Cryptocurrencies have had a bad few weeks. From heightened volatility to the missing millions of dollars from a Japanese cryptocurrency trading platform. Even more than ever before, people are ready to call the demise of cryptocurrency. However, to my mind, all of this noise misses the bigger picture.
To my mind cryptocurrency is the world’s attempt to deal with three issues. Firstly, the efforts of more and more countries and institutions to side-step the US economic and political power inevitably declines; secondly the demise of fiat currencies as central banker’s quantitative easing undermines confidence in fiat currencies as store of long-term value; and thirdly the desire of many for a new unit of currency that is relevant in the new tech/digital world.
- The global economy is in a state of flux as the omnipotent economic, and political power of the US recedes. Indeed, the US politicians have been overreaching in an attempt to maintain their control over the global economy. The consequence has been that more and more countries have sought to skirt around the dollar.
- Fiat money a currency without intrinsic value relies on the general public’s confidence in the global economic system and the credibility of governments and central banks. The acceptance of fiat money has been heavily dependent on the credibility of the US dollar over recent decades. When the US dollar came off the gold standard in 1973 only the economic power of the US economy and its core role in the pricing of key commodities such as oil maintained the credibility of currency that no longer had any intrinsic value
- The more that our world moves from the physical to the virtual reality the more than the line between physical currency and digital currency. No one would argue against the premise that it has become incredibly easy to launch a new digital currency and to build a network of people prepared to accept the currency. Already digital money has established itself in parts of the world as an option for paying for goods and services. In the future, it is possible it may take a significant share of transactions or indeed, conceivably dominate swathes of the financial system.
The global political order is changing. The US’s economic power is diminishing as China and India, in particular, grow far faster than the US. However, while US economic power has fallen back from around 50% of world GDP at the end of WWII, to 28% in 2016, the US has maintained its political dominance through financial control; it has restricted access to the dollar and military power through alliances that place US troops and military hardware in at least 55 countries around the world.
In the theory of long cycles of politics, an incumbent country in the latter stages of its world dominance often tries to overplay its hand which in the end leads to acceleration of change. Such political overreach has taken some forms. The US, by threatening to withdraw access to dollars for either sovereign states or major non-US financial entities can be seen as part of this overreach. Consider also the number of US legal/regulatory initiatives such as FATCA and the fines the US imposed on foreign banks in the wake of the world financial crisis that has seen the US exert its power way beyond its borders. For sure there were instances, there were many instances where foreign banks were being fined for misdemeanours of their US entities however the scale of the fines seemed to raise the suspicion of a trade war against European entities in particular. Militarily the Iraq war significantly undermined the US in its assumed role as a policeman of world peace.
The global scene is set for a stronger global opposition to the US perspective, or at the very least more countries and entities are likely to steer a path around this US power. That global movement is made stronger by the strong growth of BRIC countries most notably China, and greater economic integration in the Eurozone. China now represents around 18% of global GDP (on a PPP basis) with the Eurozone at 11.7% compared to the US at 15.5%.
The development of digital currencies and particularly cryptocurrency can be seen as one element of the shift away from US domination. It’s an attempt to circumnavigate the US economic power base. Developing a currency that can avoid the control of the US is a proposition that has increasing attractiveness to the new world in that doesn’t want to be beholden to US financial muscle and the overreach of US political power. While the US economy remains a significant force in the global economy it is, after all, a net importer of capital; hence ironically it’s the US that should be trying to remain open to foreign capital. Instead at times, it seems hell-bent on hurting nations such as China that export capital to them to fund their fiscal deficits. It’s the rest of the world that should be dictating terms.
The fall in the credibility of fiat currencies has of course not just been about the US dollar. Post the world financial crisis many countries have debased their currencies through massive quantitative easing. The value of anything falls where there is a significant increase in supply. In the US, Europe and Japan, wave upon wave of quantitative easing must have done damage to the credibility of their respective fiat currencies. Central bankers have risked debasing their currencies for the short-term gain of inflating the value of asset prices and funding ever-increasing government fiscal deficits. The credibility of fiat currencies as a store of value must also have been damaged. Indeed, the stellar performance of gold is, and the rapid emergence of cryptocurrencies is to my mind a manifestation of the move at the margin by investors to seek other forms of holding their wealth.
We live in a world where technology is overwhelming economic and banking systems. Cryptocurrency is part of that new digital world. It far easier for concept of cryptocurrency to infiltrate the global economic system today when so many of us ordinarily use a debit credit or payment card to make payments for goods and services. Your average household is increasingly succumbing to digital payments for goods rather than the use of physical notes and coins. Criticism of anything new is very easy and is a given. People said that electronic trading of securities would never happen but person to person trading of securities on a trading floor has all but disappeared. Hence cryptocurrencies are often belittled because they are new. Their emergence has been extremely rapid and of course inevitably the volatility of prices has been off the charts. But if you cut through the noise there is a concept that has logic and to my mind will take us on a journey to a new form of currency.
Cryptocurrency may just be a staging post on the way to a completely new digital currency. To understand what may come after cryptocurrency it is instructive to return to the basic concept of what is a currency. The simplest and original definition of a currency is something that is in circulation as a medium of exchange. Other definitions bring in the notion of government or central bank issuance but this is irrelevant as to the use of currency, they just happen to be the default issuers of currency in modern times. Originally currencies were a form of receipts for commodities in storage. The currency had an intrinsic value. Either the coinage itself had value, or paper money introduced in China under the later Tang Dynasty (618-907) represented coinage or a commodity stored somewhere. Roll forward to the last century when fiat currency with no intrinsic value and with no value backing as countries moved off the gold standard.
Could it be that we are coming full circle and that currencies will return to representing something that has intrinsic value? Cryptocurrencies have shown that the value of any currency depends critically on the scale of its network of use. Cryptocurrency has a base value or intrinsic value; Bitcoin for example has a base value around $1350 as that represents the approximate electricity cost of mining a Bitcoin. However, the recent rise in Bitcoin when the price rose to $17,000 was a reflection of a rapid rise in the number of people trading the currency (the breadth of its network) rather than any change in intrinsic value.
Already people are exploring what may come beyond cryptocurrency. In a fascinating paper by James Zdralek at SAP entitled “The Future is Money” he proposes a new blockchain-powered monetary system running on inflation-proof, bubble-resistant digital currencies. The backing to this new futures-backed currency would be agreed-upon future deliveries of products and services. In essence companies producing products and services would be able to issue money against future contracts they have in respect of things they are selling in the future. I urge readers to work their way through the paper to get a fuller understanding of the concept. However it is not far away from the original currencies that had flows of goods and services with intrinsic value that backed privately issued currency. No one ever said that currency was just the domain of government and central bankers!
This article was attributed and provided by PG International