So while the world’s first central bank digital currency, known as a CBDC, may have arrived with a whimper, make no mistake:  The floodgates have opened.  Digital currencies and cryptocurrencies are coming soon – and in a big way!  Get ready!  

 

Welcome to this week’s Steak House Index update.

 

If you are new to my blog, or you need a refresher on the SHI10, or its objective and methodology, I suggest you open and read the original BLOG: https://www.steakhouseindex.com/move-over-big-mac-index-here-comes-the-steak-house-index/

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Why You Should Care:   The US economy and US dollar are the bedrock of the world’s economy.  

But is the US economy expanding or contracting?

Before COVID-19, the world’s annual GDP was collectively about $85 trillion.  Then it shrank … then bounced back!   We can thank global fiscal and monetary policy for the bounce.   According the the Q3, 2020 ‘preliminary’ numbers, annual US GDP is back UP to about $21.1 trillion.   And still, together, the U.S., the EU and China continue to generate about 70% of the global economic output.  

 

The objective of this blog is singular.

 

It attempts to predict the direction of our GDP ahead of official economic releases. Historically, ‘personal consumption expenditures,’ or PCE, has been the largest component of US GDP growth — typically about 2/3 of all GDP growth.  In fact, the majority of all GDP increases (or declines) usually results from (increases or decreases in) consumer spending.  Consumer spending is clearly a critical financial metric.  In all likelihood, the most important financial metric. The Steak House Index focuses right here … on the “consumer spending” metric.  I intend the SHI10 is to be predictive, anticipating where the economy is going – not where it’s been.

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Taking action:  Keep up with this weekly BLOG update.  Not only will we cover the SHI and SHI10, but we’ll explore related items of economic importance.

If the SHI10 index moves appreciably -– either showing massive improvement or significant declines –- indicating growing economic strength or a potential recession, we’ll discuss possible actions at that time.

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The Blog:

By now, you’re probably thinking, “Hey Liebman:  That’s not much of a prediction!   Bitcoin is nothing new!”  And you’d be right.  But have you ever owned one?  Have you ever used one to purchase stuff?  Probably not. 

I’m not talking about Bitcoin.   In fact, the digital currencies I’m talking about are quite different than Bitcoin.  And probably far more disruptive and wide spread.

Let’s start here:  What’s the difference between a digital currency and a cryptocurrency?  Rest assured that I’m no expert on the topic, but here’s what I understand to be the distinction: A digital currency has no physical existence.  It is entirely digital and has no physical equivalent – like a US dollar bill – in the real world.   But it acts the same way as a physical currency.  You can spend it, receive, transfer and/or exchange digital currency for another currency, etc.  So like a dollar, it can be used to pay for goods and services, at the grocery store or at an online store, and it has no country or political borders.  And like the dollar, control of the currency is centralized and regulated by the body issuing the digital currency.

From what I understand, a cryptocurrency is an algorithm-powered currency that uses a token as unit of value and is backed by distinct technology.   Many consider cryptocurrency to be secure, reliable and trustworthy because of the use of Blockchain and a decentralized ledger.  There is no regulating body, thus there is no single individual or supervisory authority controls the actions in the network.  Thus, a cryptocurrency is said to be decentralized.  A cryptocurrency is one type of digital currency in that it, too, has no physical existence.

But from here, the lines begin to blur.   For example, central bankers at the Bank for International Settlements are discussing the potential issuance of BOTH a digital currency and a cryptocurrency.   Here’s what they had to say on the topic more than three years ago:

 

“To that end, we present a taxonomy of money that is based on four key properties: issuer (central bank or other); form (electronic or physical); accessibility (universal or limited); and transfer mechanism (centralized or decentralized). The taxonomy defines a CBCC as an electronic form of central bank money that can be exchanged in a decentralized manner known as peer-to-peer, meaning that transactions occur directly between the payer and the payee without the need for a central intermediary.  This distinguishes CBCCs from other existing forms of electronic central bank money, such as reserves, which are exchanged in a centralized fashion across accounts at the central bank. Moreover, the taxonomy distinguishes between two possible forms of CBCC: a widely available, consumer-facing payment instrument targeted at retail transactions; and a restricted-access, digital settlement token for wholesale payment applications.”

 

I suspect your first question — mine certainly was — what the heck is a ‘taxonomy‘?  It’s a system of classification, or differentiation. 

Above, I mentioned the term CBDC.   This is the acronym for “Central Bank Digital Currency.”   For the purposes of this discussion today, let’s assume the term CBDC includes both a DC and a cryptocurrency — a CC.

So, clearly those conservative, boring, “un-hip” developed nation Central Bankers are heavily dabbling in digital currencies –it’s not just the Bahamas.   Central banks are actively discussing how digital currency might replace (or at the minimum, supplement) traditional currencies.  And here’s a shocker for you:  A survey taken at the start of 2020, found that more than 80% of central banks were studying the subject.

Holey cannoli!  The US Federal Reserve and the European Central Bank must want to put Bitcoin out of business, right?   Nope.  That’s not their stated intent.  In fact, they are a bit concerned it might be the other way around, as you’ll see below.

It might be the outcome, however.  Bitcoin might be crushed by the central bankers and their CBDC.  It’s hard to say.   But for the time being, the central banks suggest there is plenty of room in the sandbox for both ‘private digital tokens’ and CBDC.   And the mere fact that central banks are taking digital currency seriously is a big thumbs-up to Bitcoin and other private tokens. Which country’s central bankers are studying digital currencies?   The answer is almost everyone.  The Bank for International Settlements has published numerous papers on the topic.   The committee members include central banks from:

This is serious, folks.  Make no mistake:  Digital currency is coming soon — and in a big way.  

 

Digital currencies are coming — soon.   This is not a fad. 

 

When they arrive, there will be winners and losers.  Meaning that while the Bahamian “Sand Dollar” is a really cute name, their digital currency (DC) will not become dominant.   Which DC will be dominant?   The same currency that is globally dominant now.   The US dollar. 

Consider these facts, courtesy of the International Monetary Fund about the dominance of the US dollar:

• > Almost 90% of all foreign exchange transactions (Forex) last year used the US dollar.
• > More than 60% of all foreign bank reserves are held in US dollars.
• > About 40% of all global debt is denominated in the US dollar.

 

Which suggests that once the Federal Reserve rolls out a CBDC, the dollar will likely become the world’s digital currency — just as it is the dominant physical currency.  The biggest question, in my mind, is how to implement a US dollar based digital currency — without destroying the commercial banking system.  

Yes.  You read that right:  Destroying the commercial banks.  This is a real issue.  Here’s how the Economist Magazine teed up the concern:

 

“IMAGINE IT IS 2035 and a financial crisis is raging.  Credit is drying up; banks’ share prices look like ski slopes and every news report features sweaty traders in shirtsleeves tugging at their collars. You log on to your banking app and peer anxiously at your savings. You could transfer them to another bank, but none seems safe. Luckily, there is a new escape route. At the touch of a button, you can move your funds into a central-bank digital currency (CBDC), a government-issued virtual store of value that is completely safe.

This is one scenario worrying economists working on CBDCs. There are many potential advantages to publicly backed digital currencies. They might make payments easier. They might “democratize” central-bank money, the part of the central bank’s balance-sheet which, unlike physical cash, only banks can access now. And they would reduce the risk that cryptocurrencies replace government tender; bitcoin has been on a tear lately, and Facebook’s digital coin—which on December 1st changed its name from “Libra” to “Diem”—will reportedly launch in January.

But wouldn’t CBDCs also make it dangerously easy to flee the banks in times of stress?”

 

I would answer a loud, bold “YES!”  to that question.  But I would also also add this thought:   Why would consumers wait until a time of stress.  If the central bank digital currency is completely safe — meaning, there is no risk of loss as a commercial bank depositor has today — why would you or I wait?  Why not move our money into a FED sponsored, FED guaranteed, central bank account?  I can’t imagine any reason to wait. 

And therein lies one of the most serious challenges.  But one they must resolve, because digital currencies are coming.  

Which brings us to the “Money Flower” — a conception of the BIS — showing the potential relationship between private and public digital currencies:

 

 

 

 

So pretty!  🙂

Well, pretty or not, I find it all rather interesting.   I believe this is another “trend” that has been super-charged by the pandemic.   Digital currency is soon to become the new normal. 

Still not convinced?   Then do a bit more reading … here are a few links to meaningful publications on the topic:

https://www.bis.org/publ/qtrpdf/r_qt1709f.htm

https://www.bis.org/cpmi/publ/d174.pdf

https://www.federalreserve.gov/econres/notes/feds-notes/central-bank-digital-currency-a-literature-review-20201109.htm

Happy Holidays!

• Terry Liebman