Welcome to Kobe Time, a podcast series on Markets and Economies from Devious Group Research. I'm Tambe, chief economist. Welcoming you to our 105th episode. Our guest today is a return guest is Raad Tolani, senior uh senior professor of Trade Policy at Cornell University first came to Coby Time 2.5 years ago on episode 36. And in that episode, we talked about the global economic outlook and major developments in the currency world. Since then, I has published a book called The Future
of Money. How the digital revolution is transforming currencies and finance. He has also continued to publish on China's economy, central bank, digital currencies, us dollar dominance or like thereof and cryptocurrencies. So much to talk about Iras. Welcome back to Kobe time.
It's so nice to be back on your show and certainly things have changed a little bit in the last 2.5 years. So we have much to talk about
just a little bit. All right. So uh I want to start with the broad macro initially, I uh how has the global financial system held up around the pandemic? The policy response around the pandemic and its inflationary aftermath.
So remarkably, the global financial system by and large did hold up quite well in the initial phase of the pandemic. And we did not see major banking system stresses um emerge in any part of the world. And I think that speaks to the increased resilience. Um that was um you know, put in place by the regulatory changes that took place after the global financial crisis and um some crises that occurred after that including the eurozone debt crisis. Um
More recently, of course, things have begun to change. There are parts of the world where we are beginning to see certain elements of stresses pop up in China, for instance.
Um there are some banks that are quite exposed to the real estate sector and while they don't see a major financial panic uh um or crash emerging, there are certainly some property developers that are highly leveraged, some banks, especially some of the small, medium uh medium sized banks, uh small to medium sized banks that are quite exposed to the property sector and that are already
facing some stresses. And then there are other parts of the world like the US, of course, where we had these uh um couple of uh uh banks that um uh faced a fair amount of. But there again, um things seem to have been contained to a relatively small sliver of the banking system. So there is a sense that there are elements of fragility in the banking system um in many parts of the world. But by and large things seem to be holding up.
Although um the period of rising interest rates in many of the advanced economies, you know, in some ways, it um helps banks in some ways, it puts some of their balance sheets and their stress especially. Um if as was the case with uh um uh Silicon Valley Bank and the First Republic, we see some stresses building up on the asset side of um bank balance sheets as um interest
rates on government bonds in particular, um, start rising. So I don't think we've seen the end of banking system troubles, but by and large, the financial system, especially the banking system seems to have held up reasonably well in most countries for the last few years.
Sure. One of the reasons arguably is the fact that we basically have a financial sector put in place that if you have banks experiencing runs, it seems like the regulators will come and give you a blanket guarantee. Is that an issue
that is certainly an issue that we're going to have to grapple with the sense that even in countries um including the US where there isn't a blanket full uh deposit insurance system that basically covers the entire banking system
in its entirety. What we are seeing is that when trouble erupts, especially if that trouble looks like it could spill over to the rest of the banking system, the regulators step in and you end up with uh you know, any sense of market discipline being lost now, countries like China where there is um um where there was a sense that there was an implicit, full uh insurance of the entire banking system in place. Um was something that was a concern.
Um China has been moving towards an explicit uh deposit insurance system, but what we're seeing is that across the world, um that notion of market discipline through limited deposit insurance that um prevents bank runs, but still um gives depositors an incentive to look into the books of their banks more carefully. I don't think that is holding up and that is going to have some longer term repercussions uh
for the banking system, soundness and stability. If we have a situation um where almost uh um by construction, we're going to have forces that uh feed into more concentration that lead to potentially more risk taking and so forth.
Um Any view on the state of heavily indebted emerging markets economies which are facing ever rising, you know, dollar debt, servicing costs and some of them are an outright crisis.
Now. It is true that there are some economies in crisis. But what is more striking to me is that during the last three or 44 years, we haven't had any systemically important emerging market economies facing um major crises. Now, to some extent, this is because I think many emerging market, um policymakers did learn the right lessons um from the Asian financial crisis, the Russian crisis, the Mexican tequila crisis and so on. And in the global financial crisis, of course, we had
many emerging markets holding up reasonably well. Unfortunately, in the last few years, I think some of those lessons have been unlearned. Many emerging market economies, particularly some of the frontier economies have taken on large amounts of foreign currency, external debt.
And there is a mix of this sort of lack of policy restraint and um political and economic instability in many of these countries such as um Sri Lanka, uh Pakistan, Venezuela, Turkey and so on which have put them under very significant uh uh duress. Um But the major emerging market economies do seem to be holding up um quite well uh so far. So there is this bifurcation that has emerged even among the emerging market and developing economy uh class.
It is interesting and it, I just want to share with you one insight that we run for emerging and developed markets. A, you know, sort of a cross country exchange rate, misalignment analysis and the biggest misalignment cases we find are actually in developed markets, not in emerging markets, but to your point about the countries like the Pakistan and Sri Lanka, I think the debt sustainability issue still such a big question even though they have extensively IMF programs in place.
Um If for the other big development over the last couple of years is the war in Ukraine and with Western sanctions on Russia, in particular, we have seen wide ranging weaponization of the US dollar, so to speak, what will be the legacy of that?
The fact that the US has been, um, so willing to use sanctions, of course, has been taken note of by policymakers around the world and certainly for a while now, um, you know, it's not just US rivals but also traditional allies of the US, including Europe that have been very eager to get away from a dollar dominated the global financial system. The sanctions have given an edge uh to that uh um to that effort because what we've learned is that the US is willing to bend or even break the rules.
Um in certain cases, now, one can see that the US has been aggressively using sanctions on international payments and while Swift is supposed to be um you know, in principle, um a nonpartisan um uh group, the reality is that um American banks are so important to swift that the US does maintain a bit of a chokehold over swift as well. So cutting off a country from access to the swift messaging system and from the international payment system is certainly a very
pot uh threat. So there are countries around the world trying to find their ways around it. China has set up the cross-border interbank payment system that could more directly communicate with the payment systems of other countries, both in terms of messaging and also in terms of payment and
settlement um of international transactions. But where the US is really, um I I think broken what had come to be seen um as a set of uh widely accepted rules was that it even um attempted to freeze um Russia's foreign exchange reserves now. Um it did not technically really freeze the reserves, but it made it very difficult for Russia to get access to those rainy day funds and for emerging market policymakers.
This is a real concern because after all, um if you store away a lot of um your rainy day funds in the form of foreign exchange reserves, put a lot of them in the US and um other advanced economy, um government bond markets. And then when the storm comes, you cannot use those rainy day funds. That is a real concern. However, the difficulty that countries that want to step away from the dollar face is the following. There aren't any clear alternatives in terms of either payment currencies or in
terms of reserve currencies. I'll take those one by one on the payment currency front. One can well imagine a
shift taking place. I refer to China's cross-border interbank payment system or SS one can well imagine that when China's trading partners have payment systems that reach a similar level of maturity that you could have em emerging market currency pairs being directly traded for each other, say Renminbi versus uh um uh the Rupe without having to go through an intermediate currencies such as the dollar or for that matter, the euro. Um You could also have China and Russia trading directly
in their pairs of currencies. So new technologies, financial market developments in the emerging market countries are I think reducing the need for vehicle currencies. Now, what is interesting is that it is not obvious that the dollar is going to suffer the most here.
In fact, what we've seen in the last four or five years is that the euro has if anything suffered a little more than the dollar in terms of the share of payments that are intermediate through that currency, at least based on data that we have um on um payment transactions where the messaging runs through swift. Um There is also the prospect of uh certain types of cryptocurrencies like stable coins a subject. I suspect we will turn to later in our talk um gaining traction in
international payments. But there again, it is really stable coins that are backed up by us dollar reserves that seem to be gaining the most traction. So the US dollar might indirectly gain even more prominence as a payment currency. So it is possible that the dollar will face some erosion in its role as a payment currency that even emerging market currencies will take on larger shares. But I think the dollar will remain by far the most important payment currency
as a reserve currency. Likewise, the dollar share has eroded somewhat in the last few years. Um Now, um before the euro came into being the dollar share of global foreign exchange reserves was about 71 72%. Um After the euro came into being, that share fell by about 10% points and then it fell to about, you know, 62% just before the global financial financial crisis. But since then, the dollar share has eroded
only marginally to about 59%. Right now. What is interesting is that in the last four or five years, the Euro share of global foreign exchange reserves has taken a real hit down to less than 20%. Um Professor Barry Eire of the University of California Berkeley has made this other interesting observation that if you take many of the smaller reserve currencies like the Australian dollar,
the Canadian dollar, the Swedish Corona and so on. Cumulatively, all of those small reserve currencies have increased their share, although each of them accounts for only very small share. So what is happening is sort of interesting right now, the distance between the dollar and the second tier of reserve currencies in which I'm going to
include the euro that is actually increased. So there is a lot more jockeying for position, a lot more fragmentation among the 2nd and 3rd tier reserve currency so that um pound sterling the Japanese Yen, uh the Euro have all taken a bit of a beating in the last decade or so. So the distance between them and the dollar has increased and there is a lot more um uh coming up in the form of these smaller reserve currencies. So a lot more fragmentation
and why is this fragmentation taking place? Because emerging market and other uh reserve managers desperately are looking for diversification options. But again, the paradoxical issue here is that while the dollar share may erode somewhat, it has weakened the rivals even more, putting the dollar at some level in an even more uh strong position.
Absolutely fascinating. I want to stay on the subject a little longer if, if I may uh China. So China does swaps with various central banks around the world. All these petrol cny discussions, we hear about all the time that they want to have commodities coming from the Middle East invoiced in R and B. Uh And then the Chinese, these uh fintech companies have even like mobile wallets that are now interfacing with the ecny. So I do want to talk about CBD CS and other things later with you.
But just in terms of China's desire to make the R and B more acceptable, is it even reasonably possible without capital economic liberalization?
So I was in um China um after the 3.5 year hiatus just a couple of weeks ago and this, of course, was uh a subject that I did uh discuss with the Chinese policymakers because there is something dear to my heart. Um And the um authorities seem very determined to continue uh with capital account liberalization and freeing up the exchange rate to be more uh market uh determine. In fact, over the last um um five or six years after the um 2014, 2015 episode of Renminbi depreciation.
It is true that the direct intervention in the foreign exchange market um has been quite limited. The amount of foreign exchange reserves held by the Chinese central bank has remained relatively flat in the range of somewhere between three and $3.1 trillion. There's been some marginal intervention using the balance sheets of commercial banks. But overall, they seem quite comfortable letting their in the um rise and fall in value um especially
relative to the dollar on the capital account. Um I was told quite clearly that China is never going to have a fully open capital account. But for all practical purposes, as far as international investors are concerned, they do want to make it easy and they have opened up the bond and equity markets with very few restrictions on foreign investors.
The difficult issue that China faces is whether foreign investors view that as a credible promise that the capital account will be kept open or whether if the Renminbi were to face depreciation pressures. Again, um the capital account might not be used as an exchange rate management tool essentially by limiting uh capital outflows by putting restrictions on them.
So foreign investors don't seem to be buying it yet, but the government does seem committed to continue with capital account liberalization and exchange rate uh uh liberalization as well. Now, this is certainly going to go hand in hand with the um Chinese government's desire to um you know, to uh have the Renminbi play a larger role in um international finance, particularly um in order to um you know, escape the clutches of the dollar based uh
global financial system. So I think China is trying to put in place the elements of the technical infrastructure that are necessary um to avoid um being subject to sanctions of the u wherever uh to use that as a threat against China. So it's not quite there yet. But China is clearly um using the Renminbi and using these various elements of the infrastructure, including its own payment system and um connection with other payment systems in order to move this forward
since you were in China very recently. Actually, I haven't been there in three years. Uh I want you to ask uh I, I would ask you a slightly broader question, what was your sense on the sentiments? Because you know, we sitting outside are largely reading a pretty negative narrative.
It depends on where the narrative uh is coming from. I was quite struck by the difference in tone between what I heard um from Beijing and from uh Shanghai and Beijing. Of course, I was largely meeting with uh um government um and um regulatory and financial officials um in Shanghai had a lot more meetings with the private sector.
Um And this was a couple of uh um weeks ago before the recent uh um uh um Politburo meetings um where even the government seems to be expressing some concern about the um um the momentum that the economic um um recovery has had in China. So in Beijing, I got the sense that policymakers were a little more sanguine that um they did not need to unleash huge amounts of stimulus, that there was some amount of stimulus already
in the system. Um Some of it through easing of constraints on local government borrowing um you know, reducing some of the restrictions they put on the property sector, uh some similar that was already in train, what I heard from Shanghai was a very different set of views. Um There seemed to be concern among private sector participants from a variety of sectors um that the government had not set
a clear direction of policies yet. And in particular, the government's attitude towards the private sector was something that they did not fully find credible yet. Now, Beijing of course, has been trying to send a lot of signals that after the private sector crackdown um that took place in the late part of 2022 and early 2023 that in fact, the government does view the private sector as playing a very important role in
the economy. Um That message does not quite seem to have filtered through in a credible and durable sense uh to the private sector. And we've seen that um in the dismal um private sector investment growth that we had in 2022 and the fact that it's not really picked up yet, and it may also be feeding into the lack of household confidence that we've seen in
very weak uh uh retail sales. So I think the government has a pretty significant task uh on its hand, both in terms of using some mix of macroeconomic stimulus, perhaps um uh with a little more weight on fiscal stimulus. Um but also trying to send a clear signal um in some uh credible way to the private sector that the government is um going to ease some constraints and move. Um you know, the entire policy making appetit us in a more positive direction.
Well, let, let's hope that, you know, we, we see some concrete actions, I suppose in the part of your meetings, we heard some words that were welcome from market sentiment perspective, but in terms of actual action, whether it is debt restructuring or additional fiscal support, um we're still waiting for some concrete stuff. All right, if we uh time to talk about your book, um So this came out, I believe in 2021. But
most of the reviews I read are from 2022. Uh And I highly recommend to the listeners of Kopi Time to read this book, Future of Money. How the digital revolution is transforming currencies and finance. Now, I will do this in an unorthodox manner. I will first ask you something that is not in the book. So there was a reviewer who seemed a bit disappointed by one part
of your book. So the reviewer wrote and I quote, reading through the book is unlikely to provide any insights into how to value cryptocurrencies or how digital currencies such as Bitcoin are likely to replace government issued money as a store of value. I, why don't you take a crack at these issues?
I was quite clear in the book that I cannot value uh decentralized cryptocurrencies like Bitcoin because um uh there is no clear valuation model in my mind that you can apply to a decentralized Cryptocurrency. So, you know, the um Bitcoin is a Marvel, um the fact that um whoever the creator was and you know, having written the book, I go to a lot of Cryptocurrency conferences these days that I have so far shared the stage with three people who've claimed to be
the real creator of Bitcoin. I don't know if any of them really uh is. Um But you know, the fact that um we have a technology that allows you to undertake transactions um between parties who may not even know who each other are. That is just using their digital identities and without using a centralized trust mechanism. That is remarkable. And I think the technology is spawning some interesting developments in
decentralized finance. But the reality is that Bitcoin has not functioned well in what it was supposed to be, which is a um uh trust, less or decentralized trust based um medium of exchange because it is very volatile value, it's not very efficient as a medium of exchange.
So for something that does not have intrinsic value, um and where the entire value proposition seems to be in terms of its scarcity, um which is based on the fact that ultimately, there are going to be only 21 million Bitcoins of which about 19 million have been created so far. And the supply is created on a very specific predetermined schedule that seems to give, you know, um Bitcoin maximalist confidence that Bitcoin's value is going to be preserved. But to me, just the fact that something
is scarce um does not necessarily make it valuable. So I don't know what the valuation model is. And I'm quite explicit about that. In my book, there are other decentralized cryptocurrencies like Ethereum, which potentially have a lot more functionality because the Ethereum Blockchain uh does allow for a lot of smart contracting functions. Um So these are again ways in which we can, one can conduct a lot of more complex financial transactions without using uh trusted third party intermediaries.
Um So for these other cryptocurrencies, I really don't see um a clear valuation model. Now, the interesting element of the Cryptocurrency ecosystem is that there are some cryptocurrencies that have stable value that do seem to be working quite well as mediums of exchange for transactions both within countries, but also for cross-border payments. These are of course the fiat currency backed stable coins
now fiat currency backed stable coins. Um you know, are ironic in many ways, um the whole point of decentralized cryptocurrencies like Bitcoin was to get away from the dependence on fiat currencies. Stable coins get their stable value precisely
by being backed up by stores of fiat currencies. Bitcoin was supposed to have a decentralized governance mechanism, a decentralized trust mechanism, stable coins are issued by particular companies or agencies which set the rules of the game which you decide who gets to use those stable coins which conduct the validation of all the transactions. So they are largely centralized. Um So that part of
the uh ecosystem does seem to be working well. So do I see decentralized cryptocurrencies as um you know, displacing fiat currencies as store of value, not quite and stable coins are getting their fundamental value from being tapped by fiat currencies. So they too are not displacing um fiat currencies. Uh really the important thing about cryptocurrencies and I think their true legacy, other than
the Blockchain technology. Is that what they have shown us is that there are lots of pain points, lots of inefficiencies in the traditional financial system. Now, I know that you will work for a traditional financial institution, but certainly your institution seems to be far ahead of many others in terms of taking these new technologies and adopting them uh to decrease many of these pain points.
But I think the sense that traditional finance is not working well in many respects is not working well for a lot of people that I think is what sparked the revolution. And certainly we are moving towards that now, whether it will be the decentralized finance ecosystem or traditional financial institutions, co-opting these technologies uh in order to catalyze changes is a little hard to read at
this moment. Uh But I think they are moving towards a somewhat better financial future and that may or may not have a place for decentralized cryptocurrencies. But I'm very grateful for the Bitcoin revolution because I think it has pointed the way to a lot of uh much needed changes.
Absolutely right. Uh I, but I want you to weigh in on the dramatic developments we saw around the private digital currency ecosystem last year, you know, all sorts of governance related issues came out massive price volatility. Um Is this just one of those things that happens with new technology?
You know, some people take advantage or is it revealing that in a purely digital infrastructure, there are inherent opacities or cybersecurity risks that we haven't fully addressed and therefore can't really trust the system very well.
There was this notion that because of its scarcity, something like Bitcoin might even service in inflation hedge. Now, it turns out based on what we've seen over the last uh um um few years and admittedly Bitcoin is a relatively short history. Um but it's had significant traction. Um You know, it turns out that Bitcoin basically behaves like a risky asset.
And because there is no clear valuation model, um underpinning its value, it turns out to be a highly volatile risky asset which is buffeted by the sort of macro economic factors including monetary policy factors and that seem to drive other um similar um risky assets. So I think the lack of the valuation model is leading to these huge amounts of volatility. Now, certainly we've seen a very
drastic fall in the overall market capitalization. Um If one might use that term somewhat guarded way for the uh market value of all these crypto assets taken together, which um at its height um towards the middle of 2022 was roughly $3 trillion. It's about one trillion right now. So that seems like a very big fall. But, you know, one trillion is still a pretty sizable chunk of money. So lots of people still seem to have their faith in the system.
Um But the interesting thing that has been revealed, I think over the last year is this notion of decentralization um really has given way to a great deal of centralization if you think about FTX coin base and so on. Um these are very centralized um players where uh you know, you're getting the custody as well as trading of assets, which don't necessarily
need to take place in centralized exchanges. Actually all migrating onto these centralized exchanges, partly because they're convenient, but partly also because users seem to really want to have an institution that they can rely upon. So the need for some sort of trust mechanism doesn't seem to have gone away completely. Um If you look at even something like Bitcoin, you know, the validation is undertaken in principle by mining nodes that are
distributed around the world. But in fact, about 6 to 8 clusters of computers um um essentially mining pools control much of the hash rate. Um that is the computing power that powers the Bitcoin network. So even with Bitcoin, you see a lot of centralization and as I mentioned, stable coins are all very centralized. So unfortunately, many of the promises of decentralized finance that we will have a decentralized architecture that creates more robust uh financial
systems that allow. So the democratization of finance by giving anybody easy open permission, less access to financial products and services allows developers to very easily provide these products and services at scale at very low cost those promises have not been realized yet. Instead, we've seen many of the fragilities of traditional finance essentially being imported into what was meant
to be decentralized finance. We've seen a lot of speculative activity in financial engineering taking place in this ecosystem and a lot of investors who may not be fully aware of the risks that they're taking on uh being exposed to very significant risk. So, investor protection in that part of the ecosystem has taken a hit as well. So unfortunately, at this stage, all the wonderful promises of decentralized finance have not borne out.
I still think that there is promise in this technology, but um it's going to have to require some regulatory guard rails that limit some of these risks both in terms of risk to retail investors spillovers to the traditional financial system. Um And uh finding a way to get a regulatory framework that allows for innovation without completely stifling this ecosystem is going to be a tough balance for regulators to strike. I want to stay on the
regulatory issue a little bit because we've seen a few actions by us regulators in the past year, uh cracking down on exchanges and suing the very large exchanges um for um malfeasance. And also we've seen some rulings about what is a Cryptocurrency? Is it a security? Is it a currency? Uh are the US regulators? And let's just talk with the US regulators in this context? Are they doing a good job in getting investors incentive, the regular publics incentive and the
need to sort of promote innovation. Are they getting that? Right.
So, from a regulator's point of view, I think um one needs to take an enlightened approach to this um how to um get the benefits of these innovations um without um you know, impeding the traditional functions of a regulator, which is um trying to minimize um institution of product specific risk as well as systemic financial stability risks. Um trying to maintain integrity of payment and financial systems and uh maintaining investor protection.
Um And I think um regulators in the US um are rightly asking the following question, which I think is very important in many of these issues, which is um are there alternative ways to get many of the benefits which crypto technology says that it will deliver to us? So the US has put in place for instance, um fed now, which is this um suite of retail and wholesale payment services that are supposed to make the US payment system, which um until recently has been very antiquated to move
it into a more efficient realm. So, in that circumstance, do you really need, for instance, stable coins which in principle, take fiat currencies, um convert them into tokenized form and allow them to be used more efficiently. Do you really need that? Um And then if you think about this promise of democratizing finance, are we really getting the benefits of democratizing finance without just creating grounds for um you know, uh promoters of uh a variety of crypto products to take advantage of
uh um uninformed retail investors. Um So I think regulators are asking the right questions, but there is a risk that they face that if you put up regulatory barriers, um that could make the system a lot safe. But you limit innovation and in particular, you sort of foster centralization because regulations are good in terms of keeping things safe. But they are essentially also act as barriers
to entry. And one of the promises of this decentralized finance space is that you could have much easier entry. Um So we might end up with even more centralization, which again breeds a whole new set of risks. Now, having said all this, um I think it's a very difficult task for um regulators because even enlightened regulators, and there are many of them here in Washington, despite what the crypto industry might uh
might uh might suggest. Um but they understand also that the crypto industry doesn't seem to be delivering all the promise that it suggested um it would uh deliver in terms of benefits to customers, businesses and
so on. And then even if you take something like stable coins, which have certainly shown a lot of lacking in the existing payment systems, the risk that you could have a redemption run on stable coins where they end up having to liquidate a large number of Treasury securities which ends up roiling the Treasury securities market is a real concern. So from a regulatory perspective, I think we are in
a very uncertain phase right now. Um The Cryptocurrency industry says it is clamoring for regulation because it wants the regulatory guidelines. But I think what they really want is the legitimacy of regulation with very light touch regulation. And I think regulators are rightly concerned about arriving in that halfway point, which could actually be very destructive. Um So at the moment, I think we have a mishmash of regulations which are really creating a lot more uncertainty. You referred to
this issue about the definition of crypto assets. The latest ruling against ripple, um which was partly in favor of ripple, which was partly not in favor of ripple as I think created even more cons uh confusion because basically what the judge said is that the native tokens issued by this, a Cryptocurrency called uh Ripper, if they are sold to uh institutional investors, those do count as securities. Um but if they are sold on open exchanges to retail investors,
they are not. So uh we have even less clarity right now on what exactly a crypto crypto asset uh should be defined as and therefore how it should be regulated. So I think at a minimum, some clarity is going to be essential, right? It was like
a crypto quantum moment. It can be both at the same time depending on who's holding it. Um If were a large part of your book, uh you do this masterful job of chronicling the wave of innovations we have seen in the financial technology area, not just in the last few years, but over a much longer period of time. Um from your perspective, which innovation has been the most consequential and transformative.
You know, that is a tough question to answer because if you think about new technologies, I think the Blockchain technology has certainly um um it has transformative potential. I don't think it's quite there yet.
But you know, if you think about transformation in a different sense, uh transforming the lives of ordinary people, there are very basic technologies that go on the rubric of fintech, you know, mobile payments, for instance, which have really made a dramatic difference um to the lives of uh um you know, consumer, um small businesses, merchants in many um low income economies
which had very underdeveloped financial systems to begin with. So if you think about something very basic like mobile money, um and how that has made a huge difference um in um uh low to um lower middle income um economies in Africa and Asia and so on. Um those I think are transformative in a very different way. So uh I mentioned being in China, you know, uh on my trip, I literally felt like I was the
last person in China still um using uh cash. I tried to pay for some of my camp rides using cash and I was stunned uh first that I would pull out a ¥50 note and of course, didn't have
any change to um uh to give me. Um So the fact that you have these digital payments um available at low cost um uh with easy access with a great deal of efficiency that I think is much more transformative Again, not just in terms of digital payments, but also serving as a porter uh for basic banking products and services.
Uh It short to your point on China, I mean, I have had a hard time using credit cards there. And initially, my view was this was a platform of a barrier to entry by the Chinese authorities. But it turns out that because the Chinese modes of payment are so cheap, vendors have no interest in being charged 2% 2.5% by Visa or mastercard. And that's why they don't accept them.
Um So, so to me, uh my bias was that perhaps this was some sort of a barrier to entry, but actually turns out that it's the vendors who don't carry those credit cards. And I also felt like you and I was actually trying to use a card. Um uh If we're in the world of CBD CS, uh you again, you know, have been writing about this for a while. Of course, the book does a great job at that as well. So I have a few questions in the areas of CBD CS. But let me ask you first, like uh
36,000 ft question. Uh where will we end up with CBD CS by the time this decade is over?
So retail CBD CS uh um and let's stick to that uh uh for the moment. Um So retail C BT CS would essentially be the digital equivalent um of uh physical currency, the bank notes and coins that at least some of us uh still use and love. Um The um advent of retail C BT C si think is an inevitability because um um cash is disappearing very fast in some economies like
China and Sweden. Um it's already practically non-existent. And if you think about the convenience of um digital payments for um businesses, consumers for governments, um the advantages that it has in pulling economic activity out of the shadows. Um The advantages are very clear. So uh I think we're going to get a shift towards digital currencies by any central bank that wants to keep its money relevant for retail transactions.
There is a broader question about whether you need central bank money at all for retail transactions because central banks, you know, can do their job of managing monetary policy perfectly well, even if they were not issuing um currency either in digital or physical form. Uh And if the private sector is doing a good job of providing digital payments. Maybe you don't even need a retail CBD C. So why are central banks continuing with this? The um
reason seem to be manifold in some countries. The idea is to give um you know, everyone who wants it easy access to a digital payment system no matter what your income or net worth. Another idea is to provide um a backstop uh to a purely private payments uh um uh infrastructure and the third is to ensure some payment innovation. Uh So, for instance, um both uh uh China, India and other countries that are
expanding CBD CS talk about CBD CS being interoperable. So if you take China, for instance, Alipay and wechat pay work very well, but they are not um uh mutually compatible. So they don't have interoperability. So digital um or digital yuan uh could you know, set up this interoperability? But, you know, I handed in the manuscript for my book in early 2021. The book eventually came out, as you said in late 2021.
I was much more positive about CBD CS. But I look around the world right now, I see much less um strong a case in terms of the value proposition for users. Uh take China again, Alipay and wechat pay are working perfectly well. Um The question is why does China need a digital um yuan uh India is going to face the same issue.
Sweden undertook extensive CBD C trials. But the parliamentary committee that was set up by the, but they were set up by the government to evaluate the need for a digital corner, basically decided that Sweden doesn't really need a digital corner. Um Right now, so what are central banks doing in order to make sure that the retail CBD CS might still be um useful to um to the end users interoperability is one thing that might give CBD CS a
bit of an edge of the margin. But then many central banks that I've spoken to recently talk about using the programmable features of money. And these are very exciting from the point of view of economic policies.
So if you could actually um provide, you know, uh units of money which have expiry dates, you know, if uh you have a period of extreme economic distress or even a garden variety recession, giving people money with expiry dates would incentivize them to spend that money rather than save that money. Um You could imagine um helicopter drops of money which um you know, the economists fantasize about where basically you give everybody in an economy uh in a lump sum fashion,
a certain amount of money to stimulate economic activity. These are all very powerful tools, but I've grown increasingly concerned that if all of these programmable features are put in place, you might actually start affecting the integrity of central banks and the very credibility and legitimacy of central banks central banks around the world are already under a lot of pressure. They have to manage exchange rates in some countries. They have to manage monetary policy,
financial stability, maintaining economic activity. So they have a huge amount of political pressure on them. Now, what if a central bank starts being seen as the agent of the government in terms of undertaking surveillance? Um either broadly speaking or to make sure that the digital money is issued is not falling afoul of government regulations.
Second, if you start seeing the central bank as a tool of the government, in terms of implementing fiscal policy, as I mentioned with these uh um helicopter drops of money and so on, then the central bank could become subject to a lot more pressure and then think about a world in which we have some units of central bank money that aren't just like cash, they have paid zero interest, they have no expiry dates, other units of central bank money that have expiry dates
or potentially have negative nominal interest rates. Now you could imagine secondary markets where you might want to give away your units of uh uh money with the expiry dates um because you don't want to spend it, you want to save it. So we have secondary markets with different units of central bank money trading at different prices. I really worry that this could all affect the integrity of central bank money and of central banks. Now this seems a little dystopian at
one level. But, you know, technology has taken us from what seemed like very promising outcomes to some very dark places. So I've gotten concerned a little bit about CBD CS and the notion that you could start using them as instruments of economic policy or potentially even social policy, you know, allowing CBD CS to be used for certain purchases and not for other things that a government might determine um are not
desirable uh for central bank money to be used. So I worry a great deal about where CBD CS might be taking us.
These are such fascinating discussion points. If were a couple of years ago, it seemed like, you know, we were only focusing on all the revolutionary possibilities uh to your point of, you know, programmable money. I was about to say that, you know, we have them in Singapore, they're called coupons from the government. Um But uh but all of those points that the Big Brother aspect, the capriciousness, the diluting of the role of central bank versus Mr Fit.
And uh all of those are, you know, questions that I'm glad that, you know, we are asking before we have gone ahead and rolled out CBD C's Willy Nilly and I'm glad that people like you are thinking about it really, really hard. Um I wanted to ask you a couple of questions you touched on the financial inclusion issue briefly. Um Just the experience with uh the whole digital ecosystem in parts of Africa
and parts of Asia. Um, it seems to me that a lot of these technological solutions use cases are better suited in poorer countries with less developed infrastructure than say, a country like Singapore where everybody has a bank account and everybody has a certain level of education and access to smartphones and perhaps it's not that compelling in a place like here.
That is certainly true. I mean, change is much more needed and change has been much more dramatic in countries with less developed financial systems where um much of the population, um you know, is close to substance levels of uh um income. Um and those are areas where, um you know, um the lack of very basic financial services has provided a real um boost to these kinds to the adoption of these new kinds of technologies. And certainly um some
degree of regulatory forbearance has certainly helped as well. Um Plus the fact that there aren't um uh strong legacy players who have uh an incentive to keep things um the way they are. Uh so the fact that credit cards are very easy to use uh in the US has certainly made it much harder for the US to move forward with alternative um uh
digital payment uh options. Um So we are seeing um a great deal of leap frogging by developing and emerging market economies and of course, the demand for financial services um has also been um rising very fast in many of these economies because in um many of the um middle to upper income emerging market economies, in particular, there is a rising middle class that wants um better financial services delivered um in a more efficient way and the new technologies are certainly providing ways uh
to make that happen. So yes, um I think we are seeing um the transformative potential of these new technologies uh um taking shape much more clearly um in the parts of the world um where financial systems are already not well developed
is where I had promised you a 45 minute conversation. We've gone past that because just so many interesting things to talk about. But I do want to add one more question as apo with apologies. Um capital account convertibility and digital currencies. I mean, is there a contradiction for say a country that wants to have capital controls but also want to have
digital money? So the world we are moving to is one where money is going to be much more um fungible across countries. Um um Now, stable coins are already um providing ways to um move money across national borders. And of course many central banks um recognizing that this is a real pain point in international finance because international payments right now are costly, expensive,
difficult to track in real time. They are integrating their um wholesale CBD S in some cases into their retail CBD CS and trying to set up these cross border um bridges or multiple uh wholesale central bank CBD C approaches to provide more efficient conduits for international payments. Now there are those official channels, but I think they're also going to have a lot more unofficial channels for money to flow across national borders. And this is some level is going
to be great for reducing frictions in international payments. It means for instance that economic migrants sending remittances back to their home countries can do so much more cheaply. If you have practically instantaneous settlement of cross border settlements rather than T plus two T plus three or even longer, you don't need to hedge against the exchange rate risk over those short horizons for uh payment and settlement uh are concluded. So this
is all going to be good. In principle, you could have um low income households, low network households, having access to international portfolio diversification opportunities, small and medium enterprises being able to access global pools of capital. This is all good.
But unfortunately, it's also going to mean that the more conduits for um capital flows, you have the more capital flow volatility and potentially more exchange rate volatility that emerging market economies in particular might be subjected to and the smaller open economies in particular, I think face um pretty serious macroeconomic but also um existential crises for their currencies because you can you imagine a digital version of the dollar or a
digital version of the Renminbi or stable coins issued by major corporations displacing their domestic currency. So you could get a real shake up in terms of the international monetary system at the lower tiers of that monetary system as well. Um But more specifically on capital controls, those are going to become very difficult to sustain over time. That
that sentiment was echoed to me by the central bank governor of India. Recently. I can't thank you enough. Uh This was a fantastic conversation. Thank you so much for your time and your very valuable insights.
Thank you so much for having me again on your show. That was a really fun conversation. I enjoyed it very much. Thank
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