Interest Rates and the Debt Economy
When we examine the difference between hard money (Bitcoin) and soft fiat money, it is immediately obvious that loaning out the former will have lower marginal returns than the latter. The opportunity cost of loaning out 1 bitcoin includes the appreciation/deflation rate (which I will not estimate) that you could earn by simply holding the bitcoin yourself. On the other hand, since fiat money constantly declines in value, you have every incentive to do something, anything with that money to at least cover the rate of inflation and avoid losses.
We see this exact dynamic play out in today’s economy. Dollars are so easy to come by, especially for banks and the well-connected, who are able to create new money risk-free, that they are able to set unnaturally low interest rates on loans. In the same vein, banks end up making more and riskier loans than they otherwise would if they feared bankruptcy. The end result: A bloated economy over-leveraged on careless investments. We saw one part of this bubble pop in 2008, when loans that shouldn’t have been made defaulted, triggering a credit crunch.
As a quick explainer, money creation occurs in the following ways: Banks make loans beyond their reserves (called pyramiding or fractional reserving). However, because of regulations imposed on them, banks must maintain certain reserve ratios. To fulfill these requirements, banks ask the central bank to sell them more bonds (called Open Market Operations). These bonds are usually overvalued, which allows banks to fulfill requirements without actually spending the money to acquire requisite collateral. In this way, banks, not the central bank, drives money creation, leaving the central bank to catch up by printing new bonds.
Under a Bitcoin standard, such loans and bond-printing would be strongly disincentivized as bank bailouts and Open-Market Operations woud be nearly impossible. Both of these operations require the artificial creation of new money, which is impossible on the Bitcoin protocol and other existing layers. There of course exists the possibility of banks releasing their own coins, backed or unbacked by bitcoin, and then pyramiding, but this scheme is unlikely to remain viable for several reasons. Holding bitcoin as a self-sovereign is far easier, safer, and has a higher ROI than with USD. For banks to compete with multisig solutions (see Casa Hodl), they will be forced to adopt transparent and prudent practices. Additionally, if there were ever a run on the issuing bank, its private currency would collapse, its bitcoin reserves would be drained, and it would be liquidated. A government unable to print money would hardly be able to fix their balance sheet.
So how would loans work?
Interest rates would soar. Possibly higher than under Volker. Depending on the deflation rate, people turn down potential interest in favor of the certain returns of holding. Many Keynesians fear this would cripple the economy and slow spending to a crawl. However, this betrays a misunderstanding of the nature of money. Money has very few uses other than obtaining goods and services. Bitcoin has none. It’s sole purpose is to store value and obtain stuff. Furthermore, “hoarding” is identical to self-investment and insurance against unforseen events. On the individual and macro level, high savings rates make for a more resilient, stable economy.
Dr. Guido Hülsmann, an Austrian economist, discusses this idea in terms of house ownership on Stephan Livera’s Podcast episode 51. He explains how families used to save up and buy houses with large down payments or all at once. In an era of easy money and inflationary prices, doing so is no longer rational. Instead, low down payments and large loans make sense because nominal incomes are likely to rise against a static debt. Today, everyone takes out a mortage to buy a house. While this may increase home ownership in the short term, it also buries many families in debt and results in frequent defaults.
Under a Bitcoin standard, we may still see mortgages, but not at current rates. Interest on mortgages would be significantly higher and default rates lower.
Loaning institutions themselves would likely shrink in size and multiply in number. This would allow the institutions to more carefully vet each debtor and service a local area, where they can more accurately set rates. Larger national banks would no longer have the upper hand because of connectivity or routing ability or access to money creation. Their largesse would become a hindrance on their ability to properly price loans. Similarly, institutions such as Fannie Mae, Freddie Mac, and the Federal Reserve, which today attempt to force different regions into one unitary market, would struggle to set a national rate. Data would be harder to aggregate and collect, but communities would receive more natural pricing on their loans.
