Business Archives

Can Central Bank Digital Currency Contain COVID-19 Crisis by Saving Small Businesses? (Part 2)

This piece is a follow up to our previous Money View article on the banking system during the COVID-19 crisis.

By Elham Saeidinezhad and Jack Krupinski |The COVID-19 crisis created numerous financial market dislocations in the U.S., including in the market for government support. The federal government’s Paycheck Protection Program offered small businesses hundreds of billions of dollars so they could keep paying employees. The program failed to a great extent. Big companies got small business relief money. The thorny problem for policymakers to solve is that the government support program is rooted in the faith that banks are willing to participate in. Banks were anticipated to act as an intermediary and transfer funds from the government to the small businesses. Yet, in the modern financial system, banks have already shifted gear away from their traditional role as a financial intermediary between surplus and deficit agents. Part l used the “Money View” and a historical lens to explain why banks are reluctant to be financial intermediaries and are more in tune with their modern function as dealers in the wholesale money markets. In Part ll, we are going to propose a possible resolution to this perplexity. In a monetary system where banks are not willing to be financial intermediaries, central banks might have to seriously entertain the idea of using central bank digital currency (CBDC) during a crisis. Such tools enable central banks to circumvent the banking system and inject liquidity directly to those who need it the most, including small and medium enterprises, who have no access to the capital market.

The history of central banking began with a simple task of managing the quantity of money. Yet, central bankers shortly faced a paradox between managing “survival constraint” in the financial market and the real economy. On the one hand, for banks, the survival constraint in the financial market takes the concrete form of a “reserve constraint” because banks settle net payments using their reserve accounts at the central bank. On the other hand, according to the monetarist idea, for money to have a real purchasing power in terms of goods and services, it should be scarce. Developed by the classical economists in the nineteenth and early twentieth centuries, the quantity theory of money asserted that the quantity of money should only reflect the level of transactions in the real economy.

The hybridity between the payment system and the central bank money created such a practical dilemma. Monetarist idea disregarded such hybridity and demanded that the central bank abandon its concern about the financial market and focus only on controlling the never-materializing threat of inflation. The monetarist idea was doomed to failure for its conjectures about the financial market, and its illusion of inflation. In the race to dominate the whole economy, an efficiently functioning financial market soon became a pre-condition to economic growth. In such a circumstance, the central bank must inject reserves or else risk a breakdown of the payments system. Any ambiguity about the liquidity problems (the survival constraint) for highly leveraged financial institutions would undermine central banks’ authority to maintain the monetary and financial stability for the whole economy. For highly leveraged institutions, with financial liabilities many times larger than their capital base, it doesn’t take much of a write-down to produce technical insolvency.

This essential hybridity, and the binding reality of reserve constraint, gave birth to two parallel phenomena. In the public sphere, the urge to control the scarce reserves originated monetary policy. The advantage that the central bank had over the financial system arose ultimately from the fact that a bank that does not have sufficient funds to make a payment must borrow from the central bank. Central bankers recognized that they could use this scarcity to affect the price of money, the interest rate, in the banking system. It is the central bank’s control over the price and availability of funds at this moment of necessity that is the source of its control over the financial system. The central bank started to utilize its balance sheet to impose discipline when there was an excess supply of money, and to offer elasticity when the shortage of cash is imposing excessive discipline. But ultimately central bank was small relative to the system it engages. Because the central bank was not all-powerful, it must choose its policy intervention carefully, with a full appreciation of the origins of the instability that it is trying to counter. Such difficult tasks motivated people to call central banking as the “art,” rather than the “science”.

In the private domain, the scarcity of central bank money significantly increased the reliance on the banking system liabilities. By acting as a special kind of intermediary, banks rose to the challenge of providing funding liquidity to the real economy. Their financial intermediation role also enabled them to establish the retail payment system. For a long time, the banking system’s major task was to manage this relationship between the (retail) payment system and the quantity of money. To do so, they transferred the funds from the surplus agents to the deficit agents and absorbed the imbalances into their own balance sheets. To strike a balance between the payment obligations, and the quantity of money, banks started to create their private money, which is called credit. Banks recognized that insufficient liquidity could lead to a cascade of missed payments and the failure of the payment system as a whole.

For a while, banks’ adoption of the intermediary role appeared to provide a partial solution to the puzzle faced by the central bankers. Banks’ traditional role, as a financial intermediary and providers of indirect finance, connected them with the retail depositors. In the process, they offered a retail payment- usually involve transactions between two consumers, between consumers and small businesses, or between two small to medium enterprises. In this brave new world, managing the payment services in the financial system became analogous to the management of the economy as a whole.

Most recently, the COVID-19 crisis has tested this partial equilibrium again. In the aftermath of the COVID-19 outbreak, both the Fed and the U.S. Treasury coordinated their fiscal and monetary actions to support small businesses and keep them afloat in this challenging time. So far, a design flaw at the heart of the CARES Act, which is an over-reliance on the banking system to transfer these funds to small businesses, has created a disappointing result. This failure caught central bankers and the governments by surprise and revealed a fatal flaw in their support packages. At the heart of this misunderstanding is the fact that banks have already switched their business models to reflect a payment system that has been divided into two parts: wholesale and retail. Banks have changed the gear towards providing wholesale payment-those made between financial institutions (e.g., banks, pension funds, insurance companies) and/or large (often multinational) corporations- and away from retail payment. They are so taken with their new functions as dealers in the money market and originators of asset-backed securities in the modern market-based finance that their traditional role of being a financial intermediary has become a less important part of their activities. In other words, by design, small businesses could not get the aid money as banks are not willing to use their balance sheets to lend to these small enterprises anymore.

In this context, the broader access to central bank money by small businesses could create new opportunities for retail payments and the way the central bank maintains monetary and financial stability. Currently, households and (non-financial) companies are only able to use central bank money in the form of banknotes. Central bank digital currency (CBDC) would enable them to hold central bank money in electronic form and use it to make payments. This would increase the availability and utility of central bank money, allowing it to be used in a much more extensive range of situations than physical cash. Central bank money (whether cash, central bank reserves or potentially CBDC) plays a fundamental role in supporting monetary and financial stability by acting as a risk-free form of money that provides the ultimate means of settlement for all sterling payments in the economy. This means that the introduction of CBDC could enhance the way the central bank maintains monetary and financial stability by providing a new form of central bank money and new payment infrastructure. This could have a range of benefits, including strengthening the pass-through of monetary policy changes to the broader economy, especially to small businesses and other retail depositors, and increasing the resilience of the payment system.

This increased availability of central bank money is likely to lead to some substitution away from the forms of payment currently used by households and businesses (i.e., cash and bank deposits). If this substitution was extensive, it could reduce the reliance on commercial bank funding, and the level of credit that banks could provide as CBDC would automatically give access to central bank money to non-banks. This would potentially be useful in conducting an unconventional monetary policy. For example, the COVID-19 precipitated increased demand for dollars both domestically and internationally. Small businesses in the U.S. are increasingly looking for liquidity through programs such as the Paycheck Protection Program Liquidity Facility (PPPLF) so that those businesses can keep workers employed. In the global dollar funding market, central banks swap lines with the Fed sent dollars into other countries, but transferring those dollars to end-users would be even easier for central banks if they could bypass the commercial banking system.

Further, CBDC can be used as intraday liquidity by its holders, whereas liquidity-absorbing instruments cannot achieve the same, or can do so only imperfectly. At the moment, there is no other short-term money market instrument featuring the liquidity and creditworthiness of CBDC. The central bank would thus use its comparative advantage as a liquidity provider when issuing CBDC. The introduction of CBDC could also decrease liquidity risk because any agent could immediately settle obligations to pay with the highest form of money.

If individuals can hold current accounts with the central bank, why would anyone hold an account with high st commercial banks? Banks can still offer other services that a CBDC account may not provide (e.g., overdrafts, credit facilities, etc.). Moreover, the rates offered on deposits by banks would likely increase to retain customers. Consumer banking preferences tend to be sticky, so even with the availability of CBDC, people will probably trust the commercial banking system enough to keep deposits in their bank. However, in times of crisis, when people flee for the highest form of money (central bank money), “digital runs” on banks could cause problems. The central bank would likely have to increase lending to commercial banks or expand open market operations to sustain an adequate level of reserves. This would ultimately affect the size and composition of balance sheets for both central banks and commercial banks, and it would force central banks to take a more active role in the economy, for better or worse.

As part 1 pointed out, banks are already reluctant to play the traditional role of financial intermediary. The addition of CBDC would likely cause people to substitute away from bank deposits, further reducing the reliance on commercial banks as intermediaries. CBDC poses some risks (e.g., disintermediation, digital bank runs, cybersecurity), but it would offer some new channels through which to conduct unconventional monetary policy. For example, the interest paid on CBDC could put an effective floor on money market rates. Because CBDC is risk-free (i.e., at the top of the money hierarchy), it would be preferred to other short-term debt instruments unless the yields of these instruments increased. While less reliance on banks by small businesses would contract bank funding, banks would also have more balance sheet freedom to engage in “market-making” operations, improving market liquidity. More importantly, it creates a direct liquidity channel between the central banks, such as the Fed, and non-bank institutions such as small and medium enterprises. Because central banks need not be motivated by profit, they could pay interest on CBDC without imposing fees and minimum balance requirements that profit-seeking banks employ (in general, providing a payment system is unprofitable, so banks extort profit wherever possible). In a sense, CBDC would be the manifestation of money as a public good. Everyone would have ready access to a risk-free store of value, which is especially relevant in the uncertain economic times precipitated by the COVID-19.

Elham Saeidinezhad is lecturer in Economics at UCLA. Before joining the Economics Department at UCLA, she was a research economist in International Finance and Macroeconomics research group at Milken Institute, Santa Monica, where she investigated the post-crisis structural changes in the capital market as a result of macroprudential regulations. Before that, she was a postdoctoral fellow at INET, working closely with Prof. Perry Mehrling and studying his “Money View”. Elham obtained her Ph.D. from the University of Sheffield, UK, in empirical Macroeconomics in 2013. You may contact Elham via the Young Scholars Directory

Jack Krupinski is a student at UCLA, studying Mathematics and Economics. He is pursuing an actuarial associateship and is working to develop a statistical understanding of risk. Jack’s economic research interests involve using the “Money View” and empirical methods to analyze international finance and monetary policy.

Think Uber’s Problems Stop at Its Management and Culture? Think Again.

Keep track of all of Uber’s problems with The Big List of Uber’s Controversies.

In February 2017, Susan Fowler published a blog post detailing the sexual harassment and gender discrimination she experienced during her time as an engineer at Uber, the ride-hailing company. Although this was not the first time that Uber had been accused of creating a workplace where pervasive sexism and discrimination thrive, Fowler’s piece struck a chord. It built on a wave of criticism of the company from an earlier public relations disaster — Uber’s missteps following protests of President Trump’s racist executive order at John F. Kennedy Airport starting on January 28th and the resulting #DeleteUber campaign — and emboldened others to report sexual and other misconduct at the company (215 complaints about its corporate workplace have been filed).

While the criticisms levied at Uber are generally applicable to Silicon Valley as a whole, public ire was now focused on Uber, which was having a public relations crisis seemingly every week. The one-time $70 billion-valued private company (five times more valuable than the grocery store Whole Foods, which has 431 supermarkets, and was recently acquired by Amazon) was under immense pressure from even investors too. In response, it agreed to two investigations, both led by law firms. One investigated the workplace complaints that had been lodged against the company, leading to the firing of over 20 employees as well as disciplinary action against others. The second’s task was to investigate Uber’s corporate culture and develop recommendations to restructure the company to try to address the root causes of the problems. This team was led by former Obama administration Attorney General, and former Uber advisor, Eric Holder.

The report from Holder’s team, released a few days ago, came up with 13 pages of recommendations, all of which were adopted by Uber’s board of directors. In general, they seek to bring Uber in line with the practices of a company of its size. Some of these are common sense: developing internal controls and processes in a variety of ways, eliminating bias by performing blind reviews, reducing the unusually high amount of power of key executives, giving the board of directors more power, creating oversight and audit committees, using compensation as a carrot and stick, etc. Other recommendations include ensuring that people with children can participate in company events, which is laudable. Where the proposal fails is in its recommendations for changing values and emphasizing diversity, which include training for staff, developing programs to attract qualified diverse candidates, and reforming the list of the company’s core values (from something that a frat boy would write to, no doubt, corporate-speak clichés). It also included symbolic changes, like renaming Uber’s “War Room,” the “Peace Room”.

While revamping Uber’s structure and setting a bunch of (corporate) priorities might seem like a positive change at the company, it’s important to keep a few things in mind. One is that the problems that Uber is facing with regards to its culture and diversity are pervasive in Silicon Valley. Uber might be especially bad in these areas right now, but the typical solutions are unlikely to make much of a difference at the company because they haven’t made much of a difference at most tech companies. There are complicated reasons for these failures, and there should be little confidence that these tired and hollow strategies will work.

Another is that Uber is a private company, with control intentionally held closely among certain people, like CEO Travis Kalanick, who is most responsible for Uber’s reprehensible culture. As the CEO and founder, he ultimately controls much of what happens at the company, whether the Holder recommendations are adopted, and whether they are taken seriously. The most important result from the Holder investigation — Kalanick’s decision to take leave and take on a supposedly diminished role at the company — was undoubtedly due to pressure from the investigation but still entirely Kalanick’s own decision (and he’s still the CEO). Lastly, while the recommendations wisely agreed to use compensation as a way to incentivize and punish managers for transgressions, in practice, out-of-control pay of CEOs and executives, regardless of performance, is a systemic problem among not only tech companies, but companies in general. Kalanick’s poor performance as head of Uber should lead to a pay cut, but it likely won’t.

Thus, the Holder report might have some good ideas about how Uber could be run better, although it is unlikely that Uber will fundamentally change. (Indeed, at the board of directors meeting to discuss the results of the report, an Uber board member made a sexist remark.) But what this conversation about Uber misses are the more fundamental questions about Uber and its business. The narrative that has emerged about the company since the beginning of this year is that Uber’s problems start and stop at its management (specifically, Kalanick) and culture, when they don’t.

The Big List of Uber’s Controversies is a compendium of the problems and controversies that have plagued the company since its founding in 2009. Many of these are related to the problems the company is very publicly dealing with now; others are not. The goal of the list is to point out that Uber’s problems are pervasive and fundamental to the company’s operations, yet not necessarily unique to the company (although Uber might be an outlier with regard to how poorly it is managed and structured). To that end, the controversies are divided into six categories: Business Practices; Social Costs; Misuse of Data and Software; Corporate Culture; Passenger Issues; and Driver Issues.

While the 79 controversies and problems currently on the list touch on many different and unique issues, there are themes that give some insight into the inner workings of the company and its problems, and demonstrate that Uber’s problems run much deeper than its culture or even the company itself.

Uber hemorrhages massive amounts of its investors’ money every year and does not have a viable business model, absent major changes in the industry or the creation of a monopoly;
Uber’s success depends on attracting more investment and growing quickly, as well as anti-competitive practices: it has not created efficiencies or value that would justify its poor financial performance;
Uber uses misleading research and fantastic technology forecasts to distract from the dismal failure of its core business, taxi service;
Uber has large and sophisticated lobbying, public relations, and research departments, often involving former Obama administration officials, that deliberately misleads (and outright lies to) reporters, investors, regulators, and the public in order to justify and give cover to flagrant violations of the law, defend exploitative conditions, and paper over the problems with its business model;
Uber erroneously claims that it is a technology — not a taxi — company, and that the business conducted on its platform is “sharing” in order to evade responsibility;
Uber has inadequate internal controls for its data and software tools, leading to improper, and possibly illegal, access and use by employees, including to surveil critics and regulators;
Uber’s growth-at-any-cost mentality and poor management has led to a culture that ignores problems and creates a toxic culture and workplace for its employees — significantly and negatively impacting its drivers and passengers as well;
Uber’s past behavior suggests it has a complete disregard for the safety of its drivers and passengers until it is pressured to take action;
Uber manipulates its drivers, entices them to enter into exploitative arrangements (including their misclassification as independent contractors), opposes their unionization, and exerts undue influence over their working conditions, consistently lowering their pay; and
Uber’s operation has significant social costs with implications for public safety, public finance, access for those with disabilities, discrimination, investment in public infrastructure, and the regulated taxi industry as well as the taxi driving occupation.

Recent criticism of Uber is undoubtedly a good thing, but as this list demonstrates, its problems extend far beyond the individuals that run it or its corporate culture. With these problems, the fundamental question should not be whether Uber can reform its workplace culture, or whether Kalanick should stay on as CEO, or if he is overly important to the company. Rather it should be whether Uber, and companies like it, should be tolerated at all. In Uber’s case, it is unclear whether it is any better than regulated taxis broadly. Individuals might like Uber’s service — and that’s fine, and also to be expected, considering their rides are all subsidized by Uber’s investors — but policy should not cater what certain segments of the population want, especially if they don’t understand how the company operates.

Another important point is that Uber’s reckless behavior has been tolerated and excused because of its ascending position in the market. But as the clear industry leader today, that is part of the reason why it is now in the crosshairs, even though other ride-hailing companies suffer from some of the same problems as Uber. (Lyft eagerly capitalized on Uber’s misfortunes following the JFK protests, for example.) Importantly, they too have not developed ways to be profitable or more efficient than regulated, fleet-based taxis. Even Juno, the supposedly fair and ethical ride-hailing company that gave its drivers equity in its business, sold them out when it was acquired.

So, while some have suggested that the solution is simply to stop using Uber (and, ostensibly, to use competitors like Lyft or Gett), this is no solution at all. The solution is making sure that these companies are subject to the same regulations as traditional taxis, as well as that they comply with labor and other laws, all of which was unsurprisingly absent from the Holder report. This is the innovative idea that is also a solution to many of Silicon Valley’s problems, regardless of the industry.

Uber might not be able to survive if it started caring about the safety of its passengers, the exploitation of its drivers, or the social costs it shifts onto the rest of us (it’s in trouble already), but maybe it shouldn’t. As politicians plot with Silicon Valley to take over public infrastructure and to revamp the fundamental nature of work, maybe Silicon Valley shouldn’t either.