The Strategist

Study: Digital Dollar and Euro may outperform weaker currencies

11/30/2021 - 08:43

The monetary independence of developing economies is threatened by central bank digital currencies (CBDCs). Foreign money there is allowed to circulate, but local currency can be in a small supply - although weak currencies usually win competition for circulation, while hard currencies are used for savings.

Sebastian Edwards, an economist at UCLA's Anderson Graduate School of Management, looked at the impact of developed-country CBDCs on emerging economies in a preprint of an article published by the American NBER.

Digital currencies, it is commonly agreed, may enhance payment system efficiency, simplify and lower the costs of cross-border transactions, as well as boost availability of financial services, particularly among the poor. They can, however, dramatically alter the rule according to which "bad" currencies evict "good" currencies from circulation - the latter is used for savings and big settlements owing to stability, whilst the public attempts to ditch the former by making regular settlements in them. as well as payments

This delays dollarization of emerging countries; yet, the models suggest that digital settlements in "hard" digital currencies are cheaper and easier than in national ones, and are linked with reduced risks, providing issuers enable ownership and cross-border payments.

This might result in a considerable reduction in the use of national currencies.

According to the author's calculations, this danger is greatest in nations with significant inflation, when losses from devaluation are added to transaction costs in the official currency, giving strong digital currencies a competitive edge.

In 2020, IMF analysts warned about the possibility of such a scenario in relation to the digitalization of large currency systems, noting that, without guarantees of currency sovereignty, it will be difficult for developing country central banks to enforce currency exchange restrictions and combat illegal capital flows with the emergence of CBDCs.