Luke Gromen, Bretton Woods 1 & 2 and what comes next

If you have not listened to it already then I can highly recommend this podcast in which Grant Williams interviews Luke Gromen. The podcast covers a lot of ground but the primary focus is the role of the USD in the international financial system in the aftermath of the sanctions imposed on Russia in response to its invasion of Ukraine. I have an understanding of pieces of the puzzle but this interview put them together in ways that I had not fully grasped or seen before.

It is far from clear what comes next for the international financial system in general and the USD in particular. The much discussed demise of the USD may be too apocalyptic but it seems reasonably certain that the status quo is going to change – here is a short summary of some of what the interview offers:

  • The first 20, minutes offers a short history of the Bretton Woods arrangements that have defined international finance since the late 1940s including the transition from a system based on the USD being based on gold (Bretton Woods 1) to a system where the USD is based on oil (Bretton Woods 2)
  • They discuss how the current regime (“keeping the dollar as good as gold for oil”) is breaking down analogous to the way the gold foundation broke down in the early 1970s
  • John Maynard Keynes gets an honourable mention for his “bancor” reserve currency proposal which was not adopted but might be worth revisiting (nice historical anecdote that the Governor of the Bank of China suggested this in March 2009)
  • The USD’s role as an international reserve currency has been described as an “exorbitant privilege” but Gromen argues that the arrangement has also come at a cost via the role it has played in the loss of US domestic manufacturing capacity (Triffin’s Dilemma).
  • The consequences of this trade off has come under greater attention post the GFC, initially as the social consequences of lost jobs started to impact domestic politics, and more recently as globalised just in time supply chains struggled to respond to the economic shocks created by the response to Covid 19
  • Gromen argues that the USD Department of Defence has wanted to see repatriation of the US industrial base for some time and hence will be happy to see a decline in the USD’s role as an internal reserve currency because they believe it will enhance national security
  • Interestingly he argues that it would have looked like weakness for that to happen as a consequence of pressure from China and Russia but can now be presented as a sign of strength, of standing up to Russia (“we showed those Russians”)
  • They also discuss what this means for the price of gold

Hopefully I have done a decent job of capturing the key themes but there is a lot here and some may have been lost in my translation so by all means listen yourself. Personally I need to do a bit more research to better understand the references in the interview to the “Triffin Dilemma” and to Keynes’ “bancor” proposal.

Tony – From the Outside

SWIFT …

… has been in the news lately.

This link takes you to a blog I follow written by Patrick McKenzie that offers a payment expert’s perspective on what SWIFT is, together with Patrick’s personal view on what the sanctions are intended to achieve.

This short extract covers Patrick’s assessment of the objective of the sanctions

The intent of this policy has been described variously in various places. In my personal opinion, I think the best articulation of the strategy is “We are attempting to convey enormous displeasure while sanctioning some banks which are believed to be close to politically exposed Russians, while not making it impossible for Russian firms generally to transact internationally nor sparking a humanitarian crisis either inside or outside of Russia.”

One of the key insights is that SWIFT manages the messaging that accompanies international payments and facilities their processing, not the transfers of money per se. The sanctions do not make it impossible to transact with Russia, they mostly make it operationally very difficult and not really worth the effort, especially at scale. Especially if you are a regulated bank who cares about your long term relationship with your regulator.

Another nuance that does not always come through in the newspaper reporting of the sanctions is the extent to which the compliance functions in banks are under pressure to interpret and anticipate the intent of the regulatory sanctions

Many commentators confuse the actual effects of severing particular banks from SWIFT with what they perceive as the policy goal motivating it. More important than either is, in my opinion, what it communicates about commander’s intent to the policy arms who are responsible for enforcing it.

Specifically, it communicates that Something Has Changed and that Russian institutional money, specifically “oligarch” money, is now tainted, and not in the benignly ignored fashion it has been for most of the last few decades.

Where there is some doubt or ambiguity, banks are likely to err on the side of caution.

Patrick’s post is worth reading if you are interested in this particular aspect of SWIFT and his blog worth following if you are interested in payments more generally.

Tony – From the Outside

The elasticity of credit

One of the arguments for buying Bitcoin is that, in contrast to fiat currencies that are at mercy of the Central Bank money printer, its value is underpinned by the fixed and immutable supply of coins built into the code. Some cryptocurrencies take this a step further by engineering a systematic burning of their coin.

I worry about inflation as much as the next person, perhaps more so since I am old enough to have actually lived in an inflationary time. I think a fixed or shrinking supply is great for an asset class but it is less obvious that it is a desirable feature of a money system.

Crypto true believers have probably stopped reading at this point but to understand why a fixed supply might be problematic I can recommend a short speech by Claudio Borio. The speech dates back to 2018 but I think it continues to offer a useful perspective on the value of an elastic money supply alongside broader comments about the nature of money and its role in the economy.

Borio was at the time the Head of the BIS Monetary and Economic Department but the views expressed were his personal perspective covering points that he believed to be well known and generally accepted, alongside others more speculative and controversial.

I did a post back in March 2019 that offers an overview of the speech but recently encountered a post by J.W. Mason which reminded me how useful and insightful it was.

The specific insight I want to focus on here is the extent to which a well functioning monetary system relies on the capacity of credit extended in the system to expand and contract in response to both short term settlement demands and the longer term demands driven by economic growth.

One of the major challenges with the insight Borio offers is that most of us find the idea that money is really just a highly developed form of debt to be deeply unsatisfying if not outright scary. Borio explicitly highlights “the risk of overestimating the distinction between credit (debt) and money” arguing that “…we can think of money as an especially trustworthy type of debt”

Put differently, we can think of money as an especially trustworthy type of debt. In the case of bank deposits, trust is supported by central bank liquidity, including as lender of last resort, by the regulatory and supervisory framework and varieties of deposit insurance; in that of central bank reserves and cash, by the sovereign’s power to tax; and in both cases, by legal arrangements, way beyond legal tender laws, and enshrined in market practice.

Borio: Page 9

I did a post here that explains in more detail an Australian perspective on the process by which unsecured loans to highly leveraged companies (aka “bank deposits”) are transformed into (mostly) risk free assets that represent the bulk of what we use as money.

Borio outlines how the central banks’ elastic supply of the means of payment is essential to ensure that (i) transactions are settled in the interbank market and (ii) the interest rate is controlled …

“To smooth out interbank settlement, the provision of central bank credit is key. The need for an elastic supply to settle transactions is most visible in the huge amounts of intraday credit central banks supply to support real-time gross settlement systems – a key way of managing risks in those systems (Borio (1995)).”

Borio: Page 5

… but also recognises the problem with too much elasticity

While the elasticity of money creation oils the wheels of the payment system on a day to day basis, it can be problematic over long run scenarios where too much elasticity can lead to financial instability. Some degree of elasticity is important to keep the wheels of the economy turning but too much can be a problem because the marginal credit growth starts to be used for less productive or outright speculative investment.

This is a big topic which means there is a risk that I am missing something. That said, the value of an elastic supply of credit looks to me like a key insight to understanding how a well functioning monetary system should be designed.

The speech covers a lot more ground than this and is well worth reading together with the post by J.W. Mason I referenced above which steps through the insights. Don’t just take my word for it, Mason introduces his assessment with the statement that he was “…not sure when I last saw such a high density of insight-per-word in a discussion of money and finance, let alone in a speech by a central banker”.

Tony – From the Outside

Why Canada is cultivating an M-pesa moment for bitcoin – Izabella Kaminska

Izabella Kaminska is one of the commentators that I find reliably generates interesting and useful insights. Personally I remain sceptical on crypto but this link takes you to a post where she makes an argument that I find persuasive.

For those short of time here is an extract capturing the key points I took from her post…

My position on crypto has evolved over time to appreciate this factor. Crypto may not be an optimal system. It’s clunky. It’s energy intensive. It’s confusing. But as a back-up system for when the shit really hits the fan, it’s an incredibly worthwhile system to have in place and I increasingly think we should be grateful that some deep-pocketed individuals with concerns for freedom and privacy took the risks they did to make it become a thing.

I have in the past compared crypto to a monetary equivalent of the right to bear arms, whose main purpose, many argue, is to act as a deterrent to rising authoritarianism. Its optimal deployment is as a right that it is never actually exercised.

Crypto should be treated the same way. On a day to day basis, it’s much better for us all to trust in a centralised and properly supervised system. But having crypto there as a challenger or backup system is no bad thing. It should in theory enhance the core system by helping to keep it honest and working in our interests.

“Why Canada is cultivating an M-pesa moment for bitcoin”, The Blind Spot 18 February 2022

Tony – From the Outside

SWIFT gpi data indicate drivers of fast cross-border payments

One of the use cases for cryptocurrency and\or stablecoins is that it offers cheaper and faster alternatives to the conventional payment rails. Whether they will succeed remains to be seen but I have long believed cross country payments is one of the areas where the banking system really does need to lift its game.

Against that context, this research study released by the Bank for International Settlements (BIS) suggests that TradFi banking is making some improvements.

The study lists three key takeaways …

“- The speed of cross-border payments on SWIFT global payment innovation (gpi) is generally high with a median processing time of less than two hours. However, payment speeds vary markedly across end-to-end payment routes from a median of less than five minutes on the fastest routes to more than two days on several of the slowest routes.
– Prolonged processing times are largely driven by time spent at the beneficiary bank from when it receives the payment instruction until it credits the end customer’s account. Longer processing times tend to occur in low and lower-middle income countries, which can be partly attributed to capital controls and related compliance processes, weak competition as measured by the number of banks as well as limited operating hours of and the use of batch processing by beneficiary banks.
– Cross-border payments on SWIFT involve, on average, just over one intermediary between the originator and beneficiary banks. Each additional intermediary prolongs payment time to a limited extent, while the size of time zone differences between banks has no discernible effect on speed.”

If I am reading it correctly, the study does not capture any delays the initiating bank may introduce before it processes a payment instruction. With that caveat, it is worth noting that TradFi is not standing still – competition can be a beautiful thing.

Also worth noting the extent to which domestic payment systems are improving though not necessarily in the USA.

Tony – From the Outside

Taming Wildcat Stablecoins – Revisited

Anyone following the stablecoin debate is probably familiar with a paper by Gary Gorton and Jeffrey Zhang titled (somewhat provocatively) “Taming Wildcat Stablecoins”. I did a post back in July 2021 when it first came out and have some more detailed notes on it here.

In my initial July 2021 post I listed three things I found useful and/or interesting

  1. The “no-questions-asked” (NQA) principle for anything that functions in practice or potential as money
  2. Some technical insights into the economic and legal properties of stablecoins and stablecoins issuers (i.e. what is the nature of the express or implied contract between users and stablecoin issuers)
  3. Lessons to be learned from history, in particular the experience of bank notes during the Free Banking Era in America in the early 19th century

Having reread the paper and some of the critiques it has attracted, I think these insights mostly remain valid. Of the three, the principle that money must be exchangeable on a NQA basis is (for me at least) the most useful. I must confess however that I find the lessons they draw from the Free Banking Era are muddled by the reference to “Wildcat Banking”. There are lessons for sure but you have to dig deeper into the historical record to really get a clear read on the conditions under which the uninsured liabilities of private entities can and cannot function as a reliable form of money.

This does not in itself fatally undermine the argument that stablecoins need a stronger regulatory framework to function effectively and efficiently as a form of money. It is however worth being clear on what lessons drawn from the history of private money can be usefully employed in figuring out how best to respond to the rise of stablecoins. While this post takes issue with some of analysis in the paper, I must declare that I still rate Gorton as one of my favourite commentators on banking and the NQA principle he espouses has long influenced my own views on banking.

Stablecoins according to Gorton and Zhang

At this point it might be helpful to recap the main elements of the argument Gorton and Zhang lay out in their joint paper:

  • Stablecoins can be viewed as the latest variation in a long history of privately produced money
  • The experience of the United States during the Free Banking Era of the 19th century and of Money Market Funds (MMF) during 2008 and again in 2020 suggest that “While the technology changes, and the form of privately produced money changes, the issues with privately produced money do not change – namely, private money is a subpar medium of exchange and is subject to runs
  • They concede that stablecoins are not yet of sufficient size to be a systemic issue but argue that allowing them to function like a demand deposit risks making the same mistake that allowed MMFs to reach a point where the government felt compelled to step in to underwrite the MMF redemption promise
  • Policymakers need to adjust the regulatory framework now to be ready before these new forms of private money grow further in size and and potentially evolve like MMFs did into something that can’t be ignored
  • Policy responses include regulating stablecoin issuers as banks and issuing a central bank digital currency
Problems with the Wildcat Free Banking analogy

As a rhetorical device the, Wildcat Free Banking analogy works pretty well as an attack on stablecoins. You don’t really need to delve into the detail, wildcat banking tells you all you need to know. It sounds pretty bad and lawless in Wild West kind of way and so, by association, stablecoins must also be problematic.

The problem is that Gorton and Zhang themselves explicitly state that wildcat banking was not as big a problem as is commonly asserted and the Free Banking system in fact functioned well from the view of efficient market theory .

For many years, the literature asserted that there were wildcat banks during this period. These were banks that either (1) did not deposit the requisite bonds, or (2) in some states, where bonds were valued at par and not market value, defrauded the public by issuing notes that they would never redeem in specie (gold or silver). Counterfeiting was a big problem, but the system was not chaos. Bank failures were not due to wildcat banking as has often been alleged. In fact, it functioned well from the point of view of efficient market theory. 

Gorton and Zhang, “Taming Wildcat Stablecoins”, p28

So it appears that, notwithstanding its prominence in the title of their paper, the problem they are highlighting with Free Banking is not wildcat banks per se but rather the extent to which Free Banking in America resulted in bank notes trading at discounts to their par value …

The market was an “efficient market” in the sense of financial economics, but varying discounts made actual transactions (and legal contracting) very difficult. It was not economically efficient. There was constant haggling and arguing over the value of notes in transactions. Private bank notes were hard to use in transactions.

Page 29
OK so let’s focus on Free Banking

The fundamental lesson Gorton and Zhang draw from the Free Banking Era and the subsequent development of a national currency in America is that competition and market forces alone will not by themselves ensure that privately produced forms of money can be relied on to exchange at their face value on a NQA basis under all market conditions.

In order to better understand the other side of this debate I have attempted to dig a bit deeper into the history of Free Banking. As part of the search I came across this podcast in which Nic Carter (Castle Island Ventures) interviews George Selgin (Director of the Center of Monetary Alternatives at the Cato Institute). It is long (1 hour 12 minutes) but appears to offer a good overview of the counter arguments advanced by proponents of cryptocurrencies, stablecoins and Free Banking.

Selgin argues (convincingly I think) that quite a lot of the problems experienced with Free Banking in America were a function (ironically) of poorly designed regulations – i.e. Free Banking in America did still involve regulation though maybe not as much supervision as banks are subject to today. In particular, he calls out the prohibition on branch banking (which restricted the capacity of banks to diversify the risk of their loan books) and the requirement that bank notes be backed by state government bonds (that ultimately proved to be very poor credit risks).

The Free Banking model did result in bank notes trading at discounts to their par value – that is a problem right?

This is another area where the debate gets a bit muddled.

Selgin concedes that some bank notes did trade at discounts to their par value – one of the central claims of Gorton and Zhang’s paper – but argues that these discounts were not a function of risk differences (i.e. concerns about the solvency and or liquidity of the issuing banks) but rather a reflection of the transaction costs incurred to redeem the notes at their issuing banks.

Selgin argues that “local” notes (i.e. those circulating in the local economy of their issuing bank) did in fact exchange at their par value and that the evidence of discounts cited by Gorton and Zhang were for “foreign” notes where they reflected the transaction costs of presenting the notes back to their issuing bank in another town, city or state.

However Selgin also concedes that part of the reason we don’t see evidence of local bank notes trading at discounts is that shopkeepers and other banks simply refused to accept any note where there was real or perceived default risk

In truth, antebellum banknote discounts were for the most part neither a consequence of the lack of regulation nor a reflection of distrust of their issuers. [Default risk was sometimes a factor], to be sure. But when it was, shopkeepers and banks tended to refuse them altogether, leaving it to professional note “brokers” to deal with them, much as they dealt with notes of banks that were known to be “broken,” but which might yet have some liquidation value. Discounts on “bankable” notes, on the other hand, reflected nothing more than the cost of sorting and returning them to their sources for payment in specie, plus that of bringing the specie home. This explains why, whatever the discounts placed on them elsewhere, [most notes traded at par in their home markets].

George Selgin, “The fable of the cats”

I can’t get any sense of the relative size of the instances where shopkeepers and banks simply refused to accept notes issued by suspect banks. The fact that it happened under Free Banking regimes in America does however seem to support Gorton and Zhang’s assessment that “money” requires a support framework to be capable of being exchanged widely and freely on an NQA basis.

Based on my (so far not very deep) exploration of the Free Banking literature, it seems that its proponents also believe money requires a support framework. The key difference seems to be whether the private sector can maintain that support framework on its own or whether you require public sector involvement in the form of regulation, supervision and deposit insurance to achieve that outcome.

To properly explore what lessons we can learn about money and banking from history, we need to look beyond the American experience with Free Banking.

A Better Kind of Free Banking

Selgin and Carter point to the experience of Free Banking in a range of countries other than America as evidence that unregulated stablecoins subject to the forces of market discipline not only could work but potentially offer a better model than the highly regulated, deposit insured model that has come to dominate the modern banking status quo.

Scotland and Canada figure prominently in this alternative narrative of what history teaches us. I don’t really know enough about these eras to comment with any authority but it does appear that the notes issued by banks operating under these regimes did in fact hold their value and function effectively as the primary form of money.

Nic Carter wrote a post on the Scottish Free Banking era which listed five features which kept it stable

– Competitive ‘note dueling’

– A private clearinghouse

– Full liability partnership models

– Until 1765, clauses permitting the temporary suspension of convertibility

– Branching and diversification

Nic Carter, “Scotland, Free Banks and Stablecoins” Murmurations 19 Sep 2021

… and summarised its virtues as

There was no regulatory body…. There was simply a legal structure that discouraged excessive lending, market mechanisms through which banks could competitively keep each other in check, and a vibrant information environment the public could benefit from. The Scottish banking system during the period was remarkably stable; financial crises and panics were rare, contrasting favorably with neighboring England. The Scottish experience of lightly regulated banking shows clearly that such a model can work …

Carter proposes two lessons that stablecoin issuers might extract from the Scottish Free Banking era.

Firstly that stablecoin issuers consider cooperating to create a private clearing house

First, as exchanges (oftentimes, it’s exchanges issuing stablecoins) continue mutually accepting each others notes, they might consider a private clearinghouse. That way they can achieve efficiency in settlement – moving from real time gross settlement to a net settlement model, saving on fees and on-chain headaches. If they do this, they will be fully incentivized to surface information regarding the solvency of their counterparties. This would solve the coordination problem inherent in entities like Tether being untransparent; their clients don’t have a sufficient economic motive to diligence them. A clearinghouse might in its charter insist that stablecoin issuers disclose their collateral to the group.

Secondly that stablecoin issuers include in their terms of service the right to temporarily suspend the right to exchange coins for fiat

Second, one tool that Scottish banks developed in 1750, as an alternative to deposit insurance, was an ‘option clause’. This allowed the bank to suspend redeemability of their notes for specie for a given period of time, effectively allowing solvent but illiquid banks to honor client withdrawals (albeit on a slower schedule). For the privilege, they would pay note holders interest on the normally non-interest bearing notes. This massively reduced the risk of a bank run and it was popular until it was outlawed in 1765. Now for stablecoins to eliminate run risk, they could be structured more like Money Market Mutual Funds, in which you can only withdraw a proportional share of the underlying assets, rather than a fixed claim redeemable for $1. So as a depositor you have no incentive to be the first out the door, as you do with a bank. Or they could implement something similar to the option clause, suspending redeemability if they were faced with a liquidity crunch. Larry White has suggested this, and I believe Tether may have a similar option clause in their ToS but I’d have to double check that.

The power of markets, competition and incentives … and their limits

Whether Carter’s Free Banking based suggestions are useful contributions to the debate about what to do about stablecoins is a question for another day and another post. I am sceptical but I need more time to think through exactly what concerns me. The idea of exchanges taking on a supervisory role via a private clearing house seems to lean away from the decentralised ethos that is a strong feature of many in the crypto, stablecoin, DeFi community – but maybe I am missing something.

I also want to take the time to get a better understanding of exactly how the pure forms of Free Banking that Carter and Selgin advocate actually worked. The problems that Gorton and Zhang describe with the experience of runs on MMF’s in 2008 and again in 2020 also look to me like they still have something useful to contribute to the stablecoin regulation debate.

My scepticism is also reinforced by my professional experience working through the various iterations of the Basel capital adequacy accord. In particular Basel II which introduced the idea of 3 mutually supporting Pillars. For the purposes of this discussion, Pillar 3 (Market Discipline) is the one I want to focus on. Basel II was developed at a time when conventional wisdom placed an enormous amount of faith in the power of markets to hold everyone to account.

In practice that did not really work out the way the theory suggested it should. I do not subscribe to the view that risk based capital requirements are a total failure. The enhancements introduced under the aegis of Basel III (in particular bail-in but also higher capital and liquidity requirements) have gone a long way to make the traditional banking system stronger and more resilient but I think it is fair to conclude that market discipline alone is not a reliable basis for ensuring the stability of the banking system.

Summing up

I am a big fan of using economic history as a guide to avoiding repeating the mistakes of the past but I think the evidence from the American Free Banking Era is not especially useful as a guide to the risks of stablecoins. This does not however mean that we should embrace the unregulated rise of stablecoins as a new form of private money.

As a conceptual framework, the five features underpinning the stability of the Scottish Free Banks is a good place to start when thinking about the extent to which stablecoins might also be, or become, self regulating. The practical challenge however is that stablecoins also have to fit into the financial system we have and that is one based around prudential regulation, supervision, deposit preference and deposit insurance. It is very hard to see bank regulators giving ground on the principle of same activity same regulation. Innovation is valuable for sure but it is equally true that regulatory arbitrage never ends well.

I have disclosed my bias and, as always, it is entirely possible that I am missing something. However, at this stage I am struggling with the idea that stablecoins that aim to expand in size and scope beyond facilitating the settlement of crypto asset trading can function as money without a regulatory framework that underpins the promise of repayment made by the private entities responsible for issuing them. That regulatory framework might not be the same as that applied to depositary institutions but it does need to be consistent with it.

Let me know what I am missing …

Tony – From the Outside

Stablecoin regulation

Another good post from JP Koning on stablecoin regulation. His key point, that regulation should follow the function of the activity rather than its form, is not a new contribution to the stablecoin regulation debate. There are lots of issues, ambiguities and areas for reasonable people to take different views on the question of what role stablecoins can or should play in the future of finance but this still seems to me like a sound organising principle.

What this means in practice is yet to be decided but here are a few preliminary thoughts:

  • I doubt that being regulated like a depositary institution (aka “bank”), as proposed by the recent President’s Working Group report, is the right answer – stablecoin issuers have adopted a variety of business models which tend to be quite different to the fractional reserve banking model adopted by most contemporary depositary institutions.
  • The issues Koning raises with the US Money Transmitter framework seem valid to me so that does not look like the right model either.
  • I am sceptical that the Free Banking model proposed by some stablecoin advocates will work as well as claimed but I recognise there is probably a bias at work here so I need to do some more work to properly understand how the Free Banking model works.
  • Part of the answer (I think) lies in establishing the right taxonomy that not only defines the different types of stablecoin business models but places them in a broader context that includes money transmitter businesses, depositary institutions (both the narrow bank kind and fractional reserve based models) and also the various forms of money market funds – this taxonomy would also distinguish systemically important business models from those which can be allowed to fail in an (ideally) orderly fashion

I included a link to JP Koning’s post above but if you are time poor then this extract captures the key point

“… the key point is that while there are times when stablecoins function like PayPal and Western Union, in other circumstances they are performing a role that PayPal and Western Union never do, which is to serve as the substructure for a set of financial utilities. Which suggests that stablecoins merit a different regulatory framework, one better fit for that function.

I don’t know what framework that should be. Banking, securities law, a special stablecoin license? But the old school money transmitter framework — which has very lenient requirements governing things like the safety of the transmitters underlying assets — is probably the wrong framework. If you serve as financial bedrock, you merit more robust regulation than Western Union.

Let me know what I am missing …

Tony – From the Outside

Moneyness: DeFi needs more secrecy, but not too much secrecy, and the right sort of secrecy

Another good post from JP Koning’s “Moneyness” blog on the need for DeFi to strike a balance partly between its native potential for transparency, the desire of customers to keep some secrets and the need to meet the same kinds of Know Your Customer – Anti Money Laundering laws that the conventional banking system is required to comply with.

Here is a short extract …

To make their tools palatable for Main Street, DeFi tool makers will have to unwind some of the native anonymity (potentially) afforded by blockchains by collecting and verifying identifying information from users. This way the tools can screen out criminals, assuring legitimate businesses that their clean funds aren’t being tainted by dirty money.

The implication is that DeFi tools will have to become privacy managers, just like old-school banks are. Users will have to trust the tools to be discreet with their personal information, only breaking their privacy when certain conditions are required, such as law enforcement requests.

… and a link to source post.

Tony – From the Outside

JP Koning on stablecoins

Interesting post by JP Koning arguing that the market is progressively recognising the difference between the safer and riskier forms of stablecoins …

Tether vs the New York stablecoins http://jpkoning.blogspot.com/2022/01/tether-vs-new-york-stablecoins.html

Tony – From the Outside

Never let the facts stand in the way of a good story

Shout out to Tim Harford for this introduction to the study of how, in his words, ignorance can be deliberately produced. The technical term “agnatology” is I suspect unlikely to catch on but the underlying message is one worth understanding. At a minimum it is a handy addition to your Scrabble dictionary.

The article was originally published in March 2017 but I only came across it recently via this podcast interview Harford did with Cardiff Garcia on “The New Bazaar”. The context in 2017 was the successful campaign for the US presidency that Donald Trump ran during 2016 with a bit of Brexit thrown in but this is a challenge that is not going away anytime soon.

Harford notes that it is tempting to think that the answer to the challenge posed by what has come to be known as a post truth society lies in a better process to establish the facts

The instinctive reaction from those of us who still care about the truth — journalists, academics and many ordinary citizens — has been to double down on the facts.

He affirms the need to have some agreement on how we distinguish facts from opinions and assertions but he cautions that this is unlikely to solve the problem. He cites the tobacco industry response to the early evidence that smoking causes cancer to illustrate why facts alone are not enough.

A good place to start is by delving into why facts alone are not enough – a few extracts from the article hopefully capture the main lessons

Doubt is usually not hard to produce, and facts alone aren’t enough to dispel it. We should have learnt this lesson already; now we’re going to have to learn it all over again…

Tempting as it is to fight lies with facts, there are three problems with that strategy…

The first is that a simple untruth can beat off a complicated set of facts simply by being easier to understand and remember. When doubt prevails, people will often end up believing whatever sticks in the mind…

There’s a second reason why facts don’t seem to have the traction that one might hope. Facts can be boring. The world is full of things to pay attention to, from reality TV to your argumentative children, from a friend’s Instagram to a tax bill. Why bother with anything so tedious as facts?…

In the war of ideas, boredom and distraction are powerful weapons.
The endgame of these distractions is that matters of vital importance become too boring to bother reporting…

There’s a final problem with trying to persuade people by giving them facts: the truth can feel threatening, and threatening people tends to backfire. “People respond in the opposite direction,” says Jason Reifler, a political scientist at Exeter University. This “backfire effect” is now the focus of several researchers, including Reifler and his colleague Brendan Nyhan of Dartmouth…

The problem here is that while we like to think of ourselves as rational beings, our rationality didn’t just evolve to solve practical problems, such as building an elephant trap, but to navigate social situations. We need to keep others on our side. Practical reasoning is often less about figuring out what’s true, and more about staying in the right tribe…

We see what we want to see — and we reject the facts that threaten our sense of who we are…

When we reach the conclusion that we want to reach, we’re engaging in “motivated reasoning”…

Even in a debate polluted by motivated reasoning, one might expect that facts will help. Not necessarily: when we hear facts that challenge us, we selectively amplify what suits us, ignore what does not, and reinterpret whatever we can. More facts mean more grist to the motivated reasoning mill. The French dramatist Molière once wrote: “A learned fool is more foolish than an ignorant one.” Modern social science agrees…

When people are seeking the truth, facts help. But when people are selectively reasoning about their political identity, the facts can backfire.

So what are we to do?

Harford cites a study that explores the value of scientific curiosity

What Kahan and his colleagues found, to their surprise, was that while politically motivated reasoning trumps scientific knowledge, “politically motivated reasoning . . . appears to be negated by science curiosity”. Scientifically literate people, remember, were more likely to be polarised in their answers to politically charged scientific questions. But scientifically curious people were not. Curiosity brought people together in a way that mere facts did not. The researchers muse that curious people have an extra reason to seek out the facts: “To experience the pleasure of contemplating surprising insights into how the world works.”

It is of course entirely possible that Tim Harford’s assessment is just calling to my own bias. I will admit that one the things that I always looked for when hiring, or working, with people was curiosity. These people are surprisingly rare but (IMHO) worth their weight in gold. An intellectually curious mind makes up for a lot of other areas where the person might not be perfect in terms of skills or experience. The general point (I think) also ties to the often cited problem that people with lots of knowledge can sometimes be prone to not being so street smart. Nassim Taleb makes this argument in nearly everything he writes.

So Tim Harford might not be offering the entire answer but I think his article is worth reading on two counts

  • Firstly as a cautionary tale against expecting that all debates and disputes can be resolved by simply establishing the “facts”
  • Secondly as a reminder of the power of a curious mind and the value of the never-ending search for “what am I missing?”

Let me know what I am missing

Tony – From the Outside