Bitcoin and Reserve Currencies: Vol I
- Inception of Bitcoin
- Modern Monetary Theory Vs Austrian School of Economics
- Bitcoin as a reserve currency fallacy
- Stablecoins, tether, and commercial paper
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Bitcoin’s value has exploded this year before correcting, and Coinbase, a large custodian of cryptocurrency assets, recently went public. This leaves a lot of folks wondering: is this new asset class, cryptocurrencies, still speculative or for real?
Bitcoin to United States Dollar
People who have looked down on Bitcoin for an extended period of time and called it a bubble may be under pressure to re-examine their assumptions. They may already be considered behind the curve. With firms as big as Fidelity investing capital and risking their reputation by investing in the space, can smaller firms really afford not to take a closer look?
In the backdrop of the 2008 financial crisis, cryptocurrencies were a burgeoning new space filled by computer programmers. One programmer or group of programmers dubbed Satoshi Nakamoto wrote a white paper describing the concept of his new cryptocurrency. Influenced heavily by the Austrian School of Economics, Satoshi designed this new currency system to be decentralized, in contrast to the highly centralized banking system that left the entire global economy at its knees.
Austrian economist Friedrich Hayek and his forerunner Frédéric Bastiat have both famously commented on the emergent order, where individuals rush to meet demands from the marketplace rather than by decree of governments or states. This is the spirit with which Bitcoin was founded.
Although dubbed a cryptocurrency, Bitcoin’s primary use case thus far seems to be as a speculative investment. Fortunes have been made (and lost) in the cryptocurrency market. Many Bitcoin enthusiasts, investors, and beneficiaries are cypher punks and anarchists, while many others believe in its decentralized nature. Nevertheless, this rubs some traditional individuals the wrong way.
One of Bitcoin’s largest foils is a school of economic thought called Modern Monetary Theory, or MMT for short. MMT believes in the power of the state to create and spend money.
The school has done extensive work and offers very accurate descriptions of how the pipes of the financial system work. Some of MMT’s policy prescriptions, however, call for drastic changes to the structure of the U.S. economy.
MMT offers a vision for a Utopian society that, while noble, has yet to be achieved in recorded human history. Their program calls for guaranteed government employment and healthcare, for starters. Guaranteed employment by the government, it should be added, would effectively set a price floor or minimum wage that entrepreneurs and businesses would need to pay to compete with for workers going forward.
MMT ultimately revolves around the importance of citizens needing to pay their taxes. So, if you want to earn an income or own property, U.S. dollars have value because they are your stay-out-of-jail card. Under an MMT-minded legislature, the ultimate limit on the ability to spend is due to inflationary pressures.
On the other hand, Austrian economics ultimately recognizes that its policy prescriptions are not a panacea, and that utopia is an unlikely scenario under any economic system. The Austrian School is ultimately a libertarian ideology that can be viewed as the free market religion. This is a cogent philosophy that echoes the sentiments of the founders of the US.
Bitcoin is an emergent technology that was invented to protect the purchasing power of its owners. The federal reserve has a stated target inflation rate of 2% after all.
But MMT has been gaining a lot of traction lately, with congresswoman Rashida Tlaib of Michigan going as far as introducing legislation to Mint the coin. This is a bill that states that the Treasury would mint two coins that it says are collectively worth 4 trillion dollars. These coins would alleviate the US debt problems by decree.
Rational observers predict that, under a regime where the only limit on money creation is inflation, this power will be pushed to the limit.
Some have noted that an MMT regime would put the U.S. dollar’s reserve currency status at risk. This is because a reserve currency is used by foreign governments who agree to invest their savings in the aforementioned currency. The U.S. government inflating its currency under such a cavalier regime could create fear for these holders and lead them to look at other assets to preserve their savings.
Lower demand for U.S. debt and currency ultimately means that many asset prices would rise in dollar terms, Bitcoin included, even if their real values didn’t change. While Bitcoin is primarily used as a way to store value, it could be used for payments if its value stabilized, and it continues developing network effects.
More Skepticism: Bitcoin as Reserve Currency Fallacy
But it isn’t all sunshine and rainbows. Bitcoin enthusiasts and entrepreneurs have made some extraordinary claims about cryptocurrency and what it means. As Nathan Robinson notes in his piece, some of these claims are dubious. Others may be true but offer little or negative relative value versus using current currencies as they exist.
For example, Bitcoin proponents are quick to point to the security benefits of using their cryptocurrency. However, Mastercard and Visa offer plenty of protection against fraud that the Bitcoin network does not.
That being said, Mr. Robinson is quick to dismiss the ability to use Bitcoin as an effective way to preserve one’s savings.
Yet, this is no small matter to ignore. Indeed, in certain countries like Argentina where the amount of dollars available daily are artificially limited by the government, Bitcoin can usefully supplement demand for dollars and has the potential to save citizens their life savings. Bitcoin offers an escape valve for citizens in these types of authoritarian governments where the economic policies are fickle. This potentially life-saving digital currency should not be discounted simply because it doesn’t offer the same consumer protections as Mastercard and Visa in all situations. After all, Mastercard and Visa are not accepted everywhere, especially in unstable economic environments where Bitcoin is available.
In Mr. Robinson’s piece, he advocates using the collective will to fix the problems bitcoin set out to fix by using policy. That is the opposite of emergent order and would be subject to the winds of change as sentiment could change from year to year. The beauty of Bitcoin is that its users are free to choose it among a buffet of currency options. Other currencies can be manipulated at will by their central banks but Bitcoin has a set amount of tokens that can be created.
Bitcoin as a reserve currency?
But the problems persist. It turns out starting a currency from scratch is hard. The Austrian foundation for Bitcoin could be problematic for its use as a currency. This is because the ability for central banks to act discretionarily based on particular economic circumstances can be very beneficial, particularly when times are tough.
That’s how you end up with ‘money printer’ memes on the internet.
While the memes are funny to some, the middle of a pandemic would be quite the time to find our collective religion with regard to government spending.
Michael Green, of Simplify Investing, has stated that his definition of a currency is one that relieves debt. This is a workable definition that gets to the root of the problem. In an economy that primarily used Bitcoin as a reserve currency, it would not be easy for there to be growth unless it was a consistently deflationary economy. Try explaining to employees why the number of bitcoins they were paid in wages went down but they were actually making the same amount in real terms.
Additional issues persist around stable coins. These are tokens that are used to trade in and out of Bitcoin. These institutions essentially function the same way that banks operating under the gold standard used to.
As the tweet above shows, tether has made wild claims about the amount of dollars that have been handed over to their stewardship. But given that no one can recall selling them commercial paper, it is possible they are issuing tokens without receiving dollars that they claim are flowing into their reserves. This means that by issuing new tokens and claiming they are backed by the dollar, the firm can pump the price of Bitcoin higher.
Source: Twitter, June 2021.
Reserve currency? I thought we were talking about Bitcoin?
While many people who get involved with Bitcoin think of it as an alternative investment or a speculative tool, Bitcoin enthusiasts assert that it is the finest money ever created. Some have gone as far as saying that the US dollar will be replaced by Bitcoin as the global reserve currency. The US dollar is still the dominant global currency with over 60% of global reserves held as dollars and will not be replaced by Bitcoin in that role anytime soon.
Euro, Renminbi Still Far Behind the U.S. Dollar
Percentage of allocated reserves
But the tiny country of El Salvador is adopting a bill that will turn Bitcoin into legal tender there. This means that when citizens list prices for goods, they must accept an equivalent number of Bitcoin. While Bitcoiners celebrated the announcement of this bill at a conference in Miami, El Salvador has been working on enabling anyone who prefers dollars to transfer their Bitcoin into the global reserve currency instantaneously.
El Salvador has long pegged their currency to the dollar. This kept the nation’s monetary policy stable and stability is generally valued by leaders of countries. But that stability meant giving up control over monetary policy. Something that Turkish citizens may tell you is overrated. But soon after the announcement, El Salvador’s new leader announced that, using the heat from a Volcano, the country will generate the power needed to mine Bitcoin. The move to generate hard currency from a naturally occurring power source could essentially be free revenue to the country.
Bitcoin is a relatively novel invention that has a legitimate use case as a store of value but has thus far captured global attention due to huge speculative gains made by its earliest adopters. Its uses as an actual currency have been limited but will now be put to the test in El Salvador.
Central Bankers and other policy makers are not fans of the cryptocurrency due to the competition it poses to their power to issue currency. Bitcoiners value it specifically for the reason that it cannot be issued randomly by policy makers.
While libertarians flock to the new digital asset class, others insist that even its best qualities should be implemented as a matter of public policy as opposed to through the emergent order with which digital currencies have taken the world by storm.
Reach out to Crystal to see which of our fund managers are seeking to take advantage of the volatility in the cryptocurrency space.