The purpose of this article is to highlight the consequences of the current behavior of central banks. Allowing us to bounce off the need for their independence, and therefore our monetary system. Passage during which we will of course mention the king of crypto-assets, Bitcoin (BTC)! Who in my opinion has a role to play.
Back to the origins, why did central banks become independent?
Before the onset of the independence of central banks in the 1980s monetary policy was under the control of another entity. This tool of economic policy was in the hands of the state. And in order to understand how central banks were born, we must study the “flaws” of the old system.
Indeed, in the past, the state was all-powerful and had monetary and fiscal policy. However, a movement advocating the independence of monetary policy has arisen. The main reason for the emergence of such a movement was to constitute an actor who can act in the general interest, and not in the private interest. Among those demanding such a request were the economists G. Tullock and J. Buchanan. They believed that some leaders were making economic policy decisions for electoral purposes.
More simply, the heads of state hired expansionist policies at the end of the mandate to favor economic agents. By supporting short-term purchasing power, they created the monetary illusion of households to be supported. Once re-elected, the head of state reinstated the restrictive policies required.
These works were accompanied by those of W. Nordhaus. The latter believed that the independence of central banks was essential to ensure that monetary policies were independent of electoral processes. It is therefore necessary to prioritize the general interest to the detriment of the private interest. The latter being symbolized by the leader or the pressure groups (lobby). This now gives more meaning to the independence of central banks.
One question still remains unanswered: have they really become independent? A question fraught with meaning when we know the multiple pressures exerted by the leaders to encourage the policies carried out by the latter. At the head of the list Donald Trump, for whom the FED has become a recurring target.
The printing press and the “money go brrrrrr” are back!
During the many announcements of economic measures taken by central banks, one word is on everyone’s lips: “Money printing”. The term printing press refers to the fact that a bank prints money in astronomical quantities. And the “brrrrrr” is an analogy to the noise produced by a machine printing these tickets.
If in reality the European Central Bank has not printed tickets since 2014, the amount of money in circulation is only growing.
This quantity of money grows disproportionately in relation to economic or demographic growth. Since indeed, theoretically, the level of money must be proportional to the needs of economic agents. In which case, if it is too large, it generates inflation, and the reverse of deflation. However, money creation has reached disproportionate levels since the financial crisis of 2008. And as many of you have seen, the current health crisis has not helped. The Natixis chart below illustrates this perfectly.
Now let’s get to the heart of the matter, what is the reason why the banks practice an expansionist policy? With the various options including “helicopter money” in some countries, considerable or even unlimited quantitative easing in others as well as an anecdotal fall in interest rates; the objective is clear: avoid recession or at least contain it.
It is then necessary avoid as many bankruptcies as possible and keep businesses “zombie”, by relaunching the request. In other words, they must be fed with liquidity so that they withstand the shock, while “supporting” households. However, even if some companies are heavily fueled, the cash flow will not change anything. They are doomed in the long term.
Raphael Bloch, journalist for the Express, describes this phenomenon perfectly:
– Raphaël Bloch (@Bloch_R) June 11, 2020
A policy with risky consequences
We will therefore probably be entitled to this financial crisis that we have already been promised for a few years. But then despite the importance of the measures, how can we still be condemned to suffer this crisis? Unfortunately, this crisis did not start with Covid-19, it was rather its trigger. The risk of occurrence of the latter gradually increased already upstream.
To understand why the turbulence in the financial world is not new, we need to take a leap in time. This leap back takes us to 2008 – 2009, a period characterizing the implosion of the financial and economic crisis. So for great evils the great remedies, the respective leaders of central banks opened the liquidity valves. With the help of a strongly accommodating policy, a dizzying flow of money flooded the market within a few years. Between interest rate at the floor and Quantitative Easing, the financial centers were constantly supplied.
The side effect of the liquidity trap
While this policy aimed to revive the economy through demand, very quickly flaws appeared. The first relates to the liquidity trap. It is a concept theorized by Keynes where the economic agents sterilize their liquidity rather than investing or spending it. Today, we can see this phenomenon in France, where the savings rate hovered around 15-20% during the confinement period.
Turbulence in the markets with the fall in the spread
But that’s not all. The major problem with these monetary measures concerns above all the markets, where capital flows are the most important, which is therefore subject to more risks. Or rather could we say spread? The spread is the difference in yield between a risk-free asset and a risky asset. The latter had declined steeply after monetary expansionism. As they fell, the rates of the different asset classes approached while the risk was quite different. This means that the risk premium supposed to remunerate the person who has invested in a risky asset will fall compared to an asset of lower risk. The consequence of this behavior is that this leads actors to invest in bad investments to get paid. Bad investments which in the long term will provoke a real blow of tobacco in the event of new outbreak.
We could elaborate on the consequences of the 2008 financial crisis at some length. At least, I hope you will understand that the behavior of central bankers only increased the systemic risk. Rather than solving the 2008 crisis, they made it a catalyst for the next one.
Do central banks and states have the miracle solution?
Between the expansionist policies already mentioned and new proposals, nothing will prevent the consequences of the behavior of central banks and the markets. Yet Europe has been able to be ingenious with ” coronabonds »Or the pooling of debts. More recently, the committee even proposed European taxes to finance the loan of 750 billion euros. In addition, in order to avoid bank failure in an insolvency context, central banks demanded that they pay no dividends. These amounts must first and foremost feed capital to make debt ratios less overwhelming on the one hand, and to revitalize the economy through investment on the other hand. As a reminder among the banks that had distributed dividends in 2008, there was Lehman Brothers. Hopefully, history will teach us a lesson.
Even so, it is unlikely that all of these measures will suffice. Just like the fact of seeing one day a mutualisation of debts within the euro zone.
Bitcoin, when independence becomes essential
Before recalling the monetary functioning specific to Bitcoin, we must insist on the point fundamental to independence. At the beginning of this article, we described how independence is required for a monetary system. However, you will agree, it has not been respected by central banks. On the contrary, they have served the financial markets and not the general interest. This brings us to the current situation although the coronavirus has advanced its arrival.
Therefore, apart from any consideration of the use of Bitcoin as a currency, it should be emphasized how the independence of a monetary system like Bitcoin is essential to the economy. And this, whether it is with a Bitcoin as a currency, a stablecoin or a fiat currency. Although among us crypto-enthusiasts, we are aware that the latter option is hardly synonymous with independence.
Bitcoin and its monetary policy
Before we looked at applying independent monetary policy to the economy with Bitcoin. Let’s explain how it works.
First, let’s recall an inescapable fact: Bitcoin is only governed by computer code. This code can certainly be modified, it requires a consensus for each proposed change. In other words, if in the case of Bitcoin 95% of decision makers cannot find an agreement a hard fork occurs. This implies the creation of another token with the new rules proposed on the original token.
This is what happened with Bitcoin Cash on Bitcoin in 2017. Thus, being only under the control of the code, it cannot be subjected to the will of a single entity, or lobbies. And if a community unites, it will have to represent 95%, which seems to be imaginary. All the more so when we know the libertarian aspirations of some of the maximalists working on Bitcoin.
Therefore, Bitcoin is independent, since its monetary policy depends on the code. Now let’s do a short reminder on how it works. Bitcoin is a currency whose issue model is similar to gold. As with the precious metal, bitcoins become increasingly difficult to mine over time, and their quantity is fixed. It is 21 million, the last unit of which will be mined in 2140. This operation is permitted thanks to the halving included in the code. This is to reduce the amount of bitcoins emitted by 2 when a block is validated, and this every 210,000 blocks.
What is very interesting is that in addition to being regulated by computer code and not being able to be subjected to any pressure, the number of bitcoins is limited. Let’s analyze what implication this fixed quantity can have on the economy.
👉 To go further: What will happen when the last Bitcoin is mined?
The monetary independence of digital assets in the service of the economy
Imagine a world idealized by William nordhaus, in which monetary policy is effectively independent. This world unfortunately could not be the fruit of man, so perhaps it will be thanks to the machine. Even though the code is written by men, I grant you that.
The company then relies on Bitcoin’s monetary policy, that is, with a fixed and determined amount of money. In which the budgetary tool would be the alternative to cope with supply or demand shocks. (In this context, we consider that fiscal policy is completely free. It is not constrained by agreements, as it is today in the EU with the TSCG).
Even if the shocks will be less likely in a world where the amount of money in circulation is reasonable. In addition, with a money supply whose level will be fixed and not disproportionate. We could even imagine that the latter is variable. For example, it would depend on indicators such as growth rate, demographic change or others.
The major advantage of a fixed Bitcoin specific money supply is that it does not take the risk of fueling speculative bubbles. It is more likely to meet the needs of the economy. However, the risk of deflation is often mentioned in a situation where the currency in circulation is limited. I invite you to consult the article on this subject to understand that this risk should not be at the center of concerns.
From Bitcoin to a stablecoin?
However, if today monetary policy was based on Bitcoin, it would imply an adoption of the currency. Realizing that this adoption is still a long way off, what I am going to suggest is just guesswork. So imagine today that Bitcoin is massively adopted, its price stabilizes, but is still subject to supply and demand. However, psychologically, this situation is a real problem for economic agents. How to measure your level of purchasing power if your currency fluctuates from day to day? This is why, to solve this volatility problem, we could resort to symbolic stablecoins.
Without going into governance details relating to centralization, or decentralization, they could become very interesting. And the work currently being carried out by Facebook, China and European central banks bear witness to this interest. Starting from the hypothesis of a stablecoin, one could conceive of a currency whose monetary policy would be transparent and above all independent. That is, a monetary policy based on a stable token rather than the euro. This coded policy could depend on the basket of indicators mentioned above, or others including social factors. The field of possibilities opens up to us.
We see that with a digital asset we would come closer to the independence of the monetary system; “Ideal” to W. Nordhaus. A thought that was still hardly conceivable until the recent emergence of the potential of cryptoassets.
Bitcoin, the next economic instrument for central banks?
Faced with a financial system whose vulnerability is only growing, a reform of the monetary system becomes essential. Since even if the behavior of actors in the financial markets is responsible for past and future consequences, it is the central banks that give them the means to behave in this way. Even if we would continue to regulate the markets, Bale’s successive agreements do not seem to have succeeded in curbing the risk of a crisis.
But fortunately, an orange light appeared to us and could give us some answers to this insoluble problem. Of course, considerable progress will need to be done. As much on the legislative point to create a legal structure around crypto-assets, that from the point of view economic.
Indeed, whether it is Bitcoin or a stablecoin, long-term research will have to be carried out. Although nowadays Bitcoin subsists and gains in credibility, and this despite the many predictions relating to its demise.
If there were many reasons for this resilience, for my part, it was largely enabled thanks to its decentralized nature. Will decentralization then succeed in squaring the circle?
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