A US Bitcoin reserve would do much for Bitcoin and little for taxpayers

Published in The Hill with Paul H. Kupiec. Also Published in Real Clear Markets.

Speaking at the Nashville Bitcoin 2024 conference, Sen. Cynthia Lummis (R-Wyo.) floated a “revolutionary proposal” to make the federal government a Bitcoin investor. It is hard to imagine how this might benefit U.S. taxpayers or support the dollar’s value, but it certainly would raise the dollar price of Bitcoin.

While it is unsurprising that a plan to use taxpayer dollars to benefit foreign and domestic Bitcoin owners would have the Nashville audience cheering, it is impossible to justify. Neither the Federal Reserve nor the U.S. Treasury would want to or should be permitted to support Bitcoin’s price.

According to the accompanying statement issued by Lummis’s office, this proposal would create “a strategic Bitcoin reserve” of 1 million Bitcoins that the government would “would be required to hold … for 20 years.” We couldn’t have the government selling its Bitcoin and driving down the cryptocurrency’s price, now could we? 

This plan is as quintessentially American as a Louis L’Amour novel about mining the Comstock Lode. In 1878, owners of silver mines in places like Virginia City, Nev., succeeded in lobbying Congress to pass the Bland-Allison Act which required the government to support the price of silver by buying and stockpiling large amounts. 

Few ideas are new in politics or finance. Although a plan to force the federal government to buy something to support its price is hardly new, the proposed source of funds for these purchases is especially problematic.

In her Nashville remarks, Lummis said, “We will convert excess reserves at our 12 Federal Reserve banks into Bitcoin over five years. We have the money now!” 

 If by “excess reserves” Lummis means the “paid-in capital and surplus” of Federal Reserve district banks, as we have explained elsewhere, measured by generally accepted accounting standards, the Fed’s total paid-in capital and surplus account balance is negative $145 billion. Since September 2022, the Fed has had to borrow $145 billion just to fund its own expenses.

If the Fed is going to invest in Bitcoin, it would have to borrow even more money. Or it could sell some of its deeply underwater investments and book a big loss. Neither alternative makes sense. 

Even if the Fed did have positive paid-in capital and surplus funds available to invest, there is a more fundamental problem. The Federal Reserve Act, as a bedrock principle, restricts the Fed’s open market investments to U.S. government obligations or instruments guaranteed by the federal government or its agencies. This law would have to be amended to allow the Fed to purchase Bitcoin. 

If Congress did consider changing the act, other crypto coins and special interest assets would assuredly lobby Congress to be included as Fed-eligible investments. Such legislation would create enormous pressure to use the Fed’s monetary powers to purchase these assets, allocate credit and extend implicit subsidies. 

Additionally, holding Bitcoin would create a large operating loss for the Fed. Bitcoin pays no interest, but the Fed has to pay interest on the money it borrows to finance its investments. At current rates, every dollar borrowed to hold Bitcoin would cost the Fed 5.4 percent in annual interest. 

Suppose the Fed bought half a million Bitcoins at today’s price of about $60,000 each. At an interest cost of 5.4 percent, the Fed would incur operating cash losses of $1.6 billion a year on its Bitcoin investment. Over 20 years, the operating losses would total $32 billion, or more than 100 percent of the investment.

According to a report by CoinDesk, Lummis’s proposed Bitcoin Act of 2024 would also require the Treasury to revalue its gold stock and use the resulting capital gains to buy Bitcoin. We explained the mechanics of such a transaction in an article addressing the 2023 federal debt ceiling debate.

The current market price of gold is about $2,500 per ounce. The Treasury owns about 261.5 million ounces of gold. The Gold Reserve Act, amended in 1973, requires the Treasury to value its gold at $42.22 per ounce. At current market prices, the Treasury owns about $640 billion in gold but values it at a little over $11 billion. 

If the law were changed to force the Treasury to revalue its gold, it could issue $629 billion in new gold certificates to the Fed in return for dollars. This accounting transaction would create $629 billion in newly-printed dollars for the Treasury to spend. Using an accounting adjustment to create $629 billion for the Treasury to spend on Bitcoin is inflationary and does nothing to enhance the value of the U.S. dollar.

From a risk exposure perspective, any federal government investment in Bitcoin would be leveraged speculation on the price of a notoriously volatile intangible asset. 

Bitcoin enthusiasts and promoters have long claimed that Bitcoin will be an alternative to replace the dollar, allowing cryptocurrency users to escape the Fed, the Treasury and the U.S. government. Strategically, it’s extremely unlikely that the Fed and the Treasury will embrace this proposal as a cause to subsidize and promote.

The Treasury, in particular, reaps great advantages from the worldwide, massive holdings of U.S. dollar securities and currency — this is the famous “exorbitant privilege” of issuing the global reserve currency. It is central to financing the American government and American geopolitical power.  

It is pretty hard to imagine the Treasury wanting to invest in an alternative asset that seeks to weaken or even end its crucial advantages.

The Bitcoin proposal claims it would “bolster” and “fortify” the U.S. dollar, but truth be told, it is a plan to bolster the value of Bitcoin that provides no benefit for the the dollar. Once the facts are understood, no U.S. taxpayer without Bitcoins would support a proposal to use their tax dollars to bolster its price. 

A government Bitcoin reserve is just a bad idea.

Event: Talks With Authors: Better Money: Gold, Fiat, Or Bitcoin?

Hosted by the Federalist Society:

In Better Money: Gold, Fiat, Or Bitcoin?, monetary expert Lawrence H. White delves into the timely debate surrounding alternative currencies amidst the backdrop of constant inflation in the fiat currency world. Better Money explains and analyzes gold, fiat dollars, and Bitcoin standards to evaluate their relative merits and capabilities as currencies. It addresses common misunderstandings of the gold standard and Bitcoin, and scrutinizes the evolution of currency, particularly the interplay between market and government roles. White provides provocative analysis of which standard might ultimately provide better money, and argues that we need a market competition among them.

Please join us as Professor Lawrence White joins discussants Alexandra Gaiser and Bert Ely, and moderator Alex Pollock to discuss Better Money.

Featuring: 

• Prof. Lawrence H. White, George Mason University

• Alexandra Gaiser, General Counsel, Strive

• Bert Ely, Principal, Ely & Company, Inc.

• Moderator: Alex J. Pollock, Senior Fellow, Mises Institute

Hearkening to Hayek: How About a Free Competition Between Bitcoin, Paper Money, and Gold?

Published in the New York Sun:

That object of volatile speculation, the Bitcoin, is not a physical coin or any physical object at all. It is certainly not a gold coin and is not redeemable or backed by anything, let alone gold coins. Yet it is endlessly pictured in press illustrations as a gold coin with a “B” stamped on it.

Go ahead, kid me. These illustrations are a notable marketing success for Bitcoin, but why is there such an urge among publishers to show Bitcoins as gold coins? Not one of them would dream of illustrating United States dollars as gold coins — though our own government has tried the trick.

Gold coins are physical reality, while Bitcoins, being electronic accounting entries in a complex computer algorithm, never are. Gold coins with their durability, beauty, and scarcity will still be there even if all electric systems are knocked out and your computers don’t work at all.

The ubiquitous visual suggestion that Bitcoins are gold coins is, though, a misrepresentation. How could one more accurately suggest in an illustration the electronic accounting entry which Bitcoin is, given that one can’t actually draw a Bitcoin? Could one  show a drawing of a computer screen with Bitcoin prices on it?

For those who reasonably maintain that the unbacked Bitcoin is simply a form of gambling, a computer screen with an electronic roulette wheel on it might be used. Dollars are often depicted in publications as paper currency. Paper currency is physical reality which also will still be there if the electricity and the computers don’t work.

Then again, too, it’s only cheap paper which can be endlessly depreciated by its issuing central bank. Paper currency is normally convertible into bank deposits and vice versa. Yet if the bank fails, paper currency looks a lot better than deposits. It would be there, still at par, when the bank has folded, and one would not need to worry about what government bailouts may be in process.

Even so, in holding the paper currency, one would still be a target of the inflationist drive of the Federal Reserve and other central bankers. One would be holding a unit of money, in respect of the Fed has formally set a goal of depreciating at an average of two percent — forever. 

Historically, it would have been accurate to depict dollars as gold coins. Gold coins denominated in dollars freely circulated for parts of our history. Dollar paper currency was redeemable in and backed by gold. Bank deposits were withdrawable in gold coins. The Federal Reserve was required by law to hold gold collateral against its paper currency.

This gold standard world is hardly even imaginable by most people today. It ended in 1933 when the government made owning gold illegal for American citizens, with criminal penalties. This prohibition, which lasted more than 40 years, was remarkably oppressive. It enabled a vast expansion of government power.

The Nobel laureate Friedrich Hayek, in his 1974 essay “Choice in Currency,” argued that “With the exception… of the gold standard, practically all governments in history have used their exclusive power to issue money in order to defraud and plunder the people.” 

Therefore, Hayek asked, “why should we not let people choose freely what money they want to use?” Bitcoin enthusiasts love this idea, and propose Bitcoin as the alternative money to escape the monetary control of inflationist central banks.

Despite its remarkable record as an object of speculation, Bitcoin has a scant record as a currency in general use. What a contrast to the long history of gold-backed currency.

That a revived gold-backed currency would become a renewed alternative to pure paper currencies was Hayek’s actual hope. “It seems not unlikely that gold would ultimately reassert its place…if people were given complete freedom to decide,” he wrote. This would require paper and accounting money defined as a weight of gold and freely redeemable in gold coins.

Would such a money based on gold coins be chosen by the people over paper dollars and Bitcoins in a free competition? How instructive it would be, although directly against the self-interest of every deficit-monetizing government, to run this comparison.

Letter: Bitcoin loses its lustre next to gold bullion

Published in the Financial Times.

Your editorial, “Bitcoin’s bounceback déjà vu” (FT View, December 6), is oh so right that bitcoin “has no intrinsic value, nor is it backed by anything” and is different from gold. Indeed, a mere electronic accounting entry like a bitcoin is utterly unlike a gold coin — the gold coin being a notable piece of physical reality, not dependent on anybody’s accounting system to exist. Yet at the top of your page one of December 5, illustrating your story, “Bets on cuts boost bitcoin”, you misleadingly depict bitcoin precisely as a large gold coin stamped with a “B.” This silly illustration promotes the fallacy that bitcoin is like a gold coin and flatly contradicts the sound and sensible statements of your editorial.

I suggest that FT policy should eliminate depicting bitcoin as a gold coin. Of course, it is difficult to illustrate bitcoin as the mere electronic accounting entry it is, but you should try to reflect the reality.

Alex J Pollock Senior Fellow, Mises Institute,

Lake Forest, IL, US

PG-15: FEDSOC STUDY BREAK: Cryptocurrency From All Angles

Watch the video here.

The Federalist Society’s Financial Services & E-Commerce Practice Group, Student Division & University of Pennsylvania Carey Law School Chapter

PRESENT

Cryptocurrency From All Angles

Featuring

Alex J. Pollock

Senior Fellow, Mises Institute;

Executive Committee Member,

Financial Services & E-Commerce Practice Group

Tuesday, April 18, 2023

Breaktime: 8:00 P.M. - 8:30 P.M. ET

How Should We Regulate Crypto?

Published by David G.W. Birch:

Meanwhile, Howard Adler, a former deputy assistant secretary of the Treasury for the Financial Stability Oversight Council, and Alex Pollock, a former Principal Deputy Director of the Treasury’s Office of Financial Research, advocate a more laissez-faire approach: Why regulate crypto at all?Their view is that we should allow investors to proceed at their own risk under the protections of general commercial law and existing anti-fraud and criminal laws. As they point out, since cryptocurrency originated as a libertarian revolt against the government monopoly on money, this approach is consistent with its founding ideas.

Federalist Society virtual event: Cryptocurrency Regulation in the Aftermath of FTX

Hosted by the Federalist Society. Click here for more.

The collapse of FTX has intensified the debate about how cryptocurrencies should be regulated, including proposed federal legislation. With a string of cryptocurrency failures and tens of billions in losses for investors, increased regulation has become a hot topic. As Bloomberg summarized: “Crypto is squarely in the cross hairs of Washington” and “Oversight of digital assets is among the most pressing issues for US financial watchdogs.”

Should cryptocurrency firms be regulated as banks? Should cryptocurrency assets be regulated as securities or as commodities? If so, who is the right regulator? Do we need new federal legislation? With enhanced financial and risk disclosures, should cryptocurrency firms only be subject to standard commercial law and, if they fail, normal bankruptcy proceedings? These issues will be addressed by this fourth in a continuing series of cryptocurrency webinars presented by the Federalist Society’s Financial Services and E-Commerce Practice Group.

Featuring:

The Honorable Cynthia Lummis, United States Senator, Wyoming 

Jerry Loeser, Of Counsel, Winston & Strawn LLP (Retired)

Steve Lofchie, Partner, Financial Services, Fried Frank

Alex J. Pollock, Senior Fellow, Mises Institute

Moderator: J.C. Boggs, Partner, Government Advocacy and Public Policy, King & Spalding

Opening remarks:

Will The FTX Crash Kill Crypto?

Cited in Forbes:

That includes digital currencies. This the irony which Mises Institute scholar Alex Pollock points out in his new book, Surprised Again!, coauthored with Howard Adler: that crypto’s problems may well speed the digitization of national currencies and increase the power and influence of central banks—the crypto enthusiast’s No. 1 nemesis.

Among six proposals to regulate cryptocurrency, one is superior

Published in The Hill with Howard B. Adler:

In the wake of billions in losses suffered by investors from the failure of cryptocurrency exchange FTX and other crypto collapses, how to regulate cryptocurrencies is a hot topic the new Congress must address. Competing proposals for it to consider range from banning cryptocurrencies outright, to giving them government backing, to stifling them with regulatory bureaucracy, to letting them fail or succeed entirely on their own. 

Some urge that cryptocurrencies simply be banned. This is the approach taken by China in 2021 when it banned all private cryptocurrency transactions and imposed an official “digital yuan” to monitor its citizens even more. The Chinese approach reflects the belief that currency must be a state monopoly and the official currency must have no private competitors. After FTX, some commentators have asked whether cryptocurrency should be banned in the United States. While banning cryptocurrency may be a characteristic response by an absolutist state like China, we do not believe it is appropriate for the United States. 

A second approach, unsurprisingly advocated by Securities and Exchange Commission Chairman Gary Gensler, is to have the SEC take over cryptocurrency regulation primarily by using its existing powers to regulate securities. Gensler believes that “the vast majority” of crypto tokens are securities already within the SEC’s jurisdiction. Of course, the SEC failed to head off the FTX collapse or any of the other cryptocurrency debacles. A glaring problem with this approach is that it requires the SEC to first assert that a particular form of crypto is a security and then for this issue to be litigated — a slow, expensive and inefficient process. A former SEC chair conceded that Bitcoin, the archetypal and largest cryptocurrency by market cap, is not a security and many cryptocurrencies are structured similarly to Bitcoin. 

The Commodity Futures Trading Commission has proposed that it should be the principal cryptocurrency regulator. This is called for in the Digital Commodities Consumer Protection Act, a bill reportedly pushed by former FTX CEO Sam Bankman-Fried and other members of the cryptocurrency industry. The crypto industry is said to regard the CFTC as a less stringent regulator than the SEC. One proposal is for each cryptocurrency firm to get to choose either the SEC or the CFTC as its regulator.  

From a different perspective, a group of top U.S. financial regulators has put forward a banking-based regulatory approach. This would be applied to stablecoins, a type of cryptocurrency backed by or redeemable at par in dollars (or other government currencies), and intended to maintain a stable value with respect to the dollar. This approach, advanced by the Treasury and the President’s Working Group on Financial Markets, would require that stablecoin issuers be chartered as regulated, FDIC-insured banks. The rationale for this approach is that stablecoin issuers are functionally taking deposits, which is by definition a banking function.  

Regulation as a bank is the most invasive form of financial regulation and imposes very high compliance costs.  For the business models of many cryptocurrency issuers, this may be the functional equivalent of banning cryptocurrency.  (Perhaps this is the outcome actually intended.)  More importantly, the only good thing that can be said about FTX’s and other cryptocurrency failures is that they did not damage the wider financial system or result in taxpayer bailouts.  Requiring cryptocurrency issuers to be FDIC-insured puts them in the federal safety net and puts taxpayers on the hook for future losses.  In our view, creating taxpayer support is going in exactly the wrong direction. 

A fifth approach, in a bill introduced by Sen. Pat Toomey (R-Pa.), would authorize a new type of license from the Office of the Comptroller of the Currency for stablecoin issuers, presumably less onerous than a full banking license and not requiring FDIC insurance. Issuers would be subject to examination and required to disclose their assets and redemption policies. Most importantly, they would be required to provide quarterly “attestations” from a registered public accounting firm. 

As a further step, we believe that disclosure of full, audited financial statements is critical. Right now, most cryptocurrencies are not subject to any kind of accounting disclosure. But no one should ever invest money in an entity that does not provide audited financial statements without recognizing that their funds are at extreme risk. If a federal regulatory system for cryptocurrency is to emerge, financial statement requirements are essential. 

Sixth and finally, it has been proposed that cryptocurrency not be specially regulated at all. Instead, it should be treated like a “minefield,” with appropriate warnings that investors face danger and invest entirely at their own risk. Investors would be able to rely on the protections of general commercial law and existing anti-fraud and criminal laws, but if cryptocurrency ventures crash, they crash, and their debts are reorganized in bankruptcy with losses to the investors and creditors, but not to taxpayers.  

Since cryptocurrency originated as a libertarian revolt against the government monopoly on money, this approach is consistent with its founding ideas. If people want to risk their money, they ought to be allowed to do so. However, they must be able to understand what they are doing. All parties should clearly understand that Big Brother is not protecting them when they hold or speculate in cryptocurrency. 

We believe that this sixth approach is superior in philosophy, but that it needs to be combined with required full, audited financial statements and disclosures about risks and important matters such as assets and redemption policies. Such a combination is the most promising path forward for cryptocurrency regulation. 

Howard B. Adler is an attorney and a former deputy assistant secretary of the Treasury for the Financial Stability Oversight Council. Alex J. Pollock is a senior fellow of the Mises Insitute and former Principal Deputy Director of the Treasury’s Office of Financial Research. They are the coauthors of the newly released book,” Surprised Again! The COVID Crisis and the New Market Bubble.” 

Event Sept 14: What’s Next for Crypto: Implications of Deflated Prices and Turmoil in Cryptocurrency Markets

Teleforum hosted by the Federalist Society.

Events of 2022 brought a "crypto winter," with average prices of cryptocurrencies falling about 70% from their 2021 highs, the bankruptcy of several crypto companies, the complete collapse of a popular so-called "stable" coin, unexpected suspensions of withdrawals by some crypto issuers, large losses by individual investors, and heightened efforts toward expanded regulation and legislation.  What does this all mean going forward?  Was this simply the end of another bubble and popular delusion which will now wither?  Or was it the winnowing out of a typical innovative overexpansion, with a more mature ongoing cryptocurrency industry continuing, perhaps one with significant regulation?  This webinar will examine where crypto will go from here.

Featuring:

Bert Ely, Principal, Ely & Company, Inc.

Alexandra Gaiser, Director of Regulatory Affairs, River Financial

Steven Lofchie, Corporate Partner, Fried Frank

J.W. Verret, Associate Professor of Law, Antonin Scalia Law School, George Mason University

Moderator: Alex Pollock, Senior Fellow, the Mises Institute

Register here.

Western Economic Association International: 97th Annual Conference

Conference information here.

June 29-July 3, 2022, in Portland, Oregon

Panel: Stablecoin That Might Work

Date: 6/30/2022
Time: 2:30 PM to 4:15 PM

Organizer

Walker F. Todd, Middle Tennessee State University

Chair

Walker F. Todd, Middle Tennessee State University

Papers

The Chicago Plan and CBDCs (Virtual)

• Presenter(s): Ronnie Phillips

Proposal for a U.S. National Stablecoin System (In Person)

• Presenter(s): Franklin Noll, Noll Historical Consulting, LLC

Which was the Better Design: National Banks of the 19th Century or Stablecoins of the 21st? (Virtual)

• Presenter(s): Alex J. Pollock, Ludwig von Mises Institute

Replacing the Dollar with the SDR in International Reserves (In Person)

• Presenter(s): Warren Coats, International Monetary Fund

Event: Central Bank Digital Currency--Efficient Innovation or the End of the Private Banking System?

Hosted by the Federalist Society.

Central Bank Digital Currencies (CBDC) are the subject of a global debate.  In one version, individuals and businesses would hold deposits directly with the central bank.  Critics point out that the Federal Reserve would then control how these deposits are used, allocating credit to private-sector borrowers and to government spending, arguing that CBDCs would eviscerate the private banking industry and create government surveillance of all financial transactions in the accounts. An alternate version is that CBDCs take the form of a tokenized dollars, distributed through the banking system and operating in parallel with paper currency and bank accounts.  Supporters say this could yield lower transaction costs and more rapid settlement of payments, and could strengthen the international role of the U.S. dollar.

Featuring:

Bert Ely, Principal, Ely & Company, Inc.

Chris Giancarlo, Senior Counsel, Willkie Digital Works LLP; Former Chairman, US Commodity Futures Trading Commission

Greg Baer, President & Chief Executive Officer, Bank Policy Institute

Moderator: Alex J. Pollock, Senior Fellow, the Mises Institute

Are Cryptocurrencies the Great Hayekian Escape?

Published in Law & Liberty. Also republished in RealClear Markets.

Practically all governments of history have used their exclusive power to issue money in order to defraud and plunder the people,” wrote the great economist Friedrich Hayek. He meant that when governments want to run big deficits, they can take the people’s money through currency depreciation and inflation, without having to pass any tax legislation. For governments to do this, having a central bank is very handy.

To finance government deficits, central banks with a fiat currency monopoly create as much money as desired, whether by literal printing or metaphorical printing by accounting entries, thus, as it is called, monetizing government debt. Since the 1960s, this has led to endemic inflation and continuous depreciation of the currency, sometimes fairly slowly (what used to be called “creeping inflation”), and sometimes very rapidly—like now. This is in sharp contrast to honest or sound money, which would have a stable value on average over time. 

In response, can the people escape the government’s currency monopoly with cryptocurrencies? Cryptocurrencies try to create competitive alternatives to depreciating central bank fiat money. Their development has set off an instructive dialectic between money as a government monopoly and possible private forms of money. 

A fundamental text for the concept of domestic monetary competition is Hayek’s notable essay, “Choice in Currency: a Way to Stop Inflation.” Published in 1976, in the wake of the collapse of the Bretton-Woods monetary system and during the great 1970s inflation, Hayek’s discussion included these provocative thoughts:

What is so dangerous and ought to be done away with is not governments’ right to issue money but the exclusive right to do so and their power to force people to use it.…Why should we not let the people choose freely what money they want to use? … If governments and other issuers of money have to compete in inducing people to hold their money…they will have to create confidence in its long-term stability… I hope it will not be too long before complete freedom to deal in any money one likes will be regarded as the essential mark of a free country.

These ideas or similar ones are echoed by supporters of all the cryptocurrencies that have appeared since the introduction of Bitcoin in 2009, which have had their own truly remarkable bull market. However, are today’s cryptocurrencies true alternatives to government fiat currency of the sort Hayek envisioned?

In 1976, Hayek was not thinking of the cryptocurrencies that have appeared in the last decade. He was thinking about gold. He wondered whether there might still be a rebirth for gold as money, although the last vestiges of the gold standard had just disappeared with the death of Bretton-Woods. This is apparent from the following section of his essay:

Where I am not sure is whether in such a competition for reliability any government-issued currency would prevail, or whether the predominant preference would not be in favor of some such units as ounces of gold. It seems not unlikely that gold would ultimately re-assert its place as ‘the universal prize in all countries’…if people were given complete freedom to decide what to use as their standard.

 One of the great marketing and public relations triumphs of recent years was Bitcoin’s success in convincing people, especially the media, to refer to it as a “coin,” and to publish articles about Bitcoin constantly accompanied by pictures of gold coins with a “B” in the form of a dollar sign stamped on them–just like the picture at the top of this essay. This was PR genius, a psychological reminder of the preference Hayek had expected. But obviously, a nonredeemable electronic entry in a computerized ledger bears no resemblance to an actual gold coin, with or without a ‘B’ stamped on it. The essential fact about Bitcoins is that there is no promise to redeem them with anything—in that sense, they are just like Federal Reserve dollars.

The price of Bitcoins has reached astronomical levels, accompanied in its flight by the idea of trying to escape from the Federal Reserve dollar (and all other central bank fiat currencies). In this way, buyers of Bitcoins and gold are similar. The well-known billionaire investor and speculator Stanley Druckenmiller was reported as explaining that “he finally realized what problem Bitcoin aims to solve—and that problem was called ‘central banks.’” Said Druckenmiller, without excess diplomacy:

The problem was Jay Powell and the world’s central bankers going nuts and making fiat money even more questionable than it already has been when I used to own gold.

Bitcoin, or any other cryptocurrency modeled on it, is equally a fiat currency. In these cryptocurrencies we see the radical attempt to create a private fiat currency. They are tied to no asset and no cash flow, and by definition, have no tie to government power. This is what makes them so intriguing. 

In contrast, the U.S. national bank notes of the 19th and early 20th centuries were tied to U.S. Treasury bonds as collateral, and state bank notes to the general assets of the issuing bank. It seems dubious that with no tie at all to any assets or cash flow, you can get a private currency reliably useful for ordinary exchange and as store of value. (Even with the infamous tulip bubble, there was a real tulip bulb involved. Although you might have lost a lot of money, at least you could still grow a tulip.) 

Nonetheless, the Bitcoin model has, without doubt, created a fascinating intangible object of speculation which displays extreme price volatility, with startling ascents and free-fall drops. It is often said, which seems right to me, that this volatility makes it unsuitable or unusable for ordinary, legal, everyday payments and exchange, since you have no idea from day to day what its value will be. Therefore, cryptocurrencies on the Bitcoin model create, as the Bank for International Settlements put it in 2021, “speculative assets rather than money.” While notably successful at becoming speculative assets, they thus fail to be a Hayekian competitor to central bank fiat money as money.

Trying to solve the problem of price volatility led to the development of a variety of stablecoins, which target a constant value in terms of the U.S. dollar (or other national currency), are backed by a “reserve” of dollar-denominated assets held by the issuer to support the value, and promise to various extents redemption in dollars. It is apparent, as many financial regulators have observed, that such a stablecoin looks very much indeed like a deposit in a bank, backed by the assets of the bank, and is equally dependent on the quality, riskiness, and liquidity of those assets for the ability to redeem it at par value.

But in terms of the grand objective of creating a Hayekian competitor to central bank fiat currency, there is a much more fundamental problem. A moment’s thought makes the deeper issue obvious: if the stablecoin gives itself stability and currency by linking itself to the U.S. dollar (or any other national currency), it has completely failed to escape the government’s central bank, and is instead entirely dependent on it.

If the Federal Reserve steadily depreciates the purchasing power of the dollar, the purchasing power of the stablecoin automatically goes down accordingly. If the dollar suffers rapid inflation, so will the stablecoin. If the dollar succumbs to hyper-inflation, so will the stablecoin. Thus, the stablecoin may represent a variation or perhaps an improvement on payments technology, but it does not, and cannot by design, represent a new currency. As long as it is linked to a national currency, it is part of the central bank fiat currency system, just as a bank deposit is, and fails to be a Hayekian competitive currency.

In a striking historical irony, the libertarian idea to free people from central bank monopoly money through cryptocurrencies has dialectically given rise to the idea of a central bank issuing its own cryptocurrency, with the more dignified name of “central bank digital currency.” If this should happen the central bank could become the bank for everyone, with the potential to be the monopolist of deposits, loans, and personal financial information, as well as the monopolist of money. This highly undesirable dialectical reversal would make the monetary system vastly more centralized and the central bank vastly more powerful than before. China, and more recently Canada, have shown us the direction that political control of your personal account can take. This would certainly be a non-Hayekian outcome!

Can there be a true alternative in Hayek’s sense to central bank fiat currencies, other than currency redeemable in gold? One of my friends has suggested a digital currency in which the unit is a real dollar—that is, a dollar adjusted for changes in the Consumer Price Index, so that the central bank cannot dilute its purchasing power (at least as captured by the CPI). It would resemble in this sense the Series I U.S. savings bond, which today pays its holders whatever the increase in the CPI turns out to be. But unlike the savings bond, the real dollar currency would need to be freely exchangeable, and available in large amounts. It would be an echo of the 1920s proposal of Irving Fisher, a famous economist in his day, to have a “compensated dollar,” which would automatically increase in value to offset inflation.

With today’s financial technology, would it be possible to create such a collateralized private currency, redeemable in inflation-adjusted dollars of steady purchasing power? Could an asset portfolio to back it be designed? Perhaps not, but it is an interesting thought experiment, in the spirit of Hayek, while we keep looking for a form of money to compete with the constantly depreciating, and now rapidly depreciating, Federal Reserve dollar and other central bank fiat currencies.

Letter: Here are two steps to reform cryptocurrencies

Published in the Financial Times.

Your editorial “Crypto’s rise requires a global response” (FT View, February 21), which backs the US Financial Stability Board’s proposal for “accelerated monitoring”, is good as far as it goes. Yet when it comes to stablecoins, there is another simple and obvious reform that needs to be made immediately. Whether you think stablecoins are more like a bank, a money-market fund or an exchange traded fund, the indubitable fact is that they are putting their liabilities as assets into the hands of the public. Like everybody else who does this, they need to publish full audited financial statements. Of course the statements would also include their profit and loss statement. This is a minimum requirement for the public to have an idea of what they are buying. A second simple requirement would be the publication of a clear description in plain English of the conditions and processes to redeem each stablecoin, since they all make so much of their “stable” character, and that stability depends on what happens when you want out. By all means, keep monitoring along with the Financial Stability Board, but get these two steps done in the meantime.

Alex J Pollock

Senior Fellow, Mises Institute

Auburn, AL, US

AEI Event: Will digital currencies and fintech shape the financial system of tomorrow?

Hosted by the American Enterprise Institute.

Event Summary

On January 28, AEI’s Paul H. Kupiec hosted an event delineating the roles and risks that stablecoins, central bank digital currencies, and other fintech developments might develop in our financial system. Panelists also discussed the actions financial regulators might take to manage financial markets.

Oonagh McDonald of Crito Capital outlined her reservations with the claim that stablecoins will improve upon the financial system. Current fintech developments already are sufficient to increase financial inclusion and efficiency in payments systems.

Charles Calomiris of Columbia University, however, foresees a useful role for stablecoins in the future economy. Stablecoins can develop a more safe, efficient, and rich payment system. For fintech developers, Dr. Calomiris urged that stablecoins should look less like bank deposits and more like perpetual preferred stock. However, large banks have much to lose if fintech companies expand their economic importance.

The Mises Institute’s Alex J. Pollock described the conflict between the government’s monopoly on currency and the issuance of private stablecoins. If a digital currency is tied to the dollar, one is merely creating a new payment system, not a new currency. Dr. Pollock is doubtful a currency not backed by an asset or cash flow can succeed.

— John Kearns

Event Description

Cryptocurrency, stablecoins, central bank digital currency (CBDC), and other fintech technologies are vying to change the way we borrow, lend, and pay one another. Pending financial regulation and potential CBDC issuance will shape the financial system’s evolution and shift the importance of central banks, banks, investment banks, cryptocurrencies, stablecoins, and related exchanges.

Will banks, mutual funds, and traditional broker-dealer exchange markets continue to be the systems we rely on to save, borrow, and make payments? Or will new nonbank fintech ventures and blockchain transactions displace them?

Join AEI as a panel of experts discusses the innovations, regulations, and other factors that will shape the future financial system and affect the broader economy.

Agenda

10:00 AM
Introduction:
Paul H. Kupiec, Senior Fellow, AEI

10:10 AM
Panel discussion

Panelists:
Charles Calomiris, Henry Kaufman Professor of Financial Institutions, Columbia University
Oonagh McDonald, Senior Adviser, Crito Capital
Alex J. Pollock, Senior Fellow, Mises Institute

Moderator:
Paul H. Kupiec, Senior Fellow, AEI

11:30 AM
Q&A

12:00 PM
Adjournment

Why a Fed Digital Dollar is a Bad Idea

Published in Real Clear Markets with co-author Howard Adler.

On July 19, the top-level President’s Working Group on Financial Markets met to address “the need to act quickly to ensure there is an appropriate U.S. regulatory framework in place” for stablecoins,  a form of cryptocurrency backed by assets, often denominated in dollars. The meeting cited “the risks to end-users, the financial system and national security.”  This is a pretty clear message from a group composed of the Secretary of the Treasury, the Chairs of the Federal Reserve, SEC, CFTC, and FDIC and the Comptroller of the Currency.

Another element of federal policy on this issue was telegraphed by Fed Chair Jerome Powell when he recently discussed the Federal Reserve’s research on issuing its own digital dollar stablecoin.  “You wouldn’t need stablecoins, you wouldn’t need cryptocurrencies if you had a digital U.S. currency– I think that’s one of the stronger arguments in its favor,” he said.  The impetus towards such central bank digital currencies (CBDCs) in many other countries, coupled with the thought that this might weaken the dollar’s global role, added to regulatory concerns about private stablecoins, appear to be pushing the Fed towards the issuance of its own CBDC.  The motivation is understandable, but we still think it would be a bad idea.

There are now a number of private stablecoins circulating that are backed in some fashion by U.S. dollar-denominated assets, such as Tether and USD coin.  Facebook has announced its intention to launch its own U.S. dollar-backed stablecoin, the “diem,” later this year.  If used by a meaningful proportion of Facebook’s several billion subscribers, this could enormously increase the stablecoin universe.  Government officials, unsurprisingly, are focusing on the lack of any regime for their regulation and the need for one.

At the same time, central banks worldwide are considering their own CBDCs.  As of April 2021, more than 60 countries were in some stage of exploring an official digital currency, including many highly developed countries. But it is China’s digital yuan, now being tested in a dozen Chinese cities, that causes the most concern.

China seems to have two goals in establishing a CBDC. The first is more control over its citizens. If the digital yuan became ubiquitous, the Chinese government would have instant knowledge and control over its citizens’ money, potentially allowing it, for example, to confiscate the funds of political dissidents or block their payments and receipts.

The second goal is to challenge the dominance of the U.S. dollar in international transactions. The dollar is the currency used in 88 percent of foreign exchange transactions, while the renminbi was used in only four percent, according to the Bank for International Settlements. Who, located outside of China, would choose to give the Chinese Communist Party control over their money? The answer is those potentially subject to U.S. sanctions. As the issuer of dollars that the world’s banks need to transact business, the United States government has long demanded and received access from banks to information related to international transactions, which it has used to impose sanctions on hostile states and those it considers terrorists and criminals. Some countries (perhaps Iran, Cuba and Venezuela) may choose to use the digital yuan to avoid U.S. sanctions, as may countries participating in China’s Belt and Road program whose large debts to China may provide the Chinese with leverage over their choices.

If the digital yuan and other CBDCs are widely implemented, as seems almost inevitable, proponents of the Fed digital dollar may argue that there would be erosion in the dominance of the U.S. dollar in international trade and less demand for U.S. dollar-denominated assets including U.S. Treasury securities, pushing interest rates on Treasuries up, making it more costly for the United States to fund its historic deficits. The Federal Reserve might also believe it is in the public interest to issue its own stablecoin because it would be safer and less prone to fraud than private cryptocurrencies.  In order to preserve the dollar’s dominance and to constrain the use of private cryptocurrencies, it appears likely that the Federal Reserve will decide this fall, when it is scheduled to report on its consideration of a digital dollar, to move forward with its own CBDC.  Is this desirable?

Regulation of private stablecoins is on the way in any case, regardless of whether the Fed issues a stablecoin.  More importantly, a digital dollar would further centralize and provide vastly more authority to the already powerful Federal Reserve.  The negative impact of a Fed CBDC, both on citizens’ privacy rights and by shifting the power to allocate credit from the private sector to the government, would be enormous.

A Fed CBDC would make it hard for private citizens to avoid financial snooping by the government in every aspect of their financial lives. Moreover, suppose, as one would expect, that that the Fed’s CBDC siphoned large deposit volumes from private banks. The Fed would have to invest in financial assets to match these deposit liabilities, which would centralize credit allocation in the Federal Reserve, politicizing credit decisions and turning the Fed into a government lending bank. The global record of government banks with politicized lending has been dismal. A digital dollar could therefore undo more than a century of central bank evolution, which has usefully divided the issuer of money from private credit decisions. In the process, a digital dollar would subject private banks to vastly unequal and inevitably losing competition with the government’s central bank.  Finally, a CBDC would make it easier for the central bank to expropriate the people’s savings through negative interest rates.  For these reasons, a CBDC may fit an authoritarian country like China, but not the United States.

The delicious irony in the CBDC saga is that cryptocurrency was created because people were afraid of government control and wished to insulate their financial lives from monetary manipulation by central banks. With CBDCs, their ideas would be used to increase exactly the type of government interference and control that the crypto-creators sought to escape.

What will cryptocurrency be like in 10 years?

Published in ReadWrite.

The second issue the subcommittee raised was that of government-created cryptocurrencies. Alex J. Pollock of the R Street Institute said that: “In short, to have a central bank digital currency is a terrible idea — one of the worst financial ideas of recent times.” Pollock argued that “[The Federal Reserve] would automatically become the overwhelming credit allocator of the financial system. Its credit allocation would unavoidably be highly politicized. It would become merely a government commercial bank, with the taxpayers on the hook for its credit losses. The world’s experience with such politicized lenders makes a sad history.”

EU Parliament report calls for CBDCs to level competition in cryptocurrency market

Published in Live Bitcoin News.

Last week, Alex Pollock, senior fellow at the R Street Institute, argued during a U.S. Congressional Subcommittee on Monetary Policy and Trade that “a central-bank digital currency is one of the worst financial ideas of recent times.” However, he added that “it’s still quite conceivable.”

Congressman says we should be banned from mining, using cryptocurrency

Published in Digital Trends.

Also brought up during the hearing was the idea of central banks issuing their own digital currency. Alex Pollock from the R Street Institute refuted the idea, as these banks would compete directly with the Federal Reserve. Having central banks issue digital currencies is “one of the worst financial ideas of recent times,” he said.

US Congress hearing: Central bank digital currency ‘one of the worst financial ideas’

From Cointelegraph:

Alex Pollock, senior fellow at the R Street Institute, argued that “to have a central bank digital currency is one of the worst financial ideas of recent times, but still it’s quite conceivable…” Pollock said that central bank digital currencies would only increase the size, role, and power of the bank, adding that the Federal Reserve adopting a CBDC would result in it become the “overwhelming credit allocator of the U.S. economic and financial system.” He continued:

“I think we can we can safely predict that its credit allocation would unavoidably be highly politicized and the taxpayers would be on the hook for its credit losses. The risk would be directly in the central bank.”

Pollock explained that if fiat money becomes digitized, its nature will not be changed, and will still be issued by a central bank. While Pollock can envision some type of private digital currency backed by assets, he concluded that it will not be “private fiat currency” like Bitcoin. In Pollock’s view, cryptocurrencies are essentially the same as scrip.