Crypto Bubbles Make The Case For Glass-Steagall

This is the story of two Ponzi schemes, of three entities called FTX, FFT and Alameda, and of earthquake precursors. To begin with the latter, in physics, earthquake precursors are mostly little shocks preceding the big one. In finance, a “peripheral” event precedes a systemic crisis. The bankruptcy of the cryptocurrency exchange FTX, officially filed on Nov. 11, can be considered a financial precursor.

Cryptocurrencies are the most acute form of financial insanity, a pure gambling operation based on no physical value, asset or activity. FTX had become the second largest exchange of cryptocurrencies, where a currency called FFT was traded. Both had been created by Sam Bankman-Fried, who owned the exchange on which his his company Alameda operated. US financial authorities suspect that Bankman-Fried had created a classical Ponzi-scheme, i.e., gains were paid to clients with the money from new clients. He is further suspected of speculation with money invested by clients in FTX.

When one such client, Binance, pulled out of its investments in FFT cryptocoin, the Ponzi scheme collapsed, generating a snowball reaction on all cryptocurrency markets. Bankman-Fried lost 94% of his personal wealth in one day. While we wouldn’t lose sleep over that, the consequences of this cryptocurrency earthquake on the global financial system should be a matter of concern.

It is no secret that large commercial banks have devolved increasing amounts of investments in cryptocurrencies. They can do so with money borrowed from central banks, thanks to the deregulated financial system following on the takedown of the Glass-Steagall separation between investment banks and commercial banks, which allowed the latter to make highly leveraged, high-risk investments in all kind of financial instruments.

Now, we can expect calls for emergency liquidity from the banking system, as the bursting of the cryptocurrency bubble generates margin calls on the backdrop of a growing liquidity crisis generated by central banks’ “Quantitative Tightening” (cf. SAS 44/22).

As to the latter, as we have explained, runaway inflation is a product of the hyperinflationary bubble of financial asset prices built by those central banks over the years. Even some prominent speculators have realized that. Paul Singer’s hedge fund, Elliott Management, issued a report early November, warning that the world is “on the path to hyperinflation” that could lead to “global societal collapse and civil or international strife”. The report noted that “while such an outcome is not certain, this is currently the direction” in which “the world is headed”.

Singer pins “much of the blame” for the hyperinflation “on central bank policymakers,” the Financial Times reported. Central bankers “had been ‘dishonest’ about the causes of high inflation”, blaming it on “supply chain bottlenecks” after Covid, and not the “ultra-loose monetary policy put in place at the height of the coronavirus crisis”.

That same monetary policy led to the creation of the bursting crypto bubble. Rising interest rates will accelerate the explosion, while returning to QE will accelerate hyperinflation. There is no way out of the crisis from inside the system; the solution is to remove the speculative cancer while protecting at the same time the real economy through a Glass-Steagall type of financial reform.