The Clarity Act is a ‘threat to economic sovereignty.’ So why is Donald Trump so keen on it?

Wolfgang Münchau is a columnist for DL News. He is co-founder and director of Eurointelligence, and writes a column on European affairs for UnHerd. Opinions are his own.

It is hard to overestimate the importance of cryptocurrencies for the Trump administration. At its heart, this is a fight for the future of the dollar, as Scott Bessent, the US Treasury secretary, admitted in his recent op-ed in the Wall Street Journal. By extension, this is about securing the US’ role as a global superpower.

After the passage of the Genius Act last year, a crypto-friendly regulatory framework for stablecoin issuers, the big issue now is to regulate the rest of the industry. That includes the platforms and intermediaries through which stablecoin issuers interact with the public.

The ultimate goal is to supercharge the amount of digital asset issuance in the US economy – through stablecoins; tokenised assets that replace ordinary shares; decentralised exchanges; and completely new ways for companies to raise money, and for people to save.

Controversial

The regulatory framework to get this job done is the Clarity Act that is now in front of the Senate Banking Committee, and that may come to a full vote on the Senate floor next month.

It is, unsurprisingly, controversial. The banks are up in arms about it, because it opens up a backdoor for platforms to offer hidden rewards to stablecoin holders — that look suspiciously like interest rates.

The Genius Act already banned interest payments by stablecoin issuers, but it left a backdoor open to various nodes in the stablecoin network to offer rewards.

The banks fear that this would give rise to deposit flight. A stablecoin that offers interest, either outright or in hidden forms, would be a lot more than just a virtual dollar that can be used for online payments. It would turn into a money market account.

Most likely, it would offer interest rates close to overnight rates in the money markets. No bank could compete with that. It would be the beginning of the end of the banks. I suspect this is not a bug of the proposed legislation, but a feature.

The US government has a clear interest that this legislation passes, ideally in a version that imposes few restrictions. The idea is that the more liberal the regime becomes, the more likely the global crypto industry would migrate to the US.

The EU is essentially out of the picture here. The Markets in Crypto-Assets regulation, passed in 2023, is a much more onerous regime than the combined Genius and Clarity Acts.

The reason why the US administration is keen on the crypto industry is that it regards crypto as a means to expand American economic power over the rest of the world. Its current power critically rests on the exorbitant privilege of the US dollar as the world’s largest fiat currency.

There are no competitors. The euro is a big currency, but the eurozone is a fragmented economy, at this point more likely to fragment further than to unite. The renminbi cannot challenge the dollar for as long as China imposes capital controls.

The biggest threat to the dollar comes through a large cryptoverse outside the US. Whoever wields regulatory control over the crypto industry, will regulate global finance in the future. The US hopes to become the first country to offer a comprehensive, consistent, but light regulatory regime for the crypto industry.

The EU’s MiCA is certainly comprehensive. Brussels is good at this sort of thing. But nobody can accuse MiCA of being light.

Dollar optimism

Bessent himself said that one cannot take the leadership role of the US dollar for granted. He is right. The exorbitant privilege gives the US administrations the right to borrow more than it would otherwise be able to.

There is an awful lot of complacent dollar optimism especially amongst American international economists. They are all, without exception, crypto sceptics. One of them is the well-known international economist Maurice Obstfeld, who notes that the whole point of stablecoins is to give the US government more leeway for borrowing, at lower costs. But he does not think it will work.

US residents will swap bank balances for stablecoins. So that would be just a reshuffle of domestic assets, he argues.What about foreigners? Bessent has put the potential of foreign dollar stablecoin holdings at 3.7 trillion, but Obstfeld thinks that they too will just reshuffle their holding.

“Residents of less creditworthy countries who hold dollars in US accounts (often skirting domestic law) could simply spend them on stablecoins,” he said. “Argentines reportedly hold $271 billion in offshore accounts (and stuffed in mattresses), which they could use to buy US stablecoins.”

I don’t think this is how it will work.

Say, the EU fails to create a well functioning digital currency, people might be tempted to hold stablecoin balances as a convenient way to transact online. They would not be switching dollar bank balances for dollar stablecoins but selling euro assets instead to obtain the digital money. This would be a modern version of an old phenomenon known as Gresham’s law: bad money drives out good.

If Europeans started to use stablecoins for certain payments, they will probably want to save part of their income in US dollars — or in stablecoins as a savings instrument. The EU could forbid the use of foreign currency stablecoins. They will almost surely insist that the euro must always be offered as acceptable legal tender in any commercial transaction.

Ultimately I don’t think it will be possible to stop buyers and sellers transact in the currency they both prefer. We are talking about a future scenario in which the crypto industry will have usurped parts of the traditional financial markets. The US stablecoin will at this point have become a competitive savings and transactions product everywhere in the world.

If you then consider the combination of stablecoins and artificial intelligence, an industry the US also dominates, it is quite likely that the rest of the world will be dominated by the US financial industry in more ways than it already is.

Unlike the macroeconomists who think of crypto as a scam, or a non-event at best, I see stablecoins as a potential threat to economic sovereignty, and as a potential financial stability risk.

There is no deposit insurance in the system. If a large stablecoin issuer, or platform, went bust, there would be no backstop. The financial contagion effects would be massive.

If your time horizon does not extend beyond the remaining lifespan of the Trump administration, it would be reasonable to expect that the bubble would inflate before it deflates. I can see why the White House and Bessent are keen on this.

I can also see that the rest of the world, and especially the Europeans, may be sleepwalking into a brave new world they barely understand.