– September 5, 2017

A monetary standard based on Bitcoin, a digital currency, would act something like the gold standard in making price levels more predictable and stabilizing exchange rates but would likely be undone by politicians and central bankers, according to a 2016 paper written for Canada’s central bank.

There would be no arbitrage costs for international transactions under a Bitcoin standard, wrote Warren Weber, a research consultant for the Bank of Canada who has connections to the Federal Reserve Bank of Atlanta and the University of South Carolina. Countries could not maintain independent interest-rate policies under the Bitcoin standard, he said.

Based upon what occurred under the classical gold standard, which lasted between 1880 and the Federal Reserve’s creation in 1913, there would be “mild” deflation and constant exchange rates under the Bitcoin standard. Central banks would still have some ability to act as lenders of last resort, Weber wrote in the paper.

The classical gold standard set off “the first great age of globalization,” Nathan Lewis wrote in a 2013 article on Forbes.com. “With all countries basically using the same currency — gold as the standard of value — and also with legal and regulatory foundations normalized by European imperial governance, international trade and investment was easy,” he said, calling the gold standard of that period “the most perfect one ever created.”

World War I, which began in 1914, was the major catalyst for ending the classical gold standard, with countries wanting to inflate their currencies to cover war debts.

Faulty notions held by today’s big-government economists keep the gold standard a thing of the past, Lewis said. “Once we finally abandon these funny-money notions — probably because of their catastrophic failure — it will be very easy to create, once again, a superlative world gold standard system,” he wrote.

Weber’s paper, titled “A Bitcoin Standard: Lessons from the Gold Standard,” is described as a “thought experiment” by the author. He acknowledges “skepticism” about how the standard could be adopted by even one country.

The paper, which supposes that a volatile currency makes for a less viable monetary standard, cites fluctuations in the price of Bitcoin relative to the U.S. dollar since Bitcoin came into existence eight years ago. In 2013, the value of Bitcoin ranged from $13 to $1,150, Weber notes. More recently, the price of Bitcoin rose from $954.71 on Dec. 28, 2016 to $4,195.34 on Aug. 17 of this year, an increase of 339 percent.

The reasons a Bitcoin standard wouldn’t last long involve technology and feelings of impotence among government-appointed central bankers. “The payments world is changing so rapidly that there would be a technological innovation that provides a potential medium of exchange with the same or greater benefits than Bitcoin or with lower costs,” Weber wrote. Bitcoin is among about 700 cryptocurrencies in existence today.

As for central bankers, “there would be pressure to return to a fiat money system so that a more activist monetary policy could be pursued.” This would be especially true since “the scope of monetary policy would be more limited under the Bitcoin standard than under the gold standard.”

Calls to modify a non-fiat standard come from additional quarters, with businesspeople among those displeased by commodity price declines and interest-rate increases, wrote Ludwig von Mises in his classic treatise “The Theory of Money and Credit.” Using actual gold as money, even more than an exchange arrangement such as the gold standard, would impose “considerable” costs on individual nations but do the most to prevent value erosion, he wrote.

“If people are accustomed to use actual gold in their daily affairs they will resist an inflationary policy more strongly than the peoples of Europe did in 1914,” Mises wrote in the 1953 edition of the book. “It will not be so easy for governments to disavow the reactions of war on the monetary system; they will be obligated to justify their policy.”

The U.S. dollar has been considered a fiat currency since 1971, when President Nixon eliminated gold convertibility, severing the last link to gold established at Bretton Woods 27 years earlier. The value of the dollar has diminished since that time. What $1.00 could buy in January 1972 now requires $5.96 to purchase, according to the CPI Inflation Calculator.

The U.S. government likes having an activist central bank to monetize its debt, thus enabling it to fund many more programs than it would otherwise. The Federal Reserve in effect prints money by buying U.S. government securities such as Treasury notes. The Fed’s balance sheet ballooned through such purchases in the wake of the 2008 financial crisis, a phenomenon known as quantitative easing, and now stands at about $4.5 trillion.

A Bitcoin standard is like the gold standard in that changes in the money supply are not under the control of any central bank or other monetary authority, Weber noted. Bitcoin has its supply set deterministically by the algorithm that governs how many new Bitcoins “miners” receive for verifying Bitcoin transactions and adding them to the blockchain ledger.

An empirical study of the gold standard led Weber to make predictions in the following areas:

Deflation: it would increase over time until reaching a rate equal to the inverse of the rate of growth of world output around 2026.

Prices: price levels of the various countries would be highly, but not perfectly, correlated, much as they were under the gold standard.

Exchange rates: among the fiduciary currencies of various countries, the rates would be fixed at par because the cost of Bitcoin arbitrage is essentially zero.

Financial crisis: crises would not be eliminated, since they can occur under any fractional reserve system.

Sounds intriguing. In a better world, political leaders and economists would be looking for ways to bring Weber’s thought experiment out of the world of dreams.

James Mosher


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