Perspectives From The 3 Bankers of Modern Money
The implications that follow from these innovations can over time have profound impacts on Modern Money.
Impact #1 → On Central Bankers: Central Bank Digital Currencies (CBDCs)
The essence of the CBDC discussion revolves around the extent to which non-banks can have access to the Central Bank balance sheet. Some jurisdictions take the view that any CBDC access should only be provided to Wholesale participants (e.g. Corporates, non-bank Financial Institutions like asset managers, etc). Others believe that access should be provided to Retail participants (e.g. every day citizens).
The key implication to either of these outcomes is that existing banking intermediaries (Commercial and Wholesale banks) are by-passed… along with the complex constraints (per Section 2 above) that drive financial resource management decisions to extend credit / create Modern Money. Recent discussion around the 2019 3rd quarter Repo disruption, further highlights the complex dynamics and incentives driving unintended / unpredictable financial resource management decisions at the largest banks providing US dollar liquidity.
If the goal of the Central bank is to put liquidity into the hands of real economy participants (e.g. Corporates, individuals etc), CBDCs create one possible set of rails to do it. In particular, supporters of non-traditional and direct Central bank intervention, through programs like MMT (e.g. directly monetizing national deficits) and Helicopter Money (E.g. Universal Basic Income proposals), may come to see CBDCs as the bridge to get there. Proponents against more activist Central bank intervention see CBDCs as a scary proposition that further distorts capital allocation —with Central Banks ‘becoming the market’.
Impact #2 → On Commercial Bankers: Privately issued stablecoin tokens
In the Modern Money framework, discussions around privately issued currency tokens (stablecoins) are mechanically similar to other types of fiat-denominated credit instruments that function like money in offshore markets. Analogous to time deposits being placed in foreign banks which fall outside of home regulations (offshore “Eurodollars”), stablecoin tokens can facilitate transactions beyond home borders through the internet. Global adoption scales proportionally with the availability of on/off-ramps and FX markets that convert stablecoin tokens back into legal tender mandated by law for specific payments (e.g. tax payments).
The key implication of growing stablecoin use is that its creation is done through new non-bank intermediaries with clean balance sheet capacity. Existing intermediaries (Commercial and Wholesale banks) are by-passed…along with rules imposed by their home jurisdiction (per Section 2 above) that affect credit growth / Modern Money creation . Recent debates around the subsidiarization of banking, locational ringfencing of resources, reduced Eurodollar activity post-crisis, and structural dollar shortages globally, highlights the importance of creating sufficient Modern Money to meet the demands of smooth functioning global markets.
If the goal of privately issued tokens is to fill a gap in supply (e.g. a prominent example being US dollar liquidity shortages), then privately issued stablecoins offer the rails to address it. Managing the risks to privately issued stablecoin tokens is one as old as banking itself. Successful stablecoin ecosystems must balance: 1. the degree to which the tokens are fully collateralized (vs fractionaly reserved); 2. hidden counterparty risks (e.g. where is the collateral kept?); and 3. the liquidity needs of the market. Supporters will say privately issued stablecoins bring a clean balance sheet to issue credit / Modern Money to meet market liquidity needs. Proponents will say that these systems are just creating more layers of shadow leverage and growing the ‘house of cards’.
Impact #3 → On Wholesale Bankers: Crypto-collateral in Wholesale Finance
As new crypto / digital asset collateral is introduced to the market, new possibilities with wholesale banking become available. Like any other type of collateral-backed credit / Modern Money creation, crypto / digital assets are just another type of collateral to be pledged. Unique features of crypto-collateral for lenders are that it: 1. carries different credit risk (e.g. no classic sovereign risk); and 2. carries different market risk characteristics (e.g. crypto-assets trade on global 24/7 markets with a wide range of market makers, liquidity preferences and pricing).
The key implication from increased use of crypto / digital assets as collateral, is that there is new fuel for the wholesale multiplier in Modern Money. Existing credit intermediaries (Commercial and Wholesale banks) are by-passed…along with the complex constraints and embedded incentives (per Section 2 above) that affect credit growth / Modern Money creation. While the market is still nascent and has its risks, there are a number of new FinTechs / Broker-dealers exploring this channel of Modern Money grow. Often times these businesses start by hiring away Wall Street veterans from Prime Brokerage desks, and combine their knowledge with new capabilities offered through blockchain native infrastructure.
A longer-term proposition, the use of crypto / digital asset collateral to back fiat loans is a bet on the ongoing demand for novel scarce assets with attractive liquidity features. Post 2008, wholesale lending requirements have shifted to demand sovereign instruments (e.g. US Treasuries, German Bunds, etc), which are assumed to be risk-free. But as becoming increasingly clear to the market, there is no such thing as risk-free — even for sovereigns. Supporters of crypto / digital asset collateral will argue that non-sovereign assets will become an important new type of collateral for lenders, especially as we enter into an uncertain world of protectionism and currency wars. Proponents will say that these are just another speculative asset eventually trending to zero, which will leave lenders ‘holding the bag’.
In conclusion
Building the bigger picture for crypto / digital assets and blockchain-based economies can be interestingly viewed through the lens of Modern Money — which in itself, is a not well understood topic.
This post hopes to illuminate that nothing exists in a vacuum — and that discussions about money always have two sides to the argument and are often more complex than one expects. Every action has a corresponding reaction. Sometimes well-intentions actions implemented to drive a certain outcome, creates an unintended reaction that neutralises or changes the the underlying structure/mechanics of a market.
As the narrative for Modern Money continues to evolve, crypto / digital assets will likely play a meaningful role, but is no panacea. Reaching the right middle ground and smooth transition towards the next chapter of the Modern Money narrative, requires having an appreciation for the history, concepts and mechanics, and then pragmatically taking risks that bring new innovations to address imposed constraints of incumbent systems.
Published at Tue, 24 Dec 2019 11:21:01 +0000
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