A Currency Crisis Looms: We Need a New Model

Geopolitical issues and rising U.S. interest rates are boosting the dollar and threatening emerging-market currencies. It's time for change.

AccessTimeIconSep 9, 2022 at 5:20 p.m. UTC
Updated May 11, 2023 at 6:15 p.m. UTC
AccessTimeIconSep 9, 2022 at 5:20 p.m. UTCUpdated May 11, 2023 at 6:15 p.m. UTCLayer 2
AccessTimeIconSep 9, 2022 at 5:20 p.m. UTCUpdated May 11, 2023 at 6:15 p.m. UTCLayer 2

The global economy is staring down the barrel of a currency crisis. That has huge ramifications for the crypto industry.

Emerging-market currencies face a perfect storm: the COVID-19 pandemic, the Russia-Ukraine war, soaring commodity prices, rising inflationary expectations, political crises in multiple developing economies and, now, aggressive interest rate hikes from the U.S. Federal Reserve that draw speculative money into the dollar. It’s all putting exchange rates in countless countries under extreme pressure.

Raoul Pal observed this week that, by some measures, there is a more extreme dislocation in Asian currencies now than there was during the region’s 1997-98 financial crisis.

Currency crises like these impose a vicious cycle on emerging-market countries: The exchange rate plunges, local policymakers’ try to contain the fallout but fail, and confidence in their abilities wanes, which further drives down the currency, stoking fears of default among foreign lenders and generating inflation as import prices surge. And all of that further undermines confidence in the currency and the government.

Nations such as Sri Lanka and Lebanon have already entered this dark phase. Others with less overt political problems may well be next as 1998-style “contagion” takes root.

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Vicious cycles

I see this as a periodic reminder that our dollar-centric international financial system can give rise to profound global imbalances.

One element of that system – undeniably a bug, not a feature – is that whatever the U.S. does with monetary and fiscal policy to meet its domestic objectives often has negative effects on other countries’ economies.

This was the case before COVID-19, when more than a decade of the Fed’s “quantitative easing” (QE), aimed at lifting the U.S. economy out of a long-lasting post-2008 crisis funk, created oodles of new money that fled the then low-yielding dollar for higher-yielding emerging-market assets.

Predictably, that hot money is now heading “home” to the dollar as the rate hikes make the greenback a much more appealing, higher-yielding store of value than it was a year ago and as geopolitical tensions boost its safe-haven status. That reversal has a brutal whipsaw effect on emerging markets.

It’s nearly impossible for governments of smaller economies to execute effective policy against such sweeping forces outside of their control.

Yet when a crisis arises, the only prescriptions offered – notably from the International Monetary Fund, which recently adopted its routine crisis-fighting role in Sri Lanka and Argentina – put the onus on those local governments to fix the problem.

The proposed solutions can spell political suicide. Central banks jack up rates to stop the flight of capital, and the governments adopt fiscal austerity to placate foreign creditors, squeezing the local economies at their most vulnerable moments. No wonder so many developing countries become breeding grounds for autocrats who respond to their citizens’ concerns with oppressive and xenophobic policies.

Flawed at its core

We have the worst of both worlds – a decentralized system where countries must fend for themselves and yet face excessive, system-wide vulnerability to the actions of just one of them.

Some might argue the U.S. is the exception that benefits from this system in the form of autonomous monetary policy. At the present time, for example, the stronger dollar bolsters the Fed’s efforts to curb inflation because it lowers the cost of imported goods. Previously, demand for dollar assets among central banks’ reserve managers allowed the Fed to execute trillions in QE without generating consumer inflation – at least not for 12 years.

But as former Bank of England Governor Mervyn King famously noted in 2011, these “global imbalances” also hurt the U.S. The distortions in the global price of money frequently generate excesses in the U.S. economy, as with the low mortgage rates that stoked the housing bubble before the 2008 meltdown.

In 2019, King’s successor, Mark Carney, offered a solution with crypto overtones: a new, digital international currency run by the IMF. (That radical idea didn’t get traction in Washington, which may be the reason Carney wasn’t picked for his sought-after job at the helm of the IMF.)

But at least Carney was considering action. The current system isn’t sustainable. It’s false comfort to look at the recent strength of the dollar as proof of its reserve status’s staying power. In many respects, the fear-driven flight into dollars is a symptom of the system’s failure and a sign that it must, one day, end.

If so, it’s far better that we plan now for a smooth transition to a different model than undergo the violent rupture threatened by Russia’s and China’s open rejections of the existing one.

A new model

What does that future system look like? Western governments won’t trust a currency issued by the Chinese government, and Europe’s coordination problems mean the euro isn’t really a contender. Perhaps it will be a multi-currency system.

When I wrote “The Unfair Trade” in 2011 – before I’d had any real exposure to bitcoin – I was in the Carney camp. As I saw it, a multilateral reserve currency managed by the IMF was the only way out of our broken financial system.

But now I see the problem in more sweeping terms: The rise of the internet produced a loss of confidence in governments and created new transnational communities of power as wealth imbalances in the age of globalization fueled resentment toward the incumbent neoliberal order. Whatever system emerges, multi-currency or otherwise, it needs to restore people’s sense of control over their assets and identities. And it needs to be digitally native.

That inevitably points to digital currencies – in some form or another.

While it’s not clear bitcoin is the answer, not with its failure to decouple from the past year’s slide in financial markets, I continue to believe in the principles upon which Satoshi designed it.

The dollar system’s replacement needs to incorporate some form of digital, censorship-resistant money that’s immune to the failures of centralized governments, something that looks and feels more like the original, decentralized design of the internet.

Whatever comes next, it must reflect the wishes of the human beings who use it. It shouldn’t be up to faceless international bureaucrats to decide.

Vote with your pocketbooks, people.

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Michael J. Casey

Michael J. Casey is CoinDesk's Chief Content Officer.