The Law of Credit and Competition
Most of the value of fiat currency comes from its ability to allow the creation of money through fractionally backed credit. And this ability is the base of current market economies, because of the everlasting necessity for growth incentivized by competition. Without this feature fiat monies are useless, and only commodity currencies would make financial sense.
There seems to be enough historic evidence, from competition among religions fueling the crusades and thus the necessity of institutions as the Templar Knights to finance the conflict, to the Bardis and the Peruzzis financing of medieval wars among kingdoms competing for territory and trade routes, and the war bonds to stop the advance of the Nazis. These periods of intense competition among the main owners of wealth set up the stage for the financial system that was to fuel the industrial revolution and the current banking system.
In addition to historic evidence, academic works and opinions of such notable economists as Nobel Laureate Paul Krugman and President of the Federal Reserve Bank of Minneapolis Narayana Kocherlakota reinforce the idea that debt is not only good but also necessary.
This approach challenges current perceptions about the function of money, and creates a bigger separation between fiat and commodities backed currencies since the main function of the former is the ability of allowing fractionally backed credit. This is even more relevant in the face of financial innovation and in the process of identifying the barriers of entry of new alternatives like crypto currencies, it seems now like common knowledge that the main obstacle for massive adoption of (for example) bitcoins as a mainstream currency is its volatility and acceptance at retailers, when evidence seems to show that it may be the impossibility of serving as a currency which banks can use to give credit or governments to generate debt and (oh no!) implement monetary policy. This would (ironically) mean that the success of money as currency is based on this fact, that the main value of money is the ability of depreciate itself, that a currency that can’t constantly and predictably lose value over time, can’t go mainstream.
So, it seems that the role of central banks and the government in general, more than simply regulate, must be of an efficient competitor. This idea is explored in a paper called “$=€=Bitcoin?” by Hilary J. Allen from the Suffolk University Law School, there, she suggests that the only real way to contain systemic risks associated with virtual currencies is for regulated banks to outcompete them. If bitcoins main benefit is convenience for payments not their decentralized nature, it should be easier for established government agencies to create better alternatives, specially if they still have the power of tax people and firms in the fiat currency of their choice.
All this pose a challenge for bitcoin champions, people‘s perceptions about debt -from the practical and the political/ideological perspectives- doesn’t seem to reconcile: on one hand some decry the use of deficit to finance government spending and on the other they benefit from it and oppose policies that reduce wealth transfers, and this seems to be an important source of ideological internal conflict throughout the political spectrum in relation with virtual currencies: those leaning left would like a strong regulatory framework that allows virtual currencies to flourish, but virtual coins nature seems to be at odds with the mere existence of central banks, and right-leaning crypto-fans would enjoy a world with no central banks, but with a bitcoin-based economy they wouldn’t be able to benefit for the debt-based system that generates most of the wealth.
Perhaps the solution is not complete decentralization, but Decentral Banks, institutions where monetary policy can be crowdsourced based on global inputs, seeing the world economy as a whole, Megaeconomics instead of Macroeconomics you may say. Not an easy task, but it seems that it’d take that kind of ingenuity in order to move virtual currencies into the next stage of true mass adoption.
Paul Krugman. Debt is Good. August 2015. http://www.nytimes.com/2015/08/21/opinion/paul-krugman-debt-is-good-for-the-economy.html
Narayana Kocherlakota. Public Debt and the Long-Run Neutral Real Interest Rate. August 2015. https://www.minneapolisfed.org/news-and-events/presidents-speeches/public-debt-and-the-long-run-neutral-real-interest-rate
Hilary J. Allen. $=€=Bitcoin? August 2015. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2645001
