Cannibalizing the Dollar

The U.S. should launch a digital currency to compete with the dollar, not to mimic it.

In March 2022, President Biden asked federal agencies to explore ways to regulate digital assets (cryptocurrencies). Six months later, several agencies delivered their recommendations. Chief among them is the possible launch of a Digital Dollar. The A.P. reports:

Treasury Secretary Janet Yellen said one Treasury recommendation is that the U.S. “advance policy and technical work on a potential central bank digital currency, or CBDC, so that the United States is prepared if CBDC is determined to be in the national interest.

“Right now, some aspects of our current payment system are too slow or too expensive,” Yellen said on a Thursday call with reporters laying out some of the findings of the reports.

Crypto markets are much lower today than they were in March 2022 and much lower than they were more accessible in the November 2021 peak. And yet, the Treasury Department was startled by the fast adoption of various new currencies and financial products among U.S. consumers and by the efforts by other countries to launch their own digital currencies. Such currencies could be more accessible, cheaper, and safer to use — threatening the dollar's hegemony.

America cannot afford to give up the dollar's dominance in global trade. This dominance underpins the U.S. Government's ability to finance social and military programs. Such programs are likely to become even less affordable as the country becomes older, sicker, and politically dysfunctional — and the world becomes more dangerous and less stable. As a French Minister of Finance once put it, the dollar is the source of America's "Exorbitant Privilege."

Despite America's "issues," the dollar remains as powerful and attractive as ever. America is in bad shape, but its geopolitical adversaries are even worse: China is aging, faltering, and reversing its integration with the global economy; Europe is old, starved for energy, and struggling to innovate; Russia is on the verge of imploding. America has energy independence, food self-sufficiency, the world's most formidable companies and universities, a large domestic market, and a backyard full of relatively benign countries that provide cheap on-shore manufacturing. Oh, and it has the strongest military and best weapons.

These strengths are keeping the dollar attractive. In the face of turbulence, global investors prefer to own dollars over anything else. Facing multiple bad options, America is still the best bet. It also helps that the dollar is already the world's primary reserve currency. Since many countries own dollars or dollar-denominated debt, they have a strong interest in keeping the dollar alive and well.

Investors have good reason to trust the dollar. But they also have good reasons not to trust it. More accurately, the U.S. has been abusing their trust, debasing the value of its currency to finance unaffordable wars and government programs. In the absence of fiscal discipline, American institutions have become inefficient and corrupt or just unpleasant to deal with. America's enemies have even better reasons to shun the dollar: it reduces their exposure to financial sanctions and the freezing of dollar-denominated accounts.

In short, the world cannot move away from the dollar, but it cannot afford to depend entirely on it. And America itself would be healthier if its "exorbitant privilege" were curtailed.

Janet Yellen knows this. But it's easier to tackle the first challenge than the second one. By launching a digital version of the dollar, Treasury likely wants to make USD transactions faster, cheaper, and more transparent. It wants to make it easier to track illicit payments and reduce fraud. And it wants to make it easier for companies to launch new financial products. All this should make the dollar more attractive and help slow the adoption of competing currencies.

But it will not be enough. A digital dollar will make the USD "better," but it will make it even less trustworthy and more corrosive. It will give the U.S. Government even more power: the power to "print" faster, the ability to confiscate funds more efficiently, and the power to track every transaction. This power will likely continue to corrupt U.S. policy and institutions.

Is there a better way forward? Yes. The U.S. should launch a digital currency, but that currency should not mimic the dollar. Instead, it should compete with it. The New Digital Dollar (NDD?) should be designed to make it difficult for anyone to abuse: There should be technical limits to the amount that can be printed out of thin air and built-in privacy protections. America can design a currency that behaves in line with its stated values — a currency that enables people to trade freely, that allows anyone in China or Russia (and the U.S. and Canada) to transfer their money wherever they want.

Instead of trying to cling to a world in which all money is controlled by "someone," the U.S. should support a world in which money is controlled by no one. And there's no need even to go that far: The New Digital Dollar can be designed and maintained by the U.S., but it can be designed in a way that gives its users more protection from American abuse.

If people ever lose trust in the old dollar, they can switch to NDD rather than buy Chinese Yuan (or Bitcoins). And the U.S. is in a position to offer them special incentives to do so (for example, convert your USD-denominated bonds to NDD-denominated bonds at a pre-defined discount).

More importantly, the New Digital Dollar will create new incentives for America itself. Instead of abusing its privilege, it will be forced to become fairer, more efficient, more attractive as an investment destination. I believe it can.

In 2012, Mark Zuckerberg decided to buy Instagram for $1 billion. Many people thought he was an idiot. Most people thought he overpaid. He bought a company with 13 employees, no revenue, and only 30 million users. And instead of shutting it down or integrating it, Zuck let Instagram continue to operate and cannibalize Facebook's main website and app.

It was one of the best investments of all time. Instagram has around 2 billion users today, representing about $100-150 billion of Facebook's market capitalization. Beyond the numbers, it enabled Facebook to survive and continue to grow despite fierce competition.

Today, Instagram is facing a different challenge. The fact that it's controlled by Facebook (Meta) makes it less attractive. Its users are concerned about privacy. Regulators are worried about Meta's market power. Meta's changing strategy and priorities hobble Instagram's product. And investors value Instagram's revenue at lower multiples because it is bundled with Facebook's. Instagram helped lift Facebook up. But now Facebook itself is dragging Instagram down.

The U.S. has something to learn from this story. The New Digital Dollar should be launched to compete with the traditional dollar rather than to mimic it. It should give users what they want rather than forcing them back into the old world. And it should be genuinely independent to ensure the old dollar doesn't drag it down with it.

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Cover image adapted from alicia_mb on Freepik