₿itcoin & Monetary Policy

14 min read by Luke
published 9 months ago

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We’re living through unprecedented times. 2021 is a year that will go down in history as a great inflection point. El Salvador made the groundbreaking decision to become the first country to adopt ₿itcoin as legal tender. Meanwhile China, which is one of the world’s largest countries by population and military might, waged a nation state level attack on Bitcoin, banning mining and peer-to-peer trading within their country. 

These diametrically opposing policy decisions are all the more interesting because of the extraordinary macroeconomic environment that surrounds us today. Inflation recently hit its highest levels in 30 years and is being felt more than ever by consumers as their wages continue to lag behind the increasing cost of living. The unbridled monetary policies of most of the world’s Central Banks is a major cause of the recent surge in inflation and is now becoming a heavily debated topic across many mainstream platforms and news networks. 

2021 was the 50th anniversary of the Nixon Shock. On August 15th 1971, the issuer of the global reserve currency, the United States, implicitly defaulted on their debt to the world. This event imposed a covert and historically unprecedented monetary experiment upon the entire world. The Nixon Shock ensured that every currency around the globe suddenly lost its ability to be pegged to the gold standard. In almost an instant, the US dollar was transformed into a free floating fiat currency, backed by nothing (initially). For 50 years since, the world has witnessed some of the most exuberant monetary policies in human history.

Figure 1: 5000 year chart of interest rates (source

With debts now at 5000 years highs and interest rates at 5000 year lows, what could possibly go wrong?

History suggests, such an unrestrained monetary policy is unsustainable and just one reason why many find themselves fascinated by Bitcoin as a solution to this faltering financial system. 

What is Monetary Policy?

If you’re new to the goings on in the financial world, you may be wondering, what is monetary policy? 

At a very high-level, monetary policy is the ability of a centralised, command and control central bank to manipulate the supply of money in the financial system, in addition to trying to manage the rate of unemployment, asset prices, Gross Domestic Product (GDP) and inflation in a given economy. Central banks have two main ways with which to achieve their monetary policy aims. 

The first is the often confusing term, Quantitative Easing(QE). Put simply, QE is the process whereby the central banks create currency to purchase financial assets such as stocks and bonds through credit creation. The central bank purchases these assets directly from commercial banks. In return, this supplies these banks with newly created money in the form of reserves. These assets are placed onto the balance sheet of the central banks (see Figure 2) who intend to sell these assets once the economy has “fully recovered.” 

Figure 2: FED Balance Sheet (source

Through this elaborately complicated process, central banks are able bring future money forward into the present via the creation of credit. Here, they treat future promises of money as if they were as good as present money, because the government is able guarantee the promises attached to such money creation. 

Expansionary monetary policy has resulted in seen, unseen, and unintended consequences for society. It’s addictive for monetary policy makers to use this credit creation tool, because of its clear and present short-term benefits. In response to the 2008 GFC, QE was only supposed to be a temporary solution. Fast forward to today and the US central bank is busy buying $120 Billion worth of financial assets each month.

QE is all about the quantity of assets purchased.

Another way central banks manipulate monetary policy is via bond purchases, which artificially suppresses interest rates. This is a process known as Yield Curve Control (YCC). To put it politely, this is a very curious form of monetary policy.

YCC is different in the sense that a central bank will pick a yield or interest rate they want the market to remain at and buy any quantity of bonds it takes to ensure that yields and interest rates don’t rise above their desired rate. This form of monetary policy is typically used when governments become over indebted and need to reduce their debt/GDP ratios. They achieve this by implementing YCC to pin interest rates artificially low, while letting inflation run hot, and at the same time, devaluing their currency to pay down their debt with devalued dollars. 

The last time the US had debt levels as high as they are today was in the 1940’s, at the conclusion of the previous 75-100 year long term debt cycle. Figure 3 (below) shows how the central bank pegged interest rates to 2.5% for the best part of a decade and broke their independence from the government. This enabled the government to run large fiscal deficits in order to pay for World War II. 

Figure 3: Yield Curve Control in the 1940’s (source

This action caused significant inflation throughout the 1940’s which devalued the currency and enabled the US government to decrease their nominal debt/GDP levels from over 120% in 1945, to below 60% by the 60’s (see Figure 4 below). 

Figure 4: US Federal Debt/GDP (source

Another monetary policy tool central banks can use to try to “manage” an economy is by controlling the cost of basic capital (money). Central banks are able to make money more or less accessible to commercial banks by manipulating interest rates. This is another way they can oversee and control the money supply. By lowering interest rates in times of economic slowdown, central banks attempt to incentivise people to borrow money to “stimulate the economy.” 

Conversely, if the economy is too hot and debt becomes too unproductive as inflation starts to rise, central banks can raise rates to try to cool down an overheating economy.

How Does Monetary Policy Affect You?

Why should you care?

Well, there are many consequences to QE that affect all of us in society, more often than not, in concealed and covert ways that tend to go unnoticed by many.

The first of these is moral hazard.

There are a select few policy makers who are associated with deciding whether or not to engage in QE. Those of whom should not be invested in the assets that they are deciding whether or not to bail out. This was most evident during the 2008 Global Financial Crisis (GFC). Wealthy banks and bankrupt corporations received a bail out to the tune of some $700 billion dollars. This was considered a lot of money in those days, unlike, say, the trillions that have been printed over the last two years. 👀

Meanwhile, people were booted from their homes with no such luck of a bail out when the property market collapsed down around them and finally went bust.

Does this sound like fair system to you?

In a global debt crisis operating on an inflationary monetary system, central banks and politicians cannot allow asset prices to fall unless they want to endure a devastating mass deleveraging. Such an event causes great economic pain for society, thus increasing a politicians chances of being voted out of office.

So, to avoid total ruin and a complete collapse of the economy (and therefore society), generally speaking, central banks all around the world have had little to no option but to embark on unsustainable monetary policies. At this stage of the long term debt cycle, with interest rates at or near zero and debt levels so high, their only option is to try to monetize the debt away, with morally hazardous monetary policies. The US government has accumulated nearly $29 trillion in debt, and most of that was added in just the last two years.

With sovereign debt levels coming in over 130%, the inflection point may have already been crossed.

Figure 5: Global Debt Crisis (source

Hirschmann Capital released a fascinating report showing how, since the year 1800, 51 out of 52 countries that reached sovereign debt levels greater than 130% of GDP ended up defaulting on their debt within 15 years. Default came through either devaluation, inflation, restructuring, outright nominal default, or, an implicit default – similar to the Nixon Shock of ’71. 

Mises wrote:

“There is no way to avoid the inevitable bust caused by monetary and credit expansion” (Mises).

In simple terms, Central Banks normally choose to default through inflation and currency devaluation. They do this via irresponsible monetary policies, including rampant credit creation (money printing) that devalues the currency so much that they can start to pay back their massive debts with newly devalued dollars. 

Such a policy is often referred to as ’QE Infinity’. In short, it is a reckless policy that has created large asset bubbles and price dislocations in the economy. Asset bubbles benefit those who already hold most of their wealth in certain assets; like stocks and housing. It is a policy that can (and does) exacerbate the wealth inequality gap – the one that politicians and policy makers always seem so concerned about, and yet do absolutely nothing to fix the fundamental reasons why. 

The monetary policy experiment central banks have undertaken since the Nixon Shock has undoubtedly exacerbated wealth inequality within society. A gap that has risen to levels not seen since the 1930s (see Figure 6). 

Figure 6: Rising wealth inequality (source) Figure 6: Rising wealth inequality (source

Perhaps, you have noticed the increasing un-affordability of housing, as real estate prices continue to soar, outpacing any wage growth, which always lags behind the ever inflating cost of living. Combine these policies with a looming debt crisis and it is easy to see something is terribly wrong, and that something needs to change. Sooner than later.

 

Bitcoin’s Monetary Policy

On October 31st 2008, Satoshi Nakamoto (the pseudonymous creator of Bitcoin) changed the course of history when he published the Bitcoin whitepaper. He announced he had created a new form of digital money featuring a function of unforgeable costliness to produce (PoW; the creation of new units requires real work to produce, which is easily verified) and absolute scarcity. This was not only an historic invention in the fields of technology and computer science – having solved the Byzantines General Problem (the difficulty that decentralized systems have in agreeing on a single truth) – it also signified a tremendous economic breakthrough for achieving a much fairer global monetary policy and subsequent system. 

Satoshi discovered how to create digital scarcity through proof of work mining, encoding the halving of Bitcoin’s issuance every four years. This means, Bitcoin’s distribution of new coins decreases every four years (see below), right up until the year 2140. The net result is that there will only ever be 21 million Bitcoins issued, ever. Bitcoin is digital scarcity.

Figure 7: Bitcoin 4 year or 210,000 block halving schedule (source

Figure 8: Bitcoin 4 year or 210,000 block halving schedule (source

Two Sides of the Same Bitcoin

In 2021, China continued its gross authoritarian reputation by, first, banning Bitcoin mining (for real this time), then proceeding to ban all ‘crypto’ transactions within the country. That China banned Bitcoin again should come as no surprise, since Bitcoin’s free and open financial architecture is fundamentally incompatible with China’s closed, centralised, top down command and control governance model. 

At the same time, rather than ban Bitcoin, the country of El Salvador chose, instead, to opt-into this free and open monetary protocol. In June 2021, president Nayib Bukele created history by announcing the country’s plan to become the first nation state to adopt Bitcoin as legal tender – coming into effect on September 7th 2021. 

Now, any El Salvadoran with a smartphone can voluntarily opt-in to Bitcoin’s free and open monetary policy, and even has the option to avoid using the rapidly debasing US dollar altogether. Previously, El Salvadorans had no way to shield themselves from the arbitrary devaluation of US dollars. Bitcoin is not only challenging central banks’ outdated monetary policies, but also competing with predatory commercial banks that act as parasitic middlemen in the global cross-border transactions industry. In 2020, El Salvador received nearly $6 billion in remittances, of which over $400 million dollars were captured by fees charged by commercial banks.

These two diametrically opposed policy decisions from El Salvador and China are particularly interesting as every major western central bank around the world is currently working on implementing their own version of programable fiat coin, otherwise known as a Central Bank Digital Currency (CBDC).

When these things are inevitably launched, the $1 Trillion question will be, how will western governments react? Especially, if they feel threatened by Bitcoin, like China did.

We know there are those in the highest levels of government, particularly in the US, who seem to feel threatened by Bitcoin. In July, at a congressional hearing, Senator Elizabeth Warren warned that a cryptocurrency, like Bitcoin “puts the financial system at the whims of some shadowy, faceless group of super-coders.”

It should be obvious, those currently in control of the financial system wish to remain in control. Implementing a state issued digital currency, like a CBDC, gives those in power even more control over the financial system, and therefore, over you.

Anyone thinking that implementing CBDC technology will solve the debt crisis is in for a rude shock. It won’t. Indeed, it will only increase a government’s ability to manipulate their poorly incentivised monetary policies even further. Oh, and it will make it even easier to tax, fine and surveil its citizens.

Thankfully, Bitcoin is the antithesis of a CBDC. Bitcoin wrestles control out of the hands of the few who possess the ability to manipulate money and monetary policy and puts it in the hands of the many. 

How Can Bitcoin Impact Monetary Policy

How could fiat and Bitcoin work together in tandem? It’s impossible to know for certain. We’ve never witnessed the adoption of a money that exhibits absolute scarcity. Having said that, we have seen Gresham’s Law play out many times throughout history, particularly as it relates to the evolution and adoption of a new monetary technology. 

Gresham’s Law states: bad money drives good money out of circulation. In simple terms, this means rational economic actors will choose to spend the inferior money, preferring to use it as a medium of exchange, while trying to accumulate as much of the good money as possible in order to store their savings (their value) in. While Gresham’s Law slowly embeds itself into Bitcoin’s monetary policy, and as more people stop using fiat money as a store of value – all the while adopting the harder currency of Bitcoin – Gresham’s law acts as an unstoppable forcing function compelling central banks to be more fiscally responsible or otherwise become irrelevant.

On a hypothetical Bitcoin standard, without the ease of rehypothecation, governments will find it difficult to fund their irresponsible and wasteful spending by running up large, unfunded fiscal deficits.

Why? Because they would run out money. 

A recent article  by the International Monetary Fund(IMF) makes note of the predicament many central banks may soon face:

If central bank money no longer defines the unit of account for most economic activities—and if those units of account are instead provided by crypto assets—then the central bank’s monetary policy becomes irrelevant”. – Bitcoin Policy in the Digital Age

Bitcoin’s superior monetary policy protocol – a policy written in code based on rules, not on the whims of rulers – has the ability to render a central bank’s monetary policy “irrelevant” as more and more people become aware of Bitcoins superiority as a sound, secure and highly reliable store of value. 

Government issued CBDC’s cannot compete with Bitcoin. Central Banks will need to find a way to accept it and live with it…

Conclusion

History is full of examples of currency collapses, hyperinflations and sovereign defaults occurring all throughout the world. The unifying theme amongst them is the unreal economic ideology – popularised by John Maynard-Keynes – that you can always get something for nothing.

Every single central bank around the world appears to be accelerating towards yet another currency crisis. Unlike previous hyper-inflationary events, this latest currency crisis is unlikely to remain confined within certain borders. Our globally, interconnected, modern financial system ensures any impending crisis will likely be seen, heard, and felt on a global scale. 

In this decade, every individual, corporation, institution, company and nation state has a critical decision to make in the face of growing financial repression and the increasingly likely potential of a U.S. currency collapse. In similar times of unsound currency instability, those who stored their wealth in a hard assets and sound money (like Bitcoin) were well protected and better positioned to weather the storm. Those who ignored economic reality had their wealth stolen via the covert taxation that is inflation.  

Bitcoin is financial security for those most vulnerable to inflation, including hourly wage earners and retirees on fixed incomes. Moreover, Bitcoin gives every person on Earth the ability to be their own bank; to protect their savings from devaluation and shield themselves and their family from bad government policy, a fundamental misunderstanding of money, therefore leading to more mismanagement of the wider economy over time.

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