Bitcoin and Tulips
Friday, 9/17/2021 10:58
Crypto, fiat and a big ugly truth...
The FIRST asset bubble in recorded history was 'Tulip mania',
writes Paul Tustain, founder and chairman of BullionVault.
It happened in Holland in 1637. Tulip bulbs became the centre of a financial speculation which ended in wild profits for the early few, and total loss for the later many.
We've seen many bubbles since then and they mostly look ridiculous given hindsight. But they generally had at least a grain of sense in them as prices started to take off.
Behind the prices of crypto currencies, like Bitcoin, there's more than a grain of sense, but hidden within, there is also an ugly truth which is not widely understood. No-one – not even Bitcoin's biggest enthusiasts – will be worse off for grasping it.
First the sense.
A problem that all savers face, and which Bitcoin resolves, is that we have governments which are corrupting our currency systems by issuing themselves money by decree, or 'fiat'.
The western democracies have voted for politicians and a political system neither of which are restricted by constitutional constraints on printing money. The surest way for politicians to retain power is to bully a puppet central bank into printing more money for them to spend. There used to be a way of stopping them (that's another story) but there no longer is.
In two ways cryptos – like Bitcoin – block this irresponsible political behaviour.
- Through creating an algorithmic puzzle which has a known number of unknown solutions (crypto-coins are the hard-to-find solutions to these algorithmic puzzles) cryptos subject the issue of currency to a hard top limit. Bitcoin has a hard top limit issue of 22 million coins.
- Because the solutions can be found by anyone who throws sufficient computing power at the puzzle Bitcoin takes the power to create 'money' away from government, and places it back in the hands of any citizens who are prepared to make the effort.
These are two powerfully appealing aspects of cryptos to their advocates.
Now the ugly truth.
Before government hid the issuance of money behind a miasma of central bank smoke and mirrors the creation of money was a matter for private institutions. It still is, for much of the money in issue, and how it works is very easily understood through mortgages.
If a house has been built, and is just standing there, it forms part of the capital stock, because a built house has a capital value which can be realized by selling it.
When a commercial bank offers a mortgage to a house buyer it is the commercial bank, not the central bank, which creates new money. It opens two accounts for the borrower – one in credit (the new money which is used to pay the house seller) and one in debit, which hangs around as a long-term mortgage.
The debit side is inextricably linked to the house, which acts as loan collateral. This new money was created – perfectly responsibly – from a real asset's market value. It is not, absolutely not, 'fiat' money. So while the credit side whistles around the economy as what we call 'money' the debit side provides the anchor to value, via collateral, and the integrity of the currency system is maintained because the collateral can only be released by paying down the mortgage, which automatically eliminates whatever money had been circulating on the back of the collateral's market value.
Underpinning all ordinary credit creation in a traditional (pre-1930) western monetary system was this style of debit anchor. Monetary issue was constrained by the availability of collateral capital, and its quantity floated in a natural marketplace for money, according to (a) the demand for credit by those who had the capital to collateralize it, and (b) the supply of credit available from commercial banks – itself restricted by their equity risk capital. By and large, as societies built a larger stock of houses and factories the size of their monetary aggregates shadowed the real wealth bound up in their capital stock.
What happens now is that having fooled very many people that it should be government which controls the monetary stock our politicians are abusing that power.
They have an insatiable demand for the credit which buys them votes. But because they lack the capital to underpin with physical or marketable collateral any responsible monetary issue, they have instead arranged for the Bank of England, for example, to buy their 'gilts' (these are formal government IOUs) and to place the newly printed sale proceeds into the government's own bank account, from where it all gets spent.
This uncollateralized money, all casually waved into existence by government, with the connivance of a puppet central bank, is 'fiat' money.
Before 1930 any institution, if it really wanted to, could issue 'fiat' money against weak or non-existent collateral. But those that did got found out by the marketplace. They went bust when the collateral was insufficient to eliminate a debt through its sale into the market. Junior banks often failed, which periodically cleansed the money system of the foolishness of issuing 'fiat' money unbacked by good quality assets.
Today, as government issues uncollateralized credit to itself, an increasing proportion of our monetary system becomes 'fiat'. We can demonstrate what this proportion is.
M3 is the widely accepted aggregate of the amount of 'broad' money 'out there'. It includes:-
- Physical paper and coin currency in circulation
- Bank reserves held by the central bank (the monetary base)
- Demand deposits
- Money market funds
- Savings deposits
- Large, long term deposits
In the UK,
M3 is £3.37 trillion. Public sector
net debt is £2.22 trillion. There is no physical or marketable collateral behind the public sector net debt, so we can estimate that Sterling – as measured by M3 – is now 65% 'fiat'.
On the upside, at least that means that 35% of Sterling is still backed by real collateral.
OK, so how much of Bitcoin is backed by collateral? Er...none of it. Not one cent. Bitcoin makes no call whatsoever on any real, tradeable capital stock. A bitcoin is an object – a tulip bulb, if you like – which stands (or falls) entirely on the basis of what it is. Sure, it may be limited in issue, but whatever quantity exists there is no collateral connection which binds its value to a capital stock.
Whisper it very quietly or – if you're wiser than the author – not at all. Bitcoin's value continues to rise on the assumption that it is a new form of money. Yet it is money waved into creation and taken up by people with little or no understanding of how money's value is connected to a marketplace in capital assets. Bitcoin is 100% pure 'fiat'; the very thing it sought to replace.
How will that look in hindsight?
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