50.10 Financial transition risks requiring further work

The adoption process described in the preceding chapter is a direction of travel rather than a complete financial transition plan. Introducing a new Central Bank currency while changing the tax system, the funding of UBI, and the legal treatment of commercial banks would affect every major balance sheet in the economy. A long transition reduces some risks, but the passage of time does not resolve them automatically. Before implementation, the issues below would require detailed modelling, legislation, operational design, public consultation, and testing.

The possible responses discussed here are not all compatible with one another, and some may be inconsistent with the intended final constitution if made permanent. They are candidate transitional mechanisms whose costs and consequences need to be compared. Any exceptional power used during adoption should be narrow, predetermined, transparent, and subject to a definite expiry.

Rapid movement from bank deposits into Central Bank currency

Central Bank currency would be free of commercial-bank default risk, while a bank deposit would be an unprotected private liability. Once transfers between them become easy, concern about a bank could cause depositors to seek Central Bank currency within hours. A transition lasting decades does not by itself prevent a run occurring on a particular day. Rapid outflows could force a bank to sell assets into a falling market, reduce lending, default on payments, or fail before ordinary insolvency procedures can respond. Fear about one institution could also spread to otherwise solvent banks.

Possible transitional protections include limits on the amount or rate at which legacy deposits can be converted, advance notice for unusually large conversions, and initially distributing most Central Bank currency through UBI rather than through deposit conversion. Limits could begin tightly and relax according to a published schedule as banks obtain more Central Bank currency and replace runnable funding. Such restrictions would delay voluntary exchange and could trap a person in a failing institution, so they cannot be assumed to be harmless. The transition plan must state whether any limit exists, who bears loss while it operates, and the date or objective conditions under which it expires.

Withdrawal of protection and prudential regulation

The final system gives commercial banks neither State protection nor bank-specific regulation. Deposit guarantees, lender-of-last-resort facilities, capital requirements, reserve requirements, and restrictions on lending are therefore intended to disappear. Removing regulation before protection would allow banks to take risks still borne by taxpayers. Removing protection before depositors and payment systems can adapt could instead cause disorderly failures. The two changes need a coordinated schedule, but equal percentage reductions in each will not necessarily produce equal reductions in risk.

A credible plan would define successive legal states rather than merely promise a smooth phase-out. For each state it should identify the remaining guarantee, the prudential obligations attached to that guarantee, the treatment of existing contracts, and the loss borne by shareholders, creditors, and depositors if a bank fails. Guarantees could be closed to new liabilities before they expire on legacy liabilities. Bank-specific prudential rules could then cease as the last protected claims mature. Generally applicable laws concerning contract, property, fraud, disclosure, audit, and insolvency would remain after deregulation; the boundary between these general laws and prohibited bank-specific regulation needs precise definition.

Bank resolution and continuity of payments

Ordinary insolvency can take months or years, whereas households and businesses need transaction services continuously. Even if the State does not protect a bank's creditors, it must be clear whether access to payment instructions, account records, and Central Bank currency held on behalf of customers survives the bank's failure. Otherwise the collapse of a service provider could interrupt commerce without destroying any Central Bank currency.

One possible response is to separate payment interfaces and custody of Central Bank currency from a bank's risk-taking balance sheet. Customer Central Bank currency could remain in the customer's own Central Bank account, with the bank receiving only limited authority to initiate payments. Standard data formats and account-portability procedures could allow another provider to take over that authority. Private liabilities would remain part of the failed bank's estate and would not be rescued. Resolution rules would need to preserve reliable records, determine contractual priority, and transfer essential operations without guaranteeing creditor value.

Replacement of deposit-funded credit

Commercial-bank deposits currently fund a substantial part of lending. When customers exchange deposits for Central Bank currency, a bank loses a liability but must also surrender an asset: the Central Bank currency transferred to the customer. If deposit funding contracts faster than alternative funding develops, banks may shrink their loan books, raise interest rates, or stop financing borrowers who cannot readily use capital markets. Saying that banks will become lenders of Central Bank currency does not explain where they obtain that currency.

Potential replacements include longer-term savings, bank equity and bonds, investment and loan funds, peer-to-peer lending, securitisation, and direct lending of Central Bank currency. These sources allocate risk more explicitly but may be more expensive or less available to households and small businesses. The transition needs a consolidated balance-sheet model covering banks, the Central Bank, government, households, businesses, and investment funds. It should test how each stage affects the quantity, maturity, and price of credit under normal conditions and under stress. Commercial banks may perform much of the practical conversion, but the plan should remain workable if banks resist, fail, or cease to be the principal intermediaries.

Exchange between currencies and private liabilities

Legacy State currency, Central Bank currency, and commercial-bank liabilities do not have a guaranteed one-to-one relationship. Moving from one to another is therefore an exchange at an agreed price, not an administrative relabelling of an account. A market needs buyers, sellers, price discovery, settlement rules, and a method for dealing with a party that defaults between the two legs of a trade. Liquidity may be thin and exchange rates volatile during early adoption or a banking crisis.

The design could support competing private exchanges using common technical standards and simultaneous settlement where possible. Prices, fees, spreads, redemption terms, and the identity of the liable issuer should be shown clearly before a transaction is accepted. The State need not guarantee a price, but it must decide whether it will operate an exchange at all and, if so, where the assets used by that facility originate. A public exchange cannot promise unlimited conversion without recreating a guarantee of private liabilities.

Founding issuance and price stability

The founding rule fixes a target total supply and continues creation-funded UBI under the constitutional age-weighting formula until that target is reached. Issuing the supply gradually reduces the shock compared with issuing it all at once, but duration alone cannot ensure stable prices. The effect depends on the amount issued in each period, population growth and age structure, demand for Central Bank currency, the rate at which people spend it, productive capacity, taxation, exchange rates, and the contraction or expansion of competing private money. A small issuance into a scarcely used currency may affect its exchange rate very differently from the same issuance after it has become the principal medium of exchange.

Before inception, the founding rule must specify both the target supply and the creation-funded rate per unit of constitutional age weight. The completion date is necessarily an estimate because the eligible population and its total age weight will change. Scenario analysis should show the likely duration, issuance per period, weighted supply per person, and relationship to plausible levels of production and spending. It should also test the rule for births, ageing, deaths, migration, and changes in eligibility, and specify how the final payment is reduced so the target cannot be exceeded. Because currency uses indivisible integer units, the rule must also specify how the final remainder is allocated while preserving the age-weighting rule as closely as possible.

Fixing the target prevents the founding authority from creating an unlimited quantity, but it also means the target cannot respond to unexpected inflation, deflation, war, technological change, or a collapse in currency demand. If the payment formula may be adjusted without changing the target, its decision-maker, bounds, effect on the expected duration, and constitutional expiry must be stated in advance. A price-stability objective should not become an indirect power to increase the target supply.

The handover from created currency to tax-funded UBI

During inception, UBI has two possible sources: newly created Central Bank currency and consumption tax allocated to UBI. The components follow separate rules: creation-funded UBI continues until the target supply is reached, while tax-funded UBI depends on consumption-tax receipts. The total UBI paid to each eligible person is the sum of those components and may therefore vary over time. After the target is reached, UBI can have only the tax-funded component.

The planned handover ramps down the issuance rate per unit of constitutional age weight and ramps up the consumption-tax UBI allocation rate over a published interval near the end of founding. Population, age structure, and tax receipts will differ from forecasts, so the schedule must distinguish its estimated completion date from the binding supply target. It should be tested for the possibility that planned issuance would reach the target early or leave a remainder when the handover interval ends.

The accounting should report creation-funded and tax-funded UBI separately even when they are paid in one transfer. Both components use the same age weights and eligibility rules; neither component's rate per unit of weight must remain constant over time. Lower-than-expected tax revenue should reduce the tax-funded component automatically unless the constitution provides another prospective allocation rule. It must not be used to justify borrowing, destroying currency, increasing the target supply, or continuing currency creation after the target has been reached.

Tax arbitrage during parallel operation

Exempting sales made through the new system from legacy income tax creates an adoption incentive, but it also invites taxpayers to relabel existing activity, route transactions through the new system, or move income between related entities without changing the underlying commerce. Two otherwise identical businesses could face substantially different burdens solely because of the payment path they use. The legacy tax base could then erode faster than the consumption-tax base grows, creating an unintended fiscal shortfall.

Possible responses include reducing legacy tax rates for everyone according to the announced schedule rather than granting a payment-system exemption, or giving a precisely defined credit for consumption tax already paid while preserving the ordinary treatment of income. Any incentive should be tested against simple changes of payment route, currency, legal entity, residence, and transaction timing. The phase-out of old taxes and phase-in of consumption tax should be modelled together even if their legal schedules remain distinct from founding currency issuance.

Operational resilience of the Central Bank Payment System

A payment system used for UBI, tax, and most domestic commerce becomes critical national infrastructure. Its design must address identity verification, account recovery, privacy, authorised representatives, mistaken and fraudulent payments, settlement finality, cyberattack, insider abuse, software defects, network partitions, power failure, disaster recovery, and access for people unable to use ordinary digital services. Conservation of currency also requires every transfer to remain correctly accounted for through failures and recovery.

Possible measures include independently implemented redundant systems, geographically separated operations, cryptographically verifiable records, limited transaction authority for service providers, delayed or multi-party approval for unusually risky payments, offline arrangements with strict value limits, regular recovery exercises, and published incident reports. Interfaces should be open enough that many providers can offer payment services without receiving the ability to create currency or silently assume ownership of customer funds. Capacity and failure testing must occur at realistic national scale before reliance on legacy systems is reduced.

Unit of account, contracts, and accounting

Parallel currencies with floating exchange rates create practical questions for wages, rents, debts, financial statements, damages, insolvency claims, and long-term contracts. A contract must identify the promised currency or private liability; a numerical amount without an issuer and unit is ambiguous. Businesses also need consistent rules for valuing gains, losses, inventories, and tax obligations when exchange rates change.

Legislation could establish neutral default rules for contracts that omit a currency while leaving parties free to choose another rule expressly. Existing contracts should not be redenominated retrospectively merely to accelerate adoption. Accounting standards and public price reporting should distinguish Central Bank currency from claims denominated in it. Government acceptance of Central Bank currency for public payments creates demand for it, but the exchange rate used to satisfy a legacy-currency obligation must be known before payment falls due.

Liquidity crises after currency creation ends

After inception the Central Bank cannot create currency, borrow, or act as lender of last resort. The economy must therefore absorb liquidity shocks without emergency monetary expansion. The failure of a private issuer need not destroy Central Bank currency, but it can still freeze credit, interrupt payments, force asset sales, and cause losses to spread through contracts. Fixed supply also means that growth in demand for money can produce falling prices or higher real debt burdens.

The proposed response is private loss absorption rather than public rescue: equity, long-term debt, contractual liquidity facilities, mutual arrangements, diversified funding, and insolvency. This needs stress testing against severe but plausible scenarios. The analysis should identify which services must continue, how solvent institutions obtain temporary liquidity, how collateral is valued during disorderly markets, and how failures propagate when no institution can create the final settlement asset. If any emergency exception is proposed, it must be acknowledged as an exception to currency conservation rather than described as ordinary implementation.

Competition does not guarantee adoption

Central Bank currency may be preferred because it has no private issuer-default risk, is accepted by government, and has a constitutionally constrained supply. Nevertheless, sound money does not automatically or immediately displace alternatives. Existing currencies benefit from familiar prices, established contracts, credit relationships, payment acceptance, and network effects. People may also prefer an interest-bearing or convenient private claim despite its additional risk.

Adoption forecasts should therefore treat voluntary displacement as a hypothesis to test rather than a mechanism on which the safety of the transition depends. Pilot programs can measure account registration, payment use, exchange spreads, merchant acceptance, deposit movement, and demand for credit. The system should remain functional under slow, fast, uneven, or temporarily reversing adoption rather than assuming a single path.

Governance, measurement, and decision gates

Predetermined schedules constrain arbitrary government action, but a transition also requires evidence that it is safe to proceed from one stage to the next. Pure calendar-based progression could continue despite an operational failure or an unsustainable loss of credit. Purely discretionary progression could allow temporary institutions to preserve their powers indefinitely.

A possible compromise is to legislate both maximum durations and objective readiness tests. Tests could cover payment-system availability, recovery performance, exchange-market liquidity, concentration, bank funding maturity, credit availability, unresolved insolvencies, tax revenue, UBI funding, fraud, and access for vulnerable users. Results and underlying models should be public and independently reproducible. Failure of a test could pause the next prospective step without reversing completed transfers, recreating currency, guaranteeing private losses, or extending a temporary power beyond its constitutional expiry.

Before national adoption, the entire sequence should be represented as linked stocks and flows and tested under alternative scenarios. At a minimum these should include rapid and slow currency adoption, recession, inflation, deflation, a major bank failure, a cyberattack, loss of exchange liquidity, migration and population change, weak consumption-tax revenue, and simultaneous shocks. Recognising these unresolved questions does not reject the proposed system. It distinguishes the constitutional destination from the substantial engineering, economic, and legal work needed to reach it safely.