Americans will have digital dollars accessible through smartphones within a few years. Paper money and checkbooks won’t go away completely, but the overall benefits of digital money are compelling.
Most of us already receive paychecks, Social Security benefits and some other payments digitally through direct deposit. We can swap those funds for paper currency or write checks, but most transactions are made through credit and debit cards and electronic transfers.
Usually, payers and payees have accounts at different commercial banks, and those banks have accounts at the Federal Reserve.
Payments from households and businesses first move through their bank’s internal accounting and affiliated credit-card systems. The payee’s banks make a claim against the payer’s bank, and the Federal Reserve redistributes funds from the payer’s bank to the banks where landlords, merchants and suppliers have accounts.
It’s mostly digital these days — even paper checks are photographed to speed things along — and really constitutes a crude, indirect digital currency. The system is multilayered, expensive and, with many links, offers lots of opportunities for hacking and fraud.
Bank-sponsored credit cards charge 1.5% to 3.5% on merchants to process payments to cover theft, consumer defaults and still make a nice profit. Fees are smaller but still substantial for debit cards and other direct electronic payments, mostly owing to the absence of credit risk and regulation.
The essence of a digital currency is that everyone could have an account directly at the Federal Reserve. We could pay merchants and monthly bills directly through Fed payments systems with fewer fees.
Eliminating layers and most fees could save consumers billions of dollars and shorten payment time from days to hours — perhaps minutes. With appropriate encryption and by eliminating multiple layers of transactions, it would be more secure.
Already the central bank is planning to roll out a FedNow Service that would permit instantaneous transfers among commercial bank accounts. All that is required is to establish a framework for ordinary individuals to establish similar accounts, and the digital dollar would be with us.
Households and businesses would not have to keep their money at banks. The same goes for the federal, state and local governments that have bank accounts to process tax collections and payments of benefits and for goods and services. That has banks sufficiently agitated to raise distracting questions about the legality of digital currencies.
However, the essential role of banks would not change. Folks who want to carry credit-card balances or borrow for homes, cars and to run businesses would still rely on them, but banks would have to pay more interest than the paltry sums they now offer to entice us to move money from Fed wallets to accounts with them.
The Constitution authorizes the federal government to issue paper currency, but it was written before Thomas Edison. If individual accounts at the Federal Reserve are illegal, then so must be banks’ accounts with the central bank and the entire banking system, because in all their essential characteristics those accounts function as money.
Individual accounts at the Federal Reserve could make the most basic financial services — accounts to receive paychecks, make ordinary payments and access to cash through ATMs everywhere — much more accessible to underserved, poorer Americans.
The Postal Service is experimenting with once again offering banking services. Local post offices could provide counter services in places where banks will not go. However, other than for accessing paper currency, few counter services will be needed — paper checks would be virtually obsolete.
If every American had a Federal Reserve account, then distributing governments’ benefits would be much easier. Especially at times of crisis like the pandemic, stimulus checks could get out much more quickly.
International funds transfers often impose even greater costs than the credit and debit card systems, but if central-bank digital currencies protocols were harmonized, the working poor could send money to relatives abroad — and the corner hardware store to foreign suppliers for imported items — at much lower cost.
China has already conducted pilot studies for a digital currency — as have several other countries. The United States risks the status of the dollar as the primary reserve currency if it lets China or the European Central Bank pioneer an internationally convertible, secure digital currency.
Fed Chairman Jerome Powell has dragged his feet, saying it’s better to get it right than to be first. It seems Powell didn’t read about “first mover advantage” at law school, but Vice Chairman Lael Brainard sees the economic and security benefits.
Digital dollars are an imperative, not a choice. Elevating Brainard to vice chairman could accelerate progress.
Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.