Tag: payments

Stable Coins

Digitizing our bank deposits (digital dollars—stable coins) would (will) represent another step forward in the ease and efficiency with which we can make payments and will enhance bank stability. Most of the US supply of money (US dollars) is in the form of our dollar deposits at our banks and most of our payments these days are already made by electronically transferring bank deposits from me to you via my bank to yours. I have discussed all of this in more detail earlier: “Econ 101-Money”

Developing the rails for paying with stable coins is a further improvement on our existing payment options. It is not revolutionary. The payment of cash (currency) requires no infrastructure (e.g. Merchant contract with credit card issuer and card reader, etc.). You just hand it over and anyone can accept it (hopefully the person you intended to receive it). The electronic transfer of a bank deposit balance (e.g., Zelle, Venmo, e-wire) requires the enrollment of the recipient in that particular payment vehicle.  It took decades for credit cards to be widely accepted. Hundreds of companies now issue Visa cards (mine is issued by United Airlines) and all are accepted wherever any of them are accepted. But it took a lot of work to build that system.

What do stable coins issued by banks add that might be useful? From the bank side issuing stable coins from deposit balances simplifies the bank’s management of the assets that back them. When its customers withdraw cash these days, the bank must purchase it from the Federal Reserve in order to pass it on to you. It pays the Fed for the cash from its reserve deposits at the Fed, which reduces its ability to extend credit to businesses and households. If its reserves at the Fed are not sufficient, it will need to borrow from another bank or sell another asset.

The withdrawal of cash from bank deposits tends to follow seasonal patters. Thus the squeeze on its reserves at the Fed would tend to create seasonal fluctuations in bank credit hence in the money supply.  Thus the Fed attempts to offset the impact of currency fluctuations on bank reserves and thus credit with offsetting purchases and sales of government securities (so called open market operations) or with temporary loans to banks in its “lender of last resort” function. If a bank can issue its own currency (as they did in the old days) when a customer withdraws cash from its deposits, its asset backing (and reserve deposits at the Fed) will not be affected. Banks will now be able to do this by issuing their own stable coins. While the customer’s deposit balance will fall when withdrawing cash (or stable coins), its total of stable coins “cash” plus deposit balance will not change thus the bank assets backing them do not need to change. Thus, such fluctuations in the currency/deposit ratio would not product a fluctuation in the money supply.

From the customers side the stable coins are as good as traditional cash only to the extent that the infrastructure to accept them (e.g. phone wallets) has been designed and widely acquired/accepted. Just as it took many years for credit cards (Visa, Mastercard and American Express) to be widely adopted, the same will be true with stable coins. Just as you might now swap addresses via your respective mobile phones, you will be able to make payments.

If everyone can issue their own money it degenerates to barter, i.e. it would not be money at all. The essence of a successful means of payment is the certainty of its ultimate claim on the central bank’s official monetary liability (the dollar). When central banks were limited to issuing currency redeemable for “something” such as gold or silver, the amount they issued was limited by their holding of gold or silver, etc.  Today the Fed’s supply of money is limited by Congress’s mandate for price stability and full employment. And ultimately the government must accept such dollars in payment for our tax obligations stated in the same currency.

Econ 101:  Money

My Ph.D. in economics from the University of Chicago dealt with a monetary policy issue. My five years as an Assistant Professor of Economics at the University of Virginia allowed me to lecture extensively about monetary policy and my 26 years at the International Monetary Fund were largely devoted to providing technical assistance to member (primarily post conflict) county central banks (including Afghanistan, Bosnia, Croatia, Egypt, Iraq Israel, Kazakhstan, Kenya, Kosovo, Kyrgyzstan, Moldova, Serbia, South Sudan, Turkey, West Bank and Gaza, and Zimbabwe). In case you didn’t know, central banks issue the currency (money) of their respective countries. So, I know a lot about “money” and like talking about it.

And it’s not that I haven’t already written a lot about the subject. For a few examples see: “Econ 101-the Value of Money”   “Money”  “A Libertarian Money”

A lot of interesting things are happening these days in the monetary area, but they pertain to payments (transferring money from one person to another via PayPal, Venmo, Zelle, Visa, etc.) rather than money itself. I want to talk to you about “money” (not payments) as I might with my granddaughter. Money is what is transferred in payment.

Money exists because none of us are self-sufficient and must trade what we produce with others who produce the other things we want. I will skip the presumably well-known story of barter trade and its challenge of the double coincidence of wants (you have what I want, and I have what you want so we trade). Giving you a commonly accepted asset, that you can hold until you want to buy something from someone else and can “pay” for it by passing that asset on to the next seller is the essence of money. In addition, it becomes the unit of account (the unit for stating prices). Thus, money is a unit of account, means of payment and store of value.

But now dear granddaughter, lets dig deeper to discuss where this money comes from and its key features in today’s modern electronic (digital) world. First of all, I can’t pay you with any old asset equal in value to your sale price (the barter problem). I must pay you with “money,” an asset universally accepted within the country. To cut to the bottom line, money is the asset issued by our central bank (any of our twelve Federal Reserve Banks) or creditable claims on the Fed’s monetary liability—the U.S. dollar. Until 1933 these dollars could be redeemed for gold at $20.67 per once. Now the U.S. government accepts them in payment of our taxes denominated in dollars, which insures their ultimate value.

Federal Reserve notes (dollar bills) are the most direct manifestation of our money. But almost 90% of our money (the asset with which we can pay for things) is in the form of deposits at American banks, and credit unions. These figures can be a bit misleading because over 60% of our currency is held abroad.

When you pay someone with cash, they receive a direct claim on the Federal Reserve. When you pay with your bank deposit, your bank’s deposit with (claim on) a Federal Reserve bank is transferred to the payee’s bank, which credits the payee’s bank account with the designated amount. The asset paid and received is still ultimately a claim on the Fed.

But our demand deposits with our banks amount to 15.9 trillion dollars, while the reserves that our banks keep with the Federal Reserve Banks amount to only $3.3 trillion reflecting our “fractional reserve” system. What is going on here? How did banks create more of our money (ultimate claims on the central bank) than it backs with its reserves at the Fed?

When teaching money and bank at the U. of Virginia I loved walking the class through the money/banking multiplier that resulted from our fractional reserve backing system. It has become fashionable for some to claim that banks create deposits (money) by making loans. When you received a mortgage loan from your bank, they say it creates the deposits placed in our deposit account. This is sort of true and sort of not true. Your bank actually pays your mortgage loan to the account of the person selling their home and their account is almost surely in another bank. That means that your bank must have sufficient reserve balances at the Fed to transfer to the seller’s bank.

I will leave the details of the bank money multiplier to the Money and Banking class you will hopefully take when you go to college, but the fact that your deposits are only partially backed with reserves at the Fed (the rest of the backing being the bank’s loans and other financial assets, is what lies behind the occasional bank runs we saw in the movies before deposit insurance was introduced to assure depositors that they could get the money back even if their bank failed. If enough bank borrowers default on their loans, the bank could become insolvent. Only the first to withdraw their deposits will be able to get their money back. The potential risk of such runs on a bank only partial backing your deposits with reserves at the central bank motivated the Chicago Plan of 100% reserve banking. “Protecting Bank Deposits”

If bank deposits of US dollars are money, what about cybercurrencies? What are they ultimately claims on? Bitcoin, as you hopefully know, is not a claim on anytime. They can’t be redeemed for anything. It is not unit of account or means of payment for hardly anything—it is not money. It is a speculative “asset” for those who like to speculate (gamble). “Cryptocurrencies-the bitcoin phenomena”  “The future of bitcoin exchanges”  “Bitcoin-Cybercurrencies and Blockchain”  “The difference between bitcoin and FTX”

But there is a class of cryptocurrencies that claim to be redeemable for money, such as US dollars—so called stable coins. The validity of this claim, as with your bank re your deposits there, depend on the details of its contract and the faithfulness of its adherence to that contract. Tether and USD Coin are the most popular US dollar stable coins.

But to use a stable coin for making payments, the person or firm you are paying must have the software or card reader needed to use the cryptocurrency you want to use. You might remember (probably not you, dear granddaughter) when not so many stores could accept visa, or MasterCard (or the Shell Oil, or Texico gas cards). Payment technology has continued to evolve and improve, but if it is not transferring money (US dollars in our case)—i.e. an asset ultimately redeemable for the Federal Reserve’s liability, it will not get you very far.

Other than handing someone cash, paying with your bank account requires a messaging and authorization system. Do you still write checks occasionally—so sorry. A check both indicates the amount to be paid and authorizes its transfer. Almost all payment instructions and authorizations are made electronically these days. Many central banks are considering introducing digital cash in place of or along side their currency notes (Central Bank Digital Currency). When offered through a bank, a CBDC would have the advantage of 100% reserve backing (it would be a direct claim on the Fed). On the other hand, modern electronic means of payment leave little room for further improvement as might be offered by CBDCs. “Econ 101-Retail Central Bank Digital Currency-CBDCs”

To make payments, or send money, abroad, your money must be exchanged for the money of the recipient. I regularly send dollars to Afghanistan, which are received as Afghani. A massive foreign exchange market in which the exchange rate of one currency for another is determined exists for that purpose. Such payments can be made more quickly and cheaply if both parties are willing to use the same currency. Thus, the US dollar is rather widely accepted for cross border payments. “The Dollar Again”  The Special Drawing Right (SDR) of the International Monetary Fund serves this purpose for governments but is not widely used. “What are SDRs?” Stable coins redeemable for gold provide another promising potential unit given golds historical importances. The best existing example is e-gold by Global Standard (to which I am an advisor).

But not all monies behave the same. The behavior of the value of each (its inflation rate) depends on how its issuing central bank manages its supply. Some central bank’s supply whatever their government needs, generally resulting in high inflation rates. Some, such as our Federal Reserve, regulate its money’s supply in an attempt to maintain an inflation target (in the US the target is 2%). Others follow currency board rules that leave to the market the determination of a supply that keeps the currency’s value consistent with that of another currency (The Euro in the case of the Bosnian dinar or the Bulgaria lev). So dear granddaughter there are many interesting things to study about money.

Why don’t you pop over and let’s discuss it more over lunch? Oh, I forgot that you are in the West Coast Washington (state) while I am near the East Coast Washington (DC). Well at least we can meet on FaceTime or Zoom (or even the old fashion telephone). But I would love to meet one way or the other.

P.S. In 2002 as Patrick Honohan and I were finishing up the Bank-Fund Financial Stability Assessment of Egypt (Patrick led the World Bank team and I led the IMF team) I said in an email “Patrick, why don’t you just come across the street and discuss this over tea?” Patrick replied: “Warren, I am in Dublin. I moved here several months ago.” He later became the Governor of the Central Bank of Ireland.

FedNow

The Federal Reserve has launched FedNow, which executes instant payments 24/7. What does that mean? When I led IMF technical assistance missions to the former Soviet Union (Kazakhstan, Kyrgyzstan, and Moldova) and to post conflict countries (Afghanistan, Bosnia and Herzegovina, Iraq, Kosovo, Serbia), the payment experts on my teams referred to the Clearing and Settlement of payments. I never fully understood what that meant. “Federal Reserve FedNow Payments”

The key to understanding the meaning of “clearing and settlement” is to understand the deference between the authorization to make a payment and actually debiting and crediting bank accounts to execute the payment. When I pay from my bank account to yours, mine is debited and yours is credited. My bank executes the debt and credit if your account is also at my bank. If not, my bank debits my account and “sends” the money to you at your bank via an intermediary (usually the central bank) at which both my bank and yours have accounts that can be debited and credited. When my account has been debited and your credited, the payment has been “settled.”

The clearing part of clearing and settlement has to do with communicating the authorization to our banks to execute the debit and credit. It refers to the messaging systems that authorize the actual settlement of a payment. This is what FedNow is about (as is the well-known SWIFT messaging system for authorizing cross border payments). It will replace paper checks or electronic payments such as Venmo, Zelle, PayPal, etc. that now authorize our banks to debit our accounts and credit the accounts (somewhere) of the payees.  “Econ-101-Retail Central Bank Digital Currency-CBDC”

I haven’t mentioned what it is that is being paid. If it is from my bank account, it is US dollars (ultimately a claim on the Federal Reserve Banks of the U.S.). Every currency (dollars, Euros, bitcoin) has its system of clearing and settlement.  And of course, there are markets for exchanging one currency for another (FX markets).

FedNow is a messaging system that authorizes settlement in seconds 24/7 that replaces (or supplements) systems that now can take days.

My Travels to Kosovo

Post-World War II Yugoslavia consisted of the federation of Bosnia and Herzegovina, Croatia, Macedonia, Montenegro, Serbia, and Slovenia. Though its residents were predominantly Albanian, Kosovo was a province of Serbia. During part of its post-WWII history, Kosovo was relatively autonomous within Serbia, while part of the time it was ruled directly by Serbia. Frictions between Albanian and Serbian Kosovars escalated in the 1990s into armed conflict, which ended only with the North Atlantic Treaty Organization’s (NATO) bombing of Serbian Army forces in Kosovo and Serbia proper from March 24 to June 10, 1999.

Following the June 10 end to the fighting, the United Nations Mission in Kosovo (UNMIK) took over the governance of a ruined Kosovo. Among the normal needs to be restored most urgently (food, water, electricity, etc.), was the ability to pay for things. Kosovo’s banks were closed, and its financial and monetary connection with Belgrade and the rest of the world was not functioning. There was an urgent need to revive Kosovo’s ability to make payments while also determining what sort of financial systems to build for a future, more integrated with the rest of Europe.

If only by using it, Kosovars themselves had answered what currency they wished to use—the German mark (DM). But arrangements were urgently needed for how to acquire and maintain DM banknotes and coins (I remember well the tattered currencies in post-war Bosnia and Iraq), and to adjust the procedures of banks and other money handlers to the use and safekeeping of DM, rather than the Serbian dinars previously supplied by the National Bank of Serbia.

The International Monetary Fund (IMF) joined with the United Nations, the World Bank, the United States Agency for International Development (USAID), and other international organizations to provide the needed emergency humanitarian assistance and to help in the rebuilding of a potentially transformed economy. I led the IMF missions to address the money and banking aspects of this effort. The revival and/or restructuring of Kosovo’s monetary capacities needed to be achieved in days and weeks rather than months and years. This was a tall order.

My latest book documents our work to revive and transform Kosovo’s monetary system and some of the challenges and adventures we encountered in the process. Most of us only see the public face of our payment systems (currency, ATM machines, credit cards). In recounting our experiences in restoring and transforming Kosovo’s payment system, I will endeavor to pull back the curtain a bit to expose what is behind and generally out of sight.

If this interests you, you can buy the paperback or kindle versions here. https://www.amazon.com/s?k=Warren+Coats&i=stripbooks&crid=10ON15E99H8X6&sprefix=warren+coats%2Cstripbooks%2C63&ref=nb_sb_noss_1  This will also give you the opportunity to rate the book. I hope that you will enjoy it.