In a time of doom and gloom, the digital Euro is coming to save the day

It was the year of Our Lord two thousand twenty and twenty-two. While the deadly plague had receded in Europe, news was coming from far-away Shanghai that China was once again engulfed in an outbreak of the perfidious virus. The steely eyed leader of Russia was threatening Europe with the prospect of an Armageddon surpassing all of the horrors of the previous century. People who had for years wondered if they could afford to keep a roof over their head now also lost sleep over second-hand cars, a pint of ale in the local tavern or keeping the heat on. The most titillating publications wrote that some young people had entered the ‘apocalyptic phase‘. Meanwhile the European leaders ‘rolled with exceeding smoothness down hill, making paper money and spending it’. The astute reader will recognize the last sentence from A Tale of Two cities; Charles Dickens was talking about the French government right before the revolution of 1789.

Despair not, dear reader, for Fabio Panetta, Knight Grand Cross of the Order of Merit of the Republic of Italy (and one of the leaders of the European Central Bank) travelled to windswept Ireland this week to deliver a rousing speech. In Public money for the digital era: towards a digital euro, he explained why we need a new currency. The digital euro should be like Bitcoin, only managed by the ECB. I know what you are thinking: ‘isn’t the whole point of the Bitcoin that it is DECENTRALIZED currency?’ Yes it is, and therefore the whole speech is incredibly puzzling and confusing. Panetta is not able to provide any convincing arguments. This does not mean that there are no reasons to introduce the digital euro, I will describe three of them. Only if we one understands the rationale can one begin to form and opinion on the online euro’s merit.

At the start of his speech Panetta declares that he wants ‘to engage with and listen to stakeholders and society at large’, I could not agree more and write this article as part of that engagement. Panetta goes on to describe the downsides of cryptocurrencies. First of all wider adoption could lead to uneven playing field as some big tech companies launch their own currencies. This is definitely something I am concerned about as well. Secondly, these coins are too volatile to be used as a reliable means of payment. This is also very true, just take a look at the wild swings in crypto values over the last weeks. All the more so if we take into account another statement in the speech: ‘Anyone investing in cryptos must be prepared to lose all their investment.’ Friendly advice, or a loaded gun pointed at small HODLERS?

Fabio goes on to describe where the appeal of crypto’s lies. According to him the wider adoption of cryptocurrencies such as Bitcoin ‘reveal a growing demand for immediacy and digitalisation.’ Consumers are widely using new forms of payments. Here the digital euro should come in as a ‘means of payment that is free, available for all digital payments, and accessible to everyone, everywhere.’ Panetta specifically states that the significant reduction in the number of bank branches could cause problems for vulnerable customers: a digital solution is needed. This is the part of the speech that for me is hard to understand.

First of all, where is the problem to which Panetta is proposing a solution? I personally have welcomed the digital revolution in payments. Apart from my secret stash of 100 euro notes (for when I finally enter the apocalyptic phase) I do not carry any cash. I easily pay at stores using either a debit card, credit card or even my phone. All handled by my bank’s free application. I easily order books online and exchange money with others without any hassle. All of this using no other currency than our shiny EUR. The reason why bank branches are closing down is that consumers no longer see the need to visit them. It is clear that this causes problems for those consumers who find these applications hard to use, but any further digitalization is unlikely to solve their problem.

Cryptocurrency on the other hand seems to provide no improvement in ease of transactions. On the contrary, cryptos need to be held in wallets or on central exchanges. Peer to peer transfer is so complicated that to casual users it seems impossible. Apart from the wild swings in price, the transaction speed is sluggish while the transaction costs would make a stock broker blush. On the other hand, innovation is marching ahead in the crypto space. While transactions speeds increase, costs are decreasing. In China and Brazil, countries where many people do not have bank accounts, crypto is seen as an alternative to traditional banking. Here the government is in fact competing with cryptocurrencies on ease of use. If this threat will materialize in Europe remains to be seen. Meanwhile, the benefits I see to Bitcoin and other crypto’s are entirely different:

1. Transactions are anonymous (making it a widely used medium of exchange for criminals, terrorists and well-meaning free thinkers)
2. The currency is independent from a central bank (meaning that the ECB or its counterparts cannot print more)
3. The currency is more volatile than stocks (allowing for faster gains (or losses…) for investors who appreciate a higher risk profile)

Given that the ECB is unlikely to look favorable on these three advantages, and the fact that cryptos are anything but easy to use, I conclude that the digital euro is not going to compete with crypto currencies at all. The digital euro is also not going to help reduce transaction costs, as the free market is already doing a great job on that front. That being said, I do see at least three advantages to the new euro.

First of all, a digital euro would allow the ECB more flexibility in setting interest rates. Although the ECB could theoretically set rates as high as it wants, there is a technical minimum. Known as the effective lower bound, retail interest rates can never go lower than -1%. If you are still allowed to withdraw your money in cash, many savers will decide to withdraw banknotes and keep them at home. Savers are willing to accept a small negative rate, as the bank protects your money against theft and fire, but not more than that. One way to get rid of the effective lower bound would be to ban all forms of cash and replace it with a digital currency. However, I do not think the approach needs to be that heavy handed. If the ECB introduces a digital euro alongside the normal euro it could introduce a differential monetary policy. If the interest rate on the normal euro is -10% and the rate on the digital euro is -5% it would still be rational to keep your money as digital euros. Withdrawing your money in banknotes would then entail even bigger inflation than when you keep your assets as digital euros.

A second benefit would be that the ECB gets access to far more information. Right now the relationship between us and the ECB is indirect. The ECB provides loans to the retail banks who in turn interact with us. While the retail banks know what we spend our money on, the ECB does not. This means that retail banks have a lot of responsibility to implement policies to prevent money laundering, financing of terrorism and other shady transactions. With a digital euro the ECB could centralize this treasure trove of data and employ software to detect these nefarious acts or use the information for other policy objectives.

The third and perhaps most transformational impact would be that the ECB can carry out monetary policies at multiple velocities. For many years now, the ECB has tried to kickstart consumption by lowering interest rates and through quantitative easing (printing money and buying assets with it). If the ECB wants people to visit restaurants more often to help a sector still reeling from the pandemic, it can only give a lot of money to banks in the hope that cheaper credit will help people spend more money. In the digital euro era, the ECB could write out interest free loans, provided they are spent on going out to eat. Another option would be to hand out money with expiration dates to make sure it is spent on consumption. In this way, the ECB could use monetary policy to create a system of incentives towards certain areas of consumption. It could then make it for instance more expensive to buy alcohol and cheaper to invest in education.

It is clear that the introduction of a digital euro would provide the ECB with increased policy capabilities. The debate should center on three key questions:

1. Can we trust the ECB intentions when using these measures?
2. Can we trust the ECB’s competence?
3. Given a positive answer to the prior two questions, do we want to provide the ECB with this level of power?

All of these questions merit a thorough and serious discussion. It is wise that Panetta made clear he wants to listen, it is up to the wider society to give him something to listen to.