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Opinion Proceed with caution on central bank digital currency

Vehicles pass in front of the Marriner S. Eccles Federal Reserve Board Building in Washington on Jan. 22. (Al Drago/Bloomberg)
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Central bank digital currency, or CBDC, is the hot topic in economics and finance. The idea is that official monetary authorities can harness the technology that gave us bitcoin and other cryptocurrencies, but without the volatility.

CBDC could consist of secure computer-code equivalents of conventional money created by the central bank and credited — securely and swiftly — to accounts belonging to the general public.

Stirring speculation that it intends to create an alternative to the dollar in global finance, China has already introduced a prototype digital yuan, via a mobile phone app that more than 100,000 people have been using in limited amounts, according to the Wall Street Journal. Sweden is about to test something similar. In the United States, the Federal Reserve has launched an intensive study of CBDC, with the first published results due this summer.

Some proponents see CBDC as an instrument of financial inclusion, offering “unbanked” citizens direct access through their cellphones to Social Security payments or child tax credits — or, someday, a guaranteed basic income.

Others tout the potential for more efficient tax collection: It would be harder for evaders to hide from a Treasury Department capable of asking the Fed to erase digital dollars from their accounts. Meanwhile, the Fed could dial the money supply up up and down, by paying a positive interest, or deducting a negative one, on digital holdings.

The risk is, or should be, obvious: We do not want to create a system that would give government access, in real time, to detailed information about every single transaction its individual citizens might conduct.

For the Chinese government, that’s not an issue. Beijing seems to see CBDC as a major step toward its goal of complete, digitally enabled social surveillance and control.

For a free country such as the United States, however, the calculus should be different. As the classic phrase goes, money serves three functions: It’s a unit of account, a store of value and a means of exchange. The rationale for government-backed currencies is that these represent public goods, and that a public institution should provide them.

Less often acknowledged is a fourth attribute, or benefit, of money — it can facilitate the conduct of business among one or more parties that they may not want to reveal to anyone else.

Money protects privacy most effectively when it takes the difficult-to-trace form of cash. Even in today’s rapidly digitizing payment system, however, banks and other private-sector institutions create a buffer between government and people’s financial records.

Of course, the banks themselves can muck around with your data. And the system is indeed vulnerable to money launderers, tax evaders, terrorists and other bad actors.

In a certain irreducible number of transactions, however, the participants do have a legitimate interest in confidentiality — of a competitive business idea, say, or political organizing.

“There is a legitimate market for privacy of transactions,” University of Illinois economist Charles M. Kahn has written. “Bitcoin is in this market. The providers of stored value cards are in this market. To a certain extent, PayPal is in this market, as are the credit card companies with their tokenization programs for internet transactions. And government-provided currency is also in this market.”

For this reason, mainstream CBDC proposals would channel funds through the existing commercial bank system as opposed to creating retail accounts at the Fed itself. Still, the data-protection challenges, legal and technological, would be enormous.

Americans, and people around the world, trust the dollar not just because the government behind it is powerful but also because it is constrained by a robust body of law, among whose pillars is the Fourth Amendment protection against unreasonable searches and seizures.

We should be very sure of the benefits of CBDC before granting the central bank powers that could be bent to Orwellian purposes, either by this government or, in the event of hacking, a foreign one.

An oft-cited reason to create a digital dollar — preventing China’s digital yuan from emerging as an alternative reserve currency — seems overblown. Beijing’s controls on capital flows make the yuan unattractive as a store of value and will probably prevent the yuan from displacing the dollar.

The same goes for bitcoin, whose recent roller-coaster valuation shows how ill-suited cryptocurrencies are to replace government-backed money.

As for using CBDC to help the unbanked, they numbered 7.1 million of the United States’ 124 million households in 2019, just 5.4 percent, according to the Federal Deposit Insurance Corporation. This is the lowest percentage since the FDIC began collecting data since 2009, suggesting that the problem, though real, is on its way to being solved.

Such progress reminds us that competition among private financial institutions, appropriately regulated, can produce valuable innovation. Depending on how it’s done, however, CBDC could weaken the banks by depriving them of deposits and revenue.

The dollar enjoys global primacy because, for almost everyone, almost all of the time, it’s a pretty good deal. Before the Fed launches a digital version, it should be certain that won’t change.

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