Global Uncertainty and Cryptocurrency as Risk Diversification
In 1997, South Korea suffered a foreign exchange crisis, receiving a bail-out program from the International Monetary Fund (IMF). At the time, the economy and financial system of South Korea had a problem that shouldn’t be overlooked because the restructuring of the South Korean economy had been delayed since the 1970s and the financial market was very limited and not functioning properly. Moreover, the government continued to pursue a policy of low exchange rate, and above all, the imbalance problem in the global financial system was a crucial reason.
The brief description of this global imbalance is as follows. Since the emergence of the Euro and Eurobond markets in the 1970s, the global financial markets have been closely linked. In response to the growth of the eurodollar market, the United States continued to ease regulations in the financial markets in the 1980s, which further accelerated the investment of international floating assets on risk-free assets which are the US dollar and US treasuries bonds. Although the United States has recorded a huge trade deficit, it has been able to attract foreign investments due to its dollar and government bonds as risk-free assets. Investing in the United States has become a mainstay of the United States, Germany and developing countries including South Korea.
Due to the fact that Japan took advantage of this system, accumulating a large portion of foreign funds, the imbalance in such a trading system became the cause of the financial crises. The inflow of foreign funds into Japan through trade and the excessive supply of currency caused the bubble in the real estate market. In this process, Japanese financial institutions, which hold a large amount of USD, ended having reduced value of USD funds compared to the liability of the Japanese Yen. This has reduced the capital of Japanese financial institutions and weakened their financial structure. In other words, trade imbalances have led to imbalances in the financial markets and increased international liquidity.
Since the 1970s, the international financial market has been unified and the liquidity supply has increased greatly. However, there were no significant investments to attract more investors. Looking back at the situation during the financial crisis, the Eastern Soviet Union, including the former Soviet Union, was too risky to attract capital continuously. Energy, biotechnology, and other new industries were not yet able to leap out to attract huge capital, and at that time information technology seemed to no longer need that capital. The exit of substantial investment since the 1990s was due to the German unification, the market opening of Eastern European countries due to the collapse of the Soviet Union, and the growth of Asia, but not enough to absorb the huge liquidity circulated around the world. In the end, global floating funds, which did not find attractive investment sources, were invested in US government bonds with the aim of secure and long-term profits and invested in foreign exchange markets in developing countries for short-term profits.
These international financial system problems also appeared in developing countries like South Korea. In the case of East Asian countries that have been focusing on exports, investing in safe US Treasuries or in foreign currencies, it was only a matter of stockpiling for foreign exchange reserves for defense. In other words, it is not only the developed countries such as the United States, Britain, and Japan but also developing countries knew that there is no right destination to invest and operate foreign currency earned by exports. However, the only difference was about the size of foreign exchange that can be operated.
In addition to these external circumstances, countries who suffered from a financial crisis like South Korea, Thailand, and Malaysia had a small financial market, limited information, no transparent transactions, and the excessive intervention of the Government towards the market. This tendency appeared as a factor that leading enormous speculative parties moving in the international financial market and the nation’s economy could not handle these speculative parties resulting in the financial crisis.
Thus, the situation from the 1970s to the financial crisis is quite similar to the current global economic situation. The United States still plays a key role in the global economy, but the value of the dollar has deteriorated due to quantitative easing after the 2008 financial crisis. Europe is suffering from various uncertainties such as Brexit, and emerging countries like China and India has lost its status of the mid-2000’s surprising economic growth often referred to as BRICs. Moreover, global floating funds could not find its proper investment target. Consequently, the current world economy contains significant uncertainty.
There is uncertainty clouding over the global economy. In this case, the important thing is to build a portfolio to distribute the potential threat. Cryptocurrency market sometimes reflects the financial market and sometimes doesn’t match. Hence, cryptocurrency can be one of the components building a portfolio along with other financial assets. Even though there is still uncertainty and instability coexisting, cryptocurrency can be considered as one of the financial assets when these problems are solved. The functionality of whether cryptocurrency can serve as a financial asset or not is going to be a touchstone for determining the future development of the cryptocurrency market.
