The financial landscape is evolving rapidly, and central banks worldwide are embracing the concept of Central Bank Digital Currency (CBDC) as a means to modernize their monetary systems. CBDCs are digital currencies issued by central banks with their value linked to the issuing country’s official currency. The idea of CBDCs is gaining traction globally, with 87 countries actively exploring their implementation [1] . These 87 countries represent over 90 percent of global GDP. In this week's update we will delve deeper into how CBDCs will work, their benefits, and the unnerving risks they present to privacy and freedom. How Will CBDCs Work? In theory, CBDCs have the potential to digitize and replace physical currency. They are digital representations of a country's official currency, and will be issued and regulated by that country's central bank. The main goal for digitizing traditional money is to make it more accessible, efficient, and secure. The emergence of cryptocurrencies like Bitcoin and the growing importance of digital payments have propelled the exploration of CBDCs as a modern financial tool. CBDCs have the potential to revolutionize financial transactions by streamlining processes and reducing costs. In the current financial system, each bank operates its own payment tracking system, resulting in delays and inefficiencies when multiple banks are involved in a transaction [2] . However, since CBDCs would be handled by the central bank it would allow for all the transactions to be consolidated onto a single ledger, enabling instant clearing of payments and universal acceptance, regardless of the payment method or platform used [2] . Ultimately, if this idea comes to fruition, it will eliminate the need for banks that are not the central bank. Benefits of CBDCs CBDCs would require a complete overhaul of the financial system. Therefore, CBDCs must offer several significant advantages to justify that type of overhaul. Here are the some of the most prominent benefits for CBDCs: Reduced Costs - One key benefit is the potential for reduced costs. By shifting focus from physical infrastructure to digital finance, financial-service providers could save an estimated $400 billion annually in direct costs [3] . Increase speed - CBDCs have the capacity to enhance the speed and efficiency of electronic payment systems, benefiting both individuals and businesses. Appeal to the unbanked - CBDCs offer a solution for people who do not have access to a bank account. According to a survey from 2016, 1.6 billion people around the world did not have a bank account. Another statistic shows that less than 5% of adults do not have a bank account [3] . CBDCs have the potential to increase financial inclusion, empowering those without bank accounts, but adoption isn’t a guarantee as many underbanked people may favor the total anonymity that comes with using cash. Heightened Security - This is a byproduct of the speed and single bank ledger. Private key cryptography could be implemented for users to "sign off" on transactions digitally, and they would become finalized and unalterable in a short period of time [3] . Risks and Concerns While CBDCs offer numerous benefits, they also come with risks and concerns that must be carefully addressed. One major concern is the potential for increased governmental control. Although no central bank currently plans to restrict CBDC usage, the hypothetical possibility of the government deciding which purchases are permissible raises privacy and individual freedom concerns. Additionally, the traceability of digital currency may lead to increased taxation, as every transaction becomes easily traceable. Technological stability is another challenge, as evidenced by the temporary shutdown of the digital version of Eastern Caribbean DCash due to technical issues [4] . Let's take a moment to go more in depth on the potential for governmental control. The following is a quote from professor Eswar Prasad. Prasad is a professor at Cornell University and the author of The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance. Prasad made this statement while speaking at the World Economic Forum's annual meeting of the new champions. “You could have, as I argue in my book, potentially better and some people might see a darker world, where the government decides that unit, so central bank money can be used to purchase some things but not other things that are deemed less desirable, like, say, ammunition or drugs or pornography or something of the sort. And that is very powerful in terms of the use of a CBDC and I think also extremely dangerous for central banks” [5] Prasad noted that he was only speaking hypothetically and said, “No central bank is contemplating any such uses for its CBDC but, as an academic, it is important for me to point out all the possibilities and potential—both good and bad—of a world in which all payments are digital and anonymity might be limited (relative to the use of cash).” [5] This is possible because CBDCs are programmable. For example, a CBDC could be programmable where it can only be used for certain items or even have an expiration date – which would ultimately force spending. This allows for CBDCs to make it much easier for a centralized authority to dictate and control human behavior because they can restrict the flow and opportunities if you are not behaving in a manner that they're requesting. This is very evident in China's social credit system. Use Cases for CBDCs It's important to balance the potential benefits of CBDCs with concerns related to individual privacy and governmental control. This is highlighted by China's social credit system. The China social credit system is a broad regulatory framework intended to report on the ‘trustworthiness’ of individuals, corporations, and governmental entities across China [6] . China’s “Social Credit System” rates its citizens based on their behaviors, and those who score well get privileges; those who score poorly do not. A citizen with a high score is likely to enjoy various privileges—high-speed internet, the ability to travel freely, access to the best restaurants, golf courses and nightclubs—that fellow citizens do not [7] . There are many ways to lose points and lower one’s social credit score, depending on the city where the offense takes place. Some of the more trivial score-lowering actions include: not visiting their parents on a frequent basis, jaywalking, walking a dog without putting it on a leash, smoking in a non-smoking zone, and cheating in online videogames [6] . A citizen with a poor social credit may experience one of these forms of punishment [6] : Travel bans Reports in 2019 indicated that 23 million people have been blacklisted from traveling by plane or train due to low social credit ratings maintained through China’s National Public Credit Information Center [6] . School bans The social credit score may prevent students from attending certain universities or schools if their parents have a poor social credit rating. For example, in 2018 a student was denied entry to University due to their father’s presence on a debtor blacklist [6] . Reduced employment prospects Employers will be able to consult blacklists when making their employment decisions. In addition, it is possible that some positions, such as government jobs, will be restricted to individuals who meet a certain social credit rating [6] . Increased scrutiny Businesses with poor scores may be subject to more audits or government inspections [6] . Public shaming In many cases, regulators have encouraged the ‘naming and shaming’ of individuals presented on blacklists. In addition, flow-on effects may make it difficult for businesses with low scores to build relationships with local partners who can be negatively impacted by their partnership [6] . CBDCs can also allow the government to be more targeted in their efforts to manage economic growth. One such case is the ability to combat inflation effectively. With the flexibility of CBDCs, central banks can implement different interest rates on specific balances or accounts, allowing for more precise monetary policy implementation. CBDCs also have the potential to support targeted stimulus efforts by directing funds to designated sectors or implementing expiration dates to encourage spending [8] . Implementation Timelines The timeline for CBDC implementation varies by country. In the United States, the Federal Reserve is already taking steps to address transaction inefficiencies by launching the FedNow digital payments system by the end of July 2023. This system aims to provide low-cost bill payments, money transfers, paychecks, government disbursements, and other consumer activities [9] . Time will tell when this will be fully implemented in the United States, but many see the implementation of FedNow as the first step toward a CBDC. Globally, a recent survey suggests that by 2030, approximately 24 central banks will have implemented digital currencies. This projection highlights the increasing global adoption and recognition of CBDCs as a fundamental part of future financial systems [10] . It is not a foregone conclusion that CBDCs will be implemented as there is plenty of opposition to the idea. Senator Cruz from Texas and Governor DeSantis from Florida have both introduced legislation to prohibit the Fed from establishing a CBDC [11][12] . If CBDCs take over the financial system, it appears there will be minimal options for those who do not want to participate in the system. Some of those options may include: using bitcoin that is established on a decentralized platform with options for privacy and anonymity, using physical precious metals like gold and silver, and/or exchanging value for value like in an archaic bartering system. Conclusion Central Bank Digital Currencies have the potential to revolutionize the way we transact and interact with financial systems. By leveraging digital technologies, CBDCs can offer reduced costs, increased speed, improved financial inclusion, and heightened security. However, careful consideration must be given to the risks associated with potential governmental control, privacy concerns, and technological stability. As countries progress toward a digital economy, CBDCs will play a pivotal role in shaping the future of money, transforming financial systems and enhancing economic efficiency on a global scale. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situati on. Sources: https://www.mckinsey.com/featured-insights/mckinsey-explainers/what-is-central-bank-digital-currency-cbdc https://www.forbes.com/advisor/investing/digital-dollar/ https://www.mckinsey.com/featured-insights/mckinsey-explainers/what-is-central-bank-digital-currency-cbdc https://www.bloomberg.com/news/articles/2022-02-21/eastern-caribbean-dcash-outage-is-test-for-central-bank-digital-currencies?sref=YMVUXTCK https://apnews.com/article/fact-check-world-economic-forum-cashless-society-false-cbdc-592718364311 https://nhglobalpartners.com/china-social-credit-system-explained/ https://fee.org/articles/china-s-social-credit-system-sounds-pretty-dystopian-but-are-we-far-behind/ https://financialpost.com/fp-finance/cryptocurrency/central-bank-digital-currency-inflation-fighters-best-friend https://www.forbes.com/advisor/investing/digital-dollar/ https://www.reuters.com/markets/currencies/twenty-four-central-banks-will-have-digital-currencies-by-2030-bis-survey-2023-07-10/ https://www.cruz.senate.gov/newsroom/press-releases/sen-cruz-introduces-legislation-to-prohibit-the-fed-from-establishing-a-central-bank-digital-currency https://www.flgov.com/2023/03/20/governor-ron-desantis-announces-legislation-to-protect-floridians-from-a-federally-controlled-central-bank-digital-currency-and-surveillance-state/

The global economy is facing increasing pressures, and there are growing concerns about a potential recession on the horizon. Two significant indicators that have historically foreshadowed economic downturns are an inverted yield curve and Purchasing Managers' Index (PMI) readings below 50. Over the past couple of months these two indicators have continued to point in the direction of an impending recession. In this week’s update, we will explore the historical context and significance of these indicators and analyze their current implications for the economy. Understanding the Inverted Yield Curve: An inverted yield curve occurs when short-term interest rates exceed long-term rates, typically reflected in the inversion of the two-year and 10-year Treasury yields. An inverted yield curve is often viewed as an indicator of a troubled economy because it deviates from the normal yield curve shape, where longer-term interest rates are typically higher than shorter-term rates. In an inverted yield curve scenario, short-term interest rates exceed long-term rates, implying that investors have lower expectations for future economic growth and inflation. This phenomenon has been a reliable recession predictor in the past, and suggests that the global economy is headed toward a recession despite the stock market trading near all-time highs 1 . The Fed chose to pause rate hikes during their June meeting, but many expect the rate hikes to continue in the future 2 . Persistently raising short-term rates in an inverted yield curve environment can increase the risk of an economic slowdown or recession. The inversion of the yield curve itself is often seen as a reliable predictor of economic downturns. By continuing to tighten monetary policy in this scenario, the Fed may unintentionally contribute to a deeper and more prolonged recessionary environment. PMIs Indicating Economic Contraction: PMIs, or Purchasing Managers' Indexes, are widely used economic indicators that provide valuable insights into the health and performance of various sectors within an economy. They are based on surveys conducted among purchasing managers in manufacturing, services, construction, or other sectors. The purpose of PMIs is to gauge the prevailing business conditions, sentiment, and trends within a specific sector or the overall economy. When a PMI reading falls below 50, it indicates economic contraction. The US manufacturing sector's recent contraction, raises concerns about the overall economic health and suggests a challenging road ahead 3 . The ISM Manufacturing PMI came in at 46 in June, down from 46.9 in May. This is the lowest reading since July 2020 3 . The manufacturing sector is followed closely due to it strong linkages with other sectors of the economy. Changes in manufacturing activity can impact supply chains, employment levels, and the performance of related industries. Manufacturing job losses can have a cascading effect on the economy, impacting consumer spending and business investment, and further contributing to the likelihood of a recession. Analysis of Current Economic Indicators: