• 09-NOV-2015

The Future of Currency – The Global Challange

An Initial Perspective by Six Capital. 

This is the new initial perspective on the future of currency. Authored by Patrick Teng, CEO of Six Capital, it kicks off a series of events in Asia and Europe to explore how currency is changing over the next decade.

The Future of Currency – The Global Challange

Currencies are influenced by social, economic and political change, so it is little surprise that all around the world they are in a state of flux. In Europe the future of the Euro is a real concern; the ASEAN markets, fearful of making similar mistakes, are backing away from their flirtation with a collective currency unit; in China, the ambition to extend economic influence and desire that the Yuan is recognized as an alternative reserve currency is being tempered by a financial slowdown; in the US there is growing uncertainty about whether the dollar will maintain its status as the primary unit of global currency, and on top of this, instability in the Middle East and the dramatic fall in oil prices have all combined to make the currency markets increasingly volatile. The result is a fragile global financial system continuing to face the real possibility of further financial crises.

While few are suggesting the imminent demise of the existing currency order, key questions stand out.  What will be the real role of currency in the next ten years? How will regulation adapt to this?  Given all the disruptions, how best can we stabilize the marketplace?  How can currency markets organize themselves more effectively?   In ten years’ time will the focus remain on national currencies or will alternative currencies, such as Bitcoin, Amazon Coins or BerkShares take a more prominent role?  The future seems like a complex game of musical chairs – positions are yet to be decided and it is by no means clear that there will be a seat for everyone when the band eventually stops playing.

The Future of Currency – Options and Possibilities

First let’s consider the role of currency.   Money acts as a store of value and as a means of exchange either between individuals, corporations or nations and as such its real value is derived from the faith we have in it. The buying and selling of currency effectively measures a nation’s credibility and helps to stimulate growth and stability in the global market place. But the opposite is also true. Attempts to control the impact of currency fluctuations have been unsuccessful and following the 2008 economic crises the global monetary system has become increasingly fickle, grappling with speculative investments while attempting to manage the imbalances between countries (their current account deficits and surpluses) and to control the gross capital flows that are currently overburdening emerging markets.

Given this role, there are 6 key themes expected to impact currency markets over the next 10 years:  the pace of trade; pegs and floating exchange rates; the role of the dollar as the global currency; the rise of the Chinese Renminbi; regulation; and emerging alternatives.

Technology has increased the speed and flow of currency trade.  This pace can often be at the cost of appropriate consideration and due diligence. With profit as the motivator and with deal speed at a premium, currency traders are rarely able to pause to consider what the impact of their transaction could be on a wider society.  Currencies change in nanoseconds. And yet it can take nations years to recover from a fall.  Perhaps it’s now time to recognise that the way we manage money is not fit for purpose in today’s world and is unlikely to adapt to the changes over the next decade.  We need a new order that can help stabilise the global marketplace and deliver appropriate returns.

A critical lesson that Europe has taught Asia is that combining currencies doesn’t work. Over the long term neither do currency pegs.  In many ways a single currency across a group of countries is simply an extreme version of a peg and in times of crisis its inflexibility imposes unnecessary constraints on national governments, limiting options and reducing their ability to respond to market conditions.  This can have a huge impact on the local population.  For example in Greece, a Euro member struggling under the weight of national debt, incomes have fallen by nearly 30% since 2007 while almost 26% of the workforce is unemployed.  In truth, Europe’s single currency, created to foster unity and ease trade, has become the source of significant issues for many member states.  As the challenges for continental Europe continue to increase many commentators expect that the next decade will see an unraveling of the European model, including a possible devaluation of multiple currencies in order for the smaller nation states to be able to compete globally. There are already major indications that this is taking place, including the Swiss National Bank’s decision to unpeg the Swiss franc and the European Central Bank (ECB) programme of quantitative easing.

Over in the US, the situation is in as much flux, but for different reasons.  The US has been the primary trading nation of the 20th century and it is no slouch in the 21st, accounting for 23% of global GDP and 12% of merchandise trade. This has allowed the dollar to dominate the markets.  This is, of course, good news for America as it has paved the way for US fund managers to run about 55% of the world’s assets. About 60% of the world’s output is in one way or another influenced by the dollar, either because currencies are pegged or because they move in relation to it.  It’s easy to see the advantages from a US perspective but not for everyone else, particularly because the current system does not include a guaranteed lender of last resort. Many countries have built up enormous safety buffers of dollar reserves to counter this but that means that they are obliged to mimic US policy. The result is that a rise in US interest rates or even the threat of it has knock on consequences across the world, particularly in emerging markets. For many, the cost of the dollar’s dominance is beginning to outweigh its benefits, particularly as the US share of world trade and GDP is in decline.  Countries would ideally let their currencies float so that they can more easily adjust to changing market conditions.  Despite all this, the reality today is that the dollar dominates global trade, with even China’s trade into Africa being contracted in dollars.  The question, however remains: is it sensible or sustainable for this to be centralised in one country?

As the US draws back China’s influence is extending.  Currently its share of world GDP is similar to the US, at 16% and 17% respectively[1] but all the expectations are that China will continue to grow.  Even if Chinese growth decreases as predicted, this will be the big political issue of the next decade.  Increasing international use of the Yuan is the result of the Chinese Central Banks efforts to slowly loosen the restrictions on cross border capital flows and to free up the country’s financial system. China is opening up and wants the natural privileges a vast economy might expect: a big say over global rules of finance and trade and a widely used currency. Special Drawing Rights (SDRs), are a start as they effectively mean official recognition by the IMF that the Yuan is acting as a reserve currency, despite China’s extensive capital controls. China’s government is preparing the way; the next ten years will see its financial markets continue down the path of liberalization, helping to cement its place on the world stage. Granted, the markets are still immature and no-one expects an easy ride, but the direction of travel is clear.

Regulation is key in all of this as, properly designed, it provides a basis for stability, security and confidence in the system. As with all regulation, however, it has to battle the speed of technology and come up with a process that allows innovation, competition and change but restricts malpractice, crime and terrorism.  As ever these are dynamic choices and as a consequence are not stable over time.  Ironically the response to the 2008 crisis has not had the desired effect, limiting the activity of bankers but enabling asset rich investors, sovereign wealth funds, hedge funds and the like, hungry for new investments, to take a greater share of the pie.  Because of their scale these funds bring with them huge influence and this has fundamentally changed the function of currency. Every day trillions of dollars are exchanged, much more than is needed for international trade. The currency markets are attractive to speculators whose measure of success is dependent on the yield.

Traditional currencies, despite their long history, are being challenged in other ways too.   The most important of these would appear to be the recent arrival of distributed ledger or blockchain technology.  Distributed ledger technology can be used to transact anything of value without requiring a trusted third party, with proven ownership and timestamps of transaction enabling instant settlement and clearing.  Blockchain is to trade and currency what email was for the postal service – allowing direct trade without recourse to a trusted third party and at a fraction of the transaction cost.  The mysterious Bitcoin is still the largest currency using distributed ledger technology, but both Central Banks and global banking institutions are taking seriously the potential advantages available, with initiatives such as SETL, Ripple, Uphold and Circle already showing the possibilities in currency, trade and payments.  One potential accelerator of adoption of the distributed ledger could be the growth of the Internet- of-Things, as this would allow objects to be connected directly to trade, payment and currency simultaneously.

Adjacent to this, there has also been continued exploration of more “local” currencies – be these defined by geography (e.g. the BerkShare – a hyper-local currency only accepted in the Berkshires, a region in western Massachusetts. More than 400 Berkshires businesses accept the currency, and 13 banks serve as exchange stations; according to its website “the currency distinguishes the local businesses that accept the currency from those that do not, building stronger relationships and greater affinity between the business community and the citizens”) or by a closed user group or corporate ecosystem (e.g. the Amazon Coin or Starbucks’ Stars).  None of these local currencies have yet to take off, and their widespread growth potential would appear to be limited.

There are of course other non-traditional currencies.  These include those that have been around for a few decades such as credit scores, loyalty rewards and points systems (e.g. airmiles). However, in recent years others have begun to emerge, most notably in the domain of authentication, validation reputation and trust.  Examples here include eBay seller ratings, TripAdvisor reputation scores, LinkedIn or Quora knowledge ratings – as well as the emergence of trust aggregators such as Digi.me.

Two final stresses adding to the pressure on traditional currencies as a means of exchange are also worth mentioning.  The first is the growth of peer to peer currency exchange and remittance firms (e.g. TransferWise; Western Union).  The second is the rapid growth of non-traditional payments systems (e.g. Paypal, AliPay, ApplePay, Mpesa).  In the case of AliPay (Alibaba’s equivalent of PayPal), it is worth noting that success has been not only due to its distribution via the Alibaba platform but also on the back of Chinese distrust of US based or influenced payment schemes such as Visa and Mastercard.