It’s time to reverse the major trend seen since the 2008 financial crisis—centralisation.
That’s the opinion of Alex Lipton, an academic and former Wall Street quant who now works at fintech start-up Sila.
According to Lipton, our guest on the latest New Money Review podcast, centralisation has occurred at several levels: at central banks, which are taking on more and more balance sheet risk; at central clearing counterparties (CCPs), where derivatives market risk is increasingly concentrated; and at commercial banks, where the largest firms have been getting larger still.
Alex Lipton
Decentralisation will be a generational project, warns Lipton. But it’s now time to start rebuilding, he says, even if the shape of the future system is not yet clear.
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Some highlights from the podcast:
Commercial and central banks have swapped roles
“Commercial banks are becoming narrower by choice, while central banks are becoming more fractional reserve by choice. Both trends are at odds with what has been happening in the past. And that makes the system quite unstable.”
“Before the great financial crisis (GFC) of 2008, the excess reserves kept by commercial banks with the central bank were minimal. Afterwards, when QE started in earnest, the banks got a lot of funds from the central bank that they didn’t want to lend. Essentially, those funds have gone back to the central bank and we now have trillions in excess reserves.”
Central banks face constraints
“There’s been an implicit or explicit change in the way the banking system operates. This places a great burden on central banks, who are becoming the lenders or the dealers of last resort. They buy much more commercial paper and stuff that they normally would not touch. These are super-powerful and well-informed institutions, but they are relatively small. For that reason alone, they are not really capable of evaluating properly everything that they are placing on their balance sheet.”
On centralisation
“The bigger banks became even bigger after the GFC. This is particularly true in China, but it’s also the case in the US. And there’s been a relentless push to clear derivatives trades at central clearing counterparties (CCPs). The problem is that if something bad were to happen to a CCP, the consequences would literally be incalculable.”
“We really have never tried to stress-test CCPs to the perturbations in the financial markets we are seeing at the moment (as a result of the pandemic).”
The remedy
“My preference would be to make the entire economy more decentralised. I would also advocate decentralised finance as much as possible. It would be very beneficial to use the achievements of blockchain technologies in order to supplement the central clearing system. It’s a mammoth task. But even though it’s a generational project, we need to start.”
Negative interest rates
“In the Middle Ages, negative interest rates were practised on a large scale in the form of demurrage. So it’s not an unknown phenomenon, though it’s very rare.”
“In the presence of cash, there’s a physical lower bound to interest rates, somewhere around -30 to -40 basis points. But if cash is dematerialised and made digital, there’s no lower limit.”
Stablecoins
“Private initiatives in digital currency are well worth trying. There is room for the private sector to offer its services and fill big gaps in the existing financial system.”
Cryptocurrencies
“I don’t think bitcoin will be a substitute for fiat currencies. The reason I’m sceptical about it is the same reason some other people are very enthusiastic about it: I find bitcoin’s monetary policy very rigid and tantamount to central planning. I was born and bred in Moscow and have seen the consequences of central planning: capitalism beats it hands down. Undeniably, though, bitcoin is a beautiful technical achievement.”
Hopes for a more equitable financial system
“We are at an inflection point and the next ten or twenty years will be decisive. I am optimistic, not least because being pessimistic is too frightening a perspective. Advancements in money will be extremely helpful to foster further advancements in social development. These are badly needed as society is suffering from too many afflictions. Hopefully, going forward things will become more equitable and fairer.”
End of the dollar standard
“The time has come to think about additional reserve currencies. Technology, combined with new ideas, can bring these to life.”
To listen to the podcast, click here
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