The Fed Considers Digital Dollars

Paul Winkler: All right. Back here on the Investor Coaching Show, Paul Winkler. PaulWinkler.com is the website where you can grab the podcast, the video content, the written blogs, transcripts of the show, all kinds of stuff there. If you haven’t been there, check it out. There’s just a lot of really cool stuff on that website, if I do say so myself.

So one of the things that, of course, has been a big topic of conversation for quite a while now — can’t seem to avoid it by any stretch of the imagination — digital currencies, people investing in digital currencies as if it’s an investment. It’s not. It’s a commodity. It goes up and down in value based on supply and demand.

And can you get lucky and make money? Yes, you can get lucky and make money, but you can get lucky and make money on lots of things, collecting lots of things, lots of commodities.

You can get lucky and buy a painting that happens to — I better watch myself. Paul, self-edit! Don’t say what’s always on your mind. There’s just a painting that happened to be in the news a lot. Most of you probably know what I’m talking about.

So you can actually go and buy a baseball card, and it actually goes up in value. Or you can get involved in some kind of other collectible that happens to go up in value. We have these non- fungible tokens, those types of things, and they can go up in value. And you can get a Cabbage Patch doll, and it goes up in value.

But you know, the reality of it is we have things and the greater fool theory. If somebody is willing to pay more for something than you were, you could make money on it. Does it make it an investment? No, there’s not a cost of capital. There’s not a cost for somebody to use your money, whether it be interest payments, or whether it be earnings.

So digital currencies, one of those hot things that people have gotten into lately, especially a lot of — well, I say younger people, but older people have gotten into it as well. And one of those things I’ve told people: I don’t touch it, not with a 10-foot pole.

And a lot of you who have been following that area and those markets have kind of seen, well, why. You got a wake up call as to why and what the risks are. Well, one of the things that The Wall Street Journal did this week — and I thought it was a particularly good little piece. It was in video form that they had done this. They did this thing talking about digital currencies.

And some of the things that are happening in the digital currency world are just nothing short of really, really interesting. The Federal Reserve, they’re actually in the midst of changing how we buy and sell things, possibly. They’ve been studying this like crazy.

And there have been all kinds of commentary — the chairman of the Federal Reserve talking about this particularly — and how, maybe changing your wallet, instead of leather, into your phone. It’s going to be your new wallet. Now, those of you that are worried about using leather or anything: ersatz leather, we’ll use that for you.

But there are people that are watching this closely and going, “Hey, where’s this going to lead? And how is this going to affect things going forward?”

The Downsides to the Current System

And I think it’s just fascinating because the whole idea is that physical cash — we carry around dollar bills, and people have been trying to counterfeit these things forever. You know, you can make counterfeit $20 bills and go buy, sell things and trade these things. And you’ve got to hold them up to the light to see if it’s the real thing or not.

All kinds of technologies to try to make it so that it’s really, really hard to counterfeit. But there are people that still give it their best shot. You think if they would just use their brains for something that is actually a little bit more beneficial to society, that society would be a better place. But no, we’ve gotta use it to try to counterfeit and cheat the system.

But physical cash has been on the decline for quite a while, and our entire financial system — really, with this whole changing to digital currency, our financial systems have been changing a lot. But it’s still kind of based on it, if you think about it. You still have banks talking to banks, and it’s really an inefficient system. It might take three days for a transaction to clear, and the transaction costs can be fairly costly.

You think about it: if you go and pay for something via credit card, the merchant is taking a hit. Now they’re willing to take the hit because they may not get the sale if they don’t take your credit card. So there are merchants that are willing to do that.

But could they cut their costs some? Could the cost for everybody go down? You have some places that you do pay less if you pay in cash versus paying — or debit card versus paying, well, I guess you might have some kind of an expense there — but you could have a lower cost if you pay in cash versus paying with a credit card.

So one of the things they’ve been talking about is digitizing the U.S. dollar. And what this would do is instead of walking around with cash … I remember one of my old mentors, he used to walk around with $5,000. And his friends would say, “John, you’re walking around with $5,000! You could get robbed.” And he goes, “That’s the point!” He says, “Happy people don’t shoot.”

But there’s a danger to walking around with cash. And if somebody knows you might be walking around with cash, I guess there’s a danger there.

But if you digitize the U.S. dollar, and now you’re paying with things on your phone, and it takes a password to get in your phone, I guess it could protect you to some extent by paying with that method. And you could bypass electronic payments that way. I know — electronic payments, it might be slow.

There could be costs to businesses of doing that, like I talked about: the settlement payments. And what happens is that you have this patchwork of a system that you have to go and do transactions over, and that can be expensive.

How Would A Digital Dollar Change the Way We Do Things?

But the thing that’s happening in the Federal Reserve — they’re kind of being very, very careful about this whole change — is that it could upend the traditional banking system. You go to the big banks and you do transactions, and their business model is based on having the typical systems that we have in place right now.

So the Federal Reserve is considering this and going, “Well, how do we do this without upending the whole system?” But what they’re considering is issuing digital wallets to Americans.

And how would that work? Well, money would flow directly from you, through the Federal Reserve, straight to the — so there’s a little bit of a middle person, but they wouldn’t charge anything, is what they’re talking about. Not charging anything for those transactions, unlike the credit card companies right now. So that’s why this is all being considered.

The digital dollars would be in computer code. And it would be stored on some kind of a control ledger, or maybe a distributed ledger, which — when you talk about a control ledger, it would be stored on computers at the Federal Reserve, versus distributed ledgers, is what they call it, where they have, like, cryptocurrencies and you have spread out on computers all around the world. So this is something that they’re considering just for the reason that it would be a far more efficient system than basically what we’re using right now.

And what would happen is the Federal Reserve would take digital cash from your wallet and they would drop it into a merchant’s account. And they said no fees. I mean, that’s the big draw to all of this.

And one of the things that we’re talking about is the possibility that this could help over 8 million households that don’t have credit cards or debit cards. So let’s say you have a tax refund, or you have some kind of a payment that’s coming to you. What would happen is it would be dropped in your account immediately to be spent immediately.

So you wouldn’t have a check issued, so there’s nobody to steal a check from your mailbox or anything like that. It goes straight into your federal wallet. Or your “Fed wallet” is, I guess, what they would call it. And money would be available to be spent right away.

The Fed’s Goals: Keep Things Stable

Now, one of the things that — and you’ve heard me talk about this before — regarding digital currencies and why is it that the Federal Reserve doesn’t really get terribly excited about Dogecoin or Bitcoin or the various digital currencies out there. It is the inability to control and the monetary policy.

Monetary policy, that’s what the Federal Reserve is engaged in. They’ve got a couple of different goals, which is to have a stable dollar, stable currency, and full employment. A couple of things that are on their radar screen when they enact monetary policy. And one of the things that they do to enact monetary policy is buy and sell bonds.

So let’s say that the Federal Reserve would like to try to push interest rates down simply because they want to try to get the economy rolling a little bit faster. Well, what do they do? Well, they can buy bonds. When they buy bonds, they drive the price of bonds up. They drive interest rates down.

But they give banks money — the banks have lent money to the government. They bought bonds, lending money to the federal government. Now their money, the bank’s money, is tied up in what? Government bonds. It’s tied up. It can’t be lent back out because it’s already been lent.

Well, if the Federal Reserve comes in and buys those bonds, now they’ve turned it back into cash that the bank can now lend out to the public, increasing the amount of money supply and decreasing the interest rates. Because this is a supply and demand thing. The more supply you have of something, the lower the cost for it.

If you have millions and millions of homes, more than what are needed by Americans, what happens to the price of homes? It would come down, or vice versa. If you have way fewer homes than are needed, you’re going to drive the price of homes up because you need more homes. And now it becomes a bidding war between people.

Now, with monetary policy, this is how we control interest rates. Another way that we do it is the Federal Reserve sets the borrowing rates between banks. And also banks have reserve requirements, and they have to have money set aside to meet those reserve requirements. Sometimes they borrow money from each other to make sure that they meet those reserve requirements.

And if the Fed is setting those interest rates, then in fact what’s supposed to happen is banks are supposed to follow that — what they charge the public for the use of money. And then your mortgages are supposed to follow that as well. So indirectly the Federal Reserve is driving interest rate policy, especially for short-term interest rates.

And a lot of people say, “Well, actually they’re following because the bond market is way bigger.” And there’s a big debate about that. And I think it’s pretty settled that the Federal Reserve is really far more responsible for short-term interest rates than they are long-term interest rates.

Setting Monetary Policy with a Digital Dollar

So what happens here is if we have this digital currency, then you could have the Federal Reserve actually assigning interest rates directly to alter decisions that people make. So if I have this account at the Federal Reserve, and they want to maybe give me the incentive to save more, how do we do that?

How do we get people to save more money if we want them to save more money? Increase interest rates. Increase interest rates that are going to be applied to their money that’s sitting in their Federal Reserve account. That provides you the incentive to actually save.

If I want you to spend more money, what do I do? I reduce interest rates. Because then you’re like, “Well, I might as well spend the money because it’s not going to earn anything.” And you can actually increase the incentive to spend directly by changing these interest rates. So it’s pretty interesting how digital currency can directly have more impact on monetary policy.

So is this something that just the United States is looking at? Heck, no. You got 60% of central banks around the world are actually experimenting — right now, as we speak — with central bank digital currencies. CBDCs, as they call them. And the Bahamas actually issued the Sand Dollar in October of last year.

China — I’ve talked about this here on the show before — digital yuan, their currency. And they basically handed out money and set up these accounts. They had this auction system that I talked about here to actually get people used to dealing with this.

Now one of the things about the digital dollar, and you’ll hear people talk about, “Well, what’s the benefit of this?” Well, one is to drive out bogus, digital, private money and drive it — private digital currencies.

You know, people are looking at some of these digital currencies out there, and there are thousands of them, and they’re saying, “This is nonsense. We got to stop this stuff.” So, if you have something that the Federal Reserve steps in and backs, it’ll drive out the use of a lot of these other digital currencies that are being traded out there, like commodities, like I was talking about.

Central Bank Digital Currencies Could Increase Safety

And the other thing that’s talked about is this could increase the safety of the financial system and increase inclusions. In other words, people that are kind of locked out of the system because they don’t have a credit card or a debit card could be actually given the ability to do these trades on their — “traded” as in “buy things and sell things” using their phones to both send and receive money. So you could actually change the system and modernize it. And that’s why it has all of this appeal right now.

And central banks just don’t like the idea of various, like, Dogecoin and Bitcoin and things like that because they can’t control them. They can’t set monetary policy. And monetary policy is one of their primary tools because they want to know how money is being used and what the supply is.

And that helps them understand the fundamentals of the economy and help direct it better to their two things that they have their eye on, which is full employment, number one, and making sure that the integrity of the currency is upheld. So there are two things that are really, really important. Making sure that the inflation — and the integrity, how is that measured? By the inflation rate.

You know, if you have an inflation rate that takes off, and it gets out of control — and that’s exactly what happens, if you think about it, with some of these digital currencies. They’re fluctuating in value so much. If I sell a car for one Bitcoin, let’s say, to somebody that pays me in Bitcoin, and all of a sudden the Bitcoin drops in value and cuts in half — well, I’ve just sold a car for half price. It’s not a very good deal for me.

It’s very, very dangerous from the standpoint of somebody that is selling things to accept Bitcoin as payment for that thing. So it’s very, very hazardous. I mean, it could work out the other way, where it goes up in value and it’s been a great thing. But we’re never really worried about how much we can gain. It’s just how much we stand to lose if we make a decision, a bad decision.

So this is really — it has some interesting implications. If the Fed holds money directly, though, this is one of the dangers of this. If they hold money directly, it could cut into the business model of the banking system.

But you know, on the other side, if the Fed goes and says, “Hey, let’s just do away with the whole banking system and replace them,” they’re going to be overwhelmed with dealing with the general public, dealing with all of these customers out there, millions of customers. And you have, as one guy put it — I thought this was funny — in The Wall Street Journal, he says the Fed doesn’t exactly want to get a call at midnight saying, “Hey, I forgot my password.”

So Where Are We Headed?

So maybe, and I’m thinking that, quite possibly, where could all this lead? It could lead to, well, maybe some of the banking system will be part of the solution, and we’ll have an integrated system for dealing with this. So instead of having this big, big banking system that is dealing with being the middle person in all of these transactions, maybe just the essence of the banking system will change.

But here’s the bottom line. What will happen is more efficiencies in the system, cutting expenses. And when you cut expenses, you create more ability for profitability for companies and institutions that use the systems for transactions. And if you can do that, you can increase profitability. It’s good for investors. It’s good for stockholders because I own the companies.

So that’s very, very interesting. So these are things that are happening, but just another reason not to get involved in trading these digital currencies out there is because there’s this really strong, strong possibility. And it’s being looked at closely. Like I said, 60% of central banks around the world are actually experimenting as we speak on central bank digital currencies.

And if you think that the digital currency you’re investing in is going to win in the long run, you may be in for a surprise. I don’t know. I’m just not willing to go and take that gamble to invest in these things.

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