Money is a surprisingly complex subject.
People have been searching for money all their lives, which may seem simple in some ways, but the human definition of money has changed significantly over the centuries. How can something so simple and so universal have so many different forms?
This is an important question to think about, because we can basically do four things with our resources: consume, save, invest, and share.
Consumption: When we consume, we satisfy our immediate needs and desires, including shelter, food, and entertainment.
Saving: When we save money, we store our resources in something safe, fluid and portable, aka “money”, a low-risk battery for future resource consumption across time and space.
Investing: When we invest, we put resources into a project that has the potential to multiply our resources, but also risk losing them, in an attempt to provide some new value to ourselves or others. This can act as a riskier, less liquid, and less portable amplifier for future resource consumption potential than money. There are personal investments, such as our own businesses or education, and there are outside financial investments in companies or projects led by others.
Sharing: When we share, or in other words, donate to charities and people in our community, we give some of our excess resources to those we think need and deserve it. In many ways, this can be seen as a form of investment in the continued success and stability of our larger community, which is probably why we want to do it.
Most people in the world do not invest in financial assets, they are still in the consumption stage (basic necessities and daily entertainment) or the saving stage (money and home equity), either due to income constraints, excessive consumption, or because they live in a world without A place with a good environment – a developed capital market. However, many of them do invest in expanding their own businesses or educating themselves and their children, which means they invest in their personal lives, and they may also share in their communities through religious institutions or secular initiatives.
Among the few who do invest in financial assets, they are generally used to investing in ideas that change rapidly over time, so they have to think more about how they invest. They either strategize and manage it themselves, or outsource the task to experts, allowing them to focus more on the skills they acquired the resource in the first place.
However, depending on where in the world they live, people are less accustomed to tracking the quality of the currency itself, or deciding which type of currency to hold.
Especially in developed countries, people usually only hold the currency of that country. In developing countries with a more recent and extreme history of currency devaluation, people generally think more about the type of currency they hold. For example, they might minimize their cash holdings and keep it in hard assets, or they might hold foreign currency.
This article looks at the history of money and examines this rather unusual period in which we appear to be experiencing a gradual global shift in what we define as money, parallel to the turning points from 1971 to the present (the petrodollar system), 1944. Comparable – 1971 (Bretton Woods), 1700s to 1944 (gold standard) and various commodity money transition periods (before 1700s). This has historically been relatively infrequent for any given society, but when it does, it can have a huge impact, so it deserves attention.
If we condense these stages down to the basics, the world goes through three stages: commodity money, the gold standard (the final form of commodity money), and fiat money.
The fourth stage, digital currency, is coming. This includes private digital assets (such as bitcoin and stablecoins) and public digital currencies (such as central bank digital currencies), which can change the way we do banking, and what economic tools policymakers have in terms of fiscal and monetary policy. These assets can be thought of as digital versions of gold, commodities or fiat currencies, but they also have their own unique aspects.
This article reviews the history of currency transitions from the perspectives of several different schools of thought (often conflicting), then examines the current and recent situation in relation to currency and how we invest in it, start from scratch or skip to the chapter you want :
Chapter 1: Commodity Money
Chapter 2: Fiat Currency
Chapter 3: Digital Assets
Chapter 4: Final Thoughts
Some of the people I have drawn on for this article, past and present, include Carl Menger, Warren Mosler, Friedrich Hayek, Satoshi Nakamoto, Adam Back, Saifdean Ammous, Vijay Boyapati, Stephanie Kelton, Ibn Battuta, Emil Sandstedt, Robert Breedlove, Ray Dalio, Alex Gladstein, Elizabeth Stark, Barry Eichengreen, Ross Stevens, Luke Gromen, Anita Posch, Jeff Booth and Thomas Gresham.
1. Commodity currency
Money is not an invention of the state, it is not the product of legislative acts. Even the recognition of political authority is not a necessary condition for its existence. Certain commodities naturally become money as a result of economic relations independent of state power.
—Karl Menger, 1840-1921
Barter transactions take place all over the world and go back tens of thousands of years or more.
Eventually, humans begin to develop concepts and techniques that allow them to abstract this process. The more complex an economy is, the greater the number of possible barter combinations between different types of goods and service providers, so the economy starts to need some standard unit of account or currency.
Specifically, society begins to need something divisible and universally accepted. For example, an apple farmer needs some tools (blacksmith), meat (rancher), repair work (carpenter), and medicine for her children (doctor), can’t spend time looking around for someone who has what she needs, and also happens to want a tons of apples. Instead, she just needs to be able to sell her seasonal apples to a unit that she can use to save and buy all of these things over time as she needs them.
Money, especially the type of money that requires work to generate, tends to appear arbitrary to outsiders of the culture. But this work ends up paying for itself many times over, as a standardized and trusted medium of exchange and store of value makes all other economic transactions more efficient. The apple farmer doesn’t need to find a specific doctor now, he wants to buy a ton of apples for his expensive service.
A number of economists from various schools of economics have thought about and developed the concept, but commodity money as a subject tends to emerge most often in the Austrian School of Economics founded by Carl Menger in the 1800s.
In this way of thinking, money should be divisible, portable, durable, fungible, verifiable, and scarce. It usually (but not always) has some utility of its own, and different types of currencies have different “scores” on these metrics.
- Divisible means that money can be subdivided into various sizes to account for different sized purchases.
- Portability means money can easily span distances, which means it has to pack a lot of value into a small weight.
- Durability means money is easy to save over time; it won’t rot, rust or crack.
- Fungibility means that there is no significant difference between the various units of the currency, which allows for quick transactions.
- Verifiable means that the seller of a good or service that costs money can check that the money is real.
- Scarcity means that the money supply does not change rapidly because a rapid change in supply would depreciate existing units.
- Utility means that money is intrinsically desirable in some way; for example, it can be consumed or has aesthetic value.
Adding these attributes together, money is the “best-selling commodity” in society, which means it is the commodity that has the most power to sell. Money is the most ubiquitous commodity, in the sense that people want it, or realize they can trade it, and then easily and reliably exchange it for other things they want.
Other definitions consider money to be “something that wipes out debt,” but debt is usually denominated in whatever currency unit was defined at the time the debt was issued. In other words, debt is usually denominated in units of top-selling items, rather than top-selling items being defined as units of debt. In fact, however, part of the ongoing network effects that sustain the fiat currency system is that the large amount of debt in the economy creates a constant ongoing demand for these currency units to pay off those debts.
As early as 1912, Mr. JPMorgan testified before Congress and quoted this famous quote:
Gold is money, everything else is credit.
In other words, currency and currency can be thought of as two different things for the purposes of discussion, although their terms often overlap.
We can define money as a liability of an institution, usually a commercial or central bank, used as a medium of exchange and a unit of account. For example, physical paper dollars are the official liability of the Fed, and consumer bank deposits are the official liability of that particular commercial bank (these commercial banks hold their own reserves at the Fed, which are also a liability of the Fed).
Unlike money, we can define money as a liquid and fungible asset rather than a liability. It’s something intrinsic, like gold, which is considered a high-selling commodity in its own right. In some eras, currencies were held by banks as reserve assets to back the currencies they issued as liabilities. Unlike the U.S. dollar, which is an asset to you but a liability to other entities, you can hold gold, which is an asset to you and a liability to everyone else.
Under the gold standard, money represents the demand for money. If the bearer comes to redeem their paper money, the bank will pay the bearer on demand in exchange for the amount of gold it is pegged to.
Scarcity often determines the winner between two competing commodity currencies. However, it’s not just about the rarity of the asset. A good concept to be familiar with here is the stock-to-flow ratio, which measures the amount of supply (stock) that currently exists in the region or world divided by how much new supply (flow) can be produced in a year.
For example, gold developers have historically estimated an annual increase of about 1.5% of new gold on top of existing gold supply, while the vast majority of gold is not consumed, remelted into different shapes and stored in different locations.
This gives gold an average stock-to-flow ratio of 100/1.5 = 67, the highest stock-to-flow ratio of any commodity. According to estimates by the World Gold Council, the world has an average annual production of 67 years. We call it 60 or 70 because it’s not accurate.
If money (the best-selling commodity) could easily create more, any rational economic actor would go out and create more money for itself, diluting its entire supply. If an asset has a monetary premium on top of its pure utility value, it strongly incentivizes market participants to try to use it more, so only the most depreciated form of money can withstand this challenge.
On the other hand, if a commodity is so rare that almost no one owns it, it can be very valuable if it has utility, but its usefulness as a currency is minimal. It is illiquid and widely held, so buying and selling it has higher friction costs. For example, certain atomic elements such as rhodium are rarer than gold but have low stock-to-flow ratios because they are consumed by industry as fast as they are mined. Rhodium coins or bars can be purchased as a niche collectible or store of value, but it has no use as a social currency.
So, along with the other attributes in the list above, maintaining a high stock-to-flow ratio over the long term is often the best measure of the scarcity of what is seen as a currency, rather than absolute rarity. A commodity with a high stock-to-flow ratio is difficult to produce, but a lot of it is produced and widely distributed and held because it is either not consumed quickly or not at all. This is a relatively uncommon set of properties.
Throughout history, all kinds of stones, beads, feathers, shells, salt, furs, fabrics, sugar, coconuts, livestock, copper, silver, gold and other things have been used as currency. Each of them has different scores for various attributes of money, and tends to have certain strengths and weaknesses.
For example, salt is divisible, durable, verifiable, fungible, and has significant utility, but is not very valuable per unit weight, nor is it very rare, so it scores well for portability and scarcity. not tall.
Gold is the best of almost all attributes and is by far the commodity with the highest stock-to-flow ratio. One of its weaknesses compared to other commodities is that it is not very divisible. Even a small gold coin is worth more than most purchases, worth the value of most people’s labor in a week, and it is the king of commodities.
For most of human history, silver has actually been the winner in usage. It scores second only to gold across the board for most attributes, and has the second-highest stock-to-flow ratio, but outperforms gold in divisibility, as small silver coins can be used for day-to-day transactions. It is the queen of commodities. In chess, the king is probably the most important piece, but the queen is the most useful piece.
In other words, the wealthy often hold gold as a long-term store (and display) of value and as a medium of exchange for bulk purchases, while silver is a more tactical currency, used as a medium of exchange and stored by more people. For this reason, until recently, bimetallic currency systems were common in many parts of the world, despite the challenges that came with them.
The scarcity of some other commodities has more specific weaknesses in terms of technology. Here are two examples:
The inhabitants of a South Pacific island called Yap used huge stones as currency. These stones, called “lai stones” or “flying stones,” were round discs with a hole in the middle, varying in size and diameter. From a few inches to more than ten feet. Many of them are at least a few feet wide and therefore weigh hundreds of pounds. The largest are more than ten feet wide and weigh thousands of pounds.
Interestingly, I’ve seen both the Austrian economist (Saifedean Ammous) and the MMT economist (Warren Mosler) use this example. It’s interesting because the two schools of thought have very different concepts of money.
Anyway, what makes these stones unique is that they are made of a special type of limestone that is not abundant on the island, and Yap residents will travel 250 miles to the neighboring island of Palau to mine limestone and bring it back to Yap.
They would send many men to that remote island, quarry the rock with huge slabs, and bring it back in wooden boats. Imagine moving a stone weighing thousands of pounds across 250 miles of open ocean in a wooden boat. Over the years, people have died in the process.
Once the thunderstones are made in Yap, the big ones won’t move. This is a small island and all the stones are catalogued by oral tradition. Instead of moving the stone, the owner could trade a person for some other important goods and services, which would take the form of announcing to the community that the person now owns the stone.
In this sense, Laystone is a ledger system that is no different from our current monetary system. The ledger keeps track of who owns what, and this particular ledger happens to be distributed orally, which of course only works on a small geographic scale.
By the time Europeans recorded this, there were thousands of laistones in Yap, representing hundreds of years of quarrying, transporting and manufacturing. Therefore, laistones have a high stock-to-flow ratio, which is the main reason why they can be used as currency.
In the late 1800s, an Irishman named David O’Keefe came to the island and discovered this. And, with his better skills, he could easily quarry stone from Palau and bring it to Yap to make laistone, thus becoming the richest man on the island, able to get the locals to work for him and trade various goods for him.
As the Irish learned more about Yap, he realized that there was only one commodity the locals could only dream of – the island’s famous “stone coin”, used in almost all high-value transactions. The coins are mined from aragonite, a special limestone that gleams in the sun and is valuable because it is not found on the island. O’Keefe’s genius was to realize that by importing these stones for his new friend, he could trade them for labor on Yap’s coconut plantations. Yap people are not interested in the trinkets of merchants who are the common currency elsewhere in the Pacific (nor should they, one tourist admits, when “all food, drink and clothing are readily available, so there is no bartering” deal, and no debt”), but they’ll work like demons for stone money.
– Smithsonian Magazine, “David O’Keefe: The King of Hard Currency”
Essentially, better technology ends up breaking Laystone’s stock-to-flow ratio by increasing traffic significantly. Foreigners with more advanced technology can bring any number of stones to the island and become the richest person on the island, thus increasing the supply and decreasing the value of the stones over time.
However, the locals were also smart enough to ease the process in the end. They began to assign higher value to older stones (those verifiably hand-mined decades or centuries ago) because they by definition excluded newer abundant stones, thus maintaining their scarcity. Still, the text is on the wall. This is no longer a great system.
Things then took a darker turn, as the Smithsonian article states:
With the death of David O’Keefe and the entrenchedness of the Germans, things began to deteriorate for the Yap people after 1901. The new rulers enlisted the islanders to dig a canal in the archipelago, and when the Yapians were reluctant, they began to requisition their stone money, defaced coins with black-painted crosses, and told their subjects that redemption could only be done through labor. back. Worst of all, the Germans introduced a law prohibiting Yap people from traveling more than 200 miles from their island. This immediately stopped quarrying in the Philippines, although the currency continued to be used even after the islands were occupied by Japan and then by the United States in 1945.
Many stones were taken by the Japanese during World War II and used as temporary anchors or building materials, reducing the number of stones on the island.
Laystone is a noteworthy form of currency because they have no use, so they can last for a long time. They are a way of displaying and documenting wealth, nothing more. Essentially, it was one of the earliest versions of a public ledger, as the stones didn’t move, only verbal records (or, later, physical tokens for Germans) determined who owned them.
As another example, trade beads have been used as currency in parts of West Africa for centuries, at least as far back as the 1300s or earlier, as documented by ancient travelers of the time, as documented by Emil Sandstedt. Various rare materials such as coral, amber and glass are available. Over time, Venetian glass beads have also gradually moved through the Sahara Desert.
To quote Ibn Battatu, from his travels in the 14th century (from Sandstedt’s article):
Travelers in this country carry no food, be it simple food or condiments, nor gold or silver. He only brought some salt and glass ornaments, which people call beads, and some fragrant items.
These are nomadic societies, often on the move, and the ability to wear your money in the form of beautiful beads is useful. These beads maintain a high stock-to-flow ratio because they are held and traded as currency while being difficult to produce at their technological level.
Eventually, Europeans began to travel and visit West Africa more frequently, noticing this use of trade beads, and taking advantage of it. Europeans have glass making skills and can produce beautiful beads with modest effort. As such, they can trade large quantities of these beads for merchandise and other goods (and, unfortunately, human slaves as well).
Because of this technological asymmetry, they devalued these glass beads by increasing the supply across West Africa, extracting a lot of value from these societies in the process. Locals are constantly trading scarce local “goods,” ranging from vital goods to priceless human lives, in exchange for glass beads that are far more abundant than they realize. As a result, they traded real valuables for fake valuables. Choosing the wrong currency type can have dire consequences.
However, this was not as easy for Europeans as one might think, as African preferences for certain types of beads can change over time, with different tribes having different preferences. This seems to be similar to Laystone, once new Laystone supplies started coming in faster due to European technology, Yapians began to wisely value old stones over new ones. Essentially, West African tastes seem to have shifted on the basis of aesthetics/fashion and scarcity. However, this also gives this form of money a low score for fungibility, which reduces its reliability as money, even for the pastoral West Africans who use them.
Ultimately, like Laishi, the trade beads were unable to maintain their high stock-to-flow ratios in the face of technological advancements and were eventually replaced as currencies.
Japanese invasion of money
Although it was not a commodity currency, the Japanese Empire used the same tactics against Southeast Asians as Europeans did against Africans.
During World War II, when the Japanese Empire invaded various parts of Asia, it would confiscate the hard currency of the locals and issue its own paper money instead, called “aggression money”. These conquered peoples would be forced to keep and use an unbacked currency that would eventually lose all its value over time, a way for Japan to withdraw their savings while maintaining a temporary unit of account in these regions .
To a less extreme degree, this is what is happening in many developing countries today; people are constantly saving money in their local currency, and every generation or so, it depreciates significantly.
Other types of commodity currencies
Emil Sandstedt’s book “Deposed Currencies: A Journey Through History” categorizes the various currencies used over the past thousand years or so. The book frequently cites the writings of Ibn Battuta, the 14th-century Moroccan explorer who crossed continents and who was probably the furthest traveler in the pre-modern era.
The Central Asians in the Battuta era, as a nomadic culture, used livestock as currency. The unit of account is a sheep, the larger species of livestock is worth a certain multiple of the sheep. However, as they settled in towns, the cost of storing livestock became too high. They eat a lot, they need space, and they’re messy.
Russians have a history of using fur as currency. There are even references to using a bank-like entity that would hold furs and issue paper claims against them. Parts of the U.S. border also later turned to fur as currency for a short period of time.
Shells are used as currency in a few different regions, in a sense like gold and beads, they can be used for both money and fashion.
In addition to beads, some parts of Africa also use fine fabrics as currency. Sometimes it’s not even cut into a usable shape or intended to be worn; it’s held and exchanged purely for monetary value as a marketable commodity that can be stored for a long time.
Another great example is the idea of using high-quality Parmesan cheese chunks as bank collateral. Since Parmesan cheese takes 18-36 months to mature and is relatively expensive per unit weight in lumps, niche banks in Italy are able to accept it as collateral as an attractive form of commodity money:
MONTECARVORRO, Italy (Bloomberg) — Regional bank Credito Emiliano holds 17,000 tons of Parmesan cheese in the vaults, prized by gourmets around the world.
The bank accepts Parmesan cheese as collateral for loans, helping it continue to fund northern Italy’s cheesemakers even during the worst recession since World War II. The two climate-controlled warehouses at Credito Emiliano have around 440,000 wheels and are worth 132 million euros or $187.5 million.
“This mechanism is our lifeblood,” said Giuseppe Montanari, a cheese maker and distributor who used loans to buy milk. “It’s a great way to finance our expenses at a convenient rate and the banks don’t take too much risk because they can always sell the cheese.”
Thousands of years later, two commodities outperformed all other commodities in maintaining their monetary properties across multiple regions; gold and silver. Only they can maintain a stock-to-current ratio high enough to act as money, even as civilizations continue to improve their technological capabilities around the world.
Humans have figured out how to use our improved tools to make or get all the beads, shells, stones, feathers, salt, furs, livestock and industrial metals we need, so we’ve lowered their stock-to-flow ratio and they’re all no longer for money.
However, despite all our technological advancements, we are still unable to reduce the stock-to-flow ratio of gold and silver to any meaningful level, except in the rare case of developed countries discovering new continents to draw upon. Gold’s stock-to-flow ratio has averaged between 50 and 100 throughout modern history, which means that even if the price rises more than 10 times over a decade, we cannot increase the existing supply by more than 2% per year. Silver’s stock-to-flow ratio is usually 1o to 20 or higher.
Most other items have an inventory-to-flow ratio below 1, or are very flexible. Even other rare elements, such as platinum and rhodium, have very low stock-to-flow ratios because the industry consumes them so quickly.
We’ve gotten better at mining gold with new technologies, but it’s inherently rare, and we’ve developed “easy” surface deposits. Only deep and hard-to-reach deposits remain, and it’s like an ongoing difficulty adjustment to our technological advancement. One day we could finally break the cycle with drone-based asteroid mining or seafloor mining or something like that, but until that day (if at all) gold has maintained its high stock-to-flow ratio. These environments are so inhospitable that the cost of obtaining gold there can be prohibitively high.
Basically, whenever any commodity currency comes into contact with gold and silver as money, it always wins with gold and silver. Of the two finalists, gold ended up beating silver in more monetary use cases, especially in the 19th century.
Improvements in communications and escrow services eventually led to the extraction of gold. People can deposit their gold in a bank and get a paper credit that represents a redeemable claim on that gold. Banks, knowing that not everyone would redeem their gold immediately, went on to issue more claims than they held gold, starting fractional-reserve banking. Over time, the banking system merged in various countries into a central bank, and a nationwide note represented a claim to a certain amount of gold.
Barry Eichengreen’s explanation of gold’s victory over silver in his book Global Capital: A History of the International Monetary System is that the victory of the gold standard over the bimetallic standard was mostly accidental. In 1717 England’s master mint (it was Sir Isaac Newton himself) set the official ratio of gold and silver in relation to money, and according to Eichengreen he set silver too much compared to gold. Low. As a result, most silver coins are no longer in circulation (because according to Gresham’s Law, they are hoarded rather than spent).
Then, as Britain rose to become the most powerful empire of the era, the network effects of being on the gold rather than silver standard spread around the world, with the vast majority of countries putting their currencies on the gold standard. Countries that have long adhered to the silver standard, such as India and China, have devalued their currencies due to falling demand for the metal in North America and Europe, leading to negative economic consequences.
Saifadean Ammous, on the other hand, in his book The Bitcoin Standard, focuses on banking technology that improves the divisibility of gold. As mentioned earlier, gold scores equal or higher than silver on most of the properties of the currency, except for divisibility. Silver is more divisible than gold, which has made silver a more “everyday” currency for thousands of years, while gold is best left to kings and merchants to keep in their vaults or to use as ornaments, stores and value displays respectively .
However, the technology of various denominations of paper money backed by gold increases the divisibility of gold. Then, in addition to exchanging paper money, we can eventually “send” funds to the rest of the world over telecommunication lines, using banks and their ledgers as escrow intermediaries. This is the gold standard – paper money and financial communication systems are backed by gold. There were fewer reasons to use silver back then, as gold was the rarer metal and now basically divisible and even more portable thanks to the paper/telecom abstraction.
I think there is some truth to both explanations, although I think Ammous’s explanation is more complete, starting with deeper axioms about the nature of money itself. Paper money makes gold easier to divide, so over time the harder currency wins, but the network effects of political decisions may affect the timing of these changes.
Central banks around the world still hold gold in their vaults, and many of them still buy more gold each year as part of their foreign exchange reserves. It is classified as a Tier 1 asset in the global banking system under modern banking regulations. So, while government-issued currency is no longer backed by a certain amount of gold, it remains an indirect and important part of the global monetary system as a reserve asset. So far, there is no better natural commodity that can replace it.
For thousands of years, gold has traded at 10 to 20 times the value of silver in many different regions. However, over the past century, the price ratio of gold to silver has averaged more than 50 times. Silver’s historical monetary premium over gold appears to have lost a lot of its structure over the past century.
2. Fiat currency
Historically, many cultures have experimented with the paper money period, issued by the government without any backing.
Usually it is the result of a currency that was once backed (gold or silver), but due to wars or other issues, the government created too much paper money and had to default by removing the metal’s ability to back it. Convert back to metal on request. In this sense, currency devaluation becomes a form of taxation and/or wealth forfeiture. Members of the public keep their savings in paper money and pull carpets from under them.
The general argument for why fiat money exists is that, if possible, most governments don’t want to be constrained by gold or other scarce currencies, but want more flexibility in spending.
The first discovered use of paper money was in China over a thousand years ago, which makes sense considering that paper was invented in that region. They eventually turned to the government’s monopoly on paper money, which, combined with the elimination of the ability to convert it back into silver, led to the first fiat currency, and the inflation that followed. It didn’t last long.
Fiat currency is interesting because unlike the history of commodity currencies, it has declined in scarcity. Over the centuries of globalization and technological development, gold defeated all other commodity currencies, and then gold itself was defeated by… paper money?
This is usually attributed to technology and government power. As clans became kingdoms, as kingdoms became nation-states, as banking systems were created and communication systems improved, government could become an important part of everyday life.
Once gold becomes sufficiently concentrated in bank and central bank vaults, and paper claims are issued against it, the only remaining steps are to terminate the callability of that paper currency and enforce its continued use through legal obligations.
Devaluing currencies and empowering wars
Currency devaluation often occurs gradually under the metallic and bimetallic currency system, and its history can be traced back to three or four thousand years ago. It takes the form of reducing the amount of precious metal (such as gold or silver) and adding base metal or placing a decorative hole in its center to save weight.
In other words, rulers often find themselves facing budget deficits and having to choose between spending cuts or raising taxes. Finding both politically challenging, he sometimes resorted to keeping taxes the same, diluting the amount of gold or silver in coins, and spending more coins using less of the precious metal per coin, while expecting to still end up with Treat it the same way as the purchasing power of each coin.
For example, a king could tax 1,000 gold coins, melt them down and make new gold coins, each 90% gold (with the other 10% made of some cheap filler metal), and then use 1,111 gold coins for economic use the same amount of gold. They do look very similar to most people, but some discerning people will notice. Years later, if that wasn’t enough, he could re-melt them and make 80% gold and put $1,250 of that into the economy…
At first, these slightly depreciated coins will be treated as before, but as the coins become more depreciated, it will become apparent. People’s savings depreciate because over time they find that their gold and silver are just bits and pieces. Especially foreign merchants will soon demand more of these devalued gold coins in exchange for their goods and services.
Gold-backed banknotes and fiat currencies are modern versions of it, so devaluation can happen faster. At first, fiat currencies were created ad hoc in times of war. After switching from commodity currencies to gold-backed notes, gold-backing is temporarily suspended for several years as an emergency operation, and then reinstated (often with a sharp depreciation to reduce the amount of gold per unit of currency, as a lot of money is issued during the emergency) .
This is a faster and more efficient way of devaluing a currency than actually devaluing the metal. The government doesn’t have to collect everyone’s coins and re-melt them. Instead, everyone holds paper money that they think can be redeemed for a certain amount of gold, and the government can break that trust, suspend this redeemability, print a lot of paper money, and then re-peg the paper money, so that everyone is aware of Until what happened to their savings, a unit of paper money could be exchanged for a much smaller amount of gold.
This method instantly devalues people’s money while they continue to hold it, and can be done overnight with a pen.
Throughout the 20th century, this strategy spread like a virus around the world. Before paper money, the government would lose the fight if there was a shortage of gold. Governments would use up their gold reserves and raise additional war taxes, but there were limits on how much gold they had and how much they could actually tax unpopular wars before the populace revolted. However, by having all citizens use gold-based paper money, they could devalue everyone’s war savings without official taxation, by printing a lot of money, using it for the economy, and then removing or reducing the gold peg Before people knew what happened to their money.
This allows governments to fight a bigger war by extracting more savings from their citizens, leading their international adversaries to use similar tactics to devalue their currencies if they want to win.
Ironically, the fact that fiat currencies have no production costs gives them the greatest cost.
Bretton Woods and the petrodollar
After World War I, and after the tariff war and World War II, many countries left the gold standard or devalued their currencies relative to gold.
The famous economist John Maynard Keynes said in 1924:
In fact, the gold standard is already a relic of barbarism.
By 1934, gold was banned from holding. If an American possesses it, it carries a maximum sentence of 10 years in prison. The U.S. dollar is no longer redeemable for gold by U.S. citizens, but remains convertible to official foreign creditors, an important part of maintaining the dollar’s credibility. Shortly after Americans were forced to sell gold to the government in exchange for dollars, the dollar depreciated against gold, benefiting the government at the expense of those forced to sell dollars.
For about 40 years, it remained illegal for Americans to own gold until the mid-1970s. Interestingly, this coincides perfectly with a period when U.S. Treasuries underperformed inflation. Basically, it is illegal for them to use in lieu of cash or treasury bonds as the primary release valve for a savings asset:
Source of graph: BIS Working Papers No 684
Ironically, gold was a “barbaric relic” but apparently had to be confiscated and stopped using the threat of imprisonment, only to be hoarded by the government during periods of deliberate devaluation. If it really was such a relic, it would itself be out of use and the government would hardly need to own anything.
However, making gold illegally held is difficult to enforce. There were not many prosecutions for it, and authorities didn’t go door-to-door looking for it.
By 1944, at the end of World War II, the Bretton Woods Agreement was reached after most currencies had depreciated significantly. Most countries peg their currencies to the dollar, which is still pegged to gold (but only redeemable to large foreign debtors, not U.S. citizens). By extension, a pseudo-gold standard is temporarily re-established.
This lasted only 27 years until 1971 when the US no longer had enough gold to maintain its dollar redemptions, ending the gold standard for itself and much of the world. There are too many claims on the dollar compared to the amount of gold the U.S. owns:
The Bretton Woods system was poorly constructed from the start, because domestic and foreign banks could lend dollars without maintaining a certain amount of gold to back those dollars. In other words, the dollar creation mechanism is completely decoupled from gold, so it is inevitable that the amount of dollars in existence will quickly exceed the amount of gold in the Treasury’s coffers. With the number of dollars multiplied without the amount of gold available, any smart foreign creditor would start exchanging dollars for gold and draining Treasury’s coffers. The Treasury will soon run out of gold until they either devalue the dollar peg substantially or terminate the peg entirely, which they did.
Since then, for over 50 years, almost every country in the world has adopted a fiat currency system, which is the first time in history that this has happened. Switzerland is an exception, which didn’t keep its gold standard until 1999, but for most countries it’s been over 50 years.
However, the dollar still has traces of commodity support, which is part of what keeps the system together for a long time. In the 1970s, the U.S. struck a deal with Saudi Arabia and other OPEC nations that no matter which country buys it, it sells its oil only in dollars. In return, the United States will provide military protection and trade deals. Thus, the petrodollar system was born. Since then, we’ve had to deal with the consequences of this awkward relationship.
While the U.S. dollar is not tied to any particular oil price in this system, this petrodollar system makes it necessary for any country in the world that needs to import oil to need U.S. dollars to do so. Thus, as long as the United States has sufficient military power and influence in the Middle East to maintain agreements with oil-exporting countries, a general demand for dollars is established.
Other countries continue to issue their own currencies, but hold gold, dollars (mainly U.S. Treasuries), and other foreign currency assets as reserves to back their currencies. During this period, most of their currencies were not pegged to any particular dollar, oil or gold value, but had large reserves that could be used to actively maintain the strength of their currencies, a key part of their acceptance by creditors around the world.
The biggest benefit of the petrodollar system, as analyst Luke Gromen puts it, is that it helped the United States defeat the Soviet Union in the Cold War in the 1970s and 1980s. The petrodollar agreement and the associated military build-up to enforce it are a powerful chess move by the United States to gain leverage over the Middle East and its resources. However, Groman also argues that when the Soviet Union collapsed in the early 1990s, the United States should have turned to and abandoned this system to avoid persistent structural trade deficits, but it didn’t, so its industrial base was gutted. Since then, China and other countries have used the system to fight back against the United States, and the United States has also poured huge resources into maintaining its hegemony in the Middle East through the wars in Afghanistan and Iraq.
The international gold standard was such that each major country pegged its own currency to a fixed amount of gold and held gold reserves that could be redeemed by its citizens and foreign creditors:
The pseudo-gold standard of the Bretton Woods system involved dollars backed by gold, but only redeemable in limited quantities to foreign creditors. Foreign currencies are pegged to USD and hold USD/Treasury bonds and gold reserves:
The petrodollar system allows only dollars to buy oil imports around the world, so countries around the world hold a combination of dollars, gold, and other major currencies as reserves, with an emphasis on dollars. If countries want to strengthen their currencies, they can sell some reserves and buy back their own currencies. If countries want to weaken their currencies, they can print more currency and buy more reserve assets.
Over time, demand for dollars expands through trade and debt. If two countries trade in goods or services, they usually do so in U.S. dollars. When loans are made internationally, they are usually made in U.S. dollars, and there is now more than $13 trillion in U.S. dollar-denominated debt in the world, owed to various places including lenders in Europe and China. All dollar-denominated debt represents additional demand for dollars because dollars are needed to service those debts. Basically, the petrodollar transaction helped initiate and sustain the network effect at critical times until it became fairly self-sustaining.
This system gives the United States considerable geopolitical leverage as it can sanction any country and isolate it from the dollar-based system.
However, one of the main flaws of the petrodollar system is that all the demand for dollars makes US exports more expensive (less competitive) and makes imports cheaper, so once we have the system in place, the US starts to have structural The trade deficit, as of this writing, totals more than $14 trillion in cumulative deficits. From 1944 to 1971, the United States reduced its gold reserves to maintain the Bretton Woods dollar system, and from 1974 to the present, the United States has instead reduced its industrial base to maintain the petrodollar system.
Chart source: Trading Economics
As the Financial Times described in a clever 2019 article, this petrodollar system ironically gave America a kind of Dutch disease. For those unfamiliar with the term, Investopedia has a good article on Dutch disease. Here is a summary:
The term Dutch disease was coined by The Economist magazine in 1977, when the publication analysed the crisis in the Netherlands following the discovery of large gas deposits in the North Sea in 1959. Newfound wealth and large oil exports led to a sharp rise in the guilder, making Dutch exports of all non-petroleum products less competitive on world markets. Unemployment rose from 1.1% to 5.1%, and capital investment in the country fell.
Dutch disease is widely used in economic circles as a shorthand way of describing contradictory situations where seemingly good news (such as the discovery of large oil reserves) has a negative impact on a country’s wider economy.
Making almost all global oil denominated in US dollars, as the FT said (correctly in my opinion), basically gave the US a kind of Dutch disease. In addition to finding oil or gas, we designed a system where every country needs dollars, so we need to export a lot of dollars through a structural trade deficit (so the dollar as a global reserve asset basically acts as a big oil/gas discovery ).
This system, like the natural gas discovery in the Netherlands, keeps the dollar stronger than it should be on a trade balance basis at any given time. This has made real U.S. exports quite uncompetitive, boosted our ability to import (especially for the upper classes), and prevented decades of normalizing the U.S. trade balance.
Japan and Germany became major exporters at our expense, for example, their auto industries boomed globally, while the U.S. auto industry faltered, leading to the formation of the “rust belt” in the U.S. Midwest and Northeast. And then China grew up and did the same thing to America for the past two decades; they ate our manufactured lunch. At the same time, Taiwan and South Korea became the center of the global semiconductor market, not the United States.
The petrodollar system is starting to crumble under its own weight as the trade deficit has accumulated into a massive negative net international investment position in the US, which has a higher concentration of wealth than other developed countries because we hollow out a lot of our blue collars in particular labor force. This has led to a rise in political tensions and a desire (so far unsuccessfully) to reduce the trade deficit and rebuild our industrial base. With their persistent dollar surpluses, foreigners buy productive U.S. assets such as stocks, real estate, and land. In other words, the US sells its appreciating financial assets in exchange for depreciating consumer goods:
My article on the petrodollar system covers the history of the dollar as a global reserve currency in more detail, from the pre-Bretton Woods era to the petrodollar system.
Potential Post-Petrodollar Design
Policymakers and analysts have proposed rebalancing the global payments system, and the changing nature of geopolitics is pointing in that direction.
Russia, for example, has begun partially pricing oil in euros over the past few years, while China has put a lot of work into launching a digital currency that could expand its global reach, at least among some of its most reliant trading partners. The United States is no longer the largest importer of commodities, and its share of global GDP continues to decline, making the existing petrodollar system unsustainable.
If oil could be purchased with several large fiat currencies, the model would look more like this (with many tertiary currencies self-governing relative to these major currencies with the scale and clout to buy oil and other foreign commodities):
If a primarily scarce neutral reserve asset (like gold or bitcoin or digital SDR or something like that, depending on your concept of where the trend is going in the next ten or two years) is used as a globally accepted form of money, then go for The centralized model can also look like this:
Overall, it is clear that the trend in global payments is towards digitization and decentralization, away from single-country currencies, but it is unclear how the next system will evolve and on what timeline it will change . It remains the subject of my close analysis of news and data.
Negative Baseline Price Inflation
The long arc of human history has been deflationary. As our technology improves over time, we become more productive, reducing labor/resource costs for most goods and services. This has been especially true over the past few centuries, as humans have exponentially exploited dense forms of energy. Before that, our productivity growth rate was much slower.
As an example of productivity, people used to farm with their hands. By leveraging the practicality of a work horse and simple equipment, it enables one person to do the work of several. Then, the invention of tractors and similar advanced equipment made it possible for one person to do the work of ten or more people. As tractor technology gets bigger, that number could jump to thirty or more. Then, we could imagine a fleet of self-driving agricultural equipment where one person could do the work of a hundred. As a result, in order to feed the entire population, a smaller and smaller percentage of the population needs to work in agriculture. This makes food cheaper and frees up other people’s time for other productive activities.
Historically, gold has appreciated relative to most other commodities over time, like an upward sine wave. Alternatively, we can say that most commodities depreciate in value relative to gold like a falling sine wave. For example, the price of copper increases relative to gold during an inflationary cycle, but gold has steadily appreciated relative to copper over a multi-decade cycle. This trend is even stronger for less scarce agricultural products.
Here is a copper-gold ratio chart showing structural declines and cyclical anomalies since 1850, such as:
This is wheat in gold since 1910, in gold:
This is because our advanced technology has made us more efficient at harvesting other commodities over time. However, the extreme scarcity of gold and a fairly strict stock-to-flow ratio of over 50x makes our technological progress in finding and mining gold offset by the fact that we have already mined the “easy” gold and the remaining gold , deposits are getting deeper and deeper and harder. In that sense, we’ve never really become more efficient at getting gold back. This is a built-in ongoing difficulty adjustment.
In the United States of the late 1800s and early 1900s, when the country became a rising global power, the country was on the gold standard and structural deflation. The prices of most things fell because land was plentiful and the huge technological advances in the industrial age made people much more productive.
A more extreme example is TV prices over the past five years. Moore’s Law, industrial automation, and labor outsourcing have made television exponentially better and cheaper over time, especially when priced in gold. Likewise, cell phones from decades ago were very large, basic and expensive toys for the wealthy. Many people in the poorest parts of the world now make powerful smartphones a normal part of their lives. They have supercomputers in their pockets.
In general, we can say that the benchmark inflation rate is a negative number (aka deflation), and how negative it is at any given time depends on the rate of technological progress. If we somehow backtracked, the baseline inflation would just turn into a positive, encountering more scarcity and less abundance. This could be due to improper investment or war, for example.
By holding a best-selling item (like historically gold), your purchasing power will gradually appreciate over time as labor/resource costs for most other things go down, while the saleable item retains most of it Or total scarcity and value. The prices of the vast majority of goods, products and services are structurally progressively lower relative to your strong store of value.
One way to measure this is to look at the broad per capita money supply relative to the consumer price index over time. Below is a graph of the UK’s 5-year rolling average growth rate:
We can see that there is usually a positive gap between per capita broad money supply growth and consumer prices. Over this 150-plus year period, the per capita broad money supply grew by an average of 5.3% per year, while the basket of goods and services grew by an average of only 3.1%. In other words, monetary inflation is usually a little faster than price inflation.
To put that in perspective, and in very rough terms, real productivity growth is about 2.2% per year, and that’s the difference between the numbers. This means that in any given year, the resource/labor cost of a basket of goods and services has fallen by an average of 2.2% due to technological progress, but the amount of money people own has risen by 5.3%, so real prices have risen by only 3.1%.
Thus, price inflation is not 3.1% from the zero baseline; it is a 5.3% drop from the -2.2% baseline. The real resource costs of goods and services fall most years rather than stay the same, but their prices rise anyway because of our inflationary monetary framework.
The reason this is only a rough measure is because 1) the CPI basket changes over time and may not be fully representative; 2) the money supply can become more or less concentrated over time and therefore does not always reflect digit purchasing power. There is no way to directly measure technical deflation; only estimates.
Another way to check is to simply look at how much gold has appreciated against the pound, and the answer is about 4.0% per year over the same 150+ year period. The price of gold is appreciating faster than the CPI basket inflation rate, about 0.9% per year (the difference between 4.0% and 3.1%, the compound is quite large over a century), and can buy you more copper, oil, Wheat, or many other goods and services, not 50, 100, or 150 years ago, unlike the pound, which buys far less stuff than it used to. Higher quality and scarcer commodities such as meat have roughly kept up with the price of gold (although you can’t store meat for very long), and picking a few assets such as the absolute best/scariest UK real estate locations could appreciate in value Slightly faster than gold (although they require ongoing maintenance costs to make up the difference).
The point of this section is that growth in the broad money supply per capita is the “real” rate of inflation. However, the baseline against which we measure it is not zero. It’s a slightly negative number that we can’t measure precisely, but we can estimate and infer, and it represents a continued increase in productivity from technology. In the long run, the price of most things remains relatively stable, or preferably continues to fall with the price of the best-selling commodity (such as gold in history), but with depreciation and weaker bookkeeping in most years unit (eg GBP.
MMT description for fiat currencies
Some economists disagree with the commodity view of money, arguing that money has its origins in government, known as charterism, and its origins go back more than a century.
Warren Mosler and others revived the idea decades ago, resulting in what is now widely known as Modern Monetary Theory ( MMT ).
I often feel that Mossler describes the case of that school very well, not whitewashing things, but speaking very directly:
The first is that the government tries to provide itself and how it does it. Throughout history, there have been different ways to do this. One way is to go out and take slaves. Another way the British did it was they supplied their navy by going to pubs late at night and hauling them to ships. It is called impressive sailor.
As I like to say, we pretend to be more civilized, we use a monetary system. So how does the government do it? A blank slate, what you’re doing is creating a tax that people can pay on things they don’t have. So what you’re trying to do is move resources from the private sector to the public sector. You want people out there doing what they’re doing suddenly working for the government. You need soldiers, you need police, you need health workers, you need educators. How do you get these people out of the private sector and into the public sector?
The first thing you have to do is collect taxes. You need a tax liability, and it must be mandatory. In this example, I will use property tax. You tax everyone’s house, and you pay with your new unit of account, your new unit, your stuff, your tax credit, what you used to pay your taxes. USD, JPY or EUR – they are all tax credits.
What happens is that you create real sellers of goods and services who now need your tax credit or they will lose their house. You create unemployment – people are looking for paid work. Unemployment isn’t about people looking to volunteer with the American Cancer Society; it’s about people looking for work because they need or want money. When you want to feed yourself, the problem with the government is that there is no unemployment. As far as your currency is concerned, there is no unemployment; there may be people who are willing to work for other things but not for your currency. You need unemployment in monetary terms to earn your unit of account.
So you tax and now people need your unit of account, all these people come looking for jobs, all these people are out of work. You are now hiring the unemployed created by your taxes and they are now feeding your government.
—Warren Mossler, MMT Conference 2017
I also like this description, where he explains his point in an economic debate:
The way we do it, we tax what no one owns, and in order to get the money to pay the tax, you have to ask the government so that the government can spend the worthless money and supply itself in other ways.
Now I want to explain, I’ll pull out my business card here. Now I’m asking if anyone in this room wants to buy it – it’s called “how to turn junk into money” – does anyone want to pay a hundred bucks for one of these cards? Do not? OK. Someone wants to stay after get off work to help clean floors and rooms, will I give you my card? Do not? OK. Oh by the way, there’s only one door here and my guy has a 9mm (pistol) in there, you can’t get out of here without one of these cards.
Are you feeling the pressure right now? You are now unemployed! As far as my card goes, you haven’t been unemployed before. You’re not looking for a job that pays with my card. Now you are looking for jobs that can be paid with my card or you are looking to buy them from other people to accept jobs that can be paid with my card.
The difference between money and trash is whether there is a tax collector [outside that door]. That 9mm guy is the taxman. If he can’t enforce the tax, the value of the dollar will go to zero.
-Warren Mosler, MMT vs. Austria Debate 2013
Nobel laureate in economics Paul Krugman said something similar in 2013:
Fiat currency is backed by people with guns, if you will.
Of course, we can also easily ask, since the government uses force to tax itself to supply itself, why can’t it collect commodity money through taxation like gold, and then use this gold to obtain the necessary supply? Why does it need to issue its own paper money and then tax it?
The answer is that it doesn’t have to, but it wants to. By issuing its own currency, it profits from seigniorage, which is the difference between the currency’s face value and the cost of production and distribution. Basically, it’s a subtle inflation tax that increases over time.
A weak government whose economy cannot meet most of its needs often cannot sustain a viable fiat currency for long. People started using alternative currencies out of necessity, even though the government allegedly didn’t allow them to. This happens in many developing countries. Billions of people in the world today have experienced the effects of hyperinflation or near hyperinflation over the past generation. Unfortunately, this is very common.
However, developed countries have been more successful in maintaining seigniorage over the past 5 years of fiat systems. Over time, their currencies have all lost 95% to 99% of their purchasing power, but this is usually gradual rather than sudden. The system is not without the vulnerabilities discussed earlier, but it is certainly the most comprehensive fiat currency system ever built.
When cleverly optimized, fiat currencies have low year-to-year volatility in exchange for a gradual devaluation over the long run. Through active management of taxation, spending, and central bank reserve management (creating or destroying currency in exchange for reserve assets), policymakers try to keep inflation low and stable, meaning that the purchasing power of their currency has declined modestly and consistently.
A strong government can enforce the use of its currency and not all other types of currency within its borders, at least as a medium of exchange (not necessarily a store of value) by taxing other types of transactions and accepting only its fiat currency as a payment method. tax method. They can make things like gold, silver, and bitcoin less convenient than currencies, for example, by making every transaction a taxable event for capital gains. If imminent, they could also try to ban these things with the threat of force.
Monetization of other assets
Although most of us are used to it today, fiat currency has been a polarizing and inherently political subject since the world adopted this petrodollar standard 50 years ago.
However, mainstream media and economists were quick to dismiss it as a classic, and no doubt about it. For decades, if someone thought money should not be fiat, they were considered lunatic and not taken seriously, this vibe:
But when you step back and think in terms of fundamentals, this historical period is really unusual. This is a historical deviation, like the fish in the water not even noticing the water, the monetary system we use now seems perfectly normal to us.
In thousands of years of human history, the world has never used a currency without resource costs or constraints. In other words, it’s an experiment that we’ve been doing for five years. Many will consider this a good experiment and others a bad one, but it’s not inevitable, nor the only possible outcome here. This is what we have now and who knows what it will be like in another five years.
To put it another way, this international monetary system based on centrally administered fiat money is only 16 years older than me. My father was 36 when America came off the gold standard. Growing up, after a period of financial hardship, I started collecting gold and silver coins as a child; my father gave me silver coins every year as savings.
The Swiss abandoned their gold standard when I was 12, six years after Amazon and three years before Tesla. The fiat/petrodollar standard is only four times ahead of Bitcoin and only twice as long as the first internet browser. When you think about it that way, that’s pretty recent.
Since the world adopted the fiat/petrodollar standard, debt as a percentage of GDP has soared to record levels and appears to have become unstable. Given where we are in the long-term debt cycle, investors better get creative about how they look to the future. Don’t take the past 40 to 50 years for granted and think that this will always be the case, whether it’s for money or anything else. We don’t know what money will look like in 50 years.
The last time we were in a similar debt and monetary policy situation was in the 1930s and 1940s, when there were currency devaluations and wars. That doesn’t mean these things have to happen, but basically, we’re in a very macro environment where structural currency changes tend to happen.
One of the results of fiat currencies, especially in the latter stages of the five-year experiment since the 1970s, is that more and more people are starting to see cash as a hot potato. We instinctively monetize other things, such as art, stocks, home equity, or gold. The ratio of home prices to median income, as well as the ratio of the S&P 500 to median income, or the ratio of top art to median income has all risen a lot.
This chart shows the dollar’s loss in purchasing power since the Mint Act of 1792, when the dollar and the U.S. Mint were created:
Currently, to have as much purchasing power as the $100 bought in 1792 would currently require nearly $3,000. From 1792 to 1913, the purchasing power of the dollar fluctuated moderately around the same value and was relatively stable for over 120 years. Beginning in 1913, there was a change in policy, and the dollar kept falling, especially after dropping its peg to gold completely in 1971.
And the situation today is actually worse than most of the 1971-2022 fiat/petrodollar period because interest rates have not kept up with inflation. The fiat system has become increasingly unstable due to the large amount of debt in the system, which prevents policymakers from raising interest rates above the prevailing inflation rate.
Basically, because of the lack of good money in this era of fiat petrodollars, especially post-2009 when interest rates are below inflation, we monetize other things that have high stock-to-flow ratios and view them as as a store of value.
In China, consumers actively monetize real estate. It has become the norm for families to own multiple homes. In the US, consumers actively monetize stocks. We put a portion of every paycheck into a broad stock index without analysing companies or doing any kind of due diligence, treating that basket of stocks as a better store of value than cash, regardless of what’s in it.
For example, we can ask, would we rather have $22 trillion today from $10 trillion 10 years ago and pay basically nothing to own them, or would we rather have $26 million from 26 million shares 10 years ago to $22 trillion today? 16 million shares of Apple stock have basically no income today, do you still buy it yourself? Is the U.S. dollar a better currency for storing value over a 5+ year time horizon, or is it a better currency for multiple alternatives to company stocks?
This monetization of non-monetary securities and property exposes us to greater volatility, more leverage, less liquidity, less fungibility, and more taxable events. Basically, instead of thinking carefully about investing as something special, we put most of our free capital into hundreds of index investments that we don’t even analyze, because who’s going to hold money for a long time? Fungible companies become our currency, at least for the “store of value” part of the currency, in large part because they pay a higher yield/dividend yield than bank/bond yields, and many of them in lesser quantities (deflation) instead of constantly increasing numbers.
Some technologists, like Jeff Booth, argue that this permanent currency devaluation system has a negative impact on the environment because it encourages us to spend and spend on short-sighted devaluation trinkets and improper investments, rather than our money appreciating more than it used to be time. As money appreciates, we become more selective in our purchases.
Proponents of the statutory system argue that it can eliminate recessions and allow for countercyclical investment and stimulus. By having a flexible monetary base, policymakers can increase or decrease the money supply to balance the credit cycle and industrial output capacity. In exchange for the continued devaluation of the currency, we get a more stable currency year over year.
In addition, proponents of the system also argue that the system encourages more consumption, which they believe is a good thing because it keeps GDP growing. By putting people on a constant treadmill of currency devaluation, it forces them to spend and invest rather than save. If people start saving, these policymakers often see it as “hoarding” or a “global saving glut” and see it as a problem. Then adjust monetary policy to persuade people to save less, consume more, and borrow more.
From a developing market perspective, the fiat/petrodollar standard has contributed to massive booms and busts because many of their debts are denominated in dollars, and the strength of those debts can vary depending on the actions of U.S. policymakers Violent fluctuations. Developing countries are often forced to tighten monetary policy to defend their currencies during recessions, so while the U.S. provides countercyclical support for its own economy, developing countries are forced to be pro-cyclical, leading to a vicious cycle during recessions . In this view, the fiat/petrodollar system can be viewed as a form of neocolonialism; we push most of the cost of the system to developing countries to maximize stability in developed countries.
Overall, the fiat currency system has shown more instability recently, with investors having to navigate a challenging environment of structurally negative inflation-adjusted cash and bond yields and many high asset valuations in equities and real estate.
Sovereign International Reserve
As countries accumulate trade surpluses, they keep those gains in sovereign international reserves. This represents a pool of assets that a country’s central bank can use to protect the country’s currency if needed. The more reserves a country has relative to its GDP and money supply, the more defenses it has against a fiat currency collapse. The country can sell these reserves and buy back its own currency to back up its currency unit value. The currency may not be backed by gold at a redeemable price, but if it starts to depreciate rapidly, it is backed by various assets as needed.
The world has official sovereign reserves equivalent to about $15 trillion. Less than $2.5 trillion of this is gold, and more than $12.5 trillion is held as fiat reserves (dollars, euros, yen, franks, etc.). Statutory reserves include government bonds and bank deposits, which can easily be frozen by the issuing country. Also, many gold assets are not held domestically, but rather in New York or London on their behalf.
Therefore, the vast majority of sovereign official reserves are licensed assets, not unlicensed assets. They are non-sovereign; can be frozen by foreign countries. The war embodied this fact.
In February 2022, Russia invaded Ukraine. Russia had prewar sovereign international reserves worth $630 billion, representing a trade surplus built up over decades, as sovereign savings backing its currency. Of that $630 billion, $130 billion is in gold, and another $500 billion is in fiat currencies and bonds. Of this $500 billion, there may be $7-80 billion in Chinese legal assets, and more than $40 billion in European and other legal assets. Europe then froze more than $40 billion in Russian fiat assets in response to Russia’s invasion of Ukraine, equivalent to more than 20% of Russia’s GDP and more than five years of Russian military spending; massive economic seizures. Russia is currently in a financial crisis.
Some might argue that it is a good thing that countries keep their reserves in each other’s assets, so they can be frozen. In addition to trade sanctions, this approach provides countries with another means of controlling each other’s behavior away from extremes such as war. Regardless, we all depend on each other to some extent. But from a pragmatic perspective, countries often want to minimize their vulnerabilities and external risks, which may include minimizing the ability of their central bank reserves to be confiscated or frozen by other countries.
A few months ago, in late 2021, I started writing this long article. Since then, things have accelerated, for example, the Wall Street Journal published an article in early March 2022 titled “If Russia’s currency reserves aren’t real money, the world will take a hit.” This is the opening statement:
“What is money?” Economists have pondered this question for centuries, but the blockade of Russia’s central bank reserves has restored its relevance to the world’s largest countries, especially China. In a world where accumulating foreign assets is seen as risky, the distance between military and economic blocs will grow further.
What is money?
The answer to this question has to do with the difference between currency and currency. Currency is a liability of other entities, and they can choose whether or not to take on that particular liability. Currency itself has intrinsic value to other entities, and if you keep it yourself, there is no counterparty risk (although it may have pricing risk related to supply and demand). In other words, Russia’s gold is money, their foreign exchange reserves are currency, and so are other countries.
Fiat currencies and government bonds have no intrinsic value; they represent an indirect value proposition that can be blocked and seized. Gold has value; it is sufficiently fungible, and due to its physical properties, various entities will accept gold at current market values. It can self-regulate and no outside country can shut it down.
Money is like money for the most part, until one day, it won’t.
Overall, the key feature or flaw of fiat currency (depending on how you look at it) is its flexible supply and ability to be diluted. It allows the government to spend more than tax by diluting what people already own. With this feature, it can be used to re-liquefy troubled financial conditions and stimulate the economy in a counter-cyclical fashion. Also, compared to commodity currencies, their volatility can be minimized most of the time through active management in exchange for ensuring a gradual depreciation over time.
However, when something goes wrong, fiat currencies can explode in value. Fiat currency tends to spur larger deficits (since spending doesn’t necessarily need to be taxed), and usually requires some degree of hard or soft coercion to get people to use it instead of harder money, although this coercion is usually quite Most people are invisible most of the time until something goes wrong. Its ability to be diluted can lead to longer wars, selective bailouts of influential groups, and other forms of government spending that are not always transparent to citizens.
With the development of the Internet and cryptography in the 1980s and 1990s, many people started working on Internet-native monetary systems. Hash Cash, Bit Gold, and B-Money are some early examples.
Some of these early pioneers wanted to be able to pay easily on the internet, which wasn’t so easy at the time. Others are part of the cypherpunk movement: people responding to the information age and the lack of privacy it will increasingly bring by advocating for the privacy of transactions through encryption.
Freedom House, a nonprofit founded in 1941 and originally chaired by Eleanor Roosevelt, did notice the rise of authoritarianism in recent decades. With more than half of the world’s population living in an authoritarian or semi-authoritarian state, people in privileged areas often fail to recognize this trend.
The world became freer in the 1980s and 1990s as China and the Soviet Union opened up, but then the world began to gradually diminish that freedom in the 2000s and 2010s, at least as measured by Freedom House and various other sources. Word. China, in particular, is now a huge surveillance and control state, where transactions and online behavior are monitored and organized, and social credit scores are determined by data, thus almost completely controlling the behavior of citizens.
Even developed countries have begun to introduce policies that weaken certain freedoms, so Freedom House’s scores in many developed countries have declined moderately over time. For example, the United States ranked 94th in degrees of freedom score in 2010, but only 83rd as of 2020. For more than a decade, more and more revelations have emerged over time that the CIA and NSA are reportedly engaged in massive espionage operations against Americans.
The more digital the world becomes, the more authoritarian, semi-authoritarian, or potentially authoritarian regimes are able to monitor and interfere in the lives of their subjects. Authoritarianism combined with 21st century digital surveillance technology and big data to organize it all is a pretty dire prospect for many. Science fiction books have been predicting this combination for decades.
The discovery of digital scarcity and the invention of Bitcoin
The ability to deal with others is a key part of personal freedom. The more control authoritarian regimes have, the more control they have over the lives of citizens.
Nobel Laureate in Economics Friedrich Hayek once made an interesting remark about money:
I don’t believe we’ll never have so much money again until we take things out of the government’s hands, that is, we can’t violently take them out of the government’s hands, all we can do is through some cunning The roundabout way of introducing something they can’t stop.
—Friedrich Hayek, 1899-1992
Satoshi Nakamoto’s answer to this riddle in 2008 was to avoid centralized clusters and build a peer-to-peer currency system based on a distributed ledger.
I have been working on a new electronic cash system that is completely peer-to-peer, with no trusted third parties.
Governments are good at cutting off the heads of centrally controlled networks like Napster, but pure P2P networks like Gnutella and Tor seem to hold their own.
– Satoshi Nakamoto, two separate quotes from 2008
Satoshi Nakamoto invented Bitcoin in 2008, citing many projects, and after its launch in early 2009, it did become the first widely successful and credible decentralized internet currency. In the genesis block, he cites a popular newspaper headline about a UK bank bailout, at the heart of the global financial crisis.
3 January 2009 “The Times” Chancellor on the brink of a second round of bank bailouts.
– Bitcoin genesis block
The Bitcoin network is a distributed database, also known as a public ledger or “triple entry.” This is a system that allows all participants in the world to agree on the state of the ledger every ten minutes on average. Because it is highly distributed and relatively small in terms of data, participants can store a full copy of it and continuously coordinate with the rest of the network, using specific protocols to determine the consensus state of the ledger. In addition to storing the entire database, participants can also store their own private keys, which allows them to move coins (or fractional coins) to different public addresses on the ledger.
If participants hold their own private keys, neither is the asset their bitcoins represent someone’s responsibility. In other words, like gold, they are money and not currency, as long as others see them as valuable.
More than 15,000 other cryptocurrencies have been created since Nakamoto pointed the way. Some of them are competitors to the Bitcoin network, while others are smart contract platforms for other purposes. So far, all those who are directly trying to be money have not been able to gain any traction on the Bitcoin network (none of them maintain more than 5% of the value of the Bitcoin network), and the few who aim to be used because of smart contracts Utility tokens instead retain sizable network valuations for longer periods of time.
Many believe that Bitcoin has reached critical mass in terms of network effects, security, immutability, and decentralization, so while other digital assets may continue to serve other use cases, none of them have a reasonable chance of competing with Bitcoin in hardware money conditions. Fidelity published a good paper on this topic called Bitcoin First. Here is the summary:
In this paper, we propose:
Bitcoin is best understood as a monetary commodity, and one of Bitcoin’s main investment thesis is as a store of value asset in an increasingly digitized world.
Bitcoin is fundamentally different from any other digital asset. No other digital asset is likely to improve Bitcoin as a monetary commodity, and since Bitcoin is (relative to other digital assets) the most secure, decentralized, and reliable digital currency, any “improvement” will inevitably face trade-offs.
There is not necessarily a mutual exclusivity between the success of the Bitcoin network and all other digital asset networks. Instead, the rest of the digital asset ecosystem can serve different needs or solve other problems that Bitcoin simply cannot.
1. Other non-Bitcoin projects should be evaluated from a different perspective than Bitcoin.
2. Bitcoin should be seen as an entry point for traditional distributors seeking exposure to digital assets.
3. Investors should hold two distinct frameworks to consider investing in this digital asset ecosystem. The first framework studies the inclusion of Bitcoin as an emerging monetary commodity, and the second framework considers the addition of other digital assets with a venture capital nature.
Other blockchains that try to increase transaction throughput at the base layer or add more computational power at the base layer often sacrifice some degree of decentralization and security for this. Blockchains that try to have more privacy at the base layer often sacrifice some degree of supply auditability.
Bitcoin is slowly updated over time through optional soft forks, but its underlying foundation maximizes decentralization and hardness, not throughput or additional functionality. Layers built on top of it can increase throughput, privacy, and functionality.
The discovery of a reliable way to maintain digital scarcity, and the invention of peer-to-peer money based on that discovery, is in some ways inevitable, although the particular form in which it first appeared may have been devised in multiple ways. The foundations of the Internet were developed in the 1970s, as was the concept of Merkle trees. Throughout the 1980s and 1990s, as more and more of the world’s computers were networked together, the Internet as we know it came into being. Proof-of-work using computer systems was invented in the 1990s, and SHA-256 encryption was released in the early 2000s. Satoshi Nakamoto brought these concepts together in a novel way in 2008, with the right macroeconomic context and the right design decisions, making it a success that has continued for over a decade and counting.
Bottom-Up Monetization of Bitcoin
If we go back to the gold standard for a moment, the key reason why paper claims are built on gold is to improve its medium of exchange capacity, which is well described by Ray Dalio (Founder of Bridgewater Fund):
Because of the risks and inconveniences of carrying large amounts of metal currency, and creating credit is attractive to both lenders and borrowers, credible parties have emerged to put hard currency in a safe place and issue paper claims. These parties came to be known as “banks”, although they initially included various institutions that people trusted, such as Chinese temples, and soon people came to see these “currency claims” as money itself.
-Ray Dalio, The Changing World Order
Bitcoin, on the other hand, is a bearer asset that can be safely self-custody in large quantities and can be sent peer-to-peer around the world over the internet. Thus, it removes the need for abstraction of the paper. Some holders will still prefer a custodian to hold it for them, but this is not as necessary as owning a large amount of gold, so the units of the network are less prone to centralization. Unlike gold, large amounts of bitcoin are easy to move and safe around the world.
From the very beginning, the Bitcoin network was designed as a peer-to-peer network with the intention of being a self-custodial medium of exchange. It’s not the most efficient way to exchange value, but it’s the most unstoppable online. It has no centralized third parties, no centralized attack surface, and its sophisticated way of operating can even bypass fairly hostile networks. Compared to altcoins, it is harder to attack due to its larger network effect and larger hash rate.
For example, one of the early use cases for Bitcoin in 2010/2011 was when Wikileaks was abandoned by PayPal and other payment providers, so it started accepting Bitcoin donations. Satoshi Nakamoto himself expressed concern on the forum at the time, as Bitcoin was still in its infancy relative to the amount of attention it would bring.
Kind of like a tank designed to get from point A to point B through resistance, but not ideal for daily commutes, the base layer of the Bitcoin network is designed to make global payments through resistance, but is not very suitable for buying coffee on the way to work.
In this sense, the Bitcoin network is useful to both ethical and unethical participants (like any powerful technology). And because it’s broken down into 21 million units (each with 8 decimal places, yielding 2.1 trillion subunits), it’s a finite digital good.
This is how Satoshi Nakamoto described it:
As a thought experiment, imagine that there is a base metal that is as scarce as gold, but has the following properties:
– Matte grey
– Not a good electrical conductor
– Not particularly strong, but not malleable or malleable either
– Not useful to anyone for practical or ornamental purposes
and a special, magical property:
– can be transmitted over a communication channel
If it somehow gained any value, anyone who wanted to transfer wealth over long distances could buy some, transfer it, and have the recipient sell it.
– Satoshi Nakamoto, 2010
In addition to being sent online, bitcoins in the form of private keys can be carried around the world. You cannot carry large amounts of physical cash or gold through airports and across borders. Banks can block wire transfers out of the country or even within the country. But if you have Bitcoin, you can bring in an unlimited amount of value globally, whether on your phone, on a USB stick, or on some cloud drive that can be accessed from anywhere Elsewhere, or just memorize a 12-word mnemonic (this is an indirect way to memorize the private key). It is difficult for governments to prevent this from happening without extremely strict surveillance and control, especially for tech-savvy citizens.
The utility, combined with an auditable and limited number of coins, eventually gained attention for its monetary properties, so Bitcoin earned a monetary premium. When you hold Bitcoin, especially in self-custody, what you hold is the storage power to execute hard-to-block global payments, and the storage power to move your value around the world if you want to. You hold your place on the global ledger, similar to holding a valuable domain name, except that unlike domain names, Bitcoin is decentralized, fungible, liquid, and self-custody. It may be an insurance policy for yourself someday, or you may simply hold it because you recognize that this ability is valuable to others and that you can sell this ability to others in the future.
In other words, Bitcoin is becoming a fairly popular commodity and has a higher stock-to-flow ratio than gold.
It’s volatile, but that’s largely because it’s gone from zero monetization to a trillion-dollar market cap in twelve years. As more people buy it over time, the market is exploring the technology and trying to determine its potential total market. It is still an asset for only about 2% of the global population and only a fraction of global financial assets.
Censorship resistance is an important feature in payments, while self-custody funds that cannot be diluted by more supply are an important feature in savings.
To many in the developed world, these characteristics may seem unimportant because we are privileged to take our freedom and comfort for granted. But for a large portion of the world, the wealth of being able to take self-protection with you if you have to leave your country is immeasurable. When Jews fled Nazi-controlled Europe, it was difficult for them to carry any valuables with them. When people left the decaying Soviet Union, they could only take the equivalent of $100 with them. Today, when people want to leave Venezuela, Syria, Iran, Nigeria, China, eastern Ukraine, or any number of countries, it is sometimes difficult for them to take a lot of value with them unless they have self-custody bitcoin. Millions of people (arguably billions) today can understand the value of this feature.
Reuters has documented Putin’s domestic political opponents using Bitcoin as Putin’s establishment cuts them off from banking ties. The Guardian has documented the use of Bitcoin by Nigerians as they protest the government against police brutality and freeze their bank accounts. The Chinese use it to transfer value through capital controls. Venezuelans use it to escape hyperinflation and move value out of their failed state. One of the earliest use cases was paying Afghan girls a form of money that male relatives could not confiscate and that they could take with them abroad when they left. I’ll dig deeper into these examples later. In 2022, Canada used emergency powers to freeze protesters’ financial accounts, as well as those who donated money to protesters,
The limited scalability of Bitcoin’s base layer has not been an issue so far, as there is only so much demand for tank-like censorship-resistant payments. Since the launch of Bitcoin, the network has branched into layers like any other financial system as development has continued. For example, the Lightning Network is a series of smart contracts that run on top of the base layer of the Bitcoin network, allowing custodial or non-custodial quick payments online or in person using a mobile phone to the point that it can be done easily. For buying coffee, there is almost no limit on transactions per second. As another example, the Liquid network is a sidechain that wraps Bitcoin into a federated network for fast transfers, better privacy, and additional features in exchange for some security tradeoffs.
In this sense, Bitcoin started out as a digital commodity with utility, as an internet-native and censorship-resistant medium of exchange for those who needed that ability. Bitcoin eventually gained a monetary premium as an emerging and volatile store of value (an increasingly popular commodity) and began to be held for its scarcity rather than its medium of exchange capacity. Then over time, the network developed other methods to enhance the network’s medium of exchange capabilities beyond its initial limitations.
Too many people look at Bitcoin and say, “The base layer doesn’t scale so everyone in the world can do everything with it”, but that’s not what it’s about. The base layer is a censorship-resistant payment and settlement network with an auditable supply cap capable of processing hundreds of thousands of transactions per day, while layers built on top of it can be used for more frequent transactions than needed.
Kind of like we don’t use Fedwire transfers to buy coffee, Bitcoin base layer transactions are not suitable for buying coffee. A Visa transaction running on Fedwire, or a Lightning transaction running on Bitcoin, can be used to effectively buy coffee. Even custodial payment methods like Cash App and Strike that run on top of Bitcoin/Lightning Network can be used if censorship resistance is not required. The base layer of the Bitcoin network is not competing with the likes of Visa; it is competing with central bank settlements; the roots of the global financial system. It is a completely independent root layer, built on computer network technology and Internet protocols, rather than a channel between central banks and commercial banks.
It’s also worth knowing about Gresham’s Law, “bad money drives out good money”. When choosing between two currencies, most people spend the weaker one and hoard the stronger one. Bitcoin’s current low usage as a medium of exchange is not a flaw. This is a characteristic of the system, with low issuance and a hard cap of 21 million units, especially where it is not legal tender, so every transaction is a taxable event. Bitcoin is useful for its payment utility when a tank-like medium of exchange is required, or for some other niche use case. Otherwise, it is often viewed as a scarcer asset than the U.S. dollar and other fiat currencies due to its monetary premium, and represents the storage capacity to perform tank-like payments in the future.
To date, Bitcoin as a network and surrounding ecosystem has gone through multiple boom/bust cycles, and in each cycle, a larger pool of capital has become interested in it. In the first era, user experience was challenging and required an understanding of technology, so it was mostly computer scientists and hobbyists who built and explored technology. In the second era, Bitcoin became easier to use and achieved sufficient liquidity to be quoted in USD and other fiat currencies, so it was noticed by early speculators as well as darknet buyers/sellers. In the third era, it reached early mainstream adoption, where exchanges with proper security protocols could operate in connection with banks, provide more liquidity to the market, and improve the user experience, making it easier for ordinary people to buy.
It will be interesting to watch how the Bitcoin ecosystem develops. Will it remain fairly decentralized, or will it eventually become more clustered so that transactions are easily censored? Will it continue to maintain a strong market share in the digital asset ecosystem against thousands of competitors who are diluting each other and trying to take a slice of Bitcoin’s monetary premium? I’m optimistic about the web, but it’s not without its challenges and risks.
Enterprise-custodial stablecoins are created through smart contracts to apply blockchain technology to fiat currencies. Using these systems, USD custodians can issue tokens on the smart contract blockchain, and each of these tokens can be exchanged for USD from the custodian on a one-to-one basis.
To create a custodial stablecoin, clients deposit U.S. dollars with the issuer and in return issue the stablecoin. To redeem stablecoins, customers deposit stablecoins and receive USD in return. Different custodians have different track records on the security of their USD collateral holdings; users must trust that custodians will not use funds for bad investing or fraud. Attestations and/or audits by third-party accounting firms can add to the assurance that the collateral is secure.
Once a stablecoin is issued, people can send and receive stablecoin payments between them peer-to-peer using whatever blockchain they issue, without the need for additional centralized third parties. From a user’s perspective, stablecoins represent a significant technological leap over existing bank payment systems, especially for international payments or large domestic payments. You can send $1 million to someone on another continent at 2pm on Sunday, and they can receive it in minutes, with both parties verifying the transaction on the blockchain in real-time.
In many cases, they will naturally face ongoing government regulation and be controlled and monitored as part of the banking system, but it is clear that they have utility for real payments and may increasingly be digitally distributed by central banks. Forms integrated into the financial system currency or private but highly regulated stablecoin issuers.
This is simply due to automation and superior technology. When you send a wire transfer, the bank must actively take steps to process the transaction. Wire transfers are often delayed or blocked or run into other problems as they flow between banks. From the user’s perspective, it’s often unclear which bank it’s stuck in or who to call, so it sometimes takes days to resolve. For stablecoins, the opposite is true. The automated nature of blockchain allows for peer-to-peer transactions processed by software, including international transactions and large amounts of money. Custodians are passive in this regard, letting the technology work for them and only taking action if they want to blacklist some of their tokens for some reason.
Anyone who has made a lot of international wire transfers and then used stablecoins will generally say that stablecoins are better. In other words, regulated stablecoins allow for an automated peer-to-peer international payment system, but with control overlays based on know-your-customer and anti-money laundering “KYC AML” laws, as well as an important element of escrow trust.
Central Bank Digital Currency
Some countries want to take the stablecoin concept further and fully nationalize it within their jurisdiction. This uses similar technology to stablecoins but does not require a blockchain as it is not decentralized.
After more than five years of studying bitcoin and stablecoins in China, these technologies are now being used to create central bank digital currencies. These are digital-native fiat currencies issued by central banks, able to operate over the internet, rather than through the “pipes” of the time-honored global banking system.
From a government perspective, the utility of a pure central bank digital currency is that the government can:
1. Send international payments without the SWIFT system
2. Attempt to bank the unbanked or underbanked
3. Track and monitor any transactions, including the use of big data/artificial intelligence technologies
4. Blacklist or block certain transactions that violate their rules
5. Add expiration dates or jurisdictional restrictions to currencies
6. Withdrawal of money from citizens’ wallets for various irregularities
7. Give Citizens Wallet Money for Stimulus or Rewards
8. Implement deeply negative interest rates on citizen account balances
9. Program funds to have different rules for different groups
10. Relieve commercial banks’ control and expense pressure on the system
In other words, a central bank digital currency could be more efficient, cheaper and easier to use than many existing payment systems. However, in such a system, your currency can also be monitored, given, acquired and/or programmed by the issuer to work only when authorized.
Last year, Agustin Carstens, head of the Switzerland-based Bank for International Settlements (basically the central bank of central banks), had an interesting quote about CBDCs:
For our analysis of CBDCs in general, in particular, we tend to establish equivalence with cash, and there are huge differences. For example cash, we don’t know who is using the $100 bill today, we don’t know who is using the 1000 peso bill today. A key difference from a CBDC is that the central bank will have absolute control over the rules and regulations that determine the use of the central bank responsibility statement. And, we’ll have the technology to do it. These two issues are very important and have a huge impact on what cash is.
From the summary in the above section, there are various types of digital assets. There are decentralized bearer assets, such as Bitcoin, and digital representations of fiat currencies, such as corporate stablecoins and central bank digital currencies. There are other private blockchain funds, such as utility tokens or game tokens.
Some digital assets, like Bitcoin, reduce the ability of the government to interfere with your money because you can keep it yourself and send it to anyone you want. As The Guardian reported in July, when Nigeriens began protesting their government’s violence against the police and found their bank accounts frozen as a result, many of them turned to bitcoin to stay afloat.
Nigeria saw its biggest protests in decades last October, with thousands marching against police brutality and the infamous SARS police force. During the “EndSars” protests, security forces abused their position by beating demonstrators and using water cannons and tear gas on them. On 20 October, more than 50 protesters were killed, at least 12 of them shot dead at the Lekki Toll in Lagos.
The repression is also financial. The bank accounts of demonstration-supporting civil society organizations, protest groups and individuals who raised funds to liberate protesters or provided first aid and food to demonstrators were suddenly suspended.
The Feminist Coalition, a collective of 13 young women formed during demonstrations, gained national attention when it raised funds for protest groups and supported demonstrations. When the women’s accounts were also suspended, the group began accepting bitcoin donations, eventually raising $150,000 through the cryptocurrency for its fighting fund.
Many merchants facing sanctions use Bitcoin for international transactions (also from the Guardian article):
His business — importing woven shoes from Guangzhou, China, to the northern city of Kano and his home state of Abia further south — took a hit as the country’s economy grew. The ban threatens its brink. “This is a serious crisis: I have to act quickly,” Awa said.
He turned to his younger brother Ossie, who had already started trading bitcoin. “He was just accumulating, accumulating cryptocurrencies and saying that at some point in the next few years it could be a huge investment. He also showed me how much I needed it when the FX ban happened. If they accept it Now, I can pay my suppliers in bitcoin — and they accept it.”
Likewise, Reuters has repeatedly reported that Russian opposition leader and anti-corruption lawyer Alexei Navalny is using Bitcoin in his organization to bypass government blockades:
Russian authorities regularly block the bank accounts of the Navalny Anti-Corruption Foundation, an independent group he founded to investigate official corruption.
“They’re always trying to close our bank accounts — but we can always find some way around it,” Volkov said.
“We use bitcoin because it’s a good legal way to pay. The fact that we use bitcoin as an alternative helps protect us from Russian authorities. They see if they shut down other more traditional channel, we’ll still have bitcoin. It’s like insurance.”
Reuters also reported one of the most touching stories , in the early days of bitcoin, an Afghan woman paid many girls with bitcoin because they had no bank accounts and their male relatives often tried to steal from them because they You don’t necessarily have too many rights over your own property. Over the years, the self-custody aspect of Bitcoin has allowed many girls to leave the country with their funds, which is not possible with most other assets:
When Roya Mahboob started paying her employees and freelancers in Afghanistan in bitcoin nearly 10 years ago, little did she know that for some of these women, after the fall of Kabul in August, the digital currency would be theirs. Tickets to leave the country.
Mahboob, founder of the non-profit Digital Citizenship Fund, and her sister have taught thousands of girls and women basic computer skills in centers in Herat and Kabul. Women also blog and make videos, and get paid in cash.
Most girls and women don’t have bank accounts because they’re not allowed, or because they lack documentation for bank accounts, so Mahboob used the informal hawala broker system to send money — until she discovered bitcoin.
Alex Gladstein has extensive articles covering various emerging market use cases for Bitcoin over the past few years, from Sudan to Palestine to Cuba to Iran to Venezuela and more. Anita Posch also has a great interview series titled “Bitcoin in Africa” that explores these use cases in the region. Bitcoin is a tool often used by tech-savvy people to defend against double-digit monetary inflation or the control of authoritarian financial systems.
We’re even seeing this topic pop up in developed markets. Truckers in Canada protested the government and occupied and disrupted the Capitol building, accepting donations from backers on a crowdfunding site. These crowdfunding sites eventually froze and reversed payments, so many participants turned to Bitcoin as a peer-to-peer currency. The government then invoked the 1988 Emergency Act to freeze the bank accounts of certain protesters and donors, and attempted to blacklist certain bitcoin addresses so they could be taken to exchanges to be exchanged for Canadian dollars.
People may agree or disagree with certain aspects of these protests, but the pragmatic point about money in this case is that those who put their money in the bank entirely are really frozen. Those who self-custody their digital assets (such as Bitcoin), while freed from certain conveniences, can still hold, move, and transfer their funds in a variety of ways.
In the broadest sense that applies internationally (especially for developing markets where the rule of law is weaker where most people live), I describe the problem here:
Other digital assets, such as CBDCs, are the opposite of such assets, giving the government more power to monitor and condemn your money when, in fact, it’s not even your money. This is the responsibility of your country’s central bank, and as Carstens eloquently articulates, each central bank wants to be able to determine how their debts are used. The full consequences of that statement can mean very different things, depending on whether you live in a place like Norway or a place like China.
The European Central Bank released a working paper on CBDCs in early 2020, titled “Layered CBDCs and Financial Systems,” which outlines the ability of CBDCs to better control illicit payments and allow for deeper negative interest rate policies, particularly in Physical banknotes removed from circulation. This effectively converts public savings into digital currency, which the government can more easily lower and control as needed, and get more seigniorage from:
Source: Layered CBDCs and Financial Systems, European Central Bank, January 2020
This becomes even more important when we consider that the government can always try to expand the scope of its “illegal”, especially when it comes to protests and things of this nature. Basically, we have to ask ourselves, not what the current political leadership will do with this technology, but what all the future political leadership that we don’t yet know will do with this technology. How will Norway use this technology compared to how China will use it?
Although the average understanding of Bitcoin by liberals and fiscal conservatives has increased so far, this feature is also why there are still some progressive/left voices who see Bitcoin as a tool to achieve their goals . At the end of the day, Bitcoin is more of an anti-authority monetary technology than a “left” or “right” one, especially as the Human Rights Foundation uses it extensively in its international activities.
Critics of Bitcoin often ignore these humanitarian or anti-authoritarian use cases (or don’t even realize them), and instead refer to Bitcoin as being primarily used to buy drugs or ransomware or money laundering, a truly outdated ( or intentionally misleading) views at this point. Firms such as Chainalysis, which conduct blockchain analysis for law enforcement and other clients, have found that over the past few years, Bitcoin and cryptocurrency use in illicit activities accounted for less than 1.5% of Bitcoin/cryptocurrency transaction volume, a low as a percentage of fiat currency. Transactions used for illegal activities.
Bitcoin went through an early stage from 2011 to 2013, used to buy medicines online and more, until authorities cracked down on that use by tracking down the centralized marketplaces that enabled it. Just like the invention of how drug dealers and doctors used pagers in the 1970s and 1980s, Bitcoin has gone through phases where criminals use it and humanitarians use it for their purposes. These two groups are particularly motivated to rapidly adopt new technologies to stay ahead of state-sponsored competition, and Western media must remember that “illegal activities” in some countries include protests against governments and other forms of free speech and political opposition.
Like any powerful technology, Bitcoin can be used for good or bad. Bitcoin, as proponents of the technology say, is “enemy money” because it’s a bearer asset that can be verified rather than trusted, and it’s hard to block anyone’s payments. It’s like a commodity; something that can be partially regulated in some jurisdictions but exists in a holistic sense outside of anyone’s control.
If we step back, we can catalog the history of financial surveillance. For most of human history, financial transactions were fairly private from a government perspective, as transactions mostly involved the handover of physical currency, which was difficult to trace. With the invention of modern banking, especially modern computer databases and electronic payments, transactions can be more easily tracked and monitored. The Bank Secrecy Act of 1970 required financial institutions to report transactions over $10,000 to the government, which at the time was the equivalent of $75,000 in today’s dollars. Despite 5 years of inflation, they never raised the threshold, so over time, without further laws being passed, their surveillance reporting requirements started to apply to smaller and smaller transactions.
When people use banks to send or receive money, it’s easy for governments to impose restrictions on the types of payments allowed, which banks can then enforce. Some governments can even prevent other foreign governments from using existing major international payment methods. Bitcoin threatens this surveillance and control model because it enables peer-to-peer transactions. The Bitcoin network consists of people who use free and open-source software to update the public ledger between them. It’s basically just a sophisticated way of updating the equivalents of distributed Google spreadsheets to each other without a centralized server. Governments trying to prohibit people from doing this are tantamount to prohibiting the spread of information.
Governments will be challenged by this technology, and many of them have and will fight back against it. They can allocate law enforcement resources to track truly illegal activity (tracking major cryptocurrency payments involved in serious crimes), but may struggle to maintain control over benign transactions. They can use on-chain analytics to try and track transactions, they can implement surveillance checkpoints on cryptocurrency exchanges, they can prevent banks under their jurisdiction from interacting with any cryptocurrency exchange, and in extreme cases, they can People using cryptocurrencies severely punish open source software for updating public ledgers among each other. Meanwhile, developers continue to find ways to make the Bitcoin network more private and address some of the challenges it may encounter. One can also use some privacy-specific coins.
Regardless, these different types of digital currencies or currencies will obviously be in our future in some form or another. Depending on where we live and the choices we make, we are more likely than others to experience some, from Bitcoin to enterprise stablecoins to central bank digital currencies.
something to prove
A popular topic in Bitcoin is the term “Proof of Work (POW)”. The concept was invented in various ways by cryptographers in the late 1990s, notably by Dr. Adam Back in the form of “Hashcash” – a money-like mechanism for Spam and denial of service attacks reduce computational cost.
Satoshi Nakamoto’s Bitcoin whitepaper cites Back’s work and has proof-of-work as one of its core aspects.
Today, there are various attempts to maintain the scarcity and security of digital networks with various digital assets in the form of “Proof of Stake”, “Proof of History”, “Proof of Transfer”, “Proof of Destruction”, “Proof-Space”, etc.
In any form, money is proof of something. This section explores three popular examples of Proof of Work, Proof of Stake, and Proof of Strength.
Proof-of-work assets are created or harvested from mining activities, and proof-of-stake assets are created by breaking up projects and selling some of those parts to others. Proof-of-strength assets or fiat currencies are created by the government and its designated commercial parties (bank license holders).
Proof of employment
When we go back to the example of rai stones, it is clear to their users that they are a powerful proof-of-work mechanism. In addition to having a high stock-to-flow ratio before modern technology interferes, each stone is undeniable proof that it took a lot of work to create it and put it in place.
A team of young men had to travel hundreds of miles to another island, quarrying stones with ancient tools, bringing back several tons of stones to their wooden boats, which were then carved and moved to their home island. The amount of work required to do this limits flow (new annual supply) and maintains a high stock-to-flow ratio for a long time. The larger the stone, the more work it takes to produce and ship it there.
Of course, historically, gold is the best example of proof-of-work that has stood the test of time and is different. After painstakingly searching for gold, it takes enormous mechanical effort to move tons of dirt out of a few grams of gold, which must then be refined into its pure form. Each gold coin or bar actually represents tons of rock being moved and sorted, and gold is more resistant to degradation than other elements. The Earth’s crust consists of less than 0.0000004% gold, compared to more than 28% silicon, more than 8% aluminum, and more than 5% iron. Even as our technology improves and we get better at finding and recovering gold, the easiest deposits are running out, so it’s getting harder, which offsets our improved technology.
Basically, proof of work is just that: proof that work has been done, and since work is inherently scarce, we tend to think of proof of work as proof of value, but only if the finished product in question has monetary properties. This is an important distinction; we don’t pay for non-monetary goods or services based on the amount of work put in; we pay them based on the amount of work they do for us.
In other words, something akin to the labor theory of value does not apply to utility commodities, but does apply to money commodities.
This is because market participants will naturally attempt to arbitrage any commodity that earns a monetary premium above the utility value it provides. Money commodities that do not require labor are inevitably copied and devalued (thus leaving only those commodities that require labor as proper money), while commodities without a monetary premium are not worth repeating endlessly. Basically, a lot of work to produce a unit and a consistently high inventory-to-flow ratio are essentially the same thing when it comes to money. It is this kind of work that requires keeping the stock-to-flow ratio of a commodity high, and any commodity that fails to maintain a high stock-to-flow ratio in the face of advancing technology will eventually fail in the form of money. Only the scarcest money maintains a constant currency premium, not its utility value, which continually invites devaluation attempts.
For Bitcoin, a new block of transactions is produced every ten minutes on average and contains the cryptographic hash of its previous block, linking the blocks together to form a chain. It takes work (computer processing power) to solve this puzzle and find new blocks that fit. A blockchain ends up being a long list of blocks hashed onto previous blocks, proving that a lot of work has been done. Copies of the blockchain are distributed across tens or hundreds of thousands of computers around the world and are constantly updated.
A transaction identified by the chain is inherently immutable because it is hidden under thousands of hash blocks and widely distributed across these global computers.
And because Bitcoin has a larger network effect than most other cryptocurrencies, the cost of attacking the network is much higher than attacking most other cryptocurrencies. This, coupled with a sufficiently decentralized network of nodes that monetary policy (or, more precisely, the initial coin allocation policy) cannot actually be changed, allows Bitcoin to accumulate a persistent hard currency premium rather than other cryptocurrencies having difficulty maintaining . In the big picture, though, it’s only thirteen years old.
Proof of Stake
Proof of stake is a stake-like system through which asset holders can determine how that asset will work. In other words, each coin serves as a vote for the network.
Just like proof of work, we can turn this back into a simulated example. In particular, proof of stake is often used for company ownership. The more shares of the company you own, the more say you have in electing board members to run the company and supporting or rejecting shareholder proposals. If you or a group of entities following you can control 51% of the shares, you effectively control the entire company.
Again, some blockchains use this approach. Instead of mining coins with real-world resources, users create new coins by signing transactions as validators. In order to become a validator, users must prove that they own a certain amount of coins. Some pre-Bitcoin digital currencies attempted to use such a strategy, and many post-Bitcoin attempts to use it in the form of a blockchain.
The risk with proof-of-stake systems in both the analog and digital worlds is that they tend to concentrate into oligopolies over time. Since it doesn’t require a constant investment of resources to maintain your stake and grow over time, wealth tends to compound into more wealth that they can then use to influence the system to give themselves more wealth, etc.
Adam Back (PhD in Cryptography, University of Exeter, UK, inventor of Hashcash) succinctly described this some time ago:
You’ll see this in other commodity currencies like physical gold, and it’s an efficient system because money has a cost. I think money without cost ends up being political in the end, so people who get close to money, the so-called Cantillon effect, will gain an advantage.
In digital systems in particular, another challenge is that Proof of Stake as a consensus model is much more complex than Proof of Work and is prone to more attack surfaces. If a proof-of-stake chain is split or maliciously copied, it is not self-evident which chain is the real one, with human/political decisions among oligopolistic participants normalizing one chain. However, in a proof-of-work system, the true chain is immediately verifiable, because by definition, the chain that follows the node consensus ruleset and has more work is the true chain.
In other words, what makes proof-of-stake blockchains intrinsically similar to equity is that they require some form of ongoing governance, whereas proof-of-work blockchains (especially decentralized enough to make it impossible to actually change their monetary policy) blockchain) requires some form of ongoing governance. more like a commodity. These differences can be benefits or drawbacks, depending on what participants want from the system. In my opinion, the co-existence of digital commodities and digital stocks represents a new era for the asset class, and we will see where they may be applied successfully.
Proof of Strength
As described by Warren Mosler, founder of the MMT school of economic thought earlier in this article, fiat currencies are basically proof-of-strength, which is why it can beat proof-of-work currencies for a long time.
The demand for government paper (or digital equivalent) is created by the government taxing the population and can only be paid for in units of that paper. Failure to pay taxes can lead to loss of assets, jail time, or, if you resist these prior consequences, being shot by the police. Proof-of-strength systems work by taxing, friction and other barriers to any currency harder than their own, or in some cases by making their use a felony.
Of course, proofs of power existed for thousands of years before fiat currencies were invented. Any warlord, kingdom or empire that demands tribute from the people of the lands it rules is familiar with the concept of proof of strength. The purpose may be malicious or benign, that is, to provide order to society and to collect a certain percentage of resources for the public good. Even democracies use proof of strength as a method of organization. Nature abhors a vacuum, and humans are continually agglomerating into hierarchies and social structures. In other words, not every politician is like Caligula. Some of them were more like Marcus Aurelius, or democratically elected.
In most eras, this tribute took the form of commodity money, such as gold or other trophies that were already considered money through proof of work. In modern times, however, governments have removed the proof-of-work part from the equation through technology (banking systems and efficient national communication systems), so when we think of dollars, euros, yen, and other fiat currencies, they are basically just Represents Proof of Strength. When we say the U.S. dollar is “backed by the full confidence and credit of the U.S. government,” what we really mean is that the U.S. dollar is backed by that government’s ability to tax by any means necessary, including force (and is backed by the petrodollar system) ; the ability of the U.S. government to maintain a monetary monopoly over global energy pricing).
This sounds a bit exaggerated, so we can put it in context and dial it back a bit. Even Switzerland, known for centuries of geopolitical neutrality in the face of war, has a natural use of proof of strength to tax its fiat currency. So even the most benign and non-violent societies, with as little bellicose purposes as possible, still use this proof-of-strength mechanism to secure the use of their government-issued funds in society as a way of feeding the government . In a benign environment, because people vote for the government, or if they don’t want to abide by those rules, they can leave the country and renounce citizenship, so they can choose another country’s set of rules if the other country lets them in.
To put it bluntly, if you don’t pay your taxes, and it’s in fiat currency accepted by the government, you’ll end up being knocked on your door by someone with a gun, and/or you’ll have to leave and leave somewhere else. This remains the case unless or until the country’s fiat currency collapses enough that most people can’t/won’t use it and the government can’t enforce its use at this level of monetary rebellion, which happens during and around hyperinflation – Hyperinflation, including many modern developing countries.
Stock-to-flow ratios for major fiat currencies average between 5x and 20x in most cases, so stock-to-flow ratios for major fiat currencies are higher than for most commodities, but lower than for bitcoin and gold. However, in addition to having a high stock-to-flow ratio, fiat currencies benefit from unique support from governments, including active stabilization in an attempt to reduce volatility, which gives them a degree of staying power.
Final Thoughts: Thinking Outside the Box
When money in society changes, it always feels weird to those who experience it. Imagine you’re someone who’s spent your entire life making money out of shells, just like your mother, grandmother, and great-grandmother before you. Then, thanks to interactions with foreigners, shiny yellow and grey metallic circles with photos of people’s faces started being used as money and seemed to be replacing your seashells. Foreigners, with better technology, seem to be able to produce all the shells they want (which devalues them), but their shiny metal circles are harder to make, so don’t seem to be affected by the devaluation.
Or imagine spending your entire life using gold and silver coins as money, just like your father, grandfather, and great-grandfather, thousands of years after the global history of these things being used as money. Then, due to changes in technology and government directives, you should switch to gold-backed paper money and treat them the same way, it’s actually illegal to own gold. Then they removed the peg to gold and you should still keep using the paper at the same value even though the amount of paper seems to be increasing. Successful papers that are actively managed tend to be fairly stable in most cases, even if they depreciate over time.
Finally, imagine using these unsubstantiated documents as money for your life. The interest rates on these papers are initially above price inflation and have fairly stable purchasing power each year, but over time the rates continue to fall until they are well below the prevailing inflation rate, meaning you hold these papers over time loss of purchasing power over time. Then some anonymous entity comes along and creates internet money through encryption and algorithms you don’t fully understand, but it seems to have been growing in users and value for over a decade compared to other assets. No one can earn more than a pre-set amount, it can be used for peer-to-peer domestic or international payments, and it can be self-custody and transferred more easily and securely than any previous money.
What should we do in these situations?
I think the first rational thing to do is to be skeptical, we can’t bet all on anything new that people claim to be money.
In fact, to be honest, we might ignore it at first because the probability of any given new thing becoming money is low. It is quite rare in human history for a serious new form of money to emerge. But if it doesn’t go away, and it does survive multiple 80%+ retracements over a decade and gets more and more monetized, then we actually need to study it, test its hardness, and imagine All the ways it could fail.
If we happen to have expertise or interest in the field for some reason, we might invest in it faster, or we might move on with our lives and let it continue to grow so we can learn more about it , and then maybe buy a little and understand it. If competitors pop up, we should probably investigate some of them as well and watch how they behave to see the differences. Then over time, we can basically let the market answer our questions for us. We can hold a certain amount of new money that makes sense for our risk profile and let it appreciate (or not) over time.
If it doesn’t appreciate, then that answers a whole bunch of questions and we’re taking little risk. If it does appreciate, then we’ll continue to watch the asset gain a larger and larger currency premium. It then usually gets owned by more people and becomes a larger percentage of the asset we own because it grows in value faster than our other assets. Because of Gresham’s Law (bad money drives out good money called Gresham’s Law), it doesn’t easily spend too much, but tends to be hoarded, and only used for its tank-like purposes when necessary or in a niche environment payment properties. The vast majority of participants see it as a long-term financial asset. If it becomes very large and dominant and its volatility decreases over time, its use in payouts may rise.
In the long run, it is clear that money will become increasingly digital. The question is, will stateless peer-to-peer bearer assets like Bitcoin become an ever-important version of money with trillions of dollars in market cap, or will state-created CBDCs or state-regulated corporate stablecoins be the main way forward ? And with them co-existing, how much market share can we expect each of them to take? This is a topic I will continue to analyze over time.
As I conclude this post, I will return to an earlier example of Bitcoin being used as a forfeiture-resistant self-custodial payment for women and girls in Afghanistan nearly a decade ago, some of whom Alex Gladstein documented:
Some women did keep their 2013 bitcoins. One of them is Laleh Farzan. Mahboob told me that Farzan worked for her as a network manager, earning 2.5 BTC while working at Citadel Software. At today’s exchange rates, Farzan’s income would now be more than 100 times the average annual income in Afghanistan.
In 2016, Farzan was threatened by the Taliban and other conservatives in Afghanistan for using a computer. When they raided her house, she decided to run away, leaving with her family, selling their house and assets, and paying the brokers to set them on the treacherous road to Europe.
Like thousands of other Afghan refugees, Farzan and her family travelled thousands of miles across Iran and Turkey on foot, by car and by train, eventually arriving in Germany in 2017. Along the way, dishonest middlemen and common thieves steal everything they bring, including their jewelry and cash. At one point, their ship crashed and more belongings sank to the bottom of the Mediterranean. This is a tragic story familiar to many refugees. But in this case, things are different. Through it all, Farzan was able to keep her bitcoins because she hid the seeds of her bitcoin wallet on a seemingly harmless little piece of paper. Thieves can’t take what they can’t find.
This is an example of Bitcoin transferring value across borders where gold and cash have failed. It can be done with a phone, a USB stick, a piece of paper, cloud storage, or even just memorizing a twelve-character mnemonic.
In the long run, whether the Bitcoin network ultimately succeeds or fails, this proof-of-work-backed global distributed ledger is clearly a form of money that is worth understanding.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/a-4d-review-of-the-history-of-currency-transformation-reveals-the-past-and-present-of-cryptocurrencies/
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