Part 2. Federal Reserve moves closer to ‘digital dollar’

Kiss Your Privacy Goodbye

Dollar bills under your mattress may not be any good!


Editor’s note: In this three-part series, Compass technical writer Gordon Allison explains the digital dollar, its risks to personal liberty, and vulnerability of the new payments technology to cyberattack and other extraneous threats like Electro Magnetic Pulse.

WASHINGTON, DC –  Digital Dollars may be coming sooner rather than later. The International Monetary Fund (IMF) that controls loans and bail-outs to various countries has asked El Salvador to reverse its decision to allow Bitcoin to be the legal tender for that country. Their reasoning is that the value of Bitcoin varies wildly with time.  It is great when the value goes up, but bad for users when value drops. 

The reason Bitcoin values fluctuate so wildly is that there is a finite number of Bitcoins. That number can never exceed the 21 million that was established when Bitcoin began. Therefore, when more people want to buy Bitcoins, the price goes up. When people cash them in to purchase things, the price drops.  This is not something that works very well when you pay taxes or purchase groceries or gasoline.  If you receive Bitcoins at a certain value, by the time you purchase something with them, they could be worth significantly less than the rate you purchased them. 

On the other hand, if you receive a payment that is equivalent to a Bitcoin value of X and when you purchase something with that Bitcoin, its value may have increased to X-plus so you lucked out.  But you certainly cannot run a business or manage a household around a currency that fluctuates all over the map. It’s gambling at its finest! Example: Bitcoin plummeted last week. All it took was an Executive Order from Biden last week, which suggested crypto-currency should expect more regulatory oversight. 

However, what is referred to as STABLE COIN would likely diminish the volatile nature of the digital currencies, and hopefully (?) will be tied to the value of gold or silver. This would reduce the capability of our government to continue to print additional paper money not backed by gold or silver, which causes inflation. However, on the flip side, this would put the brakes on increasing our national debt!

Could it be that the IMF is preparing to launch its own digital currency, which is typically shared among the world’s national banks?

In January, the Federal Reserve released a much-anticipated 40-page paper, which can be accessed here:

The detailed document lays out the advantages and disadvantages of a digital currency. The Fed says it’s a first step meant to kick-start an important discussion among policymakers and to gather feedback from the country’s largest financial institutions, as well as from the general public.

So, how would Digital Dollars actually work?  Policymakers stress these are early days yet, and there is a lot that needs to be hammered out.  All in all, the transactions conducted with Digital Dollars probably wouldn’t seem too different from existing private alternatives that allow us to pay for things by placing our smart phones next to digital readers. 

Of course, an Electro-Magnetic Pulse (EMP) event could wipe out all electronic devices (i.e., computers, smart phones, radios, TV, telephones, solar panels, wind generators, automobiles, light bulbs, thumb drives, the electric grid, and the internet itself).  Imagine the snafu that would cause?!?

(More on EMP next week!)

Why pursue a digital currency?  Reducing or eliminating fees is one clear benefit.  As you may have noticed, many stores and restaurants are now charging about 3% of the bill to process it on a credit card.  This has been going on in Mexico for years, but there the premium is usually 5 or 6%.  

Mexican interest rates are about 17% too!  Credit card transactions take longer to process and the credit card holder is often unaware of the fees charged at each stage of a transaction. Use of digital currency wouldn’t necessarily entirely eliminate non-government players. In China, for example, users who want to use the digital yuan can go to banks to add money to their digital wallets. If enough people start using the Fed-run version of crypto currency, just having Digital Dollars in circulation could put pressure on credit card companies and payment processors to lower fees to be competitive.

There are certainly times when electronic money exchanges can have serious problems. For example, I had to go on a business trip to Thailand. The company wasn’t willing to give my wife my paycheck while I would be in Thailand so she could deposit without my signature.  Instead, they decided to make an electronic funds transfer to our bank to solve the problem. 

Unfortunately, the company deposited twice the amount of my paycheck. When Patty found out the problem, she told the company controller, and the company promptly canceled the doubled amount of the deposit (instead of only canceling the incorrect duplicate check).  It took over three weeks for the company to straighten out the mess.  If that had happened at the wrong time of the month, we could have had massive overdraft fees!

When you make a contact-less payment today, it may seem immediate.  According to Chris Giancarlo, the former chairman of the Commodity Futures Trading Commission, a lot happens behind the scenes.  He said, “My mobile device tells another mobile device to inform a whole series of banks, to confirm who I am, how much money is in my bank, that there is enough money to move from my bank to his bank. With a Digital Dollar, you could, in theory, eliminate those middlemen.  If you wanted to buy a sandwich, for instance, you could transfer money from a digital wallet directly to a cashier.”

According to David Gura’s recent report on National Public Radio:   “Another argument for creating a Digital Dollar is to open up digital transactions to Americans who don’t have bank accounts.  According to the Fed, more than 5% of U.S. households are ‘unbanked.’  Providing them with a digital wallet would allow people to participate in our increasingly cashless financial system.”

What are the challenges of a Digital Dollar monetary system?  Without question, one of the biggest issues is privacy.  Because the Fed would implement and oversee the system, it would have vast data on your personal finances.  That makes it critical to sort out how much information the Fed could have. According to Raghuram Rajan, a professor of finance at The University of Chicago Booth School of Business and a former governor of the Reserve Bank of India, “There will be legitimate questions about how much the government knows about each individual, and also, how much it can act to restrain activities by individuals.”

Next week, digital dollars will be the target of innumerable threats. Are we ready?