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Hedging the End of Fiat

The Daily Knight

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This article looks at what is likely to emerge as a replacement currency system, and concludes that from practical and legal aspects, bitcoin and the entire cryptocurrency industry will fail with fiat, while mankind will return to gold, as it has always done in the past when state control over currency fails.

It is slowly coming clear that the fiat dollar’s hegemony is drawing to a close. That’s what the BRICS summit in Johannesburg is all about — rats, if you like, deserting the dollar’s ship. With the dollar’s backing being no more than a precarious faith in it, it is bound to be sold down by foreign holders. Being only fiat, it could even become valueless, threatening to take down the other western alliance fiat currencies as well.

How do you protect your paper wealth from this outcome? Some swear by bitcoin and others by gold.

This article looks at what is likely to emerge as a replacement currency system, and concludes that from practical and legal aspects, bitcoin and the entire cryptocurrency industry will fail with fiat, while mankind will return to gold, as it has always done in the past when state control over currency fails.


It is gradually dawning on market participants that the era of fiat currencies is drawing to a close. Monetarists, who first warned us of the inflationary consequences of the expansion of money and credit were also the first to warn us that the slowdown in monetary expansion would lead to recession, and since then we have seen broad money statistics flatline, with bank lending beginning to contract. This is interpreted by macroeconomists as the end of inflation, and the return to lower interest rates to stave off recession.

Unfortunately, this black-and-white interpretation of either inflation or recession but never both has been challenged by bond yields around the world which are rising to new highs. And the charts tell us that they are likely to go considerably higher. Consequently, conviction that inflation of producer and consumer prices will prove to be a temporary phenomenon is infected with doubt.

For those of us steeped in free market economics and with experience of the monetary and economic scene in the 1970s, the possibility of both inflation and recession occurring at the same time is less of a surprise. They called it stagflation, though the Keynesians never managed to reconcile the existence of the two conditions being present at the same time. The error, surely, is in Keynes’s denial of Say’s law, which postulates that we produce to consume. The Keynesian error was to ignore the plain fact that rising unemployment is the consequence of falling production first, so there can never be a general glut of goods in a slump which is the basis of Keynesian assumptions.

Consequently, we should concede that a return to stagflation, or worse, is eminently possible. And that rising bond yields from here are also possible, indeed even likely as the charts so clearly indicate. In the coming weeks and months as bond yields continue to rise dragging interest rates up behind them, the debate as to how to hedge this unexpected condition is bound to intensify. In one corner, we have gold, and in the other cryptocurrencies, headed by bitcoin. Both have their vocal enthusiasts.

But enthusiasm is not a sensible basis for an investment or trading strategy. It misleads investors and those seeking to protect their wealth from the debasement of currencies, which is what continuing and rising inflation of prices represents.

Sentiment driven investment tends to overlook important facts. In this article, I compare the relevant facts from very basic legal and monetary standpoints, first for cryptocurrencies represented by bitcoin and then for gold.

Bitcoin as practical money

Bitcoin and crypto currency fans argue that they are the future money. Bitcoin in particular is seen as incorruptible, secured, and self-audited on a blockchain. It is strictly limited to its hard cap of 21 million coins. It is this limitation which has led to estimates of its future value in fiat currency, depending on how much more fiat currency debasement a forecaster expects. And it can be convincingly argued that the fiat currency debasement rate is likely to accelerate further as stagflation returns, leading to ever greater government deficits and escalating increases in government debt. This might be expected to lead to a resurgence in interest in bitcoin, taking it to new highs.

Enthusiasts argue that bitcoin will increasingly replace fiat as the general public begins to realise that fiat currencies are losing purchasing power, which is why the general level of prices is rising. But we must make a distinction between using a currency, crypto or otherwise for day-to-day transactions and as a store of value. In the former case, the possession of currency resulting from the sale of something is temporary, so its changing value in terms of goods over time is of little interest to the seller of goods who receives it in payment. But it does matter to the saver with a longer time horizon.

Saving, or more correctly hoarding in the case of bitcoin, is the issue which we must address. To a saver an increasing purchasing power for currency units in which his savings are denominated is desirable. Therefore, it is likely that savers will hoard their bitcoin instead of letting them circulate because the hard stop on their quantity would be expected to continually increase its value. So powerful is this deflationary tendency likely to be that other than for bare essentials, all commerce, currently depending on credit, would grind to a halt. Taken to its logical conclusion, the world would simply regress to a feudal state with mass poverty.

The solution can only be for holders of bitcoin to lend their bitcoin to borrowers so that commercial activities could take place. This is credit and is the basis of all banking and all economic progress. The need for credit will not go away with the end of fiat currencies, nor will its counterpart, debt. Indeed, the possession of debt obligations is wealth and makes up the majority of it. I shall go into this topic later in this article. But for now, let us consider the difference between bitcoin and bitcoin credit.

In order to produce anything, capital is required. It is a simple fact that production precedes consumption. It can take years for factories to be built, and people with the relevant skills trained and employed. Most if not all of this funding requires credit. It entails a business plan to take all cost factors including the cost of funding into account in order to estimate a project’s viability.

When assembling a business plan, not only does an entrepreneur have to estimate all the input costs and the product’s final sales value, but he has to estimate the cost of repaying borrowed capital. But presumably, a hard stop of 21 million bitcoins will lead to higher bitcoin costs of future capital repayments. Uncertainty as to what bitcoin’s future value would be will likely scupper most projects, even before the difficulty of predicting future demand for goods priced in rising and volatile bitcoin. Bitcoin’s limitations would almost certainly lead to an intensely deflationary outlook, because it is simply not suited as a basis for valuing credit.

In this respect, bitcoin is fundamentally different from gold, the extraction of which in the long term has grown roughly in step with the world’s population. Furthermore, there are substantial reserves of above ground gold in the form of jewellery, which can be reallocated to monetary functions if markets demand its change of use. The flaw in the bitcoin as money argument is gold’s strength: its unsuitability to act as backing for credit, and its total inflexibility of supply.

I am not aware that anyone in the bitcoin camp has properly addressed these issues or is even aware of them. It appears that hodlers do not understand how dependent humanity is on credit. Instead, they tend to dismiss credit as being the problem. Nor is there any understanding of the relationship between money and credit in a functioning, stable economy. The very conditions which are supposed to give bitcoin its value as incorruptible currency are enough to render it entirely unsuited to act in that capacity.

The dismissal of credit is even before we are asked to swallow the fact that it is wholly inappropriate for the vast majority of users who are not tech savvy enough to even understand it. A currency must be simple enough to be understood by its users. The promotion of bitcoin and other cryptocurrencies is the dream of an elite of technological literates and speculators hitching a ride on its concepts.

Then there is the legal position. In the absence of specific legislation passed to give bitcoin or any other cryptocurrency the legal status enjoyed by gold it does not have the legal status required. Hodlers do not appreciate that legally only certain things can act as money.

In order to understand the distinction between what can pass as money and what cannot, we must define the difference between the right of possession and the right of property. If I lend a book to a friend, I allow him to have a right of possession for a period of time, but it still remains my property. The property in the book has not been transferred to him. If I went to his house to collect the book, and he was not at home, I would be free to recover the book if I saw it (though out of politeness I should let him know that I’ve recovered my property). This in Roman law was referred to as a commodatum, which is defined as “a gratuitous loan of movable property to be used and returned by the borrower”.

Money and credit are treated differently, along with consumable items, such as food and drink. When these are loaned, the property in them transfers absolutely, in return for which an obligation by the receiver is created to restore the equivalent of similar quality and quantity. To continue on from the example of the commodatum, if instead of a book I had loaned my friend $100, and going to his home to recover his obligation to me I found he was away but saw his wallet left behind, and I took $100 from it, I would be guilty of theft.

In Roman law, the loan of money, credit, and items to be consumed is a mutuum, which is defined as “a loan of a fungible thing to be restored by a similar thing of the same kind, quality and quantity”.

While in the English language the use of the terms lend and loan are ambiguous, the difference between commodatum and mutuum is still clearly recognised by us all to this day, as the examples of the different treatment of a loaned book and $100 illustrate. The same conditions apply with respect to criminal theft. If a thief steals your car and sells it on to an unsuspecting buyer, it remains your property and you are fully entitled to recover it without compensating the hapless buyer. But if a thief steals your wallet, or empties your bank account, you only have recourse against the thief and your property in the money or credit is lost.

In this legal context, the question arising is in the treatment of fully identifiable bitcoins, whose possession is recorded on a blockchain. Clearly, if someone sells you a bitcoin in return for currency you receive it as entering into your possession. But if the bitcoin had previously been stolen, say from a crypto wallet, it was nobody’s to sell and it almost certainly remains the possession of the person it was stolen from. The point is that while each bitcoin, or fraction of a bitcoin has the same value as another, the blockchain means that each bitcoin or part of it has a specific identity. Therefore, it is not fungible like banknotes or credit, nor is it consumed and so it almost certainly cannot be a mutuum. The precedents in law therefore point to the property in it having not been transferred if in the past it was the proceeds of crime, so it must be regarded as a commodatum.

This is a significant problem for bitcoin, which has become the money laundering medium of choice for criminals and tax evaders. While in Roman times, criminality was more basic, today governments have extended it to include mere suspicion as grounds for property confiscation. Software allows investigators to link bitcoin wallets with real world identities, which are easily available to the authorities from crypto exchanges. Companies such as Chainalysis have been working with the FBI successfully to identify wallets linked with criminal activity. The trail from these wallets clearly leads to those who subsequently bought bitcoin and are under the impression they are now their property.

Therefore, you cannot be sure that the bitcoin you have bought through an exchange will not be seized by the authorities on the grounds that a previous owner acquired it through the proceeds of crime. You cannot be certain you have clear title. On legal grounds alone, without the certainty of ownership bitcoin cannot act as a general medium of exchange.

Why credit matters

In discussing the practicality of bitcoin as money, its unsuitability as a medium from which credit takes its value has been mentioned, and that enthusiasts appear to have overlooked this vital function. Indeed, the creation of bank credit is seen by many in both gold and bitcoin camps as evil and therefore they say that one of the key benefits of bitcoin is it does away with the creators of credit. Those following this line of reasoning fail to understand that all money and obligations to pay are in fact credit, representing the temporary storage of unspent production. Because all of our consumption has its origin in production, the medium of exchange is a matter of intermediation.

There are two distinct forms of this credit, one in which there is no counterparty, and it is only in the form of gold, silver, or copper coined for convenience. It cannot be anything else if we rule out barter. The proper term for coin is money, to distinguish it from promises to pay in money at a future date, which is credit.

As a right to future payment, credit is always matched by an obligation on the part of the debtor. Ultimately, that right and corresponding obligation are to be settled in money — though in practice, today they are novated by way of settlement into other credit. It is not the transfer of money, but nevertheless credit is a form of property. That credit is property and has value in terms of goods and services arises from its transferability. This is apparent in valuations of financial assets, which together with the possession of the property in physical objects make up a person’s wealth.

In any economy which has progressed beyond a feudal state, it is credit which makes up the vast bulk, if not all of the circulating medium. And the more perfected the economic system becomes the less money circulates. It is simply more convenient to use credit, whether it be bank notes, bank deposits, or individual credit agreements, such as exist between families and friends.

Legally, money has a general and permanent value, while credit has a particular and precarious value. The problem we have today is that these distinctions between money and credit are poorly understood. Those who profess to support “sound money” rarely appreciate this vital distinction, routinely stating that sound money is a policy and not a definition. Accordingly, they incorrectly assume that bank notes issued by a central bank is money when it is in fact credit with counterparty risk, whose value in terms of goods and services can become subverted.

This leads us into the topic of how credit is valued. All credit, including bank notes issued by government authority, must take its value from something. But without being a credible substitute for what the Romans originally defined as money the value of credit obligations becomes inherently unstable. Furthermore, abandonment of credit’s attachment to money encourages a government to spend beyond its tax revenues by debasing the currency, and that is what is happening today at an increasing rate. It is not credit, which is the evil, but its