Money used to be a reward for value creation. Today, money is used to create value.
Since leaving the gold standard, money has essentially been backed by faith in the issuing government. This would be the preface to now-fashionable Modern Monetary Theory. No longer having to fear the shortage of gold, governments are free to print the money needed to fully employ their available resources. In other words, MMT views currency as a public good rather than a medium of exchange.
In 2008, Bitcoin was created in response to this very concept. Fundamentally different but joint in their controversy, both ideas have re-entered the mainstream conversation as we enter the post-pandemic world. At the moment, there is no consensus on either.
The fiscal response to the COVID-19 pandemic comes with unprecedented costs. The European Central Bank’s (ECB) balance sheet expansion – up €2.42 trillion since the beginning of 2020 – has been remarkable compared with its roughly €1 trillion response in 2008-2009. Interest rates remain at all-time lows, while debt levels have reached all-time highs.
During 2020, the joint budget deficits of European Area governments soared to 11.6% of GDP in Q2, more than four times the 2.5% deficit recorded in Q1, and well surpassing the 7% deficit recorded in Q1 of 2010.
Central bank policies have since been fueling markets everywhere, fostering a widening wealth gap and the notorious “BRRR” memes. While the money printer is running at full speed, here is a breakdown of how central bank monetary policy relates to crypto prices.
Central banks increase the rate of growth by cutting interest rates to encourage consumer spending, thereby increasing the effective demand and ultimately profitability. However, when interest rates are approaching zero, they are left with the option of injecting money directly into the economy by buying financial securities. This process is known as quantitative easing (QE) and has the following effects:
- Bond prices increase as their demand increases
- Interest rates are reduced
- Banks have more money reserved than required and the money supply in the economy increases.
When asset prices increase and interest rates are low, risk premiums get twisted. As a rule of thumb, cash is safer than bonds, which are safer than equities, which are safer than alternative investments. However, when bond coupons are at 0% and the money printer is running on max, equities and digital assets don't look that risky. This ultimately triggers a rally for all assets, including ones that previously were associated with the greatest risk.
Simultaneously, as the ECB continues to increase the stimulus, it is widening the wealth gap. Investors take profits and are incentivized to invest more, asset prices go up, and investors are rewarded. Rather than boosting general consumption, it boosts the inclination to invest. This is essentially how low interest rates enrich Wall Street while Main Street falls behind.
This creates an anti-corporate sentiment, driving governments to spend more on the people for the sake of keeping voters content. Thereby the MMT-style policies and addiction to QE. On an individual level, it is difficult to accept lower wages and higher taxes, although the overall economy would benefit from borrowing relative to the growth of the economy. Thus the only politically viable solution is to print more money.
(Not so) modern monetary theory
The recent comeback of MMT was triggered by U.S left-wing economists, who presented it as a solution for expensive political projects.
The essence of MMT is that budget deficits are irrelevant, because sovereign currency-issuing governments cannot default on their sovereign debt as they can always print more money. The only real constraint on governments is the availability of resources. If resources are available, governments can pay for them by printing money. If they aren’t available, printing money to buy goods will cause inflation.
As a consequence, taxes do not finance spending. Instead, the government taxes for two reasons (i) to drain excess money out of the economy to control inflation and (ii) to stimulate the circulation of the government currency. It makes sense to earn and spend euros if you pay taxes in euros. In a no-growth economy, however, that means the money supply would continue to increase, which must be unsustainable.
In a monetarist view, prices increase because the value of money decreases. This brings us to what money ultimately is: a store of value. If money is to realize its function, people must have confidence in its ability to retain its value over time. This makes fiat a melting ice cube.
Now, increasing government deficits drive the government to sell more debt to pay for the stimulus. This is causing interest rates to increase so governments can sell that debt in an already leveraged-long economy. However, as increased interest rates would stall the economy, they will instead buy the debt by printing money. In turn, that leaves investors with money that is becoming increasingly worthless, ultimately devaluing the currency and threatening it as a store of value.
Although the Euro-Area remains relatively stable, when there is boundless money printing, investors will avoid holding debt tied in a depreciating currency. If the public believes its government is becoming spendthrift, inflation expectations will become rooted in preventive price-rises, resulting in a self-fulfilling prophecy.
Bitcoin and its genesis block were the preface to a digital alternative to traditional central banks and government spending and has since programmatically reformed money as we know it. Instead of governments inflating the supply of money, Bitcoin has introduced an alternative known as a distributed ledger, otherwise known as a blockchain, granting universal access and a predictable and programmable inflation schedule.
In cases of hyperinflation like Venezuela and Zimbabwe, Bitcoin could theoretically become an economic escape-hatch allowing individuals to hedge from a local economic meltdown. Non-sovereign money allows people to reject their local monetary systems. The way countries like Zimbabwe have adopted Bitcoin is not unlike the currency substitution (dollarization) we’ve seen in many emerging countries struggling to maintain the integrity of their monetary systems.
For now, Bitcoin upholds the "digital gold" narrative – a store of value that is easily exchanged and practically impossible to counterfeit. Given its fixed supply, it is deflationary in nature.
Bitcoin is not truly deflationary in the sense that Bitcoin’s supply will not decrease but continue to increase until the block rewards run out approaching the year 2140, when Bitcoin will reach a hard cap of 21 million coins. MMT, on the other hand, promotes the printing press as a cure-all and rejects monetary policies’ relevance to inflation.
So where does it leave us?
Imagine doing the same thing over and over again, to hardly any relief. Enter quantitative-easing hell.
Ideally, we would slowly stop quantitative easing and match the money supply to meet the output gap. If it was only that easy.
The ongoing rally in the stock markets can largely be attributed to the growing expectations of economic recovery, suggesting that stock markets more than ever depend on the ECB’s every move. If there are any signs of economic weakness by Spring, the ECB will find a way to maintain the bond buying.
Ironically, the wall of liquidity that hit the public markets was to find its way to the crypto markets. But speculation aside, there are a number of other narratives justifying a bullish move higher for crypto. The two main long-term justifications are (i) potential store-of-value and (ii) currency.
Bitcoin’s volatility impedes its case as a store of value. However, for those who consider hedging potential inflation risk with a limited-supply asset that can be easily exchanged for fiat, the idea of “digital gold” is very relevant. One could even claim that Bitcoin is far more valuable than gold, considering its increased utility in terms of buying, transferring, and storing it.
Cryptocurrency as a recognized currency might be harder to imagine, but not everyone has access to the banking products we take for granted. Bitcoin is an attractive substitute to fiat allowing for easy transactions while maintaining privacy and erasing geographical borders. But circling back to the beginning, the first and most vital component is trust.
When we understand that the world is structured by belief, we understand that value can be an illusion. Money is an abstract concept. Its value requires us to believe in it, which is why banks use ancestral heroes to make money seem almost holy.
Crypto is as much of an idea as all other money; its value lies merely in belief. But instead of banks and central authorities, it is pure code. Transparent in its mechanism but private in its use, central bank currencies are the exact opposite. Their management is obscured, but our use is surveilled.
Who knows what will happen, but it is ironic that QE is reinforcing Bitcoin when it was born in opposition to said policy.
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