At the beginning of the twentieth century the founding father of modern macroeconomics, John Maynard Keynes, proposed the creation of a supranational currency based on the value of 30 representative commodities for use in international trade transactions. At the time, the world proved ill prepared for the revelation and, after a considerable degree of righteous outrage, the proposed “Bancor” was unequivocally rejected. Seventy years later, it appears that the tides may have turned.
Presently, the USD serves as the world reserve currency – meaning that central banks all over the globe buy dollars as a means of settling international debt obligations and, importantly, influencing domestic exchange rates. According to non-Western politicians, the reserve status of the USD exacerbates global power imbalances and perpetuates the American hegemon. Economists maintain that this structure played a pivotal role in precipitating the global financial crisis of 2008 by contributing to egregious imbalances in global trade. In consequence, many advocate on behalf of either significantly diluting world FX reserves with other reliable currencies or pivoting away from the USD entirely in favour of a Keynes-style supranational alternative. Given that the former has no viable execution (as you will see below), the latter must be the answer.
In order to fully understand why FX reserve diversification is not feasible, it is first necessary to briefly examine the USD and the impact its global status has on the American economy. By purchasing dollars, export driven countries such as China and Japan devalue their own currencies and run large current account surpluses by implicitly subsidizing domestic production and taxing household consumption. In contrast, higher demand for the USD forces it to appreciate, thereby increasing relative household wealth in America while simultaneously undermining the competitiveness of its tradable sector, a combination that ultimately leads to a current account deficit. As the US tradable sector contracts and production falls, the only way to avoid skyrocketing unemployment is to boost domestic demand and push excess labour into the nontradable sector by racking up public or private debt. The latter, otherwise known as consumer financing, was a direct contributor to the 2000s real estate bubble and ensuing financial crisis. All in all, the reserve currency status of the dollar allows countries to accumulate unsustainable trade surpluses at the expense of a mounting trade deficit in the US.
It appears that foreign bulk buying of USD does no favours for the US economy (or any others) in the long run, so what can be done? In recent decades, when countries have attempted to substitute the purchase of USD with other currencies, issuing states of said currencies vehemently protested. For example, Latin American and Asian acquisitions of Japanese yen in 2011 was seen as an attempt to compromise the competitive edge of Japanese production through forced appreciation. In order to offset the effects, Japan heavily accelerated purchases of US bonds, effectively reversing any shift away from the USD. Categorical unwillingness of export-driven countries to shrink trade surpluses by allowing domestic currencies to appreciate renders swapping dollars for other currencies not only unfeasible but also likely to incite currency wars.
What is the alternative? Well, up until recently there was none. Cue Bitcoin. Invented in 2008 by Satoshi Nakamoto, Bitcoin is a decentralized virtual currency used in peer-to-peer transactions. Unregulated by a central authority, injections to the Bitcoin money supply are generated through a decreasing-supply algorithm, which approximates the rate at which commodities such as gold and silver are mined. As a result of this algorithm, Bitcoin is constricted by finite supply, a characteristic that can potentially serve as a catalyst to rebalancing global trade. In previous centuries, use of specie currency (gold and silver) contributed to an automatic rebalancing of global trade flow distortions since large current account deficits or surpluses could not be maintained – limited by shrinking gold and silver reserves of deficit countries. Bitcoin could provide an opportunity to revive this advantage while conducting international trade without sacrificing the benefits of domestic fiat currencies. Further, a gradual shift to Bitcoin would allow the USD to depreciate and American production to become more competitive, without directly revaluing other domestic currencies.
Can Bitcoin step-in as the high-tech version of the supranational currency Keynes envisioned so many decades ago? Maybe. Bitcoin is still a fledgling currency and its unusual nature makes it unpredictable. Bitcoin derives its value through speculation and demand. With no underlying monetary policy supporting the cryptocurrency, it becomes vulnerable to speculation shifts. What would a cryptocurrency version of a bank-run look like? If Bitcoin does not fall under central bank regulation – how will it be revitalized after a crash? What is the recovery time? Ostensibly some form of overarching system of governance will be required, which undoubtedly involves international cooperation and negotiation. All of these (and more) are significant challenges to the Bitcoin solution. It is, however, something to think about. Keynes was clearly ahead of his time in the 1940s, but maybe time has finally caught up.
Note: Inspired by the most insightful book on trade I’ve ever read, “The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy” by Michael Pettis.