Cryptocurrencies, Helicopter Money and The Dangers of Hyperinflation
The biggest danger of the cryptocurrency bubble is not speculator losses but hyperinflation. As values of virtual currencies increase and they gain acceptance in commerce, the danger of hyperinflation that will damage economies worldwide is also increasing.
According to coinmarketcap.com there were 886 mineable currencies in circulation with a total capitalization of about 142.5 billion USD as of September 13, 2017 excluding bitcoin.
Current market cap of bitcoin (September 19, 2017) alone is about $63 billion. Market cap of bitcoin cash is about $8 billion. Ethereum comes next at about $25 billion.
Cryptocurrencies is a form of helicopter money
This is money created outside of the system through software. It is equivalent to helicopter money for those who are up to speed with the technology. Although mining bitcoins has become a lot more expensive, the rise in value with respect to established fiat currencies in an exponential fashion has provided high purchasing power to a lot of people that could not obtain it via traditional means of having a job, or starting and operating a business.
Helicopter money has the potential of igniting inflation and even hyperinflation under certain conditions. Although it seems that we are not close to that point, wider acceptance of cryptocurrencies in commerce could lead to a surge in inflation.
The potential of hyperinflation is real
If acceptance of cryptocurrencies for commercial transactions increases, there will be new money supply since no conversion to local currencies will be required. In practical terms, demand for goods will rise due to increased money supply in the form of cryptocurrencies. As a result, prices will also rise.
We are talking about new money here that is not controlled by central banks and there is virtually unlimited supply of it. At some point their impact may surpass that of quantitative easing. This could create inflationary pressures and eventually even lead to hyperinflation if there will be no move to contain this phenomenon of using the internet as a tool of money creation, i.e., a money printing machine that only central banks are supposed to possess.
In addition, a full scale adoption of cryptocurrencies with a simultaneous abolishment of the reserve currency status of the USD may create imbalances and mispricings in commodities but also in other markets. I do not believe the world has a mechanism in place to deal with a chaotic situation.
Central banks and regulators may react to protect economies from a rise in inflation and imbalances caused by this new unlimited virtual money supply. Although the increased demand may initially cause only higher prices, eventually inflation may grow out of control.
Is bitcoin currency?
In order to answer this question let us start with the Coinage Act of 1965, specifically Section 31 U.S.C. 5103, entitled “Legal tender:
United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues.
But according to U.S. Treasury,
There is, however, no Federal statute mandating that a private business, a person or an organization must accept currency or coins as for payment for goods and/or services. Private businesses are free to develop their own policies on whether or not to accept cash unless there is a State law which says otherwise.
As it turns out then, unless prohibited by law, private commerce can use bitcoin and cryptocurrencies for payment of goods and/or services. Therefore, in this respect cryptocurrencies are currencies but when it comes to paying taxes they are not. This dual status is possibly not sustainable. At some point payment for taxes in cryptocurrencies will have to be accepted and that will undermine the U.S. dollar. Usually, dual currency systems lead to black markets and unstable market conditions. Those who get paid in a weak currency desire to exchange it for a stronger currency as soon as they get it. This further creates upward pressure for the strong currency and serves as a positive feedback mechanism to drive it higher. It boils down to this: if cryptocurrencies gain wide acceptance, a process of replacing mainstream currencies must be put in place fast. Otherwise, authorities will make sure that they do not gain wide acceptance. But if this is done by the authorities, it usually creates backlash in a society that has lost trust in politicians and administrators. This task of undermining cryptocurrencies must be assumed by credible and influential agents.
The answer to the question is then that bitcoin and cryptocurrencies are partly currencies. This is both an advantage but also their disadvantage. The most probable move by regulators worldwide is to declare cryptocurrencies a form of securities, such as stocks. In this case their value will plunge because the expectation was that these virtual currencies will replace fiat currencies.
Technology is a new world with its own consciousness
I view cryptocurrencies as a move by technology to counter austerity and diminishing purchasing power from many years of failed central bank policies but an unbalanced stimulation of demand could have serious consequences.
Of course, we got to this point because of inability of the current system to maintain purchasing power without rising inflation. The result is that wealth concentration, inequality and poverty have increased significantly. But resorting to a global cryptocurrency shock will not solve these problems. Decentralization of money creation will not work without simultaneous decentralization of decision processes and resource allocation. In fact, just currency decentralization may increase inequality and wealth concentration.
I will just give an example of what I mean: protesters can gather in front of a central or commercial bank and voice their concerns. However, if the world is run by blockchain and bitcoin, no protests would be possible. In essence, the power of central banks is not abolished but surrendered to some virtual entity with no known address and none to be held accountable if something goes wrong. As far as I am concerned, this is not a good solution to economic and social problems. But others may have a different opinion.
If you have any questions or comments, happy to connect on Twitter: @mikeharrisNY
This article was originally published in Price Action Lab Blog
About the author: Michael Harris is a trader and best selling author. He is also the developer of the first commercial software for identifying parameter-less patterns in price action 17 years ago. In the last seven years he has worked on the development of DLPAL, a software program that can be used to identify short-term anomalies in market data for use with fixed and machine learning models. Click here for more.