Blogs & Articles: Fixing The Incentives: How Fiat Money Broke The World 🔗 1 year ago

The global history of fiat money and U.S. world reserve status has incentivized many countries to abandon their own cultures and sovereignty.

This is an opinion editorial by Jimmy Song, a Bitcoin developer, educator and entrepreneur and programmer with over 20 years of experience.

In the first three parts of this series, I examined the different ways that fiat money has led to terrible incentives at the individual, corporate and national levels. We are more isolated than ever, we are less satisfied with our work and we work under tyrannical, authoritarian governments as a result of fiat money. In this article, I go through the ways the entire world is incentivized by fiat money.

The previous articles spoke more generally about how individuals, companies and nations are affected by fiat money. This article will be a lot more specific as there's only the one world we live in and we don't need to speak generally. Thus, I will start this article with some historical context as that will give us a better understanding of why the financial incentives in the world are the way they are.

Bretton Woods

We start the analysis of global fiat money incentives with one of the major historical events that precipitated the world we live in today and that's the Bretton Woods Agreement from 1944.

Bretton Woods is a small town in New Hampshire where government bureaucrats from all over the world came to establish what they called "a new monetary world order." If that sounds ominous and sinister, that's because it is.

The idea of the conference was to fix the problems from World War I (WWI), where reparation payments and loopholes around the then re-established gold standard wreaked havoc over so many economies and eventually led to World War II (WWII). Returning to the pre-WWI gold standard was too difficult to square with the central banking monetary control that every country had gotten used to, so the conference was a way to figure out how to establish some other monetary order.

The main problems were that every country wanted the legitimacy of gold but also the stealth taxation of central bank fiat money. The solution they came up with was to add a level of indirection to gold redemption.

Prior to WWI, gold was convertible directly at banks. In the U.S., you could exchange $20.67 for one ounce of gold. In the U.K., you could exchange £4.25 for one ounce of gold. Currency was backed by gold and convertibility kept it scarce. Most currencies were gold-backed and for those currencies, foreign exchange was easy and didn't fluctuate because gold was the standard.

The advent of central banking changed this as some central banks spent way more than their reserves and had to suspend convertibility. Particularly during WWI, central banks printed money which had the veneer of legitimacy with a promise of future convertibility, but was in reality bankrupt. The result was very predictable. Those currencies which were backed by less gold had a lower price. Hyperinflation, like the inevitable celebrity divorce, eventually followed.

To keep everyone on a gold standard was desirable for trade as the golden age, La Belle Époque, had brought great prosperity. The main reason is that gold makes foreign exchange much easier and its scarcity makes it difficult for any one nation to cheat.

But here was the problem at the moment in history when Bretton Woods took place: About three quarters of all gold in the world was in the U.S. This was because the U.S. had large trade surpluses against other countries and those countries shipped gold to the U.S. to balance those trades, though eventually, when they ran out of gold, the U.S. lent these countries money instead. The countries at war in Europe were net spenders as they were busy fighting WWII. As such, the U.S. had the gold and like the guy with a giant chip lead at a poker game, had enormous leverage over the proceedings.

What the delegates to Bretton Woods decided was to add a level of indirection. Instead of going back to a strict gold standard, the U.S. imposed on everyone else a gold-exchange standard with the dollar as the gold substitute. Instead of using gold for international trade settlement, the dollar would now be the settlement currency. The U.S. guaranteed the exchange of the dollar for gold at $35 per ounce, but only to other central banks. Eleven years before the Bretton Woods Agreement, U.S. citizens were already barred from converting dollars to gold through Franklin D. Roosevelt’s (FDR's) Executive Order 6102.

The Bretton Woods agreement established the dollar in place of gold as the currency for international trade and subsequently gave the U.S. hegemonic economic power.

Dollar Hegemony

The reason the gold standard worked so well was because no single government could cheat. International balance of trade required real delivery of gold and that meant that any excess money printing would cause gold to flow out of the country, eventually causing bankruptcy.

The gold-exchange standard was supposed to have similar benefits, with the convertibility of dollars to gold being the backstop for any excess U.S. money printing. Yet this backstop wasn't really tested. The gold-exchange standard gave the U.S. the unique ability to print dollars that everyone else had to accept, even if it wasn't backed by physical gold. Gold wasn't being shipped for international balance of trade payments, dollars were.

The ability to print the money that every other country settled their trade in gave the U.S. more power over the rest of the world. The U.S. had monetary domination over the countries on the dollar standard. It was both a player on the field and the referee at the same time. You can imagine how fair that was. In a sense, the two superpowers after WWII had different strategies to control their spheres of influence.

The USSR used war, espionage and intrigue to conquer its sphere of influence. The U.S. used monetary imperialism in its sphere of influence. It turns out that the U.S.'s soft power using the dollar was way more effective than the USSR's strong-handed tactics of war and espionage. Indeed, so thorough was the U.S.'s monetary domination that the USSR had to resort to the Eurodollar to settle international trades.

The Eurodollar

The Eurodollar gets its name from the fact that European banks started lending out dollars despite not being a member of the Federal Reserve system. Currently, many more banks than European ones issue dollar loans, doing so on a fractional-reserve basis.

Given that the Cold War was going on at the time, the USSR couldn't get dollar loans from U.S. banks, but managed to get loans from European banks to settle international trades. Why did these banks cooperate? Remember at that time that there were Communist parties all over Europe and they all answered directly to Moscow. Some of these members started banks which the Soviets ended up using. But so great was the power of the dollar that even the Soviet Union had to submit!

The dollar hegemony clearly and massively favored the U.S. for international trade as it became the central bank for all other central banks. The Eurodollar system continues today, where non-U.S. banks will loan out liabilities in the dollar and not just in Europe, but in many other parts of the world. As a result, other central banks will keep dollars as a reserve, which can then be used on a fractional-reserve basis to create more. There's a limit to how much they can do this, though, because those dollars are needed to combat any weakness in their own fiat currencies and lending out too many dollars can quickly deplete their reserves, leaving them vulnerable to hyperinflation.

Petrodollar

Predictably, the U.S. abused its power to print money and spread inflation to the rest of the world by engaging in a lot of profligate spending. Entitlement programs such as Medicare and Medicaid were started in the ’60s and others like Social Security were expanded. Various Cold War operations were also funded through fiat money, the most expensive of which was Vietnam. The U.S. paid for all of these programs by printing dollars which were not backed by gold and this spending and printing made other central banks nervous.

Much gold had already been redeemed by the early ’70s and the supply of dollars versus the reserves meant that the Fed was likely a bankrupt enterprise. When more countries started threatening to convert their dollars for gold, Richard Nixon suspended gold convertibility in August 1971. The suspension was supposed to be temporary, but ended up being permanent.

No doubt, Nixon thought that a suspension could be ended once the dollar was strong again. Indeed, suspension of convertibility is what the Bank of England had done many times in its 300-plus year history. But getting the dollar strong again required a lot more fiscal discipline than the U.S. had and the temporary suspension quickly became permanent as the ’70s inflation brought significant malaise into the U.S. economy.

Suspending gold convertibility threatened the dollar's supremacy, so Nixon then transitioned the U.S. to oil. The transition was a bit rough and resulted in a lot of dollar inflation in the ’70s. In a sense, the inflation of the ’70s was paying the piper for the excesses of the ’60s. But with the support of Saudi Arabia, the U.S. was able to establish the dollar as the world's settlement currency for oil.

The dollar hegemony thus had a hiccup in the ’70s but it continued its domination, once the petrodollar became established.

Global Cantillon Effect

The U.S. continues having this exorbitant privilege of being able to print the money that the world uses for settlement. Among other things, this means being able to send printed dollars for goods and services from other countries. The effects of this are subtle but profound.

First, the printed money generally gets spent in the U.S. first. Thus, everyone living in the U.S. are beneficiaries of the Cantillon effect. The people in China, on the other hand, have to wait to get paid for their goods that they sell in the U.S. to get their hands on the dollar. Hence, the people getting paid in the U.S. generally get paid more.

This may sound good, but because manufacturing is portable, the global Cantillon effect has pushed manufacturing abroad. Labor is cheaper in Cantillon-losing countries so that's naturally where manufacturing moves. Manufacturing jobs have moved out of the U.S. to much cheaper labor countries since the ’70s. Not only has this meant that a lot of good middle class jobs have disappeared, but the U.S. has grown dependent on foreign manufacturing which, in any sort of conflict, leaves it vulnerable.

Second, the best and most profitable opportunities are in the U.S. A lot of people in the U.S. believe in some sort of U.S. exceptionalism, but this is just narcissism. The reason why there are so many rich people in the U.S. is because the U.S. has the global reserve currency. Business success in the U.S. results in way more monetary reward than in other countries purely because of the Cantillon effect. More money is floating around the U.S. and thus, success gives more rewards. Consequently, more people want to move to the U.S. and the U.S. gets to pick and choose who gets in, which leads to the next effect.

Third, there's a giant talent drain into the U.S. The most ambitious people in other countries come to the U.S. and make a much better living than in their home countries. The brain drain means that other countries suffer. The best and the brightest of any developing country vote with their feet. And it's not just the U.S. that benefits, but countries generally higher on the Cantillon ladder. People will generally try to immigrate to countries higher on the Cantillon hierarchy. The rich countries get richer in human capital, while the poor countries get poorer in human capital. So much of the devastation in poorer countries is simply because they're the Cantillon losers.

Three-Letter Organizations

What's even worse for these poorer countries is the authoritarian rule from the richer countries. Colonialism mostly disappeared after WWII, but we now have economic domination through the dollar hegemony. This is what we call monetary imperialism.

The U.S.'s method of monetary imperialism is through the use of three-letter organizations. The IMF, BIS, WEF and the World Bank are some of the institutions that are used for this domination. The inner workings of these organizations is beyond the scope of this article, but they essentially give the Cantillon-losing countries loans to dominate them.

The way such domination works is this: First, the banks of Cantillon-winning countries give the Cantillon-losing countries loans, which, being fiat money, come from nothing. When those loans don't get paid back, the three-letter organizations come in to "bail out" the banks that loaned these funds. Essentially, they take over the loan and extend the term in return for organizational control over the country's budget. Such restrictions may include items like how much of their national budget can be spent on infrastructure. Often, these indebted governments are required to establish an independent central bank, which can be used to obviate the need for any government approval. Among other things, the countries are required to sell off some of the nation's assets, like mineral rights or land to foreign companies, completing the domination.

In this way, fiat money is used to gain the assets of a developing country.

What's interesting now is that China is doing something very similar in its Belt and Road Initiative. It gives loans and takes over the resources of a country after the money gets mismanaged. China is getting in on the game of monetary imperialism that the U.S. has been playing all along.

Global Moral Obligation

I wrote in the last article that the power of money printing at the national level creates a moral obligation for governments to solve every problem a country might have. This is because to the uninitiated, fiat money looks like free money and if you can use money to solve a problem and don't do so, you just look like a big jerk.

The same dynamic is super-charged in the global scene, except instead of individuals or corporations that are getting the benefits of various welfare and bail out programs, it's countries. But who's the guarantor? Well, the one doing the money printing, of course. And that moral obligation at a global level belongs to the U.S. as the controllers of the world reserve currency.

The first and most obvious way in which the U.S. is morally obligated is in the bailout of other central banks. Establishing swap lines or temporary liquidity facilities are really just euphemisms for printing a lot of money on behalf of another country. We saw that the Fed was doing this for many central banks during the COVID-19 crisis. Thus, if a country is running out of dollars to combat foreign exchange rates, the U.S. gives these central banks more ammo.

What's telling here is that the countries that are out of favor with the U.S. get no such monetary lifeline, as Venezuela, Zimbabwe and Lebanon hyperinflations show. The message that the global community gets from their example is clear. Don't piss off the U.S. or you're not going to get a bailout when you really need it. Thus, every country is incentivized to follow U.S. policy.

The U.S. also takes on a lot of responsibility internationally, mostly around policing. It takes on military responsibilities all over the globe and gets involved in a lot of wars. The same was true of the last global reserve currency country, the United Kingdom. If you study history, the U.K. navy and army were deployed in far off places like South Africa, India and the Middle East as part of their moral obligation to keep the peace. The U.S. does the same today, sending in its troops to many conflicts all over the world. The main difference between the U.K. and the U.S. is that the U.K. had physical possession of the colonies while the U.S. has a monetary domination.

The U.S. can and does spend tons of money in different parts of the world. The programs to assist other countries started with the Marshall Plan and soon after, the Korean War. At the time, the U.S. was looking for allies in the Cold War and both actions were ways for the U.S. to service its allies. It printed money to fund these countries, but who were the losers? Essentially, every other country that didn't get this "free" money. The dollar, being the reserve currency, gave the U.S. the right to pick winners and losers at a global level.

Hence, it's not a surprise that the biggest allies of the U.S. have done fantastically well during the dollar hegemony. South Korea, Japan, Western Europe, Singapore and Taiwan have all prospered, partly due to being high on the Cantillon ladder. Ostensibly, the alliance payments were sold as moral obligations of world peace.

The result is that the U.S. is an implied third party to every conflict. Because the dollar is the reserve currency of the world, everything is a U.S. interest. Hence, the U.S. ends up dominating any talks of peace, wherever the conflict may be.

Global Standardization

At the nation-level, there's a tendency toward standardization because of fiat money. Large companies need lots of cog parts and supplying these parts becomes a responsibility that nations take on in the form of education and licensing.

There's an even larger level of standardization at the global level and unsurprisingly, this standardization is dominated by the U.S. U.S. college education, especially from prestigious schools, is coveted all over the world specifically because a degree from those places gives access to well-paying jobs in the U.S. And the demands of large corporations mean that similar systems are set up everywhere else. Licensing also tends to be very similar, again, dominated by what the U.S. does.

But more than these "hard" standards are the "soft" standards of culture. The U.S. has established a cultural hegemony in the same places it has a dollar hegemony. This is due to the desirable jobs being in the U.S. due to the Cantillon effect. The most successful people in each country immigrate to the U.S. and sometimes even immigrate back. They are successful, and hence imitated. Such people will be more Americanized than the typical person of a country and thus, American values, particularly those of universities and corporations get exported to every other country.

In addition, the most costly movies, the most popular music and TV shows are all going to either originate from the U.S. or have a heavy U.S. influence. The reason is that the U.S. has the most money and can afford to subsidize these culture-generating industries. Practically, this means every country uses English as a second language and most people standardize towards American manners in international business.

Tendency Toward Tyranny

The tendency toward tyranny at the nation level comes from the fact that the money printer takes on a lot of responsibility and generates a lot of dependency. At a global level, this dependency manifests in alliances and the corresponding tyranny manifests in how much the U.S. dominates other countries politically.

We can see this very clearly in the war in Ukraine where the U.S. basically got most of its allies into the conflict by having them contribute arms and money. But that's not all. Socially unacceptable behaviors in the U.S. quickly become socially unacceptable everywhere else. The U.S. gets to set the culture. Indeed, this is what a lot of the WEF meetings are all about, where the elites gather to set the agenda for the future.

There's a reason why "green" energy is universally popular and why nuclear energy has been scaling back everywhere for the past 30 years. The elites set the culture in the U.S. and that gets exported elsewhere. There's a reason why transgender issues suddenly became a major protest point in many places around the world at the same time and why BLM suddenly became an issue in many places around the world only after it became a thing in the U.S. The elitist vision gets to be cast by the people who control the money and the whole world has been subject to them.

Global Fragility

Not everything about the dollar hegemony is bad. One of the benefits is that for most of the world allied with the U.S., there's Pax Americana, or peace based on America's protection. However, this peace comes at a cost. The peace is dependent on the highly-connected trade between large companies subsidized by each government. Thus, the goods that you get now probably have components from all parts of the world.

What's more, fiat money has essentially created one or two gigantic companies producing any one good, rather than lots of competitors. Thus, you get very few sources for particular goods. Computer chips of a certain lithography process, for example, are created only by three or four companies, with TSMC being the only one that can reliably produce certain types.

This is the result of the obsession with scale that fiat money produces, which I covered in previous essays. That scale does make goods cheaper everywhere and combats the obvious inflation happening, but the tradeoff has been a fragile supply chain.

We saw what that meant during COVID-19 when there was a huge disruption. Manufacturing just isn't very robust. In 2012, automotive makers were significantly disrupted when a single supplier of a specialty resin in Germany had a plant blow up.

The fragility isn't just in the supply chain. There's a global economic fragility. We saw this in 2008 with the Great Financial Crisis. If you think about it, the triggering event was a bunch of mortgage-backed securities that weren't paying off in the United States. Somehow, that caused the entire global economy to go into turmoil. The economy is so leveraged that anything going down can trigger a whole cascade of bankruptcies.

And this isn't just companies, but entire countries. And countries going bankrupt is hyperinflation. Countries that get bailed out get put under more oppression from the international monetary order.

Entire countries are being zombified, and become servants to the IMF or the World Bank and stop making decisions for themselves anymore. The fate of such countries tend to be very bleak, as they're usually run by a small cabal of elites who control everything and restrict human freedom to stay in power. The zombie countries become a shell of their former selves and the support of the three-letter organizations allows this zombified existence to continue.

Bitcoin Fixes This

The dollar hegemony that the world is under is something of a historical serendipity for the U.S., but like any skilled operator, the U.S. has taken this advantage and used it to dominate the world. The result has been an unjust world ordered on a Cantillon hierarchy that the U.S. gets to determine. The best human capital has been captured by the U.S. even as dollars get exported out. The depleted countries become zombies, serving three letter organizations as they get exploited for their resources.

Bitcoin fixes the dollar hegemony because Bitcoin takes away the exorbitant privilege of the U.S. Unlike previous reserve currency transitions, however, Bitcoin will not be centrally controlled. And that lack of central control means we will finally have a level playing field at a global scale. The zombified countries will be revived and get a chance to develop instead of being under the control of their zombie masters. Countries will resolve their own differences instead of the U.S. controlling the proceedings as a third party. Culturally, we'll get more diversity instead of U.S. domination.

Human capital will be better used because people won't have to move to the U.S. to make the most of their talent. The jurisdictions that provide the most freedom will be the most successful, not the one country that gets to print money for the rest of the world.

I'd love to end this by telling you that Bitcoin domination is at hand and that all of these changes are just around the corner. Unfortunately, I think there's still a ways to go. The dollar continues to be the backstop for every country, especially those undergoing hyperinflation and it will take a while until the inflation in the dollar is noticeable enough. For people experiencing hyperinflation, the historical U.S. dollar expansion rate of some 7% per year is a small price to pay for something stable.

The real changes will happen when the dollar has expanded so much that it's undergoing hyperinflation itself. This, unfortunately, will take a long time. Maybe this could happen quicker in a world that has two reserve currencies, say a bipolar world with BRICS on one side and U.S. allies on the other. But rest assured, when the transition away from the dollar happens, it will be quick. Hyperinflation takes a lot to get going, but once started, there's no real stopping it because there's no regaining that trust.

Until then, it's our job as Bitcoiners to get ready. And that's not just stacking sats, though that's certainly necessary, but in building the infrastructure to handle the massive wave of demand that's coming.

Hold and build because a better future is coming.

This is a guest post by Jimmy Song. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.