The Truth Behind Bitcoin’s Opposition

What do Saddam Hussein and Bitcoin have in common? According to the government, they both have ties to terrorism. In reality, both threaten the United States dollar (USD) and its global hegemony.

“One man’s terrorist is another man’s freedom fighter.” — Gerald Seymour

Throughout this article, we are going to peel back the layers of inflationary monetary policy to be able to answer these three questions:

1. Why does the Federal Reserve target inflation?

2. What do the military and counter-terrorism have to do with protecting the inflation narrative?

3. How come bitcoin sees such strong opposition from certain individuals within the government?

Before we can answer these questions thoroughly, we must take a step back and delve into the world of money. This will give us the building blocks to better examine why the government does what it does. To do so, we must first ask the question: What is money?

The broad definition of money tends to revolve around “an economy’s generally accepted and recognized medium of exchange that is used to facilitate trade for goods and services.” In layman’s terms, money is the store of value intermediary between transactions. If money did not exist, trade would become significantly more challenging. A trade would require both parties to have the exact goods that each other needs. For example, John is a fisherman and Michelle is a carpenter. What’s to say Michelle needs fish at the same time that John needs a table? Additionally, how much fish is this table worth?

Money allows individuals to swap resources or services for a store of value, regardless of whether we have an immediate use for it. This has allowed our civilization to expand and grow much more efficiently than it otherwise would have, as both domestic and international trade becomes almost impossible without money.

For the average person, there are two methods to obtain money:

1. We must expend time and energy in return for money (e.g.., work, labor, services).

2. We must trade goods or resources in return for money. However, to obtain these goods or resources, we must have previously expended time and energy.

Therefore, in both scenarios, to obtain money, we must expend time and energy. With this, we can conclude:

Money = Time + Energy

With this simple equation in mind, we can better understand the inner workings of the monetary system.

Our Monetary System

Our economy operates on a centralized monetary system, where at the top we have the Federal Reserve (the Fed). The role of the Fed is to regulate the U.S. monetary and financial system through monetary policy. This gives the Fed the ability to control the money supply. This ultimately influences whether we are in an inflationary or deflationary environment, regardless of what should naturally occur.

Although the Fed was created as a private entity, we don’t have to look much further than the board of governors to realize that it is just an extension of the government. The board of governors, which guides decision-making, is at the heart of the Federal Reserve and is a government agency. Therefore, although the Fed appears to be independent and impartial, the government has a significant influence over the Fed’s decision-making and, subsequently, monetary policy direction.

Considering the Fed’s role in regulating the U.S. monetary system, one could conclude that it would strive for the USD to maintain sound money characteristics. However, since the introduction of the Fed, the idea of sound money has slowly but surely been undermined and destroyed, with a complete break occurring when the U.S. departed from the gold standard in 1971. Rather than the dollar being somewhat backed by gold, it is now backed by debt. Therefore, it becomes relatively easy for the U.S. to expand the money supply.¹ The Fed uses four key levers to control the money supply:

a) Open Market Operations (OMO): The Fed has the ability to purchase short-term treasury bonds from the open market. In doing so, the commercial banks who sell these treasury bonds receive payment in the form of increased bank reserves. This serves two purposes. First, this artificial demand for short-term treasuries decreases short-term interest rates. Secondly, with increased bank reserves and lower short-term rates, commercial banks tend to lend more freely. This results in an increase in the money supply since banks operate on a fractional reserve system, whereby they only need to hold a fraction (generally 10%) of their total deposits/loans in reserves. Therefore, a $1 increase in reserves can result in a $10 increase to the money supply.²

b) Quantitative Easing (QE): QE is usually only reserved for times of economic stress, otherwise it is very similar to OMO. The main difference is that with QE, the Fed targets long-term, instead of short-term, treasury bonds. This causes an artificial suppression of longer-term interest rates, as well as a potential increase in the money supply.

c) Discount Rate: The Fed has the ability to adjust the discount rate. By lowering the discount/interest rate that commercial banks have to pay on short-term loans, the Fed makes borrowing more favorable and, as borrowing increases, so does the money supply. As explained above, banks do not have to have 100% collateral-backed loans. Therefore, any loan created has the potential to cause an increase in the money supply.

d) Modifying Reserve Requirements: The Fed has the ability to modify reserve requirements. This modification refers to the amount of reserves a bank must hold against deposits in bank accounts. By lowering the reserve requirements, banks have the ability to create more loans, which can result in an increase in the overall money supply.

In all four examples, when a dollar is created through monetary expansion, it is backed by nothing but a liability. Therefore, an increase in the money supply is either an expansion of the Fed’s balance sheet or a liability on behalf of the bank that has lent out the money.

In addition to the many levers the Fed has in its arsenal, the Fed openly targets a 2% year-over-year inflation rate. “The Federal Open Market Committee (FOMC) judges that inflation of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Fed’s mandate for maximum employment and price stability.”³ In layman’s terms, the Fed seeks to achieve a 2% annual increase in the price of goods and services alongside maximum employment and price stability.

If we intuitively think about what the Fed is saying, something doesn’t seem to add up. First, it doesn’t make sense that the Fed is targeting stable prices. We live in a world where we constantly strive to get more for less by increasing efficiency and productivity. For instance:

● Cars were invented to reduce time spent traveling.

● Mass production was introduced to reduce the cost of goods to the consumer.

● The internet was born to aid communication and increase information-sharing and consumption.

● Spotify was created to consolidate music into one easy-to-access space.

● Netflix was founded to allow anyone access to movies without having to travel to the movie store.

And the list goes on. At no point has human ingenuity been used to get less for more, with the exception of inflation targeting.

Although it is possible to see prices rise (natural inflation) through structural demographic changes or supply-and-demand imbalances, prices tend to fall in the long run. However, by targeting inflation, the Fed is actively aiming for a steady increase in prices over time. They are able to achieve this through monetary expansion, which creates a slow decay in the purchasing power of the currency and, in turn, an increase in the cost of goods, services and assets. This is not natural. Instead, as technology advances and we see increased productivity, prices should naturally decline, and the currency should strengthen, allowing us to buy more for less.

Additionally, is unemployment such a bad thing? With a strengthening currency and decreasing cost of goods and services, the cost of living should also decline. In turn, we should be able to work less with a greater output. This ultimately allows us to achieve a higher standard of living. Under this lens, unemployment may not be the bad egg it is made out to be. Instead, we should view decreasing prices alongside reduced work hours and a slow increase in unemployment as a potential sign of a healthy, happy economy. So, what are the effects of inflation, and who is it benefiting?

What Are The Effects Of Inflation?

As explained above, the Fed, through its arsenal of tools, has the ability to influence the money supply with the goal of hitting specific inflation targets. However, this targeting comes at a cost. As mentioned above, monetary expansion to reach inflation targets negatively affects purchasing power, causing an increase in the cost of goods, services and assets. However, as this destruction of purchasing power occurs incrementally over time, it can be difficult for the average person to grasp inflation’s adverse effects. Irrespective of the societal and economic impacts,* the four main monetary side effects of inflation are:

1. Dilution: Creating more dollars backed by debt does not add value to the economy. Instead, it dilutes the currency that is already in circulation. For example, if a pizza is cut into four slices, doubling the money supply would not be equivalent to doubling the amount of pizza. Instead, it would be equivalent to cutting those four slices in half to create eight slices. We have not gained any additional pizza. We just have more slices.

2. Interest: As explained above, to increase the money supply, a liability must be created. When this is done, there has to be interest paid on this liability. For example, when the Fed increases bank reserves for commercial banks, it pays interest on excess reserves (IOER). Therefore, in addition to the dilution of the currency, a liability with interest payments is created. Not only has inflation diluted our existing currency, we now have to divert productive capacity to pay down debt plus interest.

3. Loss of Accurate Measurement: Currently, we measure assets, wealth, goods, services, income and so on in dollars. The challenge with using the USD as a medium of measurement is that, as inflationary monetary policy destroys purchasing power, we see a change in the value of the dollar. This inadvertently inhibits our ability to use the USD as an accurate measuring stick. The USD would be a great form of measurement if its supply was stable and consistent. However, this is unfortunately not the case. Using the dollar as a medium of measurement is like trying to build a house using a ruler, where the measurements on the ruler keep changing unexpectedly and unpredictably. I doubt the house would be structurally sound.

4. Distortion of Economic Indicators: The USD is a crucial indicator for economic decision-making. However, by performing inflationary monetary policy and masking economic stress through monetary expansion, we hinder our ability to obtain insightful economic information when analyzing the USD. Consequently, we are impeding the economy from error-correcting accurately and, in turn, hampering its ability to adapt, evolve and innovate effectively.

* For a more detailed breakdown of societal and economic impacts of inflation, check out “When More Isn’t Better: Inflation in the 21st Century.”⁴

With these side effects of inflation in mind, it can be difficult to look favorably at inflation. Additionally, it makes us question that if our dollar’s purchasing power is slowly decaying over time, is an increase in wealth in dollar terms all that it is made out to be? One way to view the reality of our situation is to change the medium of measurement. For instance, below is a chart of the S&P 500 versus the S&P 500 divided by the Fed’s balance sheet. This alternate measurement takes into account monetary expansion rather than just relying on the dollar.

Source: Equity Growth Reality Chart⁵

As we can see, the 175%+ growth in the S&P 500 over the last 12 years is, in reality, more likely a significant loss when we account for monetary expansion. However, it should be noted that many of these dollars created on the Fed’s balance sheet may never reach the public domain, and, therefore, it is difficult to determine the exact impact on the purchasing power of the dollar. This may mean the loss is not as drastic as -65%; however, the difference is still a far cry from negligible.

Why Does The Federal Reserve Target Inflation?

If we distill everything up to this point, it can be tough to understand why the Fed would target inflation when it has such adverse side effects. However, if we dig into the two main benefactors of inflationary monetary policy, we can better understand why we see such policies.

Government

As the Fed implements inflationary monetary policy, the general population and businesses start to spend and borrow, causing an increase in debt consumption. With an increase in debt, we see money supply expansion and a reduction in purchasing power. Usually, with increased demand for borrowing, we would see a rise in interest rates. However, as previously mentioned, the Fed has a couple of tools in its arsenal that allows it to suppress interest rates. Additionally, by working alongside the U.S. Treasury, the U.S. is able to implement what is called financial repression.

Financial Repression

A concept introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon, financial repression is the suppression of interest rates below that of inflation, which allows the government to borrow money at extremely low rates to fund operations.⁶ This greatly benefits debtors and is disadvantageous to creditors, aligning with the fact that the US is the largest debtor nation with a total government debt of $28.1 trillion.⁷

This suppression of interest rates is not natural and allows the treasury to obtain capital to fund operations through the issuance of treasury bonds at rates below that of inflation. This indirectly passes on the cost of borrowing onto the creditor, which, in this case, ends up being the economy. In essence, financial repression is a stealth tax on its currency holders in two ways:

1. When the Fed artificially suppresses interest rates, it negatively impacts savers (e.g., pension plans, savings accounts, fixed-income investments). Under normal interest rate environments, savers would be rewarded in the form of reasonable interest rates (i.e., they would get significantly more return on their capital). Instead, savers are punished with suppressed interest rates and this difference in performance is passed onto the government to fund its debt.

2. To suppress interest rates and drive inflation, the government has to perform OMO, QE and other inflationary monetary policies. In all three instances, we see an increase in monetary expansion. This monetary expansion causes a destruction of purchasing power, which directly impacts savers and fixed-income investors, while benefiting the debtors as it reduces their debt burden.

You may wonder why someone would ever lend money at interest rates below that of inflation. Unfortunately, this is not something that the population has much say over. The government puts such measures in place as:

● Reserve requirements. For example, international bank regulatory standards (Basel III) encourage banks to hold government debt by giving it preferential treatment for satisfying capital requirements.

● The capping of interest rates to prevent interest rates from rising above certain levels (i.e., yield curve control⁸).

● Increased regulation of capital movement between countries. This restricts capital from flowing out of the U.S. to more favorable options.

These tactics and regulations ensure the continual flow of capital into treasury bonds, allowing the government constant access to cash to fund operations and direct it to wherever they feel necessary.

Overall, the government benefits in two ways from inflation and, more specifically, financial repression.

Fund Itself

Through inflationary monetary policy and financial repression, the government no longer has to act in the best interest of its population. This is because it is able to fund itself regardless of whether or not it collects enough capital to fund operations through taxation. It is able to fund itself in the following ways:

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