Aquila Flash Part 2 - Cryptocurrencies

Cryptocurrencies are on the rise worldwide. Central banks themselves, with their policies of negative real interest rates and exploding money supply, are to blame for this. Indeed, they are probably the main culprits. Almost all countries are considering the introduction of their own cryptocurrencies and would want to ban private cryptocurrencies should these become too successful. 

 

Why are politicians so concerned about cryptocurrencies?

Central banks, and hence the state and politicians, have an enormous interest in not losing control over the money supply. Non-state-created cryptocurrencies (such as Bitcoin) threaten a loss of state control over “sound money” and thus the No 1 instrument of power. As the saying goes: “money rules the world”.

 

Cryptocurrencies were created as an antithesis to central bank currencies

Bitcoin and other cryptocurrencies emerged spontaneously without government planning and were designed in crucial aspects to differ from money created by central banks. A key attraction for many cryptocurrencies is a self-imposed quantity restriction. This should ensure that the supply of cryptocurrencies, unlike central bank money, cannot be increased arbitrarily. Two comments are in order here. First, the “old Austrians” wisely defined inflation as the growth rate of the money supply rather than the growth rate of prices since, so to speak, they wanted to focus directly on the “evil”. Second, cryptocurrency money supply will not be constant even if the number of currency units created remains constant across all cryptocurrencies. This is because the number of cryptocurrencies has exploded and continues to rise. From December 2019 to August 2021, the number of available cryptocurrencies increased from 2,388 to 5,809 (source: de.statista.com). For comparison, 193 states are members of the UN and there are 160 “official” currencies.

 

Supply of cryptocurrencies explodes

Thus, the assumption that the supply of cryptocurrencies is limited is wrong. Indeed, the total volume of all cryptocurrencies is currently experiencing high growth even though the number of newly created coins in some established cryptos, first and foremost Bitcoin, is decreasing and is expected to decrease further in future. Thus, a monetary explosion is currently taking place not only in government fiat currencies, but also in cryptocurrencies when considered in aggregate.

 

Fears of loss of control and a centralization of power

The more private cryptocurrencies replace traditional, government-issued currencies, the more politicians will fear losing control. This loss of control involves several dimensions:

1. The ability to pursue a countercyclical stimulus policy: Interest rate changes have less effect if more cryptos are used as a store of value and a means of payment, or vice versa, if government currencies lose market share as a store of value and means of payment.
2. The ability to manipulate asset prices: Should investors prefer to accept cryptocurrencies when they sell assets or prefer to make purchases with cryptocurrencies, it will become more difficult for central banks to influence bond, real estate and stock prices.
3. The ability to finance spending programs: In extreme cases, it may become difficult for the government to finance itself by issuing government bonds if investors no longer want to hold them because they can no longer assume that these bonds represent a trustworthy store of value.
4. In extreme cases, companies, especially overseas, could refuse to accept state fiat currencies in return. for their goods and services or they might demand gigantic markups to compensate for fiat currency risk. This could make it difficult for the state to buy goods and services or foreign currency, especially from abroad. In such circumstances the government would have to either raise taxes (unpopular with voters) or resort to barter (the exchange goods for goods). Government spending also includes the military. No state will accept restrictions on military (or police) spending because private cryptocurrencies prevent acceptance of the state’s legal tender.

The above suggests that governments will act against private sector cryptocurrencies if they become too successful.

The success of private cryptocurrencies has encouraged most states / central banks to consider introducing their own, “state” cryptocurrencies. This would represent a first line of defense for central banks. In a war, the successful weapons of the opponent are copied. So, in a currency war, successful “crypto weapons” of the enemy are copied. (Note: Decades of central bank policies of repression mean that bank depositors face negative real interest rates. Thus, central banks are the main culprits behind the rise of cryptocurrencies. Had central banks not waged a war on cash and allowed their own currencies to earn interest at market rates, cryptos would not have been so interesting from an investment perspective.)

A state cryptocurrency could enable the state to control all transactions to a large extent if cash were to be simultaneously abolished, thus creating a state currency monopoly. If there were a state monopoly cryptocurrency, the state could for example

1. Introduce negative interest rates as desired.
2. Perform redistributions at the touch of a button.
3. Arbitrarily prohibit transactions for one group and/or allow them for another, etc.

 

Effects on the financial sector / banks

If a state cryptocurrency were introduced, the banking sector would probably come under pressure. It is conceivable that state planning authorities (which include central banks) would take on more and more of the roles of financial intermediaries.

Presumably, payment system providers would come under particularly strong pressure. If all payments had to be processed via a legal cryptocurrency, alternative payment systems would probably only be needed for foreign transactions.

Least affected within the financial sector would probably be insurance and reinsurance companies and asset managers.

In traditional corporate and mortgage lending, it is unclear how strong the future role of the state would be after the introduction of a state monopoly cryptocurrency. Presumably, the state would over time take on more and more of the tasks traditionally done by banks. But this trend has been evident since the Great Financial Crisis of 2007 and has accelerated since the start of the Covid pandemic in 2020.

 

Impact on productivity growth

Central planning authorities can never operate as efficiently as a market economy since decisions reflect the limited brain capacity of a few central planners. In contrast, a market economy can exploit the de-centralized knowledge of all. To the extent that tasks are taken away from private financial intermediaries and given to government and central bank planners, productivity growth will fall. It can be assumed that (even more than is currently the case with paper money), too little interest will be paid on a state cryptocurrency and that redistribution at the expense of savers and in favor of debtors (the state is the largest debtor) will be pursued even more unrestrainedly.

 

Part 1 can be found here

 

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Contact: Thomas Härter, CIO, Investment Office
Telephone: +41 58 680 60 44

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Disclaimer: Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no undertaking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information provided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other transaction. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.

Disclaimer: Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.

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