Opinion: Will Central Banks be ‘Crucified on Cross’ of Cyber-Gold?
In 1896, the American populist politician (later Secretary of State) William Jennings Bryan made his famous statement attacking the gold standard with his rallying cry, “you shall not crucify mankind upon a cross of gold.”
Throughout the 1930s, the gold standard (and central bankers who advocated the gold standard) earned a bad name because the fixed price against gold brought about deflation. As the supply of gold was limited whilst demand increased with trade, the price of other goods had to shrink, creating deflation. Global prosperity (and inflation) came about when central bankers abandoned the gold standard, first in the 1930s, and again after 1971, when the US floated the dollar and de-linked it from gold.
No less than the populist philosopher, former White House strategist Steve Bannon, has made the claim that “central bankers are in the business of debasing your currency.” Although there are many critics of central banks’ unconventional monetary policy, this is the first time a serious populist politician has made an attack on the august halls of central banking since Jennings.
In the 19th century, money was either gold, silver or coins issued by the state, central bank printed notes or bank money. In his famous book on Lombard Street (Wall Street’s equivalent in the City of London), the founder of The Economist magazine Walter Bagehot was so worried about bank money that he wrote, “money will not manage itself, and Lombard Street has a great deal of money to manage.” He was a great supporter of the idea that central banks, on behalf of the state, should have a currency monopoly.
In the 21st century, even with the invention of quantitative easing, central bank money comprises less than 15% of total money in circulation — the bulk being commercial bank money (deposits). In other words, commercial banks can create money through their credit activities, by either lending to the private sector or the government. The central bank was created specifically to defend the value of the currency, through its monetary policy. Most central banks are also in charge of financial stability, since the failure of banks could affect the real economy through loss of confidence in bank money.
This broad situation began to change after 2007, when advanced country central banks engaged in quantitative easing (QE) or ultra-loose monetary policy, in an effort to reflate the domestic economy, flood the market with liquidity and help revive the economy. Consequently, advanced country central bank balance sheets expanded by somewhere between three to five times before the crisis, and government debt rose in OECD countries to over 100% of GDP, supported only by historically low interest rates.
Ostensibly, cyber-currencies were invented because users did not trust governments or central banks, preferring to effect payments with each other through digital tokens or “coins.” The whole purpose of these “tokens” is to avoid public scrutiny. Like gold, digital tokens are assets, but no one’s liability. Whereas gold is held in physical custody, digital tokens do not have any central registry except transactions operated through blockchain technology in the cloud. Because of its newness, cyber-tokens have huge price volatility, whereas gold prices have remained relatively stable in recent times.
But it is precisely their volatility and lack of transparency that makes cyber-currencies so attractive for speculators and to those who want to engage in criminal or illicit activities.
Central banks have been struggling to deal with such cyber-currencies or tokens. China and South Korea have banned them outright. Recently, the US Securities and Exchange Commission (as well as Hong Kong Securities and Futures Exchange) have treated Initial Coin Offerings (ICOs) as normal offerings which require substantial scrutiny.
I argue that it is time central bankers make a clear stand on regulation of cyber-currency or tokens.
With the market valuation of Bitcoin and others reaching a peak of $800 billion at their height in January 2018, after Bitcoin hit a peak price of $19,343, cyber-currencies are systemic in nature, since their values (even wildly fluctuating) can at their peak amount to roughly half the market value of world official gold reserves.
Agustin Carstens, former Mexican central bank governor and general manager of the Bank for International Settlements, made the most important plea for central banks to control cyber-currencies, because essentially private monetary creation is actually debasing the money supply. Cyber-tokens are created by private “miners,” who increase the supply and are rewarded by such increases in supply. According to Carstens, “the electricity used in the process of mining bitcoins is staggering, estimated to be equal to the amount Singapore uses every day, making them socially wasteful and environmentally bad.”
IMF Managing Director Christine Lagarde has come out strongly against what she calls the “dark side of the Crypto World,” because these crypto-tokens are “potentially major new vehicle for money laundering and financing of terrorism.”
Some central banks, like the Monetary Authority of Singapore, have chosen not to regulate crypto-tokens directly, for fear of stifling innovation and because they are still considering the right regulatory responses.
But in practice the use of cyber-tokens and digital payments can create a huge gap in both consumer protection and managing large “dark flows.”
Firstly, because prices of cyber-tokens are very volatile and transactions are not accessible to regulators, no one knows whether the prices are manipulated, crypto-wallets are hacked or stolen and whether customer data are used for illegal purposes.
Secondly, because cyber-tokens do not need any intermediary, there is no central register to check whether transactions comply with all regulations, tax or exchange requirements. The audit trail stops once the transactions are converted into cyber-tokens.
Thirdly, in the past all payment transactions had to go through an intermediary, such as a licensed bank, so that the legality and validity of the transaction could be traced. If cyber-tokens can be used to effect payments without any intermediary, tax authorities and regulators face a black hole in which there is no way in which the state can intervene to protect consumers or maintain system integrity or compliance with anti-terrorist funding and money laundering regulations.
Fourth, in the past, the paper trail would always enable governments to investigate unexplained wealth. Today, all kinds of wealth from criminal activities can be explained by “investing in cyber-tokens.”
As the scale, speed and scope of cyber-currencies expand, central bankers no longer can wait to make decisions on whether to enforce regulations. In order to control the expansion of systemic size, central bankers and regulators need to enforce controls now and immediately work together with other regulators to ensure that cyber-currencies comply with minimum standards of transparency and regulations that banks and financial intermediaries comply with.
There is no free lunch. If even thousands of uneducated investors lose their savings investing in cyber-tokens, the loss of faith and trust in central bankers as guardians of the monetary system would be very damaging.
No central banker was censured for not preventing or handling the Great Recession of 2007/2009. But in the next great shake-up some run the risk of being crucified because the loss from cyber-tokens will definitely be blamed on someone.
Regulation is always an asymmetric game. When people make money, its called innovation. When they lose money, its called under-regulation.
Andrew Sheng is a distinguished fellow at the Asia Global Institute, University of Hong Kong.
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