Bitcoin's role in Macroeconomics
Tue Jul 26 2022
Bitcoin is a new asset created in 2009. Believers in Bitcoin theorize that it could become the global reserve currency. They underestimate the conservative nature of government and the people who make the decisions. The United State’s interest is opposed to such an outcome because the world using USD as a reserve helps create demand for USD. But, the US cannot prevent BTC from being a global reserve asset.
Reserves and Money Printing
Bretton Woods moved the world’s central banks onto USD under the promise of gold redemption. Gold redemption stopped due to over-printing by US Government. Gold still plays a big part in sovereign reserves. The US currently leads the world with 8,133 tons of gold, with Germany in second place at 3,359 tons.
Technology is a deflationary force in the market. The cost of products decreases in real terms. According to Keynesian theory, deflation is problematic because it makes people save money instead of spending it, reducing the velocity of money and slowing down the economy. Money printing solves deflation by increasing the cost of goods and offsetting the deflationary nature of technological progress.
Low inflationary reserves allow governments to print money without increasing the risk of a speculative attack. Some simple math can let us know how much printing is safe. If we assume technology depreciates goods at a rate of 3% per year and we presume target inflation is 2% per year, holding an asset that inflates at 1% per year would allow money printing at a rate of 2 - 1 + 3 = 4% per year indefinitely with no increase in risk. Governments printing fiat is a ‘free lunch’ in today’s technological environment.
BTC Current State
Bitcoin’s fundamental properties are unique. It is mathematically more scarce than gold. It has zero cost to hold and zero expense to transport. It also has the most inelastic supply of any commodity. Based on these properties, BTC’s value will increase faster than gold’s. BTC will also be more volatile than gold (inelastic supply). BTC is the best store of value if the holding period is longer than four years. But in the short term, BTC price is easily manipulated and subject to high volatility.
This does not rule out Bitcoin as a reserve currency. When the US was on the gold standard, the purchasing power of gold was very stable. After the US moved off the gold standard, the purchasing power of gold fluctuated by 10x. The US has adapted to fluctuations in the purchasing power of its reserve currency. The continued volatility of BTC will not prevent it from being a reserve asset within limits.
Private citizens and companies all over the world now hold BTC. In the worst case, the government can attempt to seize the BTC of citizens to build reserves. But due to BTC’s pseudonymous property, it is harder to be seized by force. Governments will not be able to acquire emergency reserves by force. Countries desiring sound monetary basis to shield from speculative attacks should acquire BTC reserves. In the short term, global markets and government actors can suppress BTC prices to weaponize BTC. As a reserve, significant margins are needed to compensate for the potential 90% drawdown scenario. This financial modeling is also performed by individuals and companies holding BTC. Price suppression does not work long term as market forces become too strong. Wealth accrues to fiscal conservatives who survive the volatility.
Limitations and future state
One factor preventing BTC from its use as a reserve is low adoption. Since BTC value will increase relative to everything else due to the lowest supply issuance rate, adoption by individuals and companies will increase. Next, banks will add BTC to their reserves. The banks that do this will see their balance sheet increase over time, allowing them to provide lower loan rates relative to their competitors. As bank adoption increases, central banks will naturally begin adding BTC to their reserves.
When the ecosystem expands, the impact of individual whales on the overall price will be less. Well-funded institutions will have the power to absorb demand shocks as they are financially incentivized to make money from absorbing irrational market behavior. As volatility decreases, BTC’s appeal as a reserve will increase. As mining produces smaller shares of new supply, the impact of sales by miners will also be reduced, decreasing volatility. Financial institutions that can estimate BTC’s current value will make a lot of money as they play the market and smooth out the bumps.
BTC’s current trajectory has a high probability of becoming part of the global reserve currencies. The issues preventing BTC from being a reserve today are volatility and adoption. As the lowest supply rate asset, BTC will ensure continued long-term adoption as price increases. As adoption increases, volatility decreases as the impact of individuals are smoothed out by well-capitalized institutions.
Benefits to using BTC as the global reserve
BTC is not only an asset, but it’s also a currency. Trade deficits place pressure on currencies depending on the direction of trade. China accrues significant USD reserves due to selling products to the US. But because China doesn’t buy as much from the US, the US reserves accumulate on the Chinese side. This is a good state to be in because China can use the USD to import what it needs from abroad.
For countries short on USD, importing goods can be a nightmare since they must buy USD first and then import the goods they need. Using BTC for global trade is a secondary benefit to having BTC reserves compared to gold. Countries that are low in BTC and need imports can produce more BTC via mining (with some foresight). Only the US government can print more of the money you need with USD.
BTC ownership can be proven easily. Governments can prove that they control BTC by signing a transaction on the network. Unlike gold, there is no need to melt/verify the certification of the gold bars. Easy proof can provide governments access to loans and protect their currency without needing to move funds around (sell).
Bitcoin is difficult to seize by force. If your country’s reserves are in Bitcoin, a neighboring country will not be able to take your reserves even if they take your land. This allows for a country to continue funding a resistance against hostile aggression.
Using BTC as global reserves would create a more neutral reserve state, like when countries used primarily gold. Unlike gold, BTC has the added benefit of being useful for international trade. Once BTC is generally understood as a good store of value, countries will likely adopt a neutral reserve asset.