Why are the great and the good of the banking and financial services world suddenly extolling the virtues of blockchain, the technology that underpins the artificial scarcity of bitcoin?
Possibly because they’ve finally figured out that what the technology really facilitates is cartel management for groups that don’t trust each other but which still need to work together if they’re to protect the value and stability of the markets they serve.
Cartel enforcement, in that sense, appeals to all sorts of financial players from bankers and commodity producers to general asset creators.
Though, we’d argue, it’s particularly applicable to entities whose cost of supply is nothing — namely, those entrusted to create financial assets out of thin air in prudent and controlled form (a.k.a banks) not least because of the overriding short-term incentive to abuse the “we won’t oversupply” trust for one’s own individual gain.
As an aside, one of the key reasons central banks came about is precisely because centuries of banking history taught governments that too many cooks in the money-creation kitchen spoils the broth no end, hence it does makes sense to allow a government-mandated cartel-mechanism to exist to apply an artificial cost of supply where there wouldn’t be otherwise. For further reading on that, see Goodhart.
But the same logic also applies to commodity producers. Note, as an example, comments last week from Glencore CEO Ivan Glasenberg about who really may be to blame for the 40 per cent plus fall in the company’s share price:
“Unfortunately, our competitors . . . have produced more supply than demand and commodity prices are down for that reason,” Mr Glasenberg told shareholders at the company’s annual meeting in a casino in Zug, the low-tax city near Zurich in Switzerland.
“It’s not our fault governor! It’s the wider system’s unconstrained supply rate.”
But suppose the rate of production could be algorithmically controlled to make it more difficult to mine commodities, money or financial assets as and when too many entities enter the system? And suppose, on top of that, such a mechanism was dubbed “technology” instead of a cartel system outright.
Would anti-trust authorities be inclined to look the other way then?
Keep that in mind as we return to the underlying fundamentals that really destabilised the financial system in 2008. Yes, there was unknown risk in the system due to overzealous issuance of subprime securities. Yes, Libor rates began to skyrocket because banks refused to backstop each vis-a-vis their collective liabilities to the central bank. And yes, banks began telling porky pies about the amount of liquidity they really needed in the system.
But at its heart, we’d argue, the system failed because the cartel mechanism that controls credit issuance — the central bank — misread the supply picture to such a degree that there was no way all former members could survive at the new controlled supply rate.
Remember, from the perspective of the central bank, the system should be kept just short enough of liquidity to ensure that demand for central bank-issued money is always high.
At the same time, however, the central bank knows it must provide the liquidity the system needs for stability to be maintained — something it’s usually more than happy to do as long as the act of dispersing liquidity doesn’t have price destabilising side-effects.
This, in reality, is what price stability is all about.
If and when the central bank’s currency begins to lose purchasing power, the central bank knows it must withhold liquidity until the cartel’s weakest and least scrupulous member is identified and weeded out, or — alternatively — fear of cartel collapse makes it too costly for banks to keep creating assets at the rate they had become accosted to.
Either way, the overall result is a contraction in the broad money supply, with complementary cartel-esque price stabilisation effects.
The eurodollar situation
The central bank system described above, however, is only as good as the closed nature of the system it operates and the collective interest of the cartel members it supervises to operate within that closed system.
But herein lies the significance of the shadow banking sector. Shadow banking, by and large, is the means by which a closed controlled system is turned into an open and uncontrolled system.
This is best illustrated by the rise of the so-called “euro” dollar, pound and euro markets which exist in a hitherto unregulated and parallel capacity to those of the central-bank controlled onshore equivalents.
This is a problem because once dollars, euros or pounds leak beyond the supervisory scope of the core cartel enforcement agent, and begin to be intermediated, re-lent and cleared by less stringent cartel organisations on the sidelines, the stability of the domestic controlled system — including the implied value of the unit of account — become threatened.
The systems, effectively, end up facing their own version of the Ivan Glassenberg problem. So don’t blame the Fed, in other words, because those who clear dollar lookalike securities outside of the Fed’s control can’t be trusted to do the job reliably.
Since the crisis, it has as a result become de rigueur to clear all dollar-denominated transactions through New York. But this has exposed the world to the reality that every dollar denominated transaction is de facto subject to US foreign policy or government intervention. As Dan Davies notes with respect to the business of banks like Deutsche Bank, that does not play well with those entities that want to supervise dollar assets without having US policy enforced on them extraterritorially.
But as Davies notes, for a dollar clearing arrangement outside the USA to retain trust and operate without the need of a US central bank guarantee, it would need an extremely disciplined cartel mechanism to self-control supply (mainly because going cap in hand to the Fed for missing liquidity is unlikely to be an option again).
Small surprise then that many banks think the shared ledger “technology” of blockchain could be such an opportunity for the clearing of the eurodollar markets.
Small surprise, also, that central banks are investigating if the “technology” could provide a better and cheaper means for policing the existing bank system — which still doesn’t fully trust each other — than defaulting to a fully centralised full-reserve system like that being proposed in Iceland.
All about the eurodollars – FT Alphaville