Crypto’s Rising. So Are The Stakes For Governments Everywhere
Competition in the global market for cash is heating up. Crypto’s Rising. So Are The Stakes For Governments Everywhere
For centuries, money issued by governments has served as the lifeblood of the global economy — the currencies in which people hold savings, make payments and keep accounts, and in which nations measure their wealth and geopolitical power.
But in our digital age, it’s facing a bizarre, postmodern sort of competition. Cryptocurrencies — created to supplant the traditional, sovereign kind — have become a widespread obsession, inspiring their own counterculture and attracting hundreds of billions of dollars in speculative investment that may or may not have anything to do with their viability.
How, if at all, should issuers of the world’s official currencies respond? In a word: carefully. As financial regulators, they need to strike a balance between encouraging innovation and preventing harm.
Most important, as competitors in the global market for cash, they need to improve their products.
Money comes in various forms, none ideal. Notes and coin allow for easy face-to-face transactions and serve as a mostly stable store of purchasing power, but they’re costly to hold in significant amounts and no use for transactions at a distance. Bank deposits, along with the credit and debit cards connected to them, are more convenient but also flawed.
They often entail hefty fees, and since (unlike fiat money) they aren’t a direct liability of the government, they involve an element of risk — relying on institutions that don’t always succeed in maintaining the public’s trust. The 2008 financial crisis took a lasting toll on confidence in the banking system — one reason why holdings of physical currency have since increased.
Enter Bitcoin, the first cryptocurrency. In a 2008 white paper, the pseudonymous Satoshi Nakamoto described a system of electronic cash that would operate outside established channels and dispense with the need to trust any central authority or institution.
A computer protocol would create new digital tokens. And a voluntary network of processing nodes would maintain a dispersed public ledger known as a blockchain, employing high-powered cryptography to ensure accuracy, security and anonymity. Instead of handling paper bills or transmitting deposits, people would make payments using private alphanumeric keys establishing ownership of their Bitcoin.
More than a decade later, Bitcoin and other cryptocurrencies have succeeded beyond their creators’ wildest hopes — after a fashion. But they aren’t actually functioning as money. They’re poor stores of value, because their prices fluctuate wildly. They’re also easy to lose: An estimated 20% of all Bitcoins are stuck in wallets to which people have lost the keys.
They’re not great for payments: Most places won’t accept Bitcoin, and transactions are often slow and expensive, occasionally taking days or costing more than $25 each when the network is congested. They’re extremely wasteful: The computations required to maintain the Bitcoin blockchain alone consume as much electricity as a mid-sized country, making a significant contribution to climate change.
These seemingly fatal defects, though, haven’t prevented cryptocurrencies from becoming a cultural and financial phenomenon. They’ve taken on the trappings of a religious or revolutionary movement, promising a future in which decentralized networks displace not only money, but also companies, governments and society as we know it.
This fervor overlaps with the hyper-speculative world of day traders, where crypto has become a favorite obsession — with help from the likes of Elon Musk, who put $1.5 billion of Tesla Inc.’s cash into Bitcoin. The total market value of Bitcoin, a virtual asset with almost no practical use except for illicit commerce, recently reached $1 trillion. Even Dogecoin, created entirely as a joke, briefly topped $10 billion.
These remarkable gains are wearing down the resistance of the financial and political establishment that cryptocurrencies were intended to obliterate. Celebrity hedge-fund managers such as Paul Tudor Jones and Stanley Druckenmiller have piled in.
Big Wall Street banks are recommending Bitcoin for investors and offering safekeeping services. Bitcoin-focused trusts and derivatives — and possibly soon a U.S. exchange-traded fund — offer exposure with no need to hold the actual stuff.
Mastercard is planning to process payments denominated in cryptocurrencies. The mayor of Miami has proposed accepting property tax payments in Bitcoin. A big step toward the mainstream came when Coinbase — the leading crypto exchange, which earned more than $300 million amid the frenetic trading of 2020 — filed for an IPO that could value it at close to $100 billion.
In other words, instead of revolutionizing the world of finance, cryptocurrencies are stimulating its more casino-like aspects. They’ve become the ultimate speculative asset class, a pure product of the collective imagination, with no apparent connection to the real economy.
Yet as more people and institutions get involved — holding balances in cryptocurrency, borrowing in order to speculate in cryptocurrency — the consequences could indeed be real. Regulators are obliged to pay attention, because the volatility of cryptocurrency might begin to threaten financial stability.
Some Guidelines For Public Policy:
* Don’t Stifle Innovation. Cryptocurrencies and the underlying blockchain technology haven’t fulfilled their original purpose, but they could yet have interesting and important applications. The blockchain’s capacity to create unique and immutable digital records, for example, has enabled a burgeoning market for one-of-a-kind collectibles — such as art, music and sports highlights. Its decentralized governance has made way for new kinds of social media, such as Minds and LBRY.
Facebook’s proposed Libra system — now known as Diem — is one of many that might spur reform of slow, cumbersome cross-border payments. Authorities should be patient — giving entrepreneurs room to test concepts before subjecting them to the full weight of regulation — lest they quash ideas that could ultimately prove beneficial.
* Tread Carefully In Markets. It’s not the job of regulators to stop people making risky investments, but they do need to ensure people know what they’re getting into and don’t harm others. The Securities and Exchange Commission is right to get involved when digital tokens adopt the properties of securities — as in many initial coin offerings.
It would also make sense for the U.S. to join Europe and Canada in approving Bitcoin exchange-traded funds; this allows for adequate risk disclosure and custody procedures, and makes speculation safer and less costly for the unsophisticated investor. As more and bigger players get into the game, supervisors such as the Fed will have to ensure that exposures don’t become large enough to threaten financial stability, and that institutions have ample capital to absorb any losses.
* Work On A Better Alternative. Give cryptocurrencies credit for one thing above all. They’ve highlighted an enormous shortcoming of ordinary money: There’s no true digital version of cash — one that represents a direct claim on the government, can easily be transferred and is universally available. It’s thus encouraging (for all except those heavily invested in the existing digital tokens) to see central banks getting ready to compete. The Fed and others are seriously considering the creation of their own digital currencies.
To be sure, such radical innovation involves risk. A full-fledged central bank digital currency would upset the business model of traditional banks. If people were able to hold government-issued money directly — the equivalent of opening an account at the central bank — they might dump the deposits that remain the banking system’s primary source of funding.
To avert a collapse, central banks would have to ease the transition — by setting limits on direct holdings, by using banks as intermediaries or by providing banks with alternative financing.
Then There’s The Issue of Privacy. A digital currency could allow governments to keep track of people’s spending — a possibility of particular concern in China, which is already testing its own digital currency. To alleviate worries about surveillance, central banks will have to provide a degree of anonymity, while maintaining the access needed to track down criminals and combat money laundering.
That said, a central bank digital currency could have vast benefits. It could facilitate commerce, allowing consumers to make instant electronic payments while avoiding billions of dollars in transaction fees. It could make financial services accessible to millions of “unbanked,” helping them build wealth instead of succumbing to financial predators.
It could improve tax collection and make economic indicators more timely and precise. It could provide policy makers with new and powerful tools to fight recessions and control inflation. Imagine, for example, the effect of issuing funds that had to be spent within six months.
In the end, the legacy of the cryptocurrency craze might be a better form of money. If so, all the commotion — not to mention all the losses between now and then — will have been worth it.
Emerging Markets Brace For Rate Hikes With Debt At Record Levels
Alarm bells are starting to ring across emerging markets as countries brace for a new era of rising interest rates.
After an unprecedented period of rate cuts to prop up economies shattered by Covid-19, Brazil is expected to raise rates this week and Nigeria and South Africa could follow soon, according to Bloomberg Economics. Russia is considering tightening monetary policy sooner than previously signaled, said a person with knowledge of its central bank’s discussions.
Behind the shift: Renewed optimism in the outlook for the world economy amid greater U.S. stimulus. That’s pushing up commodity-price inflation and global bond yields, while weighing on the currencies of developing nations as capital heads elsewhere.
The turn in policy is likely to inflict the greatest pain on those economies that are still struggling to recover or whose debt burdens swelled during the pandemic. Moreover, the gains in consumer prices, including food costs, that will prompt the higher rates may exact the greatest toll on the world’s poorest.
“The food-price story and the inflation story are important on the issue of inequality, in terms of a shock that has very unequal effects,” said Carmen Reinhart, the chief economist at the World Bank, said in an interview, citing Turkey and Nigeria as countries at risk. “What you may see are a series of rate hikes in emerging markets trying to deal with the effects of the currency slide and trying to limit the upside on inflation.”
Investors are on guard. The MSCI Emerging Markets Index of currencies has dropped 0.5% in 2021 after climbing 3.3% last year. The Bloomberg Commodity Index has jumped 10%, with crude oil rebounding to its highest levels in almost two years.
Rate increases are an issue for emerging markets because of a surge in pandemic-related borrowing. Total outstanding debt across the developing world rose to 250% of the countries’ combined gross domestic product last year as governments, companies and households globally raised $24 trillion to offset the fallout from the pandemic. The biggest increases were in China, Turkey, South Korea and the United Arab Emirates.
And there’s little chance of borrowing loads easing any time soon. The Organisation for Economic Co-operation and Development and the International Monetary Fund are among those that have warned governments not to remove stimulus too soon. Moody’s Investors Service says it’s a dynamic that’s here to stay.
“While asset prices and debt issuers’ market access have largely recovered from the shock, leverage metrics have shifted more permanently,” Colin Ellis, chief credit officer at the ratings company in London, and Anne Van Praagh, fixed-income managing director in New York, wrote in a report last week. “This is particularly evident for sovereigns, some of which have spent unprecedented sums to fight the pandemic and shore up economic activity.”
Further complicating the outlook for emerging markets is they have typically been slower to roll out vaccines. Citigroup Inc. reckons such economies won’t form herd immunity until some point between the end of the third quarter of this year and the first half of 2022. Developed economies are seen doing so by the end of 2021.
The first to change course will likely be Brazil. Policy makers are forecast to lift the benchmark rate by 50 basis to 2.5% when they meet Wednesday. Turkey’s central bank, which has already embarked on rate increases to shore up the lira and tame inflation, convenes the following day, with a 100 basis-point move in the cards.
On Friday, Russia could signal tightening is imminent. It may even bring its key rate up by 125 basis points or more before the end of the year from 4.25% at present, according to the person familiar with the matter.
Nigeria and Argentina could then raise their rates as soon as the second quarter, according to Bloomberg Economics. Market metrics show expectations are also building for policy tightening in India, South Korea, Malaysia and Thailand.
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