Wednesday, 1 September 2021

Regulating stablecoins – the rules of full reserve banking proved right yet again.


This is an odd article by Frances Coppola on regulating stablecoins. The title of the article is “Regulating stablecoins for what they are.”

She claims in her second para that “....a stablecoin regulated like a bank or a money market fund (MMF) would not be able to do its job.” But in her last para, she says “….regulators should concentrate on ensuring that stablecoins . . . have 100% reserves and/or are licensed banks.” Slight inconsistency there, I think.

Another inconsistency is that in the past she has opposed 100% reserves / full reserve, e.g. in this article of hers. And while that article was published several years ago, far as I know she has not retracted any of it.

Martin Wolf also has an article on this subject in the Financial Times entitled “Time to embrace...”. The article doesn't seem to be behind a paywall.

His concluding sentence is virtually the same, word for word as Frances Coppola's.

I agree with both conclusions. Or to be more accurate, I'd advocate applying the basic rule of full reserve banking (aka “100% reserves”) to stablecoins, banks and MMFs (Money Market Mutual funds). That basic rule is that any bank or bank like entity including MMFs and stablecoins where it claims that investor / depositors' money is safe must back all deposits with reserves (though possibly short term government debt should be allowed as “backing” as well). And as for entities where there is less than 100% backing, they should be allowed to do anything they like, as long as they do not break the laws that other corporations and firms have to obey. Plus they must make it clear, if it's not already obvious to everyone, that depositor / investors face risks. i.e. if anything goes wrong with the entity and depositor / investors lose out, there is no government rescue available for them.

Indeed, MMFs in the US were made to obey the latter basic rule in the aftermath of the 2008 bank crisis.

And the beauty of the latter rule is that it complies with a principle widely accepted in science, namely that science awards top marks to simple rules that explain a lot, e.g. Einstein's theory of relatively or Newton's laws of motion. In contrast, science is skeptical of complicated laws which do not explain very much.


P.S. 8th Sept 2021.    Another reason for imposing the rules of full reserve on stablecoins, i.e. insisting they are 100% backed by central bank reserves is thus. As I explain in more detail in MPRA paper No.108488, having a stablecoin backed by something more risky than central bank reserves has superficial attractions. Indeed that's an idea that the Bank of England toys with in its recent discussion paper on CBDC and stablecoins. One attraction is that stablecoins (or any entity that resembles a bank or mutual fund) backed by more risky assets is then into money creation, which is stimulatory. But absent that stimulus, it is the easiest thing in the World to implement stimulus simply by having the central bank create money instead, and spend it into the economy (and/or cut taxes). Ergo the the above mentioned risks are entirely pointless!

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