a different animal . Animal . And until recently still had quite a large physical component coins and notes we can think of being as central bank physical currency, as you think from Central Bank digital currency, which is what we're trying to talk about. But the , the public physical currency, it's being crowded out by private digital money . And you mentioned private digital currencies, but there's also private digital money. So for example, if you take out a bank loan to buy a house, you're doing that with private digital money through a bank, commercial bank. If you finance a car through Toyota, Toyota Lease , uh, that's private digital money. If you go up for dinner and you pay with Visa or MasterCard , um, you're paying with private digital money similar with PayPal, Venmo, apple Pay , uh, Alipay and so on. And so we're now to the point where private digital money represents 95% of consumer transactions in the us . We have a charge in the paper that shows that, and it's probably going to be quite close to a hundred percent by the end of this decade . If you think about the broad money supply that circulated , probably 98.5% of that is private digital money with only 1.5% actually being public physical currency. So notes and coins and things like that. So the wholesale digital market led this change to sort of a public private partnership with digital money. We're now seeing this happen in the retail market and it puts central banks in a very uncomfortable position because, you know , <laugh> , they could become irrelevant. It looks like that way, but they still have statutory responsibilities to ensure an efficient payment system to promote financial stability, price stability, full employment and all these things. But the position, the economy is certainly becoming marginalized and will continue to be marginalized if they stick with public physical money and don't go the digital route.
Speaker 1:Okay. So, so what are they doing? How are they reacting
Speaker 3:Central banks ? Well , they're reacting by doing a lot of work on this moved to digital currencies. So to some extent there will still be, I think at least for a few years, maybe , maybe longer, there will still be public physical currencies, but increasingly it will be a public digital currency . And , and that certainly is necessary for lots of reasons. I mentioned the disappearance of physical currency being replaced by private digital money. You mentioned mentioned the rise of private digital currencies, Bitcoin, but probably more important what really discouraged people is the Facebook sponsored Libra or DM project, which is focused on stable coins and can take advantage of enormous network effects given they have billions of active users. And that's something important. And the third thing scaring is China is very advanced with their digital currency, and that could be launched as early as next February during the Winter Olympics in Beijing in February. So this is all happening. Central banks know that they need to change, and so they are coming up with up their designs, but actually coming up with the design, it won't be one size fits all . And there's still a lot of issues about the advantages of them , the disadvantages, and what is the correct design, you know , and the correct design for the United States will be very different than that for Europe versus China and so on. We certainly won't have one size fits all and and really in , in most aspects of, of any part of the economy, there is a lot of variation from region to region.
Speaker 1:Yeah . Well, let's talk about some of those, those architecture issues, because I do think they're , they're interesting, like you mentioned in the paper, the difference between, you know, an account structure versus a token structure. Yeah, I'm , I'm presuming that, you know, like Bitcoin is a token, you know, kind of Yeah , currency. Yeah. And of course it's come under a lot of criticism because it is so energy intensive to run the computers, to do all the, solving, all the mathematical problems that are involved in verifying the ledger, the continuous , the distributed ledger of blockchain, blockchain ledger for , for Bitcoin. But digital currencies don't have to work that way. So tell us about the , the other possibilities.
Speaker 3:Yeah, so private digital money is account based . So for example, the the private money, digital money you have at your bank that's based on an account, which means it's tied to your identity. It can be in a digital wallet or an account, but that's account based . Bitcoin is token based , which means it's not tied to your identity. You just have to demonstrate ownership of the token through some type of here, something actually cash , physical notes, coins , they're also tokens. They're not a tied to identity. You just have to demonstrate you own it. And typically the way you demonstrate ownership is by taking it outta your wallet and putting in your hand. But they're , they're analogs to tokens as well. And so it's not clear which way people will be going. And , and I think central banks are watching very closely, some of the more advanced experiments, certainly in China and Sweden and some other places to see which route people are going. But sometimes we, we get this feeling, well, there's only one way to do this, but there's lots of ways to do this. And there's, you know, there's lots of ways to do physical money. You can have different colors, different material, you can have the polymers in Canada, you can have pictures of different people, different denomination. So we will get lots of different money and it will evolve over time as people experiment and as the technology evolves. So account based or token based , certainly going account based is easier at first because that's what we're used to. But there are some advantages of token based . One real disadvantage of token based , we mentioned the paper is it's estimated that about 20% of bitcoins that have been issued over the last 12 years have just been lost because people lost their keys and they can't find them . They can't demonstrate their identity anymore. So that's gonna be an issue, particularly if these become widespread use . There's an issue as to whether the currency would be run on a decentralized permissionless blockchain like Bitcoin is, or some type of more centralized ledger like China is using. The reality is central banks are gonna have to have some type of permission structure and some type of centralization. But exactly how that occurs isn't clear. And there's also a question whether the fed, for example, whether it's gonna be a banker's bank as it is now, such as issues reserves to commercial banks or whether it's gonna be a people's bank and that different households and businesses will all have accounts at the Fed and the Fed will put money directly into those accounts. So there's lots of design issues people are trying to, to reconcile, but my my guess is this will be a work in process, I would think for decades as our understanding how these things work evolved . And certainly as the technology progresses.
Speaker 1:Well, I mean, that brings up a big issue. Certainly one of the key effects or side effects. If you had a , a system where people had accounts directly with the Fed as , as opposed to having an account at a commercial bank, you know, it disintermediates the commercial banks to some extent. So deposits are traditionally been one of their big sources of , uh, funds for which they then land out, you know , they create credit and land out. And if you take them out of that process, it's gonna have an effect on the commercial banking industry, presumably.
Speaker 3:Yes . So you could have a situation in say that each household and business had an account at the Fed. So the money, money goes in that way in the same way that the fed current costs reserves into the banking system. But then people could take the money from their Fed account to their account at a commercial bank or a digital wallet they had with PayPal or some type of other FinTech type company. So they could do that. So there's, there's lots of ways to manage that. But regardless, it could be that commercial banks are no longer getting most of their funding through deposits, so they would have to getting at least more money through, you know, more funding through money markets and that structure would change and , and that could affect some of their spreads. There's also an issue if we had a recession or a financial crisis, you could have a digital bank run in the sense that everyone would prefer then to have their , the money in their accounts on the central bank balance sheet rather than a commercial bank balance sheet. Because even if the commercial banks are insured through , there's certainly more risk there than there would be on the fed's challenge , because the Fed is certainly never gonna go bankrupt, given not , it can , it can always print so called print it , it can create more digital money. So it does create challenges for commercial banks and it does look like some commercial banks are recognizing these challenges and moving quickly with them , but also seems like other commercial banks are dragging their heels to some extent, sort of hoping, well, let's wait and see how this evolves. And the danger with that is , we've seen with many activities in the digital economy, things can happen quickly and and more quickly than they people expect . So I think you really do have to make sure that your infrastructure, whether you're a commercial bank or FinTech player or different type of market players, that you're ready for this process to happen. And , and obviously you're gonna have to be flexible 'cause nobody can really forecast how and when this occurs, but it is , it's gonna occur , occur . And I think it will be a competitive advantage or disadvantage for some firms in the commercial banking or FinTech space, how prepared they're for these changes.
Speaker 1:Okay. So in the paper you talk about, you know, advantages and disadvantages of, of central bank digital currencies. And one of the advantages is something that, you know , sounds too good to be true. It's like the , the dream of economists, which is no more recessions. So talk about how you think , uh, why would it be the case that Central Bank digital currencies would enable us to theoretically, perhaps, you know, never have another recession again?
Speaker 3:So in the paper we , we talk about three advantages of central bank digital currencies. The first one we mentioned is the payment system and settlement system become more efficient. And that's certainly true with legacy systems. They're slow, they're expensive, especially for international payments. And it's particularly on and off ramps from the payment system, sort of the first and last mile that often we talk about where the physical economy meets the digital economy. That does need a lot of work. So that's one potential advantage. A second is financial inclusion, and it really is mind boggling . In America there's 14 million adults who don't have bank accounts. And , and that's just crazy, particularly when we're in a situation now where 95% of consumer transactions occur with private digital money. 14 million people don't have bank accounts, they're just not part of the digital economy. And that's totally, i i I would think unacceptable. And obviously there's other ways to do this than through a central bank digital currency, but this , this has to be a public policy issue. The third advantage we talk about is the one that you mentioned is the possibility to prevent recessions. And say for example, we get into recession because of something like what happened in 2020 or what happened in 2008. What central banks typically do then is they cut interest rates and they hope , well, I'm gonna cut interest rates and that's gonna increase spending either by households or life firms , and this is gonna get us outta this mess. And sometimes you also do qe, but QE mainly occurs through financial markets and , and the wholesale markets. Now the point is that instead of moving interest rates and hoping that's gonna affect spending, what you can do is affect spending directly is if households and businesses have accounts of the central bank, you can put money into those accounts and you can target it to say , specific regions or sectors of the economy or people who need the help most with spending. And you can also put a time limit on the money. You can say this money is going to expire in one month and in some structures, and these structures exist, for example, in China. Now you can also say this money has to be sent in certain types of stores , for example, that have to be sent at a grocery store or some type of clothing store and so on. So you , you have an awful lot ability to direct spending and spending is gonna happen and it's gonna occur quickly. So this, you know , this is something which has been in the realm of theory when, when I was in graduate school in economics, you know , we would talk about in our models, but with this type of structure, it's close to reality. And I think it's in a reality in some of the experiments they've done in China and what we've been seeing with the different government programs, we've had three government programs related to the Covid recession and they've all had aspects of this. And I think the third one has been much more efficient than the , the first two . And with the first one , you've had about 90% of the money in accounts within a couple weeks . Most of it's been saved or used to pay down debt , only about a third has actually been spent . So it has worked well . But with central bank digital currencies and households, businesses having accounts at the central bank, that process would become much more direct. You can imagine there's ways in which people being people, strange things could happen. People could take more risks . But it's an interesting possibility. And in the paper we , we sort of mentioned a bit tongue in cheek , you know, the end of recession, but that is a possibility.
Speaker 1:Uh , okay, well I look forward to , uh, one day having to explain to my grandchildren what, what a recession was, <laugh> . So we've talked about some advantages just to balance it out. Let's , let's discuss some of the disadvantages. I mean, one of my thi in the paper is the possible negative effects on, on the commercial banking system, but another, a big one I think, and one that to me seems like an actual implementation hurdle is all about privacy. I mean, I, you know, this all sounds very sensible and so forth, but you know, you know, we live in a country where there's, you know, large percentage of people who, like , they're never gonna open an account to the Fed, they don't trust the Fed, that kind of thing. How are , you know, how are you gonna get people to go along with this? And you know, you mentioned in the paper, for example, possibly one day actually eliminating currency, just like saying it's, it's not valid anymore. Those, those notes and coins and you can only use digital currency and that , that would be a way, for example, for the central bank to implement negative interest rates that they would just start taking away money from you in the form of a negative interest rate. And you know, that to me, that's something people are not gonna be happy about. So talk a bit about some of the privacy implications and , and some of the implementation hurdles.
Speaker 3:Yeah, so we have two models we know a fair amount about now. One , one is China, and what China's been saying is that the central bank will actually have access to a lot of information in terms of what businesses and individuals are doing. But the banks will in some sense, and the businesses are aware of the money is being spent, will have less information. So there'll be some anonymity in the Chinese system, but it won't be anonymous from the perspective of the central bank and the state and China. So this is China. I don't think that system would work in western democracies, but that's the system. China's going with the Swedish system, which is also quite far along in terms of planning. They put together a host of safeguards to make sure the center bank, and hence the state does not have information that still, there would still remain a high degree of an anonymity and probably a similar degree of anonymity to what we have now. And , and that's been really a focal point. And , and the, the lick bonk in Sweden has put a , a lot of focus to make sure this, and I think people in Sweden would probably have similar concerns to Americans or , or people in the UK or Canada about this . So when this happens, there will be a lot of measures to ensure there is a high degree of anonymity and that's very important. But the way that's treated, I think will vary from place to place. America's a very big issue. I think most western democracies, it's a very big issue. Places like China, less of an issue and other countries , they'll, they'll have I think, different ways to trade off privacy concerns.
Speaker 1:Uh , well to , to wrap up, isn't it ? What , what sort of roadmap should we be looking for ? What , what should we expect to see over the next couple of years as this rolls out?
Speaker 3:I think one thing we've learned with the, the digital economy that swallowed the world and keeps swallowing different sectors is it's impossible predict when or what is going to be coming. It's very difficult to forecast things two years, five years or further out. But we do know short term , there's the Winter Olympics in Beijing in February of next year. Lots of potential launch date . We know lots of countries are , are working in this area. And one thing we've learned from the digitization of different parts of the economy is this can happen more quickly than people expect . And it's very important for players in the sector that are gonna be directly central banks, commercial banks or FinTech companies, or even lots of different types of businesses to be ready for when it happens. And I've met a lot of people who are , well , I would say complacent. They think this is gonna take five years, 10 years, maybe decades for occur . I I think they're gonna be surprised by how quickly this process transpires.
Speaker 1:Okay. Well thanks for joining me Kevin. And again, we've been talking about a paper that Kevin wrote, bill Priest called Money 3.0 Central Bank Digital Currencies. You can find it on our website@www.eipny.com. Thanks for listening, and again, if you enjoyed the episode, please uh, give us a , a good review or a , a rating, hopefully five star rating at wherever you get this podcast. And we'll be backing in with another episode soon.
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