Central Banks & Commercial Banking Part 1 | Blockchain and Money

[00:00:00]the following content is provided under a Creative Commons license your support will help MIT OpenCourseWare continue to offer high quality educational resources for free to make a donation or to view additional materials from hundreds of MIT courses visit MIT opencourseware at ocw.mit.edu all right we're gonna we're gonna turn today to a fun topic of how central bags right at the heart of the financial system we're thinking about blockchain and we're going to do this over two classes where we're fortunate that we have some real expertise in the room and I'm not talking about myself but Rob Ali who ran the digital efforts at the Bank of England and is now and has been for some time part of the digital currency initiative ever the Media Lab is going to come up from time to time and and give his perspective not only from mi t--'s media labs perspective but also from the history of what he's done he's authored a number of papers in this area he works with technologists creating a number of technologies but I'll let Rob tell you a little bit about what he's doing in central banking Simon Johnston's also joined us who is a former chief economist of the International Monetary Fund he's told me he doesn't want to be caught on but I will call on Simon to give his perspective at some point in time from the IMF days but as you all know Simon is a Sloan faculty a great teacher himself teaches a lot of you the global markets course and the G lab course and things like that and Simon and I and the spring teach a public policy and private sector course which is just one one more time for me to plug that that's a good course to so now let's just talk a little bit about central banking and and blockchain first what are we going to do a little bit about our readings and the study questions we're going to start with fiat currency and go back again to fiat currency and what how does it fit into central banking so the first 20 or 30 percent of today is really just about what is the central bank and how does it fit into money then how are central bank's thinking about blockchain technology what are their approaches and we're gonna talk about four different approaches that central banks are taking to blockchain tech nology then dive into one of those four approaches payment systems and how are they looking at payment systems right now dive in the probably the most interesting one central bank digital currency and what's called the money flower you might remember that money flower that was in the BIS report and so forth and then just wrap it up so that's that's a little bit of what we're trying to do the study questions were really about central banking what are they thinking about how are they thinking about digital reserves and so forth because I have a guest with me I'm not going to do as much cold calling cuz we're going to leave time for Rob to get up here and give some of his thoughts as we go through but the key questions were really how are central bank's thinking about central bank digital currency how might they think of the design considerations which we're gonna dive into in the latter part of the class designing retail versus hotel access should it be a token or account based interest bearing or not and we'll talk a lot Thursday about why Sweden right now has come out with their most recent paper which was not an assigned reading because the paper came out of about a week ago but they're saying they're thinking they should make an interest-bearing which I wouldn't have necessarily predicted but that's where they're thinking is as of October of 2018 and then what are the challenges that it might relate back to the commercial banking business the credit markets the economy as a whole so that's a little bit of the background and these were the readings I apologize because this week is probably a little heavy reading which meant you all skimmed rather than actually dove in one of these readings Broadbent Rob did you help write this this speech that Broadbent wrote I reviewed the draft and anybody working in this central bank digital currency space really goes back to broadband speech I had assumed it Rob may have written it or reviewed it and and Garrett who gave testimony in front of the US Congress on that these issues is also often quoted by the Bank of International Settlement so if there were two that you really want to think about you know the economics of money and central bank digital currency Garrett and Broadbent or picked up a lot The Economist piece was kind of lively and walked us all the way back to Adam Adam Smith did anybody read The Economist piece and remember what would he anybody remember the Adam James dude everything that's done right and wrong and any quote in the Economist piece it talks about in the 1770s when they started to move a bit away from gold money to paper money and they set up a clearing house in 1773 to deal with the paper it was going but amongst in between all the banks that Adam Smith apparently wrote that it was wagon wheels in the air and that gold was was the highway of money but paper money and central clearing of that paper money was the wagon wheels in the air so the Economist was basically saying these debates are as old as time Adam Smith was saying you can promote an economy with wagon wheels in the air money but maybe that's what's going on now as well so I've already introduced Rob research scientist from the digital currency initiative and before MIT he helped broadband he won't say did but he helped broadband do everything he did at the Bank of England and then Simon who's taking notes did I get your did I get this right yeah good picture what's that not sure about the picture so fiat currency is anybody gonna remind me what fiat currency is British you're slouching in the chair a little bit there it's the norm in the system and what are what are two very important economic features of fiat currency that make it so widely accepted in any economy that we've talked about one of the reasons is that it's typically used as the B's to pay taxes taxes and what was the other big one that almost every country you can use it for Priya you looking at me no payments so so societies come together and say you can use it for for all debts public and private you can use it for taxes it sort of gives it an enormous network effect in an advantage in in in any economy and then what happens is so many of us in a society then use it as a unit of account and there's an enormous amount of network effect just the raw economics of money is that others will use it in exchange it and thus it becomes the medium of exchange unit account and store of value so it's represented by central bank notes and commercial bank deposits relies on a system of Ledger's which makes it somewhat adaptable and why blockchains interesting in this space and taxes and debts so then I've pieced together a little bit of a slide to think about where does central banks fit into this ultimately you'll see where I'm going with this but commercial banks and central banks both have money central bank money our reserves and cash so it's not simply the cash in our pocket it's also reserves and bank deposits actually are a form of money so a little diagram if the central bank is at the top and these are number banks commercial banks reserves or the deposits that commercial banks have with the central bank when central banking started two and three hundred years ago was that commercial banks wanted something from the government they wanted some backing they wanted a lender of last resort and they would have to open up accounts at the central bank but today when we have kind of unified Ledger's then the central bank issues reserves to the banking system and those reserves are a form of money the next thing is there's the public down at the bottom Bob Alice and Charlie we all have money and it's called bank deposits but there's one other piece of this puzzle if I can get it is cash so three forms of money we can all have cash in our pocket as I commonly pull out this here right I'm gonna watch you Hugo I'm gonna watch you but no no but what is that right there right that Federal Reserve Note is a representation that at the central bank they're storing some value for me it's got a serial number that piece of paper itself is not the store of value in a sense even though we accept it would you say that's a store of value and what way is that a store of value i dollars and why is it worth $20 and see what happens if you hand it to rob he'll take it right that's how you know it's worth something but it's it's it's a tokenized means of money it's a physical token and the central bank has something stored there but you also have bank deposits and if you go into Starbucks and you buy something at Starbucks James if you buy something at Starbucks what are you giving them do you actually who here alright so when you give a credit card what are you giving to Starbucks ultimately exchange for coffee you're gonna I hope you give them more than a notion what will the payment system do Ross they just have a right that company checks to make sure they're long and ultimately that receivable would be removed bank deposit to the bank deposit you'll never be handing of my $20 bill what's that all right Rob that's his big teaching fees are cheaper than my tea but Ross you want to go through that so the receivable will be a bank deposit ultra and they collected from the credit card companies who's gonna move money from their account the Starbucks company sends you a bill so there's two separately so when they're checking your card it's just a credit card company checking its records to see if they're willing to teach you the receivable start you're really doing is you're spending a form of money caught bank deposits and you're back to pods it's gonna go down and what Starbucks back to posit gonna go go up so three forms of money the cash the deposits and the reserves because the central bank is giving some money all of this is handled in accounts and a ledger structure and we talked about it so the accounts there's central bank accounts and their bank accounts it just accounts are Ledger's I've just changed the words and it's moved through a system a payment system that we talked about last week and I'm putting to real-time gross settlement is that little box up there real-time gross settlement is a system between banks and a central bank almost every country has some form of real-time gross settlement system here in the u.s. we might call it the the Fed wire or ACH I see a lien which is ACH real-time gross settlement or maybe not just the Fed wire so in the US we have chips and the Fed wire both real-time gross settlement that's between banks and the central bank and then you have all sorts of systems what's in that little box is not as important to read is basically to move between backs so that's central banking and how it fits into money Rob how we doing all right so far you can come up here any time all right what's that all right we've got some feedback though wait so I just wanted to hit two things on cash cash in in in the economy is moving up a little bit the BIS report for those who read deeply this is just a chart that comes from your reading this is cash as a percentage of GDP you'll see one arrow going down Sweden Sweden only has about two percent of their economy in cash the u.s. is going up it's about eight percent we have a twenty trillion dollar economy we have one point six trillion dollars of those $20 bills so in most countries it's going up China Japan by the way as close to 20 percent of their GDP in cash I added this chart Simon this was to keep you guessing yes you want to answer this question at Kyra [Music] all the people are feel uncomfortable to use that number so a bit of a cultural - yeah hi Joe and technological or more culture yeah so long younger generations right to use that credit card Laura he loved it but all those people what's interesting about this slide is a lot of the other central banks in Sweden is like a canary in LA they see cash eavesdropping and they're thinking about this or you know fundamental question about should the political access is simply like me at all and they have it now in terms of cash and ship we provide digital version - is not gonna be anymore when you say this qe4 is a capturing the effect of the bank's buying a lot so facets in the market question is does this reflect because we start in 2007 to 2016 is there something else going on the quantitative easing of central banks but what else happened during this period of time what what fundamentally happened during this period align the mortgage crisis or more broadly the financial crisis so there was a I think more than quantitative easing I think that this whole sense the satoshi nakamoto tapped into to is central institutions are failing so should there be a run to physical cash should is this it's not gold but is this more more in some cases safe than commercial bank deposits now my dad if he would have been well he was alive during this period but he would have been taking his money out of the bank and getting gold there Simon you haven't heard this story but my dad always had some gold coins and a few diamonds he did not he inherently did not trust government he also carried a gun in most days - he's in a tough business but in this period of time couldn't easily get the gold a lot of people went to cash how much do you think the u.s. is 1.6 trillion or 8% of our economy is $20 bills like like that and tens and how much do you think is $100 bills anybody it was not in the readings I'm just kind of curious what are people think here worth like 80% so 80% of the of the 1.6 trillion so anybody have a different thought that was pretty good so here's a chart that I pulled out through 2017 of the 1.6 trillion it looks like about 1.3 trillion is hundred-dollar bills so what's expanding in the u.s. is not the use of $20 bills and $10 bills it's it's it's the use of the hundreds and and I could have put up another chart over half of those hundred-dollar bills are thought to be held internationally and they're not even held within the 50 Continental 48 continental states in Alaska Hawaii they're not helped domestically so it's great to be a reserve currency it's great to be a store of value Ross I was just gonna ask this core value question maybe I misheard the port when we were passing the $20 you said is it a store value might but you're sitting know and if half of that is hundreds I don't think there's a really answer to it I would say this represents a store of value ultimately on the central bank's ledger because the central bank could if they wish to deny use of this they haven't they haven't for decades but I'm saying somebody could say that's a bad serial number but most people would say that $20 piece of linen is a store of value what I was gonna ask would you expect the velocity needs to be like inverse inverse they're related yes so the question is is the velocity of 20s higher than hundreds yes meaning it they turn over faster and what measurement of it is is how quickly these currencies these linens have to be replaced and $1 bills I think have an average life about 18 months they keep coming in and out of the system and I I'm not in entirely sure but I think 20s are maybe three four five years in essence you these are all signed by secretaries of the Treasuries and I apologize for those who aren't Americans but it's hard nails to still find Reubens Bob Rubin or Benson's which was early 90s signatures on the $20 bills now part of that is because the currency design keeps changing so hundreds aren't used as often they have turned over since the currency design has changed because even in illicit activity you'd prefer a new hundred to an old hundred because a new hundred is more secure it's less less able to be counterfeited and when I served in the US Department of Treasury I had to spend a lot of time because I I i chaired something called the interagency counterfeit deterrent committee and you know I had to meet in the secure rooms where they locked us in and you learned about who was counterfeiting the money most of the rationale of the issue more cash to meet that demand compared to smaller denominations where the Brodus is asking why why in essence is this happening well a central bank has a couple of choices they can issue paper currency to meet demand and the demand is really as evidence through this thing called this does the public ask for the cash and that's what's largely happening or can they put some quota system or buy government Fiat like in India where they said no you have to hand in all the old banknotes and there was an active desire in India to take cash out of the system but in the u.s. we've not had that we have not had any you know real large government interest of taking it out of the system and so what you do have is you have more more demand for hundreds as a cost store of value whether it's for illicit activity or straight-up appropriate you know activity and the central bank is facilitating that this entire eight percent of our GDP or one point six trillion dollars of notes is interest-free borrowing for the US government so there's a there's senior edge Eric I just wanted to make if we come in regarding the sort of body and going back to what we discussed the first assets was that this actually account a social construct that believe that you're going to solve Dimps or pay taxes without without fiat currency that remind you of a story so was this is true this was a South American drug lord family this this drachma was on the verge of being caught all their assets were were being seized by the government the stories told by by his son was actually sitting in the one apartment surrounded by piles and piles of dollar bills which they actually couldn't do anything with they actually use them to burn and get some heat and then you go back to think is it is going back to the social contract right because their money was was wasn't good for any merchant in the in the South in that specific South American country if your point is it's a social construct I'm a king agreeing in that case maybe it was also a little bit of time value of paper money he was about to get arrested you know there there so there my but so I don't know enough about that circumstance but for sure so let's move a little bit on to central banking and I choose the US but it it it's true around the globe so there are economic policy goals that central banks have taken on in the US it was captured written into law in the 1970s 1977 to be precise something called the dual mandate interestingly the u.s. dual mandate for the central bank has three three things written in law this is a quote promote effectively the goals of maximum employment comma stable prices and moderate long-term interest rates that is what's known as in the u.s. is the Federal Reserve's dual mandate you might say it looks like three mandates címon DoD that's mostly people call the dual mandate is is price stability and maximum employment and then some central bankers would say the best way to promote maximum employment is stable prices you know depending on how you wouldn't say that if you're going for Senate confirmation to be a member of the Federal Reserve Board but am I not right that some economist President of the European Central Bank because one mandate so around the globe central banks might have different mandates but almost I would say though I haven't studied 180 central banks all of them would have price stability or to ensure that there's not much inflation because they are in the business of having the public mandate to secure the money that's the core thing now what do they do they manage money and I think of it as supply and price so these are genzler's way to think about what central banks do but it's about supply money supply is physical cash do we keep issuing more physical cash this 1.6 trillion of cash but there's broader things called monetary base this is not in the reading does anybody want to tell me things like m2 and m3 what what anybody taking a finance course are you studying what what monetary base is or m1 or m2 or m3 is it there's no reflection on you it's maybe reflectional and Sloane I'm just asking know so there's different measurements of money that central bankers will monitor and manage my is usually the hardest core money it used to just be cash or cash and demand deposits in the u.s. system it's about three and a half to four trillion so about half of it's the cash and then they add the the the Federal Reserve says demand deposits in a bank or just like cash and this comes back four and five decades ago started to say the hard money m1 is that m2 includes the rest of deposits so m2 in the u.s. is somewhere in the order of fourteen trillion dollars in the US there's about 13 trillion dollars or 65% of our economy is in deposits the banking system has every country that you're from has a different number I'm just using the US as an example so deposits make up more money than cash cash is about 1/2 to 2 trillion deposits or 13 trillion and you add them together you roughly I'm using this term loosely m2 which is a wider form of money is about 14 trillion dollars here in the US there's also an m3 and there's other measurements of money so the Federal Reserve tries to manage that and they manage it not only I have minutes physical cash is printed but it's also the leverage in the banking system if you let a banking system be highly leveraged then you're in essence creating more money if a banking system needs more capital then it's gonna have fewer abilities to expand the economy and those are the big tools that a Federal Reserve or the Bank of England or any central bank has to basically shape the supply of money but there's also things they do to shape the price of money and that's interest rates the price of money is like I'm lending Rob money he's giving it back to me in a year what's the price of money and and it's that so two big tools supply of money and price of money if you ever want to be a governor of your central bank your business didn't end there was a history of the eurozone shopping bodies there was a guy at the IMF I think worked on the Greek crisis knee wrote a very good book about my committees fear and how when one weekend in 1971 if I've got my year correct early 1970s Richard Nixon took to Camp David which is the presidential retreat in Western Maryland the leaders that he needed to get together in one weekend the head of the Federal Reserve the head of monetary that the undersecretary for monetary affairs at the Treasury Department who was having to be Paul Volcker at the time but he got together four or five people in one weekend and what took the u.s. off the end of the gold standard we we kind of went off the gold standard in the 1930s but after World War Two there was an international consensus Bretton Woods and there was still that central banks to central banks could exchange money for gold so we were still in somewhat a gold standard and Rob might have a different point of view a good friend of mine Jeff Gordon is writing a book about that weekend he was dean of the business school at Yale but the French had asked for some of their gold back and they got it back but then the British started to make noise Bank of England start to make noise that they wanted some of their gold back and Richard Nixon had a challenge so he decided to just take us off the gold standard there's a lot of historians debate whether the Bank of England forced it or not Simon so professor Johnson hastag was actually wait it was the u.s. gold or the UK's gone and so the question was whose gold was it and under Richard Nixon's view and I think Simon's agreeing it was I didn't know because you're you're a dual citizen aren't you I just didn't know when you said our gold whose gold so your British accent was throwing me off okay so Richard Nixon would agree with Professor Johnson that it was our gold and and and and the British to this day would say well we didn't really ask for it back there was kind of making some noises about this I don't know if that's I might even be so what did they do what is the central bank's actually do they oversee the fractional banking system providing those reserves but also regulating the banking system I mean if you're sitting on top of all of this back here you might want to regulate the whole system and that's why around the globe by and large central banks regulate the banking system not always and sometimes like in the United Kingdom they gave it up to another agency and then pulled it back you go so I understand how central banks introduce new money into the system but what would be the mechanism of trying to decrease the supply of cash would it be an increase in our like not allowing the commercial banks to so you can you can you can apply a very good question to you go saying how can you change the amount of money and I'm gonna use all digital forms of money not just physical cash but Dolf digital forms the way you can effect it if say that any one Bank needs more capital or more reserve so you're lowering the multiplier effect in fractional banking if you need 5% capital that means you can have $20 of balance sheet for every dollar of capital if all of a sudden you say no you need 10% and then you would be shrinking the banking system in half for instance so so that there's a number of tools but one of the direct tools is reserve required our mints and capital requirements it's not the only tool so it would be a mandate to the commercial banks it wouldn't necessarily directly interact with a retailer retail correct Federal Reserve manages monetary supply in numerous ways but some of the direct ways are and it's why they also regulate the fractional banking system they have that direct need but they also need very importantly the third bullet point to promote a safe and efficient payment system in some countries many of the countries represented here written right in the in the the legislative act that sets up a central bank says they must promote a safe and efficient payment system and if it's not written into legislation it's at the heart of every central bank they are also the lender of last resort when banks fail they come in and support them our central bank was set up in 1913 in 1907 we had a crisis banks were failing all around does anyone know the history of that crisis who who actually was the lender of last resort in the US economy in 1907 and it was not the US government JP Morgan and not JP Morgan the bank JP Morgan the man the man I mean he had it back he had a library he had a lot of other things going on for sure you know you could say he was the Bill Gates or Warren Buffett of his time but in sense he had more influence than a Warren Buffett or a Bill Gates in 1907 we had gone it we had had a in fact that picture in the upper right corner is the first bank of the u.s. in Philadelphia set up in 1791 it was set up with a 20-year Charter Hamilton and Jefferson had a huge fight the Congress passed the law to set up the first bank of the US and jefferson recommends hit jefferson was Secretary of State recommends to President Washington veto it Hamilton's wrong Washington gave Hamilton one week to write him a report it's an it's a really well-written report I have not read it in a number of years but I went back and read it when I was at Treasury one week later Washington signed the bill Jefferson was never forgave Hamilton for that and many other things but it was a 20 it was a compromise it only lasted 20 years in 1811 we we no longer had a central bank so we had a love-hate in the US with this central authority in central banking sort of worthless I guess what would your response or the bankers in the room what would your response to that there I think I mean money is it comes back as money as a social construct big right and anything can be money if you want until almost anything so if you've got a big enough group of people you think some things money even has but it's valuable and that's true u.s. dollar and a Bitcoin but I guess the question is how do you generate trust in the system and I guess the US government generates it through having nation-states and an army and a Treasury and everything else when a Bitcoin has this network of - and this so just generates the trust in a different way but I'd like to say like money doesn't work as if everyone thinks it's worthless or like a significant group of people so there's embodiment dollars worthless right but fiat money is a general concept being worthless it's you know you've got choice you can choose depending on your preferences but I think it's difficult to maintain it's worthless when I think also fiat currency has had a lot of challenges in crises usually related to I their poor fiscal policy than the nation the government state is overspending its taxing ability because taxes are revenue and then the spending often related to Wars but not always or to the monetary policy in essence a lot of printing of money in the old days there was physical printing of money and the new days it's digital it's it's the overseeing of the banking sector and some of the biggest banking crises have led to a significant in essence expansion of the monetary base maybe it was lending against real estate in a housing bubble in Ireland there are other countries and so forth but we're not unique in the u.s. to have housing bubbles and that can undermine the the social consensus about fiat money take China in the late 1940s where every every few minutes you had to worry about did you have enough suitcases of physical cash to pay for your restaurant bill if you were at a restaurant and so forth and in any country that's in the midst of hyperinflation you're usually then the social construct falls away but it's rare that it hasn't been replaced by another fiat currency maybe with a stronger military or a stronger central bank or but after some crisis occasionally it's replaced by another country's fiat currency and there's a number of Latin American countries that have said well this isn't working we're gonna go to the US dollar and just be door and we're not going to trust our sovereign we're gonna trust somebody else and remember I've said this once I think in this class the history and Simon bailed me out and robbed bill me up history of the Bank of England was that the King of England was at war with the King of France and needed to borrow some money and couldn't borrow it readily I think it was like one and a half million pounds and some noble Lord said well this is how we'll give you the money if we set up a board it was initially the Bank of England was in essence a contract between the sovereign and the noble Lords that it said we have to check and and then the war went on I don't remember you guys probably want and beat the French but it was in the midst of a war all right you're recorded by the way video so let's move on a little bit just so we can get to what central banks are doing but in essence what central banks do is they oversee the banking system I mean back to they promote the economy through stable prices and in some countries also this concept of a dual mandate they manage the fiat currency money through supply and pricing oversee the banking system and basically are the bankers to the government when the government's really in trouble think back to the 1690s when some noble lords were funding the king that still happens that central banks do sometimes fund governments so the US Federal Reserve balance sheet I'm not going to spend time on it it will be in the slides in canvas so let's talk about where central banks approaches to blockchain and crypto some I would say a majority or monitoring studying the US Federal Reserve would be this way the you in Central Bank Rob has a better feel because he talks to central bank's all the time but monitor and study is the dominant place restrict restrict its use I'd say the the the People's Bank of China is more towards this they're kind of a mixture between monitor and study because one of the readings was actually from a senior policy person at the People's Bank of China he's and he's written some remarkable pieces every few months there's a piece in like CNN or CC Adhan which is a crypto newsletter or corn Telegraph that this one individual from the Central Bank of China is writing these pieces now I don't know a lot about the Central Bank China he always puts at the bottom these are my personal views but I have a suspicion he would not be allowed to write these things if it weren't something bubbling underneath but you can restrict the use of crypto and some countries like China and else we're doing that there's payment system experimentation which we're gonna chat about and then there's this thing called central bank digital currency initiatives and Rob and I know the answer of this but I'm curious of the group central bank digital currency having read all that you've read for today does it rely on blockchain technology showing hands yes or no so yes it relies when my hand won't matter does it rely on blockchain technology central bank digital currency that's I don't see a single hand how about no how many people think now well you did your readings well did you read it thank you she's signing them so central bank digital currency is inspired by this whole crypto finance movement but it does not necessarily depend upon blockchain technology but I think it's central to this course and central to a study of blockchain technology and money because it's absolutely inspired by this whole movement though the first person that wrote about it was Tobin in the eighteen 1980s if I'm right right yeah yeah 1987 or something I think Tobin wrote about basically giving the public a direct tokenized means beyond paper money a digital means of an account but most people would say central bank digital currency relies on blockchain technology and you've made me proud that you said no let's talk about the pain points where this was last Thursday's lecture but there's some payment system pain points I added one or two because of your feedback but costs delayed settlement chargebacks frauds privacy Financial Inclusion and the like and for Robin Simon this was last Thursday's discussion so some of what the public sector is doing is non blockchain initiatives entire lien on blockchain initiatives the European Union the u.s. others are doing things about faster payment basically trying to move the payment system to 24 hours a day all seven days a week not locked up on the weekend where you can actually move and that merchants can do it as well as banks so whether it's the target instant payment system or what's known as tips in Europe or faster payment task force which has led to a faster payment mechanism I think I'm guessing Priya's husband's working on that right does he he was working on the task force shrimp joined us last Thursday and he talked about he's at MasterCard so a lots going on I just know the I put just two other countries India's immediate payment service is really government sponsored government pressed I think one of the gentlemen that works on it Simon you have speaking it mi t--'s campus in a few weeks Arvind worked on anything and in the UK where they're saying not only we updating a real-time gross settlement system but there's a government and eight that banks have to open up their bank accounts to what's called open API a lot is going on non blockchain related related to payments making it faster and more access but in the midst of that here's a little bit of what's happening in the blockchain space and with the help of the South African white paper on this I break it into three phases so I thank South Africa's central bank first is phase one three countries wrote papers Canada Brazil in Singapore Canada and Singapore even called them something it's called project Jasper and Canada and project Rubin in Singapore and they they they did some experimentation all based on a theory of network could you do a better payment system based on a theory 'm so an open-source blockchain permissionless system and they tested out a new real-time gross settlement system and they generally the way they do this is they to get a group of banks in their country and if you were to read each of their detailed reports there's some similarities and some differences but by and large get a group of banks in your country use the platform try to do a talking through and see if it will work aleem trying to see if they could use the theory of network to build a better payment solution or are you saying they developed a smart contract on the current or did they deploy their own a theory on permissionless network which one i think it was they just like it says now what you'll see because I want to quickly go to phase two phase two none of them used ethereal phase two two two more initiatives happened Japan and Europe together and when I say Japan and Europe I mean the central banks in all all of these are central bank focused Japan and Europe added and South Africa and all five initiatives all of all have been published already work happening in those various states and lates in mid to late seventeen and into eighteen we're all on permission they were looking at kurta hyper Leger fabric and quorum quorum is the closed loop system that JP Morgan we talked about hyper Leger fabric and kurta so I think a lien this kind of starts to answer your question that they then said well no it's not going to work on a permissionless every one of them in phase one said we don't think this is going to work on a permissionless system let's then go into a phase two experimentation we're now in kind of phase three or a third wave we haven't heard from Brazil recently don't know whether that project is basically stopped but these are big countries in big central banks that are interested is can there be a payment system solution so I'm just going to talk about Singapore for a minute and give you a flavor for outside of the readings but a little bit of what the Singapore project is but it captures all of these by just talking about this project this is from their papers but they really see that we're in a multi phase project and they are willing to publicly say we're gonna go further than where we are right now we want to get to the place where we have domestic delivery versus payment and in the future payment versus payment systems money versus money delivery versus payment DVP is basically a security versus money so if you see the words DVP it's in the in the securities business where you move a security and a payment simultaneously and there's no credit risk I will not give Rob the security unless he gives me the cash or vice versa ask me one day about when before we had DV pay what what the markets were like so Singapore is willing to publicly announce we're we're gonna take this as far as we can go all the way to a cross-border settlement of payments and securities against each other D versus P versus P is what they call it the D you can think of as securities will they succeed do they need to stay on a blockchain I can't I can't predict that but they're they're willing to say we're gonna give this a try where are they right now in Phase two well they tested court a hyper ledger fabric and quorum and they have a full 60 page report they published a month or two ago about how did each of them work to do basically payment versus payment cash large cash movements but here were the six criteria they tested and they say they passed every one of them now I read the full report and I have to say it struck me that they probably did pass it but I'm not enough of an expert and this stuff gets very granular and the question still is could you just use an Oracle database to do the same thing and it's a fair question but they tested it basically can you digitize the payments can you decentralize the processing can you do the queuing the queuing of payments and a lot of cross entity payments you have to net the payments I'm gonna pay Rob Rob is gonna pay Hugo Hugo is gonna pay me well that doesn't make sense you net it all and it's a queuing factor and all these real-time gross payments Aleen this was in what country versus Singapore Singapore and there's a central banking system boards movie very centralized what is the central what they write about they think that you could lower the single point of failure risk by not having the central bank they actively this is a central bank writing the paper saying we could have more resilience in the system if the database is distributed amongst in this case they had eleven banks participating and the eleven banks have separate nodes now it's still a permission system you might say and somehow the central bank has a notary node maybe but it's amongst the 11 banks and that there would be more resilience to the system than having its centralized monetary policy Rob what what do you what do you want to add to this because you rob swims this way and I don't I think it's because the question is like how much the central bank consciously limits its own power I think it's because if you have a system where because I think there is an instinct at certainly some central bank's they want to like a special know you for the for the central bank we could do a list on the other and my arguments of the new actions want to limit that the power of the central bank as far as you possibly can because it to the extent the central bank has special powers over the system that creates a weakness in the system because if that nobodies then taken over then whoever could you know go you know change the system has effectively all the power the set of baggage which sort of takes away the benefits of decentralization if there's because the tomorrow I can appoint decentralization is increment possibly attack by saying well to attack the system we have to attack 57 or whatever but if you have this small special no that we only have to tackle unknown and it sort defeats the object so I think when you're speaking circle times you have to persuade them of the need to have a system that they like almost stand up and let it go rather continuously with so many countries there's gonna be a wide variety and I really do think that I many of the central banks are in that monitor and studies slipstream and a couple are in there let's restrict the use slipstream and even China that says we're restricting the use is still studying the heck out of this but some countries like Singapore in Canada are in the forefront saying let's figure out maybe this technology will make the payment system and thus the system of fiat money more resilient it's it's still unknown but they're really do they're really trying to test it the edge so perhaps this is just like a peculiar observation but if you like the very like institutions that satochi and Bitcoin we're trying to disintermediate are the ones that are taking inspiration from this and then trying to advance their own technology and the pills is it a competitive threat like what what's the disconnect like how are they thinking about using this for something that was basically built to disintermediate dawn so Zhaan's asking about Bitcoin and wasn't Satoshi nakamoto's innovation about it's doing something not just decentralized but you know not trusting trust lists sort of system but every technology evolution whether it's in electronics and telecommunications or elsewhere startups if they have something good incumbents will look at that technology and see what to it to adopt for themselves partly because they're threatened by the startups and in this case I really do think central banks have felt a little bit of heat on their neck a little bit of heat like we've got to think about our payment solutions and our money solutions and maybe there's something from blockchain technology but regardless of whether it's the heat on the neck or opportunity incumbents will always look at tech technology and see and it's why the paper that you've read sometimes the Geneva report that Simon and three of our colleagues and I co-authored this past summer we call blockchain technology a catalyst for change and we were agnostic partly because there were five of us co-authoring it but we felt that captured our five points of view that it might be a catalyst for change for incumbents it might be a catalyst for change to inspire central bank digital currencies which frankly don't have to be on a blockchain at all or it might be some stored-up that does really a unique thing and I mean unique beyond crypto kitty's you know so not the study not this timeline but you're saying a timeline for specific and look back it's a good question I don't think Singapore said they're gonna finish this by 2019 but I don't know whether they said a date like 20 21 or 22 but it's a multi-year project specific transaction to process it all the way to sentiment how long it takes the test case in Singapore and Canada within seconds but I don't know if it was like nanoseconds no it's very quick three of you actually how is the central bank thinking about reporting for these transactions or is it a later stage problem to worry about well the reporting is I've read these reports and then I want to move on to central bank digital currencies which were going to be largely talking about Thursday but I want to set it up because Rob won't be with us Thursday reporting is this is a ledger this creates a database this permission block Jane amongst eleven banks in Singapore and it's just a test it was just a test is basically a form of a ledger so I don't think they've built out any customer user interface and reporting that way but but the the transaction Ledger's were kept similar to Bank Ledger's as I understood it but they didn't build out a user interface and this Rob you know any otherwise yeah so let's let's talk a little bit about the next and the toughest central bank digital currencies that may or may not be based on blockchain technology but they're absolutely inspired by blockchain technology so central bank's currently issued digital reserves we saw that earlier it's digital money already and then physical tokens I keep my eye on this physical token here right so that's the form of money commercial banks then issue bank deposits in the u.s. that's about thirteen trillion dollars to the public and bank deposits and there's only one point seven trillion of this so bank deposits are the biggest form of money and it's all digital essentially bank deposits are intermediated central bank digital currency those are my words but it's digital currency bank deposits it's just not directly with the central bank it's intermediated in between if you sort of go back to that that flow chart that I had earlier so the private sector is also experimenting with stable valued tokens we're going to talk about that Thursday there's some readings I'm not going to dive in now so there's a little bit of competition so it's exams earlier question the private sector circle and tether and others are having these stable value tokens so there's a little bit of competition coming that way so the strategic question for the central bank says should we allow direct access to digital reserves we have this intermediated central bank digital reserve caught bang deposits but should we have something direct to us like cash is a direct relationship between the central bank and the holder that's really the strategic question when you I believe when you move away from the technology you don't know I have to know about hash functions or anything that's the strategic question why do I think there's some opportunities and we're going to dive more into this Thursday but I wouldn't Rob to see if he he wants to speak about this and tell us I think this is a real question and Sweden has highlighted it they want to continued involvement in the means of payment Sweden is already down to about 2 percent of GDP or one and a half percent of GDP is there there's the Cronus the physical Cronus the US is still at eight or nine percent but but they're saying nobody's accepting physical Cronus anymore in Sweden in Norway and so forth pretty soon most retailers will not take them so they're saying maybe the government needs to have a continued direct relationship could it promote competition in the banking system because otherwise if you don't have it then the banks are controlling the payment system and the means of payment promoting financial inclusion not everybody will have a bank account well maybe they could have some digital form of central bank money instead of a bank account the pain points and I would say for some countries some countries are clearly looking at central bank digital currencies to avoid US sanctions Venezuela and Iran both have projects for central bank digital currency sorry question and so here here of course blockchain technology could be relevant for these six reasons or five reasons you didn't need blockchain technology but I'm going to say blockchain technology could be relevant fiat currencies on a ledger verification and networking costs are critical to the economics of money so I wouldn't count blockchain technology out of this because blockchain technology can lower verification and networking cost but I think we're too early to know whether blockchain technology will be at the center of central vac digital currency but it could have an effect so the challenges and again we'll dive more of these Thursday Rob you want to say anything about these challenges very much the line on bank lending if you do something which essentially drains because it's from banks are you like fundamentally changing the nature of the system and how are you gonna create a system which allows people to like fund mortgages or find businesses or whatever it is nothing that's the date change something that's like the sensual question I think which i think is the boolean three okay so basically if you disintermediate the banks and the banks are not collecting again using us numbers thirteen trillion of deposits but only twelve trillion of deposits or maybe six trillion of deposits what are we doing to credit allocation because for three to five centuries or certainly for the since the Industrial Revolution banks form an important feature in our economy to promote the extension of credit and we had this six or eight lectures ago this graph that in the US debt to our economy is about three point eight or three hundred and eighty percent of our economy in debt it's not all bank debt but Bank that's a big piece of that can you move credit allocation away from the banking system well the answer has got to be in some level yes but what are the what are the pros and cons of doing that is it's not whether you can it's whether it's a better system a better economy better growth with or without it Shawn straight stupid of color to represent different cut level risk and they use depreciation interest point as a way to fund the corporates they can get a little so the question is could you use interest rates to try to do it which leads us to design considerations which is basically I listed that the last one you could put you could have a central bank digital currency that had zero interest rate interestingly and we'll talk more Thursday Sweden said no they think they'd put an interest rate on it but you could do no interest rate well I'd like to hear your thoughts Thursday well why'd Sweden come out there and what does that make sense you could put limits or caps on it and say these are only low dollar accounts you can only have X hundred euro or X hundred kroner you know Y number of dollars and it's really just small transactional counts equivalent to $20 bills not hundred dollar or 500 euro notes so you can put limits or caps or no interest rates and so forth do you make it widely accessible and so forth so there's all these design considerations which I'm guessing Rob you've talked to a bunch of central bank's where do they come out on these issues as you see it in 2018 what practically happen is it wrong there'll be a lot of political pressure in any crisis I think a lot we see this like viable and then I think the interest-bearing thing is interesting I mean the only reason cash doesn't their interest is because it's like technologically difficult their interest so I've been with with digital they're marginally you don't matter give yourself the option so yeah well we can send the interface River Walter but why limit yourself to say we won't charge interest cuz it's again it's like that's a limitation that comes from the technology of physical banknotes and there's no real need to import it into the digital world when you can achieve the same effect one of the reasons that some countries are exploring this option is they think it would be easier to do monetary policy because you have negative interest rates physical cash makes it hard for all nobody like that huh now the two liens you don't like negative interest rates but for a while we effectively had negative interest rates certainly for corporate deposits but if everything was digital and there was no physical cash central banks say we could we could actually go and have no lower bound no zero bound to interest rates that by supply of money rather than the pricing of money and and so there's both both one of the most interesting to me is the second bullet point is a token or account based and and the two merged together in a sense this piece of paper is a token nobody's keeping in an account that I when I hand this to rob you can take it Rob that's your fee remember nobody so that's a token based a bit of money that's what it's called token based token based money is more anonymous and you can keep it more anonymous account base is when you're actually keeping the ownership somewhere on a registry even though that $20 bill is registered somewhere it has a serial number it's a token based bit of money the Swedes interestingly say they'd have to change the law their own central bank laws for one of these two and now I can't remember but they have if it's token base it would come under their emoney laws and I think they don't need to change the law to do that but in Sweden they would have to change their central bank laws to do a deposits because they would literally be opening up their central bank to something other than commercial banks that's it they have to they have to go to their legislative body and Parliament to actually do an account based and not a token based if I recall so there's some also legal reasons why you might need to do one or the other but one would have more anonymity than the other it's not well it's a token account so different sentence will say so when I see token I think about particular structures transactions which Bitcoin when I think about accounts I think a structure of transactions that are theory passed and that's how I just think we should do those two things but I think having started to do anything bankers they think about it differently because eat money is like you could think about it I mean to me that's an accounting system so it's but some bankers think about there's also some central bankers think about a stolen base it's worth noting that the definitions are very fluid so we're gonna save this for Thursday I'm not gonna go through this it was in one of the readings Garrett who testified in Congress was so popular with this than the Bank of International Settlements up this thing called the money flower but I'm gonna save this I'm gonna kick this to Thursday but it's basically the four things widely accessible is it digital is it central bank is a token based and depending upon where these intersect all you can take any form of money you could say well it's not central bank issued its token based private digital tokens down on the right hand corner is one piece of it it's just a way to take these four important features and we already have central bank digital money which is in the middle of all this is called reserves but but we're gonna we're gonna hold this for Thursday but this crazy little money flower central bankers who are in this world they kind of been using this because this professor Garrett came up with it I mean I've seen this in other papers they love it you know money and flowers together there you go but Rob I don't know if you want to come up and help close it but these are the ones we're gonna talk about on Thursday and since Rob won't be here on Thursday I'm kind of curious if he has a point of view on you can see them here as well I think it was actually shot and I think that's from the other projects for example the ones that go in say Singapore and Canada are really just in-house proofs of concept whereas the the Swedish water gathers fairly early stage that there is the burners not out there yet we've just saw starting to explore it Museum one is interesting I've spoken to one of the guys working on that and again asked about interest because it's a live project its continuing unlike the you know wine project it's a continuing project so be interesting to see how it plays out there and I think the reason being is a lot of the thing that puts off central banks from actually doing is they don't whatever and I think you will start to see when you start see people actually trying in deployed at Central Bank PLC then you will have like a real pilot real-world examples because at the moment it's very but I think once you start to see and also because of the funding effect earlier about the cash like u.s. dollars physical cash is effectively one point six trillion of interest rate borrowing on the u.s.

[01:17:50]cotton and it's a US government issued digital dollars and arguably you could retire after the national debt replacing it money so there are these big sort of fiscal implications and the body would come off paper which is two years ago I think big attraction to politicians before we close Simon because you're rarely with us but from your perspective either from your chief economist days at the IMF or just because you Simon hosts the Tuesday night blockchain seminar dinners by the way to for three years so Simon is way ahead one might say he was kind of a block J at Bitcoin maximalist three years ago I think you've moved more to the middle you can self declare where you are and Simon Johnson and Nahan Narula Michael Casey and I are gonna be standing up a blockchain lab course in the in the spring so Simon what your question is what do you think about all this and maybe for both of you in the last minute when are we gonna see a true central bank test this out I mean there's nine of them on this page that are kind of feeling it out but I think comes down to what Rob said what does it do to credit who really wants to find out the hard way and what does it do what happens in a crisis when everyone you know let's say you're not paying interest on the digital visual central bank currency and you can get into the bank account but there's a crisis and you can you say well I don't want to have this happy morning the liability but bank anymore I want to be morning though I build to you the central bank doesn't everyone run to the central bank and what does that do to credit right and how you gonna figure this out without actually running something like two predictions how many years before a country actually this 180 countries nine of them already bubbling around the two of these Ecuador stopped your gray maybe stopped and the UK Royal Mint might have been stopped by its own government but when do you think we're gonna see a country actually have a direct digital account to their reserves for the retail public so when went back together on Thursday we're gonna dig back into these nine and talk a little bit more about the money flour and the readings which I think as I always do I list them some of those are more fun and there's they're shorter readings as well so I I will see you all on Thursday at 2:30 to 4:00 and I thank you once again [Applause]