Shownotes
Our guest on this episode is Richard Holden, economics professor at the University of New South Wales Sydney author of a new book: Money in the 21st Century: Cheap, Mobile and Digital. Richard explains why the prospect of a private digital currency run by a company like Amazon or Google is a real possibility and why that would represent an enormous transfer of power from democratic governments to a private company. He also talks about China’s digital currency, its vast user base in China and how it even has users in Australia. Richard believes the US should proactively head off the threat from these digital competitors by creating ‘fedcoin’ - a digital currency managed by the Federal Reserve. He believes it could be done with little disruption to consumers and could bring enormous benefits.
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Episode TimeStamps:
02:04 - Introduction to Richard Holden
06:06 - A whole year without cash
08:08 - What are the benefits of cash?
12:40 - The implications of a cashless society
23:53 - A big hurdle
26:04 - Building a better mouse trap
28:08 - Dealing with the U.S. banking regulation
31:13 - The Fed Coin - How could it work?
38:11 - The dark side of the Fed Coin
41:36 - How the borrowing process works in banks
44:55 - How would the Fed control credits?
51:56 - Is Holden working with the Australian government?
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Transcripts
I think that's just one of the sort of timeless facts about superior technology. And I mean technology in a very broad sense.
It doesn't have to be digital or whatever, which is, you know, if you build a better mouse trap and the voters like the better mouse trap, and some politician says I want to take away the mouse trap, it ain't happening. And I think the same thing can play out with digital currencies.
Intro:Imagine spending an hour with the worlds greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more.
Welcome to top traders Unplugged, the place where you can learn from the best hedge fund managers in the world. So you can take your manager due diligence or investment career to the next level.
Before we begin todays conversation, remember to keep two things in all the discussion well have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance.
Also understand that there is a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran hedge fund manager Niels Kostrup Larsen.
Niels Kaastrup-Larsen:For me, the best part of my podcasting journey has been the opportunity to speak to a huge range of extraordinary people from all around the world.
In this series, I have invited one of them, namely Kevin Koldine, to host a series of in depth conversations to help uncover and explain new ideas to make you a better investor.
In the series, Kevin will be speaking to authors of new books and research papers to better understand the global economy and the dynamics that shape it so that we can all successfully navigate the challenges within it. And with that, please welcome Kevin Coldiron.
Kevin Coldiron:Okay, thanks Niels, and welcome everyone. So what is money going to look like in the coming decades?
Who's going to control it? Could it be a private company? Could it be Amazon or Google? Could it be a country like China?
Can banks survive in their current form if their special ability to create money is overtaken by one of these competitors? These questions might sound fantastical, but they're much more relevant and pressing than you might believe.
Our guest today is the author of a new book that addresses them directly, including a detailed recommendation for how central banks like the Fed need to respond. The book is called money in the 21st century, cheap, mobile, and digital, and the author is Richard Holden.
Richard is professor of economics at the University of New South Wales in Sydney, and he's previously been on the faculty at University of Chicago at MIT. So Richard, thanks so much for joining us. And welcome to the show.
Richard Holden:Thank you.
Kevin Coldiron:So before I ask my first question, I have to go off script a little bit. Tell you about something that happened to me a few hours ago. We had a woman come in to tune our piano.
And she's a musician, actually spends most of her time living in the mountains, hiking, meditating, that kind of person. And she says she tuned her piano. And when she's done, she gives me her Venmo QR code. And so I scan it, I pay her. It takes 5 seconds.
And when were finished, she says, yeah, I think cash is over. I think were all going to be using digital money in the future, bitcoin or something.
And then she pauses again and she says, I dont know how banks are going to survive. Theyre going to have to change their business model. And I was like, well, yeah, im talking to a Harvard economist later today.
So youre not alone in your view, about the cashless society. Could you just start off by giving us a quick overview of your background?
How did you get interested in the future of money and the potential of moving to a society that doesnt have cash?
Richard Holden:Yeah, as you said, im a PhD economist. I did my PhD in the Harvard economics department, was on the faculty at MIT in Chicago.
I work in a range of different areas of economics, but my core area is an area called contract theory, which is kind of like game theory, but where you get to design the rules of the game. And that connects to finance quite a lot.
So I've been studying and thinking about and writing about and working on issues to do with finance for 20 odd years. And this topic really comes up a great deal.
per in Australia, and January:It's like August in France kind of thing. And so the opinion page editor said, I want something a little more engaging, a little more fun for early January, little sort of beach reading.
You got something that's a little lighter. And I said, well, I think Australia and other countries are going to and could become like a fully cashless society.
January:A lot of people hate this idea, that kind of libertarian anti government types are not so jazzed about the idea of government money and no cash and no anonymity and things like that.
Anyway, that got a bit of traction and I sort of kept thinking about it and kept writing about it, and that's how I really got into ending up writing this book some years later.
Kevin Coldiron: And so you did the whole of: Richard Holden:Yeah. So I decided that, I mean, I kind of rarely used cashback at that time. Australia's pretty far down the curve on tap cards.
It's been a long time since you had to use a magnetic strip or sign a thing on a credit card in Australia. And we have by virtue of a, a banking oligopoly, where there are really four very large banks in Australia.
They distribute the point of sale equipment like the fpos terminals to every your local convenience stores or 711 equivalent, your local cafe, coffee shop. They all have these nice payment terminals and have had for a long time. So you could tap with a card.
And then, of course, when Apple pay came along, you tap with your phone or your watch and things like that. And so I never really wanted to carry cash around. It was kind of a pain.
And so just to prove a point, after I read that article and I got a bunch of people saying, well, you don't understand, and what if there's a tsunami and the lights go out and all this kind of stuff? So I made a bet with a buddy of mine that I could go a year without using cash. And to be honest, it was the easiest bet ever to win.
And I get it that I live in a major capital city and I'm kind of a bit more digitally engaged than your average 80 year old retiree and things like that. But it was the easiest thing ever. In fact, I'm not sure that I've ever used cash since then, and it's been several years since then, obviously.
But that's part of the point, which is when the system is set up well for that, as it is in countries like Sweden and other european countries, in Australia and New Zealand and a bunch of other countries, its very easy to go without using cash. And theres a whole lot of benefits for consumers and for businesses themselves.
Kevin Coldiron:What did you win in your bet?
Richard Holden:I think I won a very nice bottle of red wine. So it was definitely worth it.
Kevin Coldiron:It wasnt a dollar 20 bill then.
Richard Holden:No, it wasnt a dollar 20 bill.
Kevin Coldiron:You mentioned that libertarians hate the idea of a cashless society. Maybe before we get into the guts of your, what you'd like to see happen, what are the benefits of cash?
Or when people argue for cash, what are they saying, hey, we need cash because of this?
Richard Holden:I hear two main arguments. One is anonymity. People aren't tracing.
y, post writing this thing in:And I'd never done a lot of talk back radio before, but you get to engage with some pretty interesting characters, sometimes amusing, sometimes a little frightening, sometimes a bit of both. And I remember one really stuck in my mind. This guy came on and he said, yeah, professor, it's like, I hear what you're saying.
It's interesting, but there's one big problem. I said, okay, what's the big problem? And he said, look, if I don't have cash when I go to a sex shop, my wife is going to know about it.
She's going to see it on my bank statements and stuff. I say, yeah, can see how that would be a problem.
But maybe the cash cashless thing isn't the root cause of the problem, is the symptom, not the cause, but people like their privacy for one reason or another, including people who, on the more libertarian right, and you've got more of these folks in the United States than we have in Australia, but who think that the government is going to track them down and all this kind of stuff. So I get that cash provides anonymity.
Now, the flip side of that is cash provides anonymity for drug dealers and trial child traffickers and tax evaders and stuff.
And I, to be honest, think that's much more of a problem than it is for people who are cheating on their wives or freaking out about government unnecessarily.
The other benefit that people point to, and I think there's a bit of a misnomer, but it's a very understandable thing to point to, is they say, hang on a minute, like we have blackouts and brownouts and the network goes down.
And we had that tech crash recently around the world where there was a, a software update and all of a sudden you couldn't get it on an airplane and the banks were in trouble and stuff like that. That's totally a real thing I often respond to that in a couple of ways.
So one is to say if there's a big blackout, the way I put it is a bit overly cute, which is if there's a tsunami, you're probably not out buying coffee, scrambling for higher ground. The less glib way to put it is if the power goes out, your local convenience store is shutting their doors. Power goes out is bad news.
If you're a small business owner, you're worried about looting and various other things and you're certainly not able to operate your business safely. So you've got cash. That doesn't help you. No one's selling you anything in a big power outage or in the event of a natural disaster.
The other thing that we saw I thought, interestingly, I don't know how widely this applied, but it was certainly true in Sydney, Australia, when that software update brought down a whole bunch of computer systems around the world, the local supermarkets, I went grocery shopping and they said the only way you can pay is with a card or a phone at these terminals because their cash registers are all digital. So they couldn't have, they couldnt accept cash but they could accept cards in this thing.
So in a perverse way, actually, cash is worse maybe in these kind of things. So I hear its very natural to say cash is anonymous and cash works when the power goes out.
But I dont think thats actually true when you work through the details.
Kevin Coldiron:Yeah, I felt, I dont know, a little bit embarrassed as I was reading that section of your book because ive got a, I won't say where, but I've got cash stuffed in various places in my house just for that reason. But yeah, it's a bit like having gold. You're not going to walk down to the store and buy a loaf of bread with a gold coin either.
I think it's an important point.
Your view is that those somewhat minority, I guess, objections aside, theres a lot of benefits to moving to a cashless society if I got this right, and tell me if I do, you said theres three ways that that could happen.
A kind of existing cryptocurrency like bitcoin or ethereum could become the dominant currency, or a private digital currency issued by a company like Amazon or Google could become dominant, or a government sponsored digital currency, central bank digital currency managed by say the Fed or another central bank like China could take over.
And my sense is that of the first two, you think it's much more likely that a private digital currency issued by a company could be a viable alternative.
And that the way for governments to sort of counter that risk is almost like a preemptive strike to introduce their own central bank digital currency before that happens, and if that's done right, that you can sort of capture some of the benefit of digital currencies that a private digital currency would deliver. Anyway, so I just wanted to, first of all, just ask if I've kind of got that summary right, broadly speaking.
Richard Holden:Yeah, no, the summary is absolutely perfect. You put it much better than I do in the book.
And I should say to your listeners, there is a little bit more in the book, but that's basically the point. Please do read the book. But no, that's a perfect summary. So just to unpack that.
So first thing is, it's very unlikely that something like bitcoin, or ethereum in my view, is going to become a dominant digital currency for transaction purposes.
Bitcoin, for instance, is a store of value for some people, again, often people who want to keep their money outside of the view of say tax authorities or the like. So it's a store of value, but for transactional purposes it's really kind of useless. The transaction costs are very high.
a car or something that spent:And when you work through actually what you end up paying as fees and charges effectively in order to do, its extremely high. And so people don't want to blow 10% of their money every time they go buy something.
So I think bitcoin and Ethereum are just poorly set up for transactional purposes. That's not their goal in a way they're designed, in a way that makes them ineffective for that.
Then there's a question about private digital currencies. And yeah, you're right.
I point to some of these big platform companies have a pretty nice head start, like Amazon, or it could be Apple, or it could be a number of these other platform based companies.
And the whole book starts actually with a meeting between secretary of the Treasury Jenny Yellen and fed chair Jay Powell in Janet Yellen's office, talking about whether they should let Facebook, as it then was. I guess it's meta now. Trial. The digital currency they were proposing called Libra. They later rebadged at DM, but they had gotten.
Facebook had gone really far down the curve on getting this established. They'd got visa and Mastercard to agree to be part of the consortium.
They got a whole lot of really big vendors and quasi financial institutions, or financial institutions to sign up to it.
They had a really, really good marketing pitch, which was, there's a ton of people, particularly in sub saharan Africa and other parts of the less developed world, of the developing world, that are unbanked, like don't have bank accounts and end up being unable to save very effectively, unable to transact very effectively, can be exploited to a great extent, who basically can't store the value of their labor and therefore really get exploited at a very basic human level.
And they basically said, we're going to bank the unbanked and we're going to make this better, and we're going to solve the problems with some of the existing digital coins where you worry about how well backed they are. And there were some high profile bank runs on some of these coins that were meant to be totally safe, that turned out weren't totally safe at all.
And they said, we're going to put this thing in this Libra reserve, and it's going to be in a basket of actual currency, and we're just going to park the money with the US treasury and park the money with the bank of England and park the money in Japan and park the money in Australia, and it'll all be totally transparent. And they realized that they could make the money off of controlling this currency.
They didn't need to muck around with the reserve and trying to skimp at the margin there. So they could be totally honest about that and say, with hands above the table here. And they came breathtakingly close. In fact, it's well reported.
I'm not breaking any news here. I tell the story in my own way. But Jay Powell was kind of in favor of it and went to Janet Yellen and said, look, what's the harm here? Like a trial?
And Yellen kind of thought about it and then came back and said, Yellen's a. Apart from being a former Fed chair and a treasury secretary, he was a very distinguished economics professor as well, back in the day.
And so the kind of economics professor in her kicked in and was like, hang on a minute. This isn't just a trial. This is like the beginning of a kind of irreversible wave here where they get entrenched.
And then there's this thing economists talk about, about network externalities. And the way I always describe it is think about Uber.
And if you're a rider on Uber, it's good when there are lots of drivers on Uber because you don't have to wait very long to get picked up. Right.
If you remember, anyone remembers Uber right at the start, when it just started in your city, you know, you wait like twelve minutes because there just weren't that many cars available. And it's kind of like, is this really better than a cab? Like, I'm not so sure. It's got the math. Twelve minutes is kind of a long time.
And then because there were all these riders, the drivers way, its pretty appealing to be a driver because theres lots of business out there. And this thing just feeds on itself to where in most places now its like, wait a minute, maybe three minutes, this kind of stuff.
And so thats the power of network externalities. The more people that are on the platform, the more attractive it is to be on the platform.
So the more people there are on the platform, its this kind of virtuous circle.
Well, thats what Yellen saw coming with Facebook's currency, Libra, which was, you give them a foothold and then it's going to feed on itself just like a network, just like Uber or just like any one of these other networks. And so she said, we better not let them get going. That's like one person making one decision that the world could look very, very different.
And I really wonder if one of these other companies, like an apple or an Amazon, and I have a bit of fun with it, calling it bezos bucks and stuff like that, tried one of these digital currencies and took it out for a spin, it could get a foothold, and that would give them an enormous amount of power.
And I've got a lot of admiration for what Mark Zuckerberg's done, and I don't mean to turn him into a pinata or attribute bad motivation or anything, but you can imagine if calibra, if Libra, rather calibra is the digital wallet, if Libra had gotten a foothold and hes got this reserve where hes got hundreds of billions or trillions of dollars that he can allocate between us treasuries and british government securities and Australia and so on, you can imagine it very easily being in a position to, again, I dont want to attribute bad motives to the guy. You'd be in a position where you could say, hey, Australia, you make up 5% of the Libra reserve.
But we were thinking that you've got some quirky government policies. We're a little worried about sovereign risk taxing your mining companies too much or something.
We were thinking of making that 2.5% that would lead to a massive run on the australian dollar, create all kinds of problems.
You can imagine him saying, on the other hand, were thinking about making a big investment in Australia, but we really think we should get some concessional tax treatment.
And I dont want to be too cute about it, but it would put these if you control a meaningful amount of the money in the world, itll give you enormous power to negotiate side deals with governments about your tax treatment or various other privileges you could get or not get. Governments would find it totally, they might not like it, but it would be totally rational for them to cave in on that.
So I worry a lot about a private company having that kind of leverage. And I'm a pretty kind of centrist. Markets are good. Markets typically work kind of economist.
So it's not like I'm anti business, but I think handing business that kind of power would be pretty troubling. And then the last part in this very long winded answer is, you talked about what, about other governments controlling things.
And what I talk about at some length in the book is, again, this is out there, this isnt cutting edge reporting, but most people probably dont realize how far China has gotten. Theyre not trialing a digital currency. Its called the ecny are rolling it out.
I mean, there are hundreds and hundreds of millions of people in China who are using on a daily basis a government digital currency. And they are very clearly moving towards eliminating cash in, in China and making everything digital.
And of course, with things like WeChat Pay and Alipay and things like that, this stuff can be used around the world. Now I'm a professor at a university in Sydney, Australia. You might think like, well, how much does that affect somewhere?
We have quite a lot of international students, many of whom come from mainland China. All the food outlets on our campus, they all take WeChat pay, they all take Alipay.
Kevin Coldiron:Just to be clear, are they getting paid in the chinese electronic currency or is that getting, are they getting Aussie dollars?
Richard Holden:The merchants are getting Aussie dollars and they're doing the conversion. But you can easily imagine a situation where that tips.
Kevin Coldiron:But the merchant then needs to be able to spend those digital chinese currency somewhere else in Sydney. Right. So there has to be a network of merchants who all accept it.
Richard Holden:Exactly.
Kevin Coldiron:Their suppliers have to accept it there. Their workers have to accept it. That seems like a fairly big hurdle.
Richard Holden:It is a big hurdle. So maybe the Amazon example is most instructive to see how that works here. So if you sell stuff on Amazon.
And Amazon say you got to take bezos bucks, right? So what can you spend that on? Well, you can spend that on anything you like on Amazon. That's like a lot of stuff right now.
Thats not your workers necessarily.
It might not all happen in just one fell swoop, but all of a sudden its like, well, maybe you buy a lot of your inputs to whatever youre selling on Amazon, or maybe a lot of your personal consumption is on Amazon.
And you can imagine they say, well, you get like a 2% discount or a 3% discount or maybe in the early days you get a 7% discount for spending bezos bucks. So you get this whole kind of side economy using bezos bucks. And because its such a big platform, thats its own kind of economy.
And you can imagine how that spills over. So, yeah, how a government suddenly converts Australia into the chinese digital currency. Thats a big step.
But you can imagine sub pockets of the economy working that way. So we have Uber here, we dont have Lyft. We do have Didi, the chinese ride sharing company.
Now Didi actually do, in Sydney, Australia, take chinese digital currency. And for a lot of people who are drivers on Didi, they want to buy stuff that's the equivalent of buying stuff on Amazon.
They want to buy stuff through Alibaba and other things so they can buy books and electronics and all kinds of stuff. So you can see how they probably dont want all their money in that.
But you get a quarter of your income in that and youre spending a quarter of your income in the chinese digital currency. Maybe thats better for you. So you can see how it gets a foothold. And once it gets a foothold, it can feed on itself.
Kevin Coldiron:Preston yeah, I appreciate that. Those are good examples I guess I was working through in my own head. Why couldnt the government just ban it?
But like you say, I mean, say Trump gets elected and decides to greenlight the bezos bucks or whatever. Amazon started their own digital currency, and then four years later whoever comes in says it's not a good idea.
Well, if it's got enough of a foothold, then you start getting people saying, hold on, I like these things.
Richard Holden:Exactly. So, I mean, this was true in many cities around the world.
I don't mean to be too australian centric, but I happen to know this example extremely well when Uber, and I love Uber. And full disclosure, I've done a little work for Uber, so you can take that with a grain of salt. As to whether I'm an impartial observer, or not.
I'll mention that in the interest of full disclosure, but when Uber entered many markets, certainly true in Australia, they just entered and it wasn't legal, but consumers really liked it. It was just like a much better product got things faster. You could see where your driver was on a map rather than remember calling a cab.
Maybe it'll come in 20 minutes. Get stuffed.
You had to call back and you're worried about making your flight or whatever it is or your daughter's concert recital and all that kind of stuff. It was just a better product and they got a foothold.
And then people started to complain and a bunch of state governments in Australia came out and said we want to ban it. And people were like, the voters were like, the hell you're going to ban it. Don't take that away from us.
So I think that's just one of the sort of timeless facts about superior technology. And I mean technology in a very broad sense.
It doesn't have to be digital or whatever, which is if you build a better mousetrap and the voters like the better mouse trap and some politician says I want to take away the mouse trap. It ain't happening. And I think the same thing can play out with digital currencies.
Kevin Coldiron:Mike, one more question. I want to move on to your recommendations for how we can head off that.
Aren't there rules in the US and maybe this is outdated, that segregate or separate industrial companies from owning banks. Wouldn't that apply in this case?
Richard Holden:Yeah there are.
And you know, to go one step further, you know Apple have been quite clear that they're not really all that jazzed about getting in to all the regulation that's involved in becoming a bank so they could set up a subsidiary. You know they partner with Goldman Sachs to offer the Apple card for instance. Right. Again, full disclosure, I have one of those.
But im not sure its been a wild success for either Apple or for Goldman Sachs and they dont want to be subject to all that kind of regulation. Having said that, you can also imagine firstly rules and regulations change and are changeable.
And when youve got a literally unlimited amount of money to lobby with if you really want to, if you really want to get things done, you probably got a pretty good shot. I think the other thing is it depends on the size of the prize.
I can understand why Apple say do we really want 10% of the credit card market relative to our core business? We got a two or $3 trillion core business. What are we mucking around with that? If they say, hang on a minute, we might be able to control the world.
Take it to what sounds like a ludicrous extreme.
Sort of think like Steve Jobs might have thought for a minute and say, hang on a minute, we got a plausible chance over the next decade or so to control the world's reserve currency. That seems like a pretty big prize. That makes the iPhone market look kind of niche.
And so I could imagine an Apple chief executive or a bezos or someone like that saying, okay, it sounds extreme, but it also sounded kind of crazy that a digital bookseller would become what Amazon has come today. Sounded crazy that the company that made the Mac would become the apple of today. And a lot of these, it's part of why they're successful.
It's part of what's remarkable about them. A lot of the Silicon Valley folks, they don't think small.
If youre thinking about colonizing Mars and kind of putting your money where your mouth is on that, and I dont know whether Elon Musk is going to succeed at that or not, sounds kind of hard to me. But what do I know? Thats one of the many reasons why Elon Musk is Elon Musk and Im who I am, but these guys dont think small.
And oh, controlling the worlds reserve digital currency, that sounds like kind of chump change relative to colonizing Mars. I don't know, I could see one of them taking a tilt at this, taking it on.
Kevin Coldiron:Yeah. Okay. So given that situation, your view is, hey, we shouldn't just wait for it to happen.
We should say, okay, when I say we, I'm going to use the US here just because that's the example you use in the book we should create, I think you call it fed coin, is that right?
Richard Holden:Yeah.
Kevin Coldiron:And that would be the basic, that would be kind of a central bank digital currency operated by the Fed with a lot of the same digital benefits, but still retaining the control over the currency, the power, with the democratically elected government instead of a private company. So can you explain how that would work or how you think it should work, your particular suggestion for how that could be done?
Richard Holden:Yeah, totally. So first, just to ground ideas, pick up on what you said. It's exactly right.
Which is, I think, the answer to what China's doing and what private providers might try and do.
And we've already seen this kind of Facebook sort of failed attempt, but we should view it, I think, more as a very, very near success rather than some kind of failure. See it as a preview rather than something that's in the rearview mirror is for the Fed to preemptive. So yeah, you're right.
I call it Fedcoin for lack of a better term. And there's a little bit of a play on bitcoin. So the government should create its own central bank digital currency.
I'll say a little bit about how that would work. Why do that? There's an offensive rationale and a defensive rationale.
The defensive rationale is exactly what we've been talking about, which is don't let China become the world's reserve currency. That would be really bad for the US. The US gets a lot out of having the world's reserve currency.
It gets to borrow a lot more and run massive deficits and borrow at very cheap rates. This is what a former french finance minister many decades ago called the exorbitant privilege. And that name has kind of stuck.
And whether it's exorbitant or not, it's certainly a privilege. And the US is a great beneficiary from that.
The other thing is there's all kinds of, I wouldn't even call it soft power, I'd call it kind of hard power.
There's all kinds of real politic that comes with basically all the commodities in the world trading in us dollars and things like that in terms of international trade and the power that comes from that. So it's very valuable. So that's the kind of defensive rationale is you don't want to lose that to either a private provider or to China.
The offensive rationale comes from what's become known as web three. And web two was the Internet and stuff, and digital commerce and so on. Web three is basically smart contracts and programmable money.
And that's if you've heard of Defi or decentralized finance, that's what this stuff is.
And it includes things like instantaneous currency transfers from kiwi dollars to british pounds instantaneously basically for free, compared to that taking like three to five business days and costing meaningful amounts or annoyingly meaningful amounts of money and so on. And so all of that kind of stuff is powered by. At the moment, the way that's done is its powered by blockchain technology.
And that was the rationale for.
And I talk about one of the three protagonists in the book as I tell the story through the lens of Janet Yellen, Raghu Rajan, who was, I had the great privilege of being his colleague at the University of Chicago for several years. And he was also, he ran the central bank of India for a while. And so he's one of the other characters.
The third character is a guy called Vitalik Buterin, who was the founder of Ethereum, and it's the closest thing to the God of the blockchain and cryptocurrency world. He had this really good idea, which was bitcoins, just a coin, and it's a store of value.
And as we talked about, it's not that useful for transacting. He said, well, what if you put a programming language on top of a bitcoin type thing and allow people to write smart contracts?
He invented that idea, basically so I can write a computer script that self executing. We don't need a court of law to adjudicate the contract. We don't need to reduce evidence about whether you performed your bit of it.
If I want to write, for instance, an insurance contract on a weather event that's verifiable by stuff that's in the public domain, what was the wind speed of a cyclone? How much did it rain to boise on a particular day or whatever, which are very useful.
These contracts happen all the time for risk sharing purposes and so on.
You can just write those as part of a computer script and a smart contract that's becoming a bigger and bigger thing, these smart contracts defi and so on.
This is the offensive rationale for a fed coin, which is create a coin that's got all these programmable money features and you can smart contract is.
But that doesnt have the downside of the anonymity of the blockchain, so that it can be used for nefarious purposes, criminal purposes, money laundering, all that kind of stuff. But has the upside of being able to be used for digital contracting.
And the key design feature here is theres no need, if the feds going to do this, theres no need to use a decentralized ledger or thats what a blockchain is. Everyone holds the ledger, and you use cryptography essentially to create trust in it.
If youve got the fed running it, you can have a centralized ledger.
So you dont need to have people running around mining bitcoin using tons of energy, maybe causing environmental damage, but mainly just using a lot of energy. Its very costly. The fed, even the crazy libertarian guys, they still trust the fed to the degree that they're willing to hold us dollar banknotes.
And so there is already a lot of trust in this centralized authority, the Federal Reserve, and they could just change paper currency into digital currency.
And there's your Fedcoin run on a centralized ledger, and you'd basically just have an app on your phone and your bank account would tell you you've got this many us dollars would look exactly the same, but everything would transact digitally and there'd just be no paper currency sloshing around. There'd just be digital currency, as there currently is quite a lot of, in a sense anyway, sloshing around in the economy.
Now, there's one kind of serious wrinkle with that. I mean, there's the politics of how you would ever get that done, given the distrust that a meaningful portion of the population have of government.
And I don't want to get into the politics around the upcoming election, but you can imagine that a certain portion of the electorate that are going to vote a certain way probably aren't so enthusiastic about empowering the federal government more. But let me just bracket that for now and that's less so in a bunch of other countries.
That's not true in England or Australia or New Zealand or Canada or various other countries. But let's set that aside. Commercial banks would be in a different position here. So commercial banks, and you mentioned this right at the start.
Again, this is well known, but kind of, unless you're really in the weeds of how the banking system works, people might not be quite so aware of this. Actually, individual banks, whether it's Chase Manhattan or your run of the mill savings and loan, they actually can create money.
Sounds weird to people, but heres an example of how it works. So imagine you go get a mortgage for $400,000. So what does your bank do when they give you a mortgage for $400,000?
Kevin Coldiron:Im in California, so we better increase that number.
Richard Holden:Yeah, I didnt want to go with too big a number, but Im in Sydney, Australia. $400,000 buys you like a parking space here. Lets call it a million dollars. Keep a round number. So you borrow a million dollars.
Well, what does the bank do? Well, what they actually do is they credit and they create an account for you and they create two accounts.
They create a mortgage account that says you owe us a million dollars and you're going to make this monthly payment.
And they create a second account where they put a million dollars in it and the money pretty quickly gets sucked out of that to go pay the fendor for the seller, for the house that you buy. But what have they done in that transaction? It's good old double entry bookkeeping credit. A million, debit a million.
They just created a million dollars out of cine. And that's the way that works. Now, what if fed? So banks are doing two things here. They're acting as intermediaries.
They're matching up lenders and borrowers. So what happened when they lent you a million dollars?
each and:They find people who are willing to put money on deposit or have cds or bond investors who they can sell bonds to, then they lend it. So they borrow from depositors and bondholders. They lend to mortgages. They do that. They're acting as an intermediary.
The second thing they're doing is they're acting as credit creators. Now go to the world where there's fedcoin. Well, the Fed creates the money supply there.
They say this is how many fed coins are out there might be trillions and trillions of them, but it's like this is how much fed coin they're out there. So the commercial banks no longer get to create that. So theyre no longer credit creators. Theyre still intermediaries. So what do they do?
Kevin Coldiron:Preston, what happens in that world? This is a question im glad you brought this up that I really wanted to ask, which is what happens in that world?
When I walk into the bank and say, I want a mortgage, does the bank have to then go to the Fed and say, hey, can Kevin get a mortgage, or do they just give you the mortgage? And then the feds just assumes that their credit process is good. Do you know what I mean?
Richard Holden:I totally know what you mean. From your perspective as a borrower, everything is going to look exactly the same behind the scenes at the bank.
What they do is instead of magicing up the money by the process of debits and credits that we talked about just before, what they do is they go to the Fed and say, I want a million dollars. Now they don't have to say, this is I'm going to give it to Kevin. And trust me, he's good. It's still on their books.
So what they do is they just borrow a million dollars from the Fed, right? And the Fed decides on what the money supply is. That's the same as them setting the interest rate.
So they do this already, which is they lend money to commercial banks, okay, and commercial banks have money on deposit with them. And that's exactly what setting the federal funds rate does. So they would just go to the Fed and they would say, oh, the federal funds rates say 4%.
It's a little higher at the moment, but it's probably coming down soon.
They say oh, I can borrow from the Fed at 4% and then say well, Kevin's a really good credit risk and he's not borrowing 100% of the value of his home, he's only borrowing 70%. He's got a good income and he's always paid back his debts. He's got a great credit score.
Im going to charge him a 1.5% premium, im going to charge him 5.5% for his mortgage and id lend to him and I make 150 basis points as the bank on the way through.
Thats effectively what the economics of what happens to their income statement at the moment theyre borrowing and lending, but just what theyre not doing in Fedcoin world in the future, as I see it, is theyre not creating money.
So the Fed is controlling the money supply rather than commercial banks having a meaningful role in the creation of credit and therefore the amount of money sloshing around now they make some money out of that. At the moment, the commercial banks make some money out of creating credit the same way that the government makes money out of printing bills.
It costs not very much to print a dollar 50 bill, but people are willing to, you know, it's worth $50. And that difference is, you know, roughly speaking, that difference is what's known as senior age.
And banks, commercial banks basically earn a different kind, but it's fundamentally economically the same thing. They earn seniorage at the moment by creating credit. That money would go away. It's not the lion's share of their economics.
The lion share is the 150 or 200 basis point spread that they earn on lending the money out to you and taking the credit risk. But they would lose a bit of money from that.
And you'd have to figure out a way to make sure that the commercial banks didn't freak out too much about that. But that's the process of what would happen. That's the mechanics of what would happen.
Kevin Coldiron:I just want to circle back, make sure I understand how is the Fed controlling credit in that world.
Unless they are saying no to banks or unless they are saying hey, theres a stock of loans that were going to allow to be created this year and then banks, that will be a limit because otherwise it seems to me that the Fed either has to have some ability to reject new loans or else commercial banks are just creating credit in the same way they do. Now maybe I'm not fully understood, so.
Richard Holden:It'S a great question. So think of it this way, and this is actually how it worked. We're actually going back to how it worked in the Volcker era. So think of it this way.
Right now, what the Fed does is it sets the price of money through the federal funds rate of then the market clears their supply and demand. They set the price. And the intersection of the supply and demand curve for money basically tells you what the quantity is.
Think about your undergraduate principles course in economics. You got price on the vertical axis and quantity on the horizontal axis. You got a demand curve that slopes down, a supply curve that slopes up.
You take the intersection point and you can translate price into quantity. What happens now in the new Fed coin world? The Fed sets the quantity of money.
They say they're going to be this much amount of money, this many fed coins. And now you just start on the horizontal axis and you say, I know what the quantity is.
Now I can go up, hit the intersection of the supply and demand. That tells me what the price is. So we move from a world where the Fed sets the price of money and the quantity is the outcome.
So they set the quantity of money and price. The federal funds rate is the outcome. Thats how it used to work, kind of the sort of volcanic pre volcker era.
And so its a different world, but its not a totally unfamiliar one. And of course its not like this stuff is. Firstly, theyre adjusting these things in kind of real time, and its not really a mystery.
So its not like, oh, we set the quantity and who knows what the federal funds rate is going to shake out to be? Oh, we thought it was going to be 4%. It was actually 21%. They know what it is at the moment.
They know whats clearing the market, they know what the conditions are. So theyre just adjusting this around. Were talking about micro movements here, but thats the difference right now.
They tell you the price and quantities. What shakes out of the system. In the fed coin world, they tell you the quantity and prices. What is shake out of the system?
Kevin Coldiron:So from an individual's perspective, putting monetary policy aside, really the difference is you still have your account at whatever bank you choose to hold. You just have an account that's denominated in these fed coin tokens as opposed to bank deposits.
And these tokens then can become used as part of smart contracts in a way that, say, dollars aren't so easily done now because there's a presumably like a programming language or capability built around that 100%.
Richard Holden:So from a consumer perspective, you wouldn't even really know the difference, which is you just look at your bank account and it's not going to have a different symbol. And it wouldn't even really say coins, it'd just say us dollar.
So you just look at your checking account and say, I got $2,100 in my checking account. It's just the same as before. And you can spend it in all the same ways. It's just you can't write checks and you can't get cash out.
But you can use a card, you can use your phone, you can use your watch, you can use whatever to do that. You can use your online banking to transfer it to somebody else. You can use Venmo. The only thing is you can't use banknotes and quarters and stuff.
And then there's the layer on top, which is the web three, Ethereum programmable. Now the smart contract stuff, where because you've got this much more efficient system, I think you'd see web three really flourish.
I think one of the things I talk about is there's this big chicken and egg problem with web three. In a way, it's remarkable that smart contracts have got as far as they have, because you got to use Ethereum, Ether, the Ethereum digital currency.
Now, I've done some stuff with that as proof of concept. It's like a pain. You got to go through an exchange. You got to exchange us dollars for this stuff. It's expensive, the transaction costs are high.
Then this thing moves around wildly. So you could make or lose your money could halve or double in a week between. When you take it in, take it out.
I've done some research with this stuff around how to design smart contracts. Fine, I spent $2,000, and it's for a kind of scientific purpose, but I'd feel a lot more nervous if I was using it on a day to day basis.
The great advantage of something like Fedcoin is it'd be super stable, so you wouldn't have these big wild price swings.
And then you could imagine people much more likely to develop very useful, smart contracts for people because there would be this user base for, it's like this network externality thing. It's just like suddenly there's an uber that kind of works that people want to use, and that becomes a self fulfilling prophecy.
And so part of what's difficult, I try in the book, to foreshadow some of the things that could be done in the future. Part of what's hard about this is, I said before an obvious statement, there's a reason that Elon Musk is who he is. Theres a reason I am who I am.
I cant really envision the kind of amazing innovation that will happen with smart contracts and digital money in the future, because until we have the tools to do it, we havent seen what really creative young people can do with this stuff. But what I know for sure is that you give them the right set of tools.
This movie we've seen before, you give people the right set of tools and amazing things will happen.
at happens when Steve Jobs in:All of a sudden, people dream up amazing things, including, by the way, Uber. And who knew that online dating would be a thing?
It's hard for me to imagine the future, but I'm pretty sure it'll be interesting and exciting and possibly mind blowing.
Kevin Coldiron:And are you active in, you're back in Australia, are you active in trying to get the australian government to do something like this?
It strikes me that, well, if I just think back to, say, the history of, I dont know, meaningful changes in, say, the way central banks operate, oftentimes its small central banks that start something and then bigger ones imitate them. New Zealand, I think, was the first central bank to do inflation targeting, and that was like, hey, that works. Maybe we should do it.
Are you working with the australian government or trying to work with them to get this going down there?
Richard Holden:Yeah, yeah. So I do some stuff behind the scenes, like to overestimate my influence.
I have a weekly newspaper column in the main financial newspaper that affords me a little more influence than I say, with a degree of chagrin that I have as a lowly university economics professor. So, yeah, I get to make the case. Like a lot of central banks around the world, this is well known as public information.
The Reserve bank of Australia have been studying this and thinking about what it would look like, and they've been doing that long before I started rabbiting on about it. But yeah, I think there's a real opportunity for Australia. I do think, and to be honest, that's really the main reason I wrote this book.
And I've said to some people before that I hadn't in many, I hope plenty of people will read the book, but in a sense, this is a book for an audience of one, and that one is Janet Yellen.
And whoever ends up succeeding her as treasury secretary in due course, I suppose, which is it will take a treasury secretary and a Fed chair, obviously, with an administration that would be supportive of this, to push this in the United States. The US has the most to lose and the most to gain from really pushing this hard.
If I could predict the future of us politics, I wouldn't be an economics professor. I'd be on a beach in Malibu or something.
But I think administrations of both political persuasions, if you like, have a rationale for being concerned about what I say is the defensive rationale, the threat from China, which I think is very real, and in another way, the threat from private providers.
But I think the China thing is enough for administrations of either a democratic or a republican flavor to take very seriously and think about what the rationale for that is. And I don't think they're going to get very far with UN resolutions or kind of wagging their finger at China asking to do that.
If they could do that, there'd be all sorts of other things that wouldn't be going on. People in Taiwan wouldn't be freaking out about their future and so on. So I think the answer here is to compete, not to try and negotiate.
And I think that us leadership is really important here, and I suspect that's the way it'll go, rather than an Australia or a New Zealand being the trigger. But you never know. And you're quite right. I mean, inflation targeting came out of New Zealand, and it's been one of the most.
It's probably the most important practical thing that's happened in macroeconomics in half a century. And Australians are very competitive with Kiwis.
So in some sense, it pains me as a true blue Aussie to say this, but hats off to New Zealand for that, because they did invent inflation targeting. They showed it could work. And it's been an important thing around the world.
Kevin Coldiron:Now you got your chance with digital currencies. You got a chance to. To outdo them.
Richard Holden:I'll have to tell the governor of the Reserve bank. That's the rationale. We can't lose to the Kiwis twice in a row.
Kevin Coldiron:We already lost once 50 years ago. Well, it strikes me, I know we've got to wrap up here.
It strikes me that it will be, I think when the challenge to us power becomes manifest, it'll probably start getting taken more seriously. And that could be through a private currency getting a foothold. It could be through China's currency getting a foothold.
It could be a combination of both. It'll be interesting, but I encourage everyone. Again, the book is called money in the 21st century.
We focused on the fed coin part of it, but there's a lot more in it.
If you want to learn about how bitcoin works, if you want to learn a little bit about what countries like India have done in terms of moving to a cashless society, there's a lot to learn in this book and I think it's a topic that we're going to be talking about for a while. So it's good to get in there and learn now. So Richard, thanks so much for joining us. It's really been a tremendous conversation.
Appreciate you having you on the show.
Richard Holden:Thanks Kevin, for a great conversation. I really enjoyed it.
Kevin Coldiron:Make sure you follow Richard's work. You can tell from our conversation, I think a lot of things we've been talking about haven't been discussed enough yet on mainstream media.
So for all of us here at top traders unplugged, thanks for joining us and we'll see you next time.
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