The digital dollar can save the dollar

The digital dollar can save the dollar via freeing it from debt form.

A financial turmoil driven by mass defaults can destroy a currency.

A currency's strength hinges on the safety of the debt denominated in that currency.

Currencies are as strong as their economies

A currency's demand is strictly related to the safety of the debt denominated in that currency. In economic downturns, economic entities increasingly default on their debt. Lenders react to mass defaults by fleeing risky. As lenders flee financial assets, demand for the currency could also fall.

As long as currencies merely exist in debt forms, their demand will be driven by the demand to financial assets in that currency. The currency-debt relationship might impair a currency's strength in a protracted recession. Mass defaults can destroy the currency.

A reserve currency is not exempted from the destructive power of a depression. If the US economy tumbles in a protracted recession, defaults might soar to unprecedented levels jeopardizing banks' equities. When the US banks are on the brink, the dollar's credibility would also be questioned. In such a case, the government's insurance on deposits may not be enough to stop a a bank run which may not only lead to the cash withdrawals in dollars but also to the conversion of the dollar to alternative currencies, cryptos or physical gold. Demand for the dollar hence would substantially fall due to the run from the dollar deposits and cash. A protracted depression might thus result in the demise of the dollar as the reserve currency.

The digital dollar

The digital dollar can save the dollar via freeing it from private debt forms. Savers can safely store value at the central bank without undertaking a private borrower's default risk. Hence, the dollar demand would not be affected by the default risk of dollar denominated liabilities.

The digital dollar would preserve the dollar demand via resolving the safe asset problem. Financial institutions cannot manufacture ample private safe assets due to the collateral limitation. The tranche system produces top rated assets alongside with a larger portion of lower rated assets.

In the current practice, the digital dollar would be the liability of a central bank. The digital dollar is as safe as a government treasury due to the fact that both government and central bank are state institutions. As all savers can open an account at the central bank, supply of the digital dollar would be unconstrained. Thus, demand for safe assets would be permanently satisfied.

The digital dollar does not have to be liability

Unlike reserves, the digital dollar is central banks' asset. A central bank can place the digital dollar on the asset side of its balance sheet. In practice, this enables the central bank to transfer income as a monetary tool while lending tools are apparently impotent at the zero lower bound.

Currently, reserves are central bank money. They are recorded as liability in the balance sheet. Therefore, central banks must take an assets in return of reserves not to make losses.

The Fed issues reserves and transfers them to a bank in return of treasuries.

Treasuries $100

Reserves $100

In this transaction, the central bank'a liabilities and assets increased the same amount.

If the Fed transfers reserves in return of nothing, it makes loss.

Loss (equity) $100

     Reserves $100

The digital currency is a central bank asset. Therefore, central banks make profit whenever they issue digital currency.

The Fed issues the digital dollar and makes profit.

Digital dollar $100

Profit (equity) $100

When the Fed grants the digital dollar, it spends the profit made by the digital dollar issuance.

Profit (equity) $100

Digital dollar $100

End of the lending-based monetary system

Today, central banks promote demand by incentivizing more debt production. The lending-based monetary system is not sustainable. Borrowers' debt service capacity is already full. More debt renders the financial system fragile via resulting in higher leverages. Incentivizing borrowers via lower interest rates to pile on more debt has been producing financial crises since 1980s.

The digital currency enables central banks to generate income. While the digital dollar is an asset for central banks, producing it would result in making profit such as mining gold. Central banks can promote income based demand by issuing and granting the digital currency to the beneficiaries democratically determined by parliaments. While savings are increasingly stored in the digital dollar and decreasingly stored in debt based instruments, the debt sourced spending will be restored by the income sourced spending.

In the absence of the digital dollar, the Fed has to promote debt production against economic downturn because it is the only means to revive demand. As an income generating tool, the digital dollar will allow the Fed to promote demand and financial stability, meanwhile.