Insights

Bitcoin as the new world currency

Dr. Joseph Chen-Yu Wang

Right now, we are in the middle of a transition between an old political and economic system and a new one. The new world will be based on different economic principles, and the center of the new system will be bitcoin which will replace the US dollar as the primary means of international trade settlement.

The current world trade system is centered around the US dollar. To do any international commerce with most currencies, you must exchange the currencies from source currency to US dollar and from US dollar to the destination currency. To ensure that a nation can trade internationally, all nations other than the US must currently maintain large dollar reserves. Furthermore, to create a pool of money available to allow for large currency reserves requires that the United States maintain consistent trade deficits. In the current system, the US prints dollars and then uses them to buy manufactured goods from Asia and oil from Russia and Saudi Arabia. Once countries received US dollars, they can trade among themselves using the dollars as the international settlement currency.

However, this system is now breaking down and is being replaced by an international trade system based around bitcoin. Using bitcoin as a settlement system for international trade is why the price of bitcoin is and will continue to rise. Several factors are leading to the replacement of the US dollar by bitcoin.

The first factor is that starting in 2010, the United States has weaponized the financial system to impose sanctions to promote its foreign policy objectives. In the 1970s and 1980s, the United States began to institute currency monitoring and sanctions enforcement to control the drug trade. After 9/11 these currency monitoring systems and sanctions were extended as a means of performing counterterrorism. Until around 2010, these controls were adopted with international cooperation, and the United States largely limited sanctions to groups and nations for which there was international consensus to impose sanctions.

However, control of the dollar has proven too tempting for the US to avoid using it to advance foreign policy objectives. Since 2010, the United States has increasingly used sanctions to implement foreign policy goals that have not been agreed to internationally, and this has led many countries to consider alternatives to the US dollar.

The second factor is that for the current system to function, the United States must maintain a persistent trade deficit. The basic issue is that dollars are printed in the United States, but to be usable as a trade settlement token, they must be pushed out to other countries, and the only mechanism by which US dollars can continue to be pushed offshore is that the United States maintains large trade deficits. This system is now reaching its limits, as having a large trade deficit has generated much domestic discontent, as manufacturing jobs have disappeared. Furthermore, the United States is also worried about the national security implications of not having a manufacturing base. These factors are causing the United States to take more protectionist policies that will reduce the amount of dollar available for trade settlement.

This increase in protectionism and the desire not to run trade deficits is happening at the same time that the volume of trade is increasing between China, Russia, India, and Africa. During the 1960s and the 1970s, the United States was willing to run trade deficits with Asia and Europe to build up those economies for the benefit of strengthening a United States-centered alliance system. However, in the current situation, there is no reason to believe that the United States or anyone else is willing to run even larger trade deficits to help Africa, India, Russia, or Latin America.

Finally, the role of the dollar as a mechanism for international trade settlement has been weakened by the need to create financial stimulus and pay for infrastructure. Traditionally, the Federal Reserve has targeted a low inflation rate of 2-3 percent. However, financing the large deficits that are being generated by the stimulus and infrastructure packages by increasing the target inflation rate is likely to prove too tempting. Simply increasing the inflation target rate to 5-6 percent will allow the US to pay off its debts more easily. Unfortunately, it will do so at the expense of other nations that hold existing US debt, making adding new debt very unattractive.

These factors will end the use of the US dollar as the trade settlement mechanism, but there are reasons why the US dollar will be replaced by bitcoin rather than by some fiat currency.

First of all, one might think that some other currency such as the Euro, Japanese Yen, or Chinese Renminbi might replace the US dollar as a reserve currency. However, this would require either the EU, Japan, or China to undertake the same economic policies that the United States is no longer interested in pursuing. Moreover, becoming the world's reserve currency requires giving up economic sovereignty and control over one's currency, which the United States is now refusing to do, and which is unlikely to occur for either the EU, Japan, or China.

Second, people might object that bitcoin is unsuitable because of its wild price fluctuations. However, one can look at things from another viewpoint in which bitcoin is suitable to be the world's trade settlement system precisely because of the large fluctuations. In a bitcoin world, bitcoin would be used only to transmit value, but not to denominate the trade. The goods and services to be traded would be denominated in some other currency, and bitcoin would be used only to convert currency A to bitcoin and then to immediately convert to currency B. Therefore, for the purpose of trading, one would only be exposed to volatility for a few minutes, and this can be managed with derivatives and other financial products.

However, looking at things using macroeconomics, bitcoin volatility is a good thing for its use as a trade settlement token. Because the price of bitcoin is very volatile, the amount of trade that can be settled through bitcoin can scale up and down. The limited number of bitcoin tokens can be used to settle all global trade if the price of the coin is high enough. Furthermore, unlike fiat currencies, the exchange rate for bitcoin can undergo wild swings without causing economic damage to the real economy. In the last decade, the price of bitcoin has moved from pennies to tens of thousands of dollars per bitcoin without damaging anything in the real economy, and so the price of bitcoin can adjust to meet whatever volume of trade is necessary to settle in bitcoin.

Although these arguments apply to any cryptocurrency, bitcoin has one advantage over other cryptocurrencies for settling international trade. Existing governments benefit from the current system in which international trade is settled using fiat currency, and can be expected to block the transition to a new economic system through political and legal means. For cryptocurrencies other than bitcoin, the founders and maintainers are known, and by arresting or otherwise pressuring the key stakeholders, a government could force the operators of the coin to modify it to meet the requirements of that government. By contrast, there is no one that any government can toss in jail or threaten to influence bitcoin.

So what are the implications of a world based on bitcoin?

First, bitcoin would eliminate currency crises such as what occurred in Mexico in 1982, India in 1991, with the Asian crisis of 1998, or Russia in 1998 and 2014. In a currency crisis, an economic shock such as a change in the price of oil causes people to get nervous and dump local currency for the US dollar. Because the value of the US dollar is fixed, the value of the local currency drops, this creates a loss of confidence which then feeds back to more sales of local currency. Eventually, the nation runs out of foreign exchange reserves, and you end up with a broken economy. In a bitcoin world, any events that would have led to a currency crisis would cause an adjustment in bitcoin prices rather than creating runaway capital flight. Because the bitcoin price can be volatile, the prices of the local currency and bitcoin will adjust and although there may be economic consequences, there will be no positive feedback cycle causing a catastrophe.

The second characteristic of a world based on bitcoin trade settlement has no currency reserves. Countries must currently hold trillions of dollars of US dollars to trade internationally. In a bitcoin world, there is no need to hold currency reserves, because when you need to trade one currency you can go through bitcoin, and you can bid up the price of bitcoin to whatever one needs to settle the necessary trades.

So the new world would be one in which international trade can be done more stably. We are moving from a unipolar trading system based on the US dollar to a multipolar one based on bitcoin.

So buy bitcoin!!!

This is not investment advice, not Redot’s advice or opinion. Everyone should do their own research before trading anything.

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