Board of Governors of the Federal Reserve System

February 16, 2024

Implications of a U.S. CBDC for International Payments and the Role of the Dollar

Jean Flemming and Ruth Judson

Introduction

Technological advances in recent decades have brought about a wave of private-sector innovation in payments and have led central banks to explore a variety of improvements to their payment systems, including the possibility of issuing a central bank digital currency (CBDC). Survey evidence from the Bank for International Settlements (BIS) shows that over 90% of central banks are exploring CBDCs (Kosse & Mattei, 2022). The Federal Reserve is also exploring the implications of, and options for, introducing a CBDC.¹

As a liability of the central bank, central bank money is the most trusted and safest form of money as it presents no credit or liquidity risk. As a potentially new form of central bank money, a U.S. CBDC could affect the international role of the dollar and the role of U.S. payment systems in cross-border payments. In this note, we explore these possibilities and argue that a CBDC in itself would likely only have a marginal effect on these international considerations, though its effect would depend on policy decisions by the United States and other jurisdictions as well as the impact of ongoing international efforts to improve payments.

1. Current International Payment Systems and the Role of the Dollar

To understand whether and how a U.S. CBDC could affect cross-border payments and the role of the dollar, we first briefly describe the current environment.

1.A. Challenges for Cross-Border Payments
The value of cross-border payments in 2022 was an estimated $156 trillion, over five times the value of globally traded goods and services.² The dollar and the U.S. payment system play a central role in many cross-border payments. However, cross-border payment systems, including those based in the United States, are more expensive and slower than domestic payments due to various frictions, many of which are the result of policy choices rather than technological barriers.³ The current high cost and slow speed of cross-border payments flow from two sets of interconnected factors: first, lack of access to or seamless interoperability between payment systems and, second, the need for manual intervention at various stages in the payment process.

1.B. The current international role of the dollar
The dollar is the dominant global currency across multiple arenas and dimensions for all three functions of money: store of value, unit of account, and transactions medium, accounting for much larger shares of transactions, reserves holdings, and invoicing than can be explained by the U.S. share in world GDP and trade. The wide global use of the dollar is generally attributable to the United States' stable government, strong judicial system, and protection of property rights; solid economic growth and low inflation; and the openness, depth, and liquidity of capital markets, including large supplies of low-risk debt, including but not limited to U.S. Treasuries. The dollar's dominance confers significant benefits on the United States, but also imposes some burdens and responsibilities. In assessing the potential effects of a CBDC on dollar dominance, the roots of dollar dominance offer good guidance.⁴

2. CBDC Design and Policy Options

Design choices for CBDCs would influence their use in international payments and the role of the dollar. The primary design choices and considerations from the international perspective include access policy, interoperability, privacy standards and anti-money laundering (AML) policy, and account limits and remuneration, considerations that apply not just to CBDCs but to any payment instrument or system. For each design choice, we only discuss features that are consistent with those laid out in Federal Reserve Board (2022).⁵

2.A. Access policy
Cross-border payment frictions arise because access to payment systems that settle in central bank money is typically limited to domestic financial institutions. Access policy addresses questions about who can hold, use, and transfer central bank money, and, in particular, whether or under what conditions central bank money is available to nonresidents and their financial institutions. Expanding direct access to central bank money in the U.S. would require legislative changes, especially for non-banks, and is a policy choice not unique to the decision to issue a CBDC. Further, decisions regarding the supervision of foreign banks or non-bank payment system providers (PSPs) would need to be made carefully to mitigate risks while maintaining a level playing field.

For the international role of the dollar, a widely accessible U.S. CBDC at the margin is likely to enhance the appeal of the dollar. A U.S. CBDC that could be held by foreign residents would offer a means of holding dollars without the challenges of holding physical banknotes such as potential loss or damage, or the risks of Eurodollar deposits, including possible local authorities' interference and a lack of deposit insurance or emergency lending facilities for issuing banks. However, the distribution mechanism would matter. If CBDCs were only available through U.S. banks, then access to nonresidents could be limited by U.S. banking system access policies. Generally, the more broadly a well-designed U.S. CBDC would be made available, the more scope there would be for the dollar to gain favor as a transaction medium, unit of account, and store of value.

2.B. Interoperability
An alternative to expanding access to CBDC is to increase efficiency by establishing interoperability between payment systems across jurisdictions.⁶ In contrast to access policy decisions, choices about interoperability may require technical coordination with foreign jurisdictions. Still, it is important to think of interoperability as a tool to support efficiency and accessibility, in addition to merely being a technical state (Lawson and Herrada 2022).⁷ If able to make transactions seamlessly, a highly interoperable U.S. CBDC could strengthen the dollar's standing as a medium of exchange, and, by extension, on the margin, the dollar's appeal as a store of value might also be enhanced.

2.C. Privacy Standards and AML Policy
Data sharing, privacy protections, and thresholds for enhanced due diligence vary across jurisdictions, increasing the complexity of automation and in turn impeding the speed of payments. As described in Federal Reserve Board (2022), a U.S. CBDC would be both privacy-protected – safeguarding data on users' financial transactions – and identity-verified – ensuring that CBDC intermediaries comply with the rules designed to combat the financing of terrorism and money laundering. For traditional cross-border payment frictions, the extent to which transaction privacy and user identities are protected and the range of PSPs allowed to provide these services will affect uptake. Stringent privacy and identification standards could have offsetting effects, and the net effect on CBDC adoption is difficult to determine. Strong privacy and identification standards might enhance the appeal of a U.S. CBDC (and hence the dollar) for users concerned about the safety and soundness of the U.S. banking system, including CBDC. But stringent privacy and identification standards could also reduce the appeal of a U.S. CBDC for users concerned about anonymity. At the margin, such users might opt for other assets or currencies for use in transactions.

2.D. Account Limits
Account balance or transaction limits would likely have a significant impact on the international appeal and use of a CBDC. If limits are too low on interbank and business-to-business payments, frictions in wholesale liquidity could arise, which could adversely affect global financial stability in the case of significant CBDC use. On the other hand, imposing account or transaction limits on foreign individuals could alleviate some, but not all, AML concerns associated with granting CBDC access to foreign users. Account limits could also alleviate concerns about currency substitution and capital outflows from emerging markets. However, account limits might impose constraints on transaction flows and therefore lessen the appeal of a U.S. CBDC as a transaction medium. However, such limits would likely not directly affect the appeal of dollar assets as a store of value.

2.E. Remuneration
As long as a U.S. CBDC is seen as more appealing than a foreigner's own currency, it will be attractive to foreigners as a store of value. All else equal, the higher is the expected rate of return on an asset the higher will be its demand. In the context of CBDC, demand would be higher for the CBDC paying the higher (exchange-rate adjusted) remuneration rate. At the margin, positive interest payments (if allowed) could enhance the appeal of a U.S. CBDC and therefore the use of the dollar, though negative interest payments (if allowed) could have the opposite effect.

3. Factors within and outside U.S. control

The above discussion leaves aside consideration of the actions of other jurisdictions and private sector actors. However, other jurisdictions are also considering CBDCs, new financial assets (such as stablecoins) are evolving, and other jurisdictions could change their policies towards these assets. This section considers the effects of the choices of other entities on cross-border payments and the role of the dollar.

3.A. Non-CBDC initiatives
A number of ongoing developments in both the private and official sectors that do not involve creation of a CBDC could reduce or eliminate the frictions now seen in cross-border payments, providing similar benefits to those envisioned for CBDCs. These initiatives may also have implications for the role of the dollar.

3.B. Private-sector developments
Efforts to address the challenges of cross-border payments by the private sector include existing and new players' initiatives building on existing payment rails as well as projects based on distributed ledger technology (DLT) including unbacked crypto assets and stablecoins.⁸ Because unbacked crypto assets and stablecoins exchanged on DLT would not rely on existing payments rails, stablecoins in particular could erode demand for traditional forms of money, including dollars, as a transaction medium and store of value. The likelihood of this outcome depends on stablecoins' ability to be properly designed and regulated in order to achieve a level of user confidence sufficient to maintain their one-to-one peg to real-world assets. Low fees and other incentives to use stablecoins could lead users to hold stablecoins instead of dollars and switching costs could then keep users in stablecoins even if a superior CBDC is issued. However, demand for dollar-denominated stablecoins could strengthen or weaken the role of the dollar, depending on whether the source of demand is dollar-denominated or foreign currency-denominated assets. Conversely, the emergence and growth of one or more stablecoins backed by currencies other than the dollar would be expected to increase demand for assets in those currencies, possibly at the expense of demand for dollar assets.

3.B.1. Official-sector initiatives
The largest and most prominent official-sector initiative is the G20 cross-border roadmap developed by the Financial Stability Board (FSB) and the Committee on Payments and Market Infrastructures (CPMI), which seeks to establish and address challenges and frictions in cross-border payments (FSB, 2020). Notably, CBDC is only one of 19 options laid out in the roadmap. Many of the other focus areas are improvements to existing systems, which could provide similar benefits to a CBDC sooner and at lower cost.

3.C. Foreign Jurisdictions' CBDC Issuance
Given the large number of jurisdictions exploring CBDCs, a vast number of outcomes are possible, ranging from few or no major economies issuing to many economies, both major and minor, issuing CBDCs. Our focus in this section will be on the case of at least one large market economy issuing a CBDC, as this case is most likely to have discernable implications for a U.S. CBDC.

If one or more large countries were to introduce an internationally accessible CBDC that were appealing across several dimensions—such as cost, speed, and user experience—then the appeal of these currencies might gain on the margin, at least as a transaction medium, at the expense of the dollar if there were not an equivalent dollar option.⁹ Other factors that could contribute to a foreign CBDC's gaining traction as a transaction medium would be superior interoperability, more favorable remuneration, less stringent identification requirements or account limits, or broader access. As stated above, the dollar's role as a unit of account and store of value are unlikely to be materially affected, at least in the absence of large geopolitical changes separate from CBDC issuance. A secondary shift to another currency as a store of value could occur, diminishing the role of the dollar, but such a shift would require the availability of attractive assets and liquid markets, rather than technology-based solutions.

Differences in data privacy policies could affect the international role of the dollar if foreign jurisdictions were to adopt more stringent privacy regulations that prevented certain users from holding a U.S. CBDC that did not meet such guidelines. Similarly, more stringent AML/CFT policies could prevent the use of the dollar by end users in certain jurisdictions, constraining the dollar's use as a transaction medium or store of value. Remuneration of developed economies' CBDCs may also affect the use of the dollar as both a means of payment and perhaps store of value internationally.

As noted above, the driving factors for the popularity of dollar assets as store of value are based on the ample supply and liquid market for U.S. Treasuries and other debt and the long-standing stability of the U.S. economy and political system. If other jurisdictions were to provide similar conditions, then the dollar could lose out to these currencies. These trends, however, move slowly. In addition, there is nothing about a CBDC or its features alone that would alter the conditions noted above. Thus, although these trends may be out of U.S. policymakers' control, it is unlikely that issuance of a CBDC, even by a large country or countries, would significantly change the status quo in terms of demand for dollar assets.

4. Conclusions

In this note we discuss how a U.S. CBDC may or may not affect the cross-border payments landscape and the international role of the dollar. Our main conclusion is that although a CBDC is unlikely to harm the international role of the dollar or worsen cross-border payments, the improvements that could come from a CBDC could also be realized by improvements to non-CBDC payment systems that are already underway.

We argue that the international role of the dollar as a unit of account and especially as a store of value is unlikely to be affected by the introduction of a CBDC, even by a stable and large non-U.S. jurisdiction. The key basis for this conclusion is that the issuance of a CBDC would not directly affect either the ample supply and liquid market for U.S. Treasuries and other debt or the long-standing stability of the U.S. economy and political system. Depending on other CBDCs' (or foreign currency-denominated stablecoins') design features, there is some potential for the erosion of the dollar's role as medium of exchange if a U.S. CBDC is not issued or has unattractive design features.

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