Note (opinion)

Why can the scarcity of bitcoin destroy the dollar?

Frances Coppola, a specialist in banking, finance and economics, is one of CoinDesk’s authors. He has also published a book, The Case for People’s Quantitative Easing, which explains how creating modern money and providing financial incentives to individuals works. In addition, Coppola is a supporter of the idea of ​​”helicopter money” (injecting money into the economy) to help save the economy from recession.

Coppola in Article The latter explains how the scarcity of bitcoin can be catastrophic for the US dollar.

How does the Federal Reserve’s monetary policy work?

It is widely believed that the inflow of large sums of money by the US Federal Reserve into the US economy will eventually lead to higher inflation. If a lot of money has entered the market, but there is nothing to buy, the price of goods and services should naturally increase. The prospect of Judy Shelton joining the Federal Reserve Board raises hopes for those who want the Federal Reserve to take the power to create new money. Much of Judy Shelton’s reputation owes to her support for the reuse of gold as the backbone of the dollar.

However, the Federal Reserve is required to stabilize prices. If the Federal Reserve can not change the amount of money in circulation in response to economic conditions, it can not stabilize the price of the dollar.

Frances Coppola: Bitcoin-Like Scarcity Would Be a Disaster for the Dollar

What is the “price” of a dollar? Although the dollar has not been backed by gold since 1971, some people are willing to weigh the dollar against gold, possibly out of remorse for the past relationship between gold and the dollar. In their view, the price of the dollar is not fixed and the Federal Reserve is destroying the currency.

Despite hours of arguing with ardent gold prospectors, they think the rising dollar price of gold over the past century means the dollar is devaluing. I also have similar arguments with people who think that the dramatic growth of stock markets, bonds, real estate, as well as bitcoin, means that the dollar is growing too fast. However, given that the dollar has no backing, the rise in asset prices does not say anything special about the price of the dollar.

For businesses and ordinary people in the United States, the dollar equals purchasing power. The purchasing power of the dollar within the United States is the amount of American services and goods that American citizens can obtain in dollars. The rate of change in the purchasing power of the dollar is known as the “rate of inflation.”

If people prefer gold or other currencies to a particular currency, the purchasing power of that currency is reduced to zero. This phenomenon, known as “hyperinflation”, has never happened to the US dollar.

Frances Coppola: Bitcoin-Like Scarcity Would Be a Disaster for the Dollar

For people in different countries, the price of the dollar is equal to the exchange rate of the dollar against the currency of that country. The exchange rate is the amount of a country’s currency that a US dollar can buy. It not only assesses the amount of services and goods that American citizens can buy in other countries, but also the amount of services and goods that American citizens can buy in their own currency. Therefore, the exchange rate can be equated with the purchasing power of the US dollar abroad.

A lower exchange rate means that one dollar is less able to buy goods and services. Thus, a fall in the exchange rate is the foreign equivalent of the domestic inflation rate.

A fall in the exchange rate destroys the foreign purchasing power of the currency, just as hyperinflation can destroy its domestic purchasing power. In fact, the two are often seen together. If a country has large amounts of debt in the form of foreign currencies, a fall in the exchange rate can make that country unable to pay its debts.

In addition, if a country is dependent on imports, a sudden drop in the exchange rate can make that country unable to pay for imported goods and services. Often, the government’s response to such a crisis requires the printing of large amounts of national currency in the hope of exchanging it for foreign currency. This could accelerate the fall in the exchange rate and fuel domestic hyperinflation.

In the past, central banks and governments considered the exchange rate to be the most important price. They thought they had to find their way in the world by exporting goods and services to other countries, and they knew that controlling the exchange rate could help them export. In addition, they believe that if a country allows its exchange rate to fluctuate against other currencies, it will see the exchange rate fall, leading to hyperinflation. Thus, central banks and governments relied on gold or other assets for their currencies. In some cases, currencies even supported each other.

However, even long after the gold standard was abolished, “fear of currency fluctuations” determined countries’ monetary policies. In fact, these policies are still in place in developing countries. Until the 1980s, the Federal Reserve, with the help of other central banks, managed the dollar exchange rate effectively and actively.

The Louvre Accord was signed in 1987 in Paris. The agreement was aimed at stabilizing international currency markets and halting the US dollar’s downward trend at the time. However, the Louvre Agreement failed in 1989, after which the Federal Reserve adopted a policy of managing the dollar’s domestic purchasing power instead of managing the exchange rate. Along with most major central banks, new US policies have set consumer inflation targets at 2% per annum and relinquished control of exchange rate fluctuations.

Since then, the Federal Reserve has managed inflation by adjusting interest rates, borrowing from banks to borrow dollars. Bank loans create purchasing power. Increasing the cost of borrowing encourages banks to pay more interest on loans to individuals and businesses. This reduces the demand of individuals and institutions for borrowing and thus reduces bank lending. As bank lending decreases, so does the rate of increase in purchasing power. In other words, less bank lending means lower price inflation for the consumer.

Of course, US banks print dollars when they lend. However, the Federal Reserve does not directly control the amount of dollars printed. In addition, the institution does not place any restrictions on the printing of its own money. The Federal Reserve builds reserves in response to bank demand and provides liquidity in financial markets in response to market signals. Contrary to popular belief, this is not done to destabilize inflation, but to keep inflation within the Federal Reserve’s target range of 2 percent.

Bitcoin or Federal Reserve monetary policy; which one is better?

To better understand why the Federal Reserve is unable to implement its price stability guidelines directly by controlling the dollar in circulation, it is best to take a look at bitcoin behavior. Bitcoin algorithms control the amount of this digital currency, not its price. The amount of bitcoin in circulation is growing at a steady rate, eventually reaching 21 million units. Of course, when all of these 21 million units are available, probably none of the people who live on Earth right now will be alive!

Frances Coppola: Bitcoin-Like Scarcity Would Be a Disaster for the Dollar

The result of controlling the number of Bitcoin units instead of price is volatility and price fluctuations. The price of bitcoin fluctuates sharply as demand decreases and increases, while this is not the case for the number of bitcoins in circulation. Market fluctuations are not particularly important for Bitcoin; Because almost no one makes their weekly purchases with bitcoin or saves all their life savings in bitcoin form. However, the livelihoods of millions of people depend on the dollar, and if the price fluctuations often seen in bitcoin charts occur for the dollar, the situation will be catastrophic.

As we saw in September last year (September 1998) and March this year (March 1998), international demand for the dollar is growing exponentially in times of crisis. Therefore, the Federal Reserve is trying to keep the price of the dollar constant and has no choice but to print large amounts of dollars to meet this demand. Of course, if the policy of this institution was to control the exchange rate, this would still happen. Dollar shortages around the world are causing the dollar exchange rate to rise.

If the Federal Reserve used an algorithm that kept the rate of money production constant or linked the dollar to gold or other assets, instability would re-emerge. This instability was evident in both the foreign exchange rate of the dollar and its domestic purchasing power, not during an uptrend but during a downtrend. In fact, exchange rate fluctuations and hyperinflation are not serious risks. We remember from the 1930s that whenever the legal ban or the gold standard prevented the Federal Reserve from printing money to mitigate the negative effects of the economic crisis, there was debt deflation and a severe recession. Debt burst is a concept opposite to inflation and related to the effect of debt on the price of goods and services. Under these circumstances, borrowers face falling property prices, which can have negative consequences for the economy.

According to Frances Coppola, author of this article, the United States should be wary of such situations.


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