Debunking Myths About FedNow (EP.115)

0:28We all need to make smart decisions with our money. that is more than 50 years old. Now, through financial institutions participating in the FedNow service, businesses and individuals can send and receive instant payments in real time, 24 hours a day, 7 days a week, 365 days a year. And unlike the antiquated system it replaces, you'll no longer have to wait days for transactions to settle. Recipients will have full access to funds immediately, which allows for greater financial flexibility when making a time-sensitive payment. Now to me, this is good news, but like anything new, some questions have begun to arise about what the new payment system will mean for the future of money.

1:12And making matters worse, there's been a surprising amount of false information circulating that I'd like to address in this episode. But before I begin, I want to remind you to think deeply about the source when you're consuming information that evokes feelings of fear and anxiety. Think to yourself, what is the source's motive? And I mention this because most of the concerns that have been sent my way are coming from social media posts where the objective is simply to get as much attention as possible, or paid newsletter subscriptions where the writer's goal is to position themselves as having unique information, or low-quality internet websites that often have hidden financial or political motives.

1:56Fear sells, but it doesn't help you make good financial decisions. So let's address some of the false narratives about FedNow. The first is that FedNow represents the end of cash. FedNow does not replace physical dollars, and instead, it provides the backbone for instant payment services that look very similar to popular services such as Venmo or Cash App. Cash payments have been declining for years and currently represent only 20 % of payments made in the US. Personally, I almost never have cash on hand, but the concern among some people is that Fed now is the government's attempt to completely wipe out paper currency.

2:36While I would expect cash payments to continue to decline, it's hard for me to wrap my head around that because cash transfers happen instantly rather than over the course of two to three days. In my opinion, cash payments will continue to climb because it's simply easier to make payments with cards and electronic devices. And let's not also forget that we already use digital dollars. It's not like they're dollar bills in a bank safe for every dollar in your account. But I suppose people concerned about the disappearance of cash are thinking that the complete end of physical cash would represent a reduction in a person's privacy and control.

3:14Now, I realize that there are people who keep significant amounts of money in cash and, quote, off the grid, so to speak. But in my opinion, there will always be physical currency as long as there is actual demand for it. But the important thing in this conversation is that FedNow is simply a more efficient payment system that is more in line with what the rest of the world already has in place and does not represent any attempt to kill off physical currency. A second myth, I guess we could call it, is that the Fed now is a new digital currency. Due to crypto's popularity as a form of instant digital payment, some people are incorrectly assuming that Fed now is on blockchain or somehow related to crypto.

3:58Given the fraud and high-profile issues within the crypto space, it's no surprise to me that the idea of the US dollar becoming a digital currency would cause some anxiety. But that is not what is happening right now. As I said before, FedNow is a payment system and not a currency. The system isn't even on a blockchain. In fact, FedNow uses what's referred to as a conventional payment rail technology, similar to how systems like ACH and wire transfers work. The only difference is their ability to happen outside of traditional business hours and settle instantly rather than over the course of multiple days.

4:35Here is what is true about a U.S. digital currency. The president signed an executive order in March 2022 to promote the creation of digital assets, but the Fed has not announced any steps beyond studying the technical feasibility, the benefits, and the downsides of a central bank currency. The Fed can't even launch a retail digital currency without a law authorizing one, something that Fed Chairman Jerome Powell reaffirmed in his March 2023 hearing of the House Financial Services Committee. And for what it's worth, there are 114 countries exploring the creation of digital currency. But again, that has nothing to do with FedNow.

5:15The next series of concerns that I've been seeing around FedNow is that they might cause bank failures. The failure of Silicon Valley Bank and First Republic Bank earlier this year has generated a persistent concern among businesses and consumers about the safety of their deposits. And because both of those banks were in the 2021 FedNow pilot program, some people have incorrectly linked those two things as being correlated. And side note, there were 110 banks in the pilot program and none of the others failed. But these bank failures that did occur, they had nothing to do with electronic payment processing.

5:53You can go back to episode 93, where I explain what happened in those bank failures in greater detail, but the short version of what happened is that there was a classic run on the bank. Now, Moody's issued a warning that FedNow makes a bank run easier since depositors could pull their cash out instantly, but what this warning misses is that institutions using FedNow can still limit transactions in a manner that aligns with their risk appetite. There have been a few other bits of information tied to this fear-based narrative around FedNow and the stability of the financial system. One is that not all major banks have signed up to use FedNow.

6:32So we have JPMorgan and Chase and Wells Fargo on the platform, but there are other giants like Bank of America, Citigroup, Goldman Sachs, who are still sitting on the sidelines. But don't be fooled by any fear-mongering around this information. The banks sitting out are probably more concerned about losing profits they earn from parking cash and interest-bearing securities, while the older system takes a few days to settle transactions. Plus, a few of these banks also make money from their own payment systems. So those things will slow down their adoption of FedNow, in my opinion. The other narrative that's coming up a little bit is that FedNow is some sort of, quote, experiment that could cause the financial system to break.

7:13But this is not an experiment. There are 56 other countries in the world with similar payment systems in place. This is sort of the United States playing catch-up with the rest of the world. There are developing economies that are light years ahead of us in payment systems. It's sort of like we have the nicest house in town, but all of our electronics and appliances are from 1970. The last misconception going around about Fed now is that it is going to be used so that the Fed can somehow manipulate the monetary system. Now, I have not seen this put out by any sort of reputable source, but it is something circulating and I want to get the facts straight.

7:51Basically, some people are saying that the new payment system would allow the Fed to create money out of thin air. First of all, the Fed doesn't create money. It's actually the Treasury that creates money. And that's a very common misconception that gets amplified by the fact that most people in the media don't have a fundamental understanding of how our country's monetary system works. Second of all, people think the Fed goes completely unchecked and is never audited, but that could not be further from the truth. The Fed's Board of Governors, the 12 Federal Reserve banks, and the Federal Reserve system as a whole are all subject to several levels of audit and review.

8:29In my opinion, the Federal Reserve is just an easy target for people broadcasting information with ulterior self-serving motives because their role in our financial system and economy is so poorly understood by even the most educated people. which perhaps would make it a good topic to cover on a show at some point in the future. But this is all the time I have for today. And hopefully the information I've shared makes it clear that FedNow is a good thing and doesn't represent any type of threat that should keep you up at night. As always, thanks for listening and to Long-Term Investing. Thanks for listening to the Long-Term Investor Podcast.

9:08To access free financial resources and submit questions to be answered on the show, visit the long-term investor.com.

9:43Thank you.