Dollar’s rise to power
The story is more or less well known. At the beginning of time, god created the central banks. The central bank of each state held a reserve of gold and issued its own currency. The more gold it possessed, and the less money it issued, the greater the value of its currency. This was called the gold standard, and it meant that the value of a country’s currency was based on the gold reserves held by its central bank.
However, during World War I, the majority of states suspended the gold standard in order to print more money to finance the war expenses. During the interwar period, even the United Kingdom was eventually forced off the gold standard, which resulted in the majority of states opting to buy US Treasuries (i.e., US Treasury securities) as the dollar was still pegged to gold. Thus, the dollar became the largest reserve for many central banks.
During World War II, the United States, which chose to delay its active participation in the war, became the largest supplier of weapons and other goods to the Allied forces. The Allies paid mostly in gold, resulting in the US having the largest gold reserve in the world. As a result, after WWII ended, other states were unable to return to the gold standard.
This is how we were led in 1944 to the Bretton Woods system. Since the Allied fowers couldn’t base their currencies on gold reserves, they decided to base them on dollar reserves or, more specifically, US Treasury bonds. Since the dollar was still on the gold standard, it meant that this way states could base their currencies on gold by proxy. All this with the promise that the US, at any time a state asked them to, would exchange dollars for their value in gold.
The money printing and deficit policies adopted during the 1950s-1970s by the US to finance various domestic programs such as the so-called Great Society as well as to finance the Vietnam War increased inflation, i.e. reduced the value of the dollar. As a result, fearing for the stability of the dollar, nations that based their own currency on dollar reserves increasingly asked the US to convert more and more of their dollar reserves into gold.
As a result, in 1971, president Nixon, announced the decoupling of the dollar from gold. Despite this decoupling, according to the IMF, to this day the majority of states hold, on average, 59% of their foreign exchange reserves in dollars[1]. At the same time, approximately 90% of international transactions are executed in dollars[2]. As a result, the dollar, as the de facto world currency, has been weaponised. Decoupled from gold, the US central bank can control it (relatively) at will, thereby exerting enormous pressure on other countries by destabilizing their economies.
This is, in broad and very rough terms, the story of the dollar’s rise to omnipotence.
What is Bitcoin?
In 2009, Bitcoin, one of the first cryptocurrencies, was created by the programmer(s) under the pseudonym Satoshi Nakamoto. We will not deal here with how Bitcoin works from a programming point of view, nor with the “economic laws” that govern it as they emerge through its code. The features we are concerned with here are the following two: decentralisation and pseudonymity.
Bitcoin was created with the intention of acting as an alternative to the existing financial system. Its creator(s) found it problematic that the currency is controlled by a central authority, the central bank that issues the currency, and wanted to create a decentralised system in which it would be impossible, or at least very difficult, for any individual or organisation to be able to manipulate the currency. For this reason, Bitcoin operates outside of the existing financial system by having its own network, in which anyone can participate by creating a node. For this reason Bitcoin claims to be against “censorship”, meaning that noone participating in Bitcoin can prevent a third party from participating, and all participants are subject to the same rules derived from Bitcoin’s code.
The second feature of Bitcoin we are interested in here is pseudonymity – not anonymity as it’s often mistakenly stated. Bitcoin supports both transparency and privacy. Every transaction made in Bitcoin is public: everyone can see how many Bitcoins were transferred in a transaction as well as from which digital wallet to which. But each digital wallet has, let’s say, a “pseudonym”, and noone can know the real identity of the individual/organisation that owns the digital wallet[3].
Bitcoin rising to power?
In recent months, a debate has opened in the US to ban Bitcoin on the grounds of the high energy costs required to produce it and the high financial risk posed by its large and sharp price fluctuations for those who invest in it[4]. But this is just a pretext and not the real cause.
As mentioned above, the majority of states hold, on average, 59% of their foreign exchange reserves in dollars. However, the share of the dollar in central bank reserves has been steadily decreasing over the last two decades, as in 1999 the corresponding percentage was 70%[5]. Despite the decoupling of the dollar from gold in 1971, states continued to base their currencies on the dollar as the strength of the US economy meant financial stability. But US’s aggressive monetary policy to maintain dollar’s strength of also has negative consequences for the economies that base their economies on dollar.
For example, a few days ago the DXY (the index of the value of the dollar against other currencies) broke all records by reaching twenty-year highs[6]. Such large increases in the dollar’s price mean that countries that base their currency on loans in dollar will be forced to pay more money than they originally estimated in order to repay the loans, which could be a big blow to their economies especially if they are in recession.
Another issue arising for states from dollar’s omnipotence is access to the international financial system and international trade. Since the dollar is the de facto world currency and the vast majority of international transactions are done in it, and since the US more or less control many major international organisations, if the US cuts off or limits a country’s access to dollars they let it essentially out of world trade. Accordingly, we’ve recently seen the sanctions against Russia regarding Russian banks’ access to SWIFT, an international interbank system[7].
In recent years, some states have been trying to find a way out of this omnipotence of the dollar through Bitcoin. Let’s take a look at Iran. The Iranian state, since due to international sanctions has limited access to the international financial system and is under a trade embargo, is having difficult to sell the oil and natural gas it produces, thus losing its main national income. Therefore, it decided to use these resources to generate electricity that powers Bitcoin mining, that is, the production of Bitcoins via computers. Then, since Bitcoin has its own network which is independent from the international financial system, Iran conducts international transactions using Bitcoin, thus bypassing the sanctions. And due to Bitcoin’s pseudonimity with the difficulty of identifying the owner of a digital wallet, Iran can potentially even conduct covert transactions with individuals and companies located in states with active sanctions against Iran[8].
Iran isn’t the sole state utilising Bitcoin. More states experiencing economic instability or international sanctions have begun experimenting with Bitcoin. For example, the Russian state has stated that it is working on the possibility of making international transactions through Bitcoin to bypass the sanctions against it due to its invasion of Ukraine[9]. At the same time, El Salvador and the Central African Republic have adopted Bitcoin as legal tender[10], while at the same time Panama, Paraguay and Guatemala are considering to follow suit[11].
Surely, the large and sharp fluctuations of Bitcoin’s price don’t make it very attractive as money. But if huge amounts of Bitcoin are removed from digital exchange platforms and “freeze” as reserves in central bank accounts, the constant large reduction in Bitcoin’s supply may lead to a relative stabilisation of its price. On the other hand, there are attempts to create cryptocurrencies that have a fixed exchange rate to some other asset, they are the so-called stablecoins. For now, the most famous of these attempts has failed miserably[12], but perhaps in the future will be invented a cryptocurrency that achieves a relatively stable price accompanied by a Bitcoin-like decentralisation and pseudonymity.
The creation of a parallel network of international transactions that won’t be based on the dollar would likely mean the destabilisation of the US economy and be a huge blow to its international geopolitical power. This seems to be the fear of the US government with its thoughts on banning Bitcoin. A Bitcoin ban by the US would mean a big drop in its price, greatly reducing the value of Bitcoins that the various states have bought, at least in the short-term. And if US-allied nations also ban Bitcoin, the blow will be even greater. Such a move doesn’t remove Bitcoin’s decentralisation and pseudonomity, but it’s difficult to predict whether its price could recover or if it would mean a permanent economic loss for the states that have invested in it.
What will a relative success of these governmental experiments with cryptocurrencies mean for the global economy and geopolitics? If the option of sanctions is lost from the states’ toolkits, then will the economic war be replaced by some digital war with hackers and blockages of computer networks, or it will lead to World War III?
The night is dark, the clouds hide the stars and moon. And the dawn of the communist revolution is many hours away…
Notes:
1. https://blogs.imf.org/2022/06/01/dollar-dominance-and-the-rise-of-nontraditional-reserve-currencies.
2. https://www.nytimes.com/interactive/2022/07/16/business/strong-dollar.html.
3. At the very least, noone can find out the identity of the person who owns a digital wallet through the Bitcoin’s system itself. But a person’s identity can be linked to the digital wallet in other ways. For example, suppose that John has a digital wallet with Bitcoins and that there is an appliance store that accepts payments in Bitcoin. If John orders a refrigerator from this store, then the store can assume a connection between the digital wallet by which the purchase was made and the recipient’s details. So, the store can conclude that this digital wallet belongs to John, or at least to someone who has such a close relationship with John that is willing to buy him a refrigerator. So, if we assume that the police suspects that the particular digital wallet is being used for illegal transactions, such as arms trade, then the police will be able ask the appliance store for the details of the recipient of the particular purchase – assuming here that the store has made public the “pseudonym” of its own wallet for payments, or that state law requires stores that accept Bitcoin to declare their digital wallet to the IRS for tax purposes, so the police somehow know one of the two parties of the transaction, the appliance store. To sum up, what Bitcoin offers is pseudonymity. From there, anonymity depends on whether or not the owner of a digital wallet will make transactions that will link his digital wallet to his real identity.
5. See note 1.
6. See note 2.
7. https://www.bbc.com/news/business-60521822.
8. https://www.reuters.com/business/finance/iran-makes-first-import-order-using-cryptocurrency-tasnim-2022-08-09 and https://www.grid.news/story/global/2022/07/26/what-do-el-salvador-iran-and-north-korea-have-in-common-theyre-all-feeling-the-heat-in-the-great-crypto-crash.
10. The exact definition of legal tender may vary from state to state but, in general, legal tender is the currency that the state has designated that taxes should be paid with, and that domestic businesses are legally forced to accept as a means of payment and debt repayment.
11. https://www.cnbc.com/2022/06/25/el-salvador-bitcoin-experiment-not-saving-countrys-finances.html, https://www.bbc.com/news/world-africa-61248809 and https://www.investmentweek.co.uk/news-analysis/4042778/devere-green-bitcoin-legal-tender-countries.
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