From The Great Bullion Famine To Bitcoin

A Short History About Missing Money

Bitcoin is the modern tech variant of gold and silver, with the same problem of gold and silver. Not enough gold and silver during the Great Bullion Famine created economic devastation and hunger in dark age Europe while creating gold and silver riches in the Near East (Arabia, Silk Road) and Far East (India, China).

Similarly, Bitcoin would create a Bitcoin Famine, as the distribution of Bitcoin around the world is very unequal and thus not accessible to all economic actors equally. To solve this issue, credit money – I owe you – grew to importance during the Great Bullion Famine, leading to bankruptcy laws and economic booms and busts. The same booms and busts Bitcoin tries to prevent by being non-credit money. Can we ever learn from our monetary past?

Currency = Unit of Exchange Value (Price). Common units are US Dollar, Euro, Yen, Bitcoin

Money = Cash + Credit

Cash = Banknotes, Bitcoin token

Credit = I owe you

In 13th to 15th century, Europe was structed by series of famines and plagues. The dark age, as it become known in our history books. Portraited in movies as depressing period with foggy weather, lots of dirt and ill humans just surviving day to day life. Death a permanent constant of daily life. Mal nutrition paved the way of even greater horrors. Plagues, like the black death, wiped out whole areas of humans.

The tragedy of daily life was amplified by another great famine. No movie mentions it. It is all-encompassing and hidden in plain sight. It is like looking for the forest but only seeing trees. It caused trade to diminish and supply of goods and services to vanish. It is a major driver for miss-alignment of demand and supply and supply shortages everywhere.

The Great Bullion Famine

Bullion, especially silver coins, were the cash at the time. The day-to-day trade included silver and to a lesser extend gold. Silver was the unit to measure the price of goods and services. Silver was the measure to equalize demand and supply and to allocated resources across the economy efficiently.

The Silk Route, a trade route between Europe and China / India, was established in the 13th century. The trade route included Europe, Venice, Arabia, India and China and traded spices, silks, rare dyestuffs, pearls, and precious gems. The problem was Europe had only 2 goods, which the Chinese and Indians were really interested in: silver and gold.

What happened over the following decades was a drain of silver and gold out of Europe into India and China, creating fortunes in the trading nations, like Venice and Arabia. As the money drained out of Europe, less money was available for trading goods, thus money became highly deflationary. Hoarding of silver and gold occurred, trade was dampened and resource allocation in European economies became impaired. (A message to all gold and Bitcoin bugs: commodity money can have serious deflationary disadvantages!)

The discovery of (South) America and its vast amounts of silver and gold reserves (by robbing Indio’s and doing mining with salve labor) caused the restock of silver and gold in Europe thus revitalizing the European economies starting the conquest of the world.

In my opinion, the fear of the Great Bullion Famine is the origin of later European colonialism. Europe was fleeced, by its own free will, to trade all its silver and gold for silk and spices. Colonialism is a solution to secure important resources like silk and spices, becoming monopole supplier of necessary goods and charging monopole prices to colonies and trade partners, thus preventing the re-occurrence of the Great Bullion Famine. As a consequence, the colonies were depleted from any wealth and prohibit any economic development.

Centralized Monetary System

As we see above, having not enough money circulating in the economy is a very, very bad thing. It is as bad as having too much money circulating in the economy. Money is a tool to allow transactions (trade, financing, speculation, insurance) to happen. Balancing the supply and demand of money is not easy (keep money and supply of goods and services roughly constant) and even more difficult to execute.

If money is centralized, it is very tempting for the central actor (state, elites, special interests) to get benefits of newly money first at the costs of all others. That’s known as the Cantillon Effect. It describes how people close to the newly created money profit first from the newly create money, by being able to buy goods and services at pre-money-printed prices. Prime example is today’s states, their central banks and special interest groups (Wall Street).

Decentralized Digital Monetary System

Bitcoin is a decentralized digital monetary system. But it is not the first one. Decentralized money is actually centuries old. Decentralized electronic money was invented during the Morse telegraphy. The digitization of money came with the invention of the mainframe computer as a digital tool for the accounting ledger.

Our private and public banking system is a decentralized digital monetary system. Banks connect to other banks and form a complex global network. Within the network money, assets and liabilities are transacted digitally. No cash or gold gets shipped around physically. It has a decentralized network structure. No single entity controls the network. Even central banks control only parts of the network inside their country, not the total network as it is global and sitting in deregulated countries like Bermuda, Cayman Island and Channel Islands. The network is known as the Eurodollar system / offshore dollar system / global liquidity system.

Historically speaking banks were established along trade routes. When goods flow in one direction, money flows into the other. As trade grew, banking became more powerful and fulfilled more roles. Today banks are one of the strongest special interests in a state.

Banks have the privilege to take deposits. Namely, accept your money and take it as their own. Yes, you hear right, its not your money anymore. You have the right to get the amount back you paid in. But if your bank goes belly up, your money is gone!

To provide a basic safety net and prevent bank runs, the state guarantees deposits to some extent. This guarantee causes that a $100 deposit at Bank of America is equal to a $100 deposit at JP Morgan, thus money transfer between banks exchange one-to-one even if the risk of holding the cash at one bank versus the other can be dramatically different (visible during the Global Financial Crisis).

But how do banks create money? That’s the easy part. And you do not need to be a bank! No counterfeiting needed. You and me can be billionaires in an instant – through lending and credit. You do not believe, it’s really easy.

Let’s start with an example. We go to Starbucks and each one of us orders a $5 coffee, but I forgot my wallet. So, you pay for mine and I promise you to give the cash back next time we meet. We just expanded my balance sheet by $5. We expanded the balance sheet of the whole economy by $5! On my asset side I received a $5 coffee and on my liability side I owe you $5. And that’s how we create money, more specifically we created credit money (I owe you). When I pay you the $5 back, we eliminate the credit and reduce the balance sheet of the economy again. Thus, through credit we can expand / grew the economy.

Key is the ability to create credit when needed. Let’s say we have a new technological innovation like steam engine or electricity and an economy with an high ability to create credit, than new created credit (money) can finance the development and installation of the new technology in the real economy unlocking efficiencies gains and increased productivity. So, what drives the ability to create credit? Its assets you own (collateral), which secure the credit you receive. But first we need to understand more about banking.

Most of the money in an economy is credit. Your money on your bank account is credit. Only your money in your wallet is “real” cash money and the equivalent to a silver coin during the Great Bullion Famine, even through its just printed numbers on paper.

Similarly, a bank creates credit by enlarging your deposit (liability of the bank) and books your loan contract as an asset on their balance sheet. As both side of the bank balance sheet increase equally, the balance sheet is in equilibrium but expanded. A bank can exchange your deposit into cash. The bank sends your deposit to the central bank and get physical banknotes delivered, which you can take from an ATM.

The bank has the privilege is to hold deposits. It is a very special account, which connects credit money to cash, via the exchange of deposits for cash through central banks so that both exchange one-to-one.

Another driver of private credit expansion is so called shadow-banks. Shadow-banks are bank-like, but cannot hold deposits. They hold large amounts of assets, like money and securities. Examples for shadow-banks are asset managers, trusts, insurance companies and money-rich companies.

Shadow-banks use their assets to loan money to debtors or to buy bonds of corporations or countries. Investment securities themselves can be lent to other institutions to earn additional interest or provide collateral for loans. The core idea is, that shadow-banks create even more credit by taking collateral and loaning money and vice versa. As the collateral can be used again and again as collateral for more loans this enables the possibility to create massive amounts of credit. So called collateral chains, as long as 20 to 30 re-collateralizations (nobody knows the exact multiplier).

(It is no coincidence that double entry accounting was developed during the Great Bullion Famine in Venice. Silver and gold money was so scarce, that credit “money” was the workable alternative. It allowed to finance positive economic activities even if nobody had any silver and gold cash. As credit money expanded, bankruptcies became more common, thus bankruptcy laws became common in Europe during that time. Today’s credit-based banking and monetary system is a child of the Great Bullion Famine.)

Decentralized Monetary System, Collateral and the Global Financial Crisis

In 2008 the Global Financial Crisis (GFC) showed that a highly developed financial system is still risky.

The common sense is that, before the GFC loans were given to basically insolvent borrowers. The Fed increased interest rates to prevent rising inflation from a booming economy. As the interest increased, housing loans started failing to pay their loans. On the banking side, loans were packaged up into mortgage-backed securities (MBS) and collateralized debt obligations (CDO) and distributed around the world to banks, shadow-banks and investors. As nobody knew how safe their MBS package actually were and how (in)solvent the counterparties in trades were, the whole financial system started to distrust each other and markets started freezing up.

As there were effectively no operating financial markets anymore banks, shadow-banks, corporations and countries started to fail as no credit (or cash) was available to borrow, but still the debts needed to be paid (refinance became impossible). After Bear Stearns and Lehman Brothers gone bust, the regulators and central banks intervened, eased some regulation, started to flood banks and economy with money. This established trust, that debts could be repaid and refinanced.

Not well known is, that the MBSs and CDOs were used as collateral for loans thus the failing of MBSs and CDOs caused a failing of 20 to 30 times the amount of credit through the collateral chains!

Just imagine the size of 2008 housing bubble was about $1 Trillion which caused $20 to $30 Trillion of credit on fire globally. This credit is used everywhere in world from finance trade to building factories in China. And all of the credit became uncertain in nature, because the collateral used to secure the dept became uncertain to be paid back, unable to be sold on the market without incurring large losses.

To repeat the point. We speak about Global Financial Crisis then we imagine primarily the US housing bubble. But we should imagine the 20x to 30x bigger Collateral Shortage, which is to this day not solved. To this date the world has a dysfunctional financial system. To name a few crises and accidents since 2008: Icelandic Financial Crisis, Euro Crisis and PIGS Dept Crisis (Portugal, Italy, Greek, Spain), decade long zero and negative interest rate policies in US, Europe and Japan, Chinas growth deceleration, Repo Crisis in September 2019, 6 months before the March 2020 Corona Crisis and its massive Stimulus spending on even larger scale than the GFC.

Decentralized Collateralized Monetary System and Shortage of Safe Collateral

From the monetary system perspective, the GFC was a clear cut. There is a before GFC and an after GFC.

Before the GFC, the monetary system created money by loaning against “riskless” collateral. The GFC shocked the global financial system via risky collateral. After the GFC only selected collateral is seen as riskless and safe to lend against. A shortage of collateral causes a shortage of credit. This shortage of credit causes underinvestment into the real economy and risky future earnings.  This underinvestment causes depressed economic growth. And depressed growth, below potential growth, means we are in a depression since the GFC according to the National Bureau of Economic Research’s own definition. Sadly, only a few people point this out, like Jeff Snyder and Jim Rickards.

Money, cash and credit is like oil in an engine. If there is too little, it creates friction and energy losses. When there is not enough money in an economy, like during the Great Bullion Famine, transactions are depressed and prices are skewed. Thus, supply and demand are not balanced and resources are not allocated efficiently, causing all sorts of inefficiencies and depressed growth.

Finishing up this thought, The society overinvested into safe financial assets and underinvested into productive assets generating future earnings. Productive assets are riskier, but are the future! We sacrificed the risky future E (earnings of an asset) for the current safe P (price of an asset) in P/E ratio. The awaking will be tough, when society discovers that it did not invest enough into the future earnings E to keep its wealth measured in P.

Look at Japan. They are decades ahead. Decades of stagnation, low birth rates and a youth playing video games instead of creating a future. This will come here soon.

Solutions?

The Great Bullion Famine was overcome by the discovery of Americas and its silver and gold riches. Americas provided enough silver to pay for the resources from the far east and aggregated capital in Europe to finance economic development.

I have no easy solutions to offer but I have some ideas:

·       Emissions of safe collateral like US treasury securities, but will the state be a good capital allocator? Likely not! Will the USD weaken and take other currencies with it? Likely yes.

·       Commodity backed money for some time and then switch back to credit-based money? Commodity backed money seems to be preferred by Russia.

·       Bitcoin backed money? But Bitcoin is limited in quantity. When the economy is growing (more goods and services), how does Bitcoin supply adjust? How to deal with distribution of Bitcoin so that it is available to all economic actors and hording does not occur?

·       Some form of other crypto or NFT. How to create a trusted elastic crypto? Maybe create crypto / NFT easily by everyone like credit but make the balance sheet transparent to everyone, so that the liquidity / solvency of every actor is known to everyone in the network. As balance sheets of every actor is transparent to everyone else, exchange rates between actors will adjust to liquidity and solvency of actors.  How to handle failure and bankruptcies? How to deal with off balance sheet assets and liabilities?

·       Innovation of very dense energy sources and broad availability in the economy, causing massive productivity gains. Are these technologies there yet? Nuclear fission and fusion, battery technology, 3D printing, Software?

You see, I have many questions and no easy solution. Not as of now. Likely never. Just be aware, we are in a time, where money prefers today’s safety over future return. But there is no safety without a future.