The Federal Reserve recently unveiled a new payments system called FedNow that would replace the United State’s antiquated system created more than 50 years ago. But like anything else, change can cause anxiety and there is a lot of false information floating around making matters worse.
Listen now and learn:
- The basics of the FedNow system
- How FedNow is different from digital currency
- Why FedNow should be viewed as a good thing for everyone
Listen Now
Show Notes
On July 20, the Federal Reserve launched a new centralized payments system called FedNow to replace the country’s antiquated system that’s more than 50 years old.
Through financial institutions participating in the FedNow service, businesses and individuals can send and receive instant payments in real time 24 hours a day, seven days a week, 365 days a year.
Unlike the antiquated system it replaces, you will no longer have to wait a few days for transactions to settle. Recipients will have full access to funds immediately, which allows for greater financial flexibility when making time-sensitive payments.
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. And making matters worse, there has 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. What is the source’s motive?
I mention this because most of the concerns that have been sent my way are coming from social media posts (where the objective is to get as much attention as possible), paid newsletter subscriptions (where the writer’s goal is to position themselves as having unique information that you can only obtain from them), or low-quality internet websites that often have hidden financial or political motives.
Fear sells, but it doesn’t help you make good financial decisions. So let’s address some of the false narratives about FedNow.
FedNow Represents the End of Cash
FedNow does not replace physical dollars. Instead, it provides the backbone for instant payment services that look very similar to popular services such as Venmo or CashApp.
Cash payments have been declining for years, and currently represent only 20% of payments made in the U.S. Personally, I almost never have cash on hand, but the concern among some people is that FedNow is the government’s attempt to completely wipe out paper currency entirely.
While I would expect cash payments to continue to decline, it’s hard for me to wrap my head around this being caused by cash transfers happening instantly rather than over the course of two to three days. In my opinion, cash payments will continue to decline because it’s simply easier to make payments with cards and electronic devices.
Let’s also not forget that we already use digital dollars—it’s not like there are dollar bills in a bank safe for every dollar under 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.
I realize that there are people who keep significant amounts of money in cash and “off the grid”. In my opinion, there will always be physical currency so long as there is actual demand for it, but the important thing for this conversation is that FedNow is simply a more efficient payment system that is more in line with what the rest of the world has in place and does not represent any attempt to kill off physical currency.
FedNow is a New Digital Currency
Due to cryptocurrency’s popularity as a form of instant digital payment, some people are incorrectly assuming that FedNow is on a blockchain or somehow related to crypto. Given 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’s not what’s happening. 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.
Here is what is true about a US 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, benefits, and 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.
For what it’s worth, there are 114 countries exploring the creation of digital currency, but (again) that has nothing to do with FedNow.
FedNow Might Cause Bank Failures
The failure of Silicon Valley Bank and First Republic Bank earlier this year has generated 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.
(Side note: there were 110 banks in the pilot program, and none of the others failed.)
The bank failures had nothing to do with electronic payment processing. You 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.
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.
A few other bits of information that have been tied to a fear-based narrative of FedNow:
Not all major banks have signed up to use FedNow. JPMorgan Chase and Wells Fargo are on the platform, but other giants like Bank of America, Citigroup, and Goldman Sachs are still on the sidelines. Don’t be fooled by the fearmongering. The banks sitting out are more concerned about losing profits they earn from parking cash in interest-bearing securities while the older system takes a few days to settle transactions. A few of these banks also make money from their own payment systems, so those things will slow down their adoption.
The last narrative that I feel is related to bank failures is people calling FedNow “an experiment” that could cause the financial system to break. But this is not an experiment.
There are 56 other countries with similar payment systems in place. This is the United States catching 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 having the nicest house in town, but all your electronics and appliances are from 1970.
The Fed Will Manipulate the Monetary System
The last concern I’d like to quickly address is one I’ve yet to see from any reputable source, but it is something circulating and I want to get the facts straight.
Some people are saying that the new payment system would allow the Fed to create money out of thin air.
First, the Fed doesn’t create money. It’s the Treasury that creates money. 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, people think the Fed goes completely unchecked and is never audited, but that couldn’t 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.
In general, the Federal Reserve is 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 of people.
Perhaps that would make it a good topic to cover on the show at some point, but that’s all the time I have for today.
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.
Resources:
- About the FedNow Service, by the Federal Reserve
- Episode 93: What The Silicon Valley Bank Failure Means For You
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Long-term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.
Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.
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