The Major Problem Russia, China, and Cryptocurrency Are All Facing - YouTube

We live in a weird world where Russia, China,  

and the crypto market are all having  the same problem at the same time.

And to make things weirder, none of the problems  is causing another. They are all happening  

separately. and are perhaps the biggest threat  to any country’s—or cryptomarket’s—stability.

If China does not get it sorted out, the Chinese  communist party will face a legitimacy crisis  

and a wave of anti-government  protests not seen since 1989.

If the crypto world does not get it sorted out,  

the recent market plunge  will look tame by comparison.

And if Russia does not get it sorted  out, it means the end of Putin’s career

and a Ukrainian victory.

That thing is bank runs.

We’ve talked about bank runs a couple  of times before on this channel,  

but there have been a lot  of developments since then.

To get us all on the same page,  

here’s a quick explanation for what  a “normal” bank run looks like.

When you deposit money in a  bank, it does not just sit there.

They do not have a stack of cash in some  back room waiting for you to reclaim it.

Banks need to make money. To do that,  

they take your cash and invest in a  place where it can accrue interest.

Only a fraction of it stays behind,  

enough to cover the withdrawals  it may encounter on a normal day.

This is a major problem if everyone comes  to get their money back at the same time.  

The bank literally cannot pay  everyone. It becomes insolvent,  

leaving its customers to pick  up whatever pieces they can.

Bank runs are as old as banks themselves,

but are best-known because of  financial crises that occurred  

on both sides of the Atlantic  during the Great Depression.

To make matters worse, bank runs  are self-fulfilling prophecies.

Remember the beginning of the pandemic when  toilet paper was basically impossible to find?

It was the same idea. Even if you had  no need for toilet paper at the moment,  

you had to worry about its  medium-term availability.

That meant you’d go get some.

But everyone else realizes that all the others  have the same incentive, so they too rush to buy.  

The end result is that there is a  shortage because of the expected shortage.

Game theorists call this type  of a circular logic a stag hunt,

an idea dating back to  philosopher Jean-Jacques Rousseau.

The idea is that successfully hunting a stag  requires the coordination of many actors,  

so everyone either will  either hunt the stag or not,  

depending on their expectations  of others’ actions.

That’s true for banks as well.

If you anticipate everyone else  is going to run to the bank,  

you want to get there first  so you don’t lose your money.

But so does everyone else.

Even if the original issue was a complete lie,

the bank still becomes insolvent because  people thought it would become insolvent.

In 2022, Russia, China, and the crypto markets  all faced their own versions of bank runs.  

And each addressed the problem in its own way.

For Russia, trouble began in February  2022 with the invasion of Ukraine.

As I touch upon in my new book “What  Caused the Russia-Ukraine War”,  

western countries levied unprecedented  sanctions against Moscow almost immediately.

This triggered bank runs within  Russia for a variety of reasons.

For one, Russian citizens worried that the  Ruble would soon become effectively worthless.

Those were fears well-founded.  

At the start of the war, one hundred rubles  bought one dollar and twenty-three cents.

Two weeks later, it bought  just seventy-four cents.

Consequently, Russian citizens wanted  to withdraw their foreign currencies.

The other big issue was uncertainty whether  electronic payment systems would still work,  

at which point rubles would  be better than nothing.

Both of these concerns caused problems for the  standard way countries protect against bank runs:  

something known as deposit insurance.

In the United States, this is the FDIC

and the NCUA.

In the United Kingdom, it’s the Financial  Services Compensation Scheme, which makes  

it sound like they are up to something, but  really they are just there to provide insurance.

And in Russia, it’s the Deposit Insurance Agency.

In general, deposit insurance promises to make  customers whole if their bank experiences a run.

Under normal circumstances, that kills the  psychological aspect of the problem. No one  

needs to outrace the others to withdraw their  money because the government will cover them.

But when the bank run is  going after foreign currency,  

government guarantees only work if the  government has access to that money.

And right as the sanctions began, both the US  and European Central Bank withheld Russia’s  

foreign currency reserves. That kept the  pressure on Russians looking for dollars.  

But the ECB does not control rubles.

Russia, of course, can always print more of them.  

But that still might not solve the  problem for ruble-seeking Russians.

Their problem was more immediate. If  government insurance takes a month to process,  

that does little to allow ostensibly wealthy  Russians from, say, eating in the meantime.

It seems Russia was able to address the  liquidity problem without too much issue.

The central bank also raised interest rates to 20%  

to incentivize citizens to willingly  keep their money in the bank.

To address the systemic issues, Russia  imposed foreign capital controls to prevent  

non-Russian companies from taking  foreign currencies out of Russia.

These measures were successful. The  seventy-four cents 100 rubles used to buy  

jumped to a dollar ninety-two by the  end of June, higher than before the war.

But that does not mean that  the sanctions have failed.  

Putin has just replaced a short-term  problem with a long-term problem.

Both the capital controls and hire interest  rates reduced investments in Russian businesses.  

That means lower economic growth and a recession.

How bad it will be remains to be seen. But  forecast range from a 3% to 20% contraction.

Meanwhile, the crypto crisis began in May 2022,  three months after the invasion of Ukraine.

Here, the institutions in question  produce something known as stablecoins.

Unlike standard cryptocurrencies, stablecoins—as  their name suggests—trade at a fixed rate.

Minters of stablecoins will take one dollar from  you and create one new stablecoin for the dollar.

This is useful because trading  actual cryptocurrencies for dollars  

is difficult. Stablecoins give a  convenient way to do this implicitly.

They are a critical part of the crypto sphere,  injecting liquidity into the marketplace and  

representing four of the largest crypto  eleven currencies by market capitalization.

Stablecoin creators benefit by  investing the dollars received  

into something that will bring a return.

In other words, stablecoin  makers basically operate banks.

And like any other bank, they are  susceptible to the standard bank run issues.

Worse, the lack of regulation allows stablecoin  operators to invest in more aggressive assets  

that imply a higher risk of insolvency.

A shady stablecoin operator could also mint  

unbacked coins and use them to  purchase regular cryptocurrency.

If stablecoin holders suspect that a producer  is insolvent, then a bank run may begin.  

At that point, it might not matter whether  the producer was actually insolvent or not.

That takes us to TerraUSD.  At the beginning of May,  

it was a top 10 cryptocurrency in  terms of market capitalization.

At that time, it appeared to be  at a very stable $1 per coin.

But on May 9, it dropped by 21 percent.

By May 12, it dipped to four dimes.

Then three nickels the next day,

Less than a dime on May 18,

and under a penny by June 10.

Terra’s crash also caused instability in Tether,  

the largest stablecoin and the third  largest cryptocurrency more generally.

Its price briefly dropped as  low as 95 cents on May 12.

The bright spot is that it recovered  to the full dollar by the next day.

Its market capitalization,  however, went from $83 billion  

to $66 billion, meaning that the scare  caused 20% stake to be cashed in.

To make matters worse, stablecoin failures can  

trigger broader sell offs on  traditional cryptocurrencies.

Unbacked stablecoins artificially  inflate crypto prices.

When investors realize that worthless  currency was used to buy crypto,  

the crypto reveals itself to be less  valuable than originally thought.

Prices crater, which perhaps helps  explain why bitcoin fell from a May 2022  

price of over $35,000 to under  $20,000 by the middle of July.

The broader problem for the crypto market is that  the standard solution to bank runs—regulation  

and government-backed deposit insurance—is  unavailable by its very nature.

Instead, some producers will try to promise  

large reserves. But that does  little to alleviate trust issues.

Like we saw earlier, governments  do not have as deep of trust gap.  

At the very least, everyone knows  they can always print more money.

As a result, no one wonders whether the  United States can cover FDIC insurance.

It’s problems like these which are why  government agencies have shown increasing concern  

and are working toward trying to change that.

And indeed, Secretary of the Treasury Janet  Yellen has made it a particular focus.

China was the final piece in the  bank run puzzle to hit the spotlight,  

but their trouble began in April 2022.

Chinese law dictates that citizens are limited  to using local banks for their savings.

However, it appears that some small banks  in the Henan province broke these rules.

They began using online platforms to bring in  

customers from outside  their regional restrictions.

The Chinese government cracked down, freezing  the assets of customers of four of these banks.

Protestors responded by congregating  outside one of them on July 11,  

which brought the issue into the international  spotlight—such protests are rare in China.

Well, that’s one version of what  happened. An alternative explanation  

is that the banks made some risky investments  and lost the ability to repay their creditors.

What actually happened is almost beside the point.  

China’s economic growth is slowing, especially  in the wake of its zero-covid policy.

If people think that their banks are insolvent,  

that can be enough to trigger a run in  China just as easily as it can in Russia.

Now China has deposit insurance, but  initially they refused to honor it,  

citing how the customers broke  the regional banking rules.

That government policy could also cause a bank run  at other banks that engaged in similar practices.

Ironically, the enforcement of China’s laws  could cause greater economic instability for  

the country as a whole. Following the protests,  

China announced a change in course and  said they would honor most of the deposits.  

Whether that happens remains up in the air.  Issues with bank runs might not be over.

And there you have it: three very different  situations, all with the same underlying cause:  

bank runs, which are a specific application  of what game theorists call stag hunts.

If you enjoyed this video, check  out my book, and please like, share,  

and subscribe, and I will  see you next time. Take care.