As the institutional world starts taking Bitcoin seriously, new questions are emerging.
- Will Bitcoin replace the U.S. dollar?
- Will it push aside major fiat currency competitors?
- Could Bitcoin usher in a fiat-free world?
In our view, the answer is “no” three times over.
The destiny of Bitcoin is not to replace or dominate fiat currencies. It is to offer a global store of value, and to put a check on the governments that issue fiat currencies.
One of Bitcoin’s most important features — if not the most crucial feature of all — is permanent scarcity. The Bitcoin supply is immutably fixed. Once a certain number of Bitcoins are mined (approximately 21 million), there will never be any more.
In contrast, with fiat currencies, the supply is not at all fixed. Instead, it is the opposite: The fiat currency supply can be expanded at will. This is a feature, not a bug. Expansion of the currency supply is sometimes a helpful thing.
Imagine a scenario, for example, where a major natural disaster overtakes the United States, and hundreds of billions of dollars in emergency spending is needed to address the crisis.
With a fiat currency system, Congress can simply issue new debt and send out the funds. That is, in fact, what happened in response to the coronavirus crisis. Congress decided to spend the money, and immediately did so.
That useful ability — the ability to respond quickly in a crisis — is a function of a system with an expandable fiat currency supply.
There are situations where, if no new funds are immediately available, the likely outcome is some form of economic collapse.
An ability to expand the currency supply is like a line of credit in this regard. A business that has an emergency line of credit, only to be used in serious situations, is better off than a business with no such access to credit.
If a business takes a terrible hit — because of, say, a sharp but temporary downturn in customer traffic — then a line of credit can get that business through the rough period and help it survive to the other side. Absent that line of credit, the business is at risk of failing.
(We are seeing this reality play out for millions of businesses in real time: Those businesses with access to credit lifelines are able to weather the worst of the pandemic, while those that lack such access are more likely to close.)
So fiat currencies, in a way, provide a kind of credit lifeline for an economy that needs one. The alternative to having this lifeline can be extreme economic pain, or even a shock-induced deflationary collapse. It is good, not bad, to have a government with flexibility to respond to emergency events.
An economy that is rapidly growing may also need an expanding currency supply in order to support the expansion. That is because a shortage of currency, relative to the optimal amount needed to support business activity, can act as a constraint on growth.
In theory, the total amount of a currency in circulation doesn’t matter, as long as the currency is divisible into small enough units. This theory would argue that, if an economy is growing rapidly as the currency supply stays the same, the adjustment should come through prices. An economy that has grown larger, with a currency supply that has stayed the same, should see wages and prices that are lower.
The problem is that, in the real world, wages and prices tend to be “sticky.” It is not easy to adjust the average price level of goods and services on a whim. It is particularly hard to adjust wages downward.
Imagine an employer saying: “The currency has gotten stronger over the past 12 months, so everyone is getting a reverse raise. Your take-home pay will be reduced by 10%.” Human psychology doesn’t work that way — it is hard to adjust prices downward.
This means that, when there is not enough currency available for a growing economy, the tendency is simply for the availability of loans to be suboptimal, and the rate of new job growth to be limited.
And so the psychological inability of businesses to reduce wages and prices easily or quickly means that, as an economy grows, it is healthy, overall, for the supply of currency to grow alongside the economy at a reasonable and logical rate. You need an expandable currency supply to make that happen.
If a currency has a fixed supply, all adjustments have to come through price. In the context of a national economy, wages and prices do not change quickly or easily. This creates a mismatch that causes big problems, or restrains growth, if the supply of currency is out of whack with what makes sense.
“But hold on,” you say. “What about the tendency of governments to abuse their fiat currency privileges?
“What about the fact that governments tend to abuse their lines of credit by borrowing too much, and that expanding supplies of fiat currency tend to expand too fast (and never seem to shrink)?’
Those are, indeed, serious problems. And that is why Bitcoin provides such an elegant solution — not as a means of replacing fiat currency, but as a way to keep government policies in check.
Because the Bitcoin supply is fixed, all upward shifts in demand have to be met with upward adjustments in price. And because the total supply of Bitcoin will never exceed 21 million, the Bitcoin supply can never be debased by printing-press activity.
Those features make Bitcoin an attractive place to store savings — especially if currencies around the world are being debased by unwise government policies.
If a fiat currency is depreciating in value because its respective government is printing too much of it, Bitcoin will see its value rise sharply in relation to that currency (because the supply of one is expanding, while the supply of the other stays fixed).
This relationship allows investors and savers to vote with their feet. If they don’t like how their home currency is being treated, they can hotfoot it into Bitcoin (by moving a larger portion of their savings into Bitcoin). Bitcoin, in this manner, becomes a means of peaceful protest against undesirable government policies.
Again, the useful feature here is not replacing the fiat currency in question, but rather putting a check on it.
No sovereign government with the ability to issue its own currency will voluntarily give up that right — and nor should it. As we have explained, it is useful having the ability to spend at will in the event of a national emergency, and it is also helpful to have a slowly expanding currency supply that matches the natural rate of economic growth (because human nature does not do well with downward wage adjustments).
But sovereign governments, quite obviously, have what one might call a “discipline problem” — and Bitcoin can help with that problem by acting as a viable alternative when governments get it wrong and abuse their fiat currency privileges.
Imagine a world where sovereign governments are forced to use their fiat powers wisely, because they know that if they don’t, the nation’s savers will transfer more assets into Bitcoin.
In this world, sovereign governments can maintain access to the positive side of fiat currency issuance. They can issue more currency as needed to help the economy in emergencies, and they can grow the currency supply in accordance with growth (which is a healthy thing to do).
As Bitcoin finds success as a global store of value, it will not exactly underpin a new kind of gold standard — governments are not going back to that — but it will, in fact, be a readily available savings mechanism that investors can shift a greater portion of their savings into at will.
In this sense, one could think of Bitcoin like the famous “bond vigilantes” of old.
The bond vigilantes were a sort of mythical group who were expected to sell U.S. treasury bonds, and drive up U.S. interest rates in doing so, if government policies were too loose.
In homage to the bond vigilantes, James Carville, a political adviser to U.S. President Bill Clinton, once said:
“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”
The bond vigilantes are more or less gone now, lost to the sands of time. But Bitcoin can take up that role, in a sense, by acting as a check on the impulses of all national governments and all fiat currency regimes.
In this manner, the juxtaposition of Bitcoin’s supply being fixed — and the fiat currency supply being expandable — is an excellent thing. You want the fiat supply to have an expandable property, as long as that property is not abused. And Bitcoin as a liquid alternative will be there at the ready when politicians get abusive (as they inevitably will at times).
In another sense, Bitcoin has the potential to become a kind of “digital gold standard” for the entire world.
That does not mean national governments will affix their fiat currencies to some limited quantity. They won’t. But it does mean Bitcoin could become a price benchmark more immutable than the fluctuating value of things as priced in, say, dollars or euros or yen or renminbi.
Along with acting as a fixed supply alternative to local fiat arrangements, Bitcoin could become an iron yardstick as opposed to the rubber yardstick we now have in the U.S. dollar — a price benchmark to rule them all.
The nature and function of Bitcoin makes it the ideal vehicle to do this, while allowing governments to continue managing their currency and debt mix locally (with Bitcoin a check on their worst impulses).