A new economic era: is inflation coming back for good?

In the first in a series, Chris Giles examines whether the extraordinary post-crisis stimulus will lead to rising prices

Chris Giles in London 

© FT montage; NCJ Archive/Mirrorpix/Mirrorpix/Getty | Pensioners protest in Newcastle in 1974, as inflation soared

The December meeting of the Federal Reserve’s most important economic committee was routine. 

Policymakers agreed that the economy could cope with rising levels of spending “without any strong general upward pressure on prices”.

Although prices of a few raw materials were rising sharply, “finished goods have not been subject to pervasive upward cost pressures”.

Generalised inflation, the committee concluded, was not a serious concern.

This meeting of the Federal Open Market Committee was held on December 15 1964, just two weeks before the start of a 17-year period the Fed now dubs The Great Inflation.

Turning points in price trends tend to occur just at the moment when the authorities and expert opinion dismiss the risks. 

The current consensus is that price rises in commodities and goods markets have clear pandemic-related explanations and that the risks of a resurgence in global inflation remains remote.

Three decades after the authorities in advanced economies managed to suppress the beast, they remain confident they are in control. 

The mantra of the moment is summed up by Andrew Bailey, Bank of England governor, who likes to say he is watching inflation “extremely carefully” but not worrying.

This view is still the mainstream but it is losing supporters. One notable recent defector is Roger Bootle, author of the book The Death of Inflation, who spotted the coming decline in price rises in the mid 1990s. 

He is now worried. 

“Financial markets are going to have to get used to the return of troublesome issues that had, until recently, seemed long dead,” Bootle wrote in May.

Central bankers have not had to deal with an inflation problem during their careers. 

Having averaged around 10 per cent a year in the 1970s and 1980s, global inflation rates fell to an average close to 5 per cent in the 1990s in the rich world countries of the OECD, 3 per cent in the 2000s and 2 per cent in the 2010s. 

The question today is whether their view is complacent. 

Is the world entering another inflationary era?

While many households think the definition of price stability would be an absence of inflation, economists and policymakers favour a gentle annual increase in prices of around 2 per cent. 

This reduces the risk that an economic crisis could spark a deflationary spiral with spending, prices and wages all falling, raising the real burden of debts and further hitting spending. 

Holger Schmieding, chief economist of Berenberg Bank, explains that a little inflation also greases the wheels of the economy, allowing declining sectors to fall behind gracefully.

“Higher inflation eases economic adjustments as it creates more scope for changes in relative wages without a need for an outright fall in wages in sectors under pressure,” he says.

In most advanced economies — the US, the eurozone and Japan — central banks have fallen short of meeting their targets of inflation of around 2 per cent despite having slashed interest rates to zero and having created trillions of dollars, euros and yen, which has been pumped it into their economies by purchasing government debt. A modest rise in inflation therefore would be welcomed by central banks, which have generally been delegated the task of achieving price stability.

1950s and 1960s: Variable inflation

    © Evening Standard/Hulton Archive/Getty Images Although inflation did not surge in the US until the mid-1960s, the UK saw persistent prices rises from the 1950s, partly as a result of currency devaluations

And until this year, the main economic concern regarding prices was the risk that countries were turning Japanese and might soon emulate the nation’s 30-year struggle with mild deflation. 

Such was the difficulty of keeping inflation high enough that some economists even began to question the doctrine of Ben Bernanke, former Fed chair, who argued in 2002 that “under a paper-money system, a determined government can always generate higher spending and hence positive inflation”.

But this view of the world has turned on its head in 2021. 

A new whatever-it-takes borrowing and spending programme by the Biden administration, enforced savings during the coronavirus crisis giving households additional firepower, bottlenecks in the supply of goods and a reversal of longstanding downward pressures on global wages and prices have rekindled fears of excessive inflation.

No one is talking about hyperinflation of the sort seen in Weimar Germany in 1923 or Latin America in the 1980s or even the 10 per cent global rate of the 1970s, but a creeping rise to persistent levels of generalised price increases not seen in a generation. 

When the April rate of US inflation jumped to 4.2 per cent, financial markets swooned.

The new concern about a return to inflation is not just the result of immediate economic forces but also reflects longer-term, underlying changes in the structure of the global economy. 

The aggressive economic stimulus is being adopted at the very moment when the global economy is feeling the impact of ageing populations and the maturing of China’s 40-year transition.

1970s: The era of oil shocks

    A sign outside a service station in the UK in February 1978 © Pete Primarello/Evening Standard/Getty Images Inflation really started to take off after the 1973 oil shock when Opec imposed an oil embargo amid tensions in the Middle East

Moreover, history also tells us that neither politicians, economists nor policymakers can guarantee the world will maintain low and stable inflation. 

As the Fed’s experience from the 1960s demonstrates, turning points in inflation arrive with little warning. 

Unlike in the US, where there was no fear of inflation after the second world war, concern about inflation was “always rumbling on” following devaluations of sterling and higher import prices in the UK during the full employment years of the 1950s and 1960s, according to Nick Crafts, professor of economic history at Sussex university.

But it only really took off in the 1970s after the first Opec oil shock and a switch in government policy from austerity to “a massively excessive stimulus, pushing the economy beyond any reasonable estimate of the sustainable level of unemployment”, Crafts adds.

Research from Luca Benati, professor at Bern university, suggests that the world’s faith in central bankers being able to tame any similar episodes is probably overblown. 

The UK’s inflationary pressure in the 1970s was so strong, he found, that when he ran history again in multiple simulations assuming an independent central bank is in charge of controlling prices, inflationary forces would have been more powerful than any likely action by a Bank of England with an independent Monetary Policy Committee. 

In the 1970s, it would have had only a “limited impact” on quelling price rises which reached an annual rate of 26.9 per cent in 1975.

1980s: The central bankers take charge

Paul Volcker, then Federal Reserve chair, (R) meets then president Ronald Reagan in the Oval Office in July 1981 © Bettmann Archive / As Fed chair, Paul Volcker raised interest rates in a bid to tame inflation and launched an era of all-powerful central banks

According to Karen Ward, chief European market strategist at JPMorgan Asset Management, this means the Bernanke doctrine still stands and should not be forgotten. 

“We’ve always assumed that the structural supply side enhancements such as technology and globalisation are so great that we could never overwhelm them with demand, but it still must be the case that you can overwhelm supply with demand and ultimately generate inflation,” she says.

It is exactly this fear which is raising inflation rate expectations in the US and Europe at the moment. 

Alongside a recovery of energy prices to pre-Covid levels, there has been a shortage of microchips, wood products, many metals and even cheese. 

These have been the proximate causes of higher inflation, but financial markets worry that the ultimate cause has been the pandemic-related fiscal and monetary stimulus which has led to a much faster economic recovery in advanced economies than was thought possible at the end of 2020.

With economic policy pressing harder on the accelerator than at any time in recent history, spending could exceed the capacity of economies to provide goods and services, especially if the coronavirus crisis and government support have left people less willing to work, creating labour shortages and significant pressure on companies to raise wages.

Such is the potential imbalance between rampant demand and more constrained supply, especially in the US, some supporters of centre-left policy ideas say that warning lights are flashing. 

Larry Summers, Treasury secretary in the Clinton administration, thinks policy has become far too lax, repeatedly criticising the “dangerous complacency” over inflation of today’s policymakers in recent weeks.

While the White House has hit back, saying “a strong economy depends on a solid foundation of public investment, and that investments in workers, families and communities can pay off for decades to come”, even Janet Yellen, current Treasury secretary, has acknowledged the possible need for interest rates to rise “to make sure that our economy doesn’t overheat”.

The policy shift has come at a point when economists generally accept that some of the big global forces holding prices down are much weaker than they were. 

In the 1990s and 2000s, globalisation led to a huge transfer of the production of goods from high wage economies to China and eastern Europe, accelerating a decline in the power of workers in advanced economies to force their employers to pay them more, keeping prices low.

But these forces are at a turning point, according to Charles Goodhart, former chief economist of the Bank of England, and an author of the book The Great Demographic Reversal. 

The long boom in the size of its workforce has ended and its population is on the verge of falling for the first time in decades. 

Goodhart says that fewer new workers becoming integrated into the global labour force at a time of shrinking workforces in advanced economies as populations age will raise the pressures on companies to push up wages, increasing underlying inflationary pressures.

The change in demographic pressures have already been around for a decade and are intensifying, Goodhart says. 

He had been wary of putting a date on the coming inflation, saying that the world is likely so see rising inflationary pressure within five years and “we are fairly sure it would have happened by 2030”.

2021: Biden promises action

© Reuters The Biden administration has taken a do-whatever-it-takes approach to reviving the economy and reducing inequality, even if that risks some inflation

That was before Covid struck. 

Now, he says the underlying pressures, alongside more stimulative policies and Covid-related restrictions in supply, have brought forward the moment. 

“We tend to think that because of supply constraints in particular, it’s going to be more inflationary in 2021 than central bankers originally thought and it will last longer in 2022 and 2023 because there will be a confluence of the build-up of large monetary balances . . . combined with large continued fiscal expansion.”

Turning to specific examples of prices he expected to see rise, Goodhart notes how the added demand for holidays in the UK would push up the prices of holiday rentals, hotels and even ice cream this summer. 

“You’d have to be a saint not to raise your prices,” he says.

Demographic pressures are not something that can be reversed quickly, nor he argues can the forces of globalisation, which have gone into retreat having become politically unpopular in many advanced economies. 

Again, this is most acute in the US where economists such as Adam Posen, president of the Peterson Institute for International Economics, urges Americans to “embrace economic change rather than nostalgia” in domestic production, especially in manufacturing, as a means to improving living standards and promoting non-inflationary growth.

So far, however, although financial market expectations of inflation have risen sharply in 2021, mainstream policymakers are remaining calm.

There is increasing chatter in the Fed that at some point the current members of the interest-rate setting committee need to think about scaling back the pace of money creation and purchases of government bonds. 

But the view is that inflation is recovering to more normal levels and the US central bank has pledged to keep policy ultra accommodative until it achieves a more inclusive recovery.

This is the right approach, says Laurence Boone, chief economist of the OECD in Paris, a view which chimes with similar attitudes in central banks around the world. 

“It’s too early to ring the alarm bells about inflation,” she says. 

“That doesn’t mean one doesn’t have to watch what’s happening and we’re seeing frictions with the reopening of demand and supply after the crisis . . . but the right policy is to ease tensions on the supply side more than central bank action [to quell inflationary pressures].”

In most economies, there remains significant slack in the labour market, she adds, and the big demographic pressures could be eased significantly with later retirement, while other parts of Asia and Africa would be delighted to integrate into the global economy as China did.

Boone’s view still represents the consensus opinion among economists and there is considerable confidence in central banks that any rise in inflation this year will be temporary and easily tamed without having to tighten policy significantly.

But, for the first time in many decades, there is the possibility that a significant turning point has arrived, that price rises will be more than a flash in the pan and something more difficult to control.

Platinum: precious metal is struggling to find a positive catalyst

Switch to electric battery vehicles will mean dwindling demand in the years ahead

A red-hot bar of platinum. The metal’s rally has faded since the spring © Bloomberg

Precious metals and cryptocurrencies have a lot in common. 

Both are championed by groups who question the integrity of global monetary systems. 

Both are known for their limited supply and regarded as an alternative store of value. 

Both have received bad press for their impact on the environment.

Platinum’s contribution to climate change may seem odd given the metal helps to clean up dirty car exhaust fumes. 

But demand relies on the continued production of internal combustion cars that use fossil fuels. 

Automotive catalysts make up about a third of platinum and almost all of palladium consumption. 

A future of climate-friendly electric vehicles is bad news for suppliers.

This remains some way off. 

Plenty of new cars still require their fumes cleansed of polluting elements such as carbon monoxide and nitrogen oxide. 

Platinum prices doubled in the year to March as traders anticipated a rebound in auto sales. 

No surprise that shares in UK-listed Johnson Matthey, one of the world’s largest makers of catalytic converters, have rallied by half in the past 12 months.

But platinum’s rally has faded since the spring. 

Rival metal palladium is preferred by automakers for use in petrol emission catalysts. 

That is especially true since Volkswagen’s disastrous emissions scandal in late 2015.

Supply concerns have helped to lift palladium prices. 

Demand has outpaced global supply by an annual average of 611,000 troy ounces in the four years to the end of 2020, according to Johnson Matthey. 

Automakers cannot easily switch input materials, even if palladium trades at well over double platinum’s $1,064 per troy ounce value.

Like cryptocurrencies, platinum and palladium are both dogged by long-term ESG issues. 

The metals are predominantly mined in South Africa, where mines are often dangerously hot and deep, making safety a paramount issue. 

The switch to electric battery vehicles also means dwindling demand for platinum and palladium in the years ahead. 

While crypto may find alternative sources to power its mining, the metals will struggle to find a replacement for consumption that can match automotive catalysts. 

Platinum: precious metal is struggling to find a positive catalyst | Financial Times (ft.com)

One Mad Market & Six Cold Reality-Checks

By Matthew Piepenburg

Fact checking politicos, headlines and central bankers is one thing. 

Putting their “facts” into context is another.

Toward that end, it’s critical to place so-called “economic growth,” Treasury market growth, stock market growth, GDP growth and, of course, gold price growth into clearer perspective despite an insane global backdrop that is anything but clearly reported.

Context 1: The Rising Growth Headline

Recently, Biden’s economic advisor, Jared Bernstein, calmed the masses with yet another headline-making boast that the U.S. is “growing considerably faster” than their trading partners.

Fair enough.

But given that the U.S. is running the largest deficits on historical record…

…such “growth” is not surprising.

In other words, bragging about growth on the back of extreme deficit spending is like a spoiled kid bragging about a new Porsche secretly purchased with his father’s credit card: It only looks good until the bill arrives and the car vanishes.

In a financial world gone mad, it’s critical to look under the hood of what passes for growth in particular or basic principles of price discovery, debt levels or supply and demand in general.

In short: “Growth” driven by extreme debt is not growth at all–it’s just the headline surface shine on a sports car one can’t afford.

And yet the madness continues…Take the U.S. Treasury market, for example.

Context 2: The Treasury “Market”?

How can anyone call the U.S. Treasury market a “market” when 56% of the $4.5T of bonds issued since last February have been bought by the Fed itself?

Sounds more like an insider price-fix than a “market,” no?

Such context gives an entirely new meaning to the idea of “drinking your own Kool-aide” and ought to be a cool reminder that Treasury bonds in general, and bond yields in particular, are zombies masquerading as credit Olympians.

The Fed, of course, will pretend that such “support” is as temporary as their “transitory inflation” meme, but most market realists understood long ago that more and crazier bond yield “support” is the only way for national debt bubbles (and IOU’s) to stay zombie-like alive.

In short, the better phrase for Treasury “support,” “accommodation,” or “stimulus” is simply: “Life Support.”

With central banks like the Fed continuing to create fiat currencies to monetize their unsustainable debt well into the distant future, we can safely foresee a further weakening of the USD and further strengthening of gold prices, mining stocks and key risk assets like tech and industrial stocks.

Context 3: Deflation is back?


Last week’s jaw-boning from Powell, Fisher and Bullard had the markets wondering if the Fed will be raising rates in the distant future.

The very fact that Powell raised the issue is because the Fed is realizing that inflation is going to be sticky rather than “transitory”and thus they are already pretending to pose as Hawkish.

But if the Fed raises rates to quell real rather than “transitory” inflation, the markets and Uncle Sam will go into a tantrum. End of story.

As I’ve written elsewhere: Pick your Fed poison—tanking markets or surging inflation. 

Eventually, we foresee both.

Meanwhile, and fully aware that inflation, with some dips, is only going to trend higher, Powell is already using semantics to change the rules mid-game, now saying that rather than “allow” 2% inflation, they’ll settle for an “average” of 2%.

Translated into honest English, this just means expect more inflation around the corner.

Context 4: Rising Stock Markets

Despite reaching nosebleed levels which defy every traditional valuation ceiling, from CAPE ratios and Tobin ratios to book values and FCF data, the headlines remind us that stocks can go even higher—and they can indeed.

But context, as well as history, reminds us that the bigger the bubble the bigger the mean-reverting fall.

No Treasure in Treasuries = Lot’s of Air in Stocks

Based upon the objective facts above, we now know that the only primary buyers showing up at U.S. Treasury auctions is the Fed itself.

This is because the rest of the world (Asia, Europe etc.) doesn’t want them.

The next question is “why”?

The answer is multiple yet simple.

First, and despite the open myth of American Exceptionalism, investors in other countries can actually think, read and count for themselves, which means they’re not simply trusting the Fed—or its IOU’s– blindly.

Stated otherwise, they are not buying the “transitory inflation” or “strong USD” story pouring recently out of the FOMC mouthpieces.

Inflation is not only rising in the U.S., it’s also creeping up elsewhere—even in Japan, but especially in China. 

This is largely because the U.S. exports its inflation (and debased dollars) offshore via trade and fiscal deficits.

Such deliberate inflation exporting by the U.S. places those countries (creditors) that lent money to Uncle Sam into a dilemma: They can either 1) let their currencies inflate alongside the dollar (hardly fun), or 2) try to quell the outflow of exported (debased) US dollars to save their own currencies from further debasement.

Option 2, of course, is the better option, which means foreign investors need to buy something more appealing than discredited U.S. Treasuries.

Sadly, ironically, and yet factually, the only assets better than bogus US Treasuries are bloated U.S. stocks.

In short, nosebleed-priced US stocks are still the lesser of the two US evils, and foreigners are therefore buying/seeing stocks as a better hedge against the debased USD than sovereign bonds.

Don’t believe me?

See for yourself—the rest of the world is adding lots of air to the U.S. equity bubble:

This is contextually troublesome for a number of reasons.

First, it means the declining US of A has gone from hocking its bonds to the rest of the world to hocking it stocks to the rest of the world (i.e., China…).

Longer term, this simply means that via direct stock ownership, foreigners will slowly own more of corporate America than, well America…

As for this slow gutting of the once-great America to foreign buyers, don’t blame the data. 

Blame your Fed and other policy makers (including labor off-shoring CEO’s) for selling-out America and pretending debt can be magically solved with magical (fake) money creation.

Of course, the second pesky little problem with stocks rising beyond the pale of sanity, earnings and honest FCF data is a thing called volatility—i.e., market seasickness.

Nothing goes in a straight line, including the dollar or the market. 

There will be swings.

Right now, the short on the USD is the highest it has been in four years.

Yet if, by some chance, the Fed ever attempts to taper or raise rates, all those foreign dollars piling into U.S. stocks (above) create a bubble that always pops, as do the foregoing dollar shorts, which get squeezed.

That could cause a massive sell-off in U.S. equity markets as foreigners sell their stocks to buy more dollars.

In short, there’s a lot of different needles pointing at the current equity bubble, and a correction within the next month or so is more than likely.

The sharpest of those needles, by the way, is the appallingly comical level of U.S. margin debt (i.e. leverage) not making the headlines yet now making all-time highs.

As a reminder, whenever margin debt peaks (above), markets tank soon thereafter, as anyone who remembers the dot.com and sub-prime market fiascos of yore can attest.

Just saying…

Context 5: The Dark Side of “Surging” GDP Growth

The World Bank recently made its own headlines projecting 5.6% global GDP growth, the fastest seen in 80 years.

Good stuff, right?

Well, not when placed into context…

The last time we saw 5.6% global GDP growth was during a global world war.

Obviously, when the world is in a state of global military rubble, growth of any kind is likely to “surge” from such an historical (and horrific) baseline.

Coming out of World War II, everyone, including the U.S. was in debt. World wars, after all, can do that…

As the victorious and civilization-saving U.S. came out of that war, it made some justifiable sense to de-lever that noble yet extreme debt by printing money, repressing bond yields and stimulating GDP growth.

What followed was at least a defendable 40-year stretch in which US nominal GDP ran 500-800 bps above US Treasury yields.

In short, bond-holders got slammed, but the cause, crisis and re-building after defeating the Axis powers justified the sacrifice.

The same, however, can not be said today as bond-holders get crushed yet again in a new-abnormal in which GDP will greatly (and similarly) outpace long-term bond yields.

Needless to say, current policy makers, the very foxes who put the global economic henhouse into the current pile of debt of rubble, like to blame this on COVID rather their bathroom mirrors.

Ironically, however, central bankers (as opposed to the Wehrmacht, the Japanese Empire or Italy’s Mussolini) managed to do as much harm to the global economy today (with deficit policies and extend-and-pretend money printers) as Germany’s Blitzkrieg or Hirohito’s Banzai raids did in the 1940’s.

When it comes to context, can or should we really be comparing a global flu (death toll 3.75M) to a global war (death toll 85 million)?

The policy makers would like you to think so.

Folks like Mnuchin (last year) or Yellen, Powell and the IMF (this year), are in fact trying to convince themselves and the world that the war against COVID was the real casus belli (reason for a justifiable war) of our current debt distress—equal in scope to World War II in its drastic impact on the financial world.

But regardless of anyone’s views on the COVID “War” or its questionable policy reactions, comparing its economic impact to that of World War II is an insult to both history and military metaphors.

The simple, objective and mathematically-confirmed fact is that the global economy was already in a debt crisis long before the first Corona headline of early 2020.

Today, US debt to GDP is at levels it has not seen since that tragic and Second World War, and it’s projected to go much, much higher.

So, just in case you still think the Fed can and will meaningfully raise rates to fight obvious inflation, as it did in the 1970’s or 1980’s, think again.

In the 1970’s and 1980’s US debt/GDP was 30%. Today it’s 130%.

Given this self-inflicted (rather than COVID-blamed) reality, the Fed simply can’t afford to raise rates. Period. 

Full stop.

But as my colleague, Egon von Greyerz reminds, that by no means suggests that rates can’t and won’t rise.

The Fed (and other central banks) may be powerful, but they are not divine. 

In short, there’s a limit to their powers to simply “control” rates with a mouse-click.

At some point, there’s not enough credible fake money to manage the yield curve—especially on the long end.

As more printed and tanking currencies try to purchase lower yields and rates, eventually the entire experiment fails.

At that critical point, rates spike, inflation raises its ugly head and the central bankers look for something other than themselves to blame as the rest of the world stares at worthless currencies being replaced by comical central bank digital dollars.


Context 6: That Barbaric Relic?

What the foregoing inflation and rate contexts means is that in the years ahead, inflation will run higher and rates will run (be forced/controlled) lower until both rates and inflation spike together.

This further means that real rates (i.e., those adjusted for inflation) could run as deep as -5% to -10% in the years ahead.

Such negative real rate levels could easily surpass those seen in the 70’s and 80’s, which means gold (and silver), both of whom love negative real rates, has nowhere to go but up, up and away in this totally debt-distorted backdrop.

How’s that for context? 

Silicon Valley bets on crypto projects to disrupt finance

Wave of ‘DeFi’ projects aim to reinvent exchanges, insurance, lending and more

Miles Kruppa in San Francisco 

Decentralised finance projects have captured the interest of Silicon Valley investors © FT montage

Uniswap is not even three years old, but it has already turned millions of dollars into billions for venture capitalists who bet on a new kind of cryptocurrency exchange.

Instead of acting as a traditional broker, Uniswap is an automated software program that allows users to trade cryptocurrencies directly with each other, without any intermediary.

Last year venture capitalists who had invested a total of $12.8m in the company behind the project received a sweetener: Uniswap began distributing 1bn digital tokens to users, giving investors 18 per cent of the total.

The tokens, which give holders voting rights in the project, have surged to a price of $28, rewarding the investors with a stake worth roughly $5bn were all the tokens issued. 

Uniswap has outlined a four-year vesting schedule for the tokens, which currently have a market capitalisation of about $16bn, according to CoinMarketCap data.

Uniswap has plenty of company. 

In the past year, the fastest-growing cryptocurrency start-ups have been those aiming to abolish financial intermediaries. 

They have also brought along a new crop of venture capitalists, producing returns that are the envy of more conservative peers.

Decentralised finance, or “DeFi”, projects aim to replicate basic financial services such as lending and trading using software programs known as blockchains, cutting out traditional middlemen.

In the span of two years, and aided by the recent cryptocurrency boom, what started as a curiosity has ballooned in size, ushering in a new model for technology investing in the process.

Private investors have backed 72 DeFi companies this year, according to PitchBook data, already surpassing last year’s total by more than a quarter. 

Uniswap facilitated more than $1bn in trading on a majority of the days in May, rivalling traditional cryptocurrency exchanges such as Coinbase for business in ether and other related tokens.

Meanwhile, the value of cryptocurrency being used as collateral for loans, trades and other transactions in DeFi applications has increased by a factor of more than 60 in the past year, rising to the equivalent of more than $67bn, according to data from the website DeFi Pulse.

Backers of DeFi projects are confident that in the long term, the applications stand a good chance of rewiring the financial system.

But traditional venture capital firms, including Sequoia Capital, have largely avoided investing directly in DeFi projects, partly because of concerns about how they would be treated by regulators, according to people familiar with their thinking.

Lawyers and venture capitalists said DeFi inhabits a largely unregulated grey area that could face pressure from the new Securities and Exchange Commission chair Gary Gensler. 

Some investors drew comparisons between DeFi and the boom in initial coin offerings four years ago, which collapsed following interventions by regulators.

“The fundamental structure of US financial regulation is through intermediaries,” said Jai Massari, a partner at the law firm Davis Polk who advises on cryptocurrency transactions. 

“Here, you don’t have those intermediaries.”

Sequoia and other traditional venture firms have instead invested at arm’s length through specialist cryptocurrency funds, which often have more flexible structures that allow them to amass larger stakes in digital assets. 

Paradigm and Polychain Capital, two large investors in DeFi projects, have both received investments from Sequoia. 

The Harvard and Yale university endowments have also backed Paradigm, which is led by Coinbase co-founder Fred Ehrsam and former Sequoia partner Matt Huang. 

After raising $740m beginning in 2018, the firm’s assets had swelled to $3bn by the end of last year, according to regulatory filings.

Larger funds are on the way. Andreessen Horowitz, an investor in several of the largest DeFi projects such as lending programs Compound and Maker, has recently sought to raise $1bn for the next version of its cryptocurrency funds, almost doubling the size of its most recent version.

Not everybody in DeFi has welcomed venture capitalists, who often receive preferential terms for investing early. 

One project, PoolTogether, altered the terms of a planned token deal after some community members complained about the discount the investors would receive in exchange for providing speedy funding, according to the group’s online forums.

“The signalling that would otherwise be really valuable from having an A-tier investor — it has an inverse effect in DeFi,” said Haseeb Qureshi, managing partner at Dragonfly Capital, a cryptocurrency venture firm.

While DeFi groups often begin as companies that raise traditional venture capital, the real payout comes when the projects issue large pools of tokens.

The distributions, which reward users with effectively free assets for their participation in the networks, are meant to spread governance rights to a broad group, lessening the power of founders over time. 

They have also paid off handsomely for venture capitalists.

If Uniswap’s tokens continue to trade at current levels, venture capitalists will have returned almost 400 times their initial capital in the project by the time their shares have fully vested.

Paradigm, which led a $1.8m round of seed funding in the company behind Uniswap, was the largest outside investor when the project began issuing tokens last year, said two people familiar with the matter. 

The firm had received the rights to its share of any tokens issued by the project when it invested, one of the people said. 

Paradigm and Uniswap both declined to comment.

Some investors have already begun placing bets on alternative venues for DeFi developers. 

Ethereum, the blockchain underlying most of the projects, has struggled with high transaction costs as volume has surged, frustrating traders.

Kyle Samani, managing partner of Multicoin Capital, said investors had placed too much confidence in Uniswap becoming the dominant market maker and ethereum remaining the most important computing program for DeFi.

Solana, a new blockchain that Multicoin backed in 2019, has appreciated by a factor of more than 150 since it listed on the exchange Binance last year, giving it a market capitalisation of $9.1bn. 

Multicoin is the largest outside investor in the project, the two groups said. Solana claims it has faster speeds and lower transaction costs than ethereum.

“By the end of the year, the smartest money that’s not full-time crypto will be saying ethereum has not won,” Samani said.

Xi’s Historic Mistake

If China historically had pursued the path that its current paramount leader, Xi Jinping, seems to want to take, it would not be a rising economic superpower. History shows that it is in China's own interest to allow for more regional autonomy and less centralization.

J. Bradford DeLong

BERKELEY – Late last month, the American actor John Cena issued a groveling public apology after having referred to Taiwan as a “country” in an interview to promote his latest film. 

Though he was using the term to refer to a linguistic media market with a discrete distribution channel, not to the status of the island of Taiwan in international law, the Chinese government would make no allowance for such distinctions.

What are we to make of this episode? 

Clearly, globalization has gone terribly wrong. 

The speech restrictions dictated by China’s authoritarian government apply not just to China but also, and increasingly, to the outside world. 

Even in my own day-to-day experience, I have noticed that far too many people now speak elliptically, elusively, and euphemistically about contemporary China.

I could do that, too. 

I could subtly point out that no empire has ever had more than five good emperors in a row, and that it is important for a society to preserve a place for well-meaning critics like the sixteenth-century Chinese official Hai Rui, the early communist-era military leader Peng Dehuai, and the economic reformer Deng Xiaoping. 

But I prefer to speak frankly and directly about the real issues that lie behind terminological disputes over Taiwan.

In my view, it is in China’s own interest that the government in Taipei remains the sole authority on the island, so that it can continue to follow an institutional and governance path that is different from that of the People’s Republic. 

Likewise, it is in China’s interest that Hong Kong remains a second system. 

The government in Beijing ought to recognize that substantial regional autonomy, especially for areas with non-Han-majority populations, will serve its own long-term ambitions.

The appalling and tragic history of genocide, ethnic cleansing, and forced assimilation in the twentieth century suggests that top-down, imperial Sinicization will sow resentments that will last generations and create conditions for serious trouble in the coming years and decades. 

Humanity has grown up enough to know that diversity, regional autonomy, and cosmopolitanism are better than the alternatives. 

A regime that aspires to lead the world toward a brighter future should be especially cognizant of this.

Nonetheless, China’s current paramount leader, Xi Jinping, very much wishes to centralize authority in Beijing. 

Rightly fearing careerism and corruption in the Communist Party of China, he seeks not a Cultural Revolution but a Cultural Renaissance to restore egalitarian values and utopian aspirations across the leadership ranks. 

Supremely confident in his ability to read the situation and issue the right commands, his main concern is that his orders won’t be implemented properly. 

The solution to that problem, he seems to have concluded, is much greater concentration of power.

But even if Xi has made the right tactical calculation for the current moment, his own senescence, together with the logic of how authoritarian command organizations evolve, all but ensure that his strategy will end in tears.

It is a huge mistake to ignore the benefits that come with more regional autonomy. 

Consider an alternative history in which the People’s Liberation Army had overrun both Hong Kong and Taiwan in 1949; Sichuan had not been allowed to pursue pilot reform programs in 1975, when Zhao Ziyang was appointed provincial party secretary; and China’s centralization had proceeded to the point that the Guangzhou Military District could not offer Deng refuge from the wrath of the Gang of Four in 1976. 

What would China’s economy look like today?

It would be a basket case. 

Rather than enjoying a rapid ascent to economic superpower status, China would find itself being compared to the likes of Burma or Pakistan. 

When Mao Zedong died in 1976, China was impoverished and rudderless. 

But it learned to stand on its own two feet by drawing on Taiwan and Hong Kong’s entrepreneurial classes and financing systems, emulating Zhao’s policies in Sichuan, and opening up Special Economic Zones in places like Guangzhou and Shenzhen.

At some point in the future, China will need to choose between governmental strategies and systems. 

It is safe to assume that relying on top-down decrees from an aging, mentally declining paramount leader who is vulnerable to careerist flattery will not produce good results. 

The more that China centralizes, the more it will suffer. 

But if decisions about policies and institutions are based on a rough consensus among keen-eyed observers who are open to emulating the practices and experiments of successful regions, China will thrive.

A China with many distinct systems exploring possible paths to the future might really have a chance of becoming a global leader and proving worthy of the role. 

A centralized, authoritarian China that demands submission to a single emperor will never have that opportunity.

J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.