Elon Musk, no stranger to controversy, raised eyebrows when he said that his company bought $1.5 billion of Bitcoin. Shortly afterward, he confirmed that people can buy Tesla cars with Bitcoin. A payment system to make exchanges like this possible is springing up. Between credit card companies, banks, and hybrids like PayPal, room is being made for a new currency. Will these efforts displace traditional money? You can lead a horse to water, they say, but you can’t make it drink. There is good economic reason to believe that Bitcoin will not be used for transactions outside of the odd case.
Assume the best: Bitcoin is the real deal. Its limited supply and blockchain authentication make it better than fiat money like the dollar, which is constantly being diluted by a politically driven printing press. Gresham’s law states that bad money drives out good. That means the depreciating dollar will be used for transactions, and Bitcoin will be hoarded.
While cryptocurrencies are traded, they are not being truly used as a means of exchange. The daily volume is minor compared with their market cap. Studies have found that a high percentage of Bitcoins have not changed IP addresses for a couple of years. The more they are hoarded, the less they can achieve the networking effect that bestows money-ness, making it more of an asset than a currency, which is how the Internal Revenue Service regards crypto.
The dramatic rise in the price of Bitcoin and crypto more generally is a Rorschach test. One’s own hopes and fears are projected. It is providing new words for the old song about the decline of America and the role of the dollar. The linkages are not articulated, and the actual data are frequently not explored.
The International Monetary Fund’s latest report on the allocation of reserves showed that dollar holdings by central banks stood at a record high of a little more than $7 trillion at the end of last year. The dollar’s decline after surging at the pandemic’s onset bolstered other reserves when measured in dollars. Nevertheless, just the increase in dollar holdings in the past two years is greater than the total reserve holdings of the Chinese yuan.
The Federal Reserve offers custodial services to foreign central banks for their Treasury and agency holdings. In March, these holdings reached a record high of nearly $3.58 trillion. Contrary to the cries of doom and gloom, the lesson drawn from the 1997 Asian financial crisis, the 2008-09 financial crisis, and last year’s pandemic experience is that, when looking into the proverbial abyss, everyone wants dollars. A Bank of International Settlements study of dollar-funding of non-U.S. banks concluded that the dominance of the dollar in international finance and the attendant policy issues are likely to endure.
For all of its flaws, the greenback remains the most important invoicing and vehicle currency. Supply chains are often dollar-funded. The U.S. dollar is still on one side of more than 85% of the transactions in the $6.2 trillion-a-day foreign-exchange market. The dollar knows no rival. There is simply no compelling alternative. The Chinese yuan is not convertible and its markets not sufficiently transparent to take on a significant role. Europe’s monetary union is far from complete; progress toward a fiscal union is stuttering at best. Its bond market remains fragmented, appearing more like the U.S. municipal bond market than the Treasury market.
Former Bank of England and Bank of Canada Governor Mark Carney came to America’s heartland to attend the Fed’s Jackson Hole confab in 2019 and declared that the dollar was the cause of financial instability. He suggested a digital iteration of John Maynard Keynes’ idea of a bancor supranational currency proposed at Bretton Woods. Yet, it was the Fed’s swap lines with nine foreign central banks that helped stabilize the global capital markets a few months later. These dollar swap lines provided a powerful response during the 2008-09 financial crisis, as well.
Even many Americans who may disdain centralized authority in general concede some prerogatives to the state, like the provision of justice and the legitimate use of force. The power of coinage also resides with the state. History shows that centralized finance emerged to address the shortcomings of decentralized finance. The dollar’s role in the world economy is secured by several considerations outside of inertia: the security, transparency, and size of the U.S. Treasury market and the lack of a compelling alternative. The primary reason that crypto is even thought of as money is because it says it is, not because of its use. Its rival, as Fed Chair Jerome Powell noted, is with other non-interest-bearing assets like gold, not the dollar. That said, the public should reap the benefits of the new technology, and digital central-bank money is a likely expression. Public fiat will be preferred to private fiat.
Marc Chandler is chief market strategist, Bannockburn Global Forex.
Email: editors@barrons.com
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