When Terra and its coin collapsed, it validated what many had already critics had so stridently claimed. Crypto is nothing but a Ponzi scheme, built on a codebase developed by amateurs with zero economic training and the digital currencies in its ecosystem (bitcoin included) were only one step away from total collapse.
After all, these skeptics explain, how could a digital currency ever be worth money? They have no intrinsic value.
Now, let me say this is a particularly odd claim. Because these unbacked digital currencies are competing with old-school forms of money, government-issue dollars or euro or yen. So let’s take a closer look at these so-called “fiat currencies” and see just how government-issue money measures up to cryptocurrencies.
Central banks and government money
U.S. dollars can’t be said to be issued by amateurs… supposedly.
The dollar and other fiat currencies (what’s we call money nowadays) are issued by central banks. In the U.S. it’s called the Federal Reserve, usually abbreviated to “the Fed.” I think that makes them sound like a character in The Untouchables, personally.
You may have heard of the U.S. central bank. They’re in the headlines a lot these days. Here are a couple of highlights from the Fed’s mission statement:
- conducts the nation’s monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy;
- promotes the safety and soundness of individual financial institutions and monitors their impact on the financial system as a whole;
- fosters payment and settlement system safety and efficiency…
That doesn’t sound so bad, does it? Employment, stable prices, moderate interest rates, a sound financial and payments system – essentially, it sounds like the Fed makes sure the nation is generally financially sound.
One note: “central bank” entities are branches of the national government. There’s maybe one central bank in the world I know of that doesn’t follow this rule – the European Central Bank or ECB which is a supranational central bank, owned by the central banks of the 27 member nations of the EU member states. Maybe it’s better to think of the ECB as “a central bank of central banks.”
Now, surely, there’s plenty of trustworthy people in charge of central banks, and governments too. Surely there’s massive knowledge, huge synergy and powerful advantages when the dynamic duo of Central Bank and Central Government join forces. Like, 1 + 1 = 3
That’s how it’s supposed to work. So let’s check the math.
Evaluating the performance of central banks
Theory is great and I can hypothesize all day long. How about the real world? How do central banks perform with their authority to manage government money creation?
I’m no expert, so I’ll turn to one of the world’s best and greatest thinkers on the subject: Ray Dalio. His masterpiece Principles for Dealing with the Changing World Order considers centuries of actual, real-world historical performance. Not theory. Dalio doesn’t parse mission statements. He doesn’t waste time with press conferences. He just looks at the results.
So, here are the results:
Of the roughly 750 currencies that have existed since 1700, only about 20 percent remain, and all of them have been devalued.
By the way, “currency” in this case means “central bank issued official government money.”
That is a shocking number. What happened to these 600 or so defunct currencies?
Well, Dalio is happy to tell you.
First off, the actual mission of a central bank is inherently contradictory. Look at the Fed’s mission statement again, focusing on that first point. The Fed “conducts the nation’s monetary policy” to promote three things:
- Maximum employment
- Stable prices
- Moderate long-term interest rates
Maximum employment is most easily achieved by loose monetary policy (or quantitative easing, or printing money) which stimulates economic growth. As we know all too well this step also causes inflation. More dollars doesn’t mean you can buy more stuff, it just means that every dollar in the world buys less.
Stable prices are totally unachievable in a free market. Prices change all the time – unless you have Stalinist central economic planning (and look how well that’s worked!), there’s just no such thing.
Moderate long term interest rates are best served by a tight monetary policy (quantitative tightening, or destroying money). This improves a currency’s purchasing power, but it’s a mixed blessing. It also slows economic activity and prevents maximum employment.
What we’re looking at here is a fundamental flaw in how currencies work. (And here you thought cryptocurrency bridge hacks were bad – at least they’re fixable!)
Inevitably, a central bank faces a decision:
Juice the economy with money-printing for maximum employment, at the cost of stable prices/higher inflation?
Cool the economy with money destruction for higher interest rates and currency strength, causing unemployment?
Dalio says (and the last two years bear him out) that central banks always choose the easy path:
…when the central bank faces the choice between allowing real interest rates (i.e., the rate of interest minus the rate of inflation) to rise to the detriment of the economy (and the anger of most of the public) or preventing real interest rates from rising by printing money and buying those cash and debt assets, they will choose the second path.
Consider: In 1957, you could purchase a nice Oldsmobile 88 Fiesta for $3,541. The average home cost less than $20,000. That was a lot, because the average pay was $4,713 per year (if you were a man, a mere $3,008 for women).
Then again, a single greenback earned in 1957 had the purchasing power of over $10 today.
Fast-forward to 2022. The price of an average and far less spectacular sedan is at least $40,000 and goes much higher. And if you happen to have an 88 Fiesta in good condition, you can get upwards of $200,000 for it. Remember, we’re still talking about prices in U.S. dollars, the global reserve currency – the world’s most reliable and trusted central-bank-managed form of money.
Clearly, when central banks and governments work together, it’s not for the long-term stability of the currency.
Political goals like deficit spending and maximum employment always dominate. People notice pretty darned quickly if they don’t have a job – it usually takes them a whole lot longer to figure out why their paycheck no longer covers their bills!
So what’s the alternative to a central bank whose primary outcome is to destroy the currency?
Maybe no central bank at all?
If inflation is the solution, what was the problem?
Both Dalio and known bitcoin proponent Mike Novogratz tend to reiterate that for central banks, inflation is the opposite of what it is to the everyday person. With every nation being indebted by the trillion and the U.S. at the forefront of this terrible race, central banks see higher inflation as a way out.
Price inflation is debt deflation
As Novogratz pointed out, with 9% inflation and a 3% interest rate, our sovereign debt is essentially reduced by 6%.
The government is getting a better deal on its loans! The only ones who suffer? Well, everyone who owns dollars. Central banks are willing to make this trade-off for your own good. You don’t want your government to default on its debts, do you? And you don’t want to pay higher taxes?
Well then, we’re expected to shut up and watch the purchasing power of our dollars evaporate – and be grateful it’s not worse!
All of this was common knowledge back in 2008, when bitcoin was created. And it’s stamped into it. Novogratz, who is sticking to his $500,000-bitcoin-in-five-years forecast, also touched upon what gold’s detractors will sometimes say:
It only has value because we place value in it.
What sounds like an argument against the asset has become its reinforcing point over and over again. Over 750 currencies have failed to hold value – but gold didn’t. The same holds true for bitcoin, with a twist. Why? Because gold has historically been expensive.
Sure, gold functions great as a store of value. But it’s not quite infinitely divisible. Indeed, a 20-something or 50-something can only make so much of gold’s utility when a monthly salary gets you a couple of ounces at most, even if you’re working hard. Either group could have bought bitcoin when it was dirt cheap and would have now had the same wealth as those with vaults crammed with gold. Bitcoin can be purchased one Satoshi at a time!
And it’s not just bitcoin. There’s a vast range of cryptocurrencies specifically engineered for different purposes. There are fixed-cap issues like bitcoin and uncapped cryptos like ether. There are utility-based cryptocurrencies whose value is partially derived from work done on blockchain. And there are DAO tokens like Maker, offering voting rights to their issuing organizations.
You know what these modern forms of money have in common? They all lack a central bank. There’s no unelected cabal of political appointees colluding to destroy their values. Rather, they offer the opposite – decentralization and a transparent code base so you can actually see how they work.
Cryptocurrencies are, effectively, the exact opposite of central bank-powered currencies.
Central banks are starting to catch on, though… They’ve gone through the first two stages of grief and are now in stage 3, bargaining. “You like this computer money, huh? What if we made it and gave it to you, then it would be real cool, huh? Kids? Is this thing on?”
I really don’t want to get into central bank digital currencies (CDBCs) in all their horrific implications. Let me just say that CDBCs are probably a marketing effort to somehow make unbacked paper money even more appalling. And, as you’d expect, to make crypto even more appealing.
Remember: a central bank’s job is to manage its currency into failure. Good central banks do this slowly; bad central banks do this quickly. The end result is the same. The more people who catch on to the real Ponzi scheme here, who divest themselves of dollars in favor of uncentralized, unmanaged alternative investments for the long-term (cryptocurrencies, gold, both) – the faster people opt out of dollars, the faster the house of cards collapses.
In a race like this one, it’s probably better to a year or two early than a day or two late.