Double standards are like mosquitoes to me: after hearing their buzz for a while, I want nothing more than to shine a flashlight their way and swat them down mercilessly. One such double standard is the harsh way in which economists and commentators criticize Bitcoin technology, while at the same time taking for granted the financial system that they live under every day.
Yes, the value of Bitcoin and other cryptocurrencies is very volatile still, and the ecosystem that develops around them has been a Wild West so far. But in the six years of Bitcoin’s existence, the underlying technology—decentralized and open source in nature—has proven itself to be extremely robust and constantly evolving. Bad computer code is replaced over time by good code (or at least by a stable workaround), and likewise, bad companies are forced by the market to make way for better ones. Creative destruction rules the cloud.
The same things cannot be said about the fiat currency system. Banks and central banks are still running old cranky software, with systems that sometimes haven’t been updated since the 1960s. Vital parts of the service and technology is centralized and therefore frozen in time, in a spiderweb of ever-expanding bureaucratic rules. And bad banks don’t die; they are kept alive with “Bailout IVs” from the government, and they become zombie banks. In Fiat Land, it’s King Inertia who waves the scepter.
Fiat money itself is also increasingly fragile. According to a study of 775 fiat currencies, there is no historical record of any that have held their value:
“Twenty percent failed through hyperinflation, 21 were destroyed by war, 12 destroyed by independence, 24 were monetarily reformed, and 23 are still in circulation approaching one of the other outcomes...The average lifespan of a fiat currency is 27 years.”
The post gold standard U.S. dollar is no exception. Despite being 44 years of age, which makes it a true veteran of the fiat space, it has lost 97 of its value since inception.
And that is just touching the surface of the kind of problems the fiat system produces. As we’ll see in a moment, debt levels, certainly not a sign of economic health, are higher than ever before in history. Inflation is also on the rise in many nations—melting away people’s savings and pushing them into the arms of speculative money managers. And central banks around the world are preparing for bank holidays and bank defaults.
When a system is virtually frozen in time and changes only for the worse, it is fair to say that it is broken, and that it needs replacing. That is exactly the state of the financial system today.
Now, over to the nitty gritty. Let’s crunch some numbers to see how big the problems really are.
The Biggest Debt Crisis in History
In 2008 we saw a ferocious banking crisis, the worst since the crash of 1929. In response, central banks around the world, including those of the U.S., China, and Europe, printed unprecedented amounts of money to shore up the banking system, and governments wrote out bailout subsidies like never before.
In Europe, for example, governments committed 1.3 trillion euros to prevent the eurobanks from failing. This led to the 2011 sovereign debt crisis, which was was barely contained by the ECB. It scrambled to put together another 500 billion euro bailout program.
What have all these programs, with a combined value of at least $9 trillion, really achieved?
Well, since 2008, “leverage” in the system has dropped from 25:1 to 20:1. This means that for every $20 a bank owes to customers or other banks, it has $1 in hard cash in its own possession. To adequately convey the absurdity of these numbers, an average non-financial corporation in the emerging world (not known for prudent risk management) has a leverage ratio of less than 3:1. In other words, without a central bank as a backstop, most multi-national banks would have been long bankrupt.
Given the avalanche of bailouts and stimulus programs unleashed since the 2008 crisis, government debt in the developed world has now risen to a record level 111 of GDP.
With all this data, it should be no surprise that the BIS estimates the size of the total debt securities market at $100 trillion. That is about $40,000 for every person in the world who has a bank account.
The only way for countries to accumulate so much debt is for them to print money indefinitely, and to continuously drop interest rates. And indeed, interest rates are the lowest they have been since the Middle Ages.
From the 1700s onwards, leading western nations borrowed at rates between 3-7, whereas recently we saw a drop in interest rates down to below 1 in the U.S. The rates are a little above 1 now, but German 10-year bonds are trading with interest rates as low as 0.5. This trend is unprecedented in world history.
Governments, banks, and households borrowing from institutions that can create money out of thin air leads, of course, to inflation.
Illustrating this is an inflation world map that I made in May 2013:
Here is the updated January 2015 version:
Now, one could argue that this just shows the dollar’s strength rather than actual inflation, but consider that the U.S. dollar still is the world’s reserve currency, and the most important way for foreign central banks to defend the value of their currency is to buy back their own currency from whomever offers them U.S. dollars.
As was the case with many other collapsing currencies, the hyperinflation of the ruble in 1998 started when the Russian central bank had no more dollars with which to buy back its own currency.
That said, the long-term value of the U.S. dollar is highly questionable. Since the U.S. went off the gold standard in 1971, central banks have been increasingly diversifying their reserves, as shown below.
Whereas in the 1970s central banks had no problem with holding up to 65 in U.S. dollars, that amount has now declined to 40-45. That certainly doesn’t signal a vote of confidence in the greenback.
National central banks are also increasingly moving physical gold back within their own jurisdiction. We’ve seen both Germany and the Netherlands repatriate 120 tons each, as well as Poland, Venezuela, Ecuador, Mexico, Switzerland and others participating in the “gold repatriation movement.” It is no coincidence that this movement started in 2011 at the time of the sovereign debt crisis in Europe; governments are afraid of defaults, devaluations, and/or hyperinflation, and want to prepare for the launch of a new currency.
Take a moment to absorb how gargantuan the problems of the financial system have become.
Now consider this: central bankers often contradict each other and themselves, but one thing they unilaterally stand for is “stability.” The U.S. Federal Reserve, for example, says its goal is “a more stable monetary and financial system.” Its European counterpart, the ECB, has as its mission statement “to maintain price stability and to safeguard the value of the euro.”
Where is this “stability” central bankers keep talking about? How can we believe in a system that achieves exactly the opposite of that which its leaders proclaim?
Over the last 10 years, central banks have created new money to the tune of $14 trillion, and that amount is still growing. Just this week, the ECB announced that over the next 18 months it will pump another €1.1 trillion into the eurosystem.
Here is what Gideon Gono, Zimbabwean central banker and father of the $100 trillion bill, has to say about the newfangled post-2008 financial paradigm:
“I've been condemned by traditional economists who said that printing money is responsible for inflation. Out of the necessity to exist, to ensure my people survive, I had to find myself printing money. I found myself doing extraordinary things that aren't in the textbooks. Then the IMF asked the U.S. to please print money. I began to see the whole world now in a mode of practicing what they have been saying I should not. I decided that God had been on my side and had come to vindicate me.”
Gono is right: his example is being followed by every prestigious central bank in the world. And when journalists dare to mention the elephant in the room, they are scoffed at. In fact, this happened just this week, when ECB chairman Mario Draghi was asked whether his policy of money printing would lead to hyperinflation. He dryly responded that despite the massive stimulus programs, “Somehow this runaway inflation hasn't come yet”.
In 2008 it became clear that the emperor had no clothes. By now, it should be clear that his entire court is also threadless.
I will keep my opinion about what all these financial omens forebode for another time, but it should be clear by now that the fiat system is anything but stable.
In fact, the stability in our financial system only exists to the extent that people believe in it. It is a mirage much like Bernie Madoff’s “empire” was: as soon as enough people withdraw, it will come tumbling down.
A new crisis is brewing in the system, as has happened every 40 years since governments started monopolizing the industry of money and banking. But this time truly is different. For the first time in history, the people have access to a decentralized, open source and globally accessible backup financial system.
There may be some problems that arise when Bitcoin technology is scaled up for millions, and then hundreds of millions of users. No doubt there is angst and volatility ahead, and for all we know the Bitcoin network will fail and some other cryptocurrency will take over. But there is no way this ingenious technology is going back into the bottle.
We now have access to a protocol that allows for honest global banking with or without intermediaries. For those eager to divest from a financial system of falling cards, I highly recommend drawing from an alternative deck: the exciting world of cryptocurrencies.
 Since 1971, the dollar depreciated by 97 against gold, and by 83 against the consumer price index.
 http://www.bis.org/publ/qtrpdf/r_qt1409f.pdf, pp. 39.
 Measured by the Tier 1 / Total exposure ratio, see here: http://www.bis.org/publ/work471.pdf