Future of Money - Emerging Market Narrative

Currency Bubbles

In our world, there are close to two hundred state-issued currencies, each wielding significant power within its own borders but often losing traction beyond them. These currencies, much like casino chips or monopoly money, possess localized spendability but lack universal acceptance. The exception to this rule is the U.S. dollar, a globally recognized and easily convertible reserve currency. If you bring US dollars with you to most countries, it wouldn't be too hard to find a broker to convert them for you or a merchant to buy them directly. 

Following closely in salability are sovereign gold or silver. The euro, the Japanese yen and a handful of other major currencies trail behind, leaving a substantial number as less influential players.

Navigating this intricate web of currency monopolies becomes a considerable challenge, dependent on the happenstance of one's birthplace. For instance, my love for and connection to Sri Lanka, my home country, took on new complexities post the COVID-induced default, witnessing the local currency's sharp depreciation against the dollar and enduring high inflation. This underscores the real-world impact of a nation's monetary dynamics on its citizens, emphasizing the need for resilience and stability.

However, if we look at Argentina, things are much worse. 

Prices are what allow people to coordinate, and when money supply keeps debasing at such a fast rate, it is highly disruptive for economic coordination.

In addition to constantly diluting peoples’ liquid savings with negative real interest rates, this money supply growth constantly dilutes peoples’ wages. If they are not aggressively seeking higher wages year after year, they’re falling behind in international purchasing power terms. If small businesses are not aggressively raising prices, they’re falling behind as well. If landlords are not aggressively raising rents, their real estate investment is unlikely to keep up with international purchasing power. 

And it’s especially harsh for the least financially secure people. They’re the ones that are on daily wage, and are dealing with paper cash without even earning interest on their savings that keep devaluing. Upper-middle classes are more likely to have access to interest-bearing savings accounts that can mitigate some of the dilution, and are more likely to have access to credit, meaning they can basically short the local currency in order to buy property and other assets. Altogether, it creates a pretty strong effect to continually dilute those who are not arbitraging the money toward those who are.

According to Trading Economics, which compiles global inflation data and other economic data, there are over 30 countries that currently have double-digit price inflation, and by rough estimation they have about a billion people in them. In many of these countries, it is a chronic issue. In these countries, it is often hard to get your hands on better money. This is because governments control the only two primary ways to get money in or out.

The first way to bring money in or out of a country is through a port of entry, which today mostly means airports. However, bringing physical cash or gold with you is generally restricted to a rather modest amount.

The second way is to do a bank wire transfer, or use a fintech platform that serves as an overlay to a bank wire. Much like ports of entry, governments have tight control over what sorts of wires they allow and whether they force their citizens to convert into their local currency or not. National banking systems also have a barrier between their local currency and the outside world, and they can choose how porous or restricted that is. The majority of people in these countries tend to only have bank accounts in local currency, so any payments that they receive get turned into local currency. National governments and banking systems can determine how hard it is to get a dollar bank account, and to what extent (if any) that global dollar-based money transmitters like Western Union or Paypal can operate within their borders.

And even if you do have a dollar bank account, they are sometimes prone to forced conversion back into the local currency if the government has a dollar shortage and a lot of dollar-denominated debt. In Sri Lanka as an example, after the post Covid meltdown the Govt brought in a ruling where US dollars in business and individual accounts were converted to LKR after 30 days which saw the bigger businesses not repatriating their USD earnings to Sri Lanka and leaving them in offshore bank accounts, making the dollar shortages even worse. 

However, for normal people there seem to be only two possible options to get their hands on US dollars as a means of holding on to their purchasing power: 1) relatives who can send them dollar remittances directly with high fees or 2) Or buy dollars in the black market.

In countries experiencing high inflation, street markets specifically dedicated to physical cash dollars have become increasingly prevalent. Individuals purchase these dollars, stashing them away under mattresses for safekeeping. While this act isn't typically considered a crime, operating a cash dollar brokering business often is. These street transactions, akin to clandestine exchanges, carry an air of secrecy and risk, resembling illicit dealings. Surprisingly, the motivation behind such endeavors is the desire for liquid savings in dollars. Many resort to this clandestine practice due to a lack of direct access to dollar remittances or the unfavorable conversion terms associated with official channels (the difference between official and unofficial rate could be 20 - 40%).

Notably, a significant portion of dollar inflows into Sri Lanka during 2021-2022 veered towards these informal channels, triggered by the Central bank's autoconversion rule and less favorable exchange rates coupled with higher fees in the official market.

In many countries, the wealthy citizens have offshore bank accounts, offshore brokerage accounts, foreign property, and so forth. All of that relies on credit and a long chain of international counterparties. But then the lower you go down the income and wealth spectrum, the more people are likely to be stuck entirely within the confines of the local currency, and toward the bottom are people that are stuck purely in local cash without even the benefit of interest or credit to offset some of the ongoing inflation. Their wages and their savings are stuck in a constant spiral of dilution, with their economic value and the accumulated fruits of their labor constantly taken from them in an opaque way.

Opening the Gates

The inventions of Bitcoin and dollar stablecoins are beginning to circumvent this problem. The governments of these countries don’t generally like it, but the people do.

On the Chainalysis crypto adoption index, 16 of the top 20 countries ranked by crypto adoption are classified as developing countries and India takes the top spot.

In developed markets like the USA and Australia, people often view bitcoin and stablecoins as a solution in search of a problem, but that’s because money problems in the developed world have historically been subtle “most of the time”.  However, Nixon Shock was nothing but subtle - the aftereffect of a set of economic policies touted by former US President Richard Nixon in 1971. The policies eventually led to the collapse of the Bretton Woods system of fixed exchange rates that went into effect after World War II.

As the below chart illustrates, the Nixon Shock was the catalyst for the stagflation of the 1970s as the U.S. dollar devalued significantly.

For people in developing countries, their money problems tend to be more obvious, with either high inflation, high financial authoritarianism, or both. The sweet spot for crypto adoption is countries that have some significant tech savvy population centers, and that also deal with bad local money - Sri Lanka seems like an ideal candidate.

These technologies enable seamless transactions, allowing direct payments to a Sri Lankan Software Engineer in bitcoin or dollar stablecoins. The process involves sending funds directly to their online wallet, facilitated through a QR code during a video call, ensuring immediate payment. Alternatively, a digital address can be shared for convenient money transfers. Leveraging the Bitcoin Lightning network ensures minimal fees for such transactions. Globally, an increasing number of hubs and merchants accept bitcoin and stablecoins and convert them into local currency as needed.

At entry points into countries, individuals can enhance their financial flexibility by memorizing twelve words, storing them securely, or encrypting them in the cloud (representing private keys), effectively bringing unlimited value density with them. When confronted with airport restrictions like "cash only up to 10,000 USD," the thought arises: how many in this line might possess a substantial value in bitcoin or stablecoins, conveniently accessible? Traditional gates, constructed for an analog world, guarding analog boundaries, are now growing increasingly permeable. 

In the digital era, these gates were originally designed to confine, making it challenging for individuals to access superior currency. However, with the advent of bitcoin and stablecoins, the ability to transcend these barriers and embrace better financial options has become more attainable.

Governments may endeavor to outlaw the use of these technologies among local populations, but enforcing such bans is inherently challenging. The effectiveness of inflation and capital controls lies in their discreet operation behind the scenes. However, when individuals possess a peer-to-peer solution addressing financial issues, governments attempting to restrict its use often face the necessity of a more direct and less popular approach. Such measures can lead to declines in government approval ratings as they become more visibly involved in limiting the choices available to citizens. In a nation, overseeing a limited number of major international banks and a more extensive array of smaller domestic banks is relatively manageable. However, attempting to regulate individual actions scatters enforcement points into the millions, introducing a significantly more intricate and challenging task for authorities.

The adoption of new, decentralized money differs inherently. If it experiences smooth and rapid growth, individuals may leverage it, turning into forced sellers if the price declines. During periods of excitement, some may buy in excessively without a full understanding, while others may exploit the trend for fraudulent schemes. Subsequently, this enthusiasm can lead to significant downward volatility and liquidations. Unlike most technologies, disillusionment may set in, causing some to de-adopt the currency, buying at the peak and selling at the bottom. Bitcoin stands out as a unique asset, having undergone over 75% drawdowns on three separate occasions, yet rebounding to reach much higher highs each time. As the next few years unfold, it remains poised for a potential fourth occurrence of this pattern.

From a macroeconomic standpoint, the continued adoption of these technologies over the past 10-15 years raises the prospect of rendering the existing 160+ currency monopolies more challenging to sustain. In a digitally-connected global economy, the accessibility of superior money with global liquidity and salability becomes more apparent. People across the globe will enjoy increased choices, provided they have internet access. Envision the potential impact of these technologies in five or ten years when they are expected to be significantly larger and better comprehended. The transformative influence on global economic dynamics could be substantial.