Blockchain epitomises the digital money revolution, but if governments utilise it to issue their own digital currencies, which stores of wealth will remain truly independent? Michael Howell, MD of Cross Border Capital, makes the case for gold
Monetary history is often sensational. It’s almost 50 years since US President Nixon dramatically halted the dollar’s convertibility into gold, effectively ending the post-World War II Bretton Woods fixed exchange-rate system but such monetary shocks keep coming: right now we are seeing not one but two currency revolutions at once.
Seemingly, as fast as the US dollar fades in attractiveness, the Chinese yuan muscles forwards to take its place; thereby threatening to displace the mighty greenback as the main transaction currency in Asia. One key barometer to closely watch is the progress of the new yuan-based Shanghai oil futures contract because it threatens to knock-away the fundamental support behind what we dub the “oil exchange standard”. This secret, clock-and-dagger deal, was engineered “sometime in July” 1974 by ex-Salomon Brothers partner Bill Simon and it essentially underpinned American finance for almost five decades by reinvesting soaring OPEC oil monies back into US dollars.
That convertibility is now under threat. As the dollar’s relevance wavers in Asia, the yuan is coming forward. Not only that: gold could soon become an alternative to the greenback. If you believe something big is already unfolding, just look at how much gold bullion Russia and China have recently acquired; perhaps they could reverse Nixon’s actions by pinning their currencies to their gold reserves?
The second revolution also matters. Light years faster than oil tankers bobbing back-and-forth, electronic settlement systems now flash payments around the world with such depth and precision that our traditional banks are threatened with dis-intermediation or even extinction. Blockchain’s transferable ledger and digital accounting and settlement systems are already a reality and are likely to scale massively over the coming years. Bitcoin, blockchain’s cryptocurrency surrogate, is widely seen as the pinnacle of this revolutionary change. This flux has forged a new narrative, asking “in who and what we should trust our savings, as the dollar wanes and electronic money becomes the new wealth medium?”
Will bitcoin prove a winner? It is certainty revolutionary but after a few firecrackers it is still likely to be snuffed-out as abruptly as a failed palace coup. Putting to one side for a moment all those valid doubts about its digital integrity and its unwholesome connections to crime, consider the economic arguments. Cryptocurrencies are linked to net payment surpluses in their respective blockchain networks, with new supply dependent upon some notional, but costly, ‘verification’ rule. Despite the utopian hopes that bitcoin might soon replace paper dollars and pounds with borderless bytes, the underlying transactions still need to be denominated in national currencies for tax and legal tender reasons – not least because modern governments are wholly dependent on tax revenues and fiat currencies. Put another way: bitcoin is not an official means of settlement. A further bulwark to acceptance is the fact that modern money is credit – so, can bitcoin even become a source of credit?
Un-blocking the supply chain
Understanding how the world’s credit system will look under blockchain is the key challenge. Because governments need to keep control of taxes and tender, they will move decisively to capture control through their central banks. In other words, we will soon all have deposit accounts denominated in e-sterling, e-dollars, etc facilitated by central banks such as the Bank of England and the US Federal Reserve. It is probable that these accounts, like current fiat money, will pay low to zero interest rates (although the Bank of England has worryingly also mooted a ‘negative’ interest rate scenario).
This means traditional high street banks, as we know them, may no longer be deposit-takers in the usual way. Excess funds lying in the central banks will be speedily scooped-up and recycled through wholesale markets, where they can be either re-lent or used to buy securities. In other words, a series of money-market funds could offer higher rates to depositors, and then, in turn, re-cycle these monies through specialist lenders operating in areas, like mortgages, student loans, car finance, etc.
Credit risk will become a dominant factor in our decisions because it is unlikely that the state will now need to guarantee high street bank deposits: a fact which currently allows the Barclays pound to exchange for the same as an HSBC pound. In short, blockchain will mean that commercial banks lose their special, gatekeeper, status in the financial system, thus ensuring that the coming financial revolution is also characterised by widespread disaggregation and fragmentation.
So, why gold? Money arises as a currency unit because it radically reduces the information required for transactions to just two facts: value and ownership. Admittedly, blockchain stores ownership information more efficiently, so making it a useful ‘back office’ function, but it does not address the value question, which still lies in the hands of governments. Governments will still be forced to pay their escalating exchequer bills with paper money, and the larger these, bills the more they will need to ‘print’. What’s more, in extremis, during, say, financial crises, central banks will be forced to print more in order to provide vital market liquidity.
Governments have spent millennia trying to demonetise gold in favour of their paper money and failed. They will succeed far more easily and quickly at demonetising bitcoin and the other cryptocurrencies, particularly if they start creating them by issuing e-pounds and e-dollars. Blockchain increases, not decreases, potential state control. Therefore, gold, not cryptocurrency, will remain the free market alternative to paper money.
The burden of governments is not how much they tax, but how much they spend. As various national governments print money to pay their bills at different rates, the supplies of paper money will fluctuate and, as before, exchange rates will adjust by devaluing against gold at varying rates. Bigger governments mean bigger bills and inevitably bigger slides in the values of paper money. In this monetary merry-go-round gold will shine assuredly, while bitcoin rusts away.
Michael Howell is the Managing director of CrossBorderCapital