How Stablecoins Will Transform Banking | Charles Calomiris

What's up, everybody? My name is Demetri Cafenus, and you're listening to Hidden Forces, a podcast that inspires investors, entrepreneurs, and everyday citizens to challenge consensus narratives and learn how to think critically about the systems of power shaping our world.

My guest on this episode of Hidden Forces is Charles Calamirus, the former chief economist at the Office of the Comptroller of the Currency and the author of numerous widely cited books and papers on the subjects of money and banking, including his forthcoming "How Stable Coins Will Transform Banking," based on a presentation he delivered at the Hoover Institution's annual monetary policy conference this past May.

Charles and I spend the first hour of our conversation laying out what stable coins are and why he believes they're poised to transform our standard units of account through a revolution in real-time payments and a wholesale reinvention of the banking system, monetary policy, and the role of the dollar internationally. We discuss the significance of the recently signed Genius Act, explore the importance of bank charter modernization, and consider the enormous potential public benefits of separating deposit taking from lending, including faster programmable settlement, more competition in financial services, and a reduction of systemic risk in areas where bank lending has become increasingly overconcentrated.

The second hour is devoted to what comes next: antitrust concerns around the growth of natural monopolies and network effects in stable coin payment rails, a short-term boost to demand for U.S. government debt, including the prospects of tokenized bill issuance for gross real-time settlement, and the longer-term possibility of a move away from the dollar as the primary unit of account toward consumer bundles tied to assets, goods, and services that are more reflective of people's spending wants and needs. And what that implies for monetary policy, seigniorage rights, capital flows, and the preservation of purchasing power in the currency.

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And with that, please enjoy this incredibly informative and forward-looking conversation with my guest, Charles Calamirus.

[Music]

Charles Calamirus, welcome back to Hidden Forces.

Great to be with you, Dimitri.

Yeah, this is not a replay of your recent appearance back in May where you joined me and Grant for our Hundred-Year Pivot series. This is actually a novel podcast that came together as a result of a paper that you recently published that hasn't come out yet. In fact, I'd love for you to clarify for our audience when you expect it to come out, what the context is. The chapter in a book is titled "How Stable Coins Will Transform Banking," and you wrote in the paper that, quote, "Stable coins are about to transform the financial system." Before we get into that statement and the significance of the paper and your insights in it, just give me a little background here. This is a presentation you gave initially back in May at the Hoover Institute, right?

So, you know, the Hoover Institution has an annual conference on monetary policy that's really the top academic event of the year with lots of Fed officials, former and current, lots of professors, hundreds of people in attendance. So, it's the top event to be able to present. This was a panel that included Darrell Duffie, who was a very knowledgeable and influential professor of finance at Stanford, Luis Garicano, who was talking about the European situation in terms of crypto, Larry Summers, and me, I think, who was on the panel. And so, this panel was all about financial innovations and the remaking of the financial landscape. So, it was a great opportunity for me to present this discussion of stable coins, which I predicted, and of course, I think it was very forecastable at that time, that they would become increasingly important. And then we got the passage of the bill by Congress, signed by the President, that's really accelerated the whole process.

So, yeah, I've been writing about this though for a while because when I was chief economist at the Office of the Comptroller of the Currency, which is the top regulator of the national banking system, the acting comptroller at that time, Brian Brooks, had brought me there mainly because he wanted to modernize the bank charter. And a lot of our thinking had to do with trying to create an environment where stable coins could be part of the banking system. And by the way, the chief counsel of the OCC is now the controller of the currency. He was just appointed by President Trump to be the controller, Jonathan Gould. And I have a lot of confidence in him for bringing this forward. And so, I think, you know, the big idea out there is that the banking charter really just is in need of modernization dramatically, and it's being pushed to that because if you don't modernize the bank charter, then shadow banks, that is, unchartered banks, basically compete from the fringes in ways that are maybe it might be fine that they're not regulated, but there may be some advantages to regulating them, and I think there are.

And so, you know, a big part of this push right now is to figure out how to get this amazing, great technology called crypto, especially embodied in stable coins, which will and is already transforming banking and making the future so much better. I think how that's going to be able to evolve and how the formalizing bank chartering policy to bring this in from the shadows is such an important part of it. And politics has been the main blockage because the incumbents don't like competition. I don't know if you're aware of that, but incumbents just, they find competition unnecessary. They find new technologies unnecessary. If it were up to the incumbent banks, I think we'd still be using abacuses for our calculations, right? I mean, they love their 19th-century payment system that the Fed is currently running for them through this backward, ridiculous framework that the U.S. continues to use when, you know, this new technology has been looming on the horizon. And now banks are kind of realizing that they can't beat them, so they have to join them. And that's part of the political compromise of this bipartisan compromise of the recent bill that just got stable coins to be accepted as something that banks can do.

And, you know, the Fed, when Trump was elected, they had to reverse themselves because they were basically under the old politics, because they're in cahoots with the incumbent banks very much. They were with the Biden administration, too, trying to block this technology. And by the way, the first Trump administration wasn't so excited about it either. When Brian Brooks and I were at the OCC, we were kind of working on it, but I can't say that Secretary Mnuchin was particularly enthusiastic or helpful, right? I mean, so what's really been interesting is watching the politics of this kind of get pushed where the incumbent banks, trying to resist this, I guess, have finally figured out that there had to be a political compromise that legitimized it, formalized it within the banking system. And we're just at the very beginning of that process. But, you know, as my article tries to point out, as an economist, you can see how transformative this is going to be. But it's going to take a while because there's a lot of, some economic adjustments that are needed because you're starting from one system, you have to move to another one. There's a lot of reason why that's a bumpy process, and also because of the political resistance that continues. So, anyway, that's a brief background.

No, that's great. So for people that don't know much about stable coins, just briefly, how would you describe what they are, what the state of the industry currently is, and what progress, specifically legislative progress, has been made so far? Because the Genius Act, as you said, has already been signed into law, and I believe the Clarity Act, which probably will have some implications as well for the industry, is still something that is waiting to be finalized and finally signed by the President.

So, I think that, you know, let me start from the beginning because I'm not an engineer. I'm an old guy. You know, I sympathize with you listeners out there who are wondering, what the heck is this guy talking about? Can this possibly be important? Okay, so let me just try to explain as best I can. So, the thing to start with is blockchain. And don't confuse blockchain with Bitcoin. Bitcoin is an example of blockchain, but it's not one that I think in the grand scheme of the future is going to be very important. Blockchain, I think, is hugely important because it's a technology for creating communication in a network of bilateral agents where you can have encrypted communication where you can reveal as much or as little as you want secretly in a ledger that keeps a record of all the sequence of communications. So that's the key to what blockchain can do, and the technology can communicate very quickly, too. So you can use blockchain to do communications at the speed of light.

So, unlike a centralized payments network, let's say like the Fedwire network, you're communicating with other individuals through a non-centralized blockchain network, and you're able to communicate securely and privately, reveal as much or as little as you want, retain this thing as a record as much as you want so that it can be used. And so you have a complete kind of recording of everything you want to communicate in its sequence forever in a very secure way. So that technology, if you just stop and think about before that technology and after that technology, that's transformative because you don't need to depend on a centralized network to communicate anymore, and you can communicate very quickly.

So, for example, if I wanted to communicate with you, Dimitri, and say, "I'd like to make a payment." We do this through the blockchain. I could transfer, if I can connect with you to transfer a payment through the blockchain, which I can using a stable coin. If I do that, then you have immediately the money. You don't have to wait for your banks, clunky banks, to figure out how to transfer this. You don't have to operate through a network that might get hacked. You don't have to do a lot of things that you have to do right now that are very consequential and bad. And so blockchain is just a great way to create this communication, including payments. And, and what's so cool about it is that when we use it, we can, because it's a form of communication, we can attach a lot of information to the payment. Like, for example, suppose I was a a gambling casino operating on the internet, and you wanted to gamble, but there's a law against your gambling. If you're not 21 or older, you could communicate using a credible reference third party, like, let's say, the state in which you have your driver's license. You could communicate that your age is greater than 21. And that could be done alongside the payment that you send to make your bet, a conditional payment, right? And then what's the alternative? Well, the alternative is you have to like create a fax of your driver's license, send it to the place by fax that you or by in the internet that you know through some sort of connection, which is probably not very secure anyway, and it's a delay and it's a cost. And so the point is, it's just like much faster, it's much better, it's more secure. And as I'll explain when you get into stable coins, the overhead cost is very low.

So, the interest that you'll get on, let's say, your new checking account, not in a bank, but in a stable coin provider, maybe that'll be run by a bank now, a chartered stable coin, but it'll be able to earn you, despite some of the things in the legislation that are confusing about this, you'll be able to earn a rate of interest pretty close to the Treasury bill in the future. So you'll you'll be able to have immediate access to your funds, be able to make payments at the speed of light on anything. Now, that's not the current reality. That's a future reality using this blockchain thing, which is stable coins. And so what is the stable coin? Well, it's kind of like a money market mutual fund for your listeners that haven't experienced stable coin yet. It can be, it's just not a checking account, but it's designed by the way it's constructed to preserve its value so that when you put in $100 worth into your stable coin account, you'll be confident that it will retain its value and, in fact, grow if it's earning interest. Now, exactly how we get that to happen relative to the currency or reference basket that it's right, because it's going to be backed credibly by cash assets like U.S. Treasury bills. So, of course, you could create a stable coin. In fact, the dominant stable coin in the world, Tether, is not so clear that it's so honest and has had some ups and downs in its value. But that's of course one of the arguments for having chartered stable coins and for having more regulation so that people can be more confident that the person providing the stable coin really is taking the money that they send them and putting it into Treasuries so it's going to be stable. But without getting into too much of the complexities here, the point is, if I send money to you dollars and you put it in Treasury bills, then those dollars are still going to be there. And so I can use them like a checking account. Kind of like right now, if you invested in a money market mutual fund, let's say at your bank, an account that's not a checking account, but a money market mutual fund account, you'd have checking services to use to draw down the funds, and you'd know that the funds are invested in virtually riskless kinds of securities like Treasury bills. And so, you know, you can use them, so you know you don't need to have a checking account in a bank to be able to engage in transactions. Well, we all know that because we use money market mutual funds. Now, for decades, the stable coins are just the next version of this, but they're going to be able to operate through a completely different blockchain-based decentralized payment system that will be so much better for consumers.

Now, you ask, well, where's the state of play right now? So, the state of play right now is that stable coins are mainly used for crypto transactions. They're not used for normal kind of, you know, pay. I don't know if anybody can pay their rent with stable coins or buy a cup of coffee with stable coins. But of course, that's a trivial thing. We should be able to do that. What the reason that stable coins are so useful for crypto transactions is that the main crypto platforms have basically created ways of transacting easily so that you can buy, let's say, Bitcoin or Ethereum or other kinds of crypto assets using stable coins like Tether or others. And so people then, you can even store your Tether inside the blockchain of Bitcoin or inside the blockchain of Ethereum. So you can either create an account on a crypto exchange where you store your stable coins, or you can even store them in the blockchain of Bitcoin or the blockchain of Ethereum. And so that, I know this may sound really crazy to people who aren't familiar with this, but it's just that crypto transactions made blockchain a convenient way to pay. So you don't have to pay for your Bitcoin with dollars. You can pay for it with Tether. And that's what the real growth has been in the stable coins thus far. And they have grown very rapidly. But the real future promise is to crossover so that you're using stable coins as an alternative for paying for everything online that you're buying as a consumer, for being able to, instead of using your credit card, to have a stable coin sort of payment account hooked up to your iPhone or or something like that where you just go in. And this is not a futuristic kind of crazy thing. Back in like 10 years ago, I was working briefly for a company that already had developed that technology and had many, many patents related to actually figuring how to turn blockchain into a retail payment system. But the resistance has been, first, the the political resistance. But then there's also a kind of network economics problem, which is people are used to and are already working with a particular network. And so getting them to switch over and creating a real network is a challenge. And so one of the things that I'll talk about with you, if you like, is why this thing called the Global Dollar Network is so promising because all of this is new stuff. It's a venture by Paxos and Anchorage and Robinhood, which is envisioning getting major retailers, let's say like Amazon or Walmart, to join their blockchain stable coin and bring their customers to it and retain the customer relationship when they bring it. But then all decide they're going to go down the same railroad of this particular stable coin and then get scale, get customer relationships, create a critical mass that can then build this network out so it can be used as an alternative to the the network that already exists for credit cards or those kinds of things or PayPal or whatever. So, this is going to happen. It's we're in process, but I would say it's still a matter of several years before most people have a stable coin account. By the way, I don't have one.

So, one recommendation for listeners and then a point of clarification. We did an episode recently, episode 430, titled "Stable Coins Are Fueling a New Era of Dollar Dominance." Though that was part of the discussion, there was a much broader discussion about the industry in general, the crypto space, the progress that has been made in the last few years. Again, listeners know that I've been covering this since 2017, and also some points of technological clarification for people that are interested. So, a point of clarification with respect to our conversation today, Charles, has to do with a reference you made to the Genius Act. What exactly is the language around yield-bearing stable coins and whether or not you can actually earn interest on your stable coins in the U.S.?

So, I was at a conference just before the Genius Act was passed, and I was kind of wondering about this because, you know, I'm not a lawyer. So, I was kind of wondering the same thing that you're asking. So, I'll just tell you what the representative on my panel from Circle, which is now doing an IPO, and they're they're the first ones who have applied, I think, for a national bank charter to do stable coin. Circle is the company behind USDC, the stable coin. And their answer to me, or her answer to me, I'll just say, was, "Oh, yeah. Yeah." But what people will do is, "We'll just wrap the stable coin so that you'll own a security that will own the stable coin." So the physical stable coin won't bear interest, but the ownership right to the stable coin will bear interest. They'll use derivatives to to generate interest. Look at it as you just kind of say, well, if you want to own a stable coin, you can own it through this derivative if you like, and then that thing will pay interest. And, and that's good. It's good for the consumer. I mean, you can see the fact that the legislation would even try to create this appearance that you're blocking interest. It should really enrage consumers, right? Like, why should we tell stable coin providers that they can't pay consumers interest? And the answer to that is that's part of a political compromise that allows incumbent banks to have some influence to try to slow this process down. That's the way I read it. They're the bad guys, and they're politicians because these guys have a lot of money, and they own a lot of politicians these days, unfortunately, primarily in the Democratic Party, but also on the Republican side. And so, you know, that's really been the the sad thing about this is that we should be so much farther advanced than we are. But what's encouraging at least is this Genius Act was bipartisan. In fact, kind of remarkable, right, in this environment that you have bipartisan legislation that's passed. Yeah. And part of that is just the size of the crypto space and the lobby that has built up over the years.

So, I'm glad you brought up the banking system because historically, the dual role of banks and the banking system as both warehouses and clearing houses for money and payments, and as lenders, this is important to the commercial sector, have been complementary services with built-in economies of scale and especially before the Federal Reserve, during the period of free banking, I would say, network effects. What is the cost to the loan origination business of banks if they lose access to the information that comes with managing the deposit accounts of large private clients and businesses, if, in fact, this is what will happen again, like one of the reasons for preventing yield-bearing stable coins is to prevent deposit flight?

Absolutely. That's what the banks are all about. Yeah. So, your question is great. Right. So, let's distinguish between the cost to the incumbents and the cost to society because those are important. So, of course, the incumbents, because of the regulations that currently exist, incumbent chartered banks have this kind of huge benefit, which is that they control the checking account system, and that checking account system gives them a free ride in terms of reducing their cost of funds because of the convenience of checking accounts. They get away with, and by the way, the banking system is not very competitive, I would say, at the moment. They get away with paying very low interest. And so they love having cheap deposits to fund their activities, including lending. But now the question is, from a social standpoint, is it beneficial to combine the two? Like, you know, it would also probably be good for, suppose I'm running a restaurant, it would also be good for me to have the monopoly over checking accounts, too, right? Because I could fund my business cheaper. Oh, great. Don't take it away from me.

So, the social cost question is, does it make sense to combine the deposits with the loan origination? Now, my most cited article, which I I wrote with Charles K. in 1991, came up with one of the arguments, and there's also another article using a slightly different argument for why it is socially beneficial to combine lending and deposit taking. But I want to emphasize, as I did in in the article that I sent you, that that is not necessarily true anymore. The crux of that argument was that because information about loan customers may be very hard for third parties to observe, it can be beneficial to combine lending with demand deposit checking accounts. So, I don't know that it's that worthwhile to go through the logic of my article. It's my most cited article. I'd love for it to still be true because then I could get even more citations.

The premise being that the more information a bank has about the state of your business by having access to the flow of capital in and out of the of your accounts, the better it can determine the risk of lending to you and the prospects of generating a return. That's definitely part of it. But there's another part, which is you might want bankers to have to fund themselves with this very withdrawable kind of debt because it keeps them disciplined in an environment where they don't have where people don't know what they're doing with the money. We saw how that worked out with SVB.

Yeah. Well, if you were in in the old days when we really didn't have deposit insurance, that worked very well. But in the current environment with the Federal Home Loan Bank system and deposit insurance, the problem is the discipline comes suddenly and very late, and so it's it doesn't work. So, it's really more the protection was the problem, not the discipline, if the discipline were there all along. But anyway, so the point is that these arguments are probably true historically. I think there's a lot of evidence for them. But in today's world, we have so many ways of learning about things with big data. So, there's this company called OakNorth that came to the U.S. and basically created this platform that combines thousands of different data sources to tell bankers about each of their customers, each of their small business clients. And this web service for them had been developed in the U.K. as part of a bank lender that never had a default. And the reason they never had a default was because they could see problems that were going to on the horizon for their clients because they could see so much information about their clients before their clients even knew that they had a problem. So the point is, once you get an information technology that's able to see things about individual small firms using rich big data sets, then this whole kind of asymmetric information argument, that's the formal term for it, for why you need to combine deposits and loans, sort of goes out the window.

So, as much as I'd like to say that I think it's still highly relevant, given that I kind of invented the argument, or at least part of the argument, the truth is, I think that we're beyond that. And so, socially, there is no reason in my mind to combine payments with lending. So, lenders can just fund their loans with market kinds of debts that they raise, wholesale funding that they raise in the market. Yes, that means that the bank lenders' costs will go up, but for lending. But let me remind you, there are lots of lenders out there who already fund themselves, non-banks that are funding their lending entirely from wholesale funds. So the bankers will experience some loss as a result of this, but I don't think that this is a loss to the market or to society in general. I think that we're better off by moving to a situation where lending and payments are separate.

Is this going to be another headwind and additional drag on local banks versus the large national banks?

Absolutely. Well, for all banks, the big ones and the small ones, as they lose deposits, it's going to be a headwind. It's going to be a problem for them. There will be, I think, a lot of churning, a lot of disturbance in the banking environment, but I think that's good, frankly. I, you know, as somebody who in the 1980s and 1990s had been writing research showing that allowing bank consolidation and allowing banks to expand their powers was a positive thing, I've changed my views on that, partly because of changes in technology and but also partly because of what we've seen from a kind of corruption of our political process from the concentration of power in these largest U.S. banks. So, I think we'll all be much better off if we move away from having all of this lending and all of this deposit clearing happening through the current kind of system. We'll have a much more competitive arrangement. The large banks won't be politically as dominant, and that's a good thing for our democracy. And also, you know, if you look at what the banking system evolved into. If you go back even 50 years, banks were not doing that much real estate lending, and now banks have basically become real estate banks. We call them commercial banks, but as Alex Pollock likes to say, they should be called real estate banks.

Does that change in the constitution of bank loans reflect the larger economic transformation of the American economy during the period from one that was capital-heavy, where the banking system played a bigger role in capitalizing the needs of heavy industry, to a capital-light economy where services have taken up a larger share of economic output?

I mean, to some extent, yes. But I, I think the bigger point is that non-bank funding of loans became very important, so that loans became through markets, whether it's a bond market or securitization markets or non-bank finance companies and other kinds of lenders, they took a lot of the business away from the banks because they outcompeted them. And what was left to the banks was local real estate kinds of transactions. And so the banking system just became, I think, something like, if you put aside the largest banks, three-quarters of bank lending is just real estate. And for the biggest banks, it's more than half. And this was considered completely wrong. So, if a hundred years ago, if you brought a banker back from the dead who was around a hundred years ago, he'd have a heart attack and die again if you told him that the bank's balance sheet loans were mainly real estate because real estate's not a good fit for commercial banks that rely on short-term funding from deposits because you don't want to have that kind of extreme transformation of liquidity. So that there was something in the U.S. that we called the real bills doctrine, roughly, just said, well, you know, the kind of lending banks should do should be short-term, self-liquidating, kind of mainly commercial, to some extent industrial, too. I'm not advocating that, but I'm just saying it would be a shock to bankers from a hundred years ago to see what's happened. And I think a lot of it is just real estate was what was left over after all of the financial innovation took the industrial and commercial lending largely away from some of these local banks, especially. So that they just became real estate lenders. And that leads to a lot of concentration of risk. Remember, the real estate cycle and the business cycle are very aligned. And so when you have banks that are just focusing on commercial real estate, that means that their risk, in terms of systemic risk relating to the business cycle, and when you get a bad shock that puts real estate loans into trouble, they're very hard to liquidate because the whole market becomes very illiquid for selling those mortgages. And so you, you really, like, we experienced this in the 1980s, and I think that we also experienced it in 2008. So, you know, you just don't really want to have your banking system using the payment system to fund real estate. It's like, it just from the standpoint of the history of thinking about banking, it would be considered just incredibly bad. But we've kind of backed, like the frog in the boiling water, we kind of backed our way into this. Deposit insurance meant that the market wouldn't prevent it. If there weren't for deposit insurance, as I've shown in a paper published in the Journal of Financial Intermediation, worldwide, deposit insurance has allowed this to happen because if it weren't for the protection of bank deposits from deposit insurance, depositors wouldn't want to be in banks that primarily did real estate lending. But depositors are willing to do it since they're insured. And so the government has kind of taken our banking system through a combination of not allowing financial innovations to remove power from the banking system, as I said, so that what's left to it is real estate. And then they say, well, that's okay, we'll fund that with deposits because we'll insure the deposits. So we've kind of backed our way into a system that people, you know, from prior to this era would have regarded as very unwise. So, I'm I'm really happy at the thought that we will undermine the system and actually get rid of a lot of the existing sort of structure. I think it's a good thing for our democracy to get rid of the power of the big banks. It's a good thing for the financial system to create more competition, more diversification, less of this concentration of real estate risk in the banking system.

You know, not to take us into a conversation about unrealized or unrecognized risks and capital misallocation, but is that a good analogy? The analogy of deposit insurance, is that a good analogy to use for describing the dangerous effects that preventive Fed and government policies at large have had on sort of acting as sort of insurance providers and increasing the systemic levels of risk in the financial markets?

Absolutely. You know, it wasn't and it's not just the Fed, but the Fed is one of the examples. Deposit insurance is part of it. And the Federal Home Loan Banks are another part of it because they also are like the Fed. They're like another version of the Fed that competes with the Fed to provide subsidies to the banking system. And, you know, with SVB, just before it failed, when its bonds were falling in value, they experienced an outflow of deposits, the beginning of market discipline. In the old days, prior to this protective environment that we were talking about now, in the old days, what would have happened is that they would have seen this outflow of deposits. They would have acted in a way to manage their risk to prevent the outflow, and then they would have stabilized themselves and they wouldn't have gone bust, and they would have taken proprietary losses as opposed to socializing them.

Yes. Because, by the way, they were not very insolvent. They were borderline insolvent, and they weren't insolvent at that early point. This was like six months before the crisis. They experienced a big deposit outflow. But what happened? They said, "Oh, we got a big deposit outflow. Let's go to the Federal Home Loan Bank and borrow that money." So what they did was they replaced, when the uninsured deposits first flowed out of them, they replaced that money with Federal Home Loan Bank insured lending, basically, right? Guaranteed lending from the Federal Home Loan Bank, giving them long-term money at, you might say, a taxpayer's expense. And then that insulated them from having to do anything to correct the problem. So, we see it in the SVB crisis very clearly, the way protection operated to undermine incentives to manage risk. But we've seen this worldwide. This is probably the most important phenomenon of the past 50 years in terms of creating systemic risk, the protection of banks. And it's allowed the banking system to do things that don't make sense, like concentrate on real estate lending and create this systemic, economy-wide vulnerability of the banking system to the real estate cycle. It's not something that we, you know, prior to the 1980s, we just didn't allow that. And people now take it for granted, but it's a completely changed banking system from what it used to be. And that's not something that's worth preserving.

So, when people worry about, oh, what's going to happen to our banking system, I say, well, here, here's something for you to dream about. Make payments from a checking account-like entity where you earn much higher interest. Make them at the speed of light. Make them with attaching other messages that facilitate your communication with someone that you're you're transacting with. Do it in a way that can't be hacked, unlike the Fedwire system. You know, the New York Fed wrote a paper a few years ago called "A Premortem" on the hacking, sort of recognizing that sooner or later there was going to be a major hack of Fedwire. Do all of that, and then know at the same time that you're getting rid of the non-competitive power of these largest nationwide banks, and that you're also creating a more diversified financial system that's not going to be as prone to these kinds of housing-related banking crises. So, what part of this is bad? And the answer is, the incumbents are trying to scare everybody into thinking that getting rid of the current banking system would be such a horrible thing, and that they want to portray all of crypto as risky, risky, risky. Just go listen to Maxine Waters talk about crypto. Why? Because they don't want to disturb the cozy relationship that they currently have. And the politicians are very much in bed with the incumbent big banks in preserving that system. So, you know, I just hope your listeners will at least open their minds to the possibility that it could be great to disrupt this current incumbent equilibrium.

So, let's flesh out some of those social benefits and some of the potential disruptions a bit more because you've specifically said that stable coins may represent the most important financial technology for creating social benefit since the Bank of Amsterdam first offered merchants a centralized location for clearing bills 400 years ago, and that this marks a potential change in both not just the global medium of exchange, but in importantly, the unit of account. What exactly did the Wisselbank do to improve upon the prevailing unit of account, and why do you believe that stable coins are a much bigger potential improvement when it comes to both medium of exchange and unit of account?

Okay, great question. So, first, I just want to define terms. Medium of exchange means what you use to make your payments. Unit of account is what you denominate your payments in. So, initially, let's say for the next decade and maybe longer, when I think about the revolution of stable coins, it's really they're going to replace checking accounts, but you'll still be denominated in dollars, which is the thing the Fed has a monopoly over creating, the dollar. So, we'll still be using stable coin accounts to transact in dollar-denominated payments. But what's so cool about stable coins is because the this distributed ledger retains all of the transactions on it, you can, if you can find a way to aggregate that information, you can actually create the basis for a new unit of account. That means for a new way of denominating your transactions.

So, what I want to explain is that we actually do care what we denominate our transactions in. And the reason is because we want to denominate them in something that has a closer relationship to our consumption bundle. It means that we don't worry about inflation and inflation risk causing us to our wages to not be able to pay our rent. Right? If we're denominating our wages in the thing that we consume or something that's very close to the bundle, like if the Dimitri bundle, let's call the Dimitri bundle your consumption bundle, what you actually consume, and suppose that we took a weighted average of all the things you consume, weighted by how much of them you physically consume. Okay, we call it the Dimitri. It's what do you consume per month? And we just say that's our unit of account. That bundle is one Dimitri. You would love that because that means you'd be paid in that unit of account, and you know that you're never going to have a problem in converting what you're paid into what you consume because what you're paid is denominated in your consumption bundle.

So, this is something people aren't used to thinking about. It's the economics of the unit of account, which just says, "Oh, we really want to have a unit of account that's very close in its value to our consumption bundle." So, the dollar isn't that. The dollar doesn't vary hugely, but it wasn't designed to be particularly close to your consumption bundle or to the average consumption bundle. But you could say, well, it may be the best thing on the menu currently. And I think that's true. It's the most stable thing on the menu currently. But if you go back to Jevons in the 19th century, who was writing about optimal units of account, he was already envisioning that the best way to create a unit of account is the consumption bundle itself.

Now, you asked about the Wisselbank. So, the Wisselbank, what they did was they started off just as a clearing house for merchant bills of exchange denominated in coins, denominated in physical money. The problem is physical money was not ideal because it could be clipped, it could be forged. And so they created their own abstract paper unit of account to actually stabilize the value, and that was a big innovation of the Wisselbank to create a synthetic unit of account of, I guess it was called a guilder, that was the inbanko called guilder, which was based on their own sort of abstract concept rather than a particular coin. So, the point I was making is that was a great innovation because it stabilized value.

But now, what we can do with blockchain, and now we're thinking more than a decade in the future. So, the first transformation we need is to create the network of a medium of exchange of blockchain stable coin transactions for consumer goods, not just for crypto. Once we've done that, though, people will say, "Oh, wait a minute. We've got in the blockchain all of the actual consumption transactions. So, suppose that we we were all interested in creating a new unit of account, different from the dollar, that's going to be closer in its definition to our own consumption bundles." Well, we could use the record of transactions in the blockchain to design a nearly perfect unit of account, and it could even be a unit of account that changes over time. It could even be a unit of account that differs according to locations, even within the U.S., depending on what consumption bundles would be. So, this is very futuristic stuff. But the point I'm making in the paper is that the real promise of this is going to be initially to create a new medium of exchange that's much better for consumers and part of a reconstruction of our financial system, which is much more stable. But then in the future, what's going to happen is we're going to have this kind of like near-ideal monetary system, which is going to be based on units of account, not just mediums of exchange, but units of account that are much closer to consumption bundles. And the reason we can do that is because blockchain creates a permanent record of all the transactions that occur within it. So, you can devise a bundle that is a Dimitri, and so the Dimitri is, you would you would want to be paid in Dimitri. Now, I don't want to pay you in Dimitri because I don't have the same consumption bundle, but we'll find a way to compromise and create a consumption bundle that sort of tracks the typical person, or maybe we'll have multiple units of account that people can choose from.

Now, there are going to be some new problems that come up here, like how do banks transact and clear in these units of account that might be geographically specific or different? And the answer is that they're going to have to, and this is where it gets really fun, we're going to have to have tokenized, which means blockchain-transactable IOU's kind of that are for particular consumption goods because they have to maintain adequate reserves to back up consumption bundles.

Exactly. So, for the banks to transact, they have to have reserves. They have to have certain number. Suppose we all adopt the Dimitri based on your consumption bundle. Then we're going to have to, the banks are going to have to have reserves of Dimitri. Well, what does that mean? It means that ultimately the things you consume will have to be tokenized and be holdable as financial reserves by banks. So, just let me give you a simple example because this sounds very abstract. Suppose that you're just a Ruth's Chris steak eater. That's your entire consumption bundle. You're a hobo, but you don't have rent. You don't eat anything else. All you eat is Ruth's Chris steak. Okay. So, and then our that means our whole consumption bundle is just going to be the Dimitri, which is Ruth's Chris steak. So, what does that mean? It means Ruth's Chris, which, you know, they create these little cards that you can get to be able to use there. Well, those things get tokenized and get held at the bank so that the bank starts transacting in, well, of course, it's got to be a lot more more than just Ruth's Chris steak, but it can be that we, I know this sounds very futuristic, but it's actually technologically, this is a problem that we already have the ability to solve. It's not requiring a new technology. It's just getting us the political decisions that are going to facilitate this and the network creation that facilitates it, and then it can all be done. So, I think we're decades away because those aren't trivial problems to solve, but they're not conceptual problems.

So, this was the part of your paper that I found most interesting because I started conducting my own thought experiments. One of which was whether, and again, there's a lot to discuss here about whether or not the U.S. government would even be okay with losing the seigniorage privilege or the reserve rents that come from dollar hegemony. But just on that point around reserve rents, I was thinking, so what happens if a company, let's say Amazon, begins to actually accrue some of those reserve rents for itself? Would that actually have perverse impacts? One, would it cause new natural monopolies to form as a result of the fact that now the the currency associated with the service or product becomes an increasingly important part of the use case? And whether that would actually pervert the underlying sort of incentives of the industry? That's just one example. But look, I'm going to move us to the second hour. Charles, I want to talk more about how this consumption bundling would work in practice.

Sure. Importantly, how it would impact monetary policy because you have some interesting, you go into some interesting lines of thinking in the paper around that, and I definitely want to in our second hour address your question because I think it's an excellent question.

Yeah. Yeah. So, and and so to to that point, you know, seigniorage rights, dollar reserve rents, you know, the benefits that accrue from having the reserve currency of the world. And also, I'm curious, this is not something that you talked, I don't think you spoke about in the paper. I feel like we've talked about it in other circumstances, but, you know, what does this mean if stable coins become largely adopted? And the conversation we've had so far has been really about the use of stable coins domestically, talking about chartering. But it seems like this would actually be something, at least to the extent that before we get into a conversation about consumption bundling and that kind of innovation, just in terms of stable coins being extensions of the U.S. dollar, this seems like it would further entrench the network effects of the dollar worldwide. So that's something else I want to talk with you about in the second hour.

Charles, for anyone new to the program, Hidden Forces is listener-supported. We don't accept advertisers or commercial sponsors. The entire show is funded from top to bottom by listeners like you. If you want access to the second hour of today's conversation with Charles, head over to hiddenforces.io/subscribe and sign up to one of our three content tiers. All subscribers gain access to our premium feed, which you can use to listen to the rest of today's conversation on your mobile device using your favorite podcast app, just like you're listening to this episode right now. Charles, stick around, and we're going to move the rest of our conversation onto the premium feed.

Looking forward to it. If you want to listen in on the rest of today's conversation, head over to hiddenforces.io/subscribe and join our premium feed. If you want to join in on the conversation and become a member of the Hidden Forces Genius Community, you can also do that through our subscriber page. Today's episode was produced by me and edited by Stillanos Nikolo. For more episodes, you can check out our website at hiddenforces.io. You can follow me on Twitter, @Kofenus, and you can email me at info@hiddenforces.io. As always, thanks for listening. We'll see you next time.

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