5 Oct 2020 | Uncategorized
The idea that one or more crypto-coins could replace traditional currencies seems more like end-of-the-world dystopia than a credible scenario. Yet, not only is it a very real possibility but within the framework of current geoeconomic dynamics almost inevitable.
The short rationale as to why lies in this:
In key respects, there is no longer any fundamental difference between classical currencies and their crypto or digital equivalent. In defining essentials, the two are one.
Both are “fictitious”, though when it comes to physical currencies we use the word “fiat” from the Latin meaning “let it be done” or “let it be so” in the sense of “willed” into existence.
Ex Nihilo … “Out of nothing”.
Put another way, the dollar and the bitcoin are both payment tokens, both nonphysical creations with no inherent value and whose only practical use is the rate at which they can be converted into something else; a physical object, service, or another trading token.
By and large national currencies have been totally fictitious since the 1970s, but it has been government behaviour since 2008 that has revealed the worrying potentials that flow from this change.
At the centre of these dangers is the unimaginably large scale of currency printing undertaken in 2008 and then again in 2020, euphemistically called “quantitative easing”.
Before we can understand quantitative easing, we need to understand the events which brought central banks to the printing press.
Towards the end of the Second World War, the Western allies agreed that their currencies would be converted at a fixed rate to the American dollar, which in turn converted at a fixed rate of $35 to an ounce of gold.
This was the Bretton Woods agreement of 1944.
While private citizens could not buy gold at this price, national governments holding dollar reserves could and did.
You turned up at Fort Knox “Here is a million dollars in paper now give me my 28,571.5 ounces of gold. Thanks!”
This physical tie gold was very important. The 5.6 billion ounces of gold in existence absolutely limited the number of dollars that could ever be created.
In the real world, you can’t create something out of nothing.
Move on to 1973 and the oil crisis.
The sight of American’s lining up to fill their vehicles shocked the world. America’s humiliation at the hands of Iran more so. The French government got nervous … and were rumoured to demand all their dollars be redeemed in gold bullion. Even if the Americans had enough gold they were not sending it to France. They refused. The $35 promise was simply torn up.
Since then the American dollar and all other currencies have been “fiat”, which brings us back to what we were saying about “fictitious”. Their value simply came for where global demand and supply curve intersected.
Without the backing of a precious metal, the two major elements which determine the market value of a fiat currency are (i) utility and (ii) credibility.
Credibility is currently being undermined. What about utility? The disappearance of physical cash and a rapidly growing number of digital alternatives suggests even its utilitarian days are numbered. Most of my personal transactions are made with my watch or phone or the ever-growing variety of “wallets”. Most of us now only use physical cash perhaps twice a month.
Also, many professionals have bank accounts in several “token” types. It does not matter whether these are called dollars, pounds, Ethereum or Bitcoin. What matters is the ease of access, security, stability, privacy, and long-term trust.
People worry about the number and stability of the various cryptocurrencies. There seem so many and some seem rather shady, even criminal. But this only parallels the so-called “real currency” markets. With the latter, you have everything from Australian to Zimbabwe dollar. Produce too many and you destroy value.
For this reason, of the 100 plus different national currencies, only five are considered sound enough to be called “reserve currencies” the rest have a limited use but functional in the greater scheme of things.
The same may be said of cryptocurrencies.
The same process which evolved to exclude 95 percent of currencies from global acceptance could eventually threaten or at least fundamentally change the shape of the five that remain.
Now we must consider 2008, the year of the asset crash. More specifically the bond crisis. Over the centuries such upsets have occurred on a fairly regular cyclical basis. The South Sea Bubble and Tulip mania happened before the US became a country. What triggers them is the collective awareness — then abandonment — of the underlying fiction that was driving the growth.
What was unusual in 2008 was the exceptional level of debt to which it exposed the global banking system, which in turn threatened the normal day to day function of global commerce.
Prior to 1973 a government's ability to act would have been rather more constrained — more akin to managing asset devaluation. Certainly, the physical tie of the dollar to gold would have made it impossible to rescue on the scale that was eventually undertaken.
Had Bretton Woods still been in place, those who bet on the bubble would have lost out, and a number of global banks would have gone out of business. Unwise debtors would have suffered loss and savers would have reaped the reward of their prudence.
But this wasn’t 1973. That large amounts of debt were settled through government printing presses allowed the fiction of sound money — which most people held to at the time to give way to a narrative — still being written — that the stability of physical cash is an illusion.
By setting interest rates at zero governments paid very little on those billions of dollars; they simply created the money out of thin air to buy up all the valueless assets (itself mostly just paper).
The consequence of printing so much money in 2008 was that its real value halved in five years and halved again in the five years following that compared to the status quo ante.
Thus the government was brilliantly able to change the borrow terms of its past lenders and pay close to zero to its future ones.
That Bitcoin, the first cryptocurrency was created at this precise time is no coincidence. Once a national currency is revealed as a mere figment the market is open to anything more substantial and less arbitrary.
As this happens on a growing scale more and more people will seek viable alternatives to cash and its associated tools of exchange.
Current economic and geopolitical dynamics have given these dynamics a sharp impetus:
1. Quantitative easing has now become a permanent tool of macroeconomic policy.
2. Rather than repair the damage done to traditional currency frameworks governments feel themselves driven to exploit it more than ever.
3. The hard-won economic discipline brought about by Monetarist reforms after the oil crisis is now being globally abandoned.
4. Fiscal caution is being thrown to the wind in the USA, UK and EU with the rest of the world likely to follow. So it becomes a global problem.
5. To economic challenges we must now add the dynamics of equally problematic intra and inter-national political tensions.
6. Where cash assets were once the surest form of financial security, we are rapidly moving to a point where they will become the one the weakest.
7. As fundamental rights to economic privacy are actively eroded, fiat cash balances become less attractive still.
8. Quantitative easing is increasingly exposed as a surreptitious wealth transference (from savers to debtors, with the government being the largest debtor of all). To these pre-2020 dynamics we must now add the reality of COVID Management Economics:
9. With current estimates in the region of US$ 7 trillion, the amount of liquidity pumped into the global economy dwarfs that of 2008.
10. Whereas much of that money never strayed far from the balance sheets of banks, this time most has gone directly into the economy, potentially leading to very significant inflationary levels.
11. The sudden jump from 2% to 20% inflation in the 1970s must be taken as indicative of the levels we are talking about.
12. The highly complex factors surrounding the COVID management economics, practical withdrawn from globalisation and rising geo-political tensions, place great stress both on all commercial paradigms and fiat based transactions.
13. These trends are exacerbated by negative interest rates and other measures designed to make cash savings a thing of the past.
14. The world is entering into a period of the great unknown; high levels of unpredictability will eventually produce an altogether new paradigm in macroeconomic management.
15. This in turn will create a profound shift in commercial paradigms centred on changing attitudes towards physical currencies.
16. An intense moment of inflection looms once the global population as a whole becomes aware of these trends and their implications.
17. These will be driven home as financial interventions curtail and cease.
The most critical in regards to this article — and as previously noted — is that global government policies have discouraged cash savings for some time now. The goal was to improve the look of the economy, stave off depression, and avoid high levels of unemployment. The result was stagnant wages and productivity. That the global economy recovered as much as it did was largely due to Chinese investment and growth. Domestic Chinese debt will not allow for ditto.
These realities together with 2020 Macroeconomic management are driving us towards a shift in world-views; the moment we collectively realise that governments have destroyed the credibility of cash is the moment we realise that bitcoin and others take the helm. Crypto ceases to be a speculative medium of exchange and becomes not so much an alternative currency, as something more credible and authentic.
Understand that “mining” places a limit on the amount and speed that the digital coin can be minted we see that does not in fact, share anywhere near the same arbitrariness of fiat currencies. Grasp the blockchain principle and the threats of counterfeiting and cyber theft disappear. It is axiomatic that given a mix of favourable market conditions, and seemingly limitless quantitative easing, the era of digital currencies is only just beginning. The only challenge is which ones will win the day.
Now to backtrack a little. When I say that “fiat currencies have no inherent worth,” that is not quite the case. In fact they possess a very significant, but nascent arbitrage or seigniorage value; an implicit monetisation that comes from what they add to the economy by making bartering unnecessary. Put another way, they share in economy that is created by their being a universally accepted medium of exchange. The motivation behind the creation of the bitcoin, as all other digital currencies is to tap into this utility more competitively than fiat currencies and other digital rivals. This includes tapping into, for example, the transaction market; the fees that are charged business for using currencies.
Until the minting of the first bitcoin, Governments had a collective monopoly on this arbitrage value, itself representing billions of dollars a year in “income”. Digital coins allow private individuals and companies to wrest that monopoly and offer the consumer a better alternative. If you had always wanted to know the underlying potential legitimacy of digital currencies, this is it.
As for the future, given the events of the first six months of 2020, even 2021 seems very far away. Rule books have been torn up, economic paradigms abandoned, and we are in the process of shifting from multilateral globalisation to re-shoring and supply chain security. Where COVID has shut down large swathes of the global ec
onomy, it has opened up others, but most especially technologies serving pandemic management as well as the quantum technologies that will mark the beginning of a fifth industrial revolution; robotic, digitised and physically distanced. Rumbling beneath the surface are digital currencies rapidly evolving to find their place in what may prove to be an unrecognisable new world.