New Report Details Bitcoin’s Potential Threat to the Federal Reserve
The Congressional Research Service, aka “Congress’ Think Tank,” recently made public their report on Bitcoin, Bitcoin: Questions, Answers, and Analysis of Legal Issues. The fascinating report details in sparkling prose the history, uses, threats and regulatory implications of the world’s best-known cryptocurrency.The report’s most interesting part deals with the impact Bitcoin might have on the Federal Reserve. According to these experts, widespread adoption of Bitcoin could severely curtail the effectiveness of the Fed’s monetary policy.The report describes the Federal Reserve’s mission as aimed at achieving “stable prices, maximum employment, and financial market stability.” It’s impossible to know the counterfactual. But many are entirely unsatisfied with both the nation’s employment rate and the continuing financial crises which led to its most recent rise.For some of these people, Bitcoin is a personal escape hatch from wealth-destroying inflation. As the report dryly notes, “Some may find the removal of government from a monetary system attractive...Unlike the dollar, a Bitcoin is not legal tender nor is it backed by any government or any other legal entity, nor is its supply determined by a central bank. The supply of Bitcoins does not depend on the monetary policy of a virtual central bank.”However, as more people choose to escape inflationary monetary policy to cryptocurrency, the Fed becomes less and less able to easily artificially inflate the money supply.
At Bitcoin’s current scale of use, it is likely too small to significantly affect the Fed’s ability to conduct monetary policy. However, if the scale of use were to grow substantially larger, there could be reason for some concern.The main threats posed to the Fed by widespread Bitcoin use are Bitcoin substantially affecting how much money is in circulation and/or substantially reducing demand for dollars.Basically, if everyone is exchanging Bitcoins instead of dollars, dollars are just hanging out. The Fed would then need to tighten monetary policy to be able to have any impact on their value.
Also, a substantial decrease in the use of dollars would also tend to reduce the size of the Fed’s balance sheet and introduce another factor into its consideration of how to affect short-term interest rates (the instrument for implementing monetary policy). However, the Fed’s ability to conduct monetary policy rests on its ability to increase or decrease the reserves of the banking system through open market operations. So long as there is a sizable demand by banks for liquid dollar-denominated reserves, the Fed would likely continue to be able to influence interest rates and conduct monetary policy.There are many impediments to wide-enough adoption of Bitcoin to threaten US monetary policy. The two biggest ones, according to the report, are the fact that it’s not yet widely adopted, and its potential for deflation.But, if Bitcoin does get big enough to potentially threaten US monetary policy, or the Federal Reserve gets worried enough that it might, we may see a surge in regulation and selective law enforcement for Bitcoin businesses. New regulations and prosecutions will likely continue to be justified under the guise of preventing other crimes and protecting consumers.Hopefully, however, instead of the federal government checking Bitcoin, the very real possibility that people will leave the dollar en masse for Bitcoin will be an effective check on the federal government. We’ll see.