This is why a digital euro is essential for Europe

Bitcoin and ethereum-like cryptocurrencies like ethereum are being developed by the European Central Bank and its equivalents in the United States, China, and India. They foresee a future where everyone has their own digital wallet and can move money between them at the push of a button, with no need for high-street banks to be engaged since everything occurs on the blockchain.

Central banks would issue digital wallets with which people and businesses may make payments, pay taxes, and purchase shares or other instruments. While a bank run might prevent clients from withdrawing funds from their current bank accounts, this is impossible with CBDCs since all deposits are guaranteed 100 percent by reserves.

There is little or no need for retail banks to have any deposits in reserve, but they are nevertheless obliged to hold a percentage of their capital (ie., readily sold assets) as a kind of insurance should they lose money on loans they have taken out. If a bank’s capital is €1 billion (£852 million), its loan book cannot exceed €6.6 billion (6.6 times deposits), which is the minimum threshold for eurozone banks.

The assumption is that individuals will continue to maintain bank accounts in the CBDC era in order to invest their money or earn interest on the money they loan out on behalf of someone else. We believe that the central bank’s 100% reserve guarantee should be extended to ordinary bank accounts.

For example, the bank could not establish more accounts than it could pay upon request with a deposit of 1,000 digital euros from an individual into a retail bank account. Instead, the bank would have to rely on revenue from its other services.

The European Central Bank (ECB) now owns around a quarter of the EU’s national debt. Consider the possibility if, after the switch to a digital euro, the central bank decides to boost its stake in sovereign bonds issued by member states from 29% to 30%.

Just as when quantitative easing (QE) is employed now to prop up the economy, fresh digital euros would be created. Importantly, the total amount of money in circulation in the Eurozone almost triples for every new unit of central bank money generated in this manner. QE increases the value of bonds and other assets, which makes retail banks more inclined to lend to individuals and businesses. QE may lead to inflation because of the rise in the money supply.

This multiplier effect would not be possible if retail banks were required to maintain a 100% reserve requirement. The ECB’s money creation would be limited to that amount. As a result, QE would have a far less impact on inflation than it does now.

Benefits of Debt

In light of this, how does the national debt fit into this picture? Global financial crisis of 2007-09, eurozone crisis of 2010s, and COVID epidemic are largely responsible for excessive public debt levels in several nations. Belgium (100 percent), France (99 percent), Spain (96 percent), Portugal (119 percent), Italy (133 percent), and Greece are among the Eurozone members with the highest debt to GDP ratios (174 percent ).

It’s possible to reduce the value of debt by inflating the currency, but doing so makes people poorer, which might lead to unrest. Governments, on the other hand, may take advantage of the migration to CBDCs to amend the regulations governing retail bank reserves.

By reversing the process of generating new money in order to purchase bonds, three times as much money is being injected into the actual economy as would otherwise be the case. By exchanging bonds for today’s euros, the central bank removes three euros from the economy for every euro it removes.

A digital euro might indeed be brought into the system in this manner. It would progressively sell national bonds to remove the old euros from circulation, while at the same time producing new digital euros to repurchase them. Selling bonds for €5 million euros pulls €15 million out of the economy, while purchasing bonds for the same amount only contributes €5 million to the economy since the 100 percent reserve requirement only applies to new euros.

However, you would not just repurchase the identical number of bonds that you had previously sold. Due to the fact that bonds are not subject to a multiplier, it is possible to acquire three times as many bonds as you normally would, and there would be no additional inflation.

From 25% to 75%, the European Central Bank (ECB) might raise its holdings in European Union Member State sovereign debt. Member states are not required to pay interest to the ECB on sovereign bonds held by private individuals. As a result, instead of paying interest on 75% of their bonds, EU taxpayers would only be responsible for paying interest on 25% of them.

Other concerns, such as interest rates

Interest rates are another motivation to do this. With inflationary pressures and central banks starting to boost short-term interest rates in response, interest rates on bonds, which have been low for years, might rise dramatically on future issuances. Below is a graphic illustrating the dramatic rise in yields (interest rates) on the most carefully monitored 10-year government bonds for Spain, Greece, Italy, and Portugal in recent months.

Ten-year bond rates in the Mediterranean

In the wake of a pandemic, an energy crisis, and a war emergency, Europe’s most indebted nations may begin to believe that they can’t pay their obligations. This might lead to a flood of bond sales, which could lead to an untenable rise in interest rates. To put it another way, our strategy has the potential to salvage the Eurozone.

Even without a digital euro, the ECB might accomplish all this by increasing the present system’s reserve requirement. However, there is a strong case that retail banks should be required to ensure deposit safety by implementing a 100 percent reserve requirement if they switch to a CBDC since it is safer than bank deposits.

However, it is important to note that we may only use this drug once. Thus, EU countries will still have to be fiscally responsible.

There is a middle ground where you may make reserve requirements more severe (say a 50% rule) and yet get some of the advantages of our suggested system without entirely eliminating fractional reserve banking. Instead, the reserve requirement might be gradually decreased in response to GDP growth, inflation, and other factors once the CBDC transition concludes.

If other central banks don’t follow suit, what will happen? Even though cooperation would be helpful, current reserve needs varies across nations without causing any major issues today. In addition, numerous nations would be tempted to follow suit. Bank of England owns nearly a third of the UK government’s debt, which is presently 95 percent of GDP. Examples of other government debt held by the Bank of England