Richard Holden on Money in the 21st Century

UNSW Centre for Ideas: UNSW Centre for Ideas

Ann Mossop: Welcome to the Curiosity Lecture series supported by UNSW Sydney. I'd like to acknowledge that we meet on the lands of the Gadigal people of the Eora Nation and pay my respects to their elders, past and present. This lecture features Richard Holden on money in the 21st century. Richard Holden is Professor of Economics at UNSW Sydney and a columnist for the Financial Review. His most recent book is Money in the 21st century. Please welcome him to the stage.

Richard Holden: Thank you everybody very much for coming to hear me talk about my new book. It's a real pleasure to be able to be at the Sydney Writers’ Festival. And let me begin by also acknowledging the traditional custodians of the lands on which we meet, pay my respects to elders, past and present, and extend that to any First Nations people who are with us today.

I thought long and hard about how to describe what I tried to do in this book, and what I do do in this book, and I introduce something pretty uncharacteristic for me, which is I'm going to read from it. I'm an economist by training, and normally when I give a talk there are a lot of slides up behind and I have a laser pointer and things like that.

But as I reflected on it, I thought that I couldn't do a much better job than actually what I tried to do in writing the book. So is going to read to you a little bit, from it. Let me just say two things before I do that. The first is that my publisher told me that I should have in mind when I wrote this book, a very, very large audience.

And, I said to her at one point, 'But, you know, I get that. But in many ways, I have a kind of audience of one in mind with that', and it would become clear who that audience of one is. Don't get me wrong, I have all of you good folks in mind as well. But the audience of one I had in mind was Janet Yellen, who's Treasury Secretary of the United States, because what this book ultimately says is that the United States and other advanced economies like Australia, I think, in my view, really need to create their own central bank digital currencies.

And if there's one person who can make that happen, it's Secretary Yellen. So so in one sense she's my audience for this book. Now as I say I I'm an economics professor by trade and by training and by inclination with all the various bad things that go with that. As Ann said in a very nice introduction, I also happen to have a newspaper column for the Australian Financial Review that I write every couple of weeks.

And so I like to think that part of my role is trying to put things in, in simpler language than, than typically, I do when I do my economics. Sometimes when people ask me about my economic research, the stuff that's the real grist of our mill as research academics, I say 'If you happen to stumble across it, you will think it looks like recreational mathematics'.

And that's sadly quite accurate, actually. That description. I hope what I'm going to say here does a little more justice. to, to to maybe the, the other side of my craft than that and my, my friend and Nobel laureate Bengt Holmstrom and former colleague of mine was very gracious in writing a blurb on the, on the, on the dust jacket of this book.

And he said something along the lines of me having an uncanny knack for explaining complicated things in simple language. I don't know about that. I think that's overly generous, but I'm going to try and, see how I go about doing that. So let me just try and tell you what I did in this book. And it starts with a story, and it starts with a story in the Treasury Secretary's office that's been reported and happens to be true.

And, I'll take you through it from there. Okay. So "In the summer of 2021, US Treasury Secretary Janet Yellen sat down for breakfast with Jay Powell, her successor as chair of the Federal Reserve. It was a weekly ritual that Yellen knew well. Her office in the Treasury Building at 1500 Pennsylvania Avenue was a study in contrasts. 18th century portraits and deep mahogany woodwork offered a reminder of the past.

A Bloomberg terminal and a Herman Miller desk chair signified the present. It was a fitting backdrop for the central topic of the meeting. Should the US government give its blessing to a private cryptocurrency developed by Facebook? Powell was in favour. If there was going to be a private global cryptocurrency, then it would be better for it to be controlled by an American company like Facebook.

That way, the US government could play a role in establishing the rules of the game. In any case, Facebook just wanted to go ahead for a trial of DM, as it called its currency. What harm was there in that? Possibly quite a lot in Yellen's view. Although she had been in government for nearly two decades as President of the San Francisco Federal Reserve, then Deputy Fed Chair, then Chair and now as Treasury Secretary.

She was an economics professor at heart, and the economist in her foresaw all kinds of problems. First, digital currencies involved network externalities. The greater the number of people who use DM, the more attractive it would be for other consumers to adopt it. This phenomenon leads to a winner take all market, in which one firm ends up with a huge market share.

Like Google in Search, Uber in Ride Sharing, and Amazon in retailing and not incidentally, Facebook in social networks. Was this really just a trial for DM, or the first step on a march to market dominance? Second, would Facebook really control the digital currency? The premise of the blockchains on which digital currencies like Bitcoin are built is that they are decentralised and anonymous.

This was why a surprisingly large number of frozen yogurt shops in New Hampshire accepted Bitcoin and other digital currencies like Ether. The digital currency movement was born in 2008, out of a distrust of centralised authority in general and government in particular. Third, cryptocurrencies might have virtues, but they also come with vices. Or at least they facilitated them. Tax evasion, money laundering and the arms and illicit drug trades were already lubricated by cryptocurrencies.

For Yellen, the downsides of a Facebook digital currency were too great and the benefits too hard to see. But in professorial style, she wanted to reflect. She told Powells she would get back to it. So Powells part, although he thought he could approve the trial himself, he wanted Yellen's support in a potentially risky decision. Though Yellen was relatively centrist, she had a lot of political capital with the progressive wing of the Democratic Party as well as with President Joe Biden.

After weeks of reflection, Yellen gave Powell her view. It was his call, she acknowledged, but she couldn't provide her endorsement and hence political cover for the Facebook proposal. If he wanted to back the trial, he would have to do it alone. That was the day the DM died. But digital currencies are still very much alive. The central banks of more than 50 nations are exploring their own digital currencies or Gulf Coins.

China has introduced the e-CNY, the electronic yuan, to 260 million people. The European Union has a stated goal of having a virtual euro by 2025, and the British and US governments are planning their own digital currencies. Meanwhile, other digital currencies including Bitcoin and Ethe are worth roughly $2 trillion in total. In March 2022, Time magazine dedicated an entire issue to non-fungible tokens, or NFTs, and the blockchain with Vitalik Buterin, the 20 year old co-founder of Ethereum, on the cover.

In fact, it is the wiry, brilliant, hard blogging Buterin who was the central figure in the world of private digital currencies and the closest thing in a movement based on decentralisation can have to a leader. For the first time in centuries, there is a rivalry between private and public currencies. And for the first time in history, private currencies might actually win.

Even if they don't, the contours of the battle will shape what government currency is and what it can do. This is also an era of cheap money and mobile money. Official interest rates since the financial crisis of 2008 have been close to zero across most advanced economies, and despite a serious rise in inflation in 2021 and 2022, and I guess 2023 as well, we will not see a return to the double digit interest rates of the 1980s.

The global balance between the supply of money and the demand for money has permanently shifted. Modern money is mobile. Money is on our phones more often than it's in our pockets. A child born in America today will never ride a personal cheque. It's likely that none of us will be handling banknotes by the time that a child, that child, is old enough to vote.

After advocating for a move to a cashless Australia in January 2017, I went an entire year without using cash just to prove a point and to win a bet. And it wasn't even hard. The world of electronic payments is convenient, but it has a catch. Cash is, or at least it can be, anonymous. Mobile money is not.

Every transaction using a credit card, debit card, Apple Pay or other online payment system is recorded. Transactions can be used by tax authorities to identify illegal activity. The anonymity of cash underpins illicit activity ranging from tax evasion to human trafficking. The black economy that facilitates is huge. In India it's estimated to be as much as 40% of all economic activity.

It denies governments the tax base required to fund important services. It allows criminal activity to flourish. It was the motivation for the November 2016 Indian demonetisation ordered by Prime Minister Narendra Modi, when large denomination bank notes were withdrawn from circulation. That episode was disastrous for India's economy. But it was a telling moment. It showed that cash is a medium of exchange, even in a country that relies heavily on it is declining in importance.

At the time, the person leading India's central bank, the reserve Bank of India, was the renowned economist Raghuram Rajan. He was known not only for his academic brilliance but also for his practical mind. After Rajan left the RBI, it emerged that he had warned the government of the problems that would arise from sucking 86% of India's currency out of circulation almost overnight.

Nine months before Modi's plan went into action, Rajan told the government that, quote, 'Although there might be long term benefits, I felt the likely short term economic costs would outweigh them.' India's demonetisation is both an example of how not to become a cashless society, and also a warning about the inevitability of a cashless society. It was Rajan who pointed out that the monetary policy enacted by the US Federal Reserve had spillover effects on emerging market countries like India.

In a speech at the Brookings Institution in April 2014, Rajan observed that when monetary policy in large countries is extremely and unconventionally accommodative, capital flows into recipient countries and tends to increase local leverage. Not only did cheap money create risks of asset bubbles in countries like the United States, but these risks were exported around the world and they will endure.

This book shows how the three characteristics of modern money: cheap, digital and mobile will affect the global economy in the 21st century. And it is the story of three people Yellen, Buterin and Rajan, who have shaped and will continue to shape those three forces. It is the interwoven and interconnected tale of a woman born in Brooklyn, New York, the year after World War Two ended, who became the foremost policymaker of her generation.

Of an economist, born in the early 1960s in Bhopal out of Pradesh, who reached the pinnacle of academia while doing a stint at the International Monetary Fund, running the reserve Bank of India and trying to triage the fallout from an attempt to abruptly yank 86% of the cash in circulation from a fifth of the world's population. And of a Russian born Canadian phenom who entered the world only in the mid 1990s, and who came up with the idea for what might become the future of the internet when he was still a teenager.'

So that's the backdrop. Here's what I do in the book. In the first... and I and I call this the opening chapter of the book 'The year that changed everything'. It was a year that changed a lot of things for me, and the year was 2008. But it also changed a lot of things about the world economy. In the first millennium BCE, the total size of the world's economy hardly budged.

It went from 182 billion to $210 billion. In the next 500 years it doubled to $430 billion. Then it took off in 1700 world output was more than 640 billion. By 1820 it was 1.2 trillion. Today it is more than 100 times that amount. This exponential increase in what the world produces has had an extraordinary impact on the standard of living of billions of people.

The typical explanation for the economic progress since the mid 18th century is technological advances, particularly the transition from hand to machine production of goods that has become to be known as the Industrial Revolution. That explanation isn't wrong, but it's incomplete. Economic activity relies on two things production and also trade. The ability for a person to trade with other people in a village.

There region, there country, and other parts of the world underpins the division of labor. The idea that there are gains from people specialising in specific tasks or types of production dates from around 2400 years ago to Plato's Republic. It was rightly identified as one of the cornerstones of modern economics by Adam Smith in his classic The Wealth of Nations.

Technological advances make it possible to improve living standards, but the ability for people to trade and specialise in the use of their talents and efforts is what turns that possibility into reality. For millennia, the biggest obstacle to economic efficiency was the absence of money, or to be a little more precise, the absence of fiat currency, a currency backed by the government that issues it. Without a medium of exchange, like money, two people wanting to trade with each other would have to have something the other wanted.

This so-called 'double coincidence' of wants might be rare. A medium of exchange that circumvents this problem makes voluntary trades possible and leads to more efficient use of resources. It's not surprising then, that money's been around for a long time. The shekel, about one third of an ounce of silver, became standard currency in Mesopotamia nearly 5000 years ago. The first coins were minted in the fifth or sixth century BCE, although there is historical dispute about who minted them.

The technology spread to Persia after the conquest of Lydia in 546 BCE, and eventually throughout the world. Over the centuries currencies have come and gone, and the values of different national currencies have fluctuated wildly. Coins were supplemented by paper banknotes, beginning with the Ming Dynasty in China in 1375. From 1870 to 1971. The convertibility of currencies into gold - the 'gold standard' - was at the heart of the international monetary system.

More recently, some countries have introduced polymer banknotes that make counterfeiting harder, and credit cards and debit cards have made monetary transactions easier. Fundamentally, however, very little changed between the Ming Dynasty and the start of the 21st century. Governments of one form or another controlled centralised systems of fiat money, and the decision about what currency could be used for exchange within their borders.

That pattern was disrupted in 2008 by three seemingly unconnected phenomena that are likely to redefine money, the roles that performs and who controls it. First, in the initial decade of the 21st century, we saw that interest rates in advanced economies could remain remarkably low for long periods, perhaps indefinitely. In response to the 2008 financial crisis official interest rates in advanced economies were slashed to near zero and have stayed more or less there ever since.

The second phenomenon was technological. In 2008, Apple's CEO Steve Jobs, in a final act of genius, gave birth to the rise of the smartphone, with the launch of the iPhone 3G. And while that launch event emphasised the convenience of ordering pizzas online, making calls to friends like Jony Ive, and carrying around songs and photos in one's pocket, the truly revolutionary aspect was yet to be apparent.

To adapt a phrase from Jobs himself when he launched the iPod "It was an entire bank in your pocket", powered by the now ubiquitous smartphone digital payments with standard fiat currencies have become dramatically more common in some parts of the world. Digital payments volumes outstripped those of cash in most advanced economies. Also in 2008, the idea for the world's first decentralised currency, a cryptocurrency called Bitcoin, was announced in an obscure White Paper.

Suddenly, a single clever idea by a personal group known only as Satoshi Nakamoto ended government monopoly on money and ushered in an era of decentralised finance. This book is about those three phenomena: low interest rates, mobile money, and cryptocurrencies. It's about how they interact to change what money does and who controls it. And because money is quite literally the fuel that powers $100 trillion worth of worldwide economic activity every year, this book is necessarily about our economic future.

Although real interest rates, the cost of money accounting for inflation, have moved up and down over the last half century, they were never close to zero for an extended period, as they have been for the past decade. Money hasn't just become decentralised. It's become costless, rationed only by lenders expectations of borrowers ability to repay the principal. And though money has been somewhat geographically mobile, at least since the 1830s and 1840s, when the arrival of the telegraph made it possible to send money by wire transfers.

The internet age has dramatically increased that mobility. By the early 2000s, money could move around the world in a flash, although only between banks that were part of the international financial system, controlled by domestic regulators and international agreements such as the Basel Accords. The smartphone opened the door to digital payments that are more convenient and safer than cash.

To instantaneous money transfers between individuals, and to a safe and accessible store of value and means of transacting business to some of the poorest people on the planet. These three phenomena jointly raise one big question: can central authorities keep control of the monetary system in the digital age? The remainder of this book seeks to answer that question and to contemplate what will happen if the answer is: not for long.

It explores the various forms of control that are under threat and how those threats can be countered. Can authorities control asset bubbles and speculation that stem from arbitrarily cheap money? Can they control what money is used for? Can they still levy taxes? And let me just finish this session by reading a little bit from what I see as the challenge that our authorities face.

'All of these developments have the potential to do enormous harm or to create significant good. The challenge facing governments is how to harness these innovations without killing them. I argue that governments of advanced economies should create their own digital currencies, like a digital US dollar, digital pound and digital euro and a digital Aussie dollar, before global private currencies powered by network externalities emerge as dominant.

This is a pressing concern. Although Facebook failed in its attempt to institute digital currencies Libra and then DM, Amazon, Apple and Google could all pursue similar strategies if they chose to. The rising levels of US Government debt, combined with the growth of China into the world's largest economy, have suddenly raised the prospect of the US dollar losing its status as the global reserve currency, the currency most widely held by central banks and monetary authorities of other countries.

That would lead to the US government losing the low borrowing rates and seemingly unlimited power to issue bonds, the so-called 'exorbitant privilege' that goes with it. In what follows, I paint a picture of the future of money in the digital age and provide a roadmap for governments to preserve their role in the creation, management and regulation of money and the economic activity that goes with it.'

So that's pretty much what I do in the book. And what I argue is that the real power of cryptocurrencies is the power of what's known as Web3, and what Web3 enables is essentially programable money. So you'll have heard of Bitcoin and you'll all have heard of Ether or Ethereum, which is the blockchain on which ether operates.

The great genius of one of the three central figures in this book, Vitalik Buterin, was that he realised that Bitcoin had a great idea, but if it was going to be useful, it was defective in one really important way, which is you couldn't program it. And what he introduced with Etherium, the Ethereum blockchain with Ether, was what computer scientists call putting a 'Turing complete programming language' on top of something that looked like Bitcoin.

And I think that is and I'm not alone. The power of Web3. And that is what the future of money and finance. And as an extension our economies will look like. And what this really comes down to is a race. Advanced economies like Australia and the United States, and the European Union are in a race. They're in a race with private potential providers.

And they're in a race with China and China is currently very, very far ahead in this race. And Facebook came this close to creating a possibly completely dominant, totally non-democratic digital currency that could have supplanted the US dollar. And as the story I sort of outlined in the prolog, tells it, it was really down to a single decision by a single person, Janet Yellen, that meant that that didn't occur. That could have been our future.

And so I think that for advanced economies like Australia, like the US, it is an absolutely pressing concern to win this race, to crowd out the potential private providers of digital currencies who would end up controlling our financial world, and to push back on the possibility of China controlling our financial world.

And that's the story that I try and bring to life in the book. And one of the things that I was delighted to be able to at least make an attempt to do, in writing it, was to tell it through the lens of three totally incredible people Janet Yellen, Vitalik Buterin and Raghu Rajan. And I hope that if you get the chance to read more of it, and, and I hope that you will, you'll get to see the story of what money is in the modern world and what it will be, in my view, told through the narrative of those three extraordinary individuals.

Thank you very much for coming along, and I look forward to seeing you.

UNSW Centre for Ideas: Thanks for listening. This event was presented by the UNSW Centre for Ideas and the Sydney Writers’ Festival as part of the Curiosity Lecture Series. For more information, visit unswcentreforideas.com and don't forget to subscribe, wherever you get your podcasts.