A reader asked me the other week to do a digital currency update as many banks are signing up to test the Federal Reserve’s new FedNow digital currency.
The Federal Reserve is planning to launch its FedNow digital currency as early as July of this year. Some key points before moving on, this is still the dollar, and this is really only a move to further digitize the dollar and help it transact faster - increasing the velocity of money. I don’t believe there will be any material impacts on the dollar as a dollar.
Velocity of money is simply how many times a dollar changes hands in an aggregate economy, like the US. If the velocity is higher, more people are spending, if it is lower more people are hoarding cash/not spending. A healthy velocity would be around 1.5-2, meaning every dollar gets spend approximately one and a half to two times. The metric has become increasingly distorted, represented in the chart, because of heavy M2 money supply growth that should no longer occur at the level it has and as people have held high cash balances post pandemic.
To frame this let’s put some bounds around how fast you can reasonably spend money.
You are a prominent real estate developer, you are working on a new project and are, in part, funding it out of your own pocket, but in order to do so you need to sell some stock from your brokerage account.
That stock takes 2 business days to settle before you can withdraw the cash, then another business day to ACH out of your brokerage account to your bank account, then another couple of days to actually go buy the materials, and then your merchant likely doesn’t see cash settlement until the next business day (and longer if it is check that they need to cash). In this scenario it took, let’s say, 5 days, Monday to Friday, for the money to move fully from your pile to the next guy's pile, and it may take 5 days to move to your next guy's next guys' pile.
At 272 business/trading days in a year that is nearly 2% of the year for money to change hands once, and generally money doesn’t even move that fast.
The FedNow digital currency leverages blockchain technology to reduce the time it takes your money to go from brokerage account to your bank and from your bank to your merchant's bank. It is theoretically reducing that time to zero, and cutting the time it takes to go full circle in half.
What this allows for is faster transacting and overall higher GDP growth, because the velocity of money is a function of GDP. Faster GDP growth means the people working and operating in it are growing faster too.
Put another way if the amount of money in an economy remains constant but the number of times it changes hands goes up, GDP should go up.
The future is simply to move towards faster cash settlements. Why do stocks have a 2 day settlement in the first place? In the 1700s, stock settlements took 14 days, which was the time it usually took for a courier to make the journey on horseback and by ship.
The faster money moves the stronger the economy becomes, and thus the stronger the currency becomes.
If you have more questions about blockchain technology and how it works, shoot me an email I’d be happy to dive deeper.
If you have any topic suggestions, feel free to reach out I am happy to address any questions or concerns you have.