How digital currencies will shape the future of geopolitics

Just as oil and uranium have been used for years as tools of geopolitics, national cryptocurrencies and blockchain will be used in the future arms race to the next global reserve currency. China’s development of a digital renminbi along with its desire to create a alternative to the USD as the global reserve currency suggests the future of blockchain technology will play a role future of superpower rivalry.

The President of the European Central Bank Claude Juncker also recently voiced his frustration with the status quo in a speech in September:

“It is absurd that Europe pays for 80% of its energy import bill – worth 300 billion euro a year – in US dollars when only roughly 2% of our energy imports come from the United States. It is absurd, ridiculous that European companies buy European planes in dollars instead of euro. This all needs to be changed.”

Trade wars and tariffs:

The US hegemony in global currency, debt and commodity markets is coming to a head as the “one size fits all” unit of settlement (on US terms and in USD) drags countries into unwanted trade sanctions with trading partners that are blacklisted by President Trump.

The recent US trade wars with Russia, Turkey, China, Venezuela and Iran (among others) has sparked a backlash against US-dominated systems like the SWIFT network and Petrodollar system, and highlights the utility of a cryptocurrency like bitcoin as an agnostic international unit of settlement that is detached from the interests of one economy with a monopoly on world trade.

It is no coincidence that China has become the largest miner/producer of cryptocurrencies while trading and use is formally outlawed – it has accelerated the government’s research in digital currencies beyond any other country, the Digital Currency Research Lab of the People’s Bank of China (PBoC) is now expanding its research centres outside of Beijing. The lab filed more digital currency patents than any other entity in 2017.

Russia is also overtly working with blockchain technology with Sergei Glazyev, president Vladamir Putin’s economic advisor, giving keynote speeches at blockchain conferences around the world and recently meeting with the founder of China’s crypto exchange Huobi.

The new arms race to a digital reserve currency

China has been particularly vocal in its dissatisfaction with the USD reserve status which it has held essentially since 1944 and has been calling on the IMF to overhaul the international trade system for years.

The US has held reserve status since 1944 – the longest serving was Spain

In 2009, in the wake of the global financial crisis, then governor of the PBoC, Dr Zhou Xiaochuan, named the dollar as the root cause of the economic meltdown in his speech titled ‘Reform the International Monetary System’, in which he said:

*“The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.” *

He posits that the core criteria of a reserve currency should be:
1. Anchored to a stable benchmark and issued according to a clear set of rules
2. Supply should be flexible to allow adjustment for changing demand
3. Should be disconnected from economic conditions and sovereign interests of any single country

These are also core functions of bitcoin and several other stablecoin projects, including the ‘algorithmic central bank’ Basis – and Saga, a stablecoin pegged to the IMF’s Special Drawing Rights (XDR) basket of major currencies. China has called to expand the use of XDR for international trade and to even to use it as a global reserve currency.

A digital ‘Bancor’: Solving Triffin’s Dilemma

In the 1960s, economist Robert Triffin described the inherent conflict of interest that arises between the domestic monetary policies of the country whose currency is the global reserve, and the external demand for its currency as reserves, known as Triffin’s Dilemma. This has led to a dichotomy in US national and US global monetary policies as some goals require an inflow of dollars while others require an outflow.

In the 1940s, economist John Maynard Keynes anticipated this dilemma and proposed a supranational global reserve unit of account called ‘the Bancor’, a sort of precursor to the IMF’s Special Drawing Rights. While not conceptually a currency it was to be used as a unit of account in international trade that would be settled in a multilateral system, to be called the International Clearing Union – a distributed system.

In his 2009 speech, Zhou Xiaochuan called for “the creation of an international currency unit, based on the Keynesian proposal, a bold initiative that requires extraordinary political vision and courage”; although he also acknowledged “the reestablishment of a new and widely accepted reserve currency with a stable valuation benchmark may take a long time.”

China’s Belt and Road project expands its reach

Shortly after depegging from the gold standard in 1971 the US reached an agreement with Saudi Arabia and the now-OPEC nations to denominate their oil trading in USD, creating the Petro-dollar and effectively backing the greenback with oil reserves in foreign countries.

As a global reserve currency, the US has enjoyed the ‘exorbitant privilege’ of servicing its debt in its own currency which it can print to do so, allowing it to run huge trade deficits and debts without risk of default. This status quo is being seriously challenged by China’s ‘One Belt, One Road’ project (B&R) – a modern day maritime and land silk road to secure resources along the old trade routes from China to western Europe.

Largely funded by China it is hoped that Belt and Road associated nations will be generating 80% of the world’s GDP by 2050. China is the world’s largest importer of oil and part of its B&R strategy is to both secure oil and expand the use of its currency globally. China made an overt move towards this in March by issuing the first yuan-denominated oil futures contract trading on the Shanghai exchange, the first oil futures rival to the petro-dollar.

At the moment the ‘petro-yuan’ usurping the Petro-dollar seems far off but it is ready an alternative for US blacklisted countries like Russia and Iran to trade their oil and these are two important countries in China’s Belt and Road project. Iran and Russia have a long fractious history with the US, and the West in general, and both are more aligned to China’s politics so they would rather see the global center of power move back east.

China’s recent issuance of the Petro Yuan is the first effort by another country to disrupt the US’ monopoly in the oil market over the past 46 years. In future, it is very possible that oil will lose its status as the unit of economic productivity and the USD will lose its status as global reserve currency.

Skirting the SWIFT network: EU, China and Russia

Germany and France are working to build a European interbank transfer market outside of the USD-denominated global SWIFT network to avoid being dragged into US trade sanctions with trading partners they have no embargo against.

SWIFT, the Society for Worldwide Interbank Telecommunications, is a US-denominated network which the US government has special access to data and power to veto in. China and Russia also recently announced a new international trade network as an alternative to SWIFT that will use the ruble and yuan in trade settlements.

Europe, spearheaded by Germany and France, is also openly working on its own trade network to evade US influence. In a recent State of the Union speech, EU President Claude Juncker said:

Recent events have brought into sharp focus the need to deepen our Economic and Monetary Union and build deep and liquid capital markets. The Commission has made a series of proposals to do just that – most of which now await adoption.

Some cryptocurrencies are today already poised to fill this gap. Ripple considers itself to be in direct competition with SWIFT and is rolling out an impressive global banking network and is turning its focus to the east.

With the rival superpowers – US, Russia, China – vying to be the next world reserve currency and none wanting to cede ground, a neutral decentralized unit of trade like bitcoin is a ready solution.

A gold-backed digital yuan

Not so long ago the prospect of China issuing a “Crypto Yuan/Renminbi” seemed conspiratorial, now it is imminent. To lend it credibility in the markets it may be backed by an underlying asset such as gold. Alongside Russia, the Chinese have been buying vast amounts of gold in recent years.

China’s build up of gold inventories.

Trading patterns in the gold markets in USD and CNY (yuan) have also been markedly different in the past two years, with price action in CNY looking like a there’s a large buyer providing a strong floor around 8,200.

Trading in Gold versus CNY (XAU/CNY) has seen a strong floor since 2017 and recently saw a breakout to the upside.

The XAU/CNY price action is very similar to that in the BTC/USD market, which has seen a floor around $6,000 since the start of the year. It has been suspected that this long-term floor is from Chinese government buying.

The buying floor in bitcoin in a descending triangle pattern has an uncanny resemblance to the XAUCNY.

The upside breakout of a descending triangle pattern in the Chinese gold market is a very bullish signal and totally the opposite of what has been happening in the US gold market, which has seen a breakdown of long-term support.

Trading in gold versus USD over the past two years has taken a totally different trajectory and long-term support has been broken.

Just as the buying support for bitcoin around $6,000 has raised many eyebrows and questions – including whether it is coming from Tether/Bitfinex – it appears the Chinese government is supporting the price of gold around 8,200CNY as it rapidly increases its reserves.

Privacy coins and the battle for anonymity in China

The Chinese government’s preoccupation with capital and human surveillance has increased unabated in its effort to create a social credit system that tracks individuals on social and financial conduct and scores them on creditworthiness and behaviour which could affect their ability to get loans and at which rates. The system uses facial recognition to monitor citizens through surveillance and traffic cameras, mobile phone apps and social media so any “illegal” behaviour will be tallied and added to a person’s social ID.

Aside from the countrywide ban on all crypto trading, the government continues to tighten the reins on blockchain technology and since October requires all blockchain services to store and provide the details of its customers to the country’s internet regulator – undermining the core tenet of crypto anonymity. This is an extension of a rule already in place with digital cash platforms such as WeChat Pay which requires a national ID number when signing up.

Chinese citizens have long found ways of circumventing the government’s capital controls – most visibly funnelled into property markets across Australia, Canada and New Zealand – and China is a huge potential market for privacy-focused cryptocurrencies such as Monero and ZCash as an alternative for individuals to keep their wealth private.

Emerging markets using BTC as energy commodity

Although many have scoffed at Venezuela’s attempt to issue its “Petro” cryptocurrency, the idea of commodity exporting countries creating their own version of the “Petrodollar” independent of USD is becoming a reality and will only continue. Recently Iran formally recognized cryptocurrency mining as an official industry to be overseen by the Iranian Central Bank and there is speculation the government will issue a state-cryptocurrency to circumvent US sanctions.

What we could be seeing is the conversion of one energy commodity into another – oil to bitcoin – in a new frictionless commodity that is more transferable and arguably more fungible than oil or gold. It could be said that China has been doing the same thing for years, mining crypto with the overhang from its coal and hydro energy.

With US trade embargoes and sanctions becoming par for the course for emerging economies, major oil exporting countries are reducing their reliance on oil. The Saudi Arabia sovereign fund is a major shareholder in Tesla and is in a $200b venture partnership with Japan’s Softbank to construct the world’s biggest solar field. By the time it’s finished in 2030 the kingdom expects it to have a solar power capacity of 200GW, triple the UK’s total power capacity.

“You have never something of this scale,” said Saudi’s Crown Prince Mohammed bin Salman.

Conclusion

Usurping the US with another fiat reserve currency is no small feat and requires deep liquidity and a huge change in infrastructure.

Also there are no genuine fiat contenders: the Euro is a union teetering on collapse; the British Pound long since diminished; the Yen is still recovering from decades of deflation and the Russian Ruble and Chinese Yuan lack the transparency and convertibility of ‘democratic’ currencies. With the PBoC close to its own digital currency while having the world’s most vast reserve of gold a digital RMB/CNY backed by gold stands a good chance.

On the other hand, as oil becomes a less important driver of economic activity in a renewable energy IoT economy and the revival of supranational currency like the XDR/Bancor, a cryptocurrency replacing the USD as the default unit for pricing commodities with an ‘Electro-dollar’ would be the most neutral resolution to avoid confrontation. And arguably it is already here – bitcoin.

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