Stablecoins threaten states’ monetary sovereignty, TikTok tit for tat, US-EU snapback standoff, Germany tries to buy off US
First off I guess I should address the “FinCEN Files” leaks published by ICIJ, BuzzFeed News, and a consortium of dozens of other outlets. If you want the details, go to either of those links, but essentially a federal employee leaked a trove of suspicious activity reports (SARs) filed by banks with FinCEN that, BuzzFeed et al say, show that banks (gasp) profit from illicit transactions.
The only thing that’s interesting to me about this story is how the media is reacting to the leaks. Imagine if every communications company in the U.S., from AT&T and T-Mobile to Twitter to Gmail to Facebook, had to keep a record of every private conversation between their customers and had to file “suspicious conversation reports” with the government whenever some chat seemed fishy. Do you think BuzzFeed’s reaction to a leak of such reports would be, “Wow, the mass surveillance regime the government has over all Americans’ conversations isn’t very effective, and these companies are profiting from conversations between criminals”?
When it comes to money and banks, however, many (including the Fourth Estate it seems) give up any concern over individual privacy or the extent of government surveillance power. The frog has been boiled, it seems, so let’s move on to some news you can use. On tap this week:
- EU finance ministers issue a joint statement on stablecoins
- TikTok tit for tat
- U.S. and E.U. in Iran ‘snapback’ standoff
- Germany offered U.S. €1 billion in LNG subsidies to drop sanctions
- Cyprus spikes Belarus sanctions over Turkey
- Dollar Deathwatch
Governments perceive stablecoins, not cryptocurrency, as the more serious threat
In the fall last year, Mu Changchun, one of the architects of the digital yuan, explained in a lecture why China was pursuing a central bank digital currency, and indeed turbocharging the project. He said,
“If Libra is accepted by everyone and becomes a widely used payment tool, then after some time, it is entirely possible that it will develop into a global, super-sovereign currency. We need to plan ahead to protect our monetary sovereignty.”
Imagine a foreign entity, and indeed a corporation, controlling not just the economy’s payment rails, but the monetary standard as well. For the CCP, that wouldn’t be good for business, and clearly not for the EU, either.
Last week, following an Bundesbank-sponsored informal meeting, EU finance ministers issued a joint statement on stablecoins, obviously aimed primarily at Libra, with a focus on “monetary sovereignty.”
In implementing the joint statement, we firmly believe that the regulatory framework for asset-backed crypto-assets in the EU should serve two crucial priorities: on the one hand preserve our monetary sovereignty and address the risks to monetary policy, and on the other hand protect EU consumers.
Banque de France Governor François Villeroy de Galhau also brought up monetary sovereignty in his speech at the conference:
“We in Europe face urgent and strategic choices on payments that will have implications for our financial sovereignty for decades to come.”
The most imminent risk, in Villeroy de Galhau’s view, is that “Big Techs,” capitalizing on their global market penetration, will build “private financial infrastructures and ‘monetary’ systems, competing with the public monetary sovereignty since they will position themselves as issuers and managers of a universal ‘currency.’”
And the French and German finance ministers drove the point home:
“We all agree that it’s our task to keep financial market stable and to ensure that what is a task for states remains a task for states,” German Finance Minister Olaf Scholz told reporters during a joint statement with his counterparts.
“The central bank, I mean the ECB, is the only one to be allowed to issue a currency. And this point, it’s something that cannot be jeopardized or weakened by any kind of project including the so-called Libra project,” [French Finance Minister Bruno] Le Maire added.
What stands out to me about all this is what states perceive as a threat to their monetary sovereignty. It is decidedly not Bitcoin and cryptocurrencies, which sure they’re concerned about as far as illicit use goes, but otherwise they don’t really sweat it. Instead, it’s private stablecoins, and in particular Libra, which had serious private backing, that got the Chinese to speed up its CBDC plans and prompted the ongoing reaction from the EU, which may also culminate in a digital euro.
The thing that motivates me about cryptocurrency is the potential for private, permissionless (P2P) payments. (I’ve explained elsewhere why I think it’s important, so I won’t rehash it here.) Bitcoin and cryptocurrencies like it serve as an escape valve for otherwise politically incorrect transactions, but owing largely to their volatility won’t likely ever become global monetary standards. So, to the extent that one wants private and permissionless money to be available widely, stability becomes an important requirement.
Ideally one might want a currency that has stable value over time, perhaps measured as purchasing power, and indeed this is what the original Libra design aimed to do. Short of that, however, pegging to the U.S. dollar is good enough. We may yet see the Fed issue a digital dollar that is tokenized, P2P, and anonymous—and that would check all the items on my wishlist—but while we wait for that, how do we get private, permissionless dollars?
One avenue is a backed stablecoin like USDT, USDC, Paxos Standard, and others. You give a dollar to a company and it gives you a dollar token on the Ethereum blockchain that can always be redeemed for a dollar back from the company. Because Ethereum is permissionless, you can theoretically transfer these tokens P2P as you like. There are some caveats to that, though.
First is that backed stablecoin issuers retain the ability to freeze funds and often do so at the behest of governments. That said, there’s nothing technical or in the black letter law that would prevent a firm from issuing tokens without this ability. It’s unlikely that they will do so because of our second caveat. The permissionlessness of backed stable coins, their P2P quality, depends entirely on the current regulatory regime. Today regulators require that firms know their customers, and customer is interpreted to be only those persons to whom a firm issues and from whom it redeems. In between those customers the tokens could be possessed by a long chain of completely unrelated parties. This interpretation of the rule could change in the future, and firms could only be allowed to permit transactions between addresses that have been KYC’d. Ethereum might be permissionless (by which I mean that there is no party that can effectuate a prior restraint on a transaction), but it’s unlikely that backed stablecoins will be.
Down another potential avenue are crypto-collateralized stablecoins, like Dai. Because the backing is ultimately volatile cryptocurrency, maintaining a dollar peg is challenging, so I’m not sure it’s even a real contender. Ideally you’d want real dollars backing the stablecoin. This is why I find stablecoin-collateralized stablecoins so interesting. The new design of Libra is essentially this:
The consortium set up last year by Facebook now plans to develop a handful of stablecoins each representing a different fiat currency. One libra coin could be tied to the U.S. dollar, for example, another to the euro and so on.
Libra still intends to issue a multi-currency stablecoin, but it would be backed by the new stablecoins, rather than directly by fiat currencies held in a bank.
Ultimately Libra is still a private firm, however, so it faces the same challenges as the issuers of single-currency backed stablecoins. Whether it can allow for truly permissionless P2P transactions will be up to regulators, which is why Libra is makes a good case for unhosted wallets in its white paper:
Unhosted Wallets enable financial inclusion, broad competition, and responsible innovation and thus facilitate the creation of services for the unbanked and underbanked. Since their activities may pose a greater risk, they will be subject to balance and transaction limits. Initially, the network will only be accessible to Designated Dealers and Regulated VASPs while the Association continues to develop its certification process for other VASPs and its compliance framework for Unhosted Wallets based on the feedback received from regulators.
Ultimately, though, it plans to make unhosted wallet activity “subject to transaction and address balance limits and other controls.” Celo is another stablecoin project that as currently designed may face similar challenges.
That leaves decentralized stablecoin-backed stablecoins, like Reserve aspires to be. The idea is simple: you lock a dollar-backed stablecoin (like USDT, USDC, Paxos Standard, etc.) into a smart contract and in return you get a token that is dollar-stablecoin-backed and truly permissionless. Like Libra’s original design, Reserve aspires to diversify its backing beyond simply dollar stablecoins and eventually achieve purchasing power stability unpegged to the dollar.
One potential pitfall I can imagine is that backed stablecoin issuers (and the issuers of other backed assets), perhaps at governments’ behest, may not allow their customers to fund decentralized stablecoin smart contracts. As for privacy, one can imagine employing zkSnarks on Ethereum to anonymize transactions, or alternatively implementing something like the Reserve Protocol on a privacy-preserving chain. In a recent podcast, Peter Van Valkenburgh and Ian Miers discussed the possibility of adding “user-defined assets” to the Zcash network.
That all gets us back to last week’s joint statement by EU finance ministers. Here are some of the principles they announced for forthcoming regulation of stablecoins:
Each unit of asset-backed crypto-asset created shall be pledged at a ratio of 1:1 with fiat currency … The assets eligible for the reserve shall be limited to deposits, deposited in a credit institution approved by the European Union … The assets eligible for the reserve shall be denominated in Euro or a currency of a member state of the EU …
That seems tailored to make it impossible for Libra to launch as presently designed, and it will be interesting to see how the letter of the regs (expected to be proposed next month) might affect non-euro-denominated backed stablecoins like USDT and USDC, as well as decentralized ones like Dai. It will also be interesting to see how the EU might go about potentially enforcing the rules against transnational issuers of backed stablecoins, and against smart contracts or their authors/communities. And at what point does it start mattering that, save for the notional libra, every stablecoin depends on a permissionless cryptocurrency network base layer?
TikTok tit for tat
Tik: The U.S. declares that TikTok will be banned in the U.S. unless it is sold to an American company, Microsoft and others pursue a deal.
Last week Chinese regulators cast doubt over ByteDance’s planned sale of the US operations of its short-video subsidiary TikTok, by expanding the country’s list of controlled exports to include the algorithms that power the viral video app.
Unlike the US, China has a small and very rarely used set of export controls, which have so far been most notably deployed on the rare earth metals found in consumer electronics such as smartphones.
Oracle Corp. won the bidding for the U.S. operations of the video-sharing app TikTok, people familiar with the matter said, beating out Microsoft Corp. in a high-profile deal to salvage a social-media sensation that has been caught in the middle of a geopolitical standoff.
Oracle is set to be announced as TikTok’s “trusted tech partner” in the U.S., and the deal is likely not to be structured as an outright sale, the people said.
Chinese regulators on Saturday introduced a sanctions regime targeting foreign companies operating in China, in a long-anticipated move seen as reciprocation for US policy targeting Chinese firms like Huawei.
China's Ministry of Commerce said the "unreliable entities list" will contain foreign companies that Beijing says "harm China's national sovereignty, security, and development interests" or violate "internationally accepted economic and trade rules." The list of firms has not yet been published.
Penalties for companies the end up on the list include fines, restrictions on importing and exporting and investment, and restrictions on moving employees into China.
U.S. and E.U. in Iran ‘snapback’ standoff
Talk about a raw exercise of power. As we all know, in 2018 the U.S. withdrew from the Joint Comprehensive Plan of Action (AKA the Iran Deal), which required Iran to give up its nuclear program in exchange for an end to UN sanctions. At this point Iran seems to be clearly in violation of the deal, so last week the U.S. announced it would exercise a clause in the agreement that would cause the UN sanctions to “snap back” into place. Wait a minute, if you withdrew from the agreement, how can you trigger a clause in the agreement?
European leaders have warned the US that its claim to have the authority to reimpose sweeping UN-mandated sanctions on Iran has no effect in law, setting up a major legal clash that could lead to Washington imposing sanctions on its European allies.
In a joint statement on Sunday, France, Germany and the UK (E3) said any attempt by the US to impose its own sanctions on countries not complying with the reimposed UN ones was also legally void.
The U.S. seems silly until you think through what consequences it could impose on those that don’t follow its lead…
The question is how the Trump administration will respond to being ignored. It already has slapped extensive sanctions on Iran, but could impose penalties on countries that don’t enforce the U.N. sanctions it claims to have reimposed.
Then then the U.S. starts to seem crazy and serious. From Mike Pompeo’s statement announcing the sanctions:
The United States expects all UN Member States to fully comply with their obligations to implement these measures. … If UN Member States fail to fulfill their obligations to implement these sanctions, the United States is prepared to use our domestic authorities to impose consequences for those failures and ensure that Iran does not reap the benefits of UN-prohibited activity.
Nord Stream 2 Part 2
Checking in on Angela Merkel’s Nord Stream 2 drama (which I explained in detail last week), it seems not much has changed on the board, which means there is little appetite from the German government to seriously consider cancelling the project…
Would Berlin have to terminate the billion-euro Nord Stream 2 project shortly before its completion? In recent days, neither the foreign minister nor the chancellor has been willing to rule out that possibility. But they have very little support within their parties for taking such a step.
Although he is not opposed to sanctions as such, SPD party co-leader Norbert Walter-Borjans said he, too, is opposed to suspending construction on the pipeline. "We cannot simply stand by and watch this blatant violation of human rights. We need to show a strong European response," the SPD leader told DER SPIEGEL, and sanctions could be part of that response. "But Nord Stream 2 is something else. It's like a bridge with only the final stone missing. You don't leave it in ruins just because you have problems with each other now."
Florian Post, an SPD parliamentarian from Munich, spoke out against possible sanctions. He lamented a lack of proof that Russian authorities had ordered the poisoning of Navalny with Putin’s knowledge. "We would be shooting ourselves in the foot,” Post said. "Suspending Nord Stream 2 is not an option."
Here is a very interesting tidbit: As I explained last time, the U.S. is trying to kill Nord Stream 2 with sanctions and has a ready alternative for Germany’s energy needs in the form of U.S.-produced liquified natural gas (LNG) shipped across the Atlantic. One problem has been Germany has no infrastructure that can accept and process LNG. Well, last month, before the Navalny poisoning complicated matters…
Germany offered to spend up to €1bn to subsidise the construction of two liquid natural gas terminals capable of receiving US gas exports in exchange for Washington dropping its opposition to the Nord Stream 2 gas pipeline.
The proposal — formulated last month by German finance minister Olaf Scholz in a letter to US Treasury secretary Steven Mnuchin — shows the great lengths to which Berlin was willing to go in order to support the project before the poisoning of Alexei Navalny.
Mr Scholz expressed his concern about the latest US sanctions against companies involved in building the gas pipeline, saying they “deeply infringe European energy sovereignty” and could threaten several European companies involved in the project “with ruin”.
It is unclear whether the offer is still valid. The German Ministry of Finance, the US Treasury and the US Department of State declined to comment on the content of the letter, which was first revealed by newspaper Die Zeit.
Meanwhile, Russia is feeling the hurt even though sanctions haven’t been imposed…
Russia said on Wednesday that talk of possible sanctions over the case of Alexei Navalny was affecting its plans to borrow money on international markets, acknowledging the risk of harmful economic fallout from his poisoning.
Finance Minister Anton Siluanov said Moscow was waiting for an opportunity to tap the Eurobond market, but would not do so with the threat of sanctions hanging over it.
“All these restrictions, sanctions and hype around Navalny do not give us confidence in a good placement,” he said.
Moscow is looking for extra sources of funding to make up a budget shortfall caused by lower oil prices and the COVID-19 pandemic, so any delay is potentially problematic. It last raised $2.5 billion in June 2019 through dollar-denominated Eurobonds.
Cyprus spikes Belarus sanctions over Turkey
As I explained last week, Cyprus was threatening to block EU sanctions on Belarusian officials if the bloc didn’t also sanction Turkey over energy exploration in contested waters between Cyprus and Greece. Well, it happened:
“It’s not a secret for anyone that we don’t have unanimity because one country has not participated in the consensus,” the EU’s foreign policy chief, Josep Borrell, told journalists, adding that he hoped to see agreement at the next EU foreign ministers’ meeting on 12 October. “I understand perfectly that our credibility is at stake.”
Cyprus, with just 0.2% of the EU population, denies wielding a veto.
Turkey meanwhile has recalled its boats (they say for scheduled maintenance) …
… and EU leaders meet on Thursday, so we’ll have a better sense of where this (and the Nord Stream issue) goes then.
This week, two correct takes:
Most economists and analysts are not particularly worried about the U.S. dollar. “Those fears have been around since the mid-2000s, when people were proposing that the U.S. dollar as a reserve currency should be replaced by a basket of hard currencies,” says Paul MacDonald, chief investment officer at Harvest Portfolios Group. “When people talk of a collapse, they look at it through the lens of COVID-19, geopolitics and society. We don’t subscribe to those views. In every past crisis, when the shit hit the fan, money was still flying to the U.S. dollar, including in April this year!”
One day, the mighty dollar will fall – but that day has not come yet, considers Stéfane Marion, chief economist and strategist at National Bank of Canada. The present retrenchment of the U.S. dollar is a normal result “of people believing that the recovery is on the right path, anticipating that growth will be back next year, and willing to move out toward more risky assets again,” he says.
In other words, when things went bad, people took refuge in the greenback, which caused its value to shoot up. “Now people are leaving that refuge,” Marion notes, which causes the currency’s value to retrench – certainly not crash.
If not U.S. dollar, what? Driven by an opaque dictatorship with still relatively shallow capital markets, the yuan doesn’t make the grade; the euro depends on a mosaic of countries without any fiscal and budgetary unity; and moving to a new gold standard not appealing to the majority right now. The fact is, there are no alternatives to the U.S. dollar. As Mohamed El-Erian, chief economic adviser at Allianz, recently quipped “You can’t replace something with nothing.”
Invariably, whenever the dollar shows weakness, commentators abound who forecast the demise of the Dollar as the anchor currency of the global monetary system. These skeptics belong to two opposite camps: on one side Dollar bears, who see the end of the world coming, some of them hoping for a quick reestablishment of some form of gold standard. On the other side are Euro or Yuan bulls, who believe the Euro or the Chinese currency will replace the Dollar as the world’s reserve currency. Of course, both camps forget that as recently as 2012, the Dollar was substantially weaker than today: it briefly hit $1.50 to the Euro. If that Euro strength was not enough to propel the Euro to reserve currency status, then it is not quite clear why things would be better today at a rate of only $1.18. Similarly, the Dollar weakness at the time, coupled with talk about currency wars, did nothing to diminish the dollar’s dominance.
Overall, we do not believe that the modest decline in the percentage holdings of Dollars represents in any way a decline in the status of the Dollar but is merely a technical consequence of the addition of Yuan holdings to central bank reserves.
The reason the percentage holdings of the Dollar have declined is simply that the Yuan has been added as a reserve by some countries, and reserves in Yen have increased. We are not quite clear about the enthusiasm for the Yen in central bank circles – after all, 30 years after the Nikkei reached its all-time high, we are hard pressed to find Japan bulls among private sector investors. The rationale for adding some Yuan reserves, however, is pretty obvious, now that China permits limited currency holdings by foreigners.
Since the dollar started weakening, the Bank of China has allowed the Yuan to strengthen against the dollar, thereby reversing some of the tariff-offsetting exchange rate moves. This may be an early indication that degloblization is in full swing and that exports to the Dollar block are no longer a priority for China’s central planners. Instead, they may be targeting their exchange rate on a trade weighted basis to a combination of Euro and Dollar.