“I sincerely believe that banking establishments are more dangerous than standing armies.”
– Thomas Jefferson
Not Your Spreadsheet, Not Your Reserves
My first job out of college was as a floor broker on the Frankfurt stock exchange, where I quickly learned that dealing in shares of Allianz, the big German insurer, would make me unpopular with my new colleagues.
The commission was welcome: With Allianz at about 3,000 Deutsche Marks, trading just 1,000 shares would make about 4,000 DM of comm.
But Allianz shares were, for some reason, bearer shares: However many you traded, no matter how fleetingly you may have been long or short, that number of physical share certificates would be delivered to your door.
Someone would have to count them (and recount them and then recount them again), make sure none were damaged, make sure they all had their dividend coupons attached, and then pack them up and send them on to the next place (or places)…in the mail.
It was an anachronistic nightmare, even way back then.
If you’re the Russian central bank, however, physical stock certificates are sounding pretty good to you right now.
Because Russia has spent years stockpiling a $600 billion mountain of foreign reserves with the intention of immunizing its economy against financial sanctions.
But we’ve learned this week that it’s had the opposite effect.
All of those stockpiled dollars, euros, pounds and Swiss francs exist only on spreadsheets at their respective central banks.
They are not bearer assets, delivered in the mail like carefully counted shares of Allianz.
They are digital IOUs.
And, right now, central banks are refusing to make good on them.
The Central Bank of Russia does self-custody one bearer asset: It has about $130 billion of gold in its domestic vaults.
But central banks typically keep their gold in London and New York for a reason: It’s a lot harder to put a stack of gold bars in the mail than a stack of stock certificates.
Russia is sitting on a mountain of gold, but how much good does it do them? It’s more useful than their frozen dollars, for sure, but not a whole lot more.
So Russia’s leadership is likely thinking hard about the nature of money right now.
I expect they’re not the only ones.
China will be, of course. Should they assert their authority over Taiwan, say, they now know that the cost will include the loss of $1 trillion of digital IOUs (aka, Treasurys).
Is there any doubt they would decentralize those assets if they could? If there were an algorithmic stablecoin that could absorb trillions of dollars of demand, China would be all-in.
But it’s not just US adversaries that would be interested in un-freezable reserves. Allies would be, too.
The Swiss National Bank owns something like $160 billion of US equities. Even if those securities are custodied with Swiss banks, the US government would only have to ban them from DTC settlement to make them effectively worthless.
I can’t imagine it would ever come to that, but Swiss banks paid $1.3 billion of extortion money fines to the US Department of Justice in 2016, mostly because they couldn’t risk losing access to the highly centralized US financial system.
Norway’s sovereign wealth fund has about $400 billion invested in the US equities.
What if the Environmental Protection Agency were to sue Norway for climate change or something? Irrespective of the merits of the case, the US would have $400 billion of leverage over Norway.
If Norway’s sovereign wealth fund could tokenize its US equities holding, freeing it from reliance on financial middlemen and removing that leverage, I'm sure it would.
This is mostly a thought experiment, of course. Crypto markets will not be liquid enough to absorb the assets of a central bank much larger than El Salvador’s anytime soon.
But after the dramatic events this week, plenty of individuals will be thinking hard about self-custodying their assets, too.
Oligarchs were put on notice earlier today when Mario Draghi proposed the creation of an international wealth register that would allow the EU to freeze the assets of targeted individuals.
London townhouses and numbered Swiss bank accounts have been the preferred stores-of-value for those oligarchs. But with even Switzerland and Monaco joining in on sanctions against Russians, they are surely giving bitcoin a second look this week.
Non-oligarchs have taken notice as well: Muscovites were said to be panic-buying luxury goods over the weekend.
When Hermes handbags are seen as a store-of-value, you know that the appeal of self-custodied digital assets has taken a large step forward.
The biggest threat to financial systems occurs when what people think is money turns out not to be money.
Russia thought they had $400 billion of foreign reserves. And now they don’t.
Their central bank has been rugged.
Traditional bank runs start in the same way — when a dollar of deposits is suddenly worth less than a dollar. And they finish with unpredictable consequences.
The rugging of Russia’s reserves is likely to have similarly unpredictable knock-on effects.
Financial ones, for starters: What happens to delicately balanced monetary systems when hundreds of billions of USD collateral is suddenly frozen?
And, more worryingly, geopolitical ones: What does Putin do when his mountain of strategic reserves is suddenly $400 billion smaller?
A SWIFT ban was considered an extreme measure as recently as just last week, and now we’ve taken the much more consequential measure of freezing central bank assets.
I suspect that move has caught Putin off guard — and much of the rest of the world, as well.
The abrupt escalation is forcing central banks, oligarchs and even normal investors to rethink their assumptions around property rights and the nature of money.
A spike in new Bitcoin addresses this week suggests that decentralized assets are already winning many new converts.
Wars often mark a step change in history.
This time, it may be a step change in the direction of the decentralization of finance.
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