The pound is faltering.
The US Fed is advancing at a record pace.
Credit Suisse is faltering.
As Ryan Dinse pointed out yesterday, the cockroaches are emerging as the global economy sours.
But what struck me most about Ryan’s article was his lamentation over a financial system stressed by central bank incompetence.
As Ryan wrote:
‘If the grand fiat experiment is indeed doomed no matter how central banks try to fix it, who do you turn to?
‘The first step is to get out of centralized finance… and instead, enter the world of decentralization. It is becoming increasingly clear that this is the only way forward for our monetary system…
‘The story is so much bigger than the price of bitcoin, although it will certainly increase over time as more people realize this.
‘It’s about the idea that anyone (anywhere) can participate in a financial ecosystem without fear or favor.
‘Something we all desperately need right now.‘
Can cryptocurrencies provide a cure? And if they can, what does that mean for central banks?
East Bitcoin [BTC] their existential threat?
A world without central banks
There was a time before central banks. We have not always lived under their auspices.
For example, the US Federal Reserve was created by Congress in 1913. The Reserve Bank of Australia, as we know it, did not begin operations until 1960.
And developments in cryptocurrency may well bring us back to an era without a central bank once again.
The idea of central bank obsolescence is not new or unique to cryptocurrencies.
Prominent economists of a bygone era like John Nash and Milton Friedman both championed the role of a “algorithmic money” that would supplant the role of central banks.
In a 1994 interview, Nobel laureate Friedman even went so far as to call for the abolition of the Fed.
His record wasn’t very good, he thought.
Friedman was not alone.
In Financial stability without central banksthe economist and historian George Selgin has not done well when evaluating the history of central banks.
Here is an excerpt (emphasis added):
‘A banking system backed by a central bank tends to be unstable. Indeed, the creation of money by the central bank can inflate the creation of money and credit throughout the banking system. The mechanism of banks restricting each other’s behavior is blunted. Financial instability and price instability are the likely results.
‘Since the establishment of the Federal Reserve, financial stability has deteriorated. The pre-Federal Reserve model was itself problematic. However, the history of banking systems in other countries suggests that whatever the problem, the solution was not a central bank. Financial stability is more likely in a system that does not have central banks and that is not distorted by misguided regulation.‘
Cryptocurrencies threaten the power of central banks
Private cryptocurrencies pose a threat to the functioning of central banks because they blunt the financial instruments at their disposal.
Central banks use the domestic currency to shape financial outcomes by stimulating incentives to save, spend, or invest.
A rising cryptocurrency like bitcoin could weaken a central bank’s influence over the economy.
For example, would the RBA’s interest rate policies have much of an impact if, hypothetically, most Australians transacted with bitcoin?
A national currency is the means by which central banks operate. Money is a conduit for monetary policy.
Privatize the currency, decentralize it, disperse the spheres of influence, and a central bank loses its power.
He becomes a craftsman deprived of his tools.
It sounds hyperbolic, but the question of what happens when a cryptocurrency reaches critical mass is a serious question.
As Cornell economist Eswar Prasad explained in an article last year:
‘The major implications of such developments would not only be the reduction in demand for central bank money as a medium of exchange or store of value, but the consequences they would have on the business models of existing banks and other financial institutions. …
‘While it is premature to talk about disruption of traditional central banking concepts, it is worth asking whether the impending changes in money, financial markets and payment systems will have a significant impact on the functioning of central banks and their ability to achieve key objectives. such as low inflation and financial stability.
‘For many central banks, the responses are driven by concerns about the rapidly declining use of money and the implications for financial and macroeconomic stability if decentralized, privately run payment systems replace both cash and traditional payment systems operated by regulated financial institutions.‘
Our own Reserve Bank of Australia (RBA) has admitted that the rise of private cryptocurrencies poses a threat to central banks.
‘Widespread domestic currency substitution could threaten a country’s monetary sovereignty and reduce the central bank’s ability to influence domestic monetary conditions (including through changes in the interest rate and exchange rate structure ) and to act as a lender of last resort if necessary.‘
This is why many central banks are considering rolling out their own central bank digital currencies (CBDCs) to anticipate the rise of cryptocurrencies.
Can central banks and bitcoin coexist?
What does a world where central banks and bitcoin intertwine look like?
It might look like El Salvador.
In September 2021, El Salvador made bitcoin legal tender. The country’s Bitcoin law proclaimed:
‘The purpose of this law is to regulate bitcoin as unlimited legal tender with liberating power, unlimited in any transaction, and in any capacity that public or private natural or legal persons require to be carried out.‘
The International Monetary Fund (IMF) was unhappy with El Salvador’s surge in bitcoin adoption, suspending negotiations for a US$1.3 billion aid package.
A blog post published on the IMF site a few months before bitcoin became legal in El Salvador outlined some of the reasons for this.
The post titled ‘Crypto-assets as a national currency? One step too far’ distinguished crypto assets from digital currency.
The IMF classifies bitcoin in the first category.
The blog post also worried about the influence of crypto assets on monetary policy:
‘Moreover, monetary policy would lose bite. Central banks cannot set interest rates on a foreign currency. Usually, when a country adopts a foreign currency as its own, it “imports” the credibility of foreign monetary policy and hopes to align its economy – and its interest rates – with the foreign economic cycle. Neither is possible in the case of widespread adoption of crypto-assets.
‘As a result, domestic prices could become very volatile. Even if all prices were quoted, for example, in Bitcoin, the prices of imported goods and services would still fluctuate massively, following the vagaries of market valuations.‘
Bitcoin has yet to catch fire in El Salvador, and the country’s central bank is a bit of an outlier.
El Salvador’s economy is dollarized – pegged to the USD – so technically its central bank cannot set monetary policy.
Interest rates in El Salvador are set by market forces outside the central bank.
Bitcoin cannot make a central bank obsolete if the bank has already made much of its role redundant by hitching its cart to the USD.
The real test will be whether a cryptocurrency like bitcoin could replace much of the function of a major central bank.
Interestingly, the RBA has brushed aside the notion that cryptocurrencies usurp monetary sovereignty from “well-functioning” economies:
‘In countries with well-functioning financial and payment systems and a history of low inflation, such as Australia, the risk of widespread adoption of currency denominated in another currency appears very low. However, this would not prevent, for example, the adoption of a global stablecoin for specific use cases, such as cross-border payments, especially if it was less expensive and offered a better user experience than services. existing.‘
I guess time will tell.
Bitcoin: March to US$1 million?
Tomorrow, Ryan will host a special presentation where he will break down many of the concepts we discussed in today’s article.
But Ryan will also argue (controversial to some I bet) that bitcoin could be worth US$1 million by 2030.
Stay tuned – it will be a cracker!
Until next week,
For silver morning