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Crypto Voices @crypto_voices
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1/ Very pleased to share a summer project: a comprehensive, supply-side view of the base money supply across the globe. What is base money? Gold? Fiat? Bitcoin?? Have some charts to share…
2/ To begin, it's important to understand the universal accounting identity: Assets = Debt + Equity. Today, it's true that all fiat money is debt-based. But before exploring fiat money, let's look at asset-based money.
3/ Traditionally, commodity money has been asset-based, most notably gold. Gold is a true asset of the holder. If you own gold free and clear, it is your asset, and no one else's debt, no one else's liability.
4/ So back to the accounting identity, if you hold gold free and clear, it would be correct to say your personal balance sheet includes a 100% gold asset (matched by 100% personal equity), and *no one else* has a claim on that asset. What else is interesting about gold?
5/ As @saifedean @fernandoulrich & many sane economists point out, gold has unique characteristics that drive its demand as money. Most notably, its supply is extremely hard to produce. This is why gold is hard money. How hard? Here are the gold supply inflation rates since 1970.
6/ The compound annual inflation rate of the gold supply since 1970 is 1.77%. Not pictured, the compound annual inflation rate of gold since medieval times (1200s) is 0.76%. This is hard money.
7/ Since 1970, let's see how this looks from the supply-side. There were 2.5 billion ounces of gold above-ground in 1970. Today, 5.9 billion ounces. Hard money. However, since 1971, gold has been demonetized as money, and no central bank will redeem gold on demand, to anyone.
8/ Let's go back to fiat money. Central banks have a license, a monopoly, to print fiat money. Unlike gold, fiat money is weird. The money they print is *their* debt to the public. And they can meet this liability with a strange tool: the printing press.
9/ If you hold a dollar (Fed note), euro (ECB note), yuan (PBOC note), or yen (BOJ note), it is true, this is *your* asset. But what for? What if you took this note to the central bank in an effort to "redeem" it? What is the central bank obligated to do?
10/ Remember, the note is the central bank's liability. They have an obligation on this note. What would they give you in return? Answer: *another,* fresh banknote! What if the central bank doesn't have any fresh notes available? Answer: *they have a license to print more.*
11/ In this way, we can see that fiat money, central bank money, is different than gold. Unlike gold, which is your asset and no one else's debt; if you hold a fiat banknote, it is your personal asset, *but* it is also the central bank's debt.
12/ Now, question, can we pinpoint a fiat money supply that is "comparable" to gold's supply? You have likely heard of M1, M2, M3, maybe even M4 or L or the Divisia money supplies. Are these fiat money supplies comparable to gold's supply? No, they are not. Why?
13/ The reason is that all of the broad monetary aggregates (M1 and up) include *commercial bank liabilities.* Meaning? Those money supplies themselves are really only "claims" on money. Let's look at an example. A common "money" in M1 is demand deposits. What? Checking accounts.
14/ The checking account is very common. If you see "money" "in" your bank account on your screen, it is true, this is "close" to real money. But other banks do not actually "need" to accept your checks. A bank could, if it wanted to, actually deny payment from your check.
15/ Mostly this doesn't happen, & FDIC gives confidence to checking accounts acting as money, but this strays from our topic. Back on point, if you added all a bank's checking accounts together, does the bank have enough banknotes (dollars) in reserve, in case holders want cash?
16/ The answer is no. The bank doesn't reserve 100% of checkable deposits. It reserves less (sometimes much less) than 10% of what's on your computer screen, in cash (and central bank reserves - we will get to this). This is called fractional reserve banking.
17/ Now, this isn't an exercise on fractional reserve banking. Remember, the goal is to find a comparable money supply to gold's. M1 and above isn't good enough, because these supplies are "claims" on money, even though day-to-day checking accounts (M1) are "close" to true money.
18/ So what is a fiat money supply that is comparable to gold's supply? The answer is *base money.* This is also called the monetary base, reserve money, central bank money, outside money, or (most meaningfully) *high-powered money.* This typically includes two things...
19/ Those two things are cash (banknotes) and commercial bank reserves at the central bank. Remember how commercial banks only "reserve" less than 10% of outstanding claims? Those reserves are what I'm talking about here. Commercial bank reserves, redeemable at the central bank.
20/ Don't worry too much on the meaning of commercial bank reserves versus cash. The point is that the central bank has authority to create either, whenever it wants. In the fiat banking system, this is the "base layer" of money for all claims made by anyone, legally.
21/ This is why base money is comparable to gold's money supply. And where can we find it? Base money - that is all currency plus commercial bank reserves - is reported on central banks' balance sheets each month (remember, as a liability!).
22/ There is another reason why base money is a "good" figure, since it's a clear line item on central banks' balance sheets, and all the other Ms are aggregations of many banks and financial institutions' balance sheets (and thus much more opaque).
23/ So let's get to it. The following chart includes base money from 19 central banks and 37 countries, representing 81% of global GDP. All fiat units have been converted to US$, starting 1970. At that time, the global fiat money supply was about $80 billion. Now? $19 trillion.
24/ A note on this 37 nation / 81% of GDP figure. More than 50 nations use USD & EUR exclusively or pegged (backed), so it's unneeded to comb the balance sheets of all nations of the world. Nonetheless, more nations will be added to the "other fiat supply" category in the future.
25/ What can we make of this? Well, remember gold's supply increased 1.77% compounded since 1970. What about all the fiat units in the world put together? 11.63%. Compounded, annual inflation. This may not seem like a huge difference (it is), so let's dig into the compounding...
26/ Compound annual growth is an extremely important metric. It's "stronger" than a simple, annual rate (…). We can use this rate to understand investment returns, or long-term trends like population growth. We can also derive doubling time from this figure.
27/ For example, gold's 1.77% compounded rate means a doubling of supply every 40 years. Global fiat? 11.63% means a doubling of supply *every 6.3 years.* We can start to understand the differences between these monies.
28/ Now is about time to say something about "price inflation." But first, let's go ahead and show these global fiat base money compound inflation rates each year, as we did with gold…
29/ OK, so the chat thus far has been all about base money supply & its inflation rate, but what about "price inflation?" To be clear, it should be stressed, this analysis is not considering prices at all; rather, this is only about supply, and actual growth, of base money stock.
30/ Milton Friedman said, "Inflation is always and everywhere a monetary phenomenon." He meant *price* inflation (not graphed here) always and everywhere follows *money* inflation (painstakingly graphed here).
31/ I won't dither on the connection between "money supply inflation" and "general price inflation" in the global economy here, but ask yourself this, looking at these charts: do you think that overall prices actually only increase 1-2% per year, as central banks "target?"
32/ Finally on "price inflation" and at the very least, ceteris paribus (meaning no change in demand for money), a growing base money supply will always undermine that money's purchasing power.
33/ Note on previous chart: the "global" fiat unit base money inflation rate was calculated using a weighted factor of each base money supply (weighting respective US$ value during that period, and applying that factor to each fiat unit's actual inflation rate).
34/ Another note on previous chart: not all central bank balance sheets are available from 1970. For those that weren't, they didn't factor into that period. For example, US$ weight was 0.67 in 1970, and is only 0.19 today, as (among others), data on China only began in Dec-1999.
35/ Yet another note on previous chart: the compound annual rates were always calculated from *monthly* fiat unit growth, and compounded to annual (to the 12th exponent). This is necessary due to cases such as Brazil, which has had 6 different currencies since 1970 alone.
36/ Continuing last note, a simple annual "growth rate" of currency units since 1970 doesn't make sense for Brazil. So the *monthly* rate must be taken across time and compounded, ignoring those 6 months when the government reset (slashed zeroes) from the old currency.
37/ So we have gold's money supply, and we see why it's been hard money. We have fiat's base money supply, and we see why it's not nearly as hard as gold. No surprise many nations suffer from hyperinflation. Is there something else that can compare with these base money supplies?
38/ As a matter of fact, there is… #Bitcoin.
39/ Bitcoin is global base money. Bitcoin is hard money. If you own bitcoins on-chain, you own an asset that is also 100% your equity, and no one else's liability.
40/ Starting in only 2009, Bitcoin is now harder to produce than global fiat base money, based on two metrics:
1) Latest month's annualized supply increase was 4.15% (fiat's was 7.06%) ✅
2) Trailing twelve months' supply increase was 4.26% (fiat's was 5.54%) ✅
41/ Notice the phrase "supply increase" for Bitcoin, and not "inflation rate." This is a topic for another post, but Bitcoin's inflation is already "baked in." Everyone knows its max supply: 21 million coins. In fact, we can actually predict this rate of increase until 2140.
42/ Curious what that number is? From 2018 until 2140, the Bitcoin system will only "inflate" at a compounded rate of 0.16% per year. And "inflate" is not the best term. It's more like "issue coins"… because the total supply is already known by all... unlike fiat, or even gold!
43/ In strict issuance terms, then, from today on, Bitcoin is *already known* to be harder than fiat base money, and gold base money. There is only one supply metric, on an annual basis, that Bitcoin really has yet to "overcome" to be seen as harder than gold...
44/ That number is comparing bitcoin's *current* issuance rate to gold's *current* inflation rate. As shown, gold generally increases only 1.8% per year, so Bitcoin's current 4.2% compounded issuance rate is a bit more than 2x faster than gold… for now. See the following chart.
45/ As Bitcoin is mathematical money, adjusting its difficulty every 2 weeks, fixing its supply increase every 10 minutes, Bitcoin's system will continuously issue a lower rate of new coins, until it becomes "harder" than gold's annual supply increase, by the mid-2020s.
46/ It is true, Bitcoin's lifetime, compounded issuance rate still looks high (80%), due to its very fast supply increase in the first two years. But unlike fiat base money, or even gold, it is mathematically certain that Bitcoin's supply will never increase that fast again.
47/ Yes, the Bitcoin max supply is a function of distributed consensus, but from Bitcoin's illustrious, unyielding short history, each day adds more confidence in this money supply never changing. See the current supply curve here (monthly frequency, like the others).
48/ So what has been displayed here are three global base money supplies: fiat reserve money, gold, and bitcoin. Base money is the "transmission mechanism" of the global economy. Gold once was, fiat is now, and bitcoin very well could be in the future.
49/ Think of base money this way. You *can't* have "money" in:
Real estate (you just own real estate) ⛔️
Stocks (you just own stocks) ⛔️
Bonds (you just own bonds) ⛔️
These are all assets, indeed, and each have benefits, but also counterparty risk and varying liabilities.
50/ Think of base money this way. You absolutely have "money" when you hold:
A banknote (BUT, it is a liability of the central bank, hopefully they stead it well...) 😬
A gold coin (AND it is no one else's liability) ✅
A bitcoin (AND it is no one else's liability) ✅
51/ Base money is the thing that settles any and all outstanding liabilities. It is the ultimate asset of settlement.
52/ Few closing remarks (& charts). This isn't about "all or nothing" in money, or attempting to expose the current fiat money system as completely inept. There certainly is some value & efficiency in having a payment system based on claims to base money, i.e. checking accounts.
53/ There has been plenty of research done by @GeorgeSelgin, @lawrencehwhite1, @NickSzabo4 and others that a payment system based on claims can work fine, particularly when central banks aren't meddling around with a monopoly causing distortions, and the base money is gold.
54/ But we've also seen worse. Even with a top-down, degraded, dictatorial economy, the Soviet Union *still* beat the Americans to space (before going bankrupt 30 years later). This from an economy where the labor slogan was literally "they pretend to pay us; we pretend to work."
55/ The "unseen" is always at play, when unsound money is at play. Am certainly not saying the current payment system cannot allocate resources. The real questions are, how effectively is capital being allocated, under whose direction (and monopoly), and at what cost to society?
56/ On our podcast @crypto_voices, @fernandoulrich and I explore the varying nuances of Bitcoin as a base money contender, and we look forward to continuing this discussion with many of you.
57/ The penultimate graphic is a summary of all items. Maybe give it a glance over. 37 nations' base money supplies are included, as well as gold's money supply, as well as Bitcoin's money supply. It is, in my opinion, a supply-side summary of nearly all base money in the world.
58/ The exhibits will be up on in a few weeks and updated in the future. Fiat base money is sourced from central bank balance sheets, wonderful gold history from Nick Laird, and bitcoin from @blockchain and @CoinMarketCap.
59/ To be sure, today in 2018 the unit of account here must be (and is) in US$ for comparison. Notice the prices per bitcoin if the Bitcoin network "absorbs" the fiat money supply value, or gold's (or both). These are calculations *only* for general reference, not predictions.
60/ Nonetheless, if Bitcoin truly takes over as global base money, then an orderly (or disorderly) eventual exchange rate capture of at least $1 million per bitcoin (1 cent per satoshi) is not outside the realm of possibility.
61/ If we put these base money supplies together, you get the following. As a % of value, Bitcoin has a long way to go to truly compete as global base money. But to be sure, if Bitcoin does absorb gold and/or fiat money's value, then that will be the true #flippening.
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