Precious metals are reliable money, and bitcoin will not be able to fulfill this role. The market for this cryptocurrency is small and not recognized by the vast majority of investors. However, its price has been steadily increasing since the beginning of 2017. Recently, the demand for precious metal has decreased due to the rapid growth of bitcoin quotes. As expected, this cryptocurrency will continue to rise in price. Cryptocurrency supporters believe that bitcoin will replace paper currencies.
The assumptions underlying such statements are naive and only indicate a lack of knowledge about what characteristics must be inherent in reliable money. Current events accelerate the process of destroying paper money, and their place will take a more reliable form of money. It is free markets that will determine the form of money of the future. People will independently understand what qualities of monetary units are necessary.
In the past, preference was given to metal money. States and their central banks currently own reserves in the form of paper currencies and gold. The monetization of precious metal is the only opportunity for the authorities to survive the collapse of paper currencies. In addition, silver can perform an auxiliary monetary role along with gold.
Reasons for investing in cryptocurrency
More and more representatives of the investment community understand that the amount of paper money is increasing limitlessly. The purchase of bitcoin is a speculative game, which in a few years may end, due to the limit of its emission.
Most holders of bitcoins expect to exchange their investments for currencies with high purchasing power (dollar, euro, yen) in order to gain profit and gain independence from the currencies of their states. Despite the volatility of bitcoin, analysts are optimistic about the future of cryptocurrency and are already comparing it with gold, and well-known Wall Street investors appear among the owners of bitcoins. Bitcoin buyers claim that gold and silver will be a thing of the past, will be completely unclaimed in the market.
Investors consider bitcoin an excellent risk hedging tool. The purchase of cryptocurrency is compared with the execution of an insurance policy for the loss of purchasing power of state currencies in the future. If the risk of collapse of fiat currencies is minimal, then the insurance premium may be small. However, if it becomes obvious that the collapse of fiat currencies is approaching, then investments will have to be increased.
Investors explain the need to buy bitcoin by the fact that its volatility is due to subjective factors, while the depreciation of national currencies depends on objective conditions. The fact is that long-term holders have the greatest influence on the price of bitcoin, for whom the transactional turnover of cryptocurrency is not important. The price of bitcoin (in fiat currency) as a whole is determined by the desire of these holders to redeem it from circulation. For large investors, bitcoin is a form of electronic money that is not regulated by the state. In other words, the faith and devotion of large investors to bitcoin provides half of its value.
On the possibility of a fiat (paper, unsecured) currency crisis
Pessimistic estimates of the future of fiat currencies are so strong and popular that very few can ignore them. The decision to insure against the collapse of fiat currencies leads to the purchase of their likely successor - cryptocurrency. Global economic and monetary instability is increasing. This explains the increase in investment in bitcoin and makes it possible to benefit financially from the increase in its price. However, understanding what can happen to fiat currencies and cryptocurrencies requires knowledge of the function of money. Paper money is depreciating, but what can it mean for their substitutes - a new form of money? To do this, you need to understand what is happening with paper money. As evidenced by rising prices for commodities, housing, bitcoins, and gold and silver, whose value is expressed in paper money?
It should be noted that throughout history, society has chosen forms of money from the convenience of conducting exchange transactions. The invention of cryptocurrency led to speculation that it would replace paper money. The assessment of the suitability of each form of money is given on the basis of their long practical use. Gold, as a form of money, has proved its value, unlike bitcoin. Let's try to explain this thesis.
Recognition of gold and silver in the form of money
These two precious metals have served as money for millennia. In most cases, they were used as a means of exchange.
Silver was the basis of sterling from 775 C.E. and the monetary standard until the adoption of the gold standard in 1816. In the 18th century, Sir Isaac Newton was appointed caretaker of the London Mint. He proved to be an excellent financier and administrator. Thanks to the scientist, in 1717 the gold standard actually appeared in the world. Silver remained the monetary standard in many countries on the European continent until the Franco-Prussian War, when Germany demanded that France pay indemnities in gold, which allowed it to change its monetary standard from silver to gold.
Both metals have long functioned as money in Europe and Asia. When Columbus discovered America, it became clear that these metals were also honored by the Aztecs and Incas, who previously had no trade ties with Europeans and Asians.
Bitcoin can't be money?
At the moment, bitcoin is considered the leading and most reliable cryptocurrency. Its distribution register cannot be distorted or damaged by anything or anyone, including Governments. Bitcoin and its blockchain will exist as long as there is electricity and communication between computers and smartphones.
As a substitute for fiat currencies, bitcoin is not yet suitable for the many inherent shortcomings that may be overcome over time. The main drawback of bitcoin is the impossibility of using it as a means of exchanging those who are unwilling or unable to do so.
Long-term holders of bitcoins believe that cryptocurrency will be popular for transactions by a generation of people born in 1981-1996. However, there are not many of them in the world: perhaps less than 100 million of 7 billion people. Ultimately, not big investors, but most people will decide what happens to the money.
Bitcoins are already accepted as a means of exchange for some transactions. Elon Musk recently announced the start of Tesla car sales in exchange for bitcoins. The number of trading operations involving this cryptocurrency may increase in the near future due to the growth of its quotes. Therefore, the expansion of such exchange operations will increase, since bitcoins can be sold with additional profit. However, this does not mean that bitcoins will function as money.
For an exchange medium to be effective, it must be accepted by the majority of the population.
Importance of paper currencies secured by gold
The usability of reliable substitutes for metal money cannot be underestimated. Paper currencies, as cash and bank deposits, replaced gold and silver with the classic gold standard, while paper money could be exchanged for physical metal on demand and a fixed rate. State paper currencies were central to the economies of the world. On their basis, the markets of bills, loans, bonds and shares developed. They could be repaid in the form of gold and silver, so trading and financial partners trusted such currencies. International business was developed through exchange transactions involving national currencies. Banknotes that circulated in one country could be exchanged for physical gold or for currencies of another country at a rate established on the basis of the gold standard. This system was the basis of world trade before the First World War.
The monetary system, based on the free exchange of gold and silver substitutes, was so successful that it led to the greatest economic progress of mankind. The use of national currencies has laid the foundation for modern economics and technological progress. People trusted currencies secured by gold or silver, knowing that such money would not lose its purchasing power.
What is the lack of a gold standard?
After the collapse of the gold standard in the conditions of World War I in order to finance the army, European countries were never able to restore it, so the leading currencies lost their value. In 1925, Great Britain introduced a gold bullion standard. This system involved the removal of gold coins from circulation. The authorities agreed to sell gold bullion at a fixed price in exchange for currency in circulation. The population actually lost the possibility of exchange operations with gold, since only the exchange of pound sterling for bullion weighing 400 ounces was allowed, and it was no longer possible to repay paper money in the form of golden believers. John Maynard Keynes, an English economist, citing the danger of deflation, opposed the resumption of the gold standard. The gold bullion standard lasted until September 1931, when they decided to "temporarily" abandon it, but its restoration subsequently did not happen.
The lack of a gold standard is not explained by some fatal characteristic of precious metal. The main problem was that banks could freely increase the amount of credit money under the Banking Charter Act 1844, adopted in the UK, which allowed the existence of an unsecured bank loan. However, the possibility of obtaining a loan without security soon ceased to exist due to periodic banking crises. The situation changed when the Bank of England assumed the role of lender of last resort, which later began to be carried out by the Fed in the United States.
Now credit money is the bulk of the money in circulation. Without a reform of the banking system that restricts the role of bank credit, the return of gold and silver substitutes will not lead to anything good. To become full-fledged money in the future, bitcoin must gain a reputation as a reliable and stable asset. Of course, something like the "revolution from above" can happen, in which the authorities of several countries will make cryptocurrency money. However, such a scenario does not stand up to criticism, because it assumes that it is not the population, not investors, traders, workers, but the state decides what money is.
You can make the transition to "new" money only with the use of gold
What the authorities do not want most is to lose control of money. The authorities will continue to use unsecured paper money until the last moment, because the state must constantly maintain control over the national currency in order to successfully manage economic processes.
The collapse of unsecured paper currencies will destroy the state monetary system, as it has been more than once. No matter how long it takes, the rapid loss of purchasing power of paper currencies will result in governments no longer being able to finance their liabilities. Therefore, the moment will come when paper money will have to be abandoned in order to stabilize the economy and other financial instruments will have to be used for this. The disappearance of paper money means the abolition of public money, so in their place will come a form of money that will restore public trust.
The authorities can begin to restore confidence by reducing public spending to an economically sustainable level, maintaining a balanced budget, reforming the banking system and refusing to interfere in the functioning of free markets. However, it is unlikely that the necessary reforms will be possible politically before the major economic and monetary crises. Therefore, a crisis will first come, and then politicians will explain to the electorate, which was fully aware of the consequences of the crisis, the introduction of the necessary monetary reforms.
We have no shadow of doubt that the only way to replace paper, unsecured money is to provide "new" money with gold. At the same time, the authorities will have to reduce government interference in the economy and free markets from excessive regulation. Ideally, the stabilization of the new currency will be achieved through the establishment of the possibility of its exchange for gold coins.
Scenario of transition to "new" money secured by yellow metal
At what stage in the fall in the purchasing power of paper, unsecured money will reforms have to be introduced? In November 1923, the German paper stamp (the official sources often used the name "gold stamp") was replaced by a rental stamp. The new monetary unit corresponded to 1/2790 kilograms of pure gold or the pre-war "gold mark." The exchange rate of paper stamp to rent amounted to 1 trillion to 1 (4.2 marks = 1 US dollar). The rapid cessation of inflation was called the "miracle of the rental brand." The population positively perceived the appearance of a stable monetary unit based on the price of gold. In 1924, the Reichsmark appeared in circulation. Replacing paper, unsecured currencies with new money in the future is likely to follow the same path.
In the event of the collapse of unsecured currencies, the authorities will make such decisions that were made in such cases in the past, starting from the time of ancient Rome: they will introduce price controls and try to confiscate gold from the population. The introduction of digital currencies by central banks can be justified by a drop in the purchasing power of unsecured paper money. By the way, as a result of inflation, the middle class is greatly impoverished.
Gold will make "new" money flexible
The essence of reliable money is that it is their users, the population and enterprises, and not the authorities, who decide how many of them should be in circulation. It is the state theory of money of the political economist Georg Knapp, published in 1905, that underlies the inflationary financing of the German economy, which ended in the collapse of the paper stamp in 1923. The problem is not a strict restriction on the amount of money, but who determines their number in circulation.
The volume of ground gold reserves is about 200 thousand tons, and the growth of yellow metal production is about 1.5% per year. This figure is mistakenly mistaken for the volume of monetary gold. Monetary gold is one of the functions of metal. Officially, only 35.2 thousand tons are considered monetary gold. In addition to their own national reserves, central bank repositories contain bullion (without the status of monetary precious metal) deposited by other states, their bodies, as well as the population. About 60% of gold is contained in jewelry and other precious products. In general, the global mass of monetary gold is approximately 80 thousand tons. This makes it possible to use yellow metal as money.
Gray precious metal is mainly used in industry, so its functioning as money is problematic. An increase in the cost of silver relative to gold will lead to a gradual decrease in industrial demand until quotes stabilize.
Unlike gold, ground reserves of silver are small. In addition, states practically do not own monetary silver. In European countries, the use of silver as a means of securing banknotes was abandoned in the early 1870s. In the future, gray metal will be used, but to a much lesser extent compared to gold. The return of money status to silver coins, along with more expensive gold coins, will be further evidence that monetary reform has a solid foundation.
As you know, the supply of bitcoin is strictly limited to 21 million coins. More than 80% of the volume of the main cryptocurrency has already been "mined," and the last coin will be "mined" in about 2140. According to the standard of the bitcoin system, one country can increase the number of its bitcoins in circulation, only receiving them from another country. Therefore, the functioning of bitcoin requires the intervention of authorities who would set a limit on demand. However, if the authorities of one country manage to increase the number of circulating bitcoins, then this will cause more acute deflation in other countries. The lack of any monetary flexibility is the Achilles heel of bitcoin.
Why is financial flexibility of money important?
In the last fifty years since the closure of the Bretton Woods system, financial markets have evolved with unprecedented growth in money. In the United States alone, since August 1971, the money supply has increased from 685 billion to 19.4 trillion dollars - almost 28 times. Large American banks are increasingly choosing to finance rather than finance production. The main banking operation was the purchase of public debt, the total volume of which increased from 160 billion to 4.92 trillion dollars during the period under review. The growth of regulated futures and large OTC markets has been rapid. According to the Bank for International Settlements, the nominal value of issued OTC contracts in June 2020 amounted to $ 609 trillion.
Financial markets will be in demand for these assets even under the new monetary regime, which should allow trade financing and lending to the non-financial sector. In derivative financial instruments, a longer history than in paper money proves that metal money does not prevent them. Bond markets also existed along with bank loans, which are necessary to facilitate production and consumption.
At stable prices, the purchasing power of money increases over time as a result of competition that stimulates production innovation, as well as the development and use of new technologies. Consumers can save by knowing that they are protected from the depreciation of money by the state, and their standard of living will improve over time along with the purchasing power of savings.
If paper, unsecured currencies collapse and a change in the monetary regime is needed, the authorities must be prepared for important institutional changes. They will have to reduce financial obligations, minimize interference in the economy, abandon the regulation of free markets and not prevent the growth of savings through their taxation. Admittedly, the prospect of a smooth transition to "new" money is close to zero, but the transition will eventually happen.