Last time, I discussed the viability of cryptocurrency as a hedge during an economic collapse. I investigated how cryptocurrency performed during the recent pandemic relative to gold, stocks, and treasury securities. The conclusion was that the traditional safe havens are a better hedge than crypto. However, I also explored how cryptocurrency could be the future of money.
This begs the question of whether or not cryptocurrency can be a viable form of money. In order to fully comprehend this, we must compare it to gold. From a technical standpoint, gold and crypto could not be farther from one another. However, proponents for both of these payment systems largely have had similar objectives.
First, we will look at the problems that both of these payment systems wish to address. After that, we will compare the two to see which one of them is better suited as an alternative to fiat currency (i.e. the money that you keep in your pocket). Fiat currency is money that is not backed by any asset, but rather by the ‘full faith and credit’ of the government that issues it.
Problems with Fiat Currency
Here are a few fundamental problems with fiat currency that proponents of alternative monetary systems talk about frequently.
No Physical Backing
This is perhaps the biggest issue. Historically, a physical good backed a currency (i.e. a good that you can hold in your hand, like gold). By “backing” we mean that that the currency could be exchanged on demand for a certain amount of a precious metal like gold or silver. Adam Smith (Scottish economist and philosopher) theorized in his book “Wealth of Nations” that money is usually backed by precious metals due to their durability as well as rarity. Prior to the introduction of banknotes, money was mainly in coins (silver and gold). When talking about this physical backing by goods, we mean exactly the kinds of goods that are either present in industry or that you yourself buy (like jewelry). Every woman understands the value and worth of gold as a good. Many generations may pass down a gold necklace (for example). No one needs to explain to you that these items are valuable. So, a gold-based currency is intrinsically valuable.
Until July 1944, currencies were directly convertible to gold in most cases. This meant that you could claim your banknotes against gold directly. Since 1944, the Bretton Woods system was used. In this system, all the major currencies of the world had a fixed exchange rate with the US Dollar, which was in could be exchanged for a fixed amount of gold. Bretton Woods was in effect until 1971, when President Richard Nixon decided to suspend the dollar’s ability to be exchanged for gold. This suspension soon became permanent.
This decision is extremely controversial among economists. Numerous economists believe that fiat currencies not being backed by any physical good gives governments almost unlimited power. However, the gold standard also had quite a few problems which fiat currencies apparently solve.
Limitless Government Power
Many argue that fiat currency still has a ‘soft-backing’. While it is not backed by any physical good, it is backed by the guarantee of the government that printed it. This means that it is backed by the assets owned by the government, including the roads, military, and real estate. Or in other words, the ability of the government to tax its population. The TV Show “Billions” discusses this conundrum briefly as well. This leads us to the issue of limitless government power.
When the Gold Standard/Bretton Woods were in use, governments had limited power. Back then, governments could only print money if they had sufficient gold reserves. This is because if they printed more money than they had reserves for, people would realize that the currency was diminishing in value and start exchanging it for gold.
In the fiat system, these limits are no longer in place. The government can pretty much print as much money as it wants (to the extent that it doesn’t cause runaway inflation). This has meant that governments across the world have printed trillions of dollars to support their quantitative easing programs since the crash of 2008. In simple terms, “quantitative easing” means that the central banks printed new money to bail out failing banks during this crisis.
But once again, this news is not all bad. While printing money has a lot of ramifications, it may also have positives. Some economists believe that governments can stimulate the economy and fuel growth after the economy crashes. This is exactly what the US government and many others did around the world. Recovery after 1929 was extremely slow. However, the economy recovered within just a few years after the 2008 crash.
Concentration and Redistribution of Wealth
There is ample evidence to suggest that the way we produce money at the current time is beneficial for a privileged few and disadvantageous to the majority of people. Simply put, the government can engage in a practice called ‘deficit spending’. Deficit spending occurs when governments spend more money than they earn through taxation and other revenue streams. Governments are always incentivized to spend more than they rake in and take on debt. This allows them to finance political goals.
While this may be a good thing in a small number of circumstances, it is more often than not a way to steal money from the population. This happens due to currency debasement. Currency debasement occurs when governments print money and reduces the currency’s purchasing power. Purchasing power refers to the amount of goods that can be purchased by a specific amount of money over the course of time. By printing more money, the value of the currency decreases. Whereas $100 may have bought you a fancy suit 50 years ago, you need many times that now to get the same quality suit. This reduction in purchasing power is also popularly known as inflation.
Those who get a piece of the new money first are obviously much better off than those who get it last, since their purchasing power has decreased without them doing anything. If you have the bulk of your savings in a bank account earning negative interest, then you are one of those getting the new money last!
In relation to this, Alan Greenspan (the former Chair of the Federal Reserve of the United States) wrote an essay in 1966 titled ‘Gold and Economic Freedom’. He wrote: “Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.” In other words, with gold as a money, it’s impossible for the government to steal your money in this subtle way.
How Cryptocurrency Fares Against Fiat Currency
So far, we have outlined some of the major problems with fiat currencies. The biggest one is the fact that is that they aren’t backed by any real goods. The only reason governments could print banknotes in the first place was that the people trusted the government to exchange them for a valuable metal. That is not the case anymore.
Let’s take a look at whether or not cryptocurrency is able to tackle some of the previously mentioned issues.
Cryptocurrency Also Has no Backing
Cryptocurrency has a lot of advantages over traditional fiat currency. However, being backed by real goods them is not one of them. In fact, fiat currency is better in this regard. At the very least, a national currency has the “the full faith and credit of the government”.
This means that the government may try to ease the pressure on a economy in a downward spiral by printing more money. Once the money has been printed, governments usually use it to purchase treasury securities from institutions, banks, and the public. This injection of cash helps stimulate the economy as the institutions/banks then invest the money into businesses.
Specific commodities or currencies such as the US Dollar or gold do back some cryptocurrencies. However, the reputation of these coins is controversial, to say the least. Also, it is not possible for you to convert the coins into dollars or gold unless you sell them on the open market (which may sell for less since people may not have confidence in cryptocurrency during a crash). Simply put, those looking for a cryptocurrency that is has a solid backing are out of luck.
Crypto is Anonymous and Decentralized
This is one of the best things about cryptocurrencies. Decentralization means that no one owns the network of which they are a part of. This is because cryptocurrency works through a blockchain. Every single computer that connects to a blockchain helps maintain it. This means that no government in the world has any control over it (not does any other organization).
Cryptocurrency also provides anonymity. Contrary to popular belief, it is possible to track cryptocurrency. However, you can only track it to a specific address that made the account. A Bitcoin address is essentially used to send and receive coins. It is not tied to a name, social security number, or a real-world address. As such, cryptocurrency affords a lot more anonymity than anything else.
Cryptocurrencies also have a limited supply. The more you mine them, the lower the incentives of mining them because additional coin is more expensive to mine. This is known as halving. Cryptocurrencies (most of them) have a predictable supply that will run out one day. As such, there is no fear of hyperinflation due to excessive printing.
Hyperinflation occurs when the government prints so much money that it becomes worthless. This happened to the Weimar Republic (Germany) after World War 1. With immense reparations to pay, the government had no choice but to keep on printing money. Eventually, the entire currency collapsed and was replaced by a new one in 1923.
Portable, Digital, and Secure
Cryptocurrency is essentially just a bunch of hashes on a hard drive. As such, it is infinitely portable. You can keep it on a USB stick that you can carry with you wherever you go. Or, you can keep it in an online portal (wallet) which will hold it for you. However, make sure that the reputation and the security of the wallet are iron-clad, as there have been numerous frauds in the past.
Since it is all digital, that means that transactions are simply a press of a button away. However, cryptocurrency has yet to penetrate national retailers and become a widely used medium of exchange (i.e. money). But, the ease through which you can send and receive crypto is unmatched. It will be interesting to see how it makes our lives easier as its adoption increases across the world.
Lastly, crypto is one of the safest currencies to hold. As long as you protect your computer from malware and intrusions, it is very difficult for someone to steal your coins. On top of that, counterfeiting is virtually impossible due to the blockchain, as any alteration made to the blockchain will not be validated by other systems on the network.
Gold Against Fiat Currency
Gold has been used as a store of wealth for at least five thousand years, and as a currency since at least 700 BC. While fiat currency has pretty much replaced gold as the medium of exchange, the gold-standard still has a lot of proponents. Let’s take a look at why that is.
Gold’s History as a Store of Wealth
Gold, obviously, does not have any backing. It doesn’t need to – it’s a good all on its own! Moreover, due to its storied history, it carries a lot more trust in the eyes of the people. Being rare, having a limited supply, and being difficult to mine makes it great as a currency.
The main reason we used gold as a currency was due to its durability and shiny appearance. It is very easy to determine its purity, and to mint it into coins. Being used mainly in the form of bullion and minted coins during the middle ages, gold was later used as backing for banknotes until the fiat currency system arrived.
Just to be clear, banknotes did exist prior to fiat currency. However, they could easily be exchanged for gold as mentioned previously. With the advent of fiat currency, governments simply suspended that convertibility (into gold) indefinitely.
Having a superior trust factor among most people in the world, and a real physical value (gold is used in numerous industries), makes gold better than cryptocurrency when it comes to the notion that ‘currencies should be backed by real goods’. Gold is still widely used as a store of wealth, especially during times of high inflation or market crashes as we discussed in our last article.
Lack of Portability and Government Control
The vast majority of gold currently houses itself in government vaults across the world. This means that even if gold was to once again become a widely used medium of exchange, governments would still have a lot of control over it. This is one of the aspects where cryptocurrency is better than gold.
Gold is also difficult to carry around. Those who want to transport large amounts of the metal need to hire security teams to ensure safe passage to its destination. The vaults where gold is kept have some of the most advanced security known to man.
Due to the fact that gold will always have a high value relative to its size, gold will always be a currency that is difficult to transport. Having gold backed banknotes or a digital currency is the ideal solution, as we saw in the first half of the last century.
Gold is Very Difficult to Misuse
While governments can control their gold reserve, it is very difficult for them to abuse their power in a gold-based monetary system. Due to its limited supply, governments cannot engage in deficit spending. They also cannot interfere in the financial markets to the same extent as they have been doing in the last few decades.
This means that inflation is much easier to keep in check when governments use the gold standard. There are economists that theorize that the gold standard can cause deflation if the money supply does not increase in tandem with economic growth. Some economists believe that deflation can be devastating to the economy for a number of reasons. Deflation is when prices fall over time, rather than rise (inflation). However, like almost everything in economics, whether this is bad or not is also debatable.
So, Which One is Better?
Before we dive into this, it must be stated that the chances of the fiat monetary system going away are extremely slim. While I will not comment on whether or not the system is adequate for modern times (as both sides have a compelling argument), the fact is that that it is the governments that stand to benefit the most from the use of fiat currency, and they are the ones who are responsible for which monetary system we use in the end.
An ideal solution for the future could be a digital currency that is backed by gold. In fact, there are rumors that China and Russia are developing exactly such a system right now. Both of these countries have been trying quite hard in recent times to stop using the US dollar as the global reserve currency. This might be an ideal way for them to do it.
If we look at the fundamental principle behind money, then gold is much better than cryptocurrency in its current state. Being a physical good and in demand by a lot of industries, it has a lot of benefits over digital currency, with the only downside being the difficulty of using it as a replacement for paper based cash in our day to day lives.
Lastly, while the chances of this happening are practically non-existent, gold would be extremely useful in a global catastrophe. If we see an almost movie-like disaster hit the world which knocks out our communication lines, then digital currency would become immediately valueless. In this highly improbable event, gold would probably be the currency of choice for most people.
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