Bitcoin’s future as an alternative currency is generating heated debate and in-depth analysis of its potential effect on the money supply. Just in the past week, the Bank for International Settlements (owned by the world’s central banks) and a senior official from the Central Bank of Canada have both issued public statements on the potential impact. Just over a month ago, the Bank of England did the same. The attention that this is getting is good for headlines, perhaps, and no doubt makes for interesting intellectual debate. The debate may be intellectual, but it is also hypothetical, beside the point, and not particularly helpful, for three main reasons.
First, we lost control of the money supply years ago, when we left the gold standard. Central banks can in theory expand and contract national money supply by printing money, buying securities, tweaking banking regulations, etc. More money means lower interest rates, less money means that interest rates go up, and that is how central banks hope to influence economic growth. Yet they have much less control over the result than we generally believe. The actual amount of money in circulation is actually up to the banks, individual users, foreign investors and a long list of players each of whom has a different agenda.
Since so much of the money that we spend and save doesn’t even have physical form any more, it’s even harder to count, let alone control. Even the Federal Reserve itself admits that “over recent decades… the relationships between various measures of the money supply and variables such as GDP growth and inflation in the United States have been quite unstable. As a result, the importance of the money supply as a guide for the conduct of monetary policy in the United States has diminished over time.” And that’s just the US figures. Trying to get a feeling for the global money supply is a challenge, to say the least.
So, if we don’t know what the money supply is, how are earth are we going to know to what extent Bitcoin affects the final amount? And if the “official” money supply figures are not important anyway, as the Fed itself admits, what does it matter?
Second, a further layer to the irrelevance of this debate is that, while Bitcoin in many ways is a superior currency to the current fiat options, it won’t replace the dollar, the Euro, the Yuan or any other well-established local currency. Bitcoin is an ideal complement to local currencies, and is much better at trans-border payments and transfers. But the physical, practical, psychological and even emotional hurdles that need to be overcome before a culture relinquishes the comfort of the familiar and the convenience of the physical, outweigh the advantages of insisting on a blanket, society-wide adoption.
As Bitcoin takes over the international payments space, which is where its advantages really shine, it may end up surpassing major local currencies in terms of transaction volume, especially as trade becomes ever more international. But realistically, that won’t happen for many years yet. And even if (= when) it does, it won’t imply the elimination of other forms of payment. We will not end up with a bitcoin-dominated world.
Although it’s virtually impossible to have a reasonable idea of the global money supply, one figure that I saw earlier this year put the total at $43 trillion. The market capitalization of Bitcoin currently stands at under $5 billion. About 0.01%. Even when all the latent bitcoins have been mined and the supply stands at its potential maximum of 21 million, at current prices the Bitcoin market capitalization will only be $7.6 billion. Still not nearly enough to make a difference. Even if the price shot up (or gradually increased, if you prefer) to $1,000, and the world money supply stayed more or less the same, the total Bitcoin supply would still be less than 0.05% of the world money supply. In the year 2140. I don’t really see why central banks would tremble at that.
And third, this type of headline, while interesting, does little other than stoke the fear of this unknown financial concept that is going to bring about more change than we are comfortable with. I’m sure that if you asked a room full of anyone, even bankers who are supposed to understand the nuances, if they would like to see central banks lose control of the money supply, most would say no (even though, as I pointed out earlier, they don’t really have control of it anyway). No, we don’t want central banks to lose control of the economy. No, we don’t want Bitcoin to make our economy even more unstable.
And the headlines are actually misleading. In all three examples cited in the first paragraph (and there are many more), the word “unlikely” was prominently used. What the Senior Deputy Governor of the Central Bank of Canada actually said was: “In the unlikely situation in which cryptocurrencies were used broadly, a significant proportion of economic transactions would not be denominated in Canadian dollars.” We need to give more emphasis to the word unlikely. And we need to think about what level of “significant” is needed to wrest influence from the Central Bank. And with that we will realise that the Central Bank of Canada, the US, Europe and many other economic powers will most probably encounter greater dangers to their hegemony than Bitcoin. Which does not mean, of course, that Bitcoin won’t end up being powerful.