Then-Republican presidential nominee and former U.S. President Donald Trump speaks at the Bitcoin 2024 event in Nashville, Tenn., on July 27, 2024.Kevin Wurm/Reuters
Chris Gay has written for The Wall Street Journal, U.S. News and World Report, the Far Eastern Economic Review and others. He writes the newsletter Figure at Center.
At this month’s White House “digital assets summit,” U.S. President Donald Trump vowed “to make America the bitcoin superpower of the world and the crypto capital of the planet.”
That’s a bit like making the U.S. a world leader in blackjack, but Mr. Trump has already taken significant steps in that direction – halting Joe Biden’s aggressive crackdown on the industry, appointing crypto supporters to key administration positions and signing an executive order creating a national crypto reserve, which even The Wall Street Journal regards as “fool’s gold” and an invitation to government mischief.
All of this should worry you. Here’s why.
You may never have heard of Hyman Minsky, but his influence as an economist surged after the 2008-09 financial crisis. That’s because of his Financial Instability Hypothesis, which holds that in the absence of prudential regulation, financial crises are not just anomalies but inevitabilities.
Prof. Minsky argued that financial markets tend naturally toward instability, as the relentless pressure of competition forces investors into a vicious cycle of ever-riskier trades fuelled by ever-increasing leverage generating ever-growing systemic risk. That leads inevitably to a “Minsky moment,” the point when the market realizes the game is up and everyone rushes for the exits.
The housing bubble and subsequent crisis seemed to many to confirm Prof. Minsky’s thesis. It had followed a trajectory common in the annals of booms and busts: An irrational herd chases asset prices to unsustainable levels, fuelled by FOMO and imprudent borrowing. Eventually, general risk aversion sets in, teeing up a panic. All that’s needed is a shock – rumours of a major default, a surprise hike in interest rates, a political crisis – to spook the market herd and cue the Minsky moment. Then comes the collapse in prices, the liquidity crisis and recession – U-shaped or V-shaped, depending – topped off by a taxpayer-funded bailout of the people who burned the house down.
(For more on Prof. Minsky, The New Yorker’s John Cassidy offers a helpful chapter in his 2009 book How Markets Fail: The Logic of Economic Calamities, which, for what it’s worth, I’ve praised as a superb explanation of what happened in 2008-09.)
The thing to remember about financial crises is that they don’t start when everyone panics and markets collapse. They start long before, often when rent-seeking insiders quietly loosen the bolts of regulation while no one else is paying attention or prevent regulation in the first place, bending public policy toward private advantage in ways that put innocent bystanders at risk.
Something like that seems to be happening with Mr. Trump’s Wall Street nomenklatura. The crypto market is largely unregulated, as demonstrated by the FTX debacle, and extremely volatile, as you might expect of an asset class whose key fundamental seems to be market sentiment. And yet these digital tulip bulbs are an increasingly significant force in financial markets. Systemically important financial institutions, and even pension funds, are increasing their crypto holdings. The crypto market’s total capitalization peaked at US$3.9-trillion in December and by one projection will reach US$12-trillion by 2030.
That pales in comparison with the US$62-trillion U.S. stock market, but a meltdown in even a relatively small corner of the financial system can rock the whole boat, as shown by the 1998 collapse of Long-Term Capital Management, a hedge fund sporting 27-to-1 leverage and a notional derivatives value of US$1.25-trillion. Stocks tanked after its collapse, prompting a US$3.6-billion rescue orchestrated by the New York Federal Reserve.
The crypto market opens several avenues of systemic risk. One is its sheer volatility – 4.8 times greater than that of the S&P 500, according to one analysis. Volatility creates risk aversion and uncertainty, never a good look for public markets or the general economy. The industry’s answer is stablecoins, which are indeed less volatile than altcoins, those other than bitcoin. (An underappreciated contradiction: Stablecoins are reliable stores of value largely to the extent that they are tied to the fiat currencies and central banks that crypto proponents claim to despise.)
Another is market opacity. Initial coin offerings (ICOs) are largely unregulated in the U.S., meaning investors may have no idea who is behind the offering or who’s subscribing, quite unlike highly scrutinized stock IPOs. “Because they are less regulated,” said blockchain law firm Oberheiden, “ICOs are more likely to be used by fraudsters and scam artists who prey on uninformed investors.”
Leverage is also problematic. Some trading platforms allow 100 times leverage, which, as in any other market, amplifies gains but also losses. Excess private-sector debt can steepen a market crash and induce a “balance-sheet recession,” a prolonged downturn caused by individuals and institutions focusing on saving and paying down debt. Saving may sound like a good thing, but in the short term it can hinder aggregate spending, which ultimately is all “the economy” really is, illustrating what economists call “the paradox of thrift.”
Markets are already feeling vulnerable, as shown by the swoon prompted by Mr. Trump’s reckless tariff wars. Stocks are arguably overvalued, and the general economy is vulnerable to a recession, which Mr. Trump at one point conceded is a possibility – before walking it back.
Donald Trump is a know-nothing, but what he says matters because market outcomes are often self-fulfilling. If you can convince a critical mass of investors and consumers that something is about to happen, they will behave in ways that make it happen.
To be sure, lawmakers have proposed regulatory schemes, but who knows how effective they might be or when they would take effect. The last thing the U.S. economy needs now or in the long run is a Wild West crypto market liable to implode at any moment. As departing Commodity Futures Trading Commission Chair Rostin Behnam told Politico in January: “We’ve seen this before in our history where we leave large swaths of finance outside of oversight and responsibility, and we have seen time and time again that it ends badly.”