1. Bitcoin eats gold.
2. Bitcoin eats fiat.
3. Bitcoin eats both fiat and gold, because something like gold will also eat fiat.
To summarize my position, despite being Austrian-curious, I think the first one is right, and the second and third are probably wrong. Over time, I added a fourth
4. Bitcoin eats (some of) corporate discretionary liquidity
This one might also happen under any of the three above. But it seems that I was naively excluding a fifth.
5. Bitcoin eats central bank reserves
Like every aspect of crypto, it fits into the category of things that are obvious in hindsight, but somehow people don’t figure out ahead of time.
The proximate cause of all this is the decision by the various branch offices of the US Empire to confiscate all the assets they can of the Russian Central Bank. This comes after the loosely related incident where the Canadian Primate Minister froze the bank accounts of protestors against Covid vaccine mandates.
The theme of both of them is a confluence of various factors
-All meaningful money is already electronic, and we operate on what’s effectively a paper standard, where the convertibility of electronic dollars to pieces of paper is an increasingly redundant aspect.
-Electronically recorded assets are enormously easier for governments to seize, if they own the computers or can pressure the people that do
-The declining US Empire, in conjunction with a populace hooked on outrage-bait news stories, seems determined to lash out ever more at enemies foreign and domestic.
The Canadian story is more likely to spook the average person, but the Russian story is far more important.
Every Central Bank in the world is figuring out very fast that any assets you hold that are denominated in dollars, euros or pounds, are liable to be seized in the event that you piss off USG.
Now, what exactly are central bank reserves for? Partly, they’re for propping up your currency in the event of a depreciation. You need to sell some foreign currency and buy your own to keep your exchange rate from plummeting too far. You already have endless ability to print more money to cause your currency to depreciate (subject to how painful it is to cause more inflation). What you don’t have an unlimited ability to do is make your currency appreciate, because for that you need to sell foreign currencies and buy your own. And since central banks like to keep the option of moving their exchange rate up or down, they want to be able to do both. That said, these days competitive devaluations to spur export growth are more popular than trying to have a strong currency or maintain a currency peg, so the desire is likely not for everyday use.
Rather, it’s useful in a crisis. You may want to intervene in forex markets to support the currency when it’s crashing, such as to prevent bank runs and retail shortages from panic buying when people worry they won’t be able to import any more. You may also want foreign reserves to be able to prop up important institutions in a crisis. Recapitalizing banks with something other than your own plunging currency, for instance. Or supporting other public companies that might have debts denominated in foreign currencies, in an economic crisis where firms are on the verge of failing. Or even for just showing that the country has hard assets to back its debts.
What the current situation in Russia also highlights is that sometimes you get very bad crises where all of these problems happen at once. Your currency is crashing, because investors are fleeing the sanctions being placed on you. On its own, this makes imports suddenly very expensive (even if just the ones that you’re still allowed to buy). Ordinarily this depreciation in the medium term might spur export growth, but you have a tough time being able to export anything under the new sanctions regime. Your banks are failing, because their foreign assets are being confiscated and their ability to interact with SWIFT is turned off.
At such ordinary points, you’d start selling US dollars and buying rubles to support the currency. Or you might use US denominated assets to recapitalize your banks and spur confidence in their stability.
Well, bad luck for you, because lots of those USD and Euro denominated assets you held are now gone.
Oddly, the extra aspect of trade restrictions makes the exchange rate stakes here somewhat lower, because it’s not like you can import or export much anyway. But recapitalizing the banks sure would be handy right now. Well, for the banks that haven’t already collapsed. Too bad.
Having seen this lesson once, it becomes apparent that foreign currency reserves are only of any value in a crisis where USG is still firmly supporting you. Otherwise, they may as well not exist. If you’re China, you ought to assume that any crisis might be used against you by USG. Not that it will, but it definitely might.
(As a side note, it's interesting to go back and consider this post on how China could weaponize its Treasuries. I think most of it still holds, but it now has the wrinkle that Treasuries are like a first strike nuke - you have to use them all immediately, or they're going to get deleted the next hour as soon as the Fed can organize its response.)
I suspect China will keep buying treasuries to a certain extent, because they want to keep their currency cheap for everyday export purposes. But if I were the Chinese, I’d be treating this as just a pure expense that results in no corresponding assets. You have them, but when you need them, they’re getting written down to zero.
Which is to say, at a stroke, the days of central banks holding large amounts of major reserve currencies for strategic value are probably winding down. Certainly, the days of China holding lots of USD assets are winding down really fast. You would have to have rocks in your head.
So what might you hold instead, as assets that might be more useful in a crisis?
Well, the question re-phrased is “what electronically transactable asset can you hold that will maintain some likely value, but that is extremely difficult for a hostile government to seize from you in a crisis?”
And the most obvious answer here is Bitcoin.
Bitcoin, along with other cryptocurrencies, have the singular property of being unusually hard to expropriate, because the record is held on so many computers around the world. This is, rather, the entire point. Unless a foreign government can hack your private key because of bad storage practices, it’s very difficult for them to do much. You might also hold gold, but this is much harder to transact in internationally (unless you all agree to leave your gold at the Federal Reserve Bank of New York and just change the record of ownership, which is clearly a disastrous strategy these days). But in a crisis, if you bought Bitcoin with your Renminbi, that’s still going to be there. The treasuries, not so much.
But it's not clear that they'll necessarily just lump it forever. We do not have good models of how or when exactly the equilibrium gets shifted from one global reserve currency to another (like most games where there are two possible Nash Equilibria). In part, we just have very few observations of reserve currency status changing. Spain to the UK, and the UK to the US. And even the ones we have are in scenarios where all such currencies were backed by hard assets, so the logic may not hold as cleanly when everything is pure fiat.
I suspect China will keep buying treasuries to a certain extent, because they want to keep their currency cheap for everyday export purposes. But if I were the Chinese, I’d be treating this as just a pure expense that results in no corresponding assets. You have them, but when you need them, they’re getting written down to zero.
Which is to say, at a stroke, the days of central banks holding large amounts of major reserve currencies for strategic value are probably winding down. Certainly, the days of China holding lots of USD assets are winding down really fast. You would have to have rocks in your head.
So what might you hold instead, as assets that might be more useful in a crisis?
Well, the question re-phrased is “what electronically transactable asset can you hold that will maintain some likely value, but that is extremely difficult for a hostile government to seize from you in a crisis?”
And the most obvious answer here is Bitcoin.
Bitcoin, along with other cryptocurrencies, have the singular property of being unusually hard to expropriate, because the record is held on so many computers around the world. This is, rather, the entire point. Unless a foreign government can hack your private key because of bad storage practices, it’s very difficult for them to do much. You might also hold gold, but this is much harder to transact in internationally (unless you all agree to leave your gold at the Federal Reserve Bank of New York and just change the record of ownership, which is clearly a disastrous strategy these days). But in a crisis, if you bought Bitcoin with your Renminbi, that’s still going to be there. The treasuries, not so much.
This is the theory, anyway. There are other ways to try and make life hard for particular crypto holders. Pressure exchanges to blacklist certain wallets held by state entities, for instance. You could even pressure or coerce miners to refuse to mine transactions from certain addresses, though it's not clear how feasible this would be. But still. It's a hell of a lot better than having your treasuries / equities / bonds stored on a computer located in the United States.
Of course, this only half solves the problem. For trade flows, you care about exchange rates with your trading partners. Can you use your Bitcoin reserves, or other currency reserves, to appreciate your exchange rate with USD?
Maybe, but not obviously. If what you care about is the USD/RMB exchange rate, selling your bitcoin to buy RMB mostly is just going to lower the price of Bitcoin, but will probably have the same effect on USD denominated BTC as RMB denominated Bitcoin. You could imagine trying for some tricky indirect effects if you bought third country currencies. In other words, suppose that China could still buy Swiss Francs. In a crisis, it could dump the Francs and cause the Franc to depreciate with respect to RMB, but likely somewhat with respect to other currencies as well. Then maybe the Swiss use their own dollars to support the Franc, so you indirectly end up getting the effect you want (selling USD and buying RMB). Maybe? I tend to find this stuff hard to predict, because the more links there are in the chain, the greater the chance that some other effect that you haven’t fully anticipated comes in and the result isn’t quite what you think.
So at the end of it all, my initial presumption that no semi-hostile central bank (think China) will buy a US dollar denominated asset again is likely wrong. They will, but only for normal times currency management, and treat it as a flow expense not an asset. But to the extent that some of the purchases were also because they previously viewed USD assets as useful in a crisis, I expect that aspect to get significantly scaled back. The announcement is a significant blow to the perception of USD assets (and Euro and Pound ones too), and one that is very hard to undo.
You can also imagine deleterious effects on US dollar hegemony in terms of currencies for trade flows. This is a big part of the Gopinath and Stein model – the global reserve currency becomes the default for trade flows even between third parties. But if you’re a Turkish company trading with Brazil, how excited are you going to be about keeping your trading profits in USD? Or your treasury account for paying counterparties? Unlike Central Banks, these guys can’t just print up more exports if the US government decides to seize all their assets in a fit of pique.
What they end up holding here is less clear. There is still a winner take all aspect to this, and at the moment the winner is still USD, despite this crazy own goal. The question is not “are foreign companies and governments likely pissed off?”. The question is “is there a concrete alternative that they’re going to prefer more?”. The key part of the Gopinath and Stein paper is that whatever currency is used for trade invoices will tend to have a natural demand to be held as assets, in order to hedge future trade obligations. This means that either people will want to switch over currencies in both trade invoicing and holdings at once, or switch neither. Unless you have a strong case that people right now will prefer BTC or RMB (the two biggest alternative contenders) for both the asset they hold and the asset they invoice in, you’re pretty much going to have to lump it.
Of course, this only half solves the problem. For trade flows, you care about exchange rates with your trading partners. Can you use your Bitcoin reserves, or other currency reserves, to appreciate your exchange rate with USD?
Maybe, but not obviously. If what you care about is the USD/RMB exchange rate, selling your bitcoin to buy RMB mostly is just going to lower the price of Bitcoin, but will probably have the same effect on USD denominated BTC as RMB denominated Bitcoin. You could imagine trying for some tricky indirect effects if you bought third country currencies. In other words, suppose that China could still buy Swiss Francs. In a crisis, it could dump the Francs and cause the Franc to depreciate with respect to RMB, but likely somewhat with respect to other currencies as well. Then maybe the Swiss use their own dollars to support the Franc, so you indirectly end up getting the effect you want (selling USD and buying RMB). Maybe? I tend to find this stuff hard to predict, because the more links there are in the chain, the greater the chance that some other effect that you haven’t fully anticipated comes in and the result isn’t quite what you think.
So at the end of it all, my initial presumption that no semi-hostile central bank (think China) will buy a US dollar denominated asset again is likely wrong. They will, but only for normal times currency management, and treat it as a flow expense not an asset. But to the extent that some of the purchases were also because they previously viewed USD assets as useful in a crisis, I expect that aspect to get significantly scaled back. The announcement is a significant blow to the perception of USD assets (and Euro and Pound ones too), and one that is very hard to undo.
You can also imagine deleterious effects on US dollar hegemony in terms of currencies for trade flows. This is a big part of the Gopinath and Stein model – the global reserve currency becomes the default for trade flows even between third parties. But if you’re a Turkish company trading with Brazil, how excited are you going to be about keeping your trading profits in USD? Or your treasury account for paying counterparties? Unlike Central Banks, these guys can’t just print up more exports if the US government decides to seize all their assets in a fit of pique.
What they end up holding here is less clear. There is still a winner take all aspect to this, and at the moment the winner is still USD, despite this crazy own goal. The question is not “are foreign companies and governments likely pissed off?”. The question is “is there a concrete alternative that they’re going to prefer more?”. The key part of the Gopinath and Stein paper is that whatever currency is used for trade invoices will tend to have a natural demand to be held as assets, in order to hedge future trade obligations. This means that either people will want to switch over currencies in both trade invoicing and holdings at once, or switch neither. Unless you have a strong case that people right now will prefer BTC or RMB (the two biggest alternative contenders) for both the asset they hold and the asset they invoice in, you’re pretty much going to have to lump it.
But it's not clear that they'll necessarily just lump it forever. We do not have good models of how or when exactly the equilibrium gets shifted from one global reserve currency to another (like most games where there are two possible Nash Equilibria). In part, we just have very few observations of reserve currency status changing. Spain to the UK, and the UK to the US. And even the ones we have are in scenarios where all such currencies were backed by hard assets, so the logic may not hold as cleanly when everything is pure fiat.
Ironically, the biggest bear case for Bitcoin out of all this is that it may yet end up being an existential threat to the primacy of the US dollar even if it doesn't supplant it for everyday transaction purposes. That is, even if bitcoin only eats gold and not fiat, in the new world, this might be enough to be a serious threat to USG, and thus trigger serious crackdowns. USG may not be able to stop computers around the world storing bitcoin on the ledger, but they have their own version of the $5 wrench attack - stop trading in Bitcoin (or hand us your wallet password), or men with guns come and lock you in a cage for the rest of your life.
Still, it seems increasingly likely that the people at the wheel in the US do not have any sense of the possible fragility of the status of the US dollar as reserve currency and the associated exorbitant privilege. It is just treated as one of those facts of the universe, not something carefully obtained by sensible economic stewardship (and iron first / velvet glove hard and soft power coercion). Whereas it increasingly looks like something subject to a tragedy of the commons across different time periods. This indeed seems to be a common thread with other policies like Modern Monetary Theory. Nobody really seems to argue that it applies in Zimbabwe. They also don’t seem to argue that it applies globally for every possible amount of spending. Otherwise just send everyone a check for a million bucks! But they also don’t have a sense of where exactly the relationship breaks down, nor how far away we are from that point.
One way or another, a lot of people in power seem deadset on finding out exactly what the limits are to being a global reserve currency. I suspect they may not like the answer.
Still, it seems increasingly likely that the people at the wheel in the US do not have any sense of the possible fragility of the status of the US dollar as reserve currency and the associated exorbitant privilege. It is just treated as one of those facts of the universe, not something carefully obtained by sensible economic stewardship (and iron first / velvet glove hard and soft power coercion). Whereas it increasingly looks like something subject to a tragedy of the commons across different time periods. This indeed seems to be a common thread with other policies like Modern Monetary Theory. Nobody really seems to argue that it applies in Zimbabwe. They also don’t seem to argue that it applies globally for every possible amount of spending. Otherwise just send everyone a check for a million bucks! But they also don’t have a sense of where exactly the relationship breaks down, nor how far away we are from that point.
One way or another, a lot of people in power seem deadset on finding out exactly what the limits are to being a global reserve currency. I suspect they may not like the answer.
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