HOW MARKET DEMAND FOR BITCOIN MIGHT BE AFFECTED BY FAILED MONETARY POLICY

Ljiljana Tatic
Nicosia, 13.07.2016.all-the-worlds-money-and-markets-dv

All of the World’s Money and Markets in One Visualization How much money exists in the world? Strangely enough, there are multiple answers to this question, and the amount of money that exists changes depending on how we define it. The more abstract definition of money we use, the higher the number is. In this data visualization of the world’s total money supply, we wanted to not only compare the different definitions of money, but to also show powerful context for this information. That’s why we’ve also added in recognizable benchmarks such as the wealth of the richest people in the world, the market capitalizations of the largest publicly-traded companies, the value of all stock markets, and the total of all global debt. The end result is a hierarchy of information that ranges from some of the smallest markets (Bitcoin = $5 billion, Silver above-ground stock = $14 billion) to the world’s largest markets (Derivatives on a notional contract basis = somewhere in the range of $630 trillion to $1.2 quadrillion). In between those benchmarks is the total of the world’s money, depending on how it is defined. This includes the global supply of all coinage and banknotes ($5 trillion), the above-ground gold supply ($7.8 trillion), the narrow money supply ($28.6 trillion), and the broad money supply ($80.9 trillion). All figures are in the equivalent of US dollars.

 

If all cash money will be replaced with crypto currency, and even if Central Bank lose its clearinghouse monopoly and bitcoin is spread everywhere, the CB can still exert itself over the economy because it issues the one special asset that defines the unit of account: reserves. Central Bank monetary policy can still exist in a world without central bank money.

While bitcoin could one day shut down most of the roles that the Central Bank plays, the monetary policy will most probably stay intact. The reason for this is that the no matter what happens to all its other functions, the Central Bank will continue to define the economy’s unit of account.

Small minorities of transactions are made with bitcoin so far. Most of these transactions are rarely priced in terms of bitcoin. Rather, a merchant’s website typically display prices in terms of dollars, and then compute the amount of bitcoin that a customer must fork over by referring to the current dollar-to- bitcoin exchange rate. The dollar is very much the unit of account in the US, not bitcoin. In Europe even less.

The first of the CB functions to be shut down by bitcoin will be the issuance of paper money (banknotes). Unwanted paper money will be returned to banks and then to the CB. From there, CB officials will cancel and destroy them, the CB’s balance sheet shrinking to a fraction of its previous level. Paper banknotes will be extinct, and the CB much smaller.

CB will still continue to issue reserves. CB not pays a pecuniary rate of return on reserves. In other words, it hasn’t offered interest. Banks have been pushed to hold barren reserves because in addition to their usefulness as payments media, the CB has provide its monopoly powers to keep their supply artificially scarce.

CB can alter the relative scarcity of reserves via open market operations. This in turn either increases or decreases the non-pecuniary return on reserves, or their marginal usefulness. If increased, the rush to buy reserves causes economy-wide fall in the price level. If decreased, a rise ensues. Thus even though bitcoin has rendered cash extinct, the CB’s power over the economy isn’t diminished one cent since prices continue to be priced in the Dollar, Euro or GBP, unit of account, and the Central Bank’s artificially scarce reserves are effectively the medium that defines the unit.

But, Bitcoin and other alt-coins become popular among banks as a way to settle payments among each other. These new electronic media are faster, safer, and far cheaper than the CB interbank alternative. Banks, their electronic vaults full of bitcoin, will no longer want to hold reserves and will lobbying the governor of

 

 

 

 

CB to buy them back with the assets the CB holds in its vaults. If its happen, the CB’s balance sheet will be set to contract to zero.

At that point Central Banks will have effectively lost its tight grip on the market for interbank settlement media. Reserves will neither be special nor scarce. Banks would hold a wide variety of assets as interbank media. The CB will become powerless. It would not be able do anything to control the price level. As for the media it once issued, both cash and reserves will lose their distinct characteristic as “money”. They will no longer be the most liquid assets in the economy, having been displaced by Bitcoin.

CB still has one other tool at its disposal to start to pay a pecuniary return, or interest, on reserves. By raising or lowering the interest rate it offers banks to hold more or less reserves at any given price level. Since the economy’s prices continue to be expressed in terms of the dollar, EUR, GBP, the Central Bank can now manipulate the economy-wide price-level by increasing or reducing interest on reserves. CB can will still get impact on the macro economy by changing rates.

The CB would only become truly powerless if economic actors choose to price their goods direct in terms of cryptocoin. At that point, CB reserves will have
lost all their traditional uniqueness and become just one fixed-income asset among a millions of fixed-income assets. The economy’s unit of account will be BTC, and the economy-wide price level will now be driven by demand and supply of bitcoin. But a switch in the unit is unlikely since the network effects generated by centuries of tradition are in the money’s favor. So far, bitcoin is just too volatile to be used for price expression.

The Central Bank needn’t worry about its monetary policy could become affected by bitcoin market demand.

Ljiljana Tatic

Nicosia, 13.07.2016.

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