Can Bitcoin Glitter Like Gold?

Writing in his research paper, A Bitcoin Standard: Lessons from the Gold Standard. Warren Weber takes historical lessons learned from countries on the Gold standard to envision how a Bitcoin standard might look if implemented as the foundation for monetary policy.

An empirical examination of countries' experience with the gold standard leads to the following conjectures about how the Bitcoin standard might perform:

1. In the long run, there would be moderate deflation that would increase over time until reaching a rate of deflation equal to the negative of the rate of growth of world output around 2026.

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

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

4. There would still be financial crises, because they can occur under any fractional reserve financial system.

While there are potential benefits from the price stability a Bitcoin standard would support. Weber highlights the challenges central banks would have manipulating interests rates as an economic management tool.

Under a Bitcoin standard, however, it will not be possible for a country to conduct an interest rate policy to affect domestic economic conditions. As (1) shows, it was the cost of engaging in gold arbitrage that allowed a country to set a bank rate that differed from those in other countries under the gold standard. Such arbitrage costs do not exist for the Bitcoin standard; that is, k = 0. The costs of arbitrage between the fiduciary currencies of any two central banks are essentially zero. The time cost of obtaining Bitcoin for fiduciary currency or fiduciary currency for Bitcoin would be extremely small, and because the ledger containing transactions history is open and transactions are recorded regardless of location, no shipping or insurance costs are involved. Thus, the spot exchange rates for all fiduciary currencies would be one-to-one, and monetary authorities would be unable to set interest rates different from those in other countries.

Monetary policies of countries would also tend to converge similar to what happened with the gold standard. As the scope for activist monetary policy declined.

Price levels of the various countries would be highly, but not perfectly, correlated, much as they were under the gold standard. My reasoning is that under the Bitcoin standard, just as under the gold standard, the money supplies of different countries would not necessarily move together, although the more tightly a group of countries are linked in terms of trade and finance, the more closely their money supplies would be linked.

Continuing Weber highlights how the mechanics of currency markets would change:

Under the Bitcoin standard, the exchange rates among the fiduciary currencies of various countries would be exchanged at par, because the cost of Bitcoin arbitrage is essentially zero.

While pushing back against the notion Bitcoin’s deflationary bias would limit economic growth.

Some might be concerned, using Phillips curve reasoning, that real growth would be extremely slow under the Bitcoin standard because of the deflation that would occur under it. The evidence from countries on the gold standard shows that this concern is to some extent unwarranted.

And eliminate financial crisis’s

There would be financial crises under the Bitcoin standard. Financial crises have occurred in all financial systems, whether commodity-backed or fiat, in which financial institutions have demand liabilities that are not matched by assets with the same maturity. The Bitcoin standard would exhibit such maturity mismatches. Of course, such crises can be mitigated to some extent by government deposit insurance, which under the Bitcoin standard could be provided by fiduciary currencies issued by central banks. However, deposit insurance provision would be limited, because the ability of governments to issue fiduciary currency is limited under the Bitcoin standard. And, historically, deposit insurance has not prevented financial crises.

Concluding by highlighting the inherent advantages Bitcoin backed monetary policies would possess.

A Bitcoin standard would have two major benefits over current fiat money standards. One is that there would be greater price-level predictability due to the known, deterministic rate at which new Bitcoins are created. A second is that the resources currently devoted to hedging against fluctuations in exchange rates would be freed up to be used in more productive ways.