The governor of the Bank of England has mooted the creation of a network of central bank digital currencies to help overcome the destabilising dominance of the US Dollar on international trade.

Speaking at the Jackson Hole Symposium last Friday, Mark Carney explained that history shows the rise of a reserve currency is founded on its usefulness as a medium of exchange, by reducing the cost and increasing the convenience of international payments.

The additional functions of money - as a unit of account and store of wealth - come later, and reinforce the payments motive.

Central bank digital currencies have been increasingly discussed an trialled by monetary authorities around the world, with around 70 per cent of central banks researching them as something to complement or replace traditional money, according to a report by the Bank for International Settlements (BIS).

“Technology has the potential to disrupt the network externalities that prevent the incumbent global reserve currency from being displaced,” he commented, adding that retail transactions are increasingly taking place online rather than on the high street, and through electronic payments over cash.

“The relatively high costs of domestic and cross border electronic payments are encouraging innovation, with new entrants applying new technologies to offer lower cost, more convenient retail payment services,” stated Carney.

The most high profile of these has been Facebook’s Libra, the new payments infrastructure based on an international stablecoin fully backed by reserve assets in a basket of currencies, including the US dollar, the euro and sterling, which can potentially be exchanged between users on messaging platforms and with participating retailers.

“There are a host of fundamental issues that Libra must address, ranging from privacy to Anti-Money Laundering and operational resilience,” Carney said. “In addition, depending on its design, it could have substantial implications for both monetary and financial stability.”

The Bank of England and other regulators have been clear that unlike in social media - for which standards and regulations are only now being developed after the technologies have been adopted by billions of users - the terms of engagement for any new systemic private payments system must be in force well in advance of any launch.

“As a consequence, it is an open question whether such a new Synthetic Hegemonic Currency (SHC) would be best provided by the public sector, perhaps through a network of central bank digital currencies,” Carney noted.

“Even if the initial variants of the idea prove wanting, the concept is intriguing – it is worth considering how an SHC in the international monetary and financial system could support better global outcomes, given the scale of the challenges of the current system and the risks in transition to a new hegemonic reserve currency like the Renminbi.”

Carney pointed out that a SHC could dampen the “domineering influence” of the US dollar on global trade, as if the share of trade invoiced in SHC were to rise, shocks in the US would have less potent spillovers through exchange rates, and trade would become less synchronised across countries. But by the same token, global trade would become more sensitive to changes in conditions in the countries of the other currencies in the basket backing the SHC.

“The dollar’s influence on global financial conditions could similarly decline if a financial architecture developed around the new SHC and it displaced the dollar’s dominance in credit markets,” said Carney, adding that by reducing the influence of the US on the global financial cycle, this would help reduce the volatility of capital flows.

Widespread use of the SHC in international trade and finance would imply that the currencies that compose its basket could gradually be seen as reliable reserve assets, encouraging companies to diversify their holdings of safe assets away from the dollar. “This would lessen the downward pressure on equilibrium interest rates and help alleviate the global liquidity trap,” Carney said.

“Of course, there would be many execution challenges, not least the risk of fragmentation across digital currency areas,” he concluded. “But by leveraging the medium of exchange role of a reserve currency, an SHC might smooth the transition that the monetary system needs.”

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