Some buyers of Bitcoin and other crypto-assets may be anticipating a collapse of the dollar. For this strategy to prove profitable, the following events must take place. The U.S. government must encounter a fiscal crisis. The U.S. government must respond to this fiscal crisis by printing money. Bitcoin must out-perform other alternative assets. Let me elaborate: The U.S. government must encounter a fiscal crisis. Nowhere in history do we observe hyperinflation, in which money-printing gets completely out of control, carried out by a solvent government. There is no instance in which a national currency collapsed without being preceded by a fiscal crisis. A fiscal crisis occurs when the government engaged in deficit spending runs out of willing lenders. If lenders decide that the government is unlikely to repay new loans, this can become a self-fulfilling prophecy. For example, suppose that next Monday many of the leading money managers begin to doubt that the United States will ever get its government debt under control. These money managers will pull out of the U.S. bond market, and interest rates paid by the government will rise. With these higher interest rates, interest payments go up, and it becomes even less likely that the United States can manage its fiscal position, so that on Tuesday even more leading money managers will pull out. By Wednesday, interest rates charged to the U.S. could be 10 percent and heading higher. That would constitute a crisis. This sort of crisis, when it arrives, comes suddenly, taking most people by surprise. As we will see below, there are many ways for a government to respond to a fiscal crisis. But one option is to stop trying to raise funds by issuing debt and instead to finance its deficit by printing money. This approach will boost household spending, causing prices to rise. In turn, this will mean that in subsequent months the government will have to print more money, leading to higher prices, more money-printing, and so on, until the currency collapses. Examples of this include Weimar Germany in the 1920s and Zimbabwe more recently. A fiscal crisis is a very real possibility. The United States has a combination of outstanding debt and future obligations under Social Security and Medicare that many experts believe is unsustainable. Other major economies, notably Japan, are also making fiscal commitments that they cannot possibly keep. A sovereign debt crisis might hit one major country and then panic might spread to other countries, including the United States. In order to avoid a fiscal crisis, either economic growth must accelerate or the U.S. political system must change so that politicians are willing to take on entitlement spending. It is reasonable to be pessimistic about both possibilities. 2. The U.S. government must respond to this fiscal crisis by printing money. Printing money is not the only option for responding to a fiscal crisis. One option is to enact fiscal reforms, including tax increases and reductions in future entitlement benefits. The reforms need not eliminate deficits altogether. They only have to be sufficiently credible to convince investors that lending to the U.S. government remains a safe proposition. Credible fiscal reforms would cause interest rates on U.S. government debt to fall to affordable levels. Another option for the United States is to sell assets. For example, the U.S. government holds huge tracts of land. In the early days of our Republic, land sales were a significant source of revenue. Land sales could once again be a way for the government to raise funds in an emergency. Still another option is financial repression. Regulators could adopt measures that force financial institutions to invest in government debt. For example, the government could declare that banks or money market funds without some minimal share of government debt in their portfolios are “too risky” and can be shut down. Yet another option is a wealth tax. Think of a national property tax of 1 percent, with the tax also levied on financial assets, such as stocks, bonds, and bank deposits. Each of these options is unattractive. But they have two advantages compared with printing ever-increasing amounts of money. The first advantage is that they would solve the problem. Printing money would not work, because so much of the fiscal problem in the United States consists of future obligations under entitlement programs. As inflation goes up, the cost of these future obligations rises, so that the fiscal crisis does not go away. The second advantage these alternative approaches have is that they would be less chaotic for the middle class. A hyperinflation tends to wipe out middle-class savings, which is a recipe for political disaster. In short, although I worry about a potential fiscal crisis, I worry much less about the government printing money in response to a fiscal crisis. But even if I thought that there was a significant probability that the U.S. government would resort to money-printing, 3. Bitcoin must out-perform other alternative assets. Under circumstances in which inflation is a threat, the most desirable assets are “hard” assets. The classic hard asset is gold. What you want from a hard asset is stable purchasing power. If government currencies are about to lose purchasing power rapidly, then stable purchasing power becomes precious. When you are bailing out of a depreciating currency, you want an asset that has stable value and also is widely accepted as a means of payment. When other countries’ currencies are threatened, people in those countries try to run to dollars. That is why the dollar tends to appreciate during periods of international financial stress, even when the United States is part of the crisis. If the dollar itself becomes subject to a crisis, then people may turn to other currencies. The Swiss franc tends to perform well in a crisis, because Switzerland’s government is relatively well managed. For citizens looking for hard assets, gold is not the only option. Other commodities, such as copper or wheat, are traded in futures markets. By taking long positions in those commodities, you can profit from inflation. There are mutual funds that invest in commodity indexes, just as there are stock mutual funds that invest in stock indexes. Oil is a commodity that I think is very attractive as a hedge against inflation. Given the extensive way that oil is used in the world economy, the purchasing power of a barrel of oil is likely to be fairly stable. Of course, you cannot pay for groceries by using oil futures contracts. The supermarket is going to want payment in a currency-related medium. In a high-inflation environment, when you want to buy groceries you will have to sell some of your oil futures contracts and use those dollars to pay at the supermarket. If supermarkets were to accept Bitcoin, then it might be easier to pay for groceries using Bitcoin than going to the trouble of exchanging a hard asset for dollars to pay for groceries. So if Bitcoin becomes a widely-accepted currency, then it could out-perform other alternative assets. The problem with Bitcoin is that I am not sure that it will retain its value between now and a currency collapse. Another crypto-currency could prove more attractive. Or the speculative bubble in Bitcoin might collapse. If I were hedging against hyperinflation right now, I would buy oil futures contracts rather than Bitcoin. If Bitcoin collapses, then that would leave me with no hedge against inflation. Oil prices may move up and down, but the price of oil is not going to collapse completely. Conclusion I have argued that three things have to happen in order to make Bitcoin a useful hedge against hyperinflation. First, the U.S. government must encounter a fiscal crisis. Let us suppose that there is roughly a 50 percent chance that this will occur some time in the next fifteen years. Second, if and when a fiscal crisis hits, the U.S. government would have to choose monetary finance and hyperinflation rather than exercise other options for dealing with the crisis. The strikes me as very unlikely, so give it a 1 percent chance. Third, Bitcoin must out-perform alternative assets. This also strikes me as very unlikely, so give it a 1 percent chance. Multiplying these probabilities out, I get (1/2)(1/100)(1/100) or a one out of 20,000 chance that I will be happy if I make an investment in Bitcoin. This strikes me as an unattractive bet, particularly when an alternative is to speculate in oil or commodity-index funds.

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What about a Dollar Collapse?

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What about a Dollar Collapse?

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Arnold Kling

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