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This is the first of two articles published in Bitcoin Magazine, written by by Shawn Amick as a guest post and really looka s what could be considered the nub of the whole future of cryptcuurencies when it comes to being mainstream and thus potentially replacing Fiat currencies. Make sure you read both articles to get a feel for the issues involved. They are of course the opinion of the writer but still make for interesting reading.
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Many a Bitcoin maxi have been asked the question, “Ok, but how does bitcoin replace the dollar?” Here’s my attempt to answer that question.
This will be a short series, the first of which discusses what caused us to lose the gold standard, the second discusses architecture and the third seeks to offer solutions within those frameworks.
I’ll begin by reminding the reader that I am neither a skilled developer, nor a practiced economist. I welcome criticism of my worldview and hope that you will expand on my shortcomings with your own works, or suggestions to this one. With that being said…
At the beginning, of course. We look to systematic replacements of old to understand our current emergence of monetary technology.
Bitcoin is understood as sound money, defined as “money not liable to sudden appreciation or depreciation in value” by Merriam Webster.
Sound money was achieved through the gold standard by attaching the U.S dollar to gold. This works by determining a fixed rate at which dollars can be exchanged for gold. For instance, in 1945, one ounce of gold cost around $34.
Why measure this in one ounce? Because “the official and market prices of gold are expressed as the number of currency units per fine ounce,” per a researcher from the University of Illinois.
The idea of determining a fixed rate pegged to a scarce asset like gold is used for the purpose of making sure that the asset (gold) cannot be devalued by an increase, or decrease (rapidly) in the money supply, or total amount of dollars that exists.
But this gold standard was abandoned by the U.S. Why?
While the United States didn’t enter World War 1 until 1917, the economic effects were felt immediately in 1914, during the outbreak:
“Late in July, as foreigners began liquidating their holdings of U.S securities and as U.S. debtors scrambled to meet their obligations to pay in sterling, the dollar-pound exchange rate soared as high as $6.75, far above the parity of $4.8665,” according to “The International Gold Standard And U.S. Monetary Policy From World War I To The New Deal” by Leland Crabbe. “Large quantities of gold began to flow out of the United States as the premium on sterling made exports of gold highly profitable.”
Suddenly, talks of collapse were abound and New York felt a sharp plummet in share prices. On July 31, 1914 the New York Stock Exchange followed suit with other world players and closed its doors to prevent foreign sales of U.S. securities in exchange for gold. Relief was a necessity that couldn’t come quickly enough. Austria, Hungary, France, Germany and Russia all abandoned the gold standard in the early days of the war. Britain held on by creating bureaucratic redundancies and mass appeals to patriotism to prevent gold redemption.
“The most important relief measure came on August 3, [year?] when Secretary of the Treasury William McAdoo authorized national and state banks to issue emergency currency by invoking the Aldrich-Vreeland Act,” per Crabbe.
This “emergency currency” came in the form of bank notes, redeemable for gold. The U.S enjoyed its first taste of printing currency, and it worked. This would lead to the U.S becoming a creditor as world powers became reliant on the closest thing that the world knew as sound money.
“Five months after the United States entered the war, President Wilson issued a proclamation that required all parties who wished to export gold from the United States to obtain permission from the Secretary of the Treasury and the Federal Reserve Board,” according to Crabbe. Because most of these applications were denied, the United States effectively embargoed the export of gold, and this embargo partially suspended the gold standard from September 1917 until June 1919.”
Following the war, efforts were made in restoration of the gold standard by all participating countries, but the U.S effectively remained the only country to retain the mantle. Sound money was all but lost to time, and to summarize this change in poetic verse, William A. Brown stated:
“The United States was dragging her golden anchor. Indeed, she was carrying it on deck, but as long as she was still attached to it, she felt safe even though it was no longer fast to the ocean bed.”
We held to sound money principles, even when we no longer had them, as it was the hopes of a global economy that we would.
“At the end of 1925, thirty-nine countries had returned to par, had devalued their currency, or had achieved de facto stabilization with the dollar,” Crabbe wrote.
The financial peace agreement failed to last long. The U.S. relished in the saving graces of printed notes, and global powers began to act on their own accord.
“But the stabilization did not last, as the French government continued to run large budget deficits, a situation that led to a confrontation between the nation's monetary and fiscal authorities,” per Crabbe.
A run on the banks of Austria to claim gold led to German panic which would eventually reach London in 1931. The inability to meet demand for paper claims inevitably led to the fall of the gold standard of most global powers.
War necessitates the printing of money. Paper claims become a requirement to fictitiously meet monetary demands, as there aren’t enough sound assets in the world that allow a global economy to wage endless war.
The U.S still held onto its golden anchor at the end of 1931.
“The United States was ejected from the Gold Standard because its macroeconomic fundamentals got out of line with those of other members of the system,” according to the authors of “An Assessment Of The Causes Of The Abandonment Of The Gold Standard By The U.S. In 1933.”
Once the United Kingdom abandoned the gold standard in 1931, the world became skeptical of the market as a whole and any nation state’s ability to save the bygone monetary system.
“The main problem for the United States was that French interest rates increased relative to American interest rates, and gold flowed from the latter to the former country, eventually requiring macroeconomic adjustment in the United States, namely, a reduction in the demand for money via any combination of higher U.S interest rates, lower prices, or lower production,” per “An Assessment.”
The rest of the world had abandoned sound money principles, and because of this, gold flowed out of the states as it maintained its position. This created a need for a macro adjustment, or a change that could affect the global scale. Why?
Redemption was becoming an issue. People were running to exchange their dollars as quickly as possible for sound money, or gold.
“It is not a coincidence that gold was suspended amidst the third banking panic as Roosevelt moved decisively to save the banks and stimulate the economy by lowering interest rates,” according to “An Assessment.”
President Franklin D. Roosevelt is panicked, the U.K. has already abandoned the gold standard, French pressures are creating a gold exodus. The economy dilutes, as those who can borrow remain fearful, and those that can lend are cautious. Roosevelt needs to lower the rates to incentivize lenders. But the lenders need more room than ever to stimulate the economy, and with the currency pegged to gold, there is only so much lending to be done. This is residual pressure from World War I, during which inflationary practices bled through to the world stage.
As noted in “The Fiat Standard,” lending is the process of which new currency is created in a fiat system. The monetary adjustment required to affect change on a global scale requires more than the pegged dollar can offer at a fixed exchange rate. The United States is backed into a corner of world pressure.
“We think that this would not have been possible had the United States continued to adhere to the gold standard because realignment expectations would have gone even more strongly against the dollar,” wrote the authors of “An Assessment.”
Roosevelt initiates a bank moratorium, preventing the redemption of gold as a way to maintain consumer confidence. Keynesian economics tout the inflation of the monetary supply as the quickest solution to lowering interest rates. Keynesians often represent the Cantillon effect, by which those closest to the creation of new money are the benefactors of its creation.
Simply put, as new money is created, the creator (lender, bank) suffers no points of inflation to do so. They create a contract that says the consumer has to begin making payments toward money that never existed, prior to the creation of the loan. The lender can then take the payments they receive for lending money that didn’t exist and put it toward the creation of more money, or lodge it firmly within an investment vehicle to create more wealth.
This process creates debt and payments for everyone else, while fabricating wealth for those at the top.
We will never know what would have happened had the United States continued adherence to sound money principles. The mounting pressure of a destabilized macroeconomy hinging on the U.S dollar to fall in lockstep with the rest of the major players and depressed economy led to the eventual abandonment of the gold standard.
What lessons about replacing monetary systems have been learned so far?
Macroeconomics matter: Pressure built on the U.S. because of the willful abandonment of sound money principles at a global scale. It is not enough for one nation state to participate.
Sound money is opposition: Keynesian economics necessitates the printing of money when the economy is depressed. Without monetary supply increases, it is nearly impossible for a fiat currency to lower rates and incentivize lending.
Lenders need to create money: A fixed exchange rate for a hard asset like bitcoin requires the lender to remove the loan from their usable reserves, rather than create funds that do not exist.
The Bretton Woods monetary system rises as a reconstructive hope for the inevitable end of the second world war.
“Those at Bretton Woods envisioned an international monetary system that would ensure exchange rate stability, prevent competitive devaluations and promote economic growth,” according to “Creation Of The Bretton Woods System” by Sandra Kollen Ghizoni. “Although all participants agreed on the goals of the new system, plans to implement them differed.”
The Great Depression worsened amid the second world war. Remembering the lessons from the previous abandonment of sound money, those at Bretton Woods needed to assure global cooperation.
The need for sound money is apparent as inflation runs rampant and reconstruction efforts will be wide. But this time, the gold standard will be different. Why? Well, I would ask you to remember the Keynesian economics mentioned before, and how the solution for lowering rates in this system is to inflate the money supply.
“The primary designers of the new system were John Maynard Keynes, adviser to the British Treasury, and Harry Dexter White, the chief international economist at the Treasury Department.,” per Ghizoni.
That’s right, Keynes will be designing this system by hand.
“The Keynes plan envisioned a global central bank called the Clearing Union,” Ghizoni wrote. “This bank would issue a new international currency, the ‘bancor,’ which would be used to settle international imbalances. Keynes proposed raising funds of $26 million for the Clearing Union. Each country would receive a limited line of credit that would prevent it from running a balance of payments deficit, but each country would also be discouraged from running surpluses by having to remit excess bancor to the Clearing Union.”
This line of thinking was challenged by Harry White, a senior U.S. Treasury official at the time. White suggested a different system.
“White proposed a new monetary institution called the Stabilization Fund,” per Ghizoni. “Rather than issue a new currency, it would be funded with a finite pool of national currencies and gold of $5 million that would effectively limit the supply of reserve credit.”
White wanted to limit the supply credits. Keynes wanted central control to act on their own discretion with insatiable credit lines. Convenient, as we all know how prone to creating money out of thin air Keynes tends to be.
“The plan adopted at Bretton Woods resembled the White plan with some concessions in response to Keynes’s concerns,” according to Ghizoni. “A clause was added in case a country ran a balance of payments surplus and its currency became scarce in world trade. The fund could ration that currency and authorize limited imports from the surplus country. In addition, the total resources for the fund were raised from $5 million to $8.5 million.”
This leads to the creation of two new institutions. The International Monetary Fund (IMF), and The International Bank for Reconstruction and Development, later known as the World Bank.
The IMF was meant to “monitor exchange rates and lend reserve currencies to nations with balance-of-payments deficits,” per Ghizoni.
The World Bank entity would head reconstruction efforts and aid less developed countries with economic development.
This not only tied the U.S dollar back to a pseudo gold standard, but it also tied the global economy to the U.S dollar. The dollar was established as the global reserve, meaning every country could purchase dollars as a paper claim to gold stored in the U.S.
What lessons about replacing monetary systems have been learned so far?
Macroeconomics matter: The IMF forces global cooperation to the newly-established gold standard and the World Bank Group oversees economic development in developing countries. They forced the world to join.
Sound money is opposition: The establishment of the IMF created the credit lines Keynes wanted, just not to his extent (at first). The establishing of USD as a global reserve currency with extended lines of credit still allowed paper claims to exceed that of actual on-hand gold. They tried to have their cake and eat it too.
Lenders need to create money: Apparently the creation of money in one nation wasn’t fitting for those at Bretton Woods that day. Instead, they created two institutions in the IMF and World Bank Group to accomplish globalism.
War necessitates printable paper claims: We continuously look to return to sound money at the end of major wars because endless printing of fiat currency is not sustainable.
Of course not. But you already knew that.
“The Bretton Woods system was in place until persistent U.S. balance-of-payments deficits led to foreign-held dollars exceeding the U.S. gold stock, implying that the United States could not fulfill its obligation to redeem dollars for gold at the official price,” Ghizoni wrote. “In 1971, President Richard Nixon ended the dollar’s convertibility to gold.”
What is a “balance-of-payment deficit”? That’s what happens when a nation state does not possess enough money to cover its imports. Succinctly, it’s what happens when a country can’t pay its bills.
“The U.S. share of world output decreased and so did the need for dollars, making converting those dollars to gold more desirable,” Ghizoni wrote in “Nixon Ends Convertibility Of U.S. Dollars To Gold And Announces Wage/Price Controls.” The deteriorating U.S. balance of payments, combined with military spending and foreign aid, resulted in a large supply of dollars around the world.”
The U.S couldn’t maintain its output, which meant less dollars were needed to cover the costs of exports going to other countries. This lack of need for dollars resulted in higher levels of foreign claims on gold. The paper claims surmounted and the world beckoned as the United States failed to meet demand.
In 1971, sound money principles were abandoned. Now, I’m sure you’re asking why you’re almost 3,000 words deep and we have yet to speak on how bitcoin replaces the dollar.
If we are to discuss replacing the existing infrastructure, we need to understand that sound money principles have existed in our system before, and it still failed. We cannot lose sight of that. We must learn from the mistakes of our past. So, what did we learn?
War necessitates the printing of money: Following World War I, many countries decoupled themselves from sound money principles. The fabrication of currency to sustain costs of war is comparable to the need of an organ in the human body. While the U.S. maintained some forms of claim to gold, it was largely hanging on by a thread by the time Roosevelt came along in 1933.
Global cooperation is needed: The world was largely leaving the gold standard behind and pressure from other countries applied economic strangleholds on the United States and other global powers. With the Great Depression following the war, it was one economic mess leading into another. Roosevelt felt the pressure and exited the gold standard in 1933.
Inputs and outputs for a global reserve currency must be maintained: The dollar was thrown back into its skeptical perception when the U.S. failed to pay up. The demand for the reserve, in this case the USD, cannot falter. Demand must remain when all else fails.
Now, how do we take these lessons (and others I couldn’t fit into this article), and use them to create a new system? I hope you’ll join me for part two as we explore the current system, how it achieves scale, and applying that to Bitcoin.
