A Brief History of the US Dollar
The other day, there was an hour long senate meeting featuring everyone’s favourite Bitcoin enthusiast, Nouriel Roubini.
Of course, he went into a long diatribe about how Bitcoin wasn’t backed by anything, about the myriad of scams with alt-coins and the Tether situation.
Basically, par for the course.
He has been saying the same thing since Bitcoin was $58 as seen by this tweet from 2013 — but of course, this time is the REAL collapse.
But this post isn’t about institutional economists and how they think the world should operate but instead I want to explore the history of money.
I’ll get to why this matters at the end of the post and why we are on a collision course for a globally decentralized form of money.
The Panic of 1907
The current incarnation of fiat currencies can be traced back to the founding of the Federal Reserve in 1913 with the Federal Reserve Act.
What most don’t know is that this was a direct response to The Panic of 1907 which was the first worldwide financial crisis of the 20th century.
On October 16, 1907 — F. Augustus Heinze and Charles W. Morse attempted to corner the stock of United Copper and suffered huge losses.
As word spread that a series of Trust companies had financed this venture, there was a run on these trust companies by depositors.
The lender of last resort at the time was the New York Clearing House which ended up guaranteeing the deposits.
However, a few days later — word spread that another trust company was in trouble — The Knickerbocker Trust and another run ensued.
This time the New York Clearing House would not extend credit as it was reserved for its member institutions, the national banks.
From here a full on panic erupted and $8M was withdrawn from Knickerbocker before they closed doors and the contagion spread.
A few days later with some quick work by J.P. Morgan, who solicited cash from financial & industrial institutions, the crisis was eventually averted.
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This event was significant because it led to a group called the National Monetary Commission who were in charge of seeking bank reforms.
Eventually, the titans of the banking industry met under cover of night at a secret location on Jekyll Island and devised the Federal Reserve Act.
This led to the creation of the Federal Reserve Bank, a private institution run by these financiers who are able to print the US tender you use today.
Executive Order 1602
So that’s how the Federal Reserve came to be but another crisis struck in 1933 which led to the president, Franklin Roosevelt into taking unprecedented measures.
Following the creation of the Federal Reserve, the powers that be were free to print as much paper money as they saw fit.
This led to the period know as “the roaring 20s” and a massive boom in the stock market which was built off cheap credit and infinite paper money.
A similar situation to today.
This all came to a head in 1929 when the economy became overburdened with debt payments on all the easy credit and the stock market crashed.
Suddenly overnight banks stopped lending, people stopped borrowing and the velocity of money in circulation slowed to a crawl.
Welcome the Great Depression.
At the time, treasury gold certificates allowed you to trade your notes for gold coin as shown in the image of a one thousand dollar note.
The rate was $20.67 per troy ounce but as the free-market price of gold started creeping up, it was clear there would be a run on gold
The problem was the US Government didn’t have close to enough gold in their coffers to cover the amount of free floating paper currency.
In fact, it is estimated that total US gold reserves were $3–4 Billion dollars (4,500 to 6,000 metric tons) while US total obligations from paper money were $90 billion (135,00 metric tons).
For context, all the gold in the world amounted to $11 billion or (16,500 metric tons). In effect, 8x more paper money than gold deposits available.
FDR admitted much the same himself during a national Fireside Chat on May 7th, 1933:
“Behind government currency we have, in addition to the promise to pay, a reserve of gold and a small reserve of silver, neither of them anything like the total amount of the currency.”
What followed was arguably one of the greatest thefts by a national government in modern history.
Executive Order 1602 was issued on April 5, 1933 “forbidding the hoarding of gold coin, gold bullion and gold certificates within the continental United States”.
It was punishable by $10,000 ($188,000 in 2018 dollars) and/or five to ten years in prison. An astronomical sum of money at the time.
So FDR confiscated the nations gold, re-priced to the dollar down by 59% and made an ounce of gold now worth $35.
Paper money wasn’t exchangeable for gold by citizens only by other national banks and people couldn’t even hold gold again until 1974.
Era of Free Floating Currencies
The government’s disdain for being controlled by the quantity of gold and their lust for an unpegged currency came to a head in 1971.
President Nixon took the world off a gold standard when the US announced they would no longer convert gold to US at a fixed rate.
The US dollar was free to float without the constraints of gold.
The French called the system “America’s exorbitant privilege” and American economist Barry Eichengreen described it succinctly:
“It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries had to pony up $100 of actual goods in order to obtain one”
See while the gold standard was imperfect, it controlled excesses of governments by tying them to something with a set inflation rate.
No matter how lucrative it is to mine more gold — supply rarely grows over 1–2% annually providing a natural inflation rate.
The Great Recession & Beyond
If you are under the age of 40, this is only monetary environment you have ever known but all this excess is coming to a head in your time.
Here’s a picture of the monetary base since the 2008 financial crisis:
Think of the monetary base as the amount of money the Fed has printed while the monetary supply is what we interact with in the economy.
Without getting into too much detail, banks are able to take this monetary base and grow it 10x with fractional reserve banking.
So when you see the monetary base grow so dramatically with quantitive easing know there are orders of magnitude more money in the actual economy.
Of course this explanation is simplistic as excess federal reserve funds has increased as banks are encouraged to hold funds with the Fed.
You can read more here.
The fact of the matter is we have significantly more funds in the economy, oodles of non-performing loans (car, student) and a looming trade war that may slow down trade and therefore the velocity of money.
Conditions similar to the 1920s where the economy was crushed by all the debt servicing obligations.
Gold vs Bitcoin
Getting back to Bitcoin.
Clearly, all this excess must come to a head at some point. Countries are already feeling the effects with rampant inflation in Venezuela, Turkey, Argentina to name a few.
This threatens to spill over into western countries leading to a global slowdown.
One option to fix the mess is to continue printing more money. This lever has been largely exhausted during the previous financial crisis.
Another option is to return to the Bretton Woods system and a gold standard that worked to keep countries in check but achieving consensus on this will be difficult.
China and Russia have already taken steps to realize this scenario with both countries increasing their gold reserves significantly over the past decade.
Side note: Gold is a poorer form of money than Bitcoin given it’s hard to move (non-portable), has poor divisibility, can be confiscated (as done by FDR) and reserves are impossible to verify (non-verifiable) thus allowing countries to pull the same fractional reserve scheme.
It is my belief that over time, while few nations will adopt Bitcoin as a sovereign reserve (most won’t), people will continue to opt-out of the traditional system.
As price stability of Bitcoin improves and on-ramps are provided by friendly countries like Malta — people will naturally migrate to a form of money that preserves their wealth.
Developers are taking steps to improve the security and privacy of people making this move both easier and harder for governments to police.
Final Thoughts
While difficult for most people who grew up only knowing USD hegemony, the truth is fiat currency domination is coming to an end.
Rampant printing of money, lack of trust between hostile nations, overburdened social systems and crippling debt will draw this era to a close.
Meanwhile, with less than 0.01% global user penetration, here is where Bitcoin is in in its lifecycle:
Currently, Bitcoin is being made into a store of value with ETFs, Bakkt and institutions angling to provide custody, fiat onramps and trading tools.
With poor fiat onramps into the eco-system along with harsh regulations, think of Bitcoin as an infinitely large reservoir fed at a trickle by a stream.
Wait until that stream turns into a river.
As Bitcoins stability increases towards an M1 currencies and it integrated more closely into the economy, the exodus from inferior forms of money will commence in earnest.
Hang on for the ride.
