The evolution of money and the ever-increasing importance of sound money is not just important to understand from a financial standpoint, but from a societal perspective as well.
Many of the societal and political issues we are currently experiencing can be credited at least partially to decades of monetary debasement and poorly managed monetary policy.
Inflation, the hidden tax
A common misconception amongst society is that inflation is a necessary byproduct of economic growth, but it does not have to be this way.
Inflation is not necessary for the expansion of a nation’s financial system but is rather only necessary for the expansion of the current financial system. From a basic accounting standpoint, it is understood that every liability must be neutralized by an equivalent asset.
In the case of the Federal Reserve, there are two ways they can manage their expanding debt.
The first way is to increase revenue by taxing American’s directly. This would not only cause pushback from many but would slow economic expansion by shrinking profit margins for businesses.
The second way they can manage their debt is to insert more dollars into the system. For example, let’s say the Fed borrows $100 from a foreign country at a fixed 10% interest rate. Due to their position as the global reserve currency, they can simply increase the monetary supply by 10% to neutralize the debt in nominal dollar terms.
This is great from the Fed’s standpoint, but for American citizens it is a hidden tax, especially for those not holding assets.
How is it possible for the Fed to simply create more money? The answer is that the dollar is backed by treasuries which are a form of credit, but ultimately is backed by nothing more than trust.
To understand how we got to this point, let’s first describe what money is and then take a brief look at the history of money.
What is money?
Money can be described as a medium of exchange, store of value, and unit of account. It must be portable, divisible, verifiable, and scarce.
In early history, people would “barter”, or trade things. This was extremely inefficient due to the obvious inadequacy of different types and sizes of items. This system was soon replaced by the trading of precious metals such as silver and gold. These were perceived to have value due to the energy required to mine them, their scarcity, and their use in jewelry.
This system still had a flaw, there was no standard size or weight of the metals used to trade with. This made exchanging difficult and would require the pieces of metal to be weighed upon each transaction.
Then came along the Italian Florin in 13th century Europe, which was a great leap forward in the history of money. The Florin was the first medium of exchange to have a constant size/weight, which allowed for not only ease of transactability, but a new renaissance of economic expansion due to accounting standards made possible.
The only issue with this system was the portability of the Florin, especially for intercontinental trade across oceans. This is where the idea of IOU’s (abbreviated from the phrase "I owe you") meaning a document acknowledging debt.) or “credits” was introduced.
In the beginning, these IOU’s were 100% backed by gold, but over time turned into fractionally backed by gold (the beginning of fractional reserve banking). As these gold-backed notes became popular, rulers around the world took notice, particularly the Bank of England.
The Bank decided to take complete control of these IOU’s by issuing a demand for all gold to be turned into them. By controlling the gold that backed the notes, the Bank had complete control over monetary policy. With this control came great responsibility, which has been abused time and time again throughout history.
By simply issuing more notes without needing to be audited for the gold backing them, these monopolistic early Central Banks could use their notes to make purchases to expand their empire’s reach that was backed by nothing.
This creation of new notes backed by nothing other than trust and the respective government’s military, established the first instances of inflation; although the decrease of gold backing the notes was nothing compared to that of modern finance.
Fast forward to the emergence of the United States as the reserve currency, a majority gold-pegged dollar still existed, but not for long.
The mass creation of credit caused the contraction of the American economy in 1929, and with the dollar restricted to being 35% backed by gold, the liquidity needed to offset the loss of value through credit was not able to be created.
This prolonged the Great Depression until FDR announced the debasement from gold in April 1933. This allowed more liquidity to be pumped into the system, and eventually led to the recovery of the economy.
This also triggered a new era of inflation. This accelerated even more so when the dollar was completely debased from gold by Nixon in 1971 in response to a run on the US Central Bank from foreign countries for the gold the US claimed to be backing the Dollar. Since then, the Dollar is now backed by nothing other than trust and the might of the US military.
From this, we can conclude that inflation benefits the government itself, but not the individuals of the country that the government is supposed to consider’s its’ best interest.
The dominance of the dollar and interconnectivity with countries around the world make it seem impossible for it to be replaced. However, history has shown that currencies fail when they are either debased, or a harder form of money comes along like Bitcoin, which will soon be addressed.
The US Dollar has been debased at unprecedented levels since 2008 and particularly in the past 12 months. Over 24% of all US Dollars were printed in the year 2020, and the new 1.9 trillion-dollar stimulus bill being proposed will be greater than all the printing of last year combined.
It is also important to note money’s important role as a unit of measurement of the market value of goods, services, and other transactions. The more debased a currency, the more it fluctuates as a unit of account. A comparison to illustrate trying to make equity valuations with USD would be trying to build a house using a measuring stick that was constantly changing size.
The enlightenment period of Bitcoin
We have established that the dollar is being extremely debased, but is there a harder form of money to challenge it? The answer is yes. Bitcoin.
Many argue that Bitcoin is not viable because you are not able to transact with it currently, but by looking at the history of emerging currencies, this can be concluded to be a surface level misconception.
Emerging currencies go through “phases” of adoption, often beginning as a novelty, then a commodity, a store of value, and then ultimately a medium of exchange.
Bitcoin miners are rewarded with coins in return for validating transactions, thus keeping the network going. Every 4 years, this reward is cut in half; going from 50 coins per block in 2009, 25 BTC in 2012, 12.5 BTC in 2016, and most recently 6.25 BTC in May 2020.
This block reward is how new supply is introduced into the network, therefore meaning the incoming supply of Bitcoin cuts in half every 4 years. When these supply “halving events occur”, price will rise in the following months based off simple supply/demand dynamics.
Demand could stay the same, but since the flow of supply cuts in half, price rises over the months following the event. This price rise then draws even more buyers in, thus becoming a self-enforcing positive feedback loop. These massive inflows of the network every 4 years create programmatic entrenchment into the financial system.
The anonymous Dutch quant investor/creator of the stock-flow model, “Plan B”, describes this programmatic entrenchment with the term “phases”.
Below are Plan B’s stock-flow model, where the 4-year supply “halving” cycles can be visualized, in addition to the programmatic phases of entrenchment.
With the dollar collapsing in all aspects of monetary definition and Bitcoin emerging around the world and flourishing in each of those same aspects, it is not improbable, but inevitable that Bitcoin becomes the new global form of money.
Most importantly, the decentralization of Bitcoin means that monetary policy will finally be removed from human control and controlled by a fixed programmatic protocol.
This means that Bitcoin won’t fail due to improper management of monetary policy or debasement but would have to occur due to a harder form of money coming along.
Until then, Bitcoin will dominate as the hardest, soundest store of value and thus form of money on Earth. This then leads us to the next question, what does a world under a Bitcoin monetary system look like?
Society under a Bitcoin system
A world under a Bitcoin standard would look vastly different than today. Most importantly the system will benefit all participants.
A key aspect of Bitcoin from this standpoint is that there is close to 0 inflation. Inflation, along with the network effect growth within technology companies, is the key aspect in the current wealth distribution issue.
As more money is printed, those holding assets are the only beneficiaries, as those assets go up by default in price given the larger quantity of dollars that they are being priced in.
However, most average citizens do not own assets, therefore making inflation an accelerating hidden tax on their wealth.
With money being thought of as a measuring unit for the value of your economic value output, people are rightfully frustrating that this value of their life’s work is being diluted over time.
Due to Bitcoin’s programmatic monetary policy, there is no rapid inflation that dilutes people’s spending power. It is the polar-opposite, incentivizing saving again and proper money management.
Under the current fiat currency system, one must be actively searching for ways to deploy capital in an effort to maintain one’s current level of spending power in real terms.
If unable to outpace the rate of monetary supply expansion, they are losing spending power by default.
Under a Bitcoin system, one is not penalized for patience and has no urgency to deploy capital. This incentivizes the products/services and startups seeking capital to create greater value in an effort to get you to deploy this capital.
Easy access to capital in the current system is partially due to low interest rates but is also because many venture capital firms and investors need to find new ways to deploy capital, as idle money becomes a “melting ice cube”.
This can also be paired with another issue Bitcoin solves, which is the number of zombie companies currently in existence due to the Fed keeping them afloat.
To stack bitcoins on a companies balance sheet, a business must be generating free cash flows; a revolutionary paradigm change from the current system.
Bitcoin will also restore sanity to the equity market. Currently, equities are measured in dollars, which are an ever-growing unit of measurement, making it impossible to do any kind of rational free cash flow valuation of a business.
Under a Bitcoin standard, the unit of measurement that companies’ cash flows and valuations are measured in becomes a constant. The gravity of this cannot be emphasized enough.
Having a constant in a respective discipline is a great leap forward for understanding and innovation, with one great example being the speed of light in physics.
Earlier it was mentioned that proper money management is incentivized in a Bitcoin system, and this is true for governments just as much as individuals. Due to the scarce supply of coins and inability to create more, governments will have to take a much more serious look at what to cut back spending on, forcing them to only focus on their core responsibilities.
In other words, Bitcoin encourages limited government control and will initiate a shift towards an age of self-sovereignty. This age of sovereignty along with the incentivization to produce free cash flows to obtain bitcoins is revolutionary.
Under the current monopoly-like monetary system, societal value is not needed to be created to feed your family. This is not true with Bitcoin and will likely initiate a boom of economic productivity.
Having Bitcoin as a global reserve currency will finally empower more just the United States, but underserved sectors of the global economy. This is especially true for citizens in countries with hyperinflated currencies (Venezuela, Zimbabwe, Argentina...) that have adopted Bitcoin earlier on.
In conclusion, this new age of government limitation and economic productivity will likely lead to an explosion of innovation and empowerment around the world.
I leave you with this quote from Ron Paul:
“True prosperity, free society, and a healthy economy can only be achieved from sound money.”