Monetary Regime Cycle & BitCoin

Last Revised and Edited: 02/December/2021

Part I: Monetary Regime Cycle and Bond Yield Cycle

Since the 19th century, monetary system has transformed from metallic standards to fiat money. In its passage, the paradigm shifts in monetary regime took place around the reversal points of the bond yield cycle in the core global power states—namely UK until the early-20th century and US thereafter.

A reversal point of bond yield cycle nearly coincides with an extreme monetary condition. A top range of bond yield cycle nearly coincides with an extreme inflationary environment. On the other hand, its bottom range coincides with an extreme deflationary environment with an exception of war interruption. (A war interruption can cause inflationary force even at the bottom of the bond yield cycle. (Goldstein, 1988, pp. 252-253) As an example, the post-Great-Depression deflationary environment was transformed to be inflationary by WWII even at the bottom of the bond yield cycle at that time.)

This suggests that extreme monetary conditions have something to do with paradigm shifts in monetary regime. It might be because an incumbent regime breaks down under extreme monetary conditions and it triggers a paradigm shift in monetary regime. Or it might be because for the bond yield cycle to make a reversal, it would require a paradigm transformation in monetary regime. Here, we refrain from exploring such causal relationships. We rather focus on observing historical facts.

Framework:

In my framework, our reality is driven by at least three forces: cyclical force, evolutionary force, and by-product of accidents. Now, I would like to begin with historical analogy to derive a pattern of cyclical force.

Cyclical Force: Historical Pattern in Paradigm Shift of Monetary Regime

Now let’s get a big picture by walking through historical facts below along the chart of bond yield:

1) Multiple Metallic Standard Era:

• During the 19th century, multiple metallic standards operated among major economies. The United Kingdoms was under the gold standard; German speaking states were under the silver standard; other major states including France was under the bimetallic standards. However, since the unification of German Empire, major economies gradually had converged into the gold standard. When the United States officially adopted the gold standard to end its legacy bimetallic standard in 1900, the convergence into the gold standard was completed among major economies. This coincides with the bottom of the bond yield cycle.

2) International Gold Standard Era:

• Since the US adoption of the gold standard--at the bottom of the bond yield cycle--the major economies’ monetary system has become operated under the gold standard. It lasts until the breakout of WWI, which brings the gold standard into suspension.

3) Breakdown Era of Gold Standard:

• Since the end of the WWI at a top of the bond yield cycle, the post WWI world experienced a series of compromises and suspensions in the conduct of the gold standard. The international monetary system broke down, while failing to present a replacement until the Bretton Woods Agreement. The Bretton Woods Agreement coincides with the bottom of the bond yield cycle.

4) De-facto USD Standard (Post Bretton Woods System) Era:

• In the aftermath of WWII, the Bretton Woods System was designed as a variant of the gold-exchange standard, which allowed central banks to substitute foreign exchange reserves for gold reserves. By its statute, the Bretton Woods System did not prohibit the gold convertibility of non-USD currencies. Nevertheless, it transformed to a de-facto gold-USD standard because of economics as the rest of the world demanded USD as gold-reserve substitutes because of the US’s predominant economic position.
• Finally in 1971 with Nixon Shock US abandoned the convertibility of USD to gold. At this point, both UK and US bond yields are already above the top of the previous bond yield cycle, suggesting an extreme monetary condition then, but continue to surge.
• Thereafter, under the Smithsonian Agreement, USD became subject to speculative attacks. In 1973, when US devalued USD by 10% against the value of gold, due to speculative market pressures, major currencies went float. In practice, 1973 marks a milestone in the official shift to fiat currency world.
• UK Consols Yield peaks in 1974 and makes reversal thereafter.
• On the other hand, US Bond Yields continues to surge further and waits its reversal until  the emergence of Paul Volcker as the new Chairman of the Federal Researve Bank. Volcker’s price stability focused monetary policy during 1979-1981 via federal funds rate hike led to the reversal of the bond wave.

5) Uni-polar, Central Bank's Monetary Policy Standard Fiat Money Era:

• Volcker's move in the late 1970s was a strong political announcement that the new monetary regime, fiat money, needs to be managed by central bankers with a special attention to price stability. In other words, the new monetary regime is not merely fiat money, but also "Central Banker's Monetary Policy Standard (CBMPS)." Since then, among major advanced economies fiat money has become operated in a floating exchange rate system with price stability focuced monetary policy managed by central bankers. It was also characterised by the dominance of USD as the global reserve currency: in other words, “Uni-Polar, CBMPS Fiat Money System” under USD dominance.

These facts suggest a cyclical force that monetary regime transitions nearly synchronized with reversal points of the bond yield cycle. In other words, monetary regime cycle nearly synchronised with the bond yield cycle.

Now, living under the historically low bond yields environment, we are supposedly around the bottom reversal of the bond yield cycle (this might be proven wrong, if a persistent deflation were to re-emerge going forward). If history is a guide, we are likely to experience some sort of paradigm transformation in currency regime—potentially with some time lag. Anyway, we are compelled to ask a natural question: what sort of new monetary regime could emerge at the current, supposedly, bottom of the bond yield cycle.

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Revision Announcement: 2 December, 2021 

The original description regarding the Bretton Woods System above was misleading. The Bretton Woods System was designed as a variant of gold-exchange standard, which allowed central banks to substitute foreign exchange reserves for gold reserves. By its statute, the Bretton Woods System did not prohibit the gold convertibility of non-USD currencies. It transformed to a de-facto gold-USD standard because of economics as the rest of the world sought USD as gold-reserve substitutes because of the US’s predominant economic position. Thus, the following revision was made.

• Original: “At the end of WWII (at the bottom of the bond yield cycle) the Bretton Woods System introduced a de-facto US Dollar in disguise of a pseudo-Gold Standard, in which USD was the only currency convertible to gold and the rest of currencies were loosely pegged to USD.”
• Revised (2 December, 2021): “In the aftermath of WWII, ​the Bretton Woods System was designed as a variant of the gold-exchange standard, which allowed central banks to substitute foreign exchange reserves for gold reserves. By its statute, the Bretton Woods System did not prohibit the gold convertibility of non-USD currencies. Nevertheless, it transformed to a de-facto gold-USD standard because of economics as the rest of the world demanded USD as gold-reserve substitutes because of the US’s predominant economic position.”​

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Evolutionary Force:

Besides the presence of the aforementioned cyclical pattern, these historical facts above also present a notion of an evolutionary force: our monetary system has evolved from fixed exchange rate regimes to floating exchange rate regime: evolution from the metallic standards, in which the value of currency was anchored versus the value of metals, to fiat money that is managed by price-stability focused monetary policy by central bankers. The question is what’s the next.

Toward Future:

Now, to anticipate a new monetary regime that is expected to come along the cyclical pattern, we can contemplate underlying evolutionary forces in geopolitics, innovation, and general economy.

Among many possibilities, we can contemplate scenarios below.

a) Change in the key currency within the existing framework of fiat money CBMPS regime;

• “Multi-Polar Fiat Money CBMPS System (CBMPS: Central Bankers' Monetary Policy Standard)”: a shift to have multiple key currencies within the existing fiat money regime: for example, tri-polar world of EUR, USD, and RMB.
• “A Polar-shift in Uni-Polar Fiat Money CBMPS System”: a shift to another major currency from USD as the key currency position: for example, a polar shift from USD to RMB.

b) Crypto-currency;

• After struggling through deflationary environment, central bankers might embrace a new innovation to enable themselves to universally apply negative interest rates. Under fiat money regime, the possibility of cash hoarding makes it impossible for them to do so. By digitizing money, central bankers can universally apply negative interest rates. This is done within a centralised system by deploying a closed crypto-currency system. In a way, this remains in a category of fiat money system: in other words, “Closed (Private) Crypto-Fiat Money System.”
• Alternative to the centralized system, a distributed system, such as BitCoin, could enable a peer-to-peer monetary system. It is an open crypto-currency system: in other words, “Open (Public) Crypto-Peer-to-Peer Monetary System.” That said, an open system operated on so-called Public Blockchain such as BitCoin is energy intensive and not a sustainable solution as of today and requires a breakthrough in its energy efficiency. (to be discussed in the next chapter)
  
• Hybrid alternative: A hybrid system, which is more energy efficient than an open alternative.

c) Regress to commodity monetary standard.

• Either going back to a metallic standard or a basket of commodities standard. These standards can be viewed as a fixed exchange rate in disguise. What a depressing scenario. We do not repeat the same mistake that our previous generation made. So, this needs to be an unlike scenario.

d) Breakdown Era of Fiat money:

• As we observed in the post-WWI era, monetary regime can simply break down, while being unable to present a new replacement. If this scenario emerges, this time, with a massive liquidity under fiat money regime, we might experience an extreme condition: hyper stagflation (hyperinflation plus stagnation.)

There should be more. I welcome suggestions from readers.
 
Now, we have incorporated cyclical forces and evolutionary forces into our anticipation of the future monetary regime. We need to be aware that there remains some room for the third force, by-product of accidents, which by definition we cannot anticipate.

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Part II: Viability of BitCoin as a Public Utility, Currency.

Among the future monetary regime alternatives above, in this section we focus on BitCoin, one of the hot topics in our time. What is the viability about BitCoin as currency, a public utility?
 
In brief, BitCoin possesses a critical problem within its own model as of today. It is an energy intensive system to an extent that it raises a question about its sustainability.
 
Here, in order to get a big picture, I make a summary of existing articles in the reference below, all of which owes to the work of Alex de Vries, aka Digiconomist.
 
As of the 15th of November, 2017,

• The annual ESTIMATED energy consumption of BitCoin is 27 TWh (TERA WATT HOUR). This is comparable to an annual energy consumption of Oman. (De Vries, 2017)
• The per-transaction ESTIMATED energy consumption of BitCoin is 200 kWh (vs. 0.01 kWh per transaction for VISA (Brosens, 2017)). In other words, one single transaction of BitCoin requires a little less than an average MONTHLY household energy consumption of the Netherlands, which is 242.5 kWh. (Van Noort , 2017)

Now, BitCoin is traded among a limited number of investors. Based on these estimates as of today, we can have a big picture. If it were to become a public utility as currency, BitCoin could breakdown our energy system today. It would not be sustainable.

These estimates are changing as time goes by. Going forward, we need to monitor De Vries’ “Bitcoin Energy Consumption Index”: https://digiconomist.net/bitcoin-energy-consumption
 
Needless to say, the beauty of Bitcoin is that it enables peer-to-peer monetary model to operate in the absence of the centralised government. But the catch is that because of the absence of a centralised trusted party the verification (mining) process requires a massive energy to establish trust in the system.
 
For those who see BitCoin as merely a subject of speculation, it might not matter. But for those who see BitCoin as an alternative for currency, this fact should raise their eyebrows. And for those working in Impact Investment, BitCoin should be subject to EXCLUSION from the perspective of carbon reduction.
 
BitCoin belongs to the family of "Public Blockchain" and it is just one of many crypto-currency alternatives. Furthermore, it operates with POW algorithm (Proof of Work), which is energy intensive. There are alternative algorithms which provide better energy efficiency (Blockchainhub.net, ND).

In order to serve as currency, a public utility, peer-to-peer monetary system might need to wait for another innovation cycle for a viable algorithm from the perspective of sustainability. Let’s wait and see.

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[ Reference ]

Part I:

• Goldstein, J. S. (1988). Long cycles: prosperity and war in the modern age. New Haven: Yale University Press.
  
• Suginoo, M. (2017, June 15). THE SECULAR RHYTHM OF THE BOND WAVE: Secular Macro Behavioural Dynamics of Political Economy－Its Indisputable Uncertainty and Irregularity & Equally Undeniable Pendulum Recurrent Dynamics. Retrieved from www.reversalpoint.com: http://www.reversalpoint.com/secular-rhythm-of-bond-wave.html
• Suginoo, M. (2017, November 19). BOND WAVE MAPPING: CASE STUDY 1: Paradigm Transformations in International Monetary System Along the Bond Wave. Retrieved from ReversalPoint.Com: http://www.reversalpoint.com/bond-wave-mapping-1-paradigm-transformation-in-interntional-monetary-regime.html
• Suginoo, M. (2017, July 11). BOND WAVE MAPPING: CASE STUDY 2: Price & Inflation Cycles along the Bond Wave. Retrieved from ReversalPoint.Com: http://www.reversalpoint.com/bond-wave-mapping-2-price--inflation-cycles.html

Part II:

• BlockchainHub.net. (ND). Blockchains & Distributed Ledger Technologies. Retrieved from BlockchainHub.net: https://blockchainhub.net/blockchains-and-distributed-ledger-technologies-in-general/
• Brosens, T. (2017, 10 13). Why Bitcoin transactions are more expensive than you think. Retrieved from ING: https://think.ing.com/opinions/why-bitcoin-transactions-are-more-expensive-than-you-think/
• De Vries, A. (2017, 11 15). Bitcoin Energy Consumption Index. Retrieved from Digiconomist: https://digiconomist.net/bitcoin-energy-consumption
• Van Noort, W. (2017, 10 23). NRC checkt: ‘Een bitcointransactie voorziet huis maandlang van energie’: Dat meldde RTL Z en ook vakblad De Ingenieur nam die conclusie over. Retrieved from www.nrc.nl: https://www.nrc.nl/nieuws/2017/10/23/nrc-checkt-een-bitcointransactie-voorziet-huis-maandlang-van-energie-13641170-a1578339
  

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