The End of Modern Monetary Policy: Why Bitcoin will be the world’s reserve asset.
It is not hyperbolic to say that seismic shifts are underway for the socio-economic stability and fairness in the world today. These changes are driven by the incredible force of automation and technology, as well as an innovation called ‘Distributed Ledger Technologies’. In this article I will detail why Modern Monetary Theory (MMT) will soon fail, how the Federal Reserve is the root cause of the massive income inequality in the world today, and how we have alternatives to this unfair world that has been legislated around us. To understand why the world is about to undergo a huge transformation, first we need to start with money… which as it turns out, is pretty important.
What is money?
Money is a medium of exchange that allows goods and services to be priced relative to one another. Money has the effect of
1. Being Transferable between people or companies,
2. Creating a basis to compare the value of different things like cars and cheese
3. Representing the value of a commodity or government.
This third point: Money reflects the value of a commodity or government, is the most important property to understand how different currencies / money can become extremely valuable or completely worthless.
How has money changed?
Money was once tied to the price of gold, and this was called ‘The Gold Standard’. This was the case until 1971, when money became untethered to any asset and instead became fully controlled by the government. The term for money whose value is only derived from confidence in a government is called Fiat.
The value of a government’s Fiat money (US dollars or the Euro for example) is generally based on supply and demand. If there is more supply of money out in the world, the value goes down. If there is less supply of a currency in the world, the value goes up (purchasing power increases.)
Since virtually all governments in the world now have Fiat currencies which are not valued against any kind of physical asset, they float in value relative to one another based on supply and demand. If the European Central Bank prints more Euros compared to the US Central Bank, then the value of the Euro goes down. This creates a global game of cat and mouse, and has largely resulted in every government printing approximately the same amount of currency into existence compared to every other world currency. There are a lot of other factors that contribute to the value of a Fiat currency, but supply and demand is an essential part.
What is important about the US dollar, and how is its value controlled?
The US dollar is considered the world’s reserve currency. This happened after WW2, when the world’s economies were decimated by war. All the countries in the world came to an agreement on what their currencies would be worth compared to the US dollar and gold. This was called the Bretton-Woods agreement, and it set up a system where every country in the world would need to hold US dollars in their Central Bank if they wanted to efficiently do international trade. Businesses also needed to hold US dollars in their banks to make international trade more efficient and convenient (this is called a Country or Business ‘Reserves’.)
The value of the US dollar is controlled by a government organization called the Federal Reserve. This is the central bank of the United States. The ‘Fed’ has two mandates that define its operation: Maximum employment, and price stability. They want to make sure people stay employed (unlike 2008 financial crash), and that prices for things like groceries don’t get too high (like they did in the 1980’s).
The Fed has two tools to achieve this mandate: 1. Change the interest rate that they charge banks (Federal Funds Rate or FFR), and 2. Print new money. We will get into examples of what the Fed can do with these tools later. But for now, it’s important to know that basically everything that the Fed does is as a response to inflation or deflation in the economy. This is the most critical thing to understanding Fiat currencies, and therefore the value of the US dollar.
What is inflation?
Inflation is the increase in cost of… stuff. It is calculated as an increase in the Consumer Price Index (CPI), which piles a bunch of things like costs of cars, cell phones, healthcare, houses into a single index that can be tracked over time. CPI is the critical measure that the Fed uses to monitor the economy. In fact, the FFR is almost always set at the exact price of inflation.
CPI (inflation) and FFR are set the same so that when prices are rising, prices don’t rise too fast by making lending from banks more expensive. When prices are falling, the FFR is lowered to encourage banks to loan money to consumers and drive up spending (and the price of goods). In fact, inflation is by far the most important concept that our entire economy and US dollar currency is built around.
If Inflation is so important, what drives inflation?
There are two main types of inflation that are worth further explanation. At its core, inflation is just supply and demand: two sides of the same coin.
- Supply goes up: prices go down (abundance).
- Supply goes down: prices go up (scarcity).
- Demand goes up: prices go up (scarcity)
- Demand goes down: prices go down (abundance).
The two types of inflation (increase in prices) are representative of the scarcity situations above. These types of inflation are:
- Demand-Pull inflation: This is when demand for something goes up faster than it can be produced. For example: In San Francisco, many high paying tech jobs were created. With all this new money, people wanted to live in nice places and were willing to pay a lot to do so. Since there is only a limited supply of housing, this led to a massive increase in the price of housing in SF. Demand therefore ‘pulled’ the price of housing up.
- Cost-Push inflation: This type of inflation occurs when the raw materials or labor cost more to produce a product so supply goes down. For example: Lithium costs more to produce, so the cost of lithium-ion batteries increases, driving up the cost of cell phones.
With technology always and inevitably driving the cost of raw materials and labor down, cost-push is no longer a driver of inflation across the world. The only driver left for inflation then is Demand-Pull.
Why is inflation important to keep in our economy?
In the current monetary policy system, the Government Needs inflation to stay at a positive percent (while being controlled within a certain range.) Inflation drives people to invest or spend their money instead of save, since a dollar in cash today has less purchasing power next year due to a rise in CPI (2% inflation means any cash you have is worth 2% less next year). Inflation is a massive force to encourage people to spend instead of save, and sets the baseline and tone for the Gross Domestic Product (GDP) and the entire economy.
The next three most important reasons for inflation in descending order are 1. To inflate away the government debts, 2. To set loan rates where banks can make money and create stability for long term investments like mortgages, and 3. To provide employers flexibility to control wage growth compared to revenues. Inflation is targeted at 2% per year, so that inflation will cause the government debt to cost 2% less next year, 4% less in two years, and 8% less in three years (compounding interest.) So how are they doing at inflating away the debt?
Well not very good. Debt is exploding at an exponential rate, meaning every year debt is growing, and then growing on top of the growth it did the previous year (compounding). Many people look at the percentage of debt to GDP, which one can think of as the size of our total debt versus our ability to pay that debt back.
The percentage continues to increase, and is projected to continue its rise in the coming years. This means with our current monetary policy, we will never be able to pay back our debts.
Why does the debt matter?
If every Fiat currency in the world is in a race to inflate their currencies in response to every other currency, then debt doesn’t matter. Debt would continue to explode exponentially, and left to its own devices it would eventually increase forever. This is not an exaggeration, fitting the exponential curve of debt we can expect a 40 Trillion dollar debt by the year 2030. Then 80 Trillion debt by 2045. As long as the debt of every other economy goes relentlessly higher, then there is no issue. But a debt burden that is many times the size of the GDP (ability to pay it back), is clearly not a sustainable solution.
Will GDP grow in the future to help reduce debt?
GDP is heavily influenced by employment. More people working means more spending which drives the GDP. Technology is driving automation and efficiency, which results in the labor force participation decreasing on a downward permanent arc since the late 90’s. Meanwhile, wages are only rising as fast as CPI. This means that future GDP growth will stagnate as fewer people participate in the labor force, driving down demand and therefore the price of goods long term.
The Fed controls our money and the direction of our economy, what can they do about these problems?
The Fed has a dual mandate: maximum employment, and price stability. They have two tools to achieve this mandate: changing the FRR, and ‘printing money’ by adding treasuries to their balance sheet.
Employment is on a downward permanent arc due to technological efficiencies in automation and AI. This is something that the Fed can do nothing about other than banning the use of technology. More jobs will be automated than can ever be created: Just think about self driving vehicles coming soon which will end Taxis, Uber, and truck driving jobs. Because of technology, this mandate for maximum employment from the Fed is no longer achievable.
Price stability: To achieve price stability needed for long term investments and create profit in banking, the Fed needs to create inflation. Because Demand-Pull inflation is the only option to do this (as we discussed previously), the Fed’s only option is to simultaneously print more money, and lower interest rates to negative values.
By simple supply and demand: If the Fed prints more money, the value of the US dollar decreases. This explodes debt, and devalues the currency. This is literally the only tool the Fed has: simultaneously print more money out of thin air, and lower FRR to drive demand-pull inflation. They only have one tool left, and their only option is how much they use it. In other words, they have lost control of the value of Fiat money.
Why has the Fed lost control of money?
We have discussed what gives money relative value, and how inflation is needed for our economy. Over the past ~300 years, the US GDP has been growing at leaps and bounds driven mostly by increase in population. More people make limited resources more scarce, driving up price. The entire economy is built around this principle, the cost of everything will always go up by 2% next year.
The last 30 years however, has completely changed the game. Birth control gives women the ability to plan families, and the number of children each person has in the US is plummeting. Population is growing at a much slower rate than it was before, driving less demand for economic spending.
The even greater upheaval from the economy of the past 300 years has been driven by the invention of computers, the internet, and automation. These have created such incredible productivity increases that goods become cheaper and cheaper to produce. These two seismic shifts in the drivers of our economy mean that we can now rely on a future where supply will continue to increase, and demand will continue to fall. In other words, technology and population driven deflation is now the natural state of the economy.
We live in a deflationary economy driven by technology. Meanwhile, the entire banking system and federal monetary policy rely on inflation. This is a massive disconnect, and long term there is nothing that monetary policy only can do to make the world inflationary again. It seems that the Fed hasn’t figured this out yet. So it continues to print money at astounding rates to drive demand-pull inflation. The result is massive devaluation of the dollar because the supply of dollars explodes. There are many complex mechanisms that allow this to happen, and those interested can look into ‘money multipliers’ through the traditional and shadow banking markets, and the Fed Balance sheet.
The Game has changed. But moving away from an inflationary economy and monetary policy will require changing our mindset to restructure wealth around deflation. It is nothing short of a complete paradigm shift that will disrupt every currency in the world, overhaul saving and spending, end entire industries, lead to a massive depression worse than the 1920's, and likely cause a resulting rise in fascism and socialism fueled by people who have nothing left to lose (just like the 1930's.)
What alternatives do we have?
The Fed only has one play going forward to try to artificially create inflation, and it results in currency devaluation. There are two places we can put our money to protect it. Here we will also discuss the mechanisms by which our government is the main driver of income inequality.
- Technology stocks. Tech companies that are enabling massive efficiency and aggregating services (like amazon) to push prices down, will be a store of value against a devalued dollar. Money printing government bailouts create value in the stock market by something called the Cantillon Effect.
The Cantillon effect posits that the supply of newly created money will only cause inflation in localized parts of the economy. Through company stock buybacks and other legal but immoral financial avenues, it is easy to take the money that the Fed prints (distributed as bailouts through the banks), and reinvest in an already bloated stock market. The Fed is indeed creating demand-pull inflation, and that inflation is happening in the stock market.
By focusing single-mindedly on its inflation target, the Fed has become the main driver of the massive income inequality in our world. As of 2016, 48% of Americans were not involved in the stock market at all (including 401Ks). Meanwhile, the top 10% of households own about 84% of the value of the entire stock market (Credit: Forbes). By printing money and inflating the stock market, the Fed is making the rich richer, and the poor poorer. Income inequality is also happening because the US government has developed laws and monetary distribution pipelines to give the richest companies and people first access to newly created wealth.The only way to characterize this is either corruption, negligence, or deeply unsettling stupidity on the part of our government. Wealth is freedom, and this is government sanctioned suppression of the poor. The Fed and it’s political leaders seem happy to levy this Cantillon and inflation based ‘invisible tax’ (enabled by bailouts) on tax paying Americans to make themselves extremely wealthy.
Getting back to technology stocks. Traditionally, investors used something called the Price to Earnings ratio (PE ratio) to value stocks. This means that the price of a stock should be related to how much money the company brings in. To the bewilderment of many investors, PE ratios have skyrocketed and have turned traditional worldviews about stock valuations on their heads. The thing these investors need to understand is that in an internet connected world, we also need to consider network effects. Also known as Metcalfe’s Law, the value of a network is proportional to its number of users. More on Metcalfe’s Law later.
As the Fed is ‘forced’ to print money to achieve it’s paradigm of a 2% inflation target, technology stocks will be one of the best stores of value through: the utility tech companies create as they deflate the economy, the Cantillon effect, and Metcalfe’s Law.
2. Bitcoin. Let’s get into the details why Bitcoin is such a valuable store of value and a protection from a devaluing dollar.
Why is Bitcoin valuable?
Bitcoin is the first digital currency that has been used worldwide. In a digital age, doesn’t it make sense to have a digital currency? We already use credit cards after all. Bitcoin has some attributes that makes it extremely valuable:
- Fixed monetary supply: Bitcoin has a mathematically fixed supply that can’t be manipulated by any government, organization, or person. It will only ever have 21 Million Bitcoins. As the Fed prints money, the price of a fixed asset will grow equally as a consequence. Supply and demand. If you increase the supply of money, the price goes down relative to a fixed asset (Bitcoin). As we have already shown, the amount of money that needs to be printed to continue this grand delusion of an inflationary economy will increase exponentially. This will cause Bitcoin’s price to increase exponentially as an equal and opposite reaction.
- Network effects, also called Metcalfe’s law: Every user added to a platform greatly increases the connection of people in that network, and therefore the value. If the number of users is n, the number of connections in a network is n^2 or (n log(n) depending on who you talk to). If you are on MySpace and no one else uses it, MySpace doesn’t have much utility or value because you can’t connect with anyone. If you join Facebook however, there are billions of people you can talk to and share with. The same is true for monetary networks, and Bitcoin is so far out ahead as a digital currency, no other technological innovation can catch it. Bitcoin is analogous to Facebook, compared to Google+ (which famously failed.)
- Distributed Network: The network isn’t controlled by anyone, it is controlled by everyone. Bitcoin was created in 2009 to solve the problem of creating an effectively unhackable network that verifies transactions without a person physically looking at them. It’s called the ‘Double Spend Problem’, which is solved by a technology called Blockchain. This makes Bitcoin more secure than any company’s database, while giving anyone with an internet connection access to it. The distributed nature of Bitcoin also makes sure no government can ever ban or outlaw it, they would have to shut down the entire internet… and let’s face it, that will never happen. The government can shut down currency exchanges, but with the number of people and companies who now use Bitcoin, it is extremely unlikely to happen.
- Proof of Work: This is the name for the verification protocol that makes Bitcoin ‘unhackable’, and verifies transactions with millions of computers across the world. It works by causing computers to guess a really large number to verify transactions, and it takes massive computing resources to do so. The problem to ‘Guess the right number’ increases in difficulty every time more computing power enters the network. The computer who guesses the number is awarded some bitcoin for their trouble in validating the transactions and securing the network.
Proof of work famously uses massive amounts of computing power and energy to operate. Perhaps paradoxically, this is a positive feature of Bitcoin instead of a negative one. The two most important economic drivers in the world of tomorrow are computing power (which is used to run Artificial Intelligence and every part of our economy), and energy. If we have a currency whose value is tied to these most precious economic drivers, we realize that Bitcoin is in fact reflective of the world’s economy.
This sounds like a bad thing, since aren’t we worried about climate change that massive energy use may cause? In the short term yes. However in the next 5–10 years according to Swanson’s law, solar power will be so much cheaper and reliable than any other type of power produced (Coal, Oil, Natural Gas, Hydro, Nuclear), that it would be pointless to use any of these other means to produce energy. Bitcoin will be a major driver of the clean energy revolution in the world that is just around the corner.
Proof of work is related to the world’s two most important resources: Computing power, and Energy. Proof of Work ensures that a global currency’s value will scale with these as we progress along the exponential curves of Moore’s and Swanson’s Laws. Bitcoin through proof of work, is perfectly tied to critical real world asset prices.
Why is Bitcoin the best option for a global reserve currency?
We need a few things for a stable global reserve currency:
- Fixed Monetary Supply that can’t be controlled or manipulated by any person, company, or government.
- Large user base, Large scale adoption.
- It’s value is tied to something that reflects the real economy.
- Universal access.
Let’s look at how this list compares to the attributes we mentioned about bitcoin.
1. Trust: It is the first decentralized trustless system in the world, meaning no one has to trust the network or transactors in the way people need to trust banks to hold all their money. No one but you has access to your money. All the transactions are verified by a mathematical protocol, and not a literal person on a phone as is done currently by banks.
2. Monetary Supply: It is limited to 21 Million bitcoins, so monetary policy is mathematically fixed and can never be manipulated.
3. User base: At this time over 60 million wallets hold bitcoin. People and companies are transitioning to it in record numbers.
4. Value: Through computing resources and energy usage, Bitcoin is tied to the major drivers of our current and future economy. Additionally, people using Bitcoin don’t need to rely on bankers calling each other on phones to validate transactions. Everything is automated, and that provides value to the network.
5. Access: Do you have access to the internet? Then you have access to Bitcoin.
Despite its limited transaction volume, all of the above attributes make Bitcoin a perfect asset to hold the world’s reserve money. People, companies, and governments can all use it as a store of value instead of investing in assets like stocks or gold (whose prices can be manipulated by supply and other financial instruments). It was designed to store value with a propensity towards large and infrequent transactions.
You can imagine using Bitcoin like a savings account. You should only be using the Bitcoin network infrequently to move money from your saving’s account (Bitcoin) to your checking account (Cash). There isn’t a need to do this very often, but development continues on Bitcoin’s platform to scale transaction volumes with interoperable networks. When using Bitcoin, there is no more manipulating Fiat currencies with respect to each other. Bitcoin is just one currency that holds its value in a technology driven deflationary world. We have already seen large companies like Micro Strategy, Tesla, and Mass Mutual understand this principle and protect their money against inevitable Fiat devaluation of the dollar.
The mathematics and trends are clear: the Fed has lost control of its ability to create inflation in the real economy of goods, and has therefore lost control of the value of the dollar. Because of all these unique properties of Bitcoin (including it’s fixed monetary supply), it’s inevitable that it will become the world’s reserve currency within the next two decades. With the Fed continuing to print money and engage in Quantitative Easing, investors are being driven into the arms of Bitcoin to maintain the value of their money.
What does this mean for Bitcoin’s Price?
Many have used something called the ‘Stock to Flow model’ to understand the price of different asset classes like gold, silver, and real estate. Stock to flow is a measure of the total amount of an asset that exists in the world compared to how much of that asset is created or ‘mined’ every year (like gold). The less of an asset that is created or mined every year, the slower the supply increases. This makes the demand very high for the small quantity of it that comes on the market.
The large yellow (gold) and grey (silver) circles in the upper right of the plot below show the total money in an asset class versus the stock to flow value (the amount already in circulation divided by the amount mined every year). Looking at the small dots (Bitcoin), we can see its price as an asset evolving exactly as we expect compared to existing asset classes. (Source @100TrillionUSD)
A dramatic price increase in Bitcoin makes sense from a point of view of the world assets it is attempting to overtake. Bitcoin’s natural evolution is to replace world reserve currencies, which are generally held in Gold and Foreign Exchange Reserves. Each of these markets are worth about ~$10 Trillion. Assuming Bitcoin will overtake these markets it will mean a total expected market cap of Bitcoin to be ~$20 Trillion.
After this massive point in total market valuation, it’s my personal opinion that Bitcoin’s price will feel significant headwinds to grow further as it’s availability to engage in new markets diminishes. It’s likely that Bitcoin’s price will probably scale in a 1:1 equality with the money printing by the Fed (which is still exponential). Then again, Bitcoin may have the momentum to displace the 100 Trillion Bond market as well… forcing prices to ~10Million per Bitcoin if it does so. (Source @100TrillionUSD).
Although this plot was produced last year (showing the stock to flow model over time for Bitcoin), you can see that Bitcoin’s price in 2020 and 2021 have exactly followed this model.
There are many more reasons why Bitcoin will become the world’s reserve currency that are too detailed to cover here. These include many countries’ push to get off the US dollar as the world’s reserve currency, the central bank reserves going to Zero, the minting of trillion dollar platinum coins… among many others. All of these are important factors that will lead to Bitcoin as the world’s reserve currency, and are worthy of additional investigation at another time.
What about other Digital Currencies out there like Ethereum?
There are many other Digital Currencies out there today. These are more accurately referred to as ‘Distributed Ledger Technologies’ (DLT). These include things like Ethereum and Polkadot, which are platforms that support many different applications involving literally anything to do with technology or money. They are not like a stock, they are like owning a piece of the internet. DLTs like Theta will replace Youtube and Twitter, while DLTs like Golem will replace Amazon Web Services. I would argue that in 30 years, nearly every tech stock traded on the Nasdaq will be replaced by a DLT.
I cannot overstate how much DLTs will transform the entire economy and the world. In a world run by DLTs, people won’t have to rely on massive monopolies who buy politicians through campaign donations, and change the rules of the system so they don’t have to play fair. Just as systemic racism exists in our world, so does systemic income inequality. We have a system of economic castes that prevent us from being economically equal to the elite, who can use their money and power to create laws that don’t treat all of us the same. DLTs and Bitcoin can and will solve that by removing the incentive to rig the system of regulation and government. They will usher in an age where people own their own data, and where income inequality can be solved.
DLTs are more equitable, more efficient, faster, but much more complicated. As individual technological issues are solved to scale and integrate them, it’s clear that DLTs are not a possible future, they are inevitable.
We have seen how the current monetary policy works, and it requires inflation to properly function. We have seen that our modern world is driven by technology, and technology is deflationary. This massive disconnect leads to only one final destination, that the Fed will print money until it creates such a large supply that our money is worth nearly nothing. The debt caused by this printing will explode. We will have no way to pay it back other than forcing every Fiat currency to declare bankruptcy, and resetting the world’s economies with a Bretton-Woods 2.0. This will cause a massive amount of financial ruin and political upheaval much worse than the Great Depression of the 1920’s (which led to Fascism in the 1930’s.) It has happened many times throughout history all over the world, and it is happening again right now in front of our eyes.
There are alternatives to Fiat money: something with a fixed supply, something owned by people all over the world instead of the elite, something that can’t be manipulated, and something that is reflective of the world economy’s two most important assets: computing power and energy. This asset is digital and available to all of us, and it’s called Bitcoin. The biggest socio-economic change in the history of the world is happening right now. Anyone with an internet connection can join in by taking part in Distributed Ledger Technologies like Bitcoin, Ethereum, or the countless others that are truly transforming the world today.
Wikipedia, Real Vision
‘The Price of Tomorrow’ by Jeff Booth, a critical book for the development of the idea of deflationary technology presented in this article. Essential reading.