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Digital cash is too much for banks to bear right now

Just 4pc of money in the UK is cash, but China is better placed to chart the path ahead on virtual currencies

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When was the last time you used cash to settle a transaction? Personally, I am struggling to remember. I still carry around the same £100 in my wallet that I drew out from an ATM months ago.

Physical cash as a means of payment has been on a declining trend for decades now, with the number of UK credit and debit card transactions finally overtaking those of cash some time towards the end of 2016.

But it is the pandemic that has put a rocket under the pace of this transformation.

It used to be reckoned that as a fully cashless society, the UK was around four years behind Sweden, where less than 10pc of transactions are now cash; Covid may have brought the process of catch-up forward by at least two years.

Use of ATMs in the UK plummeted 60pc during the first lockdown, with much higher levels of online shopping, many firms for the first time refusing to take cash – which in any case is expensive to handle relative to electronic money – and widespread suspicion (largely unfounded as it happens) that physical cash is a potent form of infection.

It has recovered only slightly since. It was partly with this evolution in mind that Rishi Sunak, the Chancellor, last week hailed the start of a new chapter for UK financial services, setting out plans to bolster the dynamism, openness and competitiveness of the sector.

Most of the attention focused on proposals for “green bonds”, but the Chancellor also said he wanted Britain to lead “the global conversation on new technologies like stablecoins and central bank digital currencies”.

The Treasury, it is fair to say, is somewhat more hot to trot when it comes to starry-eyed thinking about the future of money, including how to cater for the wholly cashless society, than the Bank of England, which would be left with the unenviable task of implementation.

For Sunak, it’s all part of the Government’s post-Brexit, Global Britain agenda, with the City, finally freed of the supposedly stifling restrictions of the European Union, expected to play a starring role in that vision as a world-leading centre for financial innovation.

The Bank of England, by contrast, has to be mindful of the scope for things to go badly wrong.

Credibility in monetary matters takes decades to acquire, but is lost in the blink of an eye. At a time of rampant debt monetisation to fund the costs of Covid, do we really want to take the further risk of being the first country to launch an available-to-all central bank digital currency (CBDC)?

The potential for things to go awry could easily outweigh the first-mover advantages. Perhaps best to let China, which is the most advanced in terms of plans for a CBDC as a substitute for cash, lead the way, and learn from its mistakes.

Some explanation: around 96pc of money in the UK economy is held electronically through commercial banks as deposits, and only 4pc is physical cash.

In famously borrowing short and lending long, banks are prone to gamble with depositors’ money in the hope of making a profit for themselves, the more so because of extensive deposit insurance, which means they can rely on the Government to bail them out if they end up losing it.

Cash, on the other hand, is directly created and issued by the central bank and therefore carries no risk; other than being physically incinerated or otherwise destroyed, it cannot be lost. It is in essence a form of central bank reserves, the only part of those reserves moreover which is accessible to the average Joe or firm.

The central bank can’t run out of cash and therefore can’t suffer a “run” or any other form of loss. As such, digital cash has plenty of attractions, especially in an age of zero interest rates when most deposits are paying a negative rate of return. With a CBDC, you would no longer need the physical stuff at all.

But its widespread use would also likely be the final nail in the coffin of a commercial banking system whose traditional business model has already been stretched to the point of obsolescence by the challenges of the zero interest rate environment.

If deposits moved en masse to the relative safety of a CBDC, it would “disintermediate” the banking sector, with massive implications for the provision of credit to the economy, how changes in interest rates are passed on to savers and borrowers, and therefore the implementation of monetary policy.

Furthermore, it would oblige the central bank to transform itself into a giant payments and retail deposit-taking institution, or state-owned piece of national IT infrastructure. The history of public sector IT systems does not bode well. The debacle of test and trace suggests that to the contrary, things have got worse, not better, on the competence front.

The Chinese experiment in a CBDC aims to address some of these issues by forcing depositors to hold their currency through a commercial bank. We’ll see how that goes, but logically it would mean the central bank is on the hook for all the commercial lending that depositors’ money is used to support.

Even in the West, it might be argued, that’s been the direction of travel for nearly a year now, so why worry?

Virtually all new lending that has occurred in Europe, including the UK, since Covid has been government guaranteed.

In the US, Steven Mnuchin, the Treasury Secretary, has told Congress to consider converting much of the Paycheck Protection Program, the $670bn (£506bn) government-backed rescue of small businesses, from loans into outright grants.

Things are already so far out of control that it seems but a small step to make the central bank the guarantor of all lending via digital cash.

But it would also be the step too far.

By all means allow private payment services and other intermediaries the same access to central bank reserves as commercial banks. Payments systems are the real power brokers in finance these days in any case, not the old aristocracy of traditional banking.

Yet both the economy at large and the Bank of England itself are already facing multiple challenges. To pile transformation of the monetary system into something completely different on top might well break them beyond repair. Tread softly, even if it means treading on the Chancellor’s dreams.

Do you think digital cash is a good idea? Let us know in the comments section below.