Central Bank Currency Devaluation Drives Demand For Cryptocurrency

As central banks devalue their currencies in a tit-for-tat race to the bottom, demand for cryptocurrencies, in particular Bitcoin as a macro hedge has risen.

Vicky Lee (not her real name) uses a cotton puff to dab a few more strokes of powdered sunscreen to her already flawless complexion. With skin like alabaster, Lee, who easily looks half-a-decade younger than her already youthful 25, is careful to avoid sun damage on her skin.

Despite the 90-degree heat and 80% humidity, Lee is decked out in a long sleeved top (with UV protection no less), sunglasses and a wide-brimmed hat that would look more appropriate on a beach, than navigating the sea of humanity that is Luohu Commercial City — a bustling hive of shops selling any and all manner of counterfeit products.

But Lee is not at Luohu to source the latest “it” bag knockoff, nor is she there to score a fake luxury watch, it’s what’s hidden behind one of the many indistinguishable stores that she’s after.

Without a word being uttered between Lee and the 50-something lady manning a counterfeit designer bag shop on the second floor of Luohu Commercial City, Lee opens a hidden door to a backroom of the shop.

The action itself is not one that’s likely to draw attention.

Almost every shop in Luohu has a “backroom” where the higher quality fakes are kept, so-called “AAA”-grade fakes which can cost as much as ten times more than the cheaper knock-offs.

So when Lee makes her way into this particular backroom, other customers and curious tourists hardly notice her egress from the main shopping area — which is precisely how Lee wants it.

Because tucked in the backroom of this particular shop, behind rows of “AAA” designer bag knock-offs is a man waiting to see Lee, to complete a transaction that’s far more frowned upon by the Beijing government than the counterfeiting of Western intellectual property.

The man whom Lee is coming to see barely looks up from a mobile game that he’s playing. Seated behind a half-eaten bowl of noodles which have since gone cold, the air thick with the smell of stale cigarettes and an ashtray crammed full of butts indicating the source of the room’s odor, the man grunts in heavily-accented mandarin,

“Why do you insist on dressing like that? Don’t you know that you actually draw more attention to yourself?”

“Please…all the women, at least the smart ones, who want to stay young, cover-up to prevent sun damage. You’d rather my skin look like yours?”

If the man is offended by the jab, he doesn’t demonstrate it. Smiling, he says,

“I suppose you’re right. Have you brought the cash?”

“What do you think?”

“Okay. Okay. Relax, just checking. Let me count it.”

Lee opens up her sizable Louis Vuitton Speedy, genuine of course, she’d never be caught dead in a cheap knock-off designer bag, and takes out a brown envelope, stuffed with 100 yuan notes.

The man takes the envelope from her, removes the notes and puts them through an automatic cash machine that also detects fake yuan notes.

Aside from the whirring sound of the cash machine, the pair otherwise sit in silence in the crammed backroom of the shop, the low roar of the customers outside in the main shopping area serving as white noise to the transaction.

“Seems to be in order.”

“The transaction.”

“I’ll do it now.”

Turning around to his laptop, the man, executes a few deft keystrokes, evidencing his familiarity with the transaction that is about to be completed, as well as his dexterity with a keyboard.

“Just give it a few minutes and you can check it yourself on your phone.”

After about 15 minutes or so, during which time the man goes back to playing his mobile game and Lee surfs WeChat, the man interrupts Lee’s thoughts of her next “it” bag to buy,

“Okay. It should be done now.”

Lee takes out her Huawei smartphone and conducts a blockscan to ensure that the 50 Bitcoin she’s just purchased from the man has gone through. Sure enough a quick blockscan confirms that the 100 Bitcoin has safely entered into the string of Bitcoin addresses which she’s specified to him to complete the transfer to.

“Thank you.”

“Always a pleasure.”

Without further niceties, Lee makes her way out of the backroom and back onto the main shop floor, thronged by all manner of tourist from every corner of the world, desperate to buy a knock-off of a bag that everyone else is probably already carrying.

And while the vast majority of large Bitcoin transactions generally do not occur in the same way that Lee’s does, many in the middle to large range still do.

According to one over-the-counter trader of Bitcoin based in Guangzhou, Guangdong,

“People still prefer to deal face-to-face in China. There’s still the issue of trust. I would still say that the majority of Bitcoin transactions in China are done this way.”

But given the surreptitious nature of the cryptocurrency trade in China, it’s entirely impossible to say how the bulk of transactions are conducted with any degree of certainty. In the absence of accurate data, anecdotal data is all that remains available.

China’s Cryptocurrency Conundrum

However one thing is undeniable — and it is that the Chinese continue to maintain an appetite for cryptocurrencies — which the latest trade war with the United States has only helped to fuel.

With the value of Bitcoin and other cryptocurrencies soaring by as much as threefold in the last six months, the volume of Bitcoin and other cryptocurrency purchases in China have soared as well — with some estimates putting demand as having increased by as much as 50%.

To be sure, accurate data about Chinese demand for Bitcoin and other cryptocurrencies will always be difficult to accurately determine, but there is sufficient evidence to suggest that Beijing is growing more concerned about increased Bitcoin and cryptocurrency trading in the Middle Kingdom.

Just this month, the People’s Bank of China (PBoC), the Chinese central bank, was quick to announce that its own cryptocurrency would “soon” be launched, with scant details as to the exact timeline of that launch.

In a country where every government announcement is highly choreographed and every aspect of Chinese citizen’s lives monitored and managed, the announcement by the PBoC is anything but innocuous.

First Through The Door

That the PBoC is serious about providing a rival to Bitcoin is evident, having held deputy governor level dialogues with market participants for over two-and-a-half years now.

The PBoC is also under pressure to act quickly on its cryptocurrency, especially since first quarter data out of Beijing has shown that in the balance of payments, the errors and omissions deficit — which can largely be attributed to capital flight — rose to almost US$88 billion, close to the all-time record figure reached in the fourth quarter of 2017.

Accurate figures for capital flight are hard to come by and it’s likely the extent of the capital flight problem Beijing faces is far greater than officially advertised.

By launching its own cryptocurrency, the PBoC is trying to stem capital flight by making cash more scarce, because cash can easily purchase cryptocurrency, which fuels capital outflows from China.

It is not without some degree of irony that central banks initially regarded cryptocurrencies as a threat on their monopolistic ability to issue fiat currency, yet they have now reached a crossroads where central banks themselves have driven demand for it and are also trying to issue their own cryptocurrencies.

Victims Of Their Own Success

And central banks have played a big role in driving the latest cryptocurrency rally.

By adopting policies which amount to competitive currency devaluations in the name of reflating their economies and in response to protectionist policies as the U.S.-China trade war leads to slower growth everywhere — central banks have essentially forced investors to look for safe haven assets and investors have increasingly (and somewhat ironically) viewed Bitcoin and some other cryptocurrencies as that asset.

The European Central Bank was the first to allow the euro to weaken, to help it fuel exports, which led to interest rate cuts by the Federal Reserve and for China, August 5 marked a real turning point when the yuan was allowed to fall to 7 yuan to the dollar, crashing through a level, which till then, many had viewed as sacrosanct.

To make matters worse, late last month, U.S. President Donald Trump announced a further 10% tariff on a staggering US$300 billion worth of Chinese imports, which had originally been scheduled to be imposed at the start of September and which has since been delayed until December.

Not to be outdone, Beijing has indicated that it will raise tariffs on US$75 billion worth of U.S. imports.

Meanwhile, central banks continue to devalue their currencies, both to keep exports competitive, as well as to take advantage of U.S. tariffs on China, for which countries like Vietnam and South Korea have particularly benefited from.

And with pro-democracy protests in Hong Kong continuing unabated, many Chinese who had seen the autonomous territory as a safe haven to park their funds no longer feel as secure these days — there’s no telling what Beijing will do to the recalcitrant territory that is it’s sovereign land, yet behaves (in its opinion) like a petulant child.

Against this backdrop, more and more Chinese have turned to Bitcoin and other cryptocurrencies to facilitate and to expedite their capital leaving the Middle Kingdom.

The Digital Gold Rush

The idea that Bitcoin can become a form of “digital gold” which can be transported easily, is a feature of the digital asset many Chinese cottoned on to from the very beginning.

Grayscale Investments, a cryptocurrency asset management firm based in New York, echoed such sentiment when in a research report released last week, it said,

“Bitcoin has the potential to perform well over the course of normal economic cycles as well as liquidity crises, especially those involving currency devaluations.”

“(It has) store-of-value characteristics similar to real assets like gold, with hard-money attributes like immutable scarcity.”

And there is at least some evidence that Bitcoin has “digital gold”-like qualities.

According to Grayscale Investments’s research report, between the first week of May, when U.S. President Donald Trump ratcheted up the trade war by hiking tariffs on US$200 billion worth of Chinese imports from 10% to 25%, to the first week of August, Bitcoin rose alongside gold, the Japanese yen and the Swiss franc, with the pace of Bitcoin’s rise far outpacing the others, gaining over 100%.

Meanwhile most other assets, including the S&P, the yuan, commodities as well as the MSCI emerging market index, all fell during the same period.

The efforts of developed country-central banks to drive both their currencies as well as interest rates down may have done the hitherto unbelievable — turned cryptocurrencies into safe haven assets.

If ever there were an example of the ultimate goal of alchemy — turning copper into gold — it would appear that central banks have performed such a feat of alchemy — spinning cryptocurrencies into gold.

Central Bank Alchemy

With the bulk of government bonds trading at negative rates and with the prospect of earning any yield, somewhere between dim and dire, the opportunity cost of holding some Bitcoin falls dramatically.

Because the risk free rate of return is either zero or negative, ironically, risk is “safer.”

That Bitcoin and its imitators would have reached such a juncture can only be described of as revolutionary.

Just two years ago, Bitcoin was considered a highly speculative asset that (at best) tracked the movement of technology stocks — such a view has since proved antiquated — and some investors as well as analysts consider Bitcoin runs with gold.

To be sure, the Chinese, who have known and survived countless economic, political and social upheavals are a pragmatic lot — they use the yuan not necessarily because they want to, but because they have to and the prospect of using something else which affords them more economic freedom, will always be attractive to them.

But other central banks manage currencies which are generally coveted and accepted across the globe. So when central banks lose faith in the international monetary system and engage in systemic beggar-thy-neighbor currency devaluations, undermining the very systems they were pledged to safeguard, is it any wonder then that the most pragmatic people are turning to cryptocurrencies instead?