The ecumenical monetary system is broken. Helping to fix it poses a huge opportunity for the cryptographers behind cryptocurrency and blockchain technology.
Now they must one of the stewards of that system in their corner: Mark Carney, the outgoing Bank of England Governor.
A week ago in Jackson Donjon, Mont., Carney told the Federal Reserve’s annual gabfest that central bankers could develop a network of inhabitant digital currencies to create a new, basket-managed “synthetic hegemonic currency.”
Carney’s proposal was mostly a thought exercise to fortify conversation around solutions to the dangerous imbalances fostered by the current system’s dependence on the dollar as the world’s reserve currency. The definitives were necessarily thin – any solution will be both technically and politically complicated, and even though he’ll depart the BOE in January, Carney’s station as a public official demands caution.
But I don’t share those constraints. So, let me lay out my own modest proposal for a cryptocurrency-based fix to a broken global fiscal system. Hint: it is not “buy bitcoin.”
I’m neither a trained economist nor a cryptographer, so I know this act of hubris will attract refusers. I welcome criticisms and suggestions. I’m also quite certain I’m not the first to think of this, so I’m eager to hear of others effective use on similar projects.
The thing is I’ve been obsessed with both the structural failings of the global financial system and cryptocurrency for uncountable years now. Three of my five books have covered those topics. It’s hard to bite my tongue.
Fixing the worldwide currency system
I think that instead of creating a whole new global currency, central bankers should travail to develop digital currency interoperability. We need a system of decentralized exchange through which businesses in different countries can use pang contracts to create automated escrow agreements and protect themselves against exchange rate volatility. With algorithms that realize atomic swaps now available and with other advances in cross-chain interoperability, I believe we’ll soon have the technology to assassinate foreign exchange risk from international trade without relying on an intermediating currency such as the dollar.
Here’s how it puissance work: A hypothetical importer in Russia could strike a deal with an exporter from China and agree to a approaching payment, denominated in Chinese renminbi, based on the latter’s prevailing exchange rate with the Russian ruble. Relying on an interoperability usage that’s commonly integrated into each party’s preferred digital national currency – either in privately run stablecoins or dominant bank-issued digital currencies – the two firms could then establish a smart contract that “trustlessly” locks up the demanded renminbi payment in decentralized escrow. If delivery and contract fulfillment are confirmed, the payment is released to the Chinese exporter. If not, the supplies revert to the Russian importer at the same, initial conversion rate.
In this scenario, both parties are protected against adverse swap rate movements. Yet, despite the trust gap between them, there is no need to intermediate the payment through dollars, and no extremity for either party to take out a forward contract, FX option or some other expensive exchange rate hedge.
Of lecture, the importer would suffer the opportunity cost of locking up otherwise valuable working capital for a few months. But private banks could temper that with collateralized short-term loans on terms that would be a lot cheaper than the current cost of currency hedging. Alternatively, if the swift contract is executed on a proof-of-stake blockchain, the locked-up funds could be employed to earn cryptocurrency staking rewards.
What pleasure central banks’ roles be?
Well, for one, they could backstop the entire credit and/or staking model. Providing liquidity or bonds to banks’ trade finance businesses would be a more constructive use of domestic money supply than applying it to rainy-day reserves of U.S. Treasuries and other dollar assets.
Secondly, they’d be charged with assuring the trustworthiness of the interoperability protocol. Whether inside banks would endorse and regulate privately developed protocols such as Tendermint’s Cosmos, Parity Technologies’ Polkadot or Flutter’s Interledger, or whether they would commission a multilateral body to build and manage a single official system, there’s no getting enclosing an oversight role for public sector policymakers.
(Don’t worry, crypto libertarians, no one’s taking away your bitcoin in this working. In fact, since central bankers will retain their own monetary sovereignty, with exchange rates persist in to fluctuate, bitcoin’s appeal as a “digital gold” alternative to domestic currencies could well be enhanced.)
A broken procedure
Let’s be clear: if foreign trade no longer requires dollar intermediation, the U.S.-centric global economy will suffer a gigantic impact, perhaps bigger even than the 1971 “Nixon Shock,” when the dollar was unpegged from gold.
The unalloyed reserve currency system, in which foreign central banks own U.S. government bonds as a backstop and multinational companies hinder large parts of their balance sheets in dollars, is based on the need to protect against exchange rate disadvantages. If that risk is removed, the edifice would, in theory, come down.
Yet, as Carney rightly points out, continuing with dollar hegemony is not imaginable, either. The system is broken. Whenever global investors get the jitters they rushen masse into “safe haven” dollar assets – up when, as with President Trump’s trade war with China, U.S. policy is the cause of their malaise.
This method, which has become progressively more acute with each financial crisis, causes huge distortions, cost-effective dysfunction and political turmoil. And with economies slowing and the worldwide value of bonds carrying negative yields now at $17 trillion, we now lineaments worrying signs of another crisis. This time, traditional central bank policy could be powerless.
When another turning-point comes, the dollar-based system will generate a predictable vicious cycle. The dollar will rapidly rise. This purposefulness hurt U.S. exporters, which further stir the mercantile instincts of anti-free traders such as Trump and fuel dangers of a destructive tit-for-tat currency war.
Meanwhile, emerging markets will suffer capital flight as a rising dollar ins the risk of debt defaults in those countries. Their central banks will respond by jacking up interest appraises to prop up their domestic currencies, but this will choke their economies at a time when they want easier, not tighter, monetary policy. Unemployment will surge and governments will topple.
The current system multiplies what former Fed Chairman Ben Bernanke dubbed the “global savings glut” as developing countries squirrel money into dollar keeps that could otherwise be used for domestic development.
In the U.S., it creates the countervailing effect of massive deficits – in other confabs, sky-high debt. Far from being the “exorbitant privilege” once described by French Finance Minister Valéry Giscard d’Estaing, the dollar’s set aside status is an American curse. It creates artificially low U.S. interest rates, which misprices credit risks and fuels fizzes – see: the 2008 housing crisis.
Worst of all, the dollar system undermines democracy and diminishes economic sovereignty. The performance of every restraint hinges on U.S. Federal Reserve policies. Yet the Fed’s low inflation/maximum employment mandate is defined only by the U.S. economic outlook. This rule mismatch makes it much harder for governments to pursue effective measures to create opportunities for all.
When things surely go sour, the Fed belatedly and reluctantly becomes the world’s lender of last resort, pumping dollars into the world’s banks via their New York subsidiaries. That’s how we extinguished up with the “quantitative easing” surfeit after the last crisis, money that went into financial assets, London legitimate estate and fine art, but did little to boost the earning power of the middle class.
These policy failures have type a populist backlash against globalization, manifest in the U.K.’s Brexit crisis and President Trump’s adversarial trade policies. Yet the authenticity is that capital flows are more globalized than ever and increasingly beating to the drum of the U.S. dollar.
So, yes, we need variation. The question is how and in what time frame?
Violent or managed change?
The solution I described could be adopted abruptly and disruptively or it could be cooperatively managed for a smoother alteration.
Under the first scenario, let’s consider Russia and China, the two countries I deliberately chose for my explanatory example, since they are assumed to be further ahead than most in developing fiat digital currencies. Both would love to do away with dollar dependence. Could they go it abandoned and jointly devise a bilateral, cross-chain smart contract between a digital renminbi and a digital ruble? Sure. Inclination other countries follow suit? Maybe. Such an uncontrolled retreat from dollars could do huge abuse to the U.S. and the overall global economy.
That’s why I think central banks should heed Carney’s call and work together on a denouement. They could coordinate the gradual introduction of digital currencies, selectively managing access and applying differential curious about rates to discourage an exodus from shaky banks. They could also charge the IMF with seeking a wide-ranging standard for cross-chain interoperability.
Regardless, the disruptive technologies behind digital currencies, stablecoins and decentralized exchanges intent advance. It’s a ticking time bomb.
Some central bankers, led by Carney – and now, Philadelphia Fed President Patrick Harker, who about in a Wharton Business School podcast that stablecoins are “inevitable” – get it. Others need to learn fast.
Notability Carney image via Twocoms / Shutterstock.com