Bitcoin’s viability as a currency for a major economy
Tales of Depressions, stores of value that become a medium of exchange and workings of the economy, as well as the role of “evil” central banks
It was hard to get started on this story, because quite frankly it is hard to know where to begin.
I have a list of topics that I want to write about and this one got triggered multiple times by tweets from the so-called OGs hailing the new age of bitcoin as the global reserve currency and more importantly speculating about any country actually using it as a replacement for its fiat. “Sound money” so to speak.
That is very nonesensical and would be a really bad idea. In order to explain this, I will try to shed some light on what happens in a world that uses bitcoin.
The Great Depression was caused by the Fed’s inability to increase the money supply during the recession.
There are at least six different economic theories explaining how the Great Depression in the US came about. Only one of them, the “Austrian School” blames the Fed in EXPANDING the monetary supply previous to the Great Depression. The explanation goes something like this:
The Fed expanded the monetary base so much in the 1920s that it led to an unsustainable credit-boom. Because of that the crash that ensued was a natural correction and unavoidable.
Despite this being a niche view in the real world and all other explanations working much better with the data, for some reason this view is the main view in the cryptosphere. Obviously it fits the narrative so nicely, right? After all, we are again at a moment in time when the Fed has massively increased the money supply and so the next result must be a Great Depression and bitcoin will triumph as the store of value and “sound money” that it is when people see the light. Or maybe we all just like the idea of getting super rich when it happens so we don’t care if it’s true…
Now here is a log chart of the M2 money supply over time.
You will notice two things:
- An increase in money supply such as happened in the 1920s is not at all uncommon. Rather, looking at the log chart (which has the advantage that a 10% move will have the same size regardless of when it occurs), you can see that this was pretty much the norm. It happened, you could say, “all of the time”
- The one difference during the Great Depression was NOT the expansion of the money supply, but rather the sharp contraction of it (relatively speaking) that followed this expansion. Ie the MISSING expansion from 1929 (when the Depression started) on.
So, without looking at the hundreds of different drivers that can be made responsible for the Great Depression, the one thing that I would NOT conclude from this (and that none of the other theories suggest) is that the Fed’s INcreasing of money supply was the reason for the Great Depression. I would say that maybe it is a necessary condition, but certainly not sufficient.
Now, if I were to say that it is likely that the DEcreasing money supply was actually a stronger driver of creating an issue, wouldn’t you agree?
I would like to establish that a possible learning from the Great Depression is that if you do not increase the money supply in an economic crisis, the recession might become a depression. This, by the way, is the lesson central banks learned and have heeded in 2007/08. Do you really think that was so bad, just because you did not receive interest on your bank deposits?! It may well have prevented a depression and central bankers actually (surprise!) try to learn from past mistakes to make life better, not worse.
The reason the Fed was unable to increase the money supply in the Great Depression was the gold standard.
Now that we have established that it is at least a very reasonable conclusion from the Great Depression that missing monetary stimulation played a big part in turning a normal business cycle low into a depression, let’s look at why there was no monetary stimulus.
The answer is simple: the gold standard prevented the central bank from printing money and providing that life-saving stimulus.
In the 1920s, the Fed was required to back up 40% of the notes it circulates with actual gold bullion. In order to further increase the monetary supply, they would have had to have more gold. As they did not and people started hoarding gold as a response, the monetary supply decreased.
It was the Gold Reserve Act of 1934, which nationalized all gold and devalued the Dollar vs its gold reserves by c 40% that finally enabled money supply to rise again and ended the Great Depression. Yes, I totally get that nationalizing assets is the nightmare of any crypto enthusiast AND I understand that the defense spending associated with the 2nd World War played its part, but that is not my point.
My point is BECAUSE the national currency was fixed to a rare and deflationary asset, central banks were unable to prevent a recession becoming a depression.
If a country actually switched to bitcoin as a national currency, that country would relinquish one of two tools to stimulate the economy (monetary policy) and likely also the second (fiscal policy)
So now, let’s assume bitcoin becomes the new national currency of the US as the crypto world seems to hope. What would be the consequences?
a) Bitcoin would trade at infinity vs the USD
Hooray. We have arrived at the moon. Only it does not matter, given that the US Dollar is worthless, you likely do not have a job anymore, nor anything to eat and while you have managed the crisis better than your neighbor as you had some bitcoin and he did not, it’s really not a pretty picture. Your gun is likely more valuable than any bitcoin you own.
b) The US would be unable to stimulate the economy by providing more money
The dream of crypto enthusiasts has happened. The evil Fed that tried everything it could to prevent 2007/08 to turn into a depression (and succeeded) no longer exists. Now, when the cycle turns negative, one tool to stimulate the economy is no longer available. I note that this was the tool that ended the Great Depression. It’s gone now.
c) The US would be unable to stimulate the economy by taking on debt and spending (fiscal stimulus)
Given everything is now denominated in bitcoin, the US cannot borrow more. There is a depreciating economy with lower and lower tax income to weigh for creditors who are unlikely to want to part with their precious bitcoin to lend it to a country in distress. The government will watch helplessly from the sidelines as the economy spirals into low after low until we likely face a revolution.
So yes, that might be a tad negative and also I realize I am cutting corners here, but the above are the likely scenarios policy makers (remember, regardless of what you think of Democracy in general, these are still your elected representatives) will consider when thinking about making bitcoin their currency. So regardless of how much bitcoin or even gold rise in value, the return to a gold standard or bitcoin standard is pure economic suicide. It will not happen (consciously). Neither should you be rooting for it to happen. Honestly. We, the people, would be robbed of the two mechanisms to stimulate an economy.
In the country that runs on bitcoin, further problems would persist
Ignoring all the above and just pretending that it is wrong and short-sighted as well as “evil bankster” logic, let’s look at the other consequences of living in a world with a deflationary currency AND that currency being bitcoin. Here are the top achievements we unlock:
- No depositor insurance
Yes, today’s banks can be hacked and bitcoin MAY (no, that is not certain, you could have a centralized blockchain run by many banks, companies or governments — but I digress) be more secure, but consider that IF your bank were hacked, you could sue them. If it were a really large bank, the government would likely bail you out up to your depository insurance. Remember they can always be true to that word, as the central bank, as a very last resort would print the money.
In a world running on bitcoin, you lose that insurance. You could lose your assets because a bug in code allows double spending (for example after a hard fork), because the Chinese government decides to find all the mining farms by looking at electricity usage and use military force to make them 51% attack bitcoin or because you missed the most recent fork and did not properly upgrade. This is besides losing your private keys, which no one (not your bank, not your custody organization) can get back to you. You will have much more self-directed control over your money (which is what libertarians love so much) and that can be a hugely positive thing when your regime is oppressive, but large parts of the Western world might actually give up more than they gain here.
- You will still have debt, IF you can get any
Your debts will not magically disappear. You have to repay them. Now they are denominated in bitcoin. That has several disadvantages.
For once, bitcoin is the new deflationary currency. So the currency actually GAINS in value versus anything you do with your debt. So if you start a business with it, it will be HARDER to pay it back than before. Also, you might not even get a loan in the first place.
There is literally nothing that changes regarding your debt. You still have to pay for good private education, you still have to pay (and likely in-debt yourself) to buy a home and you still have to pay to get a product you like. Nothing changes for your country either in terms of the existing debt. It still needs to be paid back. Only now in a currency that it cannot control.
- Getting a loan in the first place will be super hard
I alluded to this above, but think about it: you want to start a business. You want to employ people and contribute to the economy. Or you simply want to buy a home (or even just ground to build it on) for your family.
Today, you would be borrowing US Dollar. The Dollar is a medium of exchange, but NOT really a store of value. That is BY DESIGN. It is an inflationary currency, so if I have a lot of Dollars, I am incentivized to lend it out or invest it so I can get a good return on my assets.
Now if I have bitcoin, a currency which is a medium of exchange AND a store of value, like gold — why would I lend it to you to buy a home. You have to offer me a really good return in bitcoin. Given bitcoin appreciates in value versus your home (on average) you will have a really really hard time to pay me back. Over time I will simply lend out less of my bitcoin.
The point is, debt in itself is not a bad thing. Too much debt is bad. But the ability to go into debt is the ability to start a business (most businesses reach break even after 3 years or more) and to move up the ladder. With bitcoin, you are likely simply cementing the ladder that already exists. The people who inherit bitcoin are the kings. No one can ever challenge them. Stories like Amazon or Google are that much harder to happen (yes, they can still happen, but your local self-employed baker might not).
- Financing is censorship resistant
Sounds great, right? That’s what we are all in crypto for, right? Regulations are bad, censorship resistance is really great.
Think about it some more please. Who needs censorship-resistant access to funds that does not require AML and KYC? Well, here is who:
a) In a Democratic, non-oppressive society
Yes, our system has issues. Maybe its even broken. But come on…
In this kind of a setting the main usages for censorship-resistant money are: financing of extremist content masquerading as a beacon of free-speech (like getongab.com), actual money laundering, tax evasion, market manipulation and avoidance of the inflationary effect that current money has. Believe it or not, in a functioning democracy (emphasis on functioning) the government being able to censor an (for example) alt-right network from access to funds is good.
I think that giving this up is way too high a price to pay.
b) In an oppressive regime
Censorship resistance is universally positive in this case. No doubt about it.
So in terms of financing being censorship resistant, the society I live in, CURRENTLY, has little to gain from that. Of course, the need can change and it is positive that an alternative exists, but I am certainly not rooting for it to become necessary (as most “OGs” seem to be).
So in summary…
A country that is not currently using another one’s currency would never make the conscious choice to use bitcoin as their home currency. It would rob them of the two only tools they have to stimulate economic activity. That is a pipe dream.
If it still happened “naturally”, say by revolution, the consequences are unlikely to be positive. Yes, if you hold bitcoin (just like gold) and the system we live in collapses, unless everyone else also holds that asset, you have a good chance of gaining wealth from it. Just know that you are doing so on the backs of everyone else. Nothing actually gets better and as I said — your gun might be more valuable than all your bitcoin without rule of law.
And yes, I am fully aware of the effect automation is having on jobs and so I can totally see a future in which social unrest topples the existing system and bitcoin plays a role in it. I am not hoping for it though, which is the big difference in my view vs parts of crypto.
Nota bene: for those who say “great, so we won’t have debt and I don’t care about the social mobility it enables, I want to go into such a world”, please watch the (entire) video by Ray Dalio linked below, which explains how the “economic machine” works. Ray Dalio is quite possibly the most successful macro investor of all time.
Next, ask yourself how this would all look without monetary or fiscal stimulus. Then, look at a chart of economic activity prior to industrialization. I did it for you. The red circle is what you will get. No movement forward at all. No transfer of wealth at all. Kings will stay Kings. Sergey Brin, Larry Page, Warren Buffet and Bill Gates never happen. Congratulations!
(yeah, I know it should have been a log chart, but did not find one)
To be absolutely clear: I am a crypto enthusiast. I believe bitcoin could one day function as a partial replacement for gold. I see great promise in a decentralized database and I can even see all the good bitcoin brings for any oppressed people. The above is much less a hit on bitcoin itself and much more a criticism of the “OGs” celebrated in crypto that spread their libertarian propaganda of no regulations, censorship resistance and hyper-bitcoinisation or “hooray we will have a recession” and are being aped by their followers. Really, all they are doing is “talking their book”. They benefit from a rising price of crypto. Think a bit about what you support and let’s build a REGULATED, sane and positive crypto future together.
Thank you for reading. If you enjoyed this, please clap and have a look if you’d like to follow me on twitter. My other works can be found here:
Lastly, the all important disclaimer: this is my personal opinion, not my professional advice. Most of all this is not investment advice in any way. Crypto assets can fluctuate widely in value and all of your capital can be lost. I have a 50/50 chance of being right. Any negative views expressed, if any, are solely aimed at the token in question, never at the development teams behind them for which I have utmost respect (if they are sincere).
