At the end of last week’s column, following the highly informative observations of Alex Gloy, I asked two questions:

1. How could bitcoin or crypto in general muddy or even poison the waters?

2. Is bitcoin important enough or a cataclysmic bitcoin event likely enough to take seriously?

Alex thanked me and responded with this disclaimer: “Of course, I see geopolitics through the viewpoint of finance, which excludes other valid viewpoints. For example, it is hard to explain US support for Israel (which will  — most likely  — cost Biden the presidency) with financial considerations.”

He then promised to “be brief” in responding and offered the following elements of response to my questions.

First, it is important to realize that central banks have allowed the private sector, via banking licenses, to assume the role of the issuer / creator of 90-95% of money, with little concern about the stability of the overall system. That responsibility still falls on central banks, who have to “mop up the mess” whenever a crisis happens.

The system of money creation coupled with the creation of debt regularly becomes unstable once the debt burden becomes too high (or debt accumulated by weak actors). Which does not mean the entire system has to collapse. But bail-outs become more costly as private sector debt can become too large for the government to assume (example: Depfa Bank almost took down Ireland in the 2008/9 financial crisis; not without irony that Depfa (“Deutsche Pfandbrief Anstalt” = “German Mortgage-backed Bank”) used to be a German bank, and only shortly before the crisis decided to become domiciled in Ireland in what turned out to be a true cuckoo’s egg).

The US dollar has already lost 97% of its purchasing power since the introduction of the Federal Reserve System in 1913, and it will continue to lose value. In fact, it is necessary for it to lose value for the system to remain stable. Debt cannot grow faster than GDP (or risk complete collapse). Inflation is the mitigating mechanism which keeps debt-to-GDP in check (or at least it tries to). Debt is a nominal value, while GDP is real. Inflation “eats” away the nominal value. Of course, savings are equally affected. But the saver is not helpless (unless he/she saves in cash), and usually receives compensation in form of interest, or can choose to invest in real assets like stocks, real estate, gold, fine art etc.

The psychological / logistical problem on hand is that “someone” needs to hold interest-free cash. In the case of the US, 60-80% of currency in circulation is held abroad, where it serves as a store of value in countries where trust in local currency has been destroyed. To some extent, the US dollar’s success depends on the failures of other currencies.

The other psychological factor is for the public not to realize that once a dollar bill is deposited into a bank account, they have exchanged a public form of money without counterparty risk into a private form of money bearing counterparty risk. Deposits carry insurance, but the size of the insurance fund amounts to less than one per cent of all US bank deposits. While a few individual bank failures can be absorbed by the fund, a system-wide failure would quickly overwhelm the capacity of the FDIC.

Most of our daily financial transactions take place with privately created money, which cannot be withdrawn. You may exchange limited amounts per day into public money (dollar bills), but there certainly is not enough currency in circulation for every bank depositor to do so. The banking system could be compared to a casino issuing gaming tokens. Those tokens have value *inside* the casino and can be used to gamble but are worthless *outside* the casino. The ability to transpose value into the “outside world” depends on the casino having enough dollar bills on hand to pay out your tokens. The functioning of the banking system / casino depends on participants feeling comfortable inside. Loss of trust can be triggered by high rates of inflation or by frequent bank failures.

Despite its obvious drawbacks, the fiat system still seems superior to a hard-money system like Bitcoin. Restriction of money supply leads to depressions, with self-reinforcing vicious circles of high unemployment, decline in consumer spending, and corporate failures. Take the example of a car dealership. The number of cars being bought without financing is very small. This implies that availability of credit is paramount for car sales. Financing can be arranged by the customer’s house bank, by the car manufacturer’s own financing arm, or packaged together with other car loans into an asset-backed security, which subsequently is bought by a hedge fund. However, no financing = no car sales (or any other large-ticket items).

A Bitcoin, like a gold coin, is nobody else’s debt. It’s a one-side ledger accounting  — either you have it or you don’t. Fiat money is double-sided accounting  — it exists as an asset (i.e. savings) and as a debt (i.e. loan). Bitcoin cannot be issued by governments as they can only be mined in limited numbers. Governments would have to live with balanced budgets. Very few governments achieve fiscal surplus (usually due to a certain set of lucky circumstances). Even countries with large current account surpluses, like Germany, have difficulties reducing fiscal deficits; Germany was unable to adhere to a 3% deficit cap agreed on in the Maastricht-Treaty (membership criterion for the Euro). If Germany is unable, how could a country like the US, with its (substantial) twin deficits, achieve balanced budgets? Any government trying to balance budgets would trigger a severe recession and, most likely, be voted out.

In conclusion, a Bitcoin standard could theoretically work, but only in a dictatorship, and cause unnecessary misery. The price to pay for “sound money” is simply too high. Money can either be a great store of value, or a great means of exchange, but never both.

These insights are precious, obviously recommended reading for anyone trying to keep up with the different layers of evolution in what I’m tempted to call a “new, emerging culture of payment.” While Alex’s observations contain several levels of complexity people like myself lack the means to juggle with intellectually, there are a few pithy trues worth repeating. Here are the ones I noticed and that help me to situate the issues and correct some of the received ideas our general culture has inculcated in us. Just to keep the reflection alive at a non-expert level, I’ll follow each point with an emotive reaction!

Banks now assume the role of the issuer / creator of 90-95% of money.

Surprise: we were always told governments or central banks print money.

The US dollar has already lost 97% of its purchasing power and it must continue to lose value for the system to remain stable.

Astonishment: We were taught to believe that anything that is not degradable should always increase in value .

The psychological / logistical problem on hand is that “someone” needs to hold interest-free cash.

 Befuddlement: even in the Bible, not making money from “talents”  — a denomination of money — is a form of sinful negligence.

To some extent, the US dollar’s success depends on the failures of other currencies.

Disappointment: Are we taught to believe in the ideal of win-win?

Money deposited in a bank morphs from being a public form of money without counterparty risk into a private form of money bearing counterparty risk.

Shock: Shouldn’t we think of banks as the one place money is sheltered from risk?

The size of the insurance fund amounts to less than one per cent of all US bank deposits. While a few individual bank failures can be absorbed by the fund, a system-wide failure would quickly overwhelm the capacity of the FDIC.

Consternation: 2007-08 was less of a shock than 1929, so, with the lessons learned shouldn’t the next one already be secured from “system-wide failure?”

The ability to transpose value into the “outside world” depends on the casino having enough dollar bills on hand to pay out your tokens.

Intrigued: Does this mean that can’t happen to the dollar but can happen to other currencies?

Finally, I expect that while the points about Bitcoin seem pretty clear, we haven’t exhausted the question of blockchain based payment systems. At this point, I might evoke mBridge and hope that we can learn about what it is and what its implications for the future may be.

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