Bitcoin is the new reserve currency


Given the title, this may seem a strange starting point. Bear with. The below is a chart of Tesla. Love it or hate it, it doesn't change the fact this company has seen stellar growth in its share price. The chart below shows a price increase from around $4 in 2010 to over $800 in 2020; growth of 20,000%. This chart is on  a log scale to better understand the growth in price. The growth is cumulative and represents some 200%, or a trebling each year on average.

The second line in the chart is simply the inverse of price and shows the same move in reverse. Whilst the first line may or may not reflect the potential of Tesla, I think the second chart is a fair representation of the prospects for the internal combustion engine; i.e. its prospects of survival declined to close to nothing.

When we think of fossil fuels, renewable energy and survival of the planet, it is not such a great leap of mind to appreciate that a 'dirty engine' will not be around in the future.


The collapse of fiat currency

There is a similar event going on with fiat currency. And it is helpful to view its price action in a similar way.

The first line in the chart below shows the growth in US Federal government debt since the 1980s. It is relevant to remember here that inflation was a problem in the 70s and was only brought under control through the use of a sharp rise in interest rates to over 20% (see Chart 1 in the Appendix below). In our modern economy with an immaterial amount of notes and coins in circulation and having moved from the gold standard in 1971, debt is money and money is debt. In any material sense, to increase the money supply, the central bank needs to increase debt. This is a problem for an economy which relies on money (debt) to control the economy. Stimulating the economy through raising the money supply adds to debt and so to the interest burden. Cutting rates or again increasing the money supply to ease that burden only works in the short term. In the long term it adds to the burden.

It's too distracting at this point to get into why debt has increased so much. It's been the topic of a number of posts on this site previously so this ground is well covered. Suffice to say for the purposes of this post, debt and therefore money has increased massively in supply since the 1980s.

All fiat currencies are built the same but in this post I focus on the US dollar.  The dollar is currently still, but just about, the world's "reserve", i.e. "go to" currency in times of trouble. An increase in debt and money is hence, as explained above, an increase in the amount of 'printed' dollars. Of course, with a lower number of physical dollar bills we are of course talking about dollars recorded in the banking system. If economic theory does one thing well, it is the basics of supply and demand, the interaction of which is price. An increase in the supply of dollars on the scale seen in the chart below has led to an inevitable decline in the price of the dollar, in both the nominal price of money, being interest rates but also, relative to those assets which have not been subject to such unlimited supply increases.

All fiat currencies measured against one another show little change relative to the size of the move against assets in fixed supply. The second line in the chart below is the dollar measured against gold. If you're happy to accept all modern fiat currencies of the developed world are similar, then the second line below represents the price of fiat currency. You can measure it against gold or any other asset in relative fixed supply. The outcome is similar.

Since the tech bubble burst in 2000, the decline in price of the US dollar in gold terms from 0.004 to 0.0005, is 87.5%. Consider that for a moment. The US dollar has fallen in price by 87.5% in 20 years. Most other fiat has fallen by an even greater amount. Have you noticed? Or were you under the impression that asset prices were going up reflecting a strengthening economy?

The third line below is gold versus silver which shows how stable these 2 assets of finite supply are in relative price terms.


Central banks are causing a massive income and wealth gap in society

It has been the stated aim of the Fed to push us out of cash and into more risky assets. The idea is to encourage entrepreneurship and create employment. That's fine sentiment but just poor planning. To encourage speculation and achieve their aim, central banks have decided in their wisdom their best method is to destroy the value of fiat and in turn increase the relative value of assets in fixed supply.

I don't know what is in their heads but they are guilty of either incompetence or an outright failing to protect those not fortunate enough to hold such assets.

We use fiat to pay for every day items. People are paid their wages or collect their benefits in fiat. Goods and services are priced in fiat. If you destroy the value of fiat receipts by those who hold no assets, then you, day by day, are destroying the income of millions in society.

It is no surprise to see an increase in support for the extreme left and right of political views at this same time. Whether immigration, corporate monopolies or the political classes are their target, millions of lower paid are rightly afraid for their financial future. Whilst many do understand, most do not appreciate, it is the destruction of their currency which is the cause of their financial misfortune.  This is a purposeful act on the part of their central bank.


Inflation - current and future

General inflation of goods and services has been muted for many years. This is good. It is the result of a combination of technology driving productivity, international global trade transferring the benefit of newly recruited labour in the East and one final factor which the Fed cannot control. The Fed cannot, despite how much wealth it creates for the rich, induce them to increase their demand of goods and services for immediate consumption. The only reason inflation has not as yet taken hold in goods and services is that you can only eat so many meals in a day. You can consume stocks ad infinitum, but not food and haircuts.

It is the stated aim of the Fed to increase general inflation to, on average over time, 2%. Not only are they increasing the wealth gap but they are also attempting to reduce the real incomes of those on low incomes. It is their false and stated belief that moderate inflation encourages spending and hence investment. They chose to ignore the fact that discretionary goods which have declined in price continue to be bought without any deferral. Further, we would continue to consume goods and services in the same way as we always have - provided we know our income and wealth is not threatened.

Only when deflation is combined with job insecurity and unemployment do people begin to defer their spending.

People then have not seen a sharp general rise in prices, only asset prices. In turn, there has then been relatively little said about the ruining of the currency and economy. Prices to many, appear stable. When judged against neighbouring countries, the currency appears stable. We are told by those in power that asset prices are increasing due to positive economic news.

But what if there was an alternative to holding fiat money? What if instead of being paid in dollars, I could be paid in Bitcoin? What would happen if enough people noticed the decline in the price of their fiat and understood it was likely to continue. What if people decided to hold Bitcoin instead of fiat?


What the introduction of Bitcoin means for fiat currencies

Many see the increase in the value of Bitcoin as mere speculation, a sign of unlimited monetary stimulus and excess. The first statement suggests Bitcoin is overpriced. Likely those people will view the Tesla chart as overpriced speculation. Those making the second statement may understand why Bitcoin is rising in terms of monetary stimulus but they may still be viewing Bitcoin as an excess. They may still be focused on the first sharply rising line in the chart. They may not have considered the second line and understood that it is not Bitcoin which is rising in value but the dollar which is falling.

There is a confluence of events happening and it is not what the central banks were planning.

At the same time that the Fed and other central banks are destroying the value of fiat, an alternative is emerging which is not an illiquid asset. Indeed, not only are many cryptocurrencies fixed in supply (unlike fiat), but many also facilitate a near immediate transfer of wealth from one party to another. Whilst I can buy stocks in a company to protect my wealth, I cannot very easily transfer said stocks to my local baker on the purchase of a morning loaf. Indeed, it is not convenient to sell my stock in the morning simply to do my shopping that same day. Albeit the rise of fractional shares, zero commissions and immediate settlement is getting there!

What if I could be paid in a currency which was fixed in supply, not under the control of any single party or group and was easy to transfer between people.

Sure, many are speculating on Bitcoin and crypto but there is within the crypto space a perfect solution for the inability of governments and central banks to remove themselves from the economy. Far better to let everyone collectively be in control.

Bitcoin with its high security will likely function as a store of wealth whilst another cryptocurrency in fixed supply with faster settlement times becomes a global payment currency. Perhaps there will be more than one. It will not however be a central bank digital currency.


Central bank digital currencies

There has been much talk of central banks introducing their own digital currency. Whilst this will negate the need to pay intermediary financial institutions a profit and hence be more cost efficient, no central bank digital currency (CBDC) will be adopted by society at large. The simple reason being the 2 main reasons why a cryptocurrency is attractive - fixed supply and no central control. If a central bank currency was fixed in total supply, it could not use it to control the money supply which is a major tool a central bank uses to try and influence economic activity.

The other major tool of central banks is influencing short term interest rates through the rate which it charges banks to borrow. With a digital currency, everyone* has an account with the central bank through which to receive benefits and pay taxes. There is therefore no need for banks as intermediaries. Central banks may decide to offer interest at all terms along the CBDC yield curve to everyone citizen who has an account (it may be a pre-requisite of voting to have an account with the central bank). In doing so they could influence the circulating supply of CBDC by adjusting rates. However, this requires people to believe the central bank (i.e. government) can maintain a balance budget over the economic cycle. If a central bank did not have this credibility and the CBDC was known to be in fixed supply, there would be no faith in the central bank being able to meet its obligations, the currency would lose value and not be widely adopted.

There would also be no incentive for people to adopt the CBDC for general transactions in the economy since spending would likely be traced. At this point there is no benefit in the central bank adopting its own digital currency. It may as well pay interest on any cryptocurrency deposited with it.

Whilst CBDCs are a utopia for governments to attempt to control behaviour, they will not become a payment standard. Governments and central banks are also very poor at obtaining desirable economic outcomes. For this reason alone, a CBDC should be resisted.


Hyperinflation and the future crypto-economy

As the adoption of a non-state digital currency grows, the value of the dollar will decline with greater speed. People will realise fiat currencies will be replaced and hence to continue to hold them will allow one's wealth to be destroyed as goods and services begin to be priced in a currency with stable value (i'll call it Stablecrypto!).

This is a very important step to watch out for and just recently look no further than Tesla which stated it planned to allow payment in Bitcoin in the future.  A small step to actually pricing their cars in Bitcoin. As fiat declines in value and businesses price their goods and services using Stablecrypto, inflation in fiat terms will begin to rise sharply.

At this point central banks and governments will blame inflation on the speculation in Stablecrypto as opposed to admitting to destroying fiat through continually increasing supply; but who couldn't see that coming.

As inflation rises toward hyperinflation (remember in fiat terms), those not fortunate enough to hold Stablecrypto will experience declining relative wealth. If they are not able to be paid in Stablecrypto they will experience a decline in real income since they will also likely not have sufficient labour bargaining power to adjust their salary upwards.

Just as we are currently experiencing, those 'who have' will experience a relative increase in their wealth whilst those who don't will see their wealth and incomes fall. What discretionary spending they were conducting will be deferred as they lose confidence in the economy and the government's ability to control it.  Spending on discretionary items will fall as people try and protect their wealth. People will invest in what they deem can hold value which will likely include canned food! Unemployment will rise and depending on how governments react, there will be civil unrest.

Governments will not be able to solve the crisis by handing out money since this exacerbates the problem of a failure in confidence of fiat. People will demand Stablecrypto and a change of government.  A whole new world emerges of governance tokens and society begins to question whether being run by a small group of officials is the wisest system to determine society's best outcomes.


Debt and the leakage into asset prices

The best solution for those in debt would be to continue to hold their debt in fiat and at long term fixed rates. There again will be a massive divergence in the economy into those who hold Stablecrypto and those who need to borrow to meet their subsistence needs. Whatever 'banks' which remain will charge exorbitant interest rates as they price in credit risk and the risk that rates will likely continue to rise during the term of the loan. Those that do not need to borrow fiat may well borrow at attractively low rates to them as they believe the loan's value will decline against other assets. The volatility however and lack of any need to borrow may dissuade them from doing so.

Mortgages which, certainly in the UK, are fixed rates over a short term of often only five years, will refix at much higher rates. People with poor credit and prospects will try and repay at lower rates whilst they still can, but will likely face the need to refix. This will lead to defaults and forced sales.

This is how defaults will be transmitted across the wider economy. As unemployment rises and mortgage defaults occur, people will be forced sellers of what other assets they own, despite those assets to this point holding or indeed increasing in value relative to fiat.

A wave of asset sales now occurs through stocks and property as people foresee declining prices in Stablecrypto terms. As wealth is destroyed, there is a lack of bids in all markets, even Stablecrypto will likely see reduced demand; but relative to other assets, its price will likely fare best.


Government debt

Since governments have large outstanding debts denominated in a currency which is falling, they too will attempt to refinance at long term rates. However, there will be a dearth of buyers. Corporates and pension funds will dump government debt and yields will rise as prices collapse. Governments will be forced to issue debt at historically high interest rates which will exacerbate their weak financial position.

Taxes will need to rise and governments will seek to apply wealth taxes on those who have been shrewd enough or lucky enough to be holding Stablecrypto.

There will be tension not just at a local level but at a supra-national level between governments whose debts cross borders.


The solution

As always I like to proffer a solution. I wouldn't start here. Many of us would not have started here. Do not say no-one saw this coming. So many did.

The solution for governments is simple but painful, adopt Stablecrypto. Politically this will be difficult until governments have changed. It is likely that the system of government not just Governments will change.

Governments will still have the legal right to tax residents. They will need to be clever not to try and influence economic activity in aggregate but instead focus on bringing cohesion to society. Adopting Stablecrypto will build trust in government. We can hope that these new blockchain technologies will increase efficiency and create many new markets that stimulate even more ideas.

Governments will no doubt try and survey and influence. Perhaps we should focus on ensuring this does not happen since we know power corrupts.  Our role as citizens will be to educate as far and as wide as possible for the benefit of all and to ensure that we do not again sleepwalk into another economic ruin by allowing society to be ruled by a small group of individuals.

Control should be minimal and power should never be centralised. (EU - you have been warned!).



Chart 1: US Fed Funds rate:

* there are many in society who do not have access to electronic currency. This is where government should find its role.