Electronic money, or e-money, is to normal money as email is to normal (snail) mail: it’s simply an electronic form of value exchange, but with a key advantage in that most types of e-money are not linked to any particular country or government. Electronic money has made big strides in social acceptance in the last decade. Dutch bank ABN Amro’s CEO recently said that the technology behind electronic money is the next big thing in global banking.
The king of e-money today is Bitcoin, created in 2009, shortly after the global economic and banking system shocks known now as the Great Recession. Bitcoin was the brain baby of a mysterious person known as Satoshi Nakamoto, who posted the 2009 Bitcoin white paper on a well-known cryptocurrency forum. His paper described the architecture and function of the new type of e-money that he had invented. Shortly thereafter he offered an open source software package that implemented the white paper’s ideas, and, with the mining of the first “block” of Bitcoin by Satoshi himself in 2009, Bitcoin was born.
Shortly after, Bitcoin’s first commercial use was to buy some pizza for a guy who had a bunch of bitcoin to spare. In 2013, just four years after its creation, Bitcoin was worth as much as $12 billion. That value has since fallen to about $4 billion.
Why would anyone use e-money? Well, the Great Recession is itself a big part of that answer. Normal money like the U.S. dollar is known as a “fiat currency” because it is offered by fiat by the central government and its value is backed simply by the power of the state issuing it, and the confidence that such power creates. Its value also comes from its ability to be used to pay taxes to the state. Until 1971, the U.S. government used gold to back the value of money it issued, but Nixon took the U.S. off the “gold standard” in favor of a new floating system of value in which the value of the dollar is determined mostly by market forces. The market that determines the dollar’s value in relation to other currencies is the international trading system, of both goods and services, which are denominated in dollars (mostly) but also the trading of dollars themselves for other currencies.
For example, China now holds about $1.5 trillion of dollars in reserve in order to pay for goods and services denominated in dollars and as a store of value for a rainy day, out of a $3.5 trillion in total currency reserves. China keeps such a large amount of dollars because the dollar is the primary reserve currency in the world today and has been for some time.
Other reserve currencies include the British pound, the euro, the Japanese yen, and, if China has its way, before too long the Chinese yuan will also be considered a reserve currency. One commentator has recently suggested that the yuan is headed toward replacing the dollar as the global reserve currency before too long. That would be a momentous shift if it does indeed happen.
The dollar became the primary reserve currency because of our central role in the global economy, which was won by a combination of our large size (more than 1/4th of the global economy after World War II) and our military might that came from being on the right side in World War II, and from our continued military dominance in the wake of the collapse of the Soviet Union in 1991. Today, fully 60% of the globe operates in this “dollar zone.” But as the Economist article linked to above describes, there are growing cracks in the dollar’s global dominance.
Since the U.S. went off the gold standard in 1971 the value of our currency has been determined entirely by social and economic acceptance around the world. In other words, the value of the U.S. dollar is based entirely on confidence in the U.S. government and its economy, and on the trust that such confidence instills in the ability of the dollar to retain its value and its use as an exchange currency.
But the 2008-2009 Great Recession shook a lot of people into the realization that nothing is written in stone, no economic foundation is entirely firm, and even the dollar can of course lose value. When the U.S. government agreed to the $700 billion (with a “b”) bailout of major U.S. banks in 2009, plus the Federal Reserves’ $trillions in additional support, it became quite obvious that our economic and currency system had some major flaws. This was not, of course, the only economic crisis we’ve suffered. Rather, it was simply the latest and most severe since the Great Depression.
Satoshi’s new form of e-money, Bitcoin, arrived in 2009 at an opportune time and a lot of hobbyists, libertarians, and tinkerers leapt at the chance to experiment with a new type of currency that didn’t rely on any central bank or any central authority whatever for its value or its operation.
The magic ingredient in Bitcoin is the distribution of trust (sometimes described as “trustless” transactions) in a vast network that moots the need for the “centralization of trust” that is the function of central banks like the Federal Reserve. The distribution of trust in the Bitcoin ecosystem is made possible with Satoshi’s invention of the “blockchain.” The blockchain is an electronic record of all Bitcoin transactions that is stored on every node of the ever-increasing network of the Bitcoin ecosystem. Because it is completely distributed and constantly updated in real time, the blockchain, which is the ledger of all Bitcoin transactions, can never be shut down by any outside force and it becomes practically immune from hackers.
(Centralized businesses that are part of the Bitcoin ecosystem can still be hacked, and there have been prominent examples of such hacking, such as Mt. Gox before it folded in 2013, but these incidents do not reflect on the security of the blockchain itself.)
In other words, the Bitcoin ecosystem is a way for anybody using it to avoid the centralized power of central banks and of national governments entirely, in terms of these entities’ ability to affect the value and use of the Bitcoin currency. ABN Amro bank chief said it well in August this year: “What the Internet has done for information and the way we communicate, the blockchain will do for value and the way we look at trust. The financial world is going to flip upside-down.”
Obviously, the decentralized nature and independence from government influence has appealed to libertarians and techno-optimists since Bitcoin’s creation. Bitcoin-enabled commerce holds the promise of reducing national borders, and the power of central governments, significantly.
Bitcoin in World Affairs
Okay, now that that introduction to e-money is out of the way, let me shift gears to talk about foreign affairs and where our global system is headed. It is well-known that China’s economy is growing rapidly and at the current pace of growth is set to exceed the size of the U.S. economy in 5-20 years (depending on various factors). Whether this happens in 5, 10, or 20 years doesn’t really matter for present purposes because my point is simply that China is on the verge of taking the top spot from the U.S. in terms of economic power on the global stage.
Recent events have cast some doubts on the sustainability of China’s economic expansion but my feeling is that the current issues facing China are temporary and that it will before too long continue to grow at a steady pace over time.
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China is already flexing its new-found muscle in various ways, including with its recent creation of the Asian Infrastructure Investment Bank (AIIB), a regional replacement in many ways for the World Bank. The World Bank is a major part of the Bretton Woods economic system that has governed world affairs in many ways since its creation in 1944 at the close of the Second World War. The World Bank chief is traditionally an American and its sister institution’s chief at the International Monetary Fund (IMF) is traditionally a European.
The U.S. and the UK were the primary architects of the Bretton Woods system and many would agree that these same powers, along with Europe and the western world more generally, have benefited greatly from this system through improved trade relations and improved stability within and between nations.
China’s creation of the AIIB is a direct challenge to the long-standing Bretton Woods system largely because it is the first institution of its kind to gain buy-in from European and other western powers, including the UK, France, Australia, and many others—over the loud objections of the U.S.
China has also worked extensively with Russia in recent years on major infrastructure projects, like a planned rail link between Moscow and Beijing, but also and more importantly in terms of using the yuan as a replacement for the dollar in economic transactions between Russia and China.
In sum, China is already in many ways pushing for a world in which U.S. power and economic strength is much reduced. And while I would agree with many critics regarding the misuse of U.S. power over the last couple of decades, in particular, I fear that China, or a China/Russia axis, would, as the replacement superpower (or “hyperpower” as some have described the U.S. today), be worse than the U.S. has been. And possibly far worse. This is because, among other reasons, China lacks a democratic tradition, is highly nationalistic and ethnicist, and is home to a growing bellicosity and assertiveness that doesn’t bode well for peace as China continues to rise and increasingly butts up against U.S. power in Asia and around the world, as well as with regional rivals like Japan. I fear increasing conflict between China, its regional neighbours, and the U.S., but also a world in which China could theoretically replace the U.S. as top dog at some point down the road.
However, I see the rise of Bitcoin as a powerful tool in helping to prevent this from happening. How? Well, the key to this dynamic is the potential for Bitcoin to replace the yuan as the currency of choice in China. Bitcoin is already being used on a minimal basis in China and China has cracked down on early Bitcoin entrepreneurs and cracked down on Bitcoin in other ways. But even with China’s crackdown on Bitcoin normal Chinese can and do conduct a significant amount of economic transactions in Bitcoin. And China is home to the most Bitcoin mining (creating Bitcoin through massive computing power) of any country, by far, controlling over 50% of all mining in 2015.
Bitcoin is appealing to the Chinese for different reasons, but its main appeal, it seems, is the ability it gives them to send money anywhere in the world with the push of a button, with no fees or very limited fees. China imposes strong capital controls on its citizens, including an annual limit of $50,000 (approximately) in Chinese money being sent out of the country, along with new daily limits on ATM withdrawals in foreign countries. These limits are imposed as a way to maintain the Chinese government’s ability to control the value of its currency, which has been pegged at a specific value to the dollar since 1993.
Bitcoin, however, allows any Chinese national to send as much money abroad as they want to because Bitcoin transactions are generally untraceable to any particular individual. This privacy is made possible because the blockchain ledger of Bitcoin transactions doesn’t contain any personal information. It only contains the Bitcoin transactions themselves.
This feature alone may lead the Chinese to expand their use of Bitcoin, continuing a very clear trend since Bitcoin was created. If this trend does continue, then Bitcoin may become, before too long, a widespread currency in China alongside the yuan, either overtly or more likely covertly.
If Bitcoin continues to be used widely, and if the yuan continues to be devalued through floating exchange rates or through government manipulation of its value, Bitcoin may well become the preferred currency and store of value for large numbers of Chinese.
This evolutionary process could lead to the yuan becoming further devalued through disuse, particularly if other countries start to reject the yuan as a reserve currency, in favor of Bitcoin or other more established currencies, which could lead to a downward spiral of declining value for the yuan. This would improve the competitiveness of Chinese exports, which would boost the Chinese economy, all else equal, but a downward spiral in the value of a national currency is never a good thing in the long-term.
Bitcoin would be well-situated in such a scenario to eventually replace the yuan as the currency of choice for the majority of Chinese people. And if that happens, the central government loses its ability to set economic policy. And if that happens, China may be stopped in its tracks from becoming a superpower capable of rivaling the U.S. If a country can’t control its own currency, or even have its own currency, it cannot be a superpower in any normal sense of the word.
This is all highly speculative, of course, but my aim is to present a plausible scenario in which China loses its ability to control the currency of choice for a majority of its citizens. We’re far too early in the development of Bitcoin to make any predictions about this unfolding dynamic but it will certainly be an interesting ride.
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