This article was inspired by a curious conclusion I read yesterday in the minutes of the Reserve Bank of Australia (RBA).

But it also carries on the ideas I wrote about in April, in an article entitled “Grab your brolly, Chimney money brings money system to crossroads after 75 years.”

Banks act as distribution pipes for the central bank.

Originally, the central banks were set up to enable the balancing of flows between trading banks and to set interest rates for the system, but their role is no longer subservient. Today, the central banks are omnipotent and the U.S. Fed sits on top of the totem pole because its widget, i.e., the USD, is still the world’s reserve currency.

In normal times when there are prudent increases in the money supply to cater for increased production and consumption, banks generally make money. Typically they do this through the net interest margin, i.e., receipts from lending minus the cost of lending (i.e., money).

In times like this where we have zero rates and a decrease in customer cash flows (serviceability), either the net interest margin contracts, or banks limit or even stop lending to certain segments of the borrowing universe.

But the other role banks play is that of a distribution pipe for the central bank’s open market activities; i.e., when the central bank exchanges bonds with banks, to stimulate or cool down the economy by manipulating the supply of liquidity.

In that capacity, banks become the paid agents of monetary policy.

When a central wants to drive down rates to stimulate business and household borrowing, it will buy bonds from primary or authorised dealers (in the U.S. for example, there are 24 primary dealers that agree to make a market in government bonds and treasuries), which in turn receive a flood of cash for selling those bonds.

The expectation is that rates come down with the oversupply of cash in the banking system, and those units are on-lent to other banks, corporations and households in the highly leveraged fractional banking system.

The end goal is to stimulate business borrowing, investment, production and consumption.

When it wants to cool down the economy it does the opposite, which makes money scarcer, in turn increasing interest rates and dis-incentivising borrowing.

Essentially, the banks sit in the middle and when not doing their part to implement a central bank’s monetary policy objectives, they try to make money for themselves and their shareholders.

At the moment, banking systems in many countries are feeling the pinch in terms of narrowing interest margins. Also, they are not properly functioning as a transfer mechanism for monetary policy, because they do not want to lend to impaired or shaky credits - so they redeposit some of those funds with the central bank and/or buy bonds and other assets.

The roles of the banking system are under threat from a digital philosopher’s stone.

There’s not a lot that banks can add these days. And it’s taken COVID-19 and the debasement of fiat currency to expose this truth.

We’ve already established that they are unable and/or unwilling to adequately transfer the central bank’s policies into practice (QE Infinity impact has diminished) and they find it difficult to make money from traditional lending due to crushed margins.

But what usually remains unspoken is that politics aside, we don’t really need them anymore, because we now have the technology to:

• enable cryptographically protected transfers of units of value directly from a central bank to an individual account, peer to peer

• confirm the ownership of a transferred unit

• transfer units at scale and speed within a system that does not need to be trusted because it is created and maintained by a collective of machines running the same software, and which are incentivised to tell and record the truth, every time

• decentralise the custodianship of the truth, so that there are multiple sources of the truth that can never be tampered with

• make those transfers almost instantaneously

• remove the high costs associated with those transfers

• add in an electronic contract layer to facilitate and automate lending, borrowing, buying, selling, investing, transacting on a peer to peer basis

This technology is based around blockchain, GPUs, the cloud and application layer software, and is essentially a digital philosopher’s stone.

It’s been with us for a few years now. It’s no longer new. But is is exploding due to the use cases, and rewrites of the original versions to make it stronger, less power hungry, and better.

Libra was a controversial philosopher’s stone that was prematurely thrown into the banking pond.

In one of it’s incarnations, the digital philosopher’s stone appeared as facebook’s proposed token, Libra.

You can get a refresher on Libra in my June 2019 blog, here.

In it I wrote:

“This is why central bankers (which incidentally can’t seem to raise interest rates due to money having lost its value) should be worried.”

And they were. Why? Like I said at the time:

• 2.7 billion customers already using the facebook platform

• Open banking rules in place

• Costless to the user

• Once you are in the ecosystem (if it gets up) you will be able to apply Libra to payments for other digital assets, creating a digital gateway

• Most likely going to be a seamless app where you won’t actually see the technology (have you tried buying bitcoin??)

• Great platform for other developers to build out their own fintech companies (a little like those who have built blockchain powered businesses off the Ethereum platform, as one example)

It’s the 2.7 billion members (a little less now) that created the tsunami in the pond. That membership base contains almost every household that is tethered to one of the major central banks through the fiat banking system.

At the time, Libra’s addressable market was the equivalent of every individual in the EU, 6 times over.

But the system was to be permissioned and controlled by a group of big companies and that was not palatable. But in reality it would have created a dystopian world directly controlled by big corporations that was even less palatable - even to you and me.

Nonetheless, the centrals are all saying that they don’t need Libra or non-government sponsored/controlled non-fiat platforms.

So, many countries are developing their own CBDCs, or digital money, even if that is still debased fiat currency in electronic form.

The RBA isn’t buying it.

The RBA has gone Emu, or should I say Ostrich.

The least sensible thing I read today in the RBA minutes was the Board’s view that it wasn’t going to take CBDC’s seriously due to financial stability risks.

Here’s how they couched it:

“The future of money

Members considered a special paper on the future of money and changes in the way payments are made. They discussed the longer-term trend towards the use of electronic payment methods by households and the apparent acceleration in this trend as a result of the pandemic. Members noted that the shift from cash to electronic payments is further advanced in Australia than in a number of other countries. However, demand for cash as a store of value had continued to grow in Australia and most other advanced economies.

Members discussed different possible design features for a retail central bank digital currency (CBDC) and the associated public policy issues. They noted that there has been significant innovation in the Australian payments system in recent years, including the provision of real-time account-to-account payments that are available on a 24/7 basis. A retail CBDC might assist with some particular use cases, but it could fundamentally change the structure of the financial system and introduce new financial stability risks. It therefore did not appear that a public policy case for a retail CBDC currently existed in Australia. Members noted that there could be stronger arguments in favour of a wholesale CBDC and that it was important for the Bank to continue to conduct research in this area and monitor developments in other jurisdictions.”

Okay, if that’s not protectionism I don’t know what is.

It’s code for not wanting to open the floodgates to a Libra or better still, a permissionless, decentralised, peer to peer cryptocurrency that can directly deal with and treat each account holder according to that account holder’s needs, in a timely and extremely low cost manner.

It could enable the rewrite of our fractured and overly complicated tax system. And, you don’t have to try hard to imagine economic stimulus (or JobKeeper for that matter) bypassing the bond market, meaning a banks’ role as a primary or authorised dealer would be over.

You would simply do a digital money drop into a business, family or individual’s account, no fuss, no cost to the recipient, and with the amount tailored to the needs of the recipient and calculated by way of a formula embedded in a smart contract (classic use of the Ethereum platform).

So far, we’re talking about a CBDC being a digital twin of a fiat currency, like the electro Aussie dollar. So, inflation. deflation, etc, would still be a problem because the RBA could still create more digital entries to increase the money supply (like they are doing now at $100 billion over the next six months, and like the $7.2 trillion sitting on the Fed’s balance sheet).

The Fed example is extreme because we now have a debased global reserve currency, that’s not good for anyone.

And banks won’t be terribly excited about what might come next.

The next step is provocative, and the proverbial stake in the heart for banks.

It has to do with removing debased fiat once and for all, and making the number of units of the CBDC, or another digital asset that the various currencies convert into, finite.

This would create a sustainable digital gold standard, and is probably what Bretton Woods could have been, had blockchain, GPUs and the cloud existed at the time.

And guess what, they do now and it’s going to become a lot faster when 5G rolls out.

I’m not saying this is around the corner, but it should be, and that’s why comments like the above from our most senior banker is at best, highly disappointing.

Imagine if you can, a global transfer mechanism that could never be debased. A free market store of value without illegal central bank intervention, recorded on a distributed ledger curated and maintained by incentivised bots based on agreed software rules.

Programmatic monetary policy!

CBDCs pegged to a decentralised cryptocurrency like Bitcoin or a similar asset yet to be designed on top of current technology is where we should be headed.

Once that is in place, the application layer fulfilled by technology offerings would then become the distribution pipe for CBDCs, or the global crypto.

That global crypto, Bitcoin or otherwise, could become the global reserve currency that powers the value layer of smart contracts, which in turn facilitates trade finance, overdrafts, all forms of lending, borrowing, investing, buying and selling on applications, once smart contract rules have been satisfied.

And if you did that, why would you need banks?

Why indeed.

Mike.