George Selgin on the Future of CBDC, Fed Accounts, and Stablecoins

George Selgin is a senior fellow and director emeritus of the Center for Monetary and Financial Alternatives at the Cato Institute and is also a long-time returning guest of Macro Musings. He rejoins the podcast to talk about central bank digital currency, stablecoins, and the future of the Fed’s balance sheet and operating system. Specifically, David and George also discuss the challenges presented by CBDC and Fed accounts, how they could create financial instability, George’s proposal for wholesale CBDC, and more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: George, welcome back.

George Selgin: Great to be back David and Happy New Year.

Beckworth: Happy New Year to you as well. And speaking of new years and being happy, I should mention for our listeners who may be appreciate this, that you and I were both at the University of Georgia, like you were my professor there. I was one of your grad students. And one of the things at least I enjoyed while I was there, I was there five years, five years of my life on that campus, was the football program. And this past Monday they won the national championship. So George I actually, I was thrown into large classrooms as a grad student. I remember my first classroom they threw me in to teach, maybe had 150. But by the time I left, I was teaching in sections with over 300. And do you remember those large auditoriums? I don't know if you had many of those classes but I did as a grad student.

Selgin: I got out of them as soon as I could David. I used to see the students sneaking out the back door in the middle of my lectures… they can't get out.

Beckworth: Yeah, I think they through those large sections on us graduate students. I had to deal with many issues in those big classes, cheating, attendance, all of those things. But it was still a joy overall to have that experience. And I had a number of football players come through the program. One that I got to know David Pollack, he's I think now an ESPN gameday announcer. But a lot of football players like that came through, you got to meet them, other athletes as well. So it was a unique experience. And anyways, it's just a great time as a Georgia fan to be relishing in the national championship. Okay, with that out of the way, let's move on to monetary economics, the Fed, what is happening around the world today in the world of central banking. And we want to focus on the Fed of course, and I want to bring up some recent developments George to just kick off our conversation.

Beckworth: So Chair Powell this week, he was in the nomination hearing to be reappointed as Fed chair. And the question came up about this white paper on central bank digital currency that the Fed’s been working on for some time. And in fact, it was supposed to have come out last year I believe it was the originally scheduled date. He said it's coming out in a few weeks. So I think they conveniently kind of postponed that till after the nomination hearings. Because why add more fuel to the fire while it may create more theater in those two hearings? One, one for him and one for Governor Lael Brainard. The other thing that was really fascinating that came out recently was a bill by Representative Tom Emmer from Minnesota, a Republican, which would restrict the Fed’s ability to create central bank digital currency only to the wholesale level.

Beckworth: Or maybe says more precisely restricts the Fed from issuing retail CBDC. So with those two things going on the news, I thought it would be useful to turn back to central bank digital currency. And you had a recent Twitter thread where you responded to Representative Emmer's bill that he was proposing. And I want to read a few of the things that you wrote on Twitter and then maybe you can expound upon them. And what you do is you outline some of the challenges of a retail and Fed account or central bank digital currency. So I'm going to read the first one here and then you tell me a little bit more. So you say, “the Fed private accounts can accomplish nothing that can't be done less intrusively, while giving greater encouragement to continued payments innovation by having the Fed extend the availability of its wholesale services to private market digital currency providers.”

The Challenges of Fed Accounts and CBDC

Selgin: Okay, yeah. Well it's important to distinguish the provision of retail payments media like digital currency which in the central bank context that can mean actually just deposits. It used to mean just having personal individual accounts at the Fed from the provision of wholesale services which is pretty much a Fed specialty. And they handle most of the wholesale dollar payments, especially the settlement of accounts among different institutions that keep deposits with it. So in Europe you have a discussion about what they call synthetic central bank digital currencies. And basically this comes out of the Bank of England but it's also been popular at the ECB. And basically what they've decided to do, the approach they've decided to take is we're going to handle the wholesale end of the payments business as we've been doing all along.

Selgin: But we're going to allow digital currencies to grow, to have more issuers by admitting more private firms that issued digital currencies into our wholesale business, we've got to deal with them. And that's the direction for example that the Bank of England took in 2017, when it opened up its settlement accounts to fintechs, which it previously couldn't have accounts at the Bank of England. Only banks and a relatively small number of clearing banks could have accounts directly at the Bank of England and therefore could have direct access to its payment services. Anyway, come back to the United States, right now we have a situation where only chartered banks can have master accounts. And not even all of those are granted such accounts, at least not expeditiously, and fintechs really haven't broken in to the Fed's wholesale system.

Selgin: And so the question is, there are really three choices out there, David. The Fed could directly provide digital currency, it could keep the status quo of course and do nothing, or it could encourage private digital currencies by making its settlements and wholesale services more widely available to them. And that last choice is the one I think we should follow.

There are really three choices out there, David. The Fed could directly provide digital currency, it could keep the status quo of course and do nothing, or it could encourage private digital currencies by making its settlements and wholesale services more widely available to them. And that last choice is the one I think we should follow.

Beckworth: You note in an article you wrote about this for the Cato Journal. In fact, this was a paper I believe you delivered at a Cato monetary policy conference two years ago but it came out this past summer. You note in there that the Bank of England when they did this, they did it in part because they wanted to foster continued technological innovation, right? Their concern was if they did everything, you wouldn't have the competition that breeds and fosters innovation.

Selgin: I think that's right. And I think that's a very important concern. Of course, in theory, you could have the Fed providing digital currency directly that is retail, and competing with the private sector in doing this. I am very, very leery of arguments that this kind of competition works as well or can work as well as ordinary competition among private institutions. And that's because it's very difficult in practice for the Fed to be a fair competitor. It's difficult because first of all, it's going to be competing with firms that it regulates, and that obviously can pose great challenges. Who wants to compete with their regulator?

Beckworth: Right.

Selgin: Second, even if it doesn't try to, the Fed finds it all too easy to implicitly at least cross-subsidize its different services. By law, it's not supposed to, it's supposed to charge the proper costs of these services to the retail institutions that provides them for. But in practice cross-subsidies creep in here and there, and sometimes the Fed frankly, thumbs its nose at the 1980 Depository Institutions Deregulation and Monetary Control Act, it's a mouthful. That is the one that says it shouldn't underprice its services or it shouldn't underprice its products, it has to be a fair competitor. For example, FedNow is the Fed’s in- progress system for real time payments. And that is already a retail sort of digital currency arrangement, a little different than the personal accounts we're talking about. But it has been set up to compete directly with an established system.

Selgin: I've written about this, which is the RTP system, real time payments, run by the clearinghouse, TCA. And they are saying well, we're going to recover the costs for this thing but we're going to take a lot longer to do it then we normally would. In essence they're allowing themselves to do what no private business that had to really recover its costs in a timely way could do. And that's a kind of unfair competition, they can lose money or do what would be losing money in the private sector. So those are some examples of reasons why I don't believe in relying on competition between central banks and private firms to provide similar payments products as a way to maintain competition over the long run and thereby maintain innovation. Currency is a good example I think, paper currency get away from the digital stuff.

In theory, you could have the Fed providing digital currency directly that is retail, and competing with the private sector in doing this. I am very, very leery of arguments that this kind of competition works as well or can work as well as ordinary competition among private institutions.

Selgin: Of course, the Fed was granted the right to issue paper notes. Originally, it still did so alongside national banks, but by 1935, it had assumed a complete monopoly of paper currency in this country putting aside I think some Treasury issues. Well, we didn't see a lot of innovation with paper currency. In fact, I would submit that the reason we still have paper currency to a considerable extent here and many other places in the world, is because we allowed central banks to monopolize currency payments. And only in relatively recent years have non-banks significantly, non-banks that were not expressly discouraged or prohibited from being in any sort of currency business, have they started to provide substitute currencies in digital form that have threatened the central bank paper currency monopolies.

Selgin: So, it took an end around restrictions on the issuance of paper currency by banks by other tech firms to reopen the door to currency competition. And now of course, the Fed is saying, well, we want to compete with them too. We don't want our monopoly currency to be limited to a kind of currency that's old fashioned, that may actually be going out of business someday, may become obsolete. And the banks now in turn, they are starting to get into digital currency fray. So we are getting long run currency competition and innovation. But it took a lot longer than it would have been if the established currency technology hadn't been monopolized by central banks some time ago.

Beckworth: That's interesting. So the counterfactual here is, had competitors been allowed to issue notes, we may be far along this journey already.

Selgin: Yes, banks would have already moved into substitute technologies for bank notes as part of their legal rights to issue currency. And we might not have much paper currency. Now, the other part of the counterfactual is we give the Fed a monopoly in digital currency, now retail, and in 100 years we're all wondering why we're still using this horse and buggy style digital currency when some innovators outside the conventional monetary system have shown that there are better ways.

Beckworth: So in short, the big point, big takeaway here is, innovation in financial services, financial transaction technology, that's a big deal. And we want to be careful that we don't get rid of the energy, the creativity we see out in the private sector from fintechs and others. We want to encourage, not discourage it. And you gave the example of FedNow going into the real time payment system space. And we have a past show with George, we'll provide a link to it in the show notes, but great discussion about that. So that is kind of a good reference point to look at and see what it could imply. But everything I've been seeing George, and we'll come back to this in a minute. Everything I'm seeing and I'm hearing from the Fed and I suspect will be in this white paper is that they too don't want to go into the retail space.

Beckworth: They want to stay wholesale and hopefully when they say they want to stay in the wholesale space they want to do it in a manner similar to what you want them to do. But before we get to your proposal and your preference for how they would do that, I want to bring up one other concern for the Fed entering the retail central bank digital currency space, we mentioned innovation. You also mentioned in that thread on Twitter, probably wouldn't get the best customer service, let's put that to the side for now. The thing that you bring up in this Cato Journal article, this presentation you gave to the conference is the concern about financial instability that even though advocates of a CBDC or a Fed account say, hey, this would actually make everyone's account super safe, right? Because the Fed has no limits on the dollar liabilities it could issue. But it could actually create more problems, more financial instability for the rest of the financial system. So walk us through that, how would a retail checking account at the Fed create problems for the rest of the financial intermediaries out there?

We are getting long run currency competition and innovation. But it took a lot longer than it would have been if the established currency technology hadn't been monopolized by central banks some time ago.

How Fed Accounts Could Create Financial Instability

Selgin: So David, the implicit assumption here and I think it's perfectly reasonable is that any amount of money that is any balance one keeps at the Fed is perfectly safe. It's 100% insured because after all deposit insurance is just a guarantee that you can get Federal Reserve money for your deposits at an ordinary bank. So that's the starting point of the argument. And then from there the problem is that if the Fed is willing to open these private accounts and anybody can access them, then one could imagine scenarios where there is a run from conventional deposits in the rest of the banking system, private, as it were, and commercial deposits too, Fed deposits such as depletes the private banking system. And the reason why this is a particular concern or should be is think about currency. We know of course, that if people run to their banks under today's arrangements and take out paper currency, this is very bad news for the banking system and the Fed has to do something about it.

Selgin: But taking out vast amounts of paper currency is impractical, it's dangerous, you got to keep it somewhere et cetera and it certainly doesn't earn any interest. So, although this can happen and there have been episodes where runs on currency have happened. There are reasons why they're not that common. Now, if we made it possible by pushing a button to take all their money out of a bank and have it in something like Federal Reserve notes, but perfectly safe in the Federal Reserve in an account, then the same kind of circumstances it might not quite lead to a terrible run on currency in the past, might not have done that or even do it today, could conceivably lead to a mass run away from ordinary bank deposits to Fed deposits in the future if the Fed offers those deposits.

Selgin: And this is particularly likely if the Fed were to issue personal accounts and pay the rate of interest it pays on bank reserves currently on those accounts, the same rate, which has been the most popular proposal. Because then we could imagine even situations where, apart from any worries about how well the private banking system is working or how safe it is, but just to take advantage of the interest rate differential because their private deposits of commercial bank deposits will bring nothing which is common enough but it's the norm today. But they can get something with their Fed deposits. Then of course, that too could mean that the commercial banks find they face massive disintermediation. Sure, the Fed doesn't want to kill the ordinary banking system. And I wouldn't want to see that happen because banks do do things that the Fed cannot do or doesn't want to do.

The problem is that if the Fed is willing to open these private accounts and anybody can access them, then one could imagine scenarios where there is a run from conventional deposits in the rest of the banking system.

Beckworth: This is more than a theoretical concern, right? You mentioned in your paper that postal savings, they did something similar during the Great Depression. They at least on the margin contributed to the run on the banking system. Is that right?

Selgin: Yeah, they did. But it wasn't bad. But it wasn't bad because there were limits. So the postal banking system which doesn't exist now but was established in 1911 and continued through the Depression, and for some time afterwards was set up to encourage immigrants especially to save with institutions that were more familiar with what they had dealt with back in Europe. And this was fine as far as that went except the interest rate paid on these postal savings accounts was set administratively much like the Federal Reserve's interest rate on bank reserves today. It was an administrative rate. So in that case I think Congress had to vote to change the rules. Well, when the Depression came along, interest rates on ordinary bank accounts collapsed. But the interest rate on postal savings didn't, it was actually they were earning more money.

Selgin: And sure enough, anybody who could put as much money as they could in the postal savings system, took it out of banks if they had any. But there were limits to the total amount that could be deposited in the postal savings account. If it hadn't been for those limits, then this could have caused a much more serious depletion of bank reserves on top of whatever was already going on in the banking system [inaudible] and made things even worse for the bank. So it's an example of what could go wrong. And particularly again, if the private accounts are unlimited accounts at the Fed, if you can put as much money as you want in there that's when you could face this kind of problem.

Beckworth: Now, this is a feature not a bug of Fed accounts for some advocates, right? They want the Fed to crowd out alternative liabilities out there the financial firms issue that act is money repo. Basically, for some people this is a way to get rid of the shadow banking system, right? And that it would be more of a feature than a bug?

Selgin: Well, yes. But it's not just the fat shadow banking system. It's the banking system that's the ordinary lighted banking system.

Beckworth: Okay.

Selgin: So, yes, some advocates of Fed accounts are quite forthright about this to be fair. So they say, oh, look, this is going to be a replacement for banks, ordinary banks for money market funds, repo markets, make them all go away and the Fed will be the only game in town. Now, if that happened of course, then you wouldn't have to worry about periodic instability because you'd already have none of these other private intermediaries or depositories. Once you get rid of all, they can't be killed again. So in that sense the problem is solved in that case. So I guess you could say that the moral is if you want to have this kind of system, you better run a habit and get rid of the banks and get it over with or be on a rocky road perhaps ultimately leading to that result. And so, pick your poison.

Beckworth: What would be interesting is to see the size of the Fed's balance sheet after this transition to the Fed being the only balance sheet for financial deposits in the country.

Selgin: Oh, it's been heading in that direction.

Beckworth: It has-

Selgin: It has already taken over a big part of the shadow banking [system].

Beckworth: Right. To be fair and one of our friends, Morgan Ricks… I mean, he's made this point I think is fair is that look, the Fed is effectively backstopping all of these private accounts already, right? Money market, commercial paper, heck, bank accounts over in Europe, Euro dollars. I mean, this is just kind of pulling away the veneer and like, yes, this is where we are let's acknowledge it.

Selgin: Well, yeah, there are two ways to look at this though, that's Morgan's way. My way is, by all means let's pull away the veneer. And then let's see what's there… encourage us to get the Fed’s footprint back down to a reasonable size again and revive the private intermediation markets that we used to have with all their faults, they were providing things that we cannot expect a central bank to do if it has all the money.

Let's pull away the veneer. And then let's see what's there… encourage us to get the Fed’s footprint back down to a reasonable size again and revive the private intermediation markets that we used to have with all their faults, they were providing things that we cannot expect a central bank to do if it has all the money.

Beckworth: Okay. One other pushback George and this one comes from our other friend David Andolfatto, you mentioned this in the paper. He says, "Look, okay, I hear your concern, George, about the Fed account offering a higher interest rate than say private banks. So the solution is just tweak that rate. So whatever rate you get at the Fed account, just make it commensurate with what you'd get at a private bank account." And what's your reply to that possible solution?

Selgin: Yeah, my reply to that is simply that I don't think the politics pass the smell test here. Remember, you're creating these accounts, not simply to have the Fed compete with ordinary banks for the same clientele. But to create a refuge especially for the unbanked or underbanked and give them a way to save and become less poor over time. So, now when you're talking about helping the poor and then you want the Fed to have to resort to manipulation of the interest rate they earn as a way to avert runs, particularly in times of zero interest rates or very low interest rates, what you're actually talking about are negative interest rates.

Selgin: Give them negative interest rates so that they take their money out of the Fed or keep it, put it somewhere else. And so, I think that once you established a system like this, it's politically very unlikely that the interest rate won't remain itself a political object the interest rate on those reserves, rather than an instrument that the Fed can manipulate at will in the way that it does manipulate the interest rate on bank reserves. And of course, even that's a controversial rate. There's a reason why we don't see negative interest rates on bank reserves yet in this country, right? It's not popular.

Beckworth: Right.

Selgin: So there are limits to what the Fed can do with its administered interest rates. And I think this particular interest rate would be one where it would face a lot of pressure not to mess around with it in ways that harm the poor depositors especially.

Beckworth: Alright, George. So we have covered essentially, the retail side of the Fed account or central bank digital currency. And that leaves us now with wholesale accounts or wholesale central bank digital currencies, or the acronym that you use and I guess is apparently popular is sCBDC. A little s. So this synthetic, at least in Europe that's what they call them, right? The wholesale CBDC. Okay.

Once you established a system like this, it's politically very unlikely that the interest rate won't remain itself a political object the interest rate on those reserves, rather than an instrument that the Fed can manipulate at will in the way that it does manipulate the interest rate on bank reserves.

Selgin: I don't know why they call them that, it doesn't sound to me like a descriptive term. I think wholesale is a lot more straightforward-

Beckworth: Yeah, I'd say little w maybe wCBDC. But in the event, so I want to go there and talk about that. And then let's outline your proposal for the US. And then after we do that we'll come back and revisit the history that has kind of been a part of the conversation, because a lot of folks are looking at stablecoins. Stablecoins would be one example of someone having access to a Fed master account. And some are concerned about financial stability reasons surrounding stablecoins, it's just another money market fund, just like them is going to be unstable. And they reference the free banking period in the US. I'm going to come back to this history with you since you've written a lot. You're one of the foremost experts on it. We had Larry White another one on a previous show. But before we do that, let's talk about your proposal. So what would you have the Fed do with wholesale CBDC or wholesale Fed accounts?

Proposals for a Wholesale CBDC or Fed Accounts

Selgin: Okay, so the question here is, it really boils down to this. To whom should the Fed offer its wholesale payment services? And especially, how easy should access to those services be for firms that would like to issue private retail digital currency? Now, right now there are no firms with access to the Fed that issue digital currency. Let me step back a bit. The first proposal is the simplest proposal is to say okay, if you're a private stablecoin issuer or you want to be and you have a full-fledged bank charter, an FDIC insured bank, if you become such a bank, then the Fed should not hesitate to allow you to issue stablecoins along with your other deposit liabilities. Now, it just so happens that only recently have we seen a full-fledged bank that is an established full-fledged bank or rather a consortium of banks make plans to issue their own stablecoin.

Selgin: Just came out, this is the plan for a stablecoin that was announced just the other day, I think it's called Figura. It's a consortium USDF. And that is fairly straightforward. There are questions about whether those coins would qualify themselves for deposit insurance, right? Because they're distinct liabilities. But anyway, that's one thing. And by the way, if insofar as it's only ordinary full-fledged banks that issue stablecoins, then that would also be consistent with the president's working group recommendation that only insured depository institutions be allowed. I don't think that's good enough. Because at least so far, with the exception of that consortium, I just mentioned, banks haven't shown much interest in issuing stablecoins. But that is insured ordinary banks. So if we were to limit stablecoin issuance or more generally, any private digital currency issuance to insured banks, we might not get as much as we want.

Selgin: Most of the real action in digital currency and stablecoins particularly is coming from the non-bank payment service providers for non-bank fintechs. And they don't have banking charters, or they have limited purpose banking charters. One at least has applied for a full-fledged banking charter, that’s Circle. I don't think they have it yet. But others have either applied for special purpose charters where they wouldn't be insured, Kraken is the most well-known example of that, or they haven't even applied for any sort of banking charter. My proposal is a modest one for opening the door for these other stablecoin issuers. And it's simply this, that if they get any kind of bank charter even without deposit insurance, like the Wyoming Special Purpose Depository Institution charter that Kraken has, then under certain conditions, the Fed should automatically grant them master accounts.

My proposal is a modest one for opening the door for these other stablecoin issuers. And it's simply this, that if they get any kind of bank charter even without deposit insurance, like the Wyoming Special Purpose Depository Institution charter that Kraken has, then under certain conditions, the Fed should automatically grant them master accounts.

Selgin: Because right now the law says that they're eligible because they are a Chartered Depository Institution, but it doesn't compel the Fed to therefore give them an account. They are only eligible and the Fed’s been sitting on, as Senator Lummis complained in the Powell testimony, the Fed’s been sitting on some of these requests for master accounts for some time and it's become very frustrating for their applicant. Anyway, my proposal specifically was that the Fed should have a fast track for any SPDI holder that issues stablecoins or not, get a master account if its deposits are 100% backed by Federal Reserve master account balances. I didn't say this should be essential, I said this should be sufficient, not necessary. The Fed could and I hope it would consider granting master accounts to non 100% stablecoin issuers or non-narrow stablecoin issuers as I call them.

Selgin: But at least it should be willing to grant master accounts to the ones that offer to keep 100% reserves and meet certain basic capital requirements. Because those firms aren't engaging in maturity transformation and they aren't taking risks. They don't need deposit insurance, it would be like having suspenders and a belt. Just as the Fed itself doesn't need to have accounts insured that it offers or might offer to ordinary citizens. Let me add by the way, the inspiration for this proposal came from the big banks or, rather, the Bank Policy Institute because they were complaining about Kraken. They said Kraken is holding less than 100% real cash reserves at the Fed. It doesn't have those. It's got other things including some risky assets and bonds, et cetera. Kraken's charter doesn't allow it to make loans. But it has some bonds, some maturity mismatching, right?

Selgin: Therefore, it shouldn't be allowed to have a master account. And I thought, okay, in that case, let's have a proposal that says if you do have 100% reserves, you can have a master account. It's a sufficient condition. And I told this to the folks at BPI, I said, that's what I'm proposing what's wrong with that? And I got to kind of [inaudible]. So this, I thought, is an unanswerable reform proposal that would take us further in the direction of a more open approach to private digital currencies. And if they have master accounts they are much much safer, because you have settlement on the Fed’s books, they can conform to all the other kinds of regulatory requirements. And I think this is where we're going to end up going. But I don't think it should just be insured banks.

Beckworth: George, just briefly define what a master account is for those listeners who don't know.

Defining Master Accounts and Their Importance

Selgin: A master account is really just a fancy term for a bank account that someone has at the Federal Reserve instead of an ordinary bank. And presently, most ordinary banks have master accounts at the Fed, almost all of them do. These are insured banks, state and federally chartered banks. Then there are some government agencies that also keep accounts at the Fed or GSEs or government sponsored enterprises I should say. And of course, the US Treasury, it has a big account at the Fed. It got really big a while back, it's now shrinking, called the Treasury General Account.

Selgin: So the proposal is to broaden accessibility to such accounts beyond the conventional banks to at least make it easier for special purpose banks that aren't insured to have such accounts. And that's the sense in which this is central bank digital currency, going beyond ordinary central bank accounts. Because the extreme proposal is that every Tom, Dick, and Harry open an account at the Fed, right? The status quo is let only insured banks have these accounts. And then in between is now let some of these retail private digital currency providers that aren't insured banks have these accounts. It's nice and in between you see.

Beckworth: You are such a moderate George, right there in the middle.

Selgin: I'm a moderate and that's a moderate proposal. Sure enough.

Beckworth: Okay. Going back to the Fed's balance sheet, who currently has access to it? So banks do as you mentioned, GSEs. Technically, you and I do in terms of physical cash, right? We have access-

Selgin: Oh yes, to the balance sheet, not to an account-

Beckworth: Not to an account but to the balance sheet. Okay, fair enough maybe I should be a little more precise.

Selgin: That's right.

Beckworth: But in terms of access to the Fed balance sheet, so put aside you and me and our physical cash, we got banks, we got GSEs. Wouldn't it be fair to say also that money market funds now have access to the Overnight Reverse Repo Facility? They're able to deposit dollars there, so in some sense the Fed has been opening up its balance sheet gradually and this would be just kind of the next step. If we're going to include money market funds why not stablecoins and other fintechs as well? If done properly, of course.

Selgin: Yes, no, I think that's fair enough. There is a difference. The overnight reverse repos do allow money market funds to park money at the Fed and in that sense to have deposits at the Fed. But they don't quite give them access to the Fed’s payment services. Not like a checking account where the Fed can debit, credit, move money around. A money market fund can't pay someone by writing a check off of its Fed account.

Beckworth: Fair enough.

Selgin: So the Fed certainly does allow a broader set of institutions and even private individuals to have access to its liabilities in various forms. But master accounts are special. And those are limited to a very small subset so far of institutions.

Beckworth: Okay, before we move on to the history of free banking and its implications for this proposal of yours. Just to be concrete here, if your proposal went through, you mentioned stablecoins being one example of a fintech firm that would be able to use it. But what would be other examples… would there be anyone providing retail digital currency that would have a master account behind them?

Selgin: Yes. When we think of things like take something like M-Pesa, which is really popular in Africa and some other countries now. Where it's the telephone company Telecom, and so this is digital currency in the sense that it's stored on phones and delivered with a keystroke. But it's not crypto in any sense and so though there are other kinds of digital currency that I think the Fed should be open to supporting through its wholesale settlement services and master accounts. So it wouldn't just be stablecoins in the strict sense of the term. But stablecoins are getting all the attention, perhaps more than they should.

There are other kinds of digital currency that I think the Fed should be open to supporting through its wholesale settlement services and master accounts. So it wouldn't just be stablecoins in the strict sense of the term. But stablecoins are getting all the attention, perhaps more than they should.

Beckworth: So would apps like PayPal and other services that we use like on our phones to do transactions, would that be fair play?

Selgin: Yes. I should have mentioned that a lot of payment service providers, non-bank payment service providers now deal with banks. So they keep accounts at banks, they have accounts at the Fed. So they indirectly access the Fed’s wholesale payment services. The reason stablecoin issuers are somewhat unique and are all running around trying to get bank charters and that sort of thing, is because a stablecoins and all cryptocurrency have a kind of a bad stigma associated with them such that ordinary banks have been discouraged, or have been unwilling to, discouraged from dealing with cryptocurrencies or cryptocurrency issuers or exchanges by regulatory authorities or they've just been afraid to do so. So for all sorts of reasons, the stablecoin issuers as well as other businesses that deal in cryptocurrency are finding it hard to find correspondent banks to deal with. And even if they do of course, those banks take a slice of the action so to speak. And that can have significant effects on a stablecoin issuer say where the profit margins are very low.

Beckworth: Okay, so one day we could have Google Pay, Stripe, PayPal all having direct access to the Fed's balance sheet via master account. In other words, we would cut out the middleman for these providers of payments.

Selgin: Yes.

Beckworth: Okay.

Selgin: I think that would encourage more entry, more innovation-

Beckworth: Lower costs for them.

Selgin: Lower cost and greater competition that would ultimately, and this is going to get to this free banking, I think if all of these issuers are closely connected through the Fed network, that means as well that their liabilities are going to be cleared and settled regularly just like cheques. And that also disciplines them, it's very important. And so you want to have a common exchange network that most monies pass through as a way to make sure that abuses don't go too far if they take place.

Beckworth: Okay, just to summarize what we have covered and maybe the conclusion we've reached at this point in the program is, retail CBDC, no, wholesale CBDC, yes. And now, let's look back to history because there's been some discussion, a lot of discussion actually. Gary Gorton had a paper out, a lot of politicians, Senator Warren, I believe, Secretary Yellen, a number of individuals are talking about stablecoins in this particular context. And they look back to what's called the free banking period in the United States. And they point to examples where they had really horrible banking systems under this regime. So, they point to Michigan, the Wildcat banking period. So maybe you can walk us through this, Larry White was on the show previously and said they aren't really given a fair representation of what happened in the US. But maybe you could speak to the US and more broadly, not just the US but Scotland and other places that use the system like this. And then finally, what are the implications for your proposal in stablecoins?

I think if all of these issuers are closely connected through the Fed network, that means as well that their liabilities are going to be cleared and settled regularly just like cheques. And that also disciplines them, it's very important. And so you want to have a common exchange network that most monies pass through as a way to make sure that abuses don't go too far if they take place.

Free Banking and Stablecoins

Selgin: So, on the one hand David, I think that an analogy between stablecoin issuers, especially if they are banks like this consortium we were talking about. And past banks that issued paper currency, their own paper currency circulating banknotes, I don't think there's anything wrong with that. I think we can use that analogy and look to the past and learn some things from it that apply to stablecoins today that could apply. The problem is that what people like Gorton have done is they've cherry picked from the past. They've actually taken the very worst examples of a bad private banknote currency system which did exist, in fact, some of the worst in the Antebellum United States. And they've argued as if that always is what's going to happen whenever you're having more than one brand of currency of any kind. And that is completely wrong. As you said, we should ultimately talk about what happened outside the United States so we can get a bigger picture.

Selgin: But even for within the United States, that Gorton type story which Gensler and Warren and many others were quick to repeat, is highly inaccurate. He talks about Wildcat banks, well there were a couple hundred maybe out of let's say a thousand banks formed during that period, more than a thousand, closer to two. And the other thing Gorton doesn't say and the others don't say is that, we know why these banking systems, the ones that went bad, why they did, and it was mainly because of the regulators, mainly because of misguided regulations. So the worst of the free banking systems, so called, that was the name of the law. This is also very misleading. They were called "free banking systems" by the state governments that created them. There are about 13 in all by the way, not all of the states had them, even states that existed before the Civil War.

Selgin: Anyway, the worst of them, the failures have been traced to the quality of the bonds that governments required these banks to invest in as a condition for issuing notes. So that was one problem. Basically, the law said here if you want to issue $100 worth of notes, you have to buy bonds, and here are the following bonds that are eligible. And they would include junk on that list or only have junk on the list or stuff that became junk. The other thing that was common to all of these systems and to most US banks at the time in all systems, was that they couldn't have any branches. And unit banking is itself a source of weakness. So, the more you know about the Antebellum US banks, the more you realize how unfair it is, or how misleading it is to draw conclusions from their problems, their shortcomings, and particularly the shortcomings are the worst of them, to formulate conclusions about what would happen if we let stablecoin issuers proliferate today.

Selgin: I mean, there are so many wrong steps in that to get from one place to the other. So, the US banking experience has been misrepresented. But if we go outside of the US, we can find plenty of examples of countries that had multiple banks issuing paper currencies, denominated in the official money, there was always some official gold or silver unit or both. And we find examples of systems that work very, very well, very stable banks, few crises if any. Uniform currencies, even over broad expanses of territory. And of course, banks failed, there were always bank failures, but they weren't systemic banking failures. So the question of course is, what would stablecoin competition be like? Would it be like free banking in Michigan in 1838, which was a flop? Or would it be like a Scottish banking system circa 1840, which was a great success? And I think the answer is if we regulated properly not prohibited, it'll be like Scotland in 1840. And if we regulated stupidly, it could be like Michigan in 1838.

The more you know about the Antebellum US banks, the more you realize how unfair it is, or how misleading it is to draw conclusions from their problems, their shortcomings...to formulate conclusions about what would happen if we let stablecoin issuers proliferate today.

Beckworth: So there is reason to be optimistic that stablecoins can be used in a productive manner. And not just as chartered banks. And the reason we care about that is not just because we like stablecoins, but because we want to foster innovation. We want to foster development, new ideas, new forms of payment, and we don't want it to tighten the screws to the point where we're losing that. So, any further thoughts on that George? Anything you would tell the Fed, you would tell Congress, as they continue to think about this? I mean, the Fed’s coming out the white paper, Congress may take this up for consideration at some point. Anything else you would tell them to think about as they write this law or change regulations to this end?

George’s Message to Congress and the Fed

Selgin: Well, as you were saying before David, I don't think that the Fed really has much of an appetite for the retail digital currency. And quite frankly, if they were to go for it in this paper to say they were proceeding in that direction, my personal conclusion based on what I know, is that that would be evidence that the Fed has yielded to political pressure. And it would be an unfortunate step for that reason alone and not just because it’s technically not the wise way to go. So I hope they won't be going in that direction and I urge them not to. And I also hope that even if they've said they're going to do it in the white paper, they don't necessarily stick to that. One of the problems with the Fed and not all central bank to some degree is, whenever they do something, they never like to say, "Oops, that was a mistake, we shouldn't have done it, we're going to do something else instead."

Selgin: So I hope the white paper doesn't take them down that road and I don't think it will. I urge them to do also something else that I think they already want to do and probably have done, is to hurry up about getting their rules for master accounts established for all banks but also for other depository institutions. I think Congress might want to revisit the Federal Reserve Act and make it easier for the Fed to grant master accounts to non-banks within limits. Because that's only possible with some changing of the wording of the Federal Reserve Act. However, I'd be perfectly happy to see representative Emmer's amendment added to the act to clarify what I believe the act already says, which is that the Fed has no business granting private accounts to ordinary individuals.

I don't think that the Fed really has much of an appetite for the retail digital currency. And quite frankly, if they were to go for it in this paper to say they were proceeding in that direction, my personal conclusion based on what I know, is that that would be evidence that the Fed has yielded to political pressure. And it would be an unfortunate step for that reason alone.

Selgin: Because if that's one way to take that off the table, I think Emmer would be doing the Fed a favor by getting that rule passed. Because I don't think they want to do it and they're under a lot of pressure. So those are some thoughts. I think ultimately, the rules for issuing a stable coins should be consistent with the particular risks involved. Not all stablecoin issuers are equally risky. Stablecoin issuers that really do hold highly liquid assets are less risky and should be less strictly regulated than others. And this is all, I think, common sense. And I think we shouldn't be letting anything but common sense dictate the treatment of these firms that too many people are too scared of to think straight about.

Beckworth: Do you foresee these fintech companies becoming an important part of the landscape for transactions?

Selgin: Oh, absolutely, yes, because you have in digital currency a unique combination, you have the speed, instantaneous practically, and low cost of transacting over any distance. Distance alone is technically meaningless with digital money, at least if you've got the right equipment. But, not all the people making these payments, and most don't have to have bank accounts, they just have to have cell phones. They don't have to qualify for minimum balances or anything like that. So the opportunities for bringing at least some banking services to the unbanked are enhanced. And finally, cryptocurrency technology allows a lot of other things to be done with these different currencies that could be custom made to suit all kinds of particular needs.

Selgin: So we would expect to see many different brands that while they might conform and all stablecoins conform to established units and basic values, they can be different in a lot of different ways to meet niche market needs. Which is not something you can say about the now dominant options of ordinary bank accounts or paper currency. So I think this is going to be a major seismic shift in the way payments are conducted in the future if we let it be, and particularly if we let it be competitive, it can keep shifting and in good ways.

Beckworth: So is it possible we could end up in a world where both retail payments and wholesale payments themselves are both… well, wholesale could be directly backed by the Fed but retail through a master account. But for example money market funds could have their own master accounts and the retail sector with it as well. Where I'm going with this George is could we get to the place where those are more important than say traditional banking? And if so, that would at least sound like or look like a version of narrow banking. I mean, we're getting to the point where every deposit is backed up by an account at the Fed.

I think ultimately, the rules for issuing a stable coins should be consistent with the particular risks involved. Not all stablecoin issuers are equally risky. Stablecoin issuers that really do hold highly liquid assets are less risky and should be less strictly regulated than others. And this is all, I think, common sense. And I think we shouldn't be letting anything but common sense dictate the treatment of these firms that too many people are too scared of to think straight about.

Master Accounts vs Traditional Banking

Selgin: Well, let's be careful. First of all on money market funds, there are reasons why settlement on those funds cannot necessarily work the way it does with bank deposits because the value or your share can fluctuate, right? Well, there are some problems [with] giving them ordinary master accounts. I think, so far, master accounts work for the exchange of debt liabilities but not shares, and not in the same way. As for 100% reserves and Morgan Ricks was very happy about my proposal because it was a kind of an olive branch to narrow banking in the sense that what I was saying is there's no reason for the Fed to hesitate to grant master accounts to fintechs that are offering narrow banking services in the strict sense of 100% reserves. However, I don't think it should be limited to that ultimately. I'm just saying that should be a no brainer, but the Fed should be willing to accommodate others. And for example, this consortium of banks, that they are insured institutions that want to issue a stablecoin, that stablecoin you can be 100% backed. And I think what they would like to see is it qualify for deposit insurance.

Selgin: So, we can have a variety of different kinds of stablecoin issuers both with regard to exactly how they make themselves safe, right? Could be insurance, could be 100% reserves. Yeah, hell of a lot of capital. Now, there are different ways to achieve a reasonable degree of safety in monetary services. And not a one size fits all arrangement. We have that now kind of, we could extend it to a new one size fits all arrangement. But that's not what I think would be ideal. I think we want to have a flexible arrangement that allows for more variety of options.

I think this is going to be a major seismic shift in the way payments are conducted in the future if we let it be, and particularly if we let it be competitive, it can keep shifting and in good ways.

Beckworth: So this goes back to your earlier point about we want to foster innovation, competition, if you want to do it one way, great. Do it another way, fantastic too. Let a thousand different models of financial intermediation bloom and see which ones the marketplace wants the most.

Selgin: Yeah, let me just set an example of that David, as many listeners will know. We've been talking mainly about stablecoins that are IOUs, that are redeemable claims. But they're also algorithmic stablecoins, where they are supposed to keep their, say, dollar value. But it's all done by a computer that makes every one of their issuers like a little mini central bank trying to manage the purchasing power of its currency. They haven't got a very good record at least, generally speaking, but I don't think they should be prohibited. They're highly risky. And caveat emptor, they're like SEC, they might be the SEC's business because they're more like that. But there's no reason to outlaw them in a world where people have plenty of choices. The only times you have to start thinking about prohibiting stuff is when you don't give people choices, so there might only be bad stuff. But there can definitely be good stablecoins. The first priority should be to encourage those make them possible. And then bad ones you can just leave alone because nobody will want them. Because if they do want them, too bad.

Beckworth: Okay. Well, George, with that our time is coming to an end. Now I did want to talk to you about the Fed's balance sheet, the future of its operating system. So what we're going to do is we're going to create a bonus show which we'll release later in the week. But for now we're going to call it wraps. So George thank you for coming back on the show discuss stablecoins, Fed master accounts and the future of payment systems.

Selgin: You're very welcome David. See you soon.

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