Digital Currencies are on their way accompanied by negative interest-rates

by Shaun Richards

The issue of a digital currency is something that is increasingly occupying both the minds and the attention of central bankers. This morning has given another example of that because as I was about to look at a couple of developments this appeared on the news wires.

Hong Kong monetary authority says it will explore issuing an e-HK dollar ( @PriapusIQ )

It would be simpler if we got a list of central banks that are not looking at it! They all have the two main drivers for this. The first is that digital currencies provide a challenged to the banks or as central banks see it “The Precious! The Precious!”. The next is their fear of the consequences of what they call the lower bound for interest-rates. Whilst this has clearly got lower to the embarrassment for example of Governor Carney of the Bank of England who assured us several times it was 0.5% in the UK and then helped to reduce it to 0.1%. There are fears in the central banking community that many have got close to if not at as low as they can go. There is a reason the ECB has not cut its deposit rate below -0.5%. So we move onto their plans for in some cases negative interest-rates in the next recession ( UK) and deeper ones ( Euro area)

Money Money Money

The issue here is the role of banks in the creation of money. Here is the Bank of England explaining this yesterday.

In the modern economy,most money takes the form of bank deposits. The principle way these deposits are created is through commercial banks creating loans.

We see here much of the reason for the central banking view that banks are “The Precious! The Precious!” and it continues.

Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money. For example, when a bank extends a mortgage to someone to buy a house, it does not typically do so by giving them thousands of pounds of bank notes. Instead, it credits their bank account with a bank deposit the size of the mortgage. At that moment money is created.

It is revealing I think that that they choose a mortgage as an example rather than business lending. But the real point here is the vital role of banks in most money creation in our monetary system. It is this that is the real “high powered money” rather than the version in the theories of economics text books which focused on central banks. If that had been right QE would have launched economies forward and we would not be where we are.

Banks are not limited as many think by some rule in the form of a money multiplier. The UK has not had anything like that for some decades. There is a limit from this.

Banks are limited in how much they can lend if they are to remain profitable in a competitive banking system.

Although that has had quite a bit of trouble as banks have in modern times struggled to make much if any profit at all. They have required quite a bit of help and some collapsed quite spectacularly with large losses. Another potential limit is prudential regulation which as I am sure you have spotted ties the banks ever more closely to the central bank.

In some ways the main restriction these days comes from us.

for instance they could quickly “destroy” money by using it to repay their existing debt.

This has been happening in the world of UK unsecured credit as highlighted a few days ago.

Individuals have made significant net repayments of consumer credit since March 2020 (Chart 2). The further net repayment of £0.4 billion in April this year was, however, less than seen on average each month over the previous year (£1.7 billion).

It is rarely put like this but money has been “destroyed”. How very dare they! Won’t anybody think of The Precious?

For a central bank replacing this with Facebook’s currency or one from any of the other tech giants in existence or about to start does not bear thinking about. It may even have been a string factor in the new apparent enthusiasm for taxing them.

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Negative Interest-Rates

This is the fantasy world of central bankers thus we find that the road to negative interest-rates is described as one with higher ones.

In response to deposits migrating to new forms of digital money, banks are assumed to compete for deposits. And they do this by offering higher interest rates.

Actually Bank of England policy ( Funding for Lending Scheme and the various Term Funding Scheme’s) has been designed to avoid this for some time. Indeed this has not really happened since our favourite Charlie Professor Sir Charles Bean promised it back in September 2010.

 “It’s very much swings and roundabouts. At the current juncture, savers might be suffering as a result of bank rate being at low levels, but there will be times in the future — as there have been times in the past — when they will be doing very well.

Actually Sir Charles has done really rather well adding the Office of Budget Responsibility and a Professorship at the LSE to his RPI-linked pension. Savers meanwhile have been stuck on the roundabouts.

Returning to its scenario the Bank makes various assumptions which lead us to this.

The interest rate banks pay on long-term wholesale funding is typically higher than on deposit funding. Other things equal, replacing lost deposits with more long-term wholesale funding therefore implies an increase in banks’ overall funding costs.

This leads us to banks charging more which many people will be familiar with. After all banks are perfectly capable of managing that without all the assumptions and intellectual innovation displayed in the discussion paper.

Under this assumption, both funding costs and bank lending rates rise by around 20 basis points.

In fact a 0.2% increase on overdraft rates which these days are 30% plus would hardly be noticed nor on credit cards. Commercial borrowing is something that may act differently mostly I think due to scale.

Under the illustrative scenario, it is assumed that some corporate borrowers find it cheaper to take advantage of credit opportunities in the non-bank sector. For example, medium-sized UK companies who were previously unwilling to accept costs associated with non-bank sources of credit, but who now find it cheaper to do so than borrowing from a bank.


This is another step on the road to ever lower interest-rates combined with central bankers twisting and turning to find a future for the banks. This is because the system as it stands suits them both.

Monetary policy is mainly implemented by setting the interest rate paid on reserves held at the central bank by commercial banks. This interest rate is known as Bank Rate.

Or at least that is their view because as we look around we see that it has in fact become less and less relevant.

Towards the end of the paper – and thus less likely to be reported- we end up at our destination though.

If it was preferred to cash, a central bank digital currency could also soften the lower bound on monetary policy.

Here is the Bank of England version of this.

In principle, a CBDC could be used, in conjunction with a policy of restricting the use of cash. If the interest rate on the CBDC could go negative, this could soften the effective lower bound on interest rates and lower the welfare loss associated with the opportunity cost of holding cash.

Actually you just set an exchange-rate between the two as the IMF suggested and Hey Presto! You have -2% or -3% and a strict form of financial repression.



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