The Chinese crackdown

Business Standard, 4 October 2021

Technology companies in India got an unexpected bonanza when the Chinese state went after a series of technology companies and industries. As an example, "ed-tech" firms fuse video and software and live English-speaking tutors to teach the children of the world. There is a natural opportunity to do this out of India, given low wage English-speaking 24 year olds who know enough to teach 12 year old kids worldwide. The Chinese state damaged Chinese firms in this space, and the opportunity for Indian firms improved.

One part of this crackdown is a Chinese ban on crypto currency activities. In this, China joined Bolivia, Indonesia, Turkey and Egypt. These five countries are similar in certain respects, and that gives us insight into what is going on.

Way back in history, kings minted coins as a way to facilitate transactions and thus foster GDP within their territory. After many false lurches, this was formalised over the centuries into "fiat money" -- mere pieces of paper or electronic tokens -- which are constructed by an inflation targeting central bank. In addition to fostering higher GDP, the use of fiat money by the populace generates income for the government. This income is called "seigniorage income" and RBI's dividend to MOF is a part of this income.

At the heart of crypto currency is the idea that it is possible to create money, to achieve transactions, without the state-built institution of a central bank. Eric Raymond coined an important phrase and associated insight into the modern world: The cathedral and the bazaar. An operating system can be built by a cathedral (Microsoft) or a bazaar (Linux). A land title system can be run through a cathedral (a depository) or through the bazaar (the blockchain). Money can be constructed through a cathedral (a state-backed central bank) or through the bazaar (bitcoin). A big idea of the modern world is the remarkable extent to which bazaar solutions can be constructed. Generally, the removal of central control improves systems.

Technical advances suggest that bazaar-made money could work well in coming years. This will give the people greater choice in how they wish to organise their lives. Faced with competition, it is not surprising that central banks and their clubs have been unhappy.

When faced with well constructed central banks, crypto currency is just a cute proof of concept. But in many parts of the world (and now we see what binds the the five countries most hostile to crypto currency), central banks work badly and it is more difficult for state-backed money to compete.

In a democracy, state power is used in ways that are good for the people. In authoritarian regimes, state power is used in ways that are good for the state. The populace cowers in fear when officials talk in grave voices about terrorists using cryptocurrency, but terrorists also use roads and airports and electricity which are not banned. As Orson Welles said, it is only in a police state that a policeman's job is easy. Rather than learn how to trace money trails in the cryptocurrency world, the policeman would like to ban it. In a democracy, policy decisions are made based on the convenience of the people and not the convenience of the policeman.

Cryptocurrency alternatives today cannot compete with a well constructed state-made fiat money, once we consider the four dimensions of this competition (store of value, capital controls, anonymity, payment frictions). State-made money and crypto-currency will both evolve so as to become more useful to real people. The technical advances here could result in unexpected benefits in other fields. As with the ed-tech situation, China's crackdown improves the opportunities for the millions of young people in India who are tinkering with bitcoin, blockchain, ethereum, etc.

The "China model" has much appeal in India, particularly among engineers with low exposure to history, economics and political science. Many engineers saw the Chinese state create value out of thin air by engaging in protectionism: e.g. by banning twitter and giving license to a favoured child of the communist party to build a domestic twitter. However, lacking global competition and participation in the global journey of ideas, the national champions become insensitive to customers and technologically weak. A national champion in social media or payments, that is built on the back of protectionism and state power, is a new age Air India or Premier Padmini.

Business folk are generally comfortable asking for and taking help from a friendly government. But as an old political saying runs A government that can give you everything you want is a government that can take away everything that you have. The politician and the businessman both know who was of decisive importance in creating an apparently successful domestic business, and each lays claim to the spoils and to control. We have seen the state in Russia, Saudi Arabia and China expropriate the richest people. This is partly to strengthen the power of the regime and partly to grab resources when faced with a rough patch.

An infrastructure contract requires private and public working closely together for 20 years, and there involves considerable political risk. We often think that the startup world is free of these problems. The founders building a startup are only thinking of becoming rich in 5 years; early stage investors are only thinking of selling off to the next investor in 2 years. On these short time horizons, it looks like the dangers of the public policy sphere are absent.

But while each investor in the life of a firm cashes out quickly, all the transactions are predicated on a long journey working out. In the countries where constitutionalism and the rule of law are weak, the 20-year horizon involves political risk, policy risk and expropriation risk. These risks corrode valuations in transactions between two perfectly short-sighted investors today. These risks also generates inferior decisions through greater short-termism, as the investment culture of quickly cashing out fares better and gets emulated. As deals can't be trusted for 20 year horizons, the only way to make capitalism work is a world of rules.

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