The surging price of the world’s best-known cryptocurrency has made some investors rich and prompted skeptics to point to the excesses of the current bull market. Central bank digital currencies (CBDCs) may offer a surer route to greater financial inclusion, but are policymakers and the public prepared for this potentially radical innovation?
In this Big Picture, Harvard University’s Kenneth Rogoff thinks that the COVID-19 pandemic could accelerate the emergence of CBDCs, and outlines two ways in which monetary policymakers could introduce them. The case for a digital dollar, however, is far from clear-cut, says Barry Eichengreen of the University of California, Berkeley, not least because fear that a digital renminbi will challenge the greenback’s global dominance is overblown. But New York University’s Nouriel Roubini makes the case that CBDCs could replace both an inherently crisis-prone banking system and worthless private cryptocurrencies such as Bitcoin.
Chatham House’s Jim O’Neill is similarly unimpressed by the Bitcoin hype, and explains why cryptocurrencies like it will never be anything more than speculative vehicles. For that reason, says Willem H. Buiter of Columbia University, only those with a robust appetite for risk and the wherewithal to absorb heavy losses should consider investing in them. By contrast, Brian Armstrong of cryptocurrency exchange Coinbase argues that cryptocurrencies with strong consumer-privacy protections should be a key feature of the post-pandemic recovery.
Either way, conclude Katharina Pistor of Columbia Law School and Co-Pierre Georg of the University of Cape Town, central banks may soon need to expand their remit and develop a new regulatory infrastructure to manage both public and private digital currencies.
The COVID-19 pandemic is accelerating the long-term shift away from cash, and monetary authorities risk falling behind. A recent report from the G30 argues that if central banks want to shape the outcome, they need to start thinking fast.
CAMBRIDGE – As the COVID-19 crisis accelerates the long-term shift away from cash (at least in tax-compliant, legal transactions), official discussions about digital currencies are heating up. Between the impending launch of Facebook’s Libra and China’s proposed central-bank digital currency, events today could reshape global finance for a generation. A recent report from the G30 argues that if central banks want to shape the outcome, they need to start moving fast.
Much is at stake, including global financial stability and control of information. Financial innovation, if not carefully managed, is often at the root of a crisis, and the dollar gives the United States significant monitoring and sanctions capabilities. Dollar dominance is not just about what currency is used, but also about the systems that clear transactions, and, from China to Europe, there is a growing desire to challenge this. This is where a lot of the innovation is taking place.
Central banks can take three distinct approaches. One is to make significant improvements to the existing system: reduce fees for credit and debit cards, ensure universal financial inclusion, and upgrade systems so that digital payments can clear in an instant, not a day.
The US lags badly in all these areas, mainly because the banking and financial lobby is so powerful. To be fair, policymakers also need to worry about keeping the payments system secure: the next virus to hit the global economy could well be digital. Rapid reform could create unexpected risks.
At the same time, any effort to maintain the status quo should provide room for new entrants, whether “stable coins” pegged to a major currency, like Facebook’s Libra, or redeemable platform tokens that large retail tech companies such as Amazon and Alibaba might issue, backed by the ability to spend on goods the platform sells.
The most radical approach would be a dominant retail central-bank currency which allows consumers to hold accounts directly at the central bank. This could have some great advantages, such as guaranteeing financial inclusion and snuffing out bank runs.
But radical change also carries many risks. One is that the central bank is poorly positioned to provide quality service on small retail accounts. Perhaps this could be addressed over time, by using artificial intelligence or by expanding financial services offered by post office branches.
In fact, when it comes to retail central-bank digital currencies, economists worry about an even bigger problem: Who will make loans to consumers and small businesses if banks lose most of their retail depositors, who comprise their best and cheapest source of borrowing?
In principle, the central bank could re-lend to the banking sector the funds it gets from digital currency deposits. This would, however, give the government an inordinate amount of power over the flow of credit, and ultimately the development of the economy. Some may see this as a benefit, but most central bankers probably have deep reservations about assuming this role.
Security is another issue. The current system, in which private banks play a central role in payments and lending, has been in place around the world for more than a century. Sure, there have been problems; but for all the challenges banking crises have created, systemic breakdowns in security have not been the major issue.
Technology experts warn that for all the promise of new cryptographic systems (on which many new ideas are based), a new system can take 5-10 years to “harden.” What country would want to be a financial guinea pig?
China’s new digital currency offers a third, intermediate vision. As the G30 report describes in greater detail than previously available, China’s approach involves eventually replacing most paper currency, but not replacing banks. In other words, consumers would still hold accounts at banks, which in turn would hold accounts with the central bank.
When consumers want cash, however, instead of getting paper currency (which is rapidly becoming passé in Chinese cities anyway), they would receive tokens in their digital wallet at the central bank. Like cash, the central-bank digital currency would pay zero interest, giving interest-bearing bank accounts a competitive edge.
Of course, the government can change its mind later and start offering interest; banks may also lose their edge if the general level of interest rates collapses. This framework does take away the anonymity of paper currency, but many monetary authorities, including the European Central Bank, have discussed ideas for introducing anonymous low-value payments.
Last, but not least, a shift to digital currencies would make it easier to implement deeply negative interest rates, which, as I have argued for many years, would go a long way toward restoring the potency of monetary policy in crises. One way or another, the post-pandemic world will move very fast in payments technologies. Central banks cannot afford to play catch-up.
Who Needs a Digital Dollar?
Recently, the idea of a digital greenback elicited support from US Treasury Secretary Janet Yellen and Federal Reserve Chair Jay Powell. Ultimately, the advantages of a digital dollar will need to be weighed against the potentially high costs and significant risks to the financial system that come with it.
BERKELEY – The idea of a digital dollar has been in the air for some time now. Recently, it descended from the ether to the lips of US Treasury Secretary Janet Yellen and Federal Reserve Chair Jay Powell. At an event in February, Yellen flagged the idea as “absolutely worth looking at,” adding that the Federal Reserve Bank of Boston, in conjunction with academics at MIT, was already doing so. In Congressional testimony the following day, Powell called a digital dollar “a high priority project for us.”
Some see this as another front in the technological cold war between the United States and China. The People’s Bank of China (PBOC) will almost certainly be the first major central bank to roll out a digital currency, in 2022 at the latest. If the US doesn’t move quickly, it will fall behind. America’s financial system will remain stuck in the twentieth century, damaging US competitiveness. The dollar’s position as the dominant international currency will be eroded by the ease of using China’s digital unit in cross-border transactions, and the US will squander a singular source of monetary and financial leverage.
In fact, such concerns are either overblown or flat-out wrong. The PBOC’s main motivation for issuing a digital renminbi is to create a government-controlled alternative to two very large and loosely regulated digital payment platforms, Alipay and WeChat Pay.
The ubiquity of Alipay and WeChat Pay raises the specter of the Chinese authorities losing control of payment flows through the economy. And because they use information on payments to inform their lending activities, their pervasiveness points to the possibility of the authorities losing control of financial flows and credit allocation more generally. Thus, the PBOC’s determination to issue a digital currency is part and parcel of the Chinese government’s decision last November to quash the initial public offering of Ant Group, Alipay’s corporate parent.
The American government has no analogous worries. In the US, scores of different platforms, such as PayPal, Stripe, and Square carry out digital payments, which are ultimately settled by banks, and hence through Fedwire, the Federal Reserve’s in-house system for clearing interbank transactions. Visa, Mastercard, Discover, and American Express process the lion’s share of card-based payments, but their actual cards are issued by banks, which are regulated, limiting risks to the payments and financial system. Here, too, settlement occurs through Fedwire.
Similarly, it is important to bear in mind how far the renminbi lags behind the greenback as an international currency. Currently, China’s currency accounts for a mere 2% of global cross-border payments, a negligible share compared to the dollar’s 38%.
To be sure, the convenience of a digital renminbi would hasten its uptake in cross-border transactions. But that digital currency might also have a hidden backdoor, enabling Chinese authorities to track transactions and identify those undertaking them, discouraging use by third parties. Given this, it’s hard to see China’s digital currency as a game changer internationally.
So, the decision to create a digital dollar would have to be justified on other grounds. The soundest justification is financial inclusion. Americans without credit cards and bank accounts, who rely entirely on cash, are denied not just financial services but other services as well. Rideshare companies ask you to link your app to your credit or debit card; no card, no pick-up. And no bank account, no card.
In this context, recall the difficulty the US Treasury had in getting pandemic relief checks to the unbanked. If everyone had a Federal Reserve-issued electronic wallet into which digital dollars could be deposited, this problem would be solved.
Digital dollars could also address the exorbitant cost of cross-border money transfers. But foreign governments might be reluctant to permit their nationals to install the Fed’s digital wallet, because that would leave them and their central banks unable to enforce their capital controls, which they value as macroprudential tools.
Alternatively, the Fed’s digital wallet could be made interoperable with foreign digital wallets. But interoperability would require close cooperation between central banks on the details of technology and security. While there are efforts in this direction, making it work would be a daunting task, to say the least.
Ultimately, such advantages should be weighed against the costs and risks of digitizing the dollar. If people shift their savings from banks to digital wallets, banks’ ability to lend will be hamstrung. Some banks will close, and small businesses that rely on banks for credit will have to look elsewhere.
Moreover, a Fed-run network of retail payments would be a rich target for hackers and digital terrorists. Security and financial stability are of the essence, and it is not obvious that they can be guaranteed. All this is to say that while the case for a digital dollar may be worthy of examination by Yellen and Powell, it is hardly a slam-dunk.
Why Central Bank Digital Currencies Will Destroy Cryptocurrencies
Leading economic policymakers are now considering whether central banks should issue their own digital currencies, to be made available to everyone, rather than just to licensed commercial banks. The idea deserves serious consideration, as it would replace an inherently crisis-prone banking system and close the door on crypto-scammers.
NEW YORK – The world’s central bankers have begun to discuss the idea of central bank digital currencies (CBDCs), and now even the International Monetary Fund and its managing director, Christine Lagarde, are talking openly about the pros and cons of the idea.
This conversation is past due. Cash is being used less and less, and has nearly disappeared in countries such as Sweden and China. At the same time, digital payment systems – PayPal, Venmo, and others in the West; Alipay and WeChat in China; M-Pesa in Kenya; Paytm in India – offer attractive alternatives to services once provided by traditional commercial banks.
Most of these fintech innovations are still connected to traditional banks, and none of them rely on cryptocurrencies or blockchain. Likewise, if CBDCs are ever issued, they will have nothing to do with these over-hyped blockchain technologies.
Nonetheless, starry-eyed crypto-fanatics have seized on policymakers’ consideration of CBDCs as proof that even central banks need blockchain or crypto to enter the digital-currency game. This is nonsense. If anything, CBDCs would likely replace all private digital payment systems, regardless of whether they are connected to traditional bank accounts or cryptocurrencies.
As matters currently stand, only commercial banks have access to central banks’ balance sheets; and central banks’ reserves are already held as digital currencies. That is why central banks are so efficient and cost-effective at mediating interbank payments and lending transactions. Because individuals, corporations, and non-bank financial institutions do not enjoy the same access, they must rely on licensed commercial banks to process their transactions. Bank deposits, then, are a form of private money that is used for transactions among non-bank private agents. As a result, not even fully digital systems such as Alipay or Venmo can operate apart from the banking system.
By allowing any individual to make transactions through the central bank, CBDCs would upend this arrangement, alleviating the need for cash, traditional bank accounts, and even digital payment services. Better yet, CBDCs would not have to rely on public “permission-less,” “trustless” distributed ledgers like those underpinning cryptocurrencies. After all, central banks already have a centralized permissioned private non-distributed ledger that allows for payments and transactions to be facilitated safely and seamlessly. No central banker in his or her right mind would ever swap out that sound system for one based on blockchain.
If a CBDC were to be issued, it would immediately displace cryptocurrencies, which are not scalable, cheap, secure, or actually decentralized. Enthusiasts will argue that cryptocurrencies would remain attractive to those who wish to remain anonymous. But, like private bank deposits today, CBDC transactions could also be made anonymous, with access to account-holder information available, when necessary, only to law-enforcement authorities or regulators, as already happens with private banks. Besides, cryptocurrencies like Bitcoin are not actually anonymous, given that individuals and organizations using crypto-wallets still leave a digital footprint. And authorities that legitimately want to track criminals and terrorists will soon crack down on attempts to create crypto-currencies with complete privacy.
Insofar as CBDCs would crowd out worthless cryptocurrencies, they should be welcomed. Moreover, by transferring payments from private to central banks, a CBDC-based system would be a boon for financial inclusion. Millions of unbanked people would have access to a near-free, efficient payment system through their cell phones.
The main problem with CBDCs is that they would disrupt the current fractional-reserve system through which commercial banks create money by lending out more than they hold in liquid deposits. Banks need deposits in order to make loans and investment decisions. If all private bank deposits were to be moved into CBDCs, then traditional banks would need to become “loanable funds intermediaries,” borrowing long-term funds to finance long-term loans such as mortgages.
In other words, the fractional-reserve banking system would be replaced by a narrow-banking system administered mostly by the central bank. That would amount to a financial revolution – and one that would yield many benefits. Central banks would be in a much better position to control credit bubbles, stop bank runs, prevent maturity mismatches, and regulate risky credit/lending decisions by private banks.
So far, no country has decided to go this route, perhaps because it would entail a radical disintermediation of the private banking sector. One alternative would be for central banks to lend back to private banks the deposits that moved into CBDCs. But if the government was effectively banks’ only depositor and provider of funds, the risk of state interference in their lending decisions would be obvious.
Lagarde, for her part, has advocated a third solution: private-public partnerships between central banks and private banks. “Individuals could hold regular deposits with financial firms, but transactions would ultimately get settled in digital currency between firms,” she explained recently at the Singapore Fintech Festival. “Similar to what happens today, but in a split second.” The advantage of this arrangement is that payments “would be immediate, safe, cheap, and potentially semi-anonymous.” Moreover, “central banks would retain a sure footing in payments.”
This is a clever compromise, but some purists will argue that it would not solve the problems of the current fractional-reserve banking system. There would still be a risk of bank runs, maturity mismatches, and credit bubbles fueled by private-bank-created money. And there would still be a need for deposit insurance and lender-of-last-resort support, which itself creates a moral hazard. Such issues would need to be managed through regulation and bank supervision, and that wouldn’t necessarily be enough to prevent future banking crises.
In due time, CBDC-based narrow banking and loanable-funds intermediaries could ensure a better and more stable financial system. If the alternatives are a crisis-prone fractional-reserve system and a crypto-dystopia, then we should remain open to the idea.
The Bitcoin Lottery
The sudden rise of “special purpose acquisitions companies” and cryptocurrencies speaks less to the virtues of these vehicles than to the excesses of the current bull market. In the long term, these assets will mostly fall into the same category as speculative “growth stocks” today.
LONDON – I was recently approached about setting up my own “special purpose acquisition company” (SPAC), which would allow me to secure financial commitments from investors on the expectation that I will eventually acquire some promising business that would prefer to avoid an initial public offering. In picturing myself in this new role, I mused that I could be doubly fashionable by also jumping into the burgeoning field of cryptocurrencies. There have been plenty of headlines about striking it big, quickly, so why not get in on the action?
Being a wizened participant in financial markets, I declined the invitation. The rising popularity of SPACs and cryptocurrencies seems to reflect not their own strengths but rather the excesses of the current moment, with its raging bull market in equities, ultra-low interest rates, and policy-driven rallies after a year of COVID-19 lockdowns.
To be sure, in some cases, pursuing the SPAC route to a healthy return probably makes a lot of sense. But the fact that so many of these entities are being created should raise concerns about looming risks in the surrounding markets.
As for the cryptocurrency phenomenon, I have tried to remain open-minded, but the economist in me struggles to make sense of it. I certainly understand the conventional complaints about the major fiat currencies. Throughout my career as a foreign-exchange analyst, I often found that it was much easier to dislike a given currency than it was to find one with obvious appeal.
I can still remember my thinking during the run-up to the introduction of the euro. Aggregating individual European economies under a shared currency would eliminate a key source of monetary-policy restraint – the much-feared German Bundesbank – and would introduce a new set of risks to the global currency market. This worry led me (briefly) to bet on gold. But by the time the euro was introduced in 1999, I had persuaded myself of its attractions and changed my view (which turned out to be a mistake for the first couple of years, but not in the long term).
Similarly, I have lost count of all the papers I have written and read on the supposed unsustainability of the US balance of payments and the impending decline of the dollar. True, these warnings (and similar portents about Japan’s long-running experiment in monetary-policy largesse) have yet to be borne out. But, given all this inductive evidence, I can see why there is so much excitement behind Bitcoin, the modern version of gold, and its many competitors. Particularly in developing and “emerging” economies, where one often cannot trust the central bank or invest in foreign currencies, the opportunity to stow one’s savings in a digital currency is obviously an inviting one.
By the same token, there has long been a case to be made for creating a new world currency – or upgrading the International Monetary Fund’s reserve asset, special drawing rights – to mitigate some of the excesses associated with the dollar, euro, yen, pound, or any other national currency. For its part, China has already introduced a central bank digital currency, in the hopes of laying the foundation for a new, more stable global monetary system.
But these innovations are fundamentally different from a cryptocurrency like Bitcoin. The standard economic textbook view is that for a currency to be credible, it must serve as a means of exchange, a store of value, and a unit of account. It is hard to see how a cryptocurrency could meet all three of these conditions all of the time. True, some cryptocurrencies have demonstrated an ability to perform some of these functions some of the time. But the price of Bitcoin, the canonical cryptocurrency, is so volatile that it is almost impossible to imagine it becoming a reliable store of value or means of exchange.
Moreover, underlying these three functions is the rather important role of monetary policy. Currency management is a key macroeconomic policymaking tool. Why should we surrender this function to some anonymous or amorphous force such as a decentralized ledger, especially one that caps the overall supply of currency, thus guaranteeing perpetual volatility?
At any rate, it will be interesting to see what happens to cryptocurrencies when central banks finally start raising interest rates after years of maintaining ultra-loose monetary policies. We have already seen that the price of Bitcoin tends to fall sharply during “risk-off” episodes, when markets suddenly move into safe assets. In this respect, it exhibits the same behavior as many “growth stocks” and other highly speculative bets.
In the interest of transparency, I did consider buying some Bitcoin a few years ago, when its price had collapsed from $18,000 to below $8,000 in the space of around two months. Friends of mine predicted that it would climb above $50,000 within two years – and so it has.
Ultimately, I decided against it, because I had already taken a lot of risk investing in early-stage companies that at least served some obvious purpose. But even if I had bet on Bitcoin, I would have understood that it was just a speculative punt, not a bet on the future of the monetary system.
Speculative bets do of course sometimes pay off, and I congratulate those who loaded up on Bitcoin early on. But I would offer them the same advice I would offer to a lottery winner: Don’t let your windfall go to your head.
Notwithstanding the recent spectacular surge in its price, Bitcoin will remain an asset without intrinsic value whose market value can be anything or nothing. Only those with healthy risk appetites and a robust capacity to absorb losses should consider investing in it.
NEW YORK – On February 8, Elon Musk’s electric-car firm Tesla announced that it had invested $1.5 billion of its cash reserves in Bitcoin back in January. The news helped to boost the cryptocurrency’s already skyrocketing price by a further 10%, to a record high of more than $44,000. But, especially in Bitcoin’s case, what goes up can just as easily come crashing down.
Bitcoin was invented in 2008 and began trading in 2009. In 2010, the value of a single Bitcoin rose from around eight-hundredths of a cent to eight cents. In April 2011, it traded at 67 cents, before subsequently climbing to $327 by November 2015. As recently as March 20 last year, Bitcoin traded at about $6,200, but its price has since increased more than sevenfold.
Today, Bitcoin is a perfect, 12-year-old bubble. I once described gold as “shiny Bitcoin,” and characterized the metal’s price as a 6,000-year-old bubble. That was a bit unfair to gold, which used to have intrinsic value as an industrial commodity (now largely redundant), and still does as a consumer durable widely used in jewelry.
Bitcoin, by contrast, has no intrinsic value; it never did and never will. It is a purely speculative asset – a private fiat currency – whose value is whatever the markets say it is.
But Bitcoin is also a socially wasteful speculative asset, because it is expensive to produce. The cost of “mining” an additional Bitcoin – solving computational puzzles using energy-intensive digital equipment – increases at such a rate that the total stock of the cryptocurrency is capped at 21 million units.
Of course, even if Bitcoin’s protocol is not changed to allow for a larger supply, the whole exercise can be repeated through the issuance of Bitcoin 2, Bitcoin 3, and so on. The real costs of mining will thus be replicated, too. Moreover, there are already well-established cryptocurrencies – for example, Ether – operating in parallel with Bitcoin.
But as the success of government-issued fiat currencies shows, the universe of speculative bubbles is by no means restricted to cryptocurrencies like Bitcoin. After all, in a world with flexible prices, there is always an equilibrium where everyone believes the official fiat currency has no value – in which case it consequently has no value. And there are infinitely many “non-fundamental” equilibria where the general price level – the reciprocal of the fiat currency’s price – either explodes and goes to infinity or implodes and falls to zero, even when the money stock remains fairly steady or does not change at all.
Finally, there is the unique “fundamental” equilibrium at which the price level (and the value of the currency) is positive and neither explodes nor implodes. Most government-issued fiat currencies appear to have stumbled into this fundamental equilibrium and stayed there. Keynesians ignore these multiple equilibria, viewing the price level (and thus the price of money) as uniquely determined by history and updated gradually through a mechanism like the Phillips curve, which posits a stable and inverse relationship between (unexpected) inflation and unemployment.
Regardless of which perspective one adopts, real-world hyperinflations – think of Weimar Germany or the recent cases of Venezuela and Zimbabwe – that effectively reduce the value of money to zero are examples not of non-fundamental equilibria, but rather of fundamental equilibria gone bad. In these cases, money stocks exploded, and the price level responded accordingly.
Private cryptocurrencies and public fiat currencies have the same infinite range of possible equilibria. The zero-price equilibrium is always a possibility, as is the unique, well-behaved fundamental equilibrium.
Bitcoin clearly is exhibiting neither of these equilibria at the moment. What we have instead appears to be a variant of a non-fundamental explosive price equilibrium. It is a variant because it must allow for Bitcoin to make a possible, if unexpected, jump from its current explosive price trajectory to either the nice fundamental equilibrium or the not-so-nice zero-price scenario. This multiple-equilibrium perspective doubtless makes it appear risky to invest in intrinsically valueless assets like Bitcoin and other private cryptocurrencies.
The real world is of course not constrained by the range of possible equilibria supported by the mainstream economic theory outlined here. But that makes Bitcoin even riskier as an investment.
Tesla’s recent Bitcoin buy-in shows that a large additional buyer entering the market can boost the cryptocurrency’s price significantly, both directly (when markets are illiquid) and indirectly through demonstration and emulation effects. But an exit by a single important player would likely have a similar impact in the opposite direction. Positive or negative opinions voiced by market makers will have significant effects on Bitcoin’s price.
The cryptocurrency’s spectacular price volatility is not surprising. Deeply irrational market gyrations like the one that drove GameStop’s share price to unprecedented highs in January (followed by a significant correction) should serve as a reminder that, lacking any obvious fundamental value anchor, Bitcoin is likely to remain a textbook example of excess volatility.
This will not change with time. Bitcoin will continue to be an asset without intrinsic value whose market value can be anything or nothing. Only those with healthy risk appetites and a robust capacity to absorb losses should consider investing in it.
Cryptocurrencies’ Time to Shine?
Now that the COVID-19 pandemic has accelerated the trend toward e-commerce, policymakers and the general public should apprise themselves of the latest developments in cryptocurrencies. And just as e-commerce requires encryption to protect personal privacy, so do digital coins.
SAN FRANCISCO – Even as all of humanity mobilizes against COVID-19, thoughts are turning to how the world will be different after the crisis. As businesses rush to adapt to the new world of social distancing, the pandemic has accelerated an already inexorable trend toward digital commerce. This broader shift should also include the widespread adoption of digital currencies, which provide stronger consumer financial and privacy protections.
For most of the twentieth century, encryption was reserved for national-security needs. Cryptography helped the Allies win World War II, and then protected secret communications during the Cold War. Until as recently as 1992, the United States, as a matter of national security, did not allow cryptographic technology to be exported. Encrypted communication was not widely available, and anyone using it was assumed to have something to hide.
But starting in the 1990s, early Internet entrepreneurs began calling for encryption to be used in e-commerce, arguing that it was needed in order to protect customer credit card numbers, passwords, and other information entered online. It turned out that the same encryption technology that had been created in academic labs – where trust and collaboration reigned – could be useful to everyone.
US policymakers and law enforcement initially balked at this push toward widespread encryption. In their view, privacy for everyone meant privacy for terrorists, drug dealers, and money launderers. As FBI Director Louis J. Freeh told Congress in 1994, preserving the US government’s ability to intercept Internet communications was “the No. 1 law enforcement, public safety, and national security issue facing us today.”
The debate about end-to-end encryption is still raging. But, crucially, consumer expectations have changed since the 1990s. The overwhelming majority of Internet traffic is now encrypted, and most of us have been trained to look for the closed-lock icon in our browser before entering sensitive information. Popular apps like WhatsApp, Telegram, iMessage, and Signal have led the way in normalizing private messaging that can’t be tracked by third parties.
But there is one area of our lives where privacy is not yet the norm: our personal financial information. By law, financial firms are required to collect reams of personal information about their customers. This information ultimately ends up on online databases, where it presents a tempting target for hackers. In 2017, the credit-rating firm Equifax revealed that a data breach had exposed sensitive information about more than 147 million consumers, or just under half the US population. That followed a similar breach in 2013, when hackers famously obtained the names, credit card numbers, and other information about tens of millions of Target customers.
Fortunately, a solution is on the horizon. Cryptocurrencies hold the promise of creating a more open financial system, with worldwide access, instantaneous fund transfers, lower costs, and vastly improved consumer-privacy protections. When Bitcoin first gained popularity, many people incorrectly assumed that it was anonymous money. In fact, as a blockchain technology, it uses a public ledger that records a digital trail of every transaction. Blockchain analytics firms are thus now helping law enforcement track down criminals who thought their trail was covered. And cryptocurrency exchanges like Coinbase have instituted robust anti-money-laundering and know-your-customer programs that rival those of any financial institution.
Several more recent developments in cryptocurrency technologies promise to take consumer privacy to even higher levels, and they are sure to be controversial. First, “privacy coins” such as Zcash and Monero offer new cryptocurrency protocols that make every transaction untraceable. Other cryptocurrencies aspire to replicate these features, and even JP Morgan has explored private transactions through its Quorum cryptocurrency. This shift is a bit like when websites moved from HTTP to HTTPS as the global standard: it lets consumers know that their information is protected by default.
Second, so-called non-custodial cryptocurrency wallets now enable customers to store their own private keys (which allow one to move funds) instead of relying on a third party. By not actually storing customer funds, the providers of non-custodial wallets are aiming to position themselves as software companies rather than financial institutions subject to regulation. In the past, non-custodial wallets required a certain degree of technical sophistication to operate, limiting their use. But, like encrypted messaging apps, they are becoming increasingly accessible to a mass market.
Unsurprisingly, these innovations have alarmed banks, regulators, and law-enforcement agencies. But just as the early Internet needed encryption to enable digital commerce, cryptocurrencies need privacy protections to unlock their full power and potential. Whether one needs to guard against authoritarian regimes, data harvesters, or criminals, the best way to ensure that sensitive financial data isn’t hacked is to avoid having to collect it in the first place.
Enhancing consumer financial protections does not mean giving free rein to criminals. Law-enforcement agencies still have a wide range of tools at their disposal, from subpoenaing cryptocurrency exchanges to examining conversions into and out of fiat currencies (which are likely to remain the choke points for law enforcement). And these exchanges will continue to be regulated as financial services, regardless of whether consumers are using privacy coins or non-custodial wallets.
Having watched the US benefit enormously from the creation of the world’s leading Internet companies, many countries are now working to attract the next generation of cryptocurrency firms. For countries thinking about cryptocurrency policy, the best approach, as always, will be to strike a balance between law enforcement, cybersecurity, privacy, innovation, and economic competitiveness.
Consumers in a free society will always demand and expect reasonable levels of privacy. Our financial lives are no exception. Fortunately, cryptocurrencies can fix some of the most vexing issues in financial services. As we plan to rebuild economically after the COVID-19 crisis, we must allow these technologies to grow.
The Right Response to the Libra Threat
Facebook’s plans for a digital currency and payments system have understandably been met with skepticism, bordering on outrage. Clearly, if a serial violator of the public trust can unilaterally insinuate itself into the global monetary system, something must be done to manage the rise of digital private monies.
NEW YORK – Facebook’s plan to launch a new digital currency, Libra, within a year has won few friends. Regulators, policymakers, and academics reacted to the news swiftly, and for the most part skeptically. US congressional committees quickly arranged hearings, and the issue featured prominently at the G7 meeting in France last month.
Facebook’s disrepute as a guardian of user privacy helps to explain some of the blowback. The real bombshell, however, was the sudden realization of the threat posed by digital currencies to the existing monetary system – not at some later date, but right now. Cryptocurrencies have been around for over a decade, but none has been adopted widely enough to challenge the existing order. With the potential to mobilize more than two billion monthly active users, Facebook could change that.
Now that the company has thrown down the gauntlet, governments should use the opportunity to advance a form of digital currency that serves the public good. Even the staunchest defenders of the current monetary system will admit that it does not work equally well for everyone. Moreover, the system is being rapidly outpaced by technological change, much of which is insufficiently regulated and could expose consumers to unforeseen risks.
It doesn’t have to be this way. Technology could enable the development of a far better system. One of the original motivations behind Bitcoin and other cryptocurrencies was to establish an alternative, censorship-resistant payment system. Sweden and Singapore are on track to create central-bank-backed digital currencies (CBDCs) of their own. In China, a handful of companies, including Alibaba and Tencent, have launched closely regulated and supervised digital currencies for transactions that are settled in renminbi. In Kenya, Mali, and elsewhere, phone companies offer digital-payment services to everyone, even those without a bank account.
These experiments offer plenty of models to choose from. But first, we must consider a fundamental question: Should the state allow the creation of private money, or should it tightly limit efforts like Bitcoin and Libra, even at the risk of curtailing innovation?
Money is conventionally defined by the functions it performs: it is a means of exchange, a store of value, and a unit of account. The dollar, pound, yen, and euro each perform all three functions, but not without some help from the private sector. Banks play a critical role in payment systems (the exchange function of money), by issuing private monies in the form of book money and the like. They also offer deposits, which can be viewed as stores of value (assuming they are insured). Only the unit-of-account function – which guarantees a currency’s nominal value as legal tender for paying taxes – is in the hands of the state alone.
Given that some of the defining functions of money can be farmed out to private actors, the question is whether, and to what extent, they should be. Shouldn’t we favor CBDCs over all the different forms of privately issued digital monies? After all, there are powerful normative arguments to be made for CBDCs. As public goods, payment systems should be available on equal terms to everyone. And with modern technologies, we can finally cut out the middlemen (banks) who have been skimming the cream off the top for centuries.
On the other hand, there is also a case to be made against the monopolization of the payment system. Under ideal circumstances, CBDCs could usher in a fully integrated, highly efficient system that works for everyone. But in the real world, even a slight technical glitch or other governance failure could have systemic effects. Generally speaking, monolithic systems lack the resilience of diversified systems, not to mention the incentives for further innovation.
Still, a multiplicity of payment systems comes with problems of its own. The transaction costs of converting diverse currencies, either into one another or into fiat currency, could be enormous. And the history of free banking tells us that unregulated monetary systems are prone to collapse.
This conundrum could be solved by creating a single framework for all digital currencies, which would keep the door open for innovation. Alternatively, it could be addressed through common protocols to govern interoperability among separate systems, similar to how the Internet has evolved.
Either way, we need a new infrastructure for managing both public and private monies. They should be treated as a public good, and thus accessible on a non-profit basis. They should be open to anyone looking to develop specific new products or services, subject to a simple registration requirement. Depending on the service, all offerings should be regulated to ensure the safety and stability of the monetary system. To reduce compliance costs for smaller start-ups, supervisory authorities could provide free consultation about the appropriate regulatory channels for new products. And, where necessary, regulation should be streamlined to avoid unnecessary overlap and other sources of inefficiency.
Digital monies present us with a massive challenge. Traditionally, the guardians of the money system, central banks, have focused narrowly on monetary policy and financial stability. Guiding financial innovation is far outside their existing mandates. But given the pace of change, they may have no choice but to expand their remit sooner rather than later.
After the 2007-09 financial crisis, the imbalances and risks pervading the global economy were exacerbated by policy mistakes. So, rather than address the structural problems that the financial collapse and ensuing recession revealed, governments mostly kicked the can down the road, creating major downside risks that made another crisis inevitable. And now that it has arrived, the risks are growing even more acute. Unfortunately, even if the Greater Recession leads to a lacklustre U-shaped recovery this year, an L-shaped “Greater Depression” will follow later in this decade, owing to 10 ominous and risky trends.
The first trend concerns deficits and their corollary risks: debts and defaults. The policy response to the Covid-19 crisis entails a massive increase in fiscal deficits – on the order of 10% of GDP or more – at a time when public debt levels in many countries were already high, if not unsustainable.
Worse, the loss of income for many households and firms means that private-sector debt levels will become unsustainable, too, potentially leading to mass defaults and bankruptcies. Together with soaring levels of public debt, this all but ensures a more anaemic recovery than the one that followed the Great Recession a decade ago.
A second factor is the demographic timebomb in advanced economies. The Covid-19 crisis shows that much more public spending must be allocated to health systems, and that universal healthcare and other relevant public goods are necessities, not luxuries. Yet, because most developed countries have ageing societies, funding such outlays in the future will make the implicit debts from today’s unfunded healthcare and social security systems even larger.
A third issue is the growing risk of deflation. In addition to causing a deep recession, the crisis is also creating a massive slack in goods (unused machines and capacity) and labour markets (mass unemployment), as well as driving a price collapse in commodities such as oil and industrial metals. That makes debt deflation likely, increasing the risk of insolvency.
A fourth (related) factor will be currency debasement. As central banks try to fight deflation and head off the risk of surging interest rates (following from the massive debt build-up), monetary policies will become even more unconventional and far-reaching. In the short run, governments will need to run monetised fiscal deficits to avoid depression and deflation. Yet, over time, the permanent negative supply shocks from accelerated de-globalisation and renewed protectionism will make stagflation all but inevitable.
A fifth issue is the broader digital disruption of the economy. With millions of people losing their jobs or working and earning less, the income and wealth gaps of the 21st-century economy will widen further. To guard against future supply-chain shocks, companies in advanced economies will re-shore production from low-cost regions to higher-cost domestic markets. But rather than helping workers at home, this trend will accelerate the pace of automation, putting downward pressure on wages and further fanning the flames of populism, nationalism, and xenophobia.
This points to the sixth major factor: deglobalisation. The pandemic is accelerating trends toward balkanisation and fragmentation that were already well underway. The US and China will decouple faster, and most countries will respond by adopting still more protectionist policies to shield domestic firms and workers from global disruptions. The post-pandemic world will be marked by tighter restrictions on the movement of goods, services, capital, labour, technology, data, and information. This is already happening in the pharmaceutical, medical-equipment, and food sectors, where governments are imposing export restrictions and other protectionist measures in response to the crisis.
The backlash against democracy will reinforce this trend. Populist leaders often benefit from economic weakness, mass unemployment, and rising inequality. Under conditions of heightened economic insecurity, there will be a strong impulse to scapegoat foreigners for the crisis. Blue-collar workers and broad cohorts of the middle class will become more susceptible to populist rhetoric, particularly proposals to restrict migration and trade.
This points to an eighth factor: the geostrategic standoff between the US and China. With the Trump administration making every effort to blame China for the pandemic, Chinese President Xi Jinping’s regime will double down on its claim that the US is conspiring to prevent China’s peaceful rise. The Sino-American decoupling in trade, technology, investment, data, and monetary arrangements will intensify.
Worse, this diplomatic breakup will set the stage for a new cold war between the US and its rivals – not just China, but also Russia, Iran, and North Korea. With a US presidential election approaching, there is every reason to expect an upsurge in clandestine cyber warfare, potentially leading even to conventional military clashes. And because technology is the key weapon in the fight for control of the industries of the future and in combating pandemics, the US private tech sector will become increasingly integrated into the national-security-industrial complex.
A final risk that cannot be ignored is environmental disruption, which, as the Covid-19 crisis has shown, can wreak far more economic havoc than a financial crisis. Recurring epidemics (HIV since the 1980s, Sars in 2003, H1N1 in 2009, Mers in 2011, Ebola in 2014-16) are, like climate change, essentially manmade disasters, born of poor health and sanitary standards, the abuse of natural systems, and the growing interconnectivity of a globalised world. Pandemics and the many morbid symptoms of climate change will become more frequent, severe, and costly in the years ahead.
These 10 risks, already looming large before Covid-19 struck, now threaten to fuel a perfect storm that sweeps the entire global economy into a decade of despair. By the 2030s, technology and more competent political leadership may be able to reduce, resolve, or minimise many of these problems, giving rise to a more inclusive, cooperative, and stable international order. But any happy ending assumes that we find a way to survive the coming Greater Depression.
• Nouriel Roubini is professor of economics at New York University’s Stern School of Business. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.
In September 2006, Nouriel Roubini told the International Monetary Fund what it didn’t want to hear. Standing before an audience of economists at the organization’s headquarters, the New York University professor warned that the U.S. housing market would soon collapse — and, quite possibly, bring the global financial system down with it. Real-estate values had been propped up by unsustainably shady lending practices, Roubini explained. Once those prices came back to earth, millions of underwater homeowners would default on their mortgages, trillions of dollars worth of mortgage-backed securities would unravel, and hedge funds, investment banks, and lenders like Fannie Mae and Freddie Mac could sink into insolvency.
At the time, the global economy had just recorded its fastest half-decade of growth in 30 years. And Nouriel Roubini was just some obscure academic. Thus, in the IMF’s cozy confines, his remarks roused less alarm over America’s housing bubble than concern for the professor’s psychological well-being.
Of course, the ensuing two years turned Roubini’s prophecy into history, and the little-known scholar of emerging markets into a Wall Street celebrity.
A decade later, “Dr. Doom” is a bear once again. While many investors bet on a “V-shaped recovery,” Roubini is staking his reputation on an L-shaped depression. The economist (and host of a biweekly economic news broadcast) does expect things to get better before they get worse: He foresees a slow, lackluster (i.e., “U-shaped”) economic rebound in the pandemic’s immediate aftermath. But he insists that this recovery will quickly collapse beneath the weight of the global economy’s accumulated debts. Specifically, Roubini argues that the massive private debts accrued during both the 2008 crash and COVID-19 crisis will durably depress consumption and weaken the short-lived recovery. Meanwhile, the aging of populations across the West will further undermine growth while increasing the fiscal burdens of states already saddled with hazardous debt loads. Although deficit spending is necessary in the present crisis, and will appear benign at the onset of recovery, it is laying the kindling for an inflationary conflagration by mid-decade. As the deepening geopolitical rift between the United States and China triggers a wave of deglobalization, negative supply shocks akin those of the 1970s are going to raise the cost of real resources, even as hyperexploited workers suffer perpetual wage and benefit declines. Prices will rise, but growth will peter out, since ordinary people will be forced to pare back their consumption more and more. Stagflation will beget depression. And through it all, humanity will be beset by unnatural disasters, from extreme weather events wrought by man-made climate change to pandemics induced by our disruption of natural ecosystems.
Roubini allows that, after a decade of misery, we may get around to developing a “more inclusive, cooperative, and stable international order.” But, he hastens to add, “any happy ending assumes that we find a way to survive” the hard times to come.
Intelligencer recently spoke with Roubini about our impending doom.
You predict that the coronavirus recession will be followed by a lackluster recovery and global depression. The financial markets ostensibly see a much brighter future. What are they missing and why?
Well, first of all, my prediction is not for 2020. It’s a prediction that these ten major forces will, by the middle of the coming decade, lead us into a “Greater Depression.” Markets, of course, have a shorter horizon. In the short run, I expect a U-shaped recovery while the markets seem to be pricing in a V-shape recovery.
Of course the markets are going higher because there’s a massive monetary stimulus, there’s a massive fiscal stimulus. People expect that the news about the contagion will improve, and that there’s going to be a vaccine at some point down the line. And there is an element “FOMO” [fear of missing out]; there are millions of new online accounts — unemployed people sitting at home doing day-trading — and they’re essentially playing the market based on pure sentiment. My view is that there’s going to be a meaningful correction once people realize this is going to be a U-shaped recovery. If you listen carefully to what Fed officials are saying — or even what JPMorgan and Goldman Sachs are saying — initially they were all in the V camp, but now they’re all saying, well, maybe it’s going to be more of a U. The consensus is moving in a different direction.
Your prediction of a weak recovery seems predicated on there being a persistent shortfall in consumer demand due to income lost during the pandemic. A bullish investor might counter that the Cares Act has left the bulk of laid-off workers with as much — if not more — income than they had been earning at their former jobs. Meanwhile, white-collar workers who’ve remained employed are typically earning as much as they used to, but spending far less. Together, this might augur a surge in post-pandemic spending that powers a V-shaped recovery. What does the bullish story get wrong?
Yes, there are unemployment benefits. And some unemployed people may be making more money than when they were working. But those unemployment benefits are going to run out in July. The consensus says the unemployment rate is headed to 25 percent. Maybe we get lucky. Maybe there’s an early recovery, and it only goes to 16 percent. Either way, tons of people are going to lose unemployment benefits in July. And if they’re rehired, it’s not going to be like before — formal employment, full benefits. You want to come back to work at my restaurant? Tough luck. I can hire you only on an hourly basis with no benefits and a low wage. That’s what every business is going to be offering. Meanwhile, many, many people are going to be without jobs of any kind. It took us ten years — between 2009 and 2019 — to create 22 million jobs. And we’ve lost 30 million jobs in two months.
So when unemployment benefits expire, lots of people aren’t going to have any income. Those who do get jobs are going to work under more miserable conditions than before. And people, even middle-income people, given the shock that has just occurred — which could happen again in the summer, could happen again in the winter — you are going to want more precautionary savings. You are going to cut back on discretionary spending. Your credit score is going to be worse. Are you going to go buy a home? Are you gonna buy a car? Are you going to dine out? In Germany and China, they already reopened all the stores a month ago. You look at any survey, the restaurants are totally empty. Almost nobody’s buying anything. Everybody’s worried and cautious. And this is in Germany, where unemployment is up by only one percent. Forty percent of Americans have less than $400 in liquid cash saved for an emergency. You think they are going to spend?
You’re going to start having food riots soon enough. Look at the luxury stores in New York. They’ve either boarded them up or emptied their shelves, because they’re worried people are going to steal the Chanel bags. The few stores that are open, like my Whole Foods, have security guards both inside and outside. We are one step away from food riots. There are lines three miles long at food banks. That’s what’s happening in America. You’re telling me everything’s going to become normal in three months? That’s lunacy.
Your projection of a “Greater Depression” is premised on deglobalization sparking negative supply shocks. And that prediction of deglobalization is itself rooted in the notion that the U.S. and China are locked in a so-called Thucydides trap, in which the geopolitical tensions between a dominant and rising power will overwhelm mutual financial self-interest. But given the deep interconnections between the American and Chinese economies — and warm relations between much of the U.S. and Chinese financial elite — isn’t it possible that class solidarity will take precedence over Great Power rivalry? In other words, don’t the most powerful people in both countries understand they have a lot to lose financially and economically from decoupling? And if so, why shouldn’t we see the uptick in jingoistic rhetoric on both sides as mere posturing for a domestic audience?
First of all, my argument for why inflation will eventually come back is not just based on U.S.-China relations. I actually have 14 separate arguments for why this will happen. That said, everybody agrees that there is the beginning of a Cold War between the U.S. and China. I was in Beijing in November of 2015, with a delegation that met with Xi Jinping in the Great Hall of the People. And he spent the first 15 minutes of his remarks speaking, unprompted, about why the U.S. and China will not get caught in a Thucydides trap, and why there will actually be a peaceful rise of China.
Since then, Trump got elected. Now, we have a full-scale
- trade war,
- technology war,
- financial war,
- monetary war,
- pretty much anything across the board. Look at tech — there is complete decoupling. They just decided Huawei isn’t going to have any access to U.S. semiconductors and technology. We’re imposing total restrictions on the transfer of technology from the U.S. to China and China to the U.S. And if the United States argues that 5G or Huawei is a backdoor to the Chinese government, the tech war will become a trade war. Because tomorrow, every piece of consumer electronics, even your lowly coffee machine or microwave or toaster, is going to have a 5G chip. That’s what the internet of things is about. If the Chinese can listen to you through your smartphone, they can listen to you through your toaster. Once we declare that 5G is going to allow China to listen to our communication, we will also have to ban all household electronics made in China. So, the decoupling is happening. We’re going to have a “splinternet.” It’s only a matter of how much and how fast.
And there is going to be a cold war between the U.S. and China. Even the foreign policy Establishment — Democrats and Republicans — that had been in favor of better relations with China has become skeptical in the last few years. They say, “You know, we thought that China was going to become more open if we let them into the WTO. We thought they’d become less authoritarian.” Instead, under Xi Jinping, China has become more state capitalist, more authoritarian, and instead of biding its time and hiding its strength, like Deng Xiaoping wanted it to do, it’s flexing its geopolitical muscle. And the U.S., rightly or wrongly, feels threatened. I’m not making a normative statement. I’m just saying, as a matter of fact, we are in a Thucydides trap. The only debate is about whether there will be a cold war or a hot one. Historically, these things have led to a hot war in 12 out of 16 episodes in 2,000 years of history. So we’ll be lucky if we just get a cold war.
Some Trumpian nationalists and labor-aligned progressives might see an upside in your prediction that America is going to bring manufacturing back “onshore.” But you insist that ordinary Americans will suffer from the downsides of reshoring (higher consumer prices) without enjoying the ostensible benefits (more job opportunities and higher wages). In your telling, onshoring won’t actually bring back jobs, only accelerate automation. And then, again with automation, you insist that Americans will suffer from the downside (unemployment, lower wages from competition with robots) but enjoy none of the upside from the productivity gains that robotization will ostensibly produce. So, what do you say to someone who looks at your forecast and decides that you are indeed “Dr. Doom” — not a realist, as you claim to be, but a pessimist, who ignores the bright side of every subject?
When you reshore, you are moving production from regions of the world like China, and other parts of Asia, that have low labor costs, to parts of the world like the U.S. and Europe that have higher labor costs. That is a fact. How is the corporate sector going respond to that? It’s going to respond by replacing labor with robots, automation, and AI.
I was recently in South Korea. I met the head of Hyundai, the third-largest automaker in the world. He told me that tomorrow, they could convert their factories to run with all robots and no workers.Why don’t they do it? Because they have unions that are powerful. In Korea, you cannot fire these workers, they have lifetime employment.
But suppose you take production from a labor-intensive factory in China — in any industry — and move it into a brand-new factory in the United States. You don’t have any legacy workers, any entrenched union. You are going to design that factory to use as few workers as you can. Any new factory in the U.S. is going to be capital-intensive and labor-saving. It’s been happening for the last ten years and it’s going to happen more when we reshore. So reshoring means increasing production in the United States but not increasing employment. Yes, there will be productivity increases. And the profits of those firms that relocate production may be slightly higher than they were in China (though that isn’t certain since automation requires a lot of expensive capital investment).
But you’re not going to get many jobs. The factory of the future is going to be one person manning 1,000 robots and a second person cleaning the floor. And eventually the guy cleaning the floor is going to be replaced by a Roomba because a Roomba doesn’t ask for benefits or bathroom breaks or get sick and can work 24-7.
The fundamental problem today is that people think there is a correlation between what’s good for Wall Street and what’s good for Main Street. That wasn’t even true during the global financial crisis when we were saying, “We’ve got to bail out Wall Street because if we don’t, Main Street is going to collapse.” How did Wall Street react to the crisis? They fired workers. And when they rehired them, they were all gig workers, contractors, freelancers, and so on. That’s what happened last time. This time is going to be more of the same. Thirty-five to 40 million people have already been fired. When they start slowly rehiring some of them (not all of them), those workers are going to get part-time jobs, without benefits, without high wages. That’s the only way for the corporates to survive. Because they’re so highly leveraged today, they’re going to need to cut costs, and the first cost you cut is labor. But of course, your labor cost is my consumption. So in an equilibrium where everyone’s slashing labor costs, households are going to have less income. And they’re going to save more to protect themselves from another coronavirus crisis. And so consumption is going to be weak. That’s why you get the U-shaped recovery.
There’s a conflict between workers and capital. For a decade, workers have been screwed. Now, they’re going to be screwed more. There’s a conflict between small business and large business.
Millions of these small businesses are going to go bankrupt. Half of the restaurants in New York are never going to reopen. How can they survive? They have such tiny margins. Who’s going to survive? The big chains. Retailers. Fast food. The small businesses are going to disappear in the post-coronavirus economy. So there is a fundamental conflict between Wall Street (big banks and big firms) and Main Street (workers and small businesses). And Wall Street is going to win.
Clearly, you’re bearish on the potential of existing governments intervening in that conflict on Main Street’s behalf. But if we made you dictator of the United States tomorrow, what policies would you enact to strengthen labor, and avert (or at least mitigate) the Greater Depression?
The market, as currently ordered, is going to make capital stronger and labor weaker. So, to change this, you need to invest in your workers. Give them education, a social safety net — so if they lose their jobs to an economic or technological shock, they get job training, unemployment benefits, social welfare, health care for free. Otherwise, the trends of the market are going to imply more income and wealth inequality. There’s a lot we can do to rebalance it. But I don’t think it’s going to happen anytime soon. If Bernie Sanders had become president, maybe we could’ve had policies of that sort. Of course, Bernie Sanders is to the right of the CDU party in Germany. I mean, Angela Merkel is to the left of Bernie Sanders. Boris Johnson is to the left of Bernie Sanders, in terms of social democratic politics. Only by U.S. standards does Bernie Sanders look like a Bolshevik.
In Germany, the unemployment rate has gone up by one percent. In the U.S., the unemployment rate has gone from 4 percent to 20 percent (correctly measured) in two months. We lost 30 million jobs. Germany lost 200,000. Why is that the case? You have different economic institutions. Workers sit on the boards of German companies. So you share the costs of the shock between the workers, the firms, and the government.
In 2009, you argued that if deficit spending to combat high unemployment continued indefinitely, “it will fuel persistent, large budget deficits and lead to inflation.” You were right on the first count obviously. And yet, a decade of fiscal expansion not only failed to produce high inflation, but was insufficient to reach the Fed’s 2 percent inflation goal. Is it fair to say that you underestimated America’s fiscal capacity back then? And if you overestimated the harms of America’s large public debts in the past, what makes you confident you aren’t doing so in the present?
First of all, in 2009, I was in favor of a bigger stimulus than the one that we got. I was not in favor of fiscal consolidation. There’s a huge difference between the global financial crisis and the coronavirus crisis because the former was a crisis of aggregate demand, given the housing bust. And so monetary policy alone was insufficient and you needed fiscal stimulus. And the fiscal stimulus that Obama passed was smaller than justified. So stimulus was the right response, at least for a while. And then you do consolidation.
What I have argued this time around is that in the short run, this is both a supply shock and a demand shock. And, of course, in the short run, if you want to avoid a depression, you need to do monetary and fiscal stimulus. What I’m saying is that once you run a budget deficit of not 3, not 5, not 8, but 15 or 20 percent of GDP — and you’re going to fully monetize it (because that’s what the Fed has been doing) — you still won’t have inflation in the short run, not this year or next year, because you have slack in goods markets, slack in labor markets, slack in commodities markets, etc. But there will be inflation in the post-coronavirus world. This is because we’re going to see two big negative supply shocks. For the last decade, prices have been constrained by two positive supply shocks — globalization and technology. Well, globalization is going to become deglobalization thanks to decoupling, protectionism, fragmentation, and so on. So that’s going to be a negative supply shock. And technology is not going to be the same as before. The 5G of Erickson and Nokia costs 30 percent more than the one of Huawei, and is 20 percent less productive. So to install non-Chinese 5G networks, we’re going to pay 50 percent more. So technology is going to gradually become a negative supply shock. So you have two major forces that had been exerting downward pressure on prices moving in the opposite direction, and you have a massive monetization of fiscal deficits. Remember the 1970s? You had two negative supply shocks — ’73 and ’79, the Yom Kippur War and the Iranian Revolution. What did you get? Stagflation.
Now, I’m not talking about hyperinflation — not Zimbabwe or Argentina. I’m not even talking about 10 percent inflation. It’s enough for inflation to go from one to 4 percent. Then, ten-year Treasury bonds — which today have interest rates close to zero percent — will need to have an inflation premium. So, think about a ten-year Treasury, five years from now, going from one percent to 5 percent, while inflation goes from near zero to 4 percent. And ask yourself, what’s going to happen to the real economy? Well, in the fourth quarter of 2018, when the Federal Reserve tried to raise rates above 2 percent, the market couldn’t take it. So we don’t need hyperinflation to have a disaster.
In other words, you’re saying that because of structural weaknesses in the economy, even modest inflation would be crisis-inducing because key economic actors are dependent on near-zero interest rates?
For the last decade, debt-to-GDP ratios in the U.S. and globally have been rising. And debts were rising for corporations and households as well. But we survived this, because, while debt ratios were high, debt-servicing ratios were low, since we had zero percent policy rates and long rates close to zero — or, in Europe and Japan, negative. But the second the Fed started to hike rates, there was panic.
In December 2018, Jay Powell said, “You know what. I’m at 2.5 percent. I’m going to go to 3.25. And I’m going to continue running down my balance sheet.” And the market totally crashed. And then, literally on January 2, 2019, Powell comes back and says, “Sorry, I was kidding. I’m not going to do quantitative tightening. I’m not going to raise rates.” So the economy couldn’t take a Fed funds rate of 2.5 percent. In the strongest economy in the world. There is so much debt, if long-term rates go from zero to 3 percent, the economy is going to crash.
You’ve written a lot about negative supply shocks from deglobalization. Another potential source of such shocks is climate change. Many scientists believe that rising temperatures threaten the supply of our most precious commodities — food and water. How does climate figure into your analysis?
I am not an expert on global climate change. But one of the ten forces that I believe will bring a Greater Depression is man-made disasters. And global climate change, which is producing more extreme weather phenomena — on one side, hurricanes, typhoons, and floods; on the other side, fires, desertification, and agricultural collapse — is not a natural disaster. The science says these extreme events are becoming more frequent, are coming farther inland, and are doing more damage. And they are doing this now, not 30 years from now.
So there is climate change. And its economic costs are becoming quite extreme. In Indonesia, they’ve decided to move the capital out of Jakarta to somewhere inland because they know that their capital is going to be fully flooded. In New York, there are plans to build a wall all around Manhattan at the cost of $120 billion. And then they said, “Oh no, that wall is going to be so ugly, it’s going to feel like we’re in a prison.” So they want to do something near the Verrazzano Bridge that’s going to cost another $120 billion. And it’s not even going to work.
The Paris Accord said 1.5 degrees. Then they say two. Now, every scientist says, “Look, this is a voluntary agreement, we’ll be lucky if we get three — and more likely, it will be four — degree Celsius increases by the end of the century.” How are we going to live in a world where temperatures are four degrees higher? And we’re not doing anything about it. The Paris Accord is just a joke. And it’s not just the U.S. and Trump. China’s not doing anything. The Europeans aren’t doing anything. It’s only talk.
And then there’s the pandemics. These are also man-made disasters. You’re destroying the ecosystems of animals. You are putting them into cages — the bats and pangolins and all the other wildlife — and they interact and create viruses and then spread to humans.
- First, we had HIV. Then we had
- SARS. Then
- MERS, then
- swine flu, then
- Zika, then
- Ebola, now
- this one.
And there’s a connection between global climate change and pandemics. Suppose the permafrost in Siberia melts. There are probably viruses that have been in there since the Stone Age. We don’t know what kind of nasty stuff is going to get out. We don’t even know what’s coming.
Former senior economist for International Affairs on the White House Council, Nouriel Roubini discusses why he believes the ‘crypto-bubble’ has burst for good.
Famed for predicting the 2007 Global Financial Crisis and Credit Crunch, Nouriel Roubini has predicted two of the biggest bubbles in the 21st century. He is now turning his attention to the cryptocurrency markets and has been highly critical of not only the currencies but the technology behind them, blockchain.
Roubini is a well-respected Professor of Economics at New York University’s Stern School of Business and the Chairman of Roubini Macro Associates, a global macroeconomic consultancy firm in New York. From serving as the Senior Economist for International Affairs on the White House Council of Economic Advisors, to advising the International Monetary Fund and The World Bank, Roubini is thought of as a highly esteemed economist.
Cryptocurrencies have been in steady decline since their peak in January 2018. Do you think this market is capable of ever reaching its original glory or has the bubble well and truly burst?
I have called crypto-currencies the mother and father of all bubbles now gone bust. The crypto bubble has burst for good and will not recover as these were assets with no intrinsic value. Since their peak in early 2018 Bitcoin has lost more than 80% of its value; the other top 10 crypto-currencies – such as ETH, XRP, etc – have lost over 90% of their value while 1000s of other “shitcoins” (a technical term of jargon for this garbage of pseudo-currencies) have lost between 95% and 99% of their value. This is no surprise as a study suggests that 81% of all Initial Coin Offerings (non-compliant securities illegally skirting all securities laws) were a scam in the first place, 11% are dead or failing and the remaining 8% traded on some crypto exchanges have lost over 90% of their value.
Crypto was the biggest bubble in human history as, compared to other historical bubbles – such as Tulipmania, the South Sea Bubble and the Mississipi Bubble, the parabolic price increase in the three years before the peak was much worse – at 60X price increase – than other bubbles (that increase at 10 to 30X rates) while its bust since the 2018 peak has been as fast and furious as any previous bubble (see the chart below). The Nasdaq bubble in the late 1990s was miniscule compared to the Bitcoin bubble as it increased 4X in the three years before the peak, not 60X. And this internet bubble included many real companies with real business plans, revenues and profits, not the scammy “white papers” of cryptocurrencies.
Comparing crypto-currencies to the early days of the internet is nonsense. A decade since the launch of the WWW in 1991 there were over 1 billion users of the internet, not the approximate 70 million wallets of crypto most of them dormant. A decade after the launch of the internet there were dozens of killer apps – such as email, web sites, etc – and exponentially increasing transactions in the billions of units; while in crypto there is not a single killer app – apart from useless “krypto-kitties”, Ponzi Pyramids and Casino Games with miniscule transactions – while total transaction volume has collapsed since 2018 by over 85%. And in successful real technologies like the internet or stock trading transaction costs collapse over time. Instead in crypto, transaction costs – measured as miners’ revenues divided by number of transactions – have skyrocketed since 2018. So any comparison of crypto to the early days of the internet is nonsense.
You publicly debated and criticised Ethereum with Vitalik Buterin, its founder. What do you think is the most flawed aspect of these cryptocurrencies in comparison to fiat currencies?
The most flawed aspect of so called “crypto-currencies” is that that they aren’t really currencies or moneys. For an asset to be considered a money or currency it must satisfy three criteria:
- it has to be the unit of account for all transactions and the single numeraire for pricing all goods, services and assets/liabilities.
- It must be a widely used and cheap means of payments. And
- it has to be a stable store of value and have stable purchasing power over goods and services.
Bitcoin alone – let alone thousands of other “shitcoins” fails miserably on all criteria. It is not a unit of account and given the proliferation of thousands of “crypto-currencies” there is no single numeraire for all transactions. It is a lousy means of payments as the “proof of work” authentication method doesn’t allow more than five transactions per second; instead, for example, the Visa network allows for 25K transactions per second and growing. And the transaction costs/fees – as measured by miners’ revenues – are high and growing over time. And it is a very poor store of value as its price can fluctuate by 5% to 20% per days. So, any merchant accepting Bitcoin could lose all its profit margin in a day given the price fluctuations. Also, the supply of most cryptocurrencies – with the exception of Bitcoin – is increased and debased at will by its issuers; so price inflation and currency debasement in the crypto world is several orders of magnitude worse than fiat currency in stable low inflation economies like all advanced economies and most emerging markets.
These fundamental flaws of cryptocurrencies cannot be resolved over time given the famous Buterin “Inconsistent Trinity” principle: ie no cryptocurrency can be at the same time
- scalable (in terms of number of transactions),
- decentralized and
Fiat currencies and traditional banking system are scalable and secure but are centralized with reputable institutions that have decades long histories of trust, credibility and reputation (central banks, private banks, other financial institutions). Cryptocurrencies are not scalable and future solutions that may lead to scalability – such as proof of stake – would not be decentralized and would thus not be secure. Decentralization in crypto is a myth as miners are now a centralized oligopoly in shady jurisdictions with poor rule of law such as China, Russia, Belarus, etc.; trading is centralized as 99% of trading occurs in highly insecure and hackable centralized exchanges rather than decentralized exchanges that are all failing given no volume or liquidity. Wealth is centralized as the index of inequality for Bitcoin is worse than North Korea where Kim Jung Un and his lackeys control most of income and wealth. And developers are centralized too as Vitalik Buterin is “benevolent dictator for life” while developers are effectively police, prosecutors and judges as the myth of “the code is law” is over-turned when things go wrong – an hack – and a fork of a crypto-currency takes places on totally arbitrary terms.‘Cryptocurrencies: Irrational Exuberance or Brave New World?’ Watch Nouriel Roubini speaking:
It is clear that central banks are in talks about challenging current cryptocurrencies with central bank digital currencies. Do you think that central bank digital currencies could compete with our current cryptocurrencies and in what timescale?
A number of central banks are considering issuing central bank digital currencies – or CBDC – but such CBDCs would have nothing to do with crypto-currencies or blockchain while completely dominating such inferior assets. Starry-eyed crypto-fanatics have seized on policymakers’ consideration of CBDCs as proof that even central banks need blockchain or crypto to enter the digital-currency game. This is nonsense. If anything, CBDCs would likely replace all private digital payment systems, regardless of whether they are connected to traditional bank accounts or cryptocurrencies.
As matters currently stand, only commercial banks have access to central banks’ balance sheets; and central banks’ reserves are already held as digital currencies. That is why central banks are so efficient and cost-effective at mediating interbank payments and lending transactions. Because individuals, corporations, and non-bank financial institutions do not enjoy the same access, they must rely on licensed commercial banks to process their transactions. Bank deposits, then, are a form of private money that is used for transactions among non-bank private agents. As a result, not even fully digital systems such as Alipay or Venmo can operate apart from the banking system. By allowing any individual to make transactions through the central bank, CBDCs would upend this arrangement, alleviating the need for cash, traditional bank accounts, and even digital payment services.
Better yet, CBDCs would not have to rely on public “permission-less,” “trustless” distributed ledgers like those underpinning cryptocurrencies. After all, central banks already have a centralized permissioned private non-distributed ledger that allows for payments and transactions to be facilitated safely and seamlessly. No central banker in his or her right mind would ever swap out that sound system for one based on blockchain.
If a CBDC were to be issued, it would immediately displace cryptocurrencies, which are not scalable, cheap, secure, or actually decentralized. Enthusiasts will argue that cryptocurrencies would remain attractive to those who wish to remain anonymous. But, like private bank deposits today, CBDC transactions could also be made anonymous, with access to account-holder information available, when necessary, only to law-enforcement authorities or regulators, as already happens with private banks. Besides, cryptocurrencies like Bitcoin are not actually anonymous, given that individuals and organizations using crypto-wallets still leave a digital footprint. And authorities that legitimately want to track criminals and terrorists will soon crack down on attempts to create crypto-currencies with complete privacy.
Insofar as CBDCs would crowd out worthless cryptocurrencies, they should be welcomed. Moreover, by transferring payments from private to central banks, a CBDC-based system would be a boon for financial inclusion. Millions of unbanked people would have access to a near-free, efficient payment system through their cell phones.‘Crypto Brawl, Alex Mashinsky vs Nouriel Roubini. BlockShow Americas’ Watch Nouriel Roubini speaking:
What advice would you give to a business that are thinking of offering the possibility of transacting with their customers and clients in cryptocurrency?
First of all, almost no business accepts the use of crypto-currencies in transactions or as a means of payments. Not even crypto or blockchain conferences accept Bitcoin to register, they require hard dollars or euros. Second, any merchant using a cryptocurrency in transactions would be subject to massive market risk as the price of the cryptocurrency can change so fast that the entire profit margin of the business can be wiped out in minutes or hours by such price volatility.
Third and most important point, the business model behind firms requiring the use of cryptocurrencies to do purchases of goods or services is simply to rip off their customers. Indeed, in normal business transactions, customers can buy goods and service with conventional fiat currencies. But in an ICO, customers must convert that currency by buying into a limited pool of tokens in order to make a purchase. No legitimate business that is trying to maximize profits would require its customers to jump through such hoops. In fact, the only reason to restrict a purchase to token-holders is to create an illegal cartel of service providers who are safe from price competition and in a position to gouge their customers. Consider Dentacoin, a ridiculous cryptocurrency that can be spent only on dental services (and which almost no dentist actually accepts). It would be hard to come up with a better illustration of why business cartels are illegal in all civilized countries.
Of course, the crypto-cartels would counter that customers who incur the cost of buying a token will benefit if that token appreciates in value. But this makes no sense. If the price of the token rises above the market value of the good or service being provided, then no one would buy the token. The only plausible reason for forcing the use of a token, then, is to hike prices or bilk investors.
Beyond facilitating illegal activity, crypto-tokens obfuscate the price-discovery benefits that come when a single currency operates as a unit of account or numeraire. In a crypto-utopia, every single good and service would have its own distinct token, and average consumers would have no way to judge the relative prices of different – or even similar – goods and services. Nor would they have any real certainty about a token’s purchasing power, given the volatility of crypto-token prices.
Imagine living in a country where instead of simply using the national currency, you had to rely on 200 other world currencies to purchase different goods and services. There would be widespread price confusion, and you would have to eat the cost of converting one volatile currency into another every time you wanted to buy anything.
The fact that everyone within a given country or jurisdiction uses the same currency is precisely what gives money its value. Money is a public good that allows individuals to enter into free exchange without having to resort to the kind of imprecise, inefficient bartering on which traditional societies depended.
That is precisely where the ICO charlatans would effectively take us – not to the futuristic world of “The Jetsons,” but to the modern Stone Age world of “The Flintstones” where all transactions occur through the barter of different tokens or goods. Even the Flintstones had a more sophisticated financial system than the barter of crypto: they used shells as coins for payments and as a numeraire. Crypto instead takes us back to pure inefficient barter. It is time to recognize their utopian rhetoric for what it is: self-serving nonsense meant to separate credulous investors from their hard-earned savings.
Can we expect Blockchain to disrupt the finance industry over the next 10 years?
Blockchain will not disrupt the finance industry over the next decade. There is indeed a revolution in financial services, but it has nothing to do with crypto or blockchain. This revolution is called “FinTech” and is based on three related elements:
- Artificial Intelligence/Machine Learning (AI),
- Big Data (BD) and the
- Internet of Things (IoT).
It will revolutionize digital payment systems, credit allocation, insurance, asset management, capital market activities, risk management, etc. In the payments sphere you already have digital payment systems used by billions of individuals in billions of transactions a day that have nothing to do with blockchain or crypto: they are Alipay and WeChat Pay in China; UPI- based systems in India, M-Pesa in Kenya and all over Africa; PayPal, Venmo, Square and many other ones in the US and Europe. So, there is a revolution in the provision of financial services that will disrupt many traditional banks and providers of financial services, but it has nothing to do with a decentralized blockchain.
Blockchain is also failing to deliver solutions for both financial services firms and for corporations, non-profit organizations and governments in spite of the myth that blockchain will revolutionize all sorts of financial and corporate transactions. Indeed, faced with the public spectacle of a market bloodbath in cryptocurrencies, boosters have fled to the last refuge of the crypto scoundrel: a defense of “blockchain,” the distributed-ledger software underpinning all cryptocurrencies. Blockchain has been heralded as a potential panacea for everything from poverty and famine to cancer. In fact, it is the most overhyped – and least useful – technology in human history. In practice, blockchain is nothing more than a glorified spreadsheet.
But it has also become the byword for a libertarian ideology that treats all governments, central banks, traditional financial institutions, and real-world currencies as evil concentrations of power that must be destroyed. Blockchain fundamentalists’ ideal world is one in which all economic activity and human interactions are subject to anarchist or libertarian decentralization. They would like the entirety of social and political life to end up on public ledgers that are supposedly “permissionless” (accessible to everyone) and “trustless” (not reliant on a credible intermediary such as a bank). Yet far from ushering in a utopia, blockchain has given rise to a familiar form of economic hell. A few self-serving white men (there are hardly any women or minorities in the blockchain universe) pretending to be messiahs for the world’s impoverished, marginalized, and unbanked masses claim to have created billions of dollars of wealth out of nothing. But one need only consider the massive centralization of power among cryptocurrency “miners,” exchanges, developers, and wealth holders to see that blockchain is not about decentralization and democracy; it is about greed.
As for blockchain itself, there is no institution under the sun – bank, corporation, non-governmental organization, or government agency – that would put its balance sheet or register of transactions, trades, and interactions with clients and suppliers on public decentralized peer-to-peer permission-less ledgers. There is no good reason why such proprietary and highly valuable information should be recorded publicly.
Moreover, in cases where distributed-ledger technologies – so-called enterprise DLT – are actually being used, they have nothing to do with blockchain. They are private, centralized, and recorded on just a few controlled ledgers. They require permission for access, which is granted to qualified individuals. And, perhaps most important, they are based on trusted authorities that have established their credibility over time. All of which is to say, these are “blockchains” in name only. It is telling that all “decentralized” blockchains end up being centralized, permissioned databases when they are put into use. As such, blockchain has not even improved upon the standard electronic spreadsheet, which was invented in 1979.
No serious institution would ever allow its transactions to be verified by an anonymous cartel operating from the shadows of the world’s authoritarian kleptocracies. It is no surprise that whenever “blockchain” has been piloted in a traditional setting, it has either been thrown in the trash bin or turned into a private permissioned database that is nothing more than an Excel spreadsheet or a database with a misleading name. Indeed, a recent study of 43 experiments trying to use blockchain for development and non-profit purposes (remittances, refugees identities and services, banking the poor and unbanked, and other lofty philanthropic causes) has shown that zero out of 43 experiments have had any success; so blockchain experiments have had a 100% failure rate.
Do you believe that once the flaws and shortcomings surrounding security, scalability and of cryptocurrencies have been addressed, it would make more sense to transact using it?
I do not believe that the problems of security and scalability of cryptocurrencies can ever be resolved. At the conceptual level security and scalability are incompatible with the decentralization that crypto and blockchain claim to want to achieve. And if you have a system that gets you scalability and security with centralization you are back to traditional financial systems and/or their modern evolution that is non-blockchain based FinTech. The problems of security in cryptocurrencies are extremely severe and cannot be resolved. If you take traditional financial systems based on central banks, fiat currencies and commercial banks you have significant amounts of security. You have deposit insurance for your deposit; you have lender of last resort support by central banks in case of destructive runs; you have support of systemically important financial institutions; you have supervision and regulation with liquidity and capital requirements. And when something goes wrong – like fraud on your credit card balances or bank account – it takes one phone call to block or reverse such fraud and being issued a new credit card or bank accounts. Of course, the provision of such public goods of financial security comes at a modest price of some reasonable fees for the safety of your financial assets, accounts and transactions.
In crypto-land you have instead a total Wild West of financial insecurity; no deposit insurance, no lender of last resort, no support of systemically important institutions, no proper regulation and enforcement of security laws. If an exchange is hacked your money is gone for good as scores of episodes of centralized exchanges being hacked show. If you are subject to a crypto-robbery as someone hacked your computer, or tablet or smart-phone your financial wealth is gone in the black-hole of crypto. If there is a “51% attack” – a form of crypto-robbery that is very common among smaller crypto-currencies your wealth is gone for good. If you lose your private key or someone steals it from you your crypto assets are gone for good. The only safe solution is “cold storage”, the equivalent of hiding your crypto wealth in a cave and hiding on a piece of paper your private key for good and not being able to transact your crypto-assets. It is a return to stone-age financial technology.
There is a reason why all societies rely on trusted institutions with a history of reputation, credibility and redress of fraud to ensure the safety and legality of financial and other transactions. The utopia of having decentralized, permission-less, trust-less algorythms that replace trusted and reputable institutions is a delusion that technology can provide a solution to fundamental problems of trust that only human institutions that have developed for millennia can resolve. There is no decentralized trust-less security or scalability in crypto and there will never be one.