CBDCs versus crypto: A new phase of ‘ Money Wars’

[7 min read]

Dear Reader,

The digital currency medium has a global impact that can be a force for unification but can also be a source of obsessive behaviour, greed, dysfunction, and social disruption. In that sense, cryptocurrencies can undermine confidence in existing currency systems even without displacing them. Their existence has a hallucinogenic effect. Every affected party sees what he wants to see, and no two participants see the effects in quite the same way.

This series of The Daily Reckoning Australia editions, beginning with this article, looks at these new and old forms of money — gold, CBDCs, SDRs, and cryptocurrencies — in the context of today’s global economy. It’s an economy that is itself immersed in the effects of an electronic technological revolution and the third-worst pandemic in 650 years. We’ll look at each form of money separately, including new applications like digital gold and new combinations such as gold-backed SDRs.

Since 2010, the major global economies have been engaged in a currency war involving repeated competitive devaluations of currencies in order to export deflation, import inflation, promote exports, and create export-related jobs. This is a zero- or even negative-sum game that inevitably leads to trade wars, which began in 2018. These also accomplish nothing unless accompanied by internal infrastructure investment and growth-oriented policies.

Now a new phase that could be called ‘money wars’ has begun. It involves non-government cryptocurrencies competing with government money and governments embracing new sovereign digital money called Central Bank Digital Currencies (CBDCs).

CBDCs aren’t really new currencies but are new payment channels for existing currencies. The development of CBDCs enables the true elite agenda — the elimination of cash, confiscation of wealth through negative interest rates (difficult in a system that allows cash), and the perfection of the totalitarian surveillance State.

Cryptocurrencies, which are different from CBDCs, are also gaining wide acceptance. These cannot be analysed generically but must be sorted based on criteria such as anonymity, issuance cap, governance, permissioned versus permissionless systems, transaction speed, and liquidity.

Some cryptocurrencies have better use cases and are safer and more pragmatic than others. Bitcoin [BTC] has no utility because it’s deflationary by design and, therefore, unsuitable for use in bond markets, which is the key to reserve currency status. Bitcoin mining contributes materially to global CO2 emissions through electricity consumption. Bitcoin prices are also highly manipulated through the use of fraudulent stablecoins such as Tether.

The only serious rival to the US dollar as a global reserve currency might be a permissioned blockchain maintained by the International Monetary Fund (IMF) using Special Drawing Rights, or SDRs, as a World CBDC. This challenge to the dollar would be made more potent if the SDR-World CBDC were linked to gold.

Gold is the classic form of money, having performed that role in various ways for more than 3,000 years. The issue for gold is whether it can still perform these roles in an environment of digital money. Gold’s future also points to the possibility of a new kind of monetary trilemma in which any form of money (gold, cryptocurrencies, CBDCs, or SDRs) can perhaps only perform two out of three of the classic three-part definition of money — unit of account, store of value, and medium of exchange — but not all three because of the comparative advantage of rival forms of money in one or more of those functions.

Beyond that, cryptocurrencies and CBDCs must be considered in light of Marshall McLuhan’s thesis that the medium is the message (I will explain that thesis in a future article in this series). Factors such as price, use case, design features, etc., are not the message; they’re content, a medium in a medium, and mostly irrelevant. The message is that cryptocurrencies are an extension of human reach and scale and a cool medium requiring extensive involvement by the user to comprehend a mosaic of information.

China understands CBDCs’ true potential

China already uses facial recognition software, mobile phone GPS tracking, and the purchase of plane or train tickets to track their citizens. This surveillance can be used to detect anti-State activities and to arrest dissidents or anyone who doesn’t strictly follow the orders of Chairman Xi.

China’s lead in producing the first major central bank digital currency is well-known. The Chinese CBDC is already being used in prototype form and may receive a global coming-out party at the 2022 Winter Olympics in Beijing. Recently, China has revealed an even greater ambition; it wants to take its rules for using CBDCs and make them the global standard.

[Editor’s note: The original article this piece was adapted from was written in May of this year.]

Even if the US and Europe don’t agree, it’s likely that many Asian and African countries might agree in exchange for aid from China. That aid can, for example, take the form of access to scarce COVID vaccines. Once China’s totalitarian surveillance software is perfected, they can make it the standard for much of the world and facilitate intrusive 24/7 surveillance by every dictator and autocratic leader in the world. No doubt China would arrange to have access to the same surveillance information it was providing to client States.

While China may be the leader in the race to build CBDCs, the Fed has not been caught napping. The US Federal Reserve System has been working with scientists at the Massachusetts Institute of Technology to develop a dollar form of CBDC. The rollout of this new digital dollar may still be a few years away, but the implications are enormous.

Look out for next Wednesday’s article, which delves into gold and the relationship between the tangible (gold) and the intangible (digital currencies).

Until then,

Jim Rickards,
Strategist, The Daily Reckoning Australia

This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.

Dear Reader,

Yes, dear reader, it’s a YODO world now. Investors are realising that when they are dead, they are dead forever — no Fed voodoo to raise them from the grave.

And it’s the first time for most of them. No chance to practice. No opportunity to learn.

And so, the mood was glum at the end of last week. The jobs report on Thursday showed a stronger employment market than expected. Investors figured the odds of a Fed U-turn had gone down. They sold stocks. From MarketWatch:

‘While markets have not yet morphed into an actual state of alarm, an increasingly dark sentiment is starting to brew behind the scenes.

‘Nikko Asset Management’s John Vail said a “short but scary” global recession is likely to be ahead. Ben Emons of Medley Global Advisors said Wednesday’s decision by major oil producers to cut production, starting next month, has the potential to turn into a prolonged stretch of higher inflation and big market swings. And volatility expert Harley Bassman said stocks could drop as much as 20% from where they are now — a magnitude similar to the single-day decline that took place during 1987’s “Black Monday” scare.’

As the Fed raises rates, they become more ‘normal’ than they’ve been for many years. But ‘normal’ terrifies investors. It makes them realise how weird things have gotten and that they may have to back up before they can go forward. That is, they may have to give up their Bubble Era profits and admit that much of what they believed was either a lie or a delusion.

Disorderly fashion

You don’t get real money from a printing press.

Credit from the central bank is not the same as money that has been earned and saved.

And there are limits to what assets are worth…and how much debt you can support.

And prices go down as well as up.

And fake interest rates — zero! — do far more harm than good.

And a group of hacks at the Fed can’t really improve a US$24 trillion economy.

That would be normal. But when you’ve been living in a dream world, a return to normal can be brutal.

So far, the decline in stocks and bonds has been orderly. There’s been selling, but no panic selling. Today, we wonder when it will become disorderly.

All over the world, from the largest institutions — such as Larry Fink’s BlackRock — to the smallest minimum-wage household, normal interest rates squeeze the space between income and outgo. For many, the space disappears completely…and then outgo exceeds income. And as our old friend Sid Taylor, a defence budget analyst, used to say: ‘When your outflow exceeds your income your upkeep is your downfall’.

The Bank of England (BoE) ‘pivoted’ when it realised what ‘normal’ would do to the gilt (UK Government bond) market. These are, by the way, the safest investments in the UK. They’re not NFTs or cryptos. England is not going to default. Gilts are not going to disappear.

But you can still lose a lot of money in government bonds. And that’s what Britain’s pension and insurance giants were doing when the BoE saved them.

Lessons unlearned

Imagine that you are running a giant pension company. You have billions in assets. But you have billions in liabilities too. People are going to retire; you have to make sure they have the money they were promised.

You invest safely, prudently…careful not to lose money. This is money that absolutely, positively has to be there when it is needed.

Trouble is, you based your projections on ‘normal’ interest rates. At 4% interest, you had it made. Your assets would earn enough to cover upcoming payouts. But at zero interest rates? You had to innovate.

Along comes Larry Fink. He tells you not to worry. You can use his ‘liability-driven investing’ strategy (LDI). In the last major market hoop-de-doo, in 2008, Larry lost US$100 million for First Boston in mortgage-backed securities. But now, he’s learned his lesson, or so he says.

You don’t want to gamble with pension savings. But what else can you do? And Larry makes it sound…well…almost scientific. He shows you some neat charts and graphs. The idea is simple enough. If you need 4% interest, and your investments are only earning 1%...you borrow three times your assets in order to end up with four times as much yield.

Larry wears a nice suit. He says he cares deeply about the environment, social justice, and enlightened corporate governance. And he makes it sound so easy.

And soon, your pension fund has borrowed billions of dollars and Larry’s LDI funds have more than US$1 trillion in assets. But wouldn’t you know it? Just when you thought things might work out, UK bond yields went up (bond prices went down). Gilts were the collateral behind the billions the funds had borrowed. When they went down, pension funds got margin calls and had to sell their gilts to make payments to their creditors — further impairing the value of their collateral.

Panic early, beat the rush

That was the situation on 29 September. The bond market was becoming disorderly. Larry Fink’s LDI empire of debt was tottering. If it toppled over…it could bring down the whole system.

Such is the wacky world created by the ultra-low interest rates. Nothing is safe. Stocks are down. Bonds are down. Even gold, though flat for the year, is down US$300 since March.

When asset prices go down, lenders and investors — and all their tricked-up speculations — get into trouble. Because the assets of the latter are the collateral of the former. So, it was that the UK approached its moment of clarity and normalcy…and wanted nothing to do with it.

Meanwhile, over on this side of the Atlantic…Larry Fink has his headquarters in New York. US pension funds have made similar bets, trying to make up for a lack of yield by taking bigger gambles. Corporations, meanwhile, borrowed more than at any time in history, in order to disguise weak earnings and bid up their share prices. And even the federal government begins to teeter under the weight of US$31 trillion in debt. It soon faces interest payments of US$1 trillion per year.

Something’s gonna give. Then investors, standing in line patiently now, will begin to push and shove…and rush the exits.

Regards,

Bill Bonner,
For The Daily Reckoning Australia