Digital Dollars recede into the future
What’s behind the extreme swings of global markets?
On Monday this week, the Dow Jones Industrial Average fell 1,000 points, only to close about 100 points up on the previous day. The S&P 500 closed on 20 January below its 200-day moving average for the first time since 2020. On Monday it fell by as much as 4% but closed slightly higher. The Nasdaq is still headed for its biggest one-month loss since October 2008. The mini-flight from those assets perceived to be risky (tech stocks were badly hit) spilled over into cryptocurrencies. The leading crypto — Bitcoin — plunged by 50% from its peak of almost $69,000 2 ½ months ago. According to Bloomberg, “the most-speculative stuff is leading the way down… Cryptocurrencies were (and are) even more vulnerable to a sudden shift in investors’ faith”. Gold, however, rose, by around 2% in Dollar and Sterling terms.
Bitcoin’s nose-dive is bad news for El Salvador, whose President, Nayib Bukele, uses his mobile to trade public funds for Bitcoin. Some Salvadorans have claimed that money had gone missing from their digital wallets linked to Bitcoin, which has been legal tender in the country since last year. The International Monetary Fund (IMF) has urged El Salvador to drop its Bitcoin dalliance, but that message is likely to fall on deaf ears. El Salvador has been hoping for an IMF handout of $1 billion, but maybe more generous and less exigent donors — China, Russia maybe? — will step up.
Was it the rising tension between Russia and NATO over Ukraine? Was it an uncomfortable feeling that the US economic recovery is shakier than assumed? Or was it a sense among investors that finally the US Federal Reserve has to get serious about inflation — now shockingly around 7% officially — and will therefore raise interest rates several times this year? Shockingly, the Federal Open Market Committee (FOMC, the policymaking arm which sets interest rates) on Wednesday this week said it would leave the key interest rate at its record low of 0%-0.25%; it might start rate hikes in March.
According to a Gallup poll published this week almost 80% of Americans expect inflation to increase over the next six months — and, as we know, expectations about inflation often become a self-fulfilling prophecy. When the Fed eventually ends its purchases of Treasury and mortgage bonds borrowing costs will become higher, in addition to higher prices for everything else. And now that the IMF is pencilling-in global economic growth slowing this year to 4.4% (from an estimated 5.9% in 2021) the possibility is that with too much monetary tightening the US economy will suffer. The Fed is “at risk of tightening policy into a slowing economy” says one seasoned observer. The greatest impact of higher interest rates will be on — the US government, the world’s largest borrower, with almost $30 trillion in debts. In the US fiscal year of 2021, the federal government spent more than $562 billion in interest on this debt.
As some air squeaked from the ‘bubble of everything’, the US Federal Reserve published its white paper on a possible Dollar Central Bank Digital Currency (CBDC). CBDCs share their underlying technology — blockchain — with cryptocurrencies, but they differ in just about everything else. One commentator, disappointed at the report’s ‘on the one hand, on the other-ness’, dismissed it as “lame”. The report said: “the Federal Reserve does not intend to proceed with issuance of a CBDC without clear support from the executive branch and from Congress, ideally in the form of a specific authorizing law”. The Fed’s report changed the CBDC landscape little, if at all. It stopped short of calling for a CBDC to be introduced, saying instead that it wants a public debate about it, taking in the views of Congress and other ‘stakeholders’. Digital Dollars may be on their way, but not yet.
While the Fed was publishing its report on The US Dollar in the Age of Digital Transformation, in the UK the upper house of Parliament, the House of Lords, published its own CBDC analysis, with the rather more sceptical title Central bank digital currencies: a solution in search of a problem?
The House of Lords report notes that more than 90 central banks are exploring CBDCs and thinks that’s because central banks are worried that big tech companies, such as Meta/Facebook, could issue their own digital currencies to the users of their vast networks, giving them tremendous market power. And there is the decline in the use of physical cash, which may undermine public confidence in the monetary system.
But a UK CBDC may pose significant risks, it adds. “These risks include state surveillance of people’s spending choices, financial instability as people convert bank deposits to CBDC during periods of economic stress, an increase in central bank power without sufficient scrutiny, and the creation of a centralised point of failure that would be a target for hostile nation state or criminal actors”.
“When there’s no stability, people look for alternative solutions”. That quote deserves to be engraved on the heart of every central banker and government finance minister. It belongs to ‘Orhan’, said to be a 39-year-old Turkish web security expert, who was interviewed in the Financial Times about the surge in cryptocurrency trading in Turkey, which in 2021 was an estimated 10 times greater than 2020. The temptation of cryptocurrencies for Turks had been that it was seen as a protection against the declining purchasing power of the Lira, the country’s fiat currency. By the end of 2021 the Turkish lira had lost around 40% of its value against the US Dollar. With the slide in cryptocurrencies, that protection now looks weaker.
Russia’s central bank, which is planning its own (rouble) CBDC, has now proposed a ban on the use and creation of cryptocurrencies on Russian territory, because, (it says) of threats to financial stability, and to protect citizens’ wellbeing and monetary policy sovereignty. Cryptocurrencies were given legal status in Russia in 2020 but were barred from use as a means of payment. Following China’s ban on all cryptocurrency transactions and mining last September, Russia became the third-biggest cryptocurrency miner, after the US and Kazakhstan.
Cryptocurrencies had a good pandemic, achieving a global market value estimated at $3 trillion at the peak (now halved), thanks in part to the massive monetary stimulus from the US administration. One commentator suggests that “over the last five years, its massive price gains appear to be driven by a heady mix of speculation, network effects, and hype”.
Meanwhile, Russia’s central bank has been steadily building up its official gold reserves, which now are higher than its US Dollar reserves. The rouble has slid to around 79 to the Dollar, its lowest since late 2020. On the other hand Russia is very happy that one of its major exports, crude oil, has now hit $90 per barrel, the first time that level has been seen in seven years.
Threats to global payments
To Winston Churchill is attributed the saying “to jaw-jaw is always better than to war-war”; we must hope that Presidents Putin and Biden agree. They have much more in common than they perhaps realise, not the least of which is the international SWIFT (Society for Worldwide Interbank Financial Telecommunications) payments’ system, which is a secure communications platform used by financial institutions, although it does not hold or move money and securities. Each year it facilitates trillions of Dollars in cross-border payments; it is trusted by all.
The 11,000 SWIFT member institutions sent more than 35 million transactions per day through the network in 2020. Prior to SWIFT, Telex was the only available means of message confirmation for international funds transfer. Telex was slow, insecure concerns, prone to human error, and lacked a unified system of codes to name banks and describe transactions, which SWIFT has had since its formation in 1973.
President Biden has dropped strong hints that cutting Russia off from the SWIFT system might be one of the sanctions imposed against Russia if it invades or conducts and incursion into Ukraine. SWIFT is governed by Belgian and EU law, so it could ignore the US, but the US might indulge in some arm-twisting to get it to cooperate. Cutting Russia out of SWIFT is a ‘nuclear’ option but one that Russia might feel it can shrug off; like the US’s other major ideological opponent, China, Russia has been busily constructing its own domestic financial communications system, called the System for Transfer of Financial Messages (SPFS), with more than 400 member banks. By 2020 the SPFS handled 20% of all domestic financial communications. China’s SWIFT alternative is called the Cross-Border Interbank Payment System (CIPS). But China is backing more than one horse; a year ago it became known that China had created a new entity, Finance Gateway Information Services, 55% of which is owned by SWIFT and the other 45% by China’s central bank and other Chinese entities, including CIPS. Finance Gateway is charged with information system integration, data processing and tech consultancy.
Reserve status fight
Both Russia and China are clearly taking steps to shore up their financial ramparts against any high-level sanctions by the US. While the rouble can only dream of achieving global reserve currency status, that’s not true of China’s yuan. Co-opting SWIFT, by approaching with stealth, China is playing a much cannier game than seeking outright naked conflict.
At Beijing’s Winter Olympics starting next week, China’s own CBDC, the e-yuan, will be much in evidence. Despite its zero-Covid policy, the number of athletes and visitors will be large; they will all be encouraged to use the CBDC, for taxis, luggage-trolleys, restaurants. And meanwhile, digital Dollars recede into the future.
Where does all this leave gold? Sitting comfortably, I’d propose. Gold has been an internationally accepted form of payment for centuries; it has undergone periods of inflation, deflation, cold wars, hot wars, government hostility and the mockery of the conventionally-minded. And now, with Glint, gold finally has its very own super-fast payments system.
At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.