Bitcoin scenarios

In TBSRB1, we discussed the possibility of Bitcoin being adopted by modern central banks. In TBSRB2, we discussed three different scenarios for Bitcoin monetization. In this month's TBSRB5, I will outline what I view as the two worst case scenarios for Bitcoin, where it fails and collapses. In total, this will give us six potential scenarios for how bitcoin's development could happen, which can be arranged in order of decreasing favorability for bitcoin as 

Possible scenarios for Bitcoin:


1. Central bank adoption

In this scenario, global central banks decide to start using bitcoin as a reserve asset to settle trade between one another and back their local currencies. The political independence of international settlement and the hardness of the monetary asset would give countries who use bitcoin as a reserve asset an advantage over countries that haven't. As the price rises, more central banks will want to join. It is conceivable that in this sort of scenario, bitcoin, as the hardest money invented, would win the global monetary race as decisively as gold had won it in the nineteenth century.

But as discussed in more detail in TBSRB1, I do not find this scenario compelling, primarily because: 

the mental models governing the people in power in governments and central banks all over the world, the self-interest of these elites which lies in maintaining inflationary money at home, and the threat of US military and economic power against any defections from the dollar standard all lead me to be highly skeptical of the possibility that central banks will adopt Bitcoin any time soon.


2. Hyperinflation

My impression is that a majority of bitcoiners imag ine that bitcoin's rise must be accompanied by hy perinflationary collapse of government money. In TBSRB2, I offer a detailed explanation of why I think this is far from certain.

The key is to remember that the process of money creation in the current monetary system is driven by lending and credit creation, whether in the narrow banking system or the shadow banking system.

With artificially manipulated interest rates, it becomes harder and harder for people to save for the future, and thus more likely that they get into debt. Fractional reserve based credit creation does not just increase the money supply, the flip side of this coin is that money supply increases and lower interest rates drive demand for more credit creation.

When the value of money is constantly dropping, and interest rates are artificially low, people will move from saving to borrowing. But when a new and completely decentralized, depoliticized, and automated hard money enters into the economic calculations of the individual today, that individual's relationship with credit is likely to change. With the presence of a hard money that can appreciate in value over time, people's need for credit will likely decline. As those who move to Bitcoin witness its value appreciate, they find themselves able to pay off their debts sooner.
As they become debt free with hard savings that nobody can inflate, they're likely to start living off of their savings and accumulating more, rather than continuing to borrow and pay interest.

As more people pay off their loans and fewer people demand new loans, the financial system's credit creation is contracted significantly, and as a result, the growth in the supply of money slows down, or possibly even reverses into a shrinking supply.

The availability of bitcoin as a hard store of value will seriously undermine the value proposition of going into debt that keeps the current monetary system able to create money. It is true that demand for government money would be reduced as people move to bitcoin, but the flipside of this process is that supply is also reduced, rather than expanded, as the appreciation in bitcoin's value makes individuals less likely to demand credit.


3. Smooth upgrade

As discussed in TBSRB2, the calamity that was government-run money allowed for the monetization of debt. As discussed in The Bitcoin Standard, anything which can be used as money will offer a large incentive for people to produce more of it, and debt is no exception. As debt became a form of money, anyone who could produce monetizable debt was able to practically print money. Banks and governments, and their central banking bastard children, are the only entities legally allowed to create money through the creation of debt, and they have inflated the supply of their money enormously by plastering the entire planet with debt. Bitcoin is a neat technological solution to this problem because it introduces a superior monetary asset that cannot be stopped by government. Bitcoin getting monetized means more and more people will choose to hold it rather than government money, and more importantly, perhaps, that fewer people will want to take on government debt, and thus, less government money will be created.


4. Monetary vigilante in the shadows

If we accept the premise that bitcoin popularity is an inverse function of the popularity of central bank policies, then bitcoin adoption might be most effectively stalled through improvements in central banking monetary policies around the world. It is an empirical question whose answer we will have to observe in the real world, and to examine just how good a monetary policy would be needed to kill growth in demand for bitcoin.

As discussed in TBSRB2, it is quite conceivable that if the majority of the world's central banks were able to achieve monetary policies as successful as those of the 1990s in major western economies, (without the financial bubbles, which, of course, is no walk in the park) then demand for bitcoin
would be stalled from growing too quickly. Austrian economists and sound money fanatics will find much that is wrong with the central planning of monetary policy as it was practiced by most global central banks in the 1990s, and will correctly point out that this mirage of stability that the central banks offered came at the expense of creating larger fragilities which came crumbling periodically with asset bubbles and market collapses. But the average citizen arguably does not care a lot about this, and if central banks have the extra fear of bitcoin to discipline them, they might end up doing a better job than even in the 1990s, and in the process under mine demand for bitcoin. Due to the very nature of government-controlled central banking, financial crises will occur, governments will find it hard to resist the temptation to inflate in various episodes, and bitcoin will likely continue to have some marginal demand keeping it and its network alive.

But continuing on the premise that bitcoin adoption is stalled through effective monetary policy, what would be the result of returning monetary policy to the best form of monetary policy the modern world has seen? In other words, forget about the 1990s, what would be the impact on bitcoin if we returned to the monetary system of the 1890's?