Money and Bitcoin

Money is an illusion, a belief among a group of people. With human’s imagination, money has manifest itself in many forms through human history: shell, barley, silver, gold, paper and now digital. Let’s talk about gold for example. Why do people from thousands of miles away come to the same belief in gold? The economist has an explanation. If the gold price in region A is higher than it in region B, the traders buy bulk gold from region B and sell it to region A. The people in region B soon realize the value of gold even they don’t fully understand why people from region A value gold. The gold price in region A goes down given the increasing supply and the gold price increases in region B. Eventually, the prices reach an equilibrium among regions. This creates a common belief in the value of gold.

We have seen gold like any other commodity is subject to the supply-demand equilibrium. So does money in any form. I cannot help pondering upon the question: How does quantitative easing and stimulus affect our life? The context discussed below is within the large economic entities.

I recently came across an emerging and controversial perspective called Modern Monetary Theory (MMT). A government with an independent monetary policy can print as much money as it wants given the inflation is under control. A government does not need to collect tax to spend the money. Instead, tax is just a way to eliminate excessive money the government has produced, to avoid inflation. As long as the factories are not operating at their full capacity, we can always produce more commodities to keep the price stable. This theory partially aligns with the phenomenon of the decreasing inflation rate over the last few decades. The working-age population has been growing over the last few decades and globalization liquidizes the human capital. Simply, society can create more supplies than demands. Based on this rationale and the assumption of contained regional conflicts, I am still optimistic for the near future.

Is inflation the only spending limit? This can encourage irresponsible spending and eventually destabilize the currency and society. A simplistic view of a balance sheet is composed of three sections: government, private, foreign. If we only looked at the first two, the government always has to operate in deficit to give the private section surplus. There are two reasons: people can default on an excessive deficit but the government won’t, people need to feel safe by investing in treasury bonds issued by the government.

The “policy trilemma” states that it is not possible to have all three of the following at the same time: a fixed foreign exchange rate, free capital movement and an independent monetary policy. Thus a floating foreign exchange rate is required to modulate the balance with the foreign section. The deficit in the government section means excessive money being created. The higher deficit is, the lower the floating exchange rate has to go eventually, the less worthy of the money. Can the foreign section just dump the reserve currency into the market? It will cause damage to everyone in the market. That is the last resort until there are alternatives and a good currency substitution plan. How much fluctuation of the floating exchange rate is acceptable? That is a trillion-dollar question.

If the government cannot default, it tends to produce more money, in perpetuity. People are looking into alternative money like Bitcoin since 2008 crisis. Bitcoin here intends for all forms of cryptocurrencies. To meet the requirement of three functions of money: unit of account, means of payment, and store of value, the new currency has to be stable. Bitcoin is not at the moment. The most attractive narrative for Bitcoin in this round of boom is “digital gold”. Bitcoin has a 757 billion market cap as of today. It is still a little pond compared to the gold reserve. The larger its cap gets, the less the value fluctuates caused by the demand-supply relationship, the higher chance it can be long-lived. The hype and speculation is a magic potion to prosperity in a short time.

The biggest uncertainty of Bitcoin is from government regulation in my opinion. The government is in the process of killing the autonomous form of money: paper money, with central bank digital currency (CBDC). It is very attractive for economic monitoring and regulation. Cross-border use of digital currency can greatly reduce the latency and cost. But it will still be subject to complications of foreign exchange rates if the CBDC is only a digital version of the current money. A new financial system with a global digital currency in foreseeable future is unlikely. Accepting such a global digital currency is equivalent to giving up independent monetary policy, as members of the European Union. It is also unlikely that the government will give up seigniorage and allow autonomous usage of cryptocurrency in full. The official attitude towards Bitcoin remains ambiguous. Some countries are more friendly towards it. How their policies influence other countries and the development of cryptocurrency globally will be revealed in the coming years. But it is highly likely Bitcoin will find a place to live and prosper. When Bitcoin market grows bigger and more mature, big whales will be inclined to jump in. It is a global game in which people play a tradeoff between the risk of all-in and being left out of the technological advancement.

I would like to end this article with a quote from “The case for digital assets”:

Faith is not something that is lost in a smooth line. It is gained slowly, arduously and lost abruptly.