“Dominant Money” is a descriptive paper, not a prescriptive paper. In it the monetary theorist and activist Dr. Joseph Huber describes the change he sees currently taking place in the monetary world. He also puts this change in the context of changes that have taken place over the past 400 years. Changes in money systems occur gradually in response to social, economic and technological developments. The current change taking place is the displacement of bank money by central bank money. Bank money is money created by private banks as an intrinsic component of their lending. Central bank money is money created by central banks. The evolution of central bank digital currencies (CBDCs) is central to that displacement. The picture Huber paints is useful for understanding what is happening and useful for activists working toward monetary reform.
Just as unregulated paper money came to replace metallic coins beginning in the 1600’s, for reasons of convenience, regulated paper money in the form of central bank notes came to replace unregulated money beginning in the mid-1800’s, because of their more universal acceptance. This helped trade. The central bank paper money system, which was nominally backed by gold until 1971, failed to provide the needed growth of the money supply. Private banks stepped to create their own money, but this time with the backing of governments. Banks created money denominated in units of the official currencies. This bank money was created as account money, not as notes or coins. Over time this account money came to outweigh the value of notes and coins created by central banks. This is the bank money system which dominates today.
Huber’s historical account of this history in Part 1 of his paper makes a very enlightening read.
Taxonomy of Money
His historical account is preceded by a discussion of the taxonomy of money, addressing the question of what constitutes money. He describes three levels of money: 1) base money, 2) second-level money, which stems from base money, and 3) third level money, which stems from second-level money. There are also other money systems, such as bitcoin and complementary currencies, not linked in value to dominant money systems, which can potentially compete with existing base money.
Included in base money are 1) coins, created by government departments of treasury, 2) bills, created either by Treasury or by the central bank, and 3) reserves. This lumps two different kinds of money, namely money that circulates in the general economy, and reserves. Reserves circulate only among banks – private banks and central banks. Huber discusses reserves, pointing out that, with the exception of high level of reserves created through Quantitative Easing, they have been at a very low level compared to money in circulation, and that reserve requirements imposed by regulators are effectively near zero.
The term “reserves” seems to this writer to be a holdover from the days of the gold standard when reserves of gold were thought necessary to back up currencies. If doubt began to arise about the value of the currency, currency could be turned in for gold coins or gold bullion from the reserves that banking system held. Reserves no longer serves that function. The primary function of reserves today is for the payment system. Reserves are transferred from the account of one bank to that of another corresponding to transactions occurring in the real economy.
Reserves are also thought of as providing liquidity for bank lending. But that is a holdover from the now discredited idea of banks functioning as intermediaries, lending out money deposited by customers. It is now clear that banks create deposits as they make loans. As long as loaned money leaves the bank in the form of account money only, not as cash, no reserves are needed for lending to occur. On bank balance sheets the term “reserves” does not appear. In reference to bank balance sheets the terms, “cash” and “reserves,” are sometimes used interchangeably. Banks do need to have enough cash to meet the demands for cash of their customers. But reserves are created by the central bank and function simply to make the payment system work.
Second level money is bank money, created by banks as they make loans or buy securities. This is account money and constitutes more than 90% of the money in circulation. It is completely interchangeable on a 1:1 basis with base money.
Third level monies are based on second level monies. They are created by nonbank firms. These include Money Market Mutual Fund (MMMF) shares and complementary currencies which are covered 1:1 with bank money. The bank money that bought the mutual fund shares is loaned on, while the shares themselves are traded, used as a kind of money. Thereby the money supply is increases by the value of the shares. MMMF shares are counted in M2, but not in M1.
Another category of money is called base-level competition. These money systems include bitcoin and complementary currencies which are not covered, i.e., interchangeable with, bank money on a 1:1 basis.
The Current Transition
The bank money system is now beginning to lose its grip. Its failings are becoming clear and technology is opening new possibilities.
In Huber’s view new money systems are evolving out of the digital age. Newer digital systems will replace the old ones for at least two reasons: first, because they are faster and cheaper, and second, because the old systems exhibit unacceptable excesses and instabilities, and they are no longer capable of being regulated. Regulation is needed given the intrinsic instabilities of the current bank money system. The freeing of the bank money system from the gold standard after WWII “lifted the boundaries of monetary quantities and enabled hitherto unknown economic growth and comparatively broad-based wealth in industrialized countries. The downside was – similar to unregulated paper money in the 18th century, but on a larger scale – that bankmoney also unleashed new excess dynamics of overshooting money creation and the related continued growth of credit and debt in increasing disproportion even to nominal economic output, resulting in increased inflation and/or asset inflation, financial instability and proneness to crisis. Private banks now control the money supply. Central banks have lost control. The methods open to them to control the economy have lost their effectiveness. The bank money regime is approaching a state of ungovernability.” This point is also made in McMillan’s book, The End of Banking.
In Part 2, Huber discusses new forms of digital currencies currently being developed and places them in the hierarchy he outlined in Part 1. In this hierarchy. CBDC will be second level money, tied directly to CB “reserves.” New third level currencies include electronic money systems, such as the M-Pesa in Kenya and Tigo Cash in Latin America and some African countries, and what Huber calls stable coins, such as the Libra, Tether and JP Morgan coin, both pegged to bank money. Unregulated complementary currencies and bitcoin-like system have no money base or coverage. So far these are not seen as a threat to monetary sovereignty.
Huber focuses on CBDC. Huber argues that “CBDC is, or is close to being, sovereign DC, in contrast to private digital monies.” The option for customers to use CBDC instead of bank money “will bring in its wake the necessary tidal change in the composition of the money supply, re-expanding the weight of base money.” He goes on to say, “Not the least, an expanded DC base generates increases seigniorage to the public benefit.”
Huber describes seven different ways CBDC may be implemented:
1. Direct access by individuals to accounts in the central bank (CB) – transaction accounts only; no lending. It would increase the CB’s role in the payment system. Example – the Swedish e-krona.
2. Custodial access to the CB – Payment service providers would hold customers’ funds in trust; the PSP’s would have accounts in the CB for customer transactions – examples – the Dutch Onsgeld proposal; Lithuania’s CENTROlink
3. Digital currency as mobile money – transfers are carried out in real time and directly from one mobile wallet into another without a payment intermediary. This digital currency (DC) is issued by the central bank and used through a mobile phone app. Use mobile phone technology. Examples: Equador’s dinero electronico and Uruguay’s e-peso.
4. CB issued cryptocurrency – CB issues tokens denominated in the official currency. Who has these tokens at any time is tracked. Example – Lithuania’s LBCoin and China’s digital renminbi.
5. Synthetic DC – a supranational cryptotoken issued privately but based on CB money. Example – Libra
6. Indirect DC as e-money issued 1:1 against central bank money. Payment systems in the past have been based on bank money, but payment systems in China are now being required to replace bank money reserves with central bank reserves
7. Indirect DC and 100% reserve bank money. This is full reserve banking as proposed by Irving Fisher and other economists in the 1930’s, requiring banks to have liquid reserves equal to their deposits. Example – The Narrow Bank proposal in the US.
Huber discusses the relative merits of each of these, while indicating that all of them provide a pathway by which CBDC gradually displaces bank money. He also points out that this isn’t the end of banking. “Banks and non-bank financial institutions offer numerous useful and partly indispensible functions in the areas of money and currency management, payments, lending, investment banking and wealth management. These functions that are now based on bankmoney can just as well be fulfilled using DC.”
“The sovereign monetary prerogatives comprise three components:
1. Determining the currency as the realm’s monetary unit of account
2. Issuing the money or several types of money denominated in that currency
3. Benefiting from the seigniorage, i.e. the gain from money creation.”
For a state to be fully sovereign none of these can be left to foreign or private powers. “In modern monetarised and financialised societies being in control of money – its creation, first uses and its ongoing allocation thereafter – means wielding superior power, second only to legal command power and the authority to issue directives.”
In the rise of bank money, components #2 and #3 have been lost and ceded to banks. “But because of failure of the system government has had to step in to save it, with insurance for depositors and for the banks themselves. Rather than thinking about the way of functioning of the present money and banking system, politicians and central bankers have chosen time after time to save the private bankmoney privilege, falling to the illusion of being able to make banks safe by ever more and tighter bureaucratic regulation. Among recent examples is the Dodd-Frank-Act from 2010 that comprises almost a thousand pages, including, among many other things, ring fencing and living wills. Another example is the Basel rules on the liquidity and solvency of banks. Such measures remain ‘inside the box’ and will help as little today as they did not help much in the past.” Politicians are now trying to save monetary sovereignty from private challengers, without realizing that most of it has already been given away.
Paving the Way for Sovereign Digital Currency
Huber addresses two objections to CBDC. One is that bank lending will be dangerously curtailed by the shift of deposit money from banks to the central bank. This concern is a holdover from the view of banks as intermediaries, a view that has now been discredited. Liquidity is furnished by reserves from the central bank, not from customer deposits. The second objection, apparently raised by some central bankers, is that out of fear there could be a massive bank run. Huber points out, however, that the likelihood of bank runs will in fact “diminish to the extent to which safe and secure DC replaces bank money.”
Huber lists 7 design principles for CBDC. The ones most relevant to the thinking of monetary reformers are 1) state warranty of bank money must be gradually reduced and ultimately removed, and 2) the mechanisms of central bank issuance of money must be enlarged, so as to include a) a citizens’ dividend and b) genuine seigniorage to the Treasury. Guidelines are offered to make sure that third level money surrogates, like MMMFs, 1:1 complimentary currencies, e-moneys and stable coins, are not used as money. This deals with the question of money creation by shadow banks.
Huber cautions that, with the existence of two currencies, CBDC and bank money, side by side, the right transition won’t occur if banks continue to offer interest on deposits and the “far-reaching state guarantees for bank money are maintained.”
Huber concludes by saying, “Despite foreseeable frictions related to the coexistence of DC and bankmoney, introducing DC is a step in the right direction, that is, the pending tidal change from bankmoney to central-bank DC. By comparison, the problems inherent to the present near-complete rule of bankmoney and other new money surrogates are still much bigger. It is about time to recall the sovereign monetary prerogatives.”
Huber’s presentation leaves some questions unanswered. Lacking is any specific mention of the mechanisms by which central banks will begin to create new money. Will this be money lent into circulation or will it be made available for government to spend it into circulation? Will the debt money system persist, or will it be finally ended?
Also unanswered are questions of strategy in pushing the development toward sovereign money. But the paper is, as pointed out above, descriptive, not prescriptive. The broad picture Huber has given us will be helpful to those interested in advocating for change. Although the movement may, as Huber depicts, be tidal, steps in both public education and legislative action will be required. These are efforts advocacy groups like the Alliance for Just Money can pursue.
Huber, Joseph. 2020. “Dominant Money“. SSRN, 3 Jan 2020.
McMillan, Jonathan. 2015. The End of Banking: Money, Credit, and the Digital Revolution. Zurich, Switzerland: Zero/One Economics .