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Tag: reserve currency

Here is another economics/policy question that I was asked to address at Quora. It provides great fodder for a quick Lifeboat economics review.

The US used quantitative easing to deal with one monetary crisis, and a bailout of the automotive and banking industry to deal with another. If nations, economies or individuals begin to embrace a decentralized currency, they will inevitably shift away from government issued money. Won’t this hinder a nation’s ability to intervene in a crisis?

Answering this question goes to the very heart of the ethics and politics of cryptocurrency.

Yes. Without centralized control over monetary policy, government options for intervention in a money crisis would be severely limited. But this fact may lead to a false impression…

First, most money crises begin with government, and so there are likely to be far fewer monetary emergencies.

Here’s how the options would be limited:

  • Governments would have fewer ways to manipulate a public resource. They will still have the ability to budget, tax, borrow, build infrastructure and even wage war. But…
  • Governments could no longer amass debts that outstrip their ability to be accountable. That’s because they can no longer covertly tax via rampant printing of money.
  • They could not “raise the debt ceiling” without demonstrating fiscal responsibility, because they no longer control what everyone uses as money.
  • Government spending (and intervention, such as quantitative easing) would have to be balanced by revenue. Borrowing would be limited to creditors who truly believe in their will and ability to repay debt.

All of these “limitations” are good things—even for the governments and banks involved. It only seems limiting, because our understanding of what is money is tainted by millennia of authoritarian systems.

A capped, open source, transparent, traceable, immutable, decentralized, distributed and permissionless money supply is both fair and more robust than Fiat paper, promises or credit.

Let’s explore that last bullet, above. The point is subtle—yet, it is the key to answering your question…

Every individual, household, business, state and NGO must balance its books. If one cannot cover bills, they must find a creditor who believes in their ability to get back to fiscal health. Even nations are eventually forced to balance their books or seek a bail-out from neighbors.

But, this is not the case for the United States. We have had an ability whitewash our largess and declining industrial productivity by printing more money. How has this been possible while retaining a strong dollar?

The US dollar has been the world’s reserve currency for 47 years. This development was one of the most clever, yet potentially damaging developments of the post war order. It led other nations and consumers to treat it like gold (even though the link to any underlying asset or promise was severed by Richard Nixon in 1972).

Now that other nations are shifting this special status away from the US, we are gradually becoming just as susceptible to a house-of-cards collapse as Venezuela, Argentina, Zimbabwe, or Germany between the wars. Our massive consumer market cannot protect us. Eventually, we must ship the fruit of our sweat and intellectual bounty to serve others. After all, for more than a half century, we have been giving them pieces of paper (dollars or treasury bonds) for their TVs, underwear, sneakers, toys and sheet rock.

This unbalanced trade must be reversed. Building walls at the boarder and stiff tariffs are desperate acts that fail to recognize cause or containment. They are certainly not the way to restore a robust economy. There must be a better way for nations to get their houses in order. Fortunately, there is.

A distributed currency built on math, trust and transparency—rather than the integrity of transient elected officials from one nation is far less susceptible to manipulation, inflation or any form of shock. It won’t solve all problems immediately, be it will prevent us from getting further mired in a debt that blows up like a balloon.

The decoupling of a money supply from government will yield benefits that are difficult to imagine today. Money doesn’t need authoritarian oversight like airline safety. The situation is more analogous to the deregulation of telephone and package delivery services. Without those blockbuster decisions of the 1980s, we would not have Smartphones or the internet today.

Philip Raymond co-chairs CRYPSA, hosts the Bitcoin Event and is keynote speaker at Cryptocurrency Conferences. He is a top writer at Quora.

Other than the United States, 5 U.S. territories and 12 sovereign nations use the US dollar as their legal currency. (Note that Micronesia covers six sovereign countries).

Additionally, I have traveled to island nations and some countries in Asia and Pacific that peg their currency to the US dollar. In these regions, citizens accept US dollars interchangeably with their own national currency, and their governments don’t seem to discourage or prosecute such transactions.

What gives value to paper?

Around 350 BC, Aristotle worked for the Greek council, trying to get farmers, weavers, chariot makers and tradesman to use government issued currency for the exchange of goods and services, rather than bartering with neighbors. This would not only facilitate taxation and public works, but it would help farmers to store and forward their wealth, instead of seeing their assets perish with each change of season.

He reflected on what makes a currency trusted and functional. He felt that one critical trait was “intrinsic value”. Today, most economists interpret this phrase as a currency having inherent or self-contained value. That is, it mustn’t be paper nor even a promise of redemption (for example, a picture of Caesar). And it mustn’t rely on the ‘good faith and credit’ of citizens. After all, nations are subject to the whims of transient politicians and any economy can collapse because of war, drought or over-spending. Rather, the money must be made from something of useful and dense value. For example, it could be gold, silver or some useful thing, like chocolate, coveted jewelry or a tool.

Today, money is no longer backed by gold or even a government promise of redemption (offering to exchange dollars for gold, grain, goats or land). For developed nations, this backing—a method of establishing intrinsic value—ended between 1971~1973, when President Richard Nixon dissolved the Bretton Woods Agreement and withdrew the promise of a conversion guaranty.

Instead, today, the value of national currencies floats in response to supply and demand.

Supply and demand is a natural economic mechanism, and for fluid and widely distributed commodities, it can be an elegant solution to the problem of establishing value, function and durability—but only if the supply is capped or very tightly regulated and the issuer is trusted by individuals, organizations and nations that quote prices, save or trade with the currency.

Unfortunately, this is not the case for any national currency across the world.

  • Supply: National currencies increase in supply when the government spends more than it raises from fees, taxes, government owned industries and borrowing—or whenever it cannot meet debt obligations. With fiat currency, the supply is open ended and uncertain.
  • Demand: The demand for a currency is a function of its issuer’s economy: How much are its people producing? How high are their debts? Do creditors believe that they will repay their debts in kind?—at least, someday, down the road.

Today, it’s all about trust—Trust in the ability of a country to return the goods and services that were bought by their people and trust in their government to avoid printing more money, which depreciates savings, redistributes wealth, and cheats creditors through the insipid dilution of inflation.

Whenever a government prints money, it reneges on debt and breeches the trust of creditors.

Why would any country substitute the currency of another country?

One need only look at this Zimbabwe money to understand why an independent nation might substitute the US dollar as legal tender. The same has happened to Argentina, Greece, Venezuela and Germany between the wars.

It was withdrawn from circulation in 2008. At the time, it was worth US 40¢ (40 cents). Today, Zimbabwe uses the US dollar as its legal currency, because its spending value is stable relative to monies issued African central banks. That is, the citizens trust the US dollar to resist inflation—and so they use it to store and trade their hard-earned wealth.

Is Adoption of the US Dollar growing around the world?

The days of our friends and enemies trusting the dollar or even using it to negotiate large international trades is gradually coming to an end. This is changing, because:

1. Bitcoin is gradually displacing the dollar as the world’s reserve currency. Even though it is slow to gain traction as a commercial and consumer payment instrument, it has all the components of an ideal currency for large international quotation, exchange and settlement.

The fundamental reason for the gradual trust in Bitcoin is illustrated by these graphs. Bitcoin is a capped commodity backed by a robust 2-sided network. Understanding and trust in its distributed consensus mechanism is growing. It cannot be manipulated by transient politicians. Nations that use it for significant transactions cannot be cheated when their trading partner or a 3rd party prints money to cover their own shortfall. It is an ideal reserve settlement instrument.

2. In recent decades, the dollar is built on debt rather than domestic output, a trade surplus, or high quality credit. This creates the potential for a collapse, if US citizens or creditor nations begin to doubt the likelihood of the United States reversing its slumping exports and staggering trade imbalance.

3. In recent years, the United States has lost gravitas in world forums due to the projection of power beyond its borders without a clear mandate or international support, and its recent lack of leadership in issues like the environment, trade accords and arbitrating regional peace agreements. This impression—along with the erratic statements and behavior of U.S. politicians causes both allies and enemies to seek an alternate reserve currency. Why so? …

A reserve currency is an international quotation and settlement instrument—even when the United States is not a party to a sale or transaction, and even if one or both parties is not a US ally. Many countries, banks and producers (of oil, food, military gear, etc) do not desire or appreciate the tremendous side-benefit that accrues to USA.

In effect, when you adopt the currency of one nation as the reserve currency for others, you grant credit to that country, without collateral. You allow them to print money without substantive backing, guarantees or even a balance of trade that makes it likely you will be repaid without the dilution of inflation.

Ellery Davies co-chairs CRYPSA, hosts the New York Bitcoin Event and is keynote speaker at Cryptocurrency Conferences. He sits on the New Money Systems board of Lifeboat Foundation. Book a presentation or consulting engagement.

On August 1 2017, the value of a Bitcoin was at $2,750 US dollars. Today, just over one month later, it is poised to leap past $5,000 per unit. With this gain, many people are asking if Bitcoin has any genuine, inherent value. Is it a pyramid scheme? —Or is it simply a house of cards ready to collapse when the wind picks up?

In a past article, I explained that Bitcoin fundamentals ought to place its value in the vicinity of $10,000.* (At the time, it was less than $450, and had even fallen to $220 in the following year).

For many consumers viewing the rising interest in Bitcoin from the stands, there is great mystery surrounding the underlying value. What, if anything, stands behind it? This is a question with a clear and concise answer. In fact, it has a very definitive and believable answer—but it is easiest to understand with just a little bit of historical perspective.

At one time, G7 fiat currencies were backed by a reserve of physical Gold or the pooling or cross-ownership of other currencies that are backed by gold. That ended in 1971 when the Bretton Woods agreement was dissolved by president Richard Nixon in Ithaca NY.

Today, US currency is backed by “The good faith and credit of the American worker” (This is the government explanation of intrinsic value). But in truth its future value is loosely tied to one simple question: Does the typical vendor or consumer (for example, someone accepting a $20 bill in exchange for a movie ticket or 2 large pizzas) expect it to buy these same things in the next few months?

A considerable number of speculative components contribute to the answer. For example:

  • What About the Big Picture? DEBT! Everyone knows that a house built on debt cannot thrive forever without a continuous stream of productivity and income. Is the money being printed without a commensurate added value to the nation’s capacity to repay debts?
  • Public Trust: Good faith goes beyond debt. Can consumers and creditors be certain that a change of government won’t cause rampant inflation or a willful failure to retire future debt? Can they be assured that their fellow workers will continue to produce and export manufactured goods in ever increasing quantity?
  • Guns & Tanks: Citizens are compelled by law to pay their taxes in official state currency. Even for those who attempt to fly under the wire or use alternate currencies during the tax year, this ultimately forces fiat currency to be recognized and honored.
  • Geopolitical Stability: We have been a debtor nation for decades and we have significant political and economic disputes with our largest creditors (China and nations of oil-rich gulf states). What would be the effect of them (a) moving away from the dollar as their reserve currency, or (b) investing the trillions of dollars they have earned in some other country?

This list is not exhaustive, but all constituents boil down to two fundamental concepts: Supply-and-demand and How long will demand last?

The dollar is an invention of a transient government. Even with a long history and complex banking framework, it is no more real than Bitcoin. Supply and demand for any commodity is based on popular recognition, anti-counterfeit features, innate desire and public goodwill. The real question is what contributes to the desire to own or spend Bitcoin?

The answer is that Bitcoin is backed by something far more reliable and trustworthy than the transient whim of elected legislators. It is backed by something that carries more weight than the US government. What could possibly guaranty the value of a Bitcoin? After all, it does not convey ownership in gold, and it has no redemption guarantee. There is no engraving of Caesar on the coin. (In fact, there is no coin at all!)…

Answer: Bitcoin is backed by math, a firm cap, a completely transparent set of books, and the critical mass of a two-sided network. Although it can be taxed (like any asset), it can be owned and transferred with impunity and without recourse. These may not seem like critical components of intrinsic value, but they are. In fact, they define intrinsic value in the modern era.

Related:

Philip Raymond co-chairs CRYPSA, produces The Bitcoin Event, edits A Wild Duck and is keynote at this year’s Digital Currency Summit in Johannesburg.