Argentina’s Failed Peg
In the 1990s, the Argentine peso was pegged to the U.S. dollar. This meant that the Argentine government guaranteed that anyone could exchange one Argentine peso for one U.S. dollar. If you had 1,000 Argentine pesos in your bank account, you could walk into the bank and ask for US$1,000 and the teller would hand it over.
By 2001, the peg had become unsustainable and the government of Argentina abandoned it. As a result, the exchange rate went into freefall.
Imagine if you looked at your bank account and the value of your assets had gone down by 75 percent over the course of a year without you spending a dime. That’s effectively what happened to the citizens of Argentina in 2001.
In less than a year, the exchange rate went from 1:1 to 4:1. If you had $10,000 worth of pesos in your bank account in 2001, a year later you would have had only $2,500.
Attempts to withdraw U.S. dollars as the exchange rate plummeted were thwarted for most citizens because the run on the bank meant there were no U.S. dollars left to hand out.
I spent a year living with a retired woman in Córdoba in the 2000s who recounted to me the feeling of watching her retirement savings slashed by 75 percent as she slept on the street outside the bank, hoping to be able to withdraw it.
Though few of us who grew up in the developed world can relate, this story is not unique to Argentina in 2001.
The Debut of Paper Money
As Jack Weatherford details in his book, The History of Money, the story of fiat began in the 17th century, which marked the debut of paper money on the modern world scene. As long as this paper money was supported by some form of commodity money, like gold or silver, all seemed well. Carrying and holding paper seemed just as reliable, and far more convenient, than holding the actual precious metals that backed them.
Invariably, however, the government or bank in charge of printing the money issued more paper than it had metal to back it. Whether or not this was the “right” thing to do is a matter of debate, but once the devaluation process began, it inevitably spiraled, with more and more bills being issued at less and less value.
An analysis of fiat currencies in the 20th century found that there were 56 episodes of hyperinflation. Another study found that the average life expectancy for a fiat currency is 27 years: 20 percent failed through hyperinflation (37 currencies experience hyperinflation in the 20th century), 21 percent were destroyed by war, 12 percent were destroyed by independence, 24 percent were monetarily reformed, and only 23 percent are still in circulation.
Of those that remain in circulation, all have lost huge amounts of their original value as measured in commodity money like gold or silver. Founded in 1694, the British pound Sterling is the oldest fiat currency in existence. At the ripe old age of 325 years, it must be considered a highly successful fiat currency. Yet, the British pound was originally defined as 12 ounces of silver, so its worth today is about half of 1 percent of its original value.
The U.S. dollar was taken off of the gold standard in 1971 when it was 1/35th an ounce of gold. By 2011, it had already lost 97 percent of its value.
In his book, The Ascent of Money, historian Niall Ferguson relates that one of the main ways this seems to have happened is that rulers were forced to print money to finance wars. Once one ruler started doing this, it became a classic prisoner’s dilemma and others had to follow suit. It would be better for everyone if no one fired up the presses, but as soon as one ruler or government warmed them up, then everyone else had to keep up or they risked being conquered.
Part of the reason Germany lost World War I and suffered worse inflation of their currency than the Allies was because the German and Austrian bond market was much less developed than the French, English and American markets, which had access to far more capital. Unable to raise money through bond issuances, Germany was forced to print money faster than other powers to finance their war effort.
It’s also worth noting that in a democratic society, politicians are often unwilling to raise taxes or balance the budget because of the expected voter anger. For them, inflation and the devaluation of the currency are preferable because they constitute a hidden tax.
The consequences of poor decisions about monetary policy can take decades to show up, but politicians’ terms only last a few years — kicking the can down the road to finance their constituents and donors favorite projects is a time tested way to get elected.
When you make choices about your personal spending, you inevitably run into difficult decisions — you could take out a bigger mortgage and buy a bigger house but that would mean working an extra five years before you could retire, is that worth it? The ability to print money meant that politicians could, in effect, buy the bigger house for themselves or their constituents today and make someone else work an extra five years in the future to pay for it.
Bitcoin’s Case Against Fiat
Ultimately, all the reasons for devaluation boil down to mismatched incentives between the politicians or others in control of the monetary policy and the individuals holding the currency. Any time a system lets somebody change history with a keystroke, you have no choice but to trust that everyone who can make that keystroke will be both perfectly honest and perfectly competent. Alas, humanity, much less politicians, don’t have the best track record on either of those fronts.
When the Bitcoin network went live in January 2009, Satoshi embedded the headline of a story running that day in The London Times:
“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”
Though we can’t know for sure what was going through Satoshi’s mind(s) at the time, the most likely explanation is that Satoshi was commenting on the decisions being made in response to the 2008 global financial crisis by the small group in charge of global monetary policy. Though many people around the world were affected by these decisions, very few had any say in the matter.
Instead of impactful decisions about the monetary system, like a bailout or quantitative easing, depending on the perfect honesty and competency of a single individual or small group, Satoshi envisioned Bitcoin as a more robust monetary system, with a more distributed power structure that would make it impossible for a single individual or small group of individuals to act unilaterally.
Instead of impactful decisions about the monetary system like a bailout being reliant upon a single individual or small cabal, like the Chancellor of the Exchequer and Chairman of the Federal Reserve, Satoshi and the Bitcoin proponents that followed him, envision bitcoin as having a more distributed power structure, beyond the control of a single individual.
Viewed as money, bitcoin has many gold-like properties. We know exactly how many bitcoins will be created — 21 million — and the rate at which they will be created. Just as gold mining is limited by gold’s geological properties, the ability to change these variables in bitcoin is outside of the control of any one person or small group of individuals. This gives bitcoin a predictable stock-to-flow ratio. No single individual can decide to create twice as much bitcoin tomorrow, even if it is politically expedient.
However, bitcoin also as a few properties gold lacks. For one, it is easily divisible and transportable. Someone in Singapore can send 1/100th of a bitcoin to someone in Canada in less than an hour.
It is also extremely difficult to censor bitcoin transactions. If I have an internet connection and agree to pay the network’s fee, effectively nothing can stop me from sending bitcoin to anyone I want.
This doesn’t mean, of course, that bitcoin is not primarily a highly volatile tool of speculation today — it is — but it points to why many of those speculators are in the market. If central banks in any country fail to unwind their balance sheets gracefully and inflation sets in, savers will go looking for a safe place to store their wealth.
In this scenario, bitcoin, an easily divisible and transferable “digital gold,” may shine.