LUNA's new monetary policy: shorting itself
Do Kwon's new monetary policy takes a sorry page from Asian central banking practice
Terra’s big fundraising round, led by Binance, Jump, and Three Arrows, was in my view a favorable development. Do Kwon, to me, is like the central banker of an extremely promising emerging-market economy. Terra has a certain cocktail of fundamental characteristics which has given it a significant medium-term competitive edge, guaranteeing significant FX inflows, for now.
The LUNA community seems thrilled with Do Kwon’s stated intention of building a Bitcoin reserve. The reserve is currently $1.1B and Do plans to scale it up to $10B over the coming years, inline with growth in demand for Terra.
Mechanically, the BTC can’t come from thin air. It can only come from the Luna Foundation Guard (LFG) selling LUNA tokens in the open market for UST, which is then swapped out for BTC.
Accumulating currency reserves beyond the point of establishing a modicum of credibility is a loser’s game, and is not bullish for LUNA’s price.
Going from “no reserves” to “significant reserves,” as accomplished by the Jump/Binance/Three Arrows investment, is generally a net win for a currency’s credibility, and was something that most LUNA hodlers rightfully applauded.
Do Kwon’s new monetary policy is, in fact, a crypto replica of Asian central banking. If past is prologue, it implies that LUNA’s upside is capped, because Do, in the tradition of the PBOC and the BOJ, is effectively shorting his own currency.
In introductory Macro 101, we’re taught that no countries should sustain long-term trade surpluses. Short-term trade surpluses should result in currency appreciation which makes a country’s exports less competitive, erasing said trade surpluses.
In reality, some countries maintain lasting trade surpluses, which result in chronic reserve accumulation by those countries’ central banks. There are several possible drivers:
A supermajority of the country’s exports consists of a quasi-monopoly on something that can’t be easily replicated or competed away, and the owner(s) of the monopoly have a very high savings preference relative to its native country’s average consumer.
Examples: Russia (metals and oil), Taiwan (semiconductors), Saudi Arabia (zero-marginal-cost oil).
The country’s government policy is captured by interests which benefit from artificially cheap currency (exporters) and/or artificially cheap debt (capital-intensive industries, like construction, real estate, etc.)
Examples: Japan (most acutely 1960-late 1980s), China (most acutely 1990s-2015), Germany post-GFC.
The country pursues a fiscal/monetary policy that’s ‘too prudent’ relative to its economic fundamentals, making its so attractive to foreign investors that its currency appreciates by an amount that the central bank deems permanently destabilizing. As foreign capital pours in, the central bank aggressively intervenes in local debt or FX markets to punish foreign carry trades, artificially depreciating its currency and causing FX accumulation.
Examples: tax/regulatory havens for global capital (Switzerland, Hong Kong, Singapore, etc).
The first example (an extremely prudent public-private ruling clique in a country) is the proverbial exception that proves the rule, and arguably not in the long-run national interest because it tends to breed a wealth-soaked elite that eventually squanders the centralized gains, all the while bestriding an uncompetitive middle class: the resource curse. As Russia just showed us, macroeconomic policy which centralizing the positives while decentralizing the negatives can, with just a few bad decisions, lead to national economic ruin.
The latter two drivers can make sense in the very short term, if the country wants to establish baseline credibility with global capital markets by accumulating a minimum reserve as a buffer against external shocks. Turkey under Erdogan’s first decade in power (2001-2012, before Erdogan turned into a nutty dictator) was a great example of this.
To maintain reserve accumulation beyond the point of markets pricing in generational stability and credibility (10-15 years of reserve accumulation and prudent macroeconomic policy), the country has to print more of its currency and sell it on international FX markets: effectively shorting itself. This is never a good long-run policy, instantly punishes savers, and always leads to unintended consequences later.1
LUNA’s fundraising in the short to medium term ($1.1B today, quickly ramping to $2B) has been sensible and prudent, consistent with Emerging Market Central Banking 101.
But LUNA’s new stated monetary regime (BTC reserve accumulation to $10B+) seems like a crypto equivalent of the failed Japanese central banking model. Reserve accumulation beyond a modest point of credibility-establishment is a counterproductive tax on LUNA holders. The marginal return on credibility of a $10b+ BTC reserve over the near-term aspiration ($2B) is weak, imho.
Do Kwon has put his flashy mastery of seizing and controlling the all-important crypto media narrative on display with this move. But Do Kwon is also a genius, so I speculate that Do Kwon also sees some kind of negative catalyst incoming — like lowering the Anchor Reserve’s floor below its stated 15% amidst a new renaissance for Ethereum after the Merge — that justifies accumulating a precautionary warchest in the meantime. But if I were an average-Joe LUNA hodler, I would be more concerned than happy about it.
In the Chinese example, the initial distortion was amplified through the Chinese banking system, as new USD central bank reserves collateralized new, RMB-denominated domestic lending (and capital controls prevented Chinese from exporting that growth back out to international markets), pushing down the cost of domestic debt and encouraging additional domestic leverage.
Then, the initial distortion metastasized into bigger problems. Policy became completely captured by exporters, governments, and real estate developers, while the part of the Chinese economy that most needed to grow (consumption) was kneecapped instead, and the healthy reckoning with imbalances was pointlessly postponed. The domestic “average Joe” (average Zhou?) was heavily punished to sustain something which was never truly sustainable.