As a principal adviser to the then treasurer Wayne Swan, Jim Chalmers had a ringside seat to observe the impact of the global financial crisis on the Australian economy and financial system. We were spared the initial impact of the GFC largely because, still bearing the scars of financial disasters in the 1980s and early 1990s, Australian financial institutions had been slow to embrace the exotic derivatives that brought down their counterparts in the US and UK. That delay allowed time for vigorous fiscal stimulus (here and in China, our main export market) to stave off the long and deep recessions seen elsewhere.
But a few days ago, Jim Chalmers made comments suggesting that Australia’s financial system will not be insulated from a crisis that seems all too likely to emerge in the next few years. When Donald Trump assumes his role as the US president, it will bring an end to policies that have maintained a wall of separation between the traditional financial system and the crypto sector. Chalmers, citing Trump’s moves, has suggested that Australia will follow suit.
Much of the concern about the incorporation of crypto into the financial system has focused on the fact that crypto prices are highly volatile. This ought not to be a concern: commodity prices are volatile, but commodity futures have been traded in financial markets for well over a century. Indeed, the central role of financial markets is to manage risk and volatility.
The real problem is that crypto is essentially worthless. A typical crypto asset, such as a bitcoin, is a certification that the producer has performed a complex, but uninteresting, mathematical calculation (roughly, finding an input to a complicated function which produces an output near enough to zero). No one can make any use of this.
By contrast, other assets, including those used as currency, have value either because they are useful or desirable in themselves (like gold and silver) or because a government is willing to accept them as payment for tax obligations, like fiat currency. Stocks and corporate bonds represent a claim on the earnings and assets of the companies that issue them. And so on. Unless the Trump administration decides to treat bitcoin in the same way as US dollars (the idea has been proposed!), none of these applies to crypto.
What this means is that, as soon as people decide that crypto is valueless it will become so. As holders seek to cash out, the price will fall, producing more sales, with no stable floor above zero.
At this point, it might reasonably be objected that critics (like me) have been calling crypto worthless ever since its introduction in 2009, and yet its price has soared spectacularly. It’s worth observing that the relatively simple Ponzi scheme operated by the late Bernie Madoff ran for at least 17 years, with the sum involved growing into tens of billions of dollars. He was only exposed by the GFC.
In previous downturns in the crypto market, the loss in value has affected owners of crypto who are unwilling or unable to “Hold On for Dear Life”, but had no effect on the mainstream financial sector. By contrast, in the next few years, the exposure of traditional institutions is likely to run into the hundreds of billions, perhaps trillions. Mortgages will increasingly be secured against crypto collateral and serviced by the (hoped-for) profits from crypto speculation. Loans to crypto exchanges, which have been restricted in the past, will be allowed and encouraged, creating more opportunities for contagious collapse.
An obvious starting point for a crash would be a failure of one of the crucial, but opaque, “stablecoins”, which are designed to trade at a fixed price of one US dollar, and to facilitate the conversion of crypto into fiat currency. Tether, the leading stablecoin, claims assets of over $100bn, but has never produced more than a vague account of what those assets are. Chalmers’ statement includes a promise of legislation for “payment stablecoin” reforms, but it is hard to see how Australia can regulate a global firm like Tether.
A combination of good luck and good management, in which Jim Chalmers played a prominent role, helped Australia avoid most of the consequences of the GFC. If crypto is allowed to play a prominent role in our financial system, we will be counting entirely on luck to avoid a future disaster.
John Quiggin is a professor at the University of Queensland’s school of economics
