Asia | Bitcoin & Crypto | China | Politics & Geopolitics
This is the third of my notes on digital currencies. Although I had not intended them as such, these notes have effectively become an annual survey of the evolving use of digital currency. In 2017, the focus was on the Bitcoin bubble and how it might evolve (badly). In 2018-19, it was on the emerging second generation of private sector digital currencies – stablecoins.
In 2020, the focus returns to the first-generation digital currencies. This is due to post-COVID fears of inflation in traditional major currencies caused by the widespread de facto adoption of modern monetary theory (MMT). Focus has also been on the emergence of central bank digital currencies (CBDC). China has benefitted in both areas: it had the best COVID crisis among the major economies, and it is leading CBDC development.
V1: Bitcoin’s Second Wind
The price of bitcoin has returned to its highest level since early 2018, when the 2017 H2 bubble was bursting (Chart 1). The bitcoin price fell by 74% through 2018. It then rose sharply through 2019H1 before collapsing again through mid-March 2020.
The most recent inflection point up since then corresponds to the surge in the monetary base in DM economies. Economic policy post COVID has become extraordinarily easy in the DM world, with both monetary and fiscal policies wide open. DM budget deficits in 2020 will be in the 10-20% of GDP range (with the US at the higher end). These deficits are being entirely financed through monetary base expansion – a policy approach advocated by MMT. Early in 2020, the US administration warned that the policies that Bernie Sanders was advocating in the Democratic Party primary campaign – which included a massive increase in government spending on health care and social support – would lead to runaway inflation. Within weeks, the COVIC crisis had caused them to adopt the very policies that Sanders was talking about phasing in over several years. In these circumstances, it was unsurprising that Bitcoin enjoyed a burst of investor interest as a hedge against the risks of both higher inflation and the potential for losses on DM government bonds – the traditional safe asset in the system. Since mid-March, bitcoin has outperformed gold, an alternative hedge (Chart 2).
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- The 2020 focus has been bitcoin’s rebound and efforts to develop CBDCs
- In the middle, the Facebook-led effort to promote stablecoins has faltered
- The MMT shift by DM central banks in 2020 has driven Bitcoin’s second wind
- BIS leads the CBDC effort, but development is independent of China
This is the third of my notes on digital currencies.[1] Although I had not intended them as such, these notes have effectively become an annual survey of the evolving use of digital currency. In 2017, the focus was on the Bitcoin bubble and how it might evolve (badly). In 2018-19, it was on the emerging second generation of private sector digital currencies – stablecoins.
In 2020, the focus returns to the first-generation digital currencies. This is due to post-COVID fears of inflation in traditional major currencies caused by the widespread de facto adoption of modern monetary theory (MMT). Focus has also been on the emergence of central bank digital currencies (CBDC). China has benefitted in both areas: it had the best COVID crisis among the major economies, and it is leading CBDC development.
V1: Bitcoin’s Second Wind
The price of bitcoin has returned to its highest level since early 2018, when the 2017 H2 bubble was bursting (Chart 1). The bitcoin price fell by 74% through 2018. It then rose sharply through 2019H1 before collapsing again through mid-March 2020.
The most recent inflection point up since then corresponds to the surge in the monetary base in DM economies. Economic policy post COVID has become extraordinarily easy in the DM world, with both monetary and fiscal policies wide open. DM budget deficits in 2020 will be in the 10-20% of GDP range (with the US at the higher end). These deficits are being entirely financed through monetary base expansion – a policy approach advocated by MMT. Early in 2020, the US administration warned that the policies that Bernie Sanders was advocating in the Democratic Party primary campaign – which included a massive increase in government spending on health care and social support – would lead to runaway inflation. Within weeks, the COVIC crisis had caused them to adopt the very policies that Sanders was talking about phasing in over several years. In these circumstances, it was unsurprising that Bitcoin enjoyed a burst of investor interest as a hedge against the risks of both higher inflation and the potential for losses on DM government bonds – the traditional safe asset in the system. Since mid-March, bitcoin has outperformed gold, an alternative hedge (Chart 2).
One attractive feature of bitcoin in an MMT environment is its limited supply (in contrast with central bank money). A total of 21 million can ever be (digitally) mined; there are currently 18.525 million in circulation (about 88% of the max). The technology of bitcoin mining is such that new production will shrink asymptotically until all bitcoins are in circulation (a terminal date estimated at 2140).
The counter to this bullish argument is that there is technically no limit to the creation of new, alternative cryptocurrencies. The 2017 bitcoin bubble spurred the growth of alternatives, pushing bitcoin’s crypto market share down to 40% (Chart 3). It has since risen back to about 60%. Globally, some legal restrictions have been imposed on new digital coins, most notably in China which banned the creation of new coins in September 2017 amid a local issuance frenzy.
V2: Stablecoins Suffer From Trust Issues
Facebook launched its Libra ‘stablecoin’ project in June 2019 as a way to combine digital currency technology with the store of value stability of traditional (central bank issued) currency. The plan was to offer a convenient payment and money transfer technology, rather than an alternative form of monetary asset. Central bank liabilities would back Libra one-for-one to ensure stability. The original plan was to launch the new Libra ‘ecosystem’ in 2020H1. This ‘ecosystem’ would consist of the Libra Blockchain, a blockchain built from scratch to prioritize scalability, security, and reliability, as well as the flexibility required to evolve over time; and the Libra Reserve, a stock of hard assets that would back the Libra currency, providing low volatility, wide global acceptance, and fungibility. As we approach the end of 2020, Libra’s launch remains elusive.
Some of this reflects the erosion in private sector support for a Facebook-led venture (Visa, Mastercard E-Bay and PayPal exited the Libra Association in 2019H2). The COVID crisis in 2020 might have slowed the project, although the shift to online shopping and health worries over handling physical money increased the case for improved digital payment technology (Chart 4). But the most decisive force slowing the project has been pushback from the official sector, which has emphasized that no global stable coin (GSC) project should be allowed to start without extensive global regulatory approval (Chart 5).
The FSB summarized the latest official thinking on financial stability and regulatory concerns surrounding stablecoins (especially, but not specifically, Facebook’s Libra project) in a report on 13 October. The 10 key recommendations from that report effectively said this: we have spent a decade building a more robust financial system; we refuse to allow an upstart GSC to emerge that could endanger all that progress.
V3: CBDC – Watch China
Aside from strong regulatory pushback, DM central banks have another workstream developing designed to address the emergence of privately run digital currencies as a means of payment: develop their own CBDCs (Chart 6). As befits its status in the global system (and its name), the Bank for International Settlements (BIS) is coordinating the development of principles governing CBDC (Chart 7).
Central banks already provide digital money to the banking system through the provision of reserve balances (one way of defining a bank is any institution maintaining an account at the central bank). CBDC is all about the direct provision of digital CB liabilities to all – especially individuals. CBDC is therefore best seen mainly as a retail product, ultimately likely to replace cash. The emergence of private sector digital currencies has spurred central banks to be more adventurous on CBDCs in recent quarters than they might otherwise have been. Their thinking is that the world has changed, and CBs need to keep up or risk the evolution of a system over which they have less control. That rampant central bank money creation could fuel this substitution is a perspective absent from this thinking.
Sweden is the DM economy furthest ahead in developing a CBDC (e-krona). The use of cash has already fallen to a lower level there than in any other major economy (Chart 8). Governor Stefan Ingves recently observed that ‘if we were to find ourselves in a situation where the Swedish krona is no longer regarded as the most important currency alternative for making payments in Sweden, we could ultimately lose the possibility to conduct our own monetary policy and to provide the banks with liquidity in a crisis.’ Since February 2020, the Riksbank has been running a pilot project with Accenture to develop a robust technical platform for the e-krona (using blockchain technology). This pilot project is purely internal and will run (at least) through February 2021.
The People’s Bank of China (PBoC) is leading CBDC development. Work on its plans began in 2014, although it has been obscure over the development timeline. Most recently, however, it has launched a pilot program to trial using digital-RMB in the real economy. In October, it held a lottery in Shenzen where CNY2,000 was gifted to 5,000 winners who received ‘red envelopes’ to spend at designated retailers via the government’s digital-RMB app. Unsurprisingly, there was massive excess demand (2 million) for the free money. The response to the tool was poor, however, since the local payment system is already very sophisticated thanks to Alipay and We Chat Pay (Chart 9).
Two additional factors could help China’s digital currency development. First, the PBoC’s balance sheet expansion has been far more moderate than both the Federal Reserve and ECB through the COVID crisis (Chart 10). Second, foreign holdings of the CNY are far lower than those of the ECB and, especially, the Federal Reserve.
Geopolitics Affect CBDC Development
In my view, it is unfortunate that digital currency development is occurring just as US-China relations are souring fast, with a key source of geopolitical tension being influence over the course of the next phase of digital technology.
For example, I am unsure why the PBoC is not part of the BIS initiative on CBDCs (ironic, since it is further along than anyone else). Were they not invited, or did they choose to opt out? China was not fully part of the Bretton Woods system of international monetary cooperation in its early years for obvious reasons. Its exclusion from the next generation of (digital) international monetary cooperation seems (to me) an unfortunate development. This is partly because it will encourage the Chinese authorities to develop their own system, which they could cajole client states along the Belt and Road Initiative into using – at a cost to more general global initiatives.
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The emergence of digital currency: a macro view, Suttle Economics Notes #17, 6 December 2017; Digital Currencies: an update, Suttle Economics Notes #99, 9 October 2019. ↑
Phil Suttle is the founder and principal of Suttle Economics.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)
Regarding the Shenzhen pilot case, PBOC couldn’t use AliPay and Wechat Pay wallets because of the nature of the DCEP distributed – the e-money had a time constraint, i.e. if it were not spent with a certain time, it expired. Once spent, it becomes fungible with the regular e-money already in existence. And yes, PBOC confirmed that AliPay and WeChat Pay will continue to play important role in the DCEP project. Not sure what you mean when you say “The response to the tool was poor”.