Crypto-currencies held out the ambition of an alternative to the contemporary financial system whose excesses threw the world into crisis in 2008.
But the shockwave of illiquidity from the FTX platform is spreading (the Blockfi platform is suspending withdrawals). It blows away the fragile edifices of savers’ confidence and hope. It reveals the same stigma of the deregulated past of traditional finance: that of a system in the grip of greed.
Could one imagine in 2022 that a bank would accept its own shares as collateral for a loan it makes? And yet, by accepting its native cryptocurrency (FTT) as collateral for its clients’ loans (for leveraged investment purposes), this is the mistake the platform founded by the influential Sam Bankman-Fried has made… in addition to flouting the principle of account segregation.
Of the $16 billion in customer deposits, $10 billion was taken by the founder’s hedge fund (Alameda Research) to finance its speculative positions… The $8 billion gap between the platform’s assets and its liabilities now separates the founder’s former glory from bankruptcy.
The reaction has been overwhelming. A quarter of the value of bitcoin was wiped out in two days. Such volatility will have a lasting effect on the use of digital assets as currency. Would the euro still exist today if it had suffered such daily fluctuations when Dexia’s accounts were discovered in October 2011, or as Italian or Spanish banks were successively bailed out and rescued?
With the increasing scope of their actions on the markets and the measures taken with regard to commercial banks since the 2008 crisis, central banks have established their authority. But their credibility (and that of their currency) can also be tested when, as is currently the case, their ability to curb inflationary pressures is challenged.
Emerging central bankers are then on the front line when the global battle against inflation begins. They have to fight against the fall of their currency against the dollar, which is becoming more expensive as the FED raises rates, fuelling the local inflationary spiral, increasing the interest cost of foreign currency debt and eroding foreign exchange reserves. Their salvation lies in gold.
Since 2018, emerging countries have dominated central banks’ purchases of bullion: the Russian central bank is the largest buyer (nearly 600 tonnes accumulated in four years), followed by Turkey, India, Poland, Kazakhstan and China, which is very secretive about keeping its accounts in precious metal…
In 2022, a veritable gold rush has taken place among the emerging banks. The volume traded in the third quarter quadrupled compared to the same period last year. In the first nine months of the year, 700 tonnes, a volume not seen for 55 years, found buyers among these institutional investors. Losing its leadership due to a lack of foreign currency reserves, Russia was replaced on the podium by Turkey, Egypt and Iraq, closely followed by Uzbekistan and India. China, very active in this market, remains anonymous. It is known that between 2017 and 2022, it was able to buy up to 1,262 tonnes of gold per year… The world’s leading gold producer ahead of Russia (followed by Australia, Canada and the United States), the Middle Kingdom can source its gold locally.
Unlike foreign currencies, property titles and debts, gold stored in the vaults is safe from external economic sanctions. The West’s organisation of a freeze on 300 billion in foreign assets held by the Russian central bank set a precedent.
The decline in the precious metal this year has convinced emerging central bankers of the desirability of filling the coffers. In 2022, physical gold fell as real dollar interest rates rose. A significant decline of 7.2% (compared to a 20% decline in government bonds and investment grade credit) compared to the agony of digital gold, which was endorsed by the President of El Salvador… Down 63%, Bitcoin is costing the country’s public funds $300 million….
Fearing that yields would be too low relative to inflation, emerging market central bankers may also have seen fit to diversify their reserves away from US Treasuries.
Nevertheless, the publication of a lower than expected increase in consumer prices (7.7%) in the United States in October last week revived hopes of a peak in US inflation. Patrick Harker’s (Philadelphia Fed) comments that the lag effect between monetary policy and its impact on the real world may not be as long as expected made the market forget about the details that tarnish these figures (a historic drop in health care costs caused by a change in accounting by the Bureau of Statistics and a continued rise in services inflation).
This was enough for the market to ease financial conditions on its own and before the next FED action (which is still expected to raise rates by 50 basis points at the next policy meeting). Indeed, over the session, 5-year rates fell by 30 basis points… A magnitude that is only found when central bankers take concrete action (FED rate cuts of 75 basis points on 22 January 2008, Greenspan’s pivots in 1995, the start of Quantitative Easing in 2009 for example). The equity markets also ignored the devil in the details, with the Nasdaq, the big loser in 2022, offering one of the five best performances of the last twenty years (+7.5%). Gold rose along with risky assets, buoyed by the fall in rates, recording a rebound of nearly 8% over the past seven sessions.
However, it will be necessary for the most recalcitrant “sticky” inflation, measured by the Atlanta Fed, to show real signs of retreat before we can be sure that the inflation genie will finally decide to return to its lamp. Finally, let’s not forget that by announcing a relaxation of health restrictions, China is moving towards reopening its economy. The return to normalcy of the world’s largest importer of raw materials will not be without effect on global inflation…
Thomas Planell, Portfolio manager – analyst at DNCA. This article was finalised in November 10th, 2022.
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