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Regulating private money
To address a once-dead issue, policymakers should revive a Civil War-era approach
Note: This piece is co-authored with Gary Gorton.
Stablecoins pose systemic dangers to the economy, and they are not going to disappear by themselves. To properly address their risks to financial stability and monetary sovereignty, policymakers should borrow insights from the National Bank Act of 1863—tax stablecoins and create a sovereign alternative.
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Bringing a dead issue back to life
Over the past two centuries, every country decided that its central bank would be the sole issuer of circulating money. The consensus was so strong that Milton Friedman and Anna Schwartz wrote in 1986 that “[t]he question of government monopoly of hand-to-hand currency is likely to remain a largely dead issue.”
Indeed, the sovereign’s money monopoly was considered a settled issue until the recent advent of “stablecoins,” which are privately produced digital tokens that reside on blockchains. It is a type of cryptocurrency that aims to keep its value trading at par—one stablecoin for one dollar. While the technology is new, the underlying economics are not. As we argue below, the proliferation of private money poses risks to financial stability and monetary sovereignty.1 The question for contemporary policymakers is whether they want to relearn these lessons the easy way or the hard way.
Importantly, waiting for stablecoins—or cryptocurrencies generally—to disappear is not the right policy response. The market capitalization for stablecoins is north of $100 billion, Visa is settling transactions using stablecoins, and PayPal just announced that it intends to enter the stablecoin market. Policymakers should borrow insights from the National Bank Act of 1863 to address the proliferation of stablecoins and protect the sovereign’s money monopoly.
Stablecoins threaten financial stability and monetary sovereignty
First, let’s understand what we’re dealing with. We categorize types of money into a 2x2 matrix: (1) circulating (token-based) private money, (2) circulating sovereign money, (3) account-based private money, and (4) account-based sovereign money. Private money is a debt claim where the issuer (obligor) is a private firm, not a public institution; and sovereign money is a claim where a federal government or other sovereign entity is either the issuer or the guarantor. Account-based money refers to money in a specific bank account, whereas token-based money can circulate as a medium of exchange outside of accounts.
Under their present design, stablecoins fit into the upper-left quadrant of the matrix because they are privately issued and can circulate as tokens. They are digital versions of cash but privately produced. This is why stablecoin issuers claim that consumers will one day use stablecoins (stored in their digital wallets) to pay for items in the same way that consumers now use cash (stored in their physical wallets). Stablecoins are designed as digital substitutes for physical cash.
From an economic perspective, there are two crucial problems with respect to circulating private money: (1) heightened risks to financial stability and (2) the erosion of monetary sovereignty.
Financial Stability. The further proliferation of stablecoins would weaken financial stability. Money is an instrument that should be information-insensitive. Its price is not supposed to change based on new information. The price adjustments that occur because of changes in supply and demand—like the price adjustments for apples or oranges—should not apply to money. A one-dollar bill should always transact for one dollar. However, if the price is designed to remain fixed, then the law of supply and demand dictates that the quantity must change. These quantity adjustments occur most dramatically during a bank run, when people no longer wish to hold any of the money in question. This financial stability risk has manifested itself throughout history, as seen with uninsured bank deposits before the advent of deposit insurance, repos during the 2008 financial crisis, money market funds in 2008 and 2020, and the bank failures in 2023.
Although both account-based private money and token-based private money share this common financial stability weakness, there is one notable difference between the two: Account-based money is the dominant form of money in today’s economy by design and has corresponding regulatory guardrails. Since the early 20th century, generations of financial regulators have established guardrails, like FDIC deposit insurance and accompanying supervisory requirements, around account-based money. Deposit insurance is not designed for circulating money. During bank runs, the government insures funds sitting in accounts at FDIC member institutions, not cash existing outside of those accounts. Trying to insure circulating stablecoins is not feasible under the current model.
Monetary Sovereignty. Previously, stablecoins did not erode monetary sovereignty because they circulated in a confined ecosystem—specifically in the ecosystem of cryptocurrencies. They were used primarily in the speculative trading of Bitcoin, Ethereum, and other cryptocurrencies. The risk to monetary sovereignty is that, in the not-too-distant future, stablecoins could expand beyond the cryptocurrency ecosystem—see, for example, the developments with Visa and PayPal—and compete with U.S. dollars in everyday economic transactions. At that point, central banks would clearly see the importance of Paul Tucker’s insight: “We are able to implement monetary policy because the economy has a demand for central bank money and, as monopoly suppliers, we can set the terms on which we provide it.” In short, the Federal Reserve could lose control of the money supply and not be able to conduct monetary policy as effectively.
History provides a useful guide for policymakers today
The circulation of private money is not a new phenomenon. Historically, private banks issued their own circulating bank notes in response to shortages of sovereign money. During the mid-19th century, for instance, the U.S. government did not print money and there was a shortage of metal coins, so private bank notes were used pervasively as money. This origin story is similar in other countries, where shortages of circulating currency held back economic growth, and governments permitted the coexistence of private and sovereign money to fill the gap. However, the proliferation of circulating private money led to greater financial instability and to an erosion of monetary sovereignty.
In the United States, the road to the sovereign’s money monopoly began during the Civil War. Congress passed the National Bank Act in 1863 to help finance the war by creating national banks to issue their own national bank notes, which had to be backed by U.S. Treasuries. To facilitate adoption of these new national bank notes, Congress passed legislation that required all banks to pay a 10 percent tax on payments that they made in currency other than the national currency.
State banks were not pleased as the circulation of their bank notes would be greatly impeded. After a legal challenge by a bank in Maine, which refused to pay the tax, the Supreme Court upheld the tax on the circulation of private money in Veazie Bank v. Fenno (1869). Notably, this tax on circulating private money was expanded in subsequent years and stayed “on the books” for over a century, until 1976.
Why did Congress eventually repeal the tax? Was it because Congress suddenly wished for private money to circulate alongside sovereign money? No. It was because Congress wanted to streamline the Internal Revenue Code and thought the tax provision no longer served any purpose. Nothing in the legislative history suggests that Congress consciously decided to erode the sovereign’s monopoly on issuing circulating money. Congress repealed the tax on private money circulation because it was so obvious that coexistence was a dead issue at that time—deadwood, to be precise. Who could have imagined that, in the 21st century, entrepreneurs would attempt to reinvent digital versions of the private bank notes that circulated during the 19th century?
Today, policymakers face a similar decision with stablecoins. How should we regulate private money? To date, all proposals assume that having stablecoins circulate alongside sovereign money is the optimal path forward. That is mistaken. Instead, policymakers should contemplate a 21st-century version of the National Bank Act—a constitutionally sound tax on the circulation of private stablecoins paired with the creation of digital sovereign money. Such legislation could capture the benefits—for example, reducing cross-border transaction costs—without the costs to financial stability and monetary policy associated with private stablecoins.
In this context, “private money” refers to circulating (not account-based) money that is issued by a private entity.