Innovation

The Big World Problem for Bitcoin to solve

By August 22, 2018 One Comment

This post is an analysis and explanation of the problem for Bitcoin to solve. It’s a big problem and a lot of people experience the problem.

During my time at Switch, I’ve spent a lot of time working in a Design Thinking and Lean Start-Up fashion. From this, I’ve learnt that you can set yourself up for success if you start with a good look at the human problem that a solution needs to solve.

People use money to store value into the future

As humans, we use the time that we have to create value. We create this value using our skills and talents. In exchange for creating this value, we receive money. Some of this money will be spent immediately to cover living expenses etc. and the rest of it will be saved to be spent in the future. Therefore, one of the things that we expect money to do is to transport our wealth into the future so that it can to be used by our future self. For this reason, money must function as a good ‘store of value’.

For humans, time is a finite resource. We can’t get more time so it’s important that money does a good job of storing the value that we create.

Public Service Announcement!

So, how good at storing the value that we create is present-day money? Said in another way, do we have the same purchasing power when we, at a later stage, spend the money that we’ve saved? The answer to these questions is a resounding NO!

What follows is a look at the current monetary system (central banking and government money), the expansion of the supply of government money, and how this negatively affects the vast majority of people. And you don’t even have to take my word for it because I’ve provided you with data, too.

Current monetary system and expansion of the supply of money

We live in a time of government money and central banking. Government money is the currency that the government has declared to be legal tender (examples are USD, Euro, Yen etc.). The central bank in each country is in control of the country’s monetary policy, and, generally speaking, their mandate is price stability and sustainable economic growth. Central banks work to deliver on this mandate by managing the supply of money and the interest rates.

Three big central banks in the world are The Federal Reserve in the USA, the European Central Bank and the Bank of Japan. Using these three, we can look at what the general effect of central bank policy has been on the supply of money.

Below are graphs showing the serious expansion of M2 money supply in these three geographies. A general definition of M2 includes cash and checking deposits, savings deposits, money market securities, mutual funds and other time deposits. Economists use M2 (instead of M1) when discussing money supply because modern economies often involve transfers between different account types.

M2 Money Stock – The Federal Reserve (USA)

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From 3 November 1980 to 6 August 2018, money supply went from 1592.4 billion to 14148.2 billion US Dollars. An increase of 888%.

M2 for Euro Area

From January 1980 to March 2017, money supply went from about 1.1 trillion to just more than 10.8 trillion Euros. An increase of 981%.

M2 for Japan

From January 1980 to February 2017, money supply went from about 190.9 trillion to 963.2 trillion Japanese yen. An increase of 504%.

At this point you will probably be thinking “ok, there has been a significant increase in the supply of money but so what?” The answer: an increasing money supply erodes the purchasing power of most people’s money. Let me do my best to explain how this happens.

Why an increasing supply of money erodes your purchasing power

The issue with money ‘printing’ is this. In the real world, an increase in the supply of money does not confer a general benefit on everyone. When the supply of money increases by, for example, 20%, there is no magic wand that makes everyone’s bank balance also rise by the same 20%.

In the world today, the central authority, that has a monopoly over the issue and supply of new money, dictates which specific goods and services the new money is spent on. As these goods and services are chosen, the demand for them rises in relation to all other goods and services that are not chosen. The increased demand for the chosen items results in an increase in the price of those chosen items. This price increase is explained by the economic principle that when available supply remains constant and demand increases, the price of the good or service will increase.

The consequence of the price of certain items rising in relation to others at a given point in time is that wealth and income are partially redistributed to the producers of those chosen items away from the people who produce items that are not chosen. This is because the ‘chosen ones’ can sell their items to society at a higher price than before, while still being able to purchase the items produced by other members of society at the same prices as before.

The ‘chosen ones’ will at some point then spend their new-found wealth on items produced by other members of society. The producers of the next in line items then feel a benefit of the new money but only at a point in time after the economy has already been distorted by the new money. Therefore, while these people next in line experience a benefit, it is not as exaggerated as the benefit experienced by the people who received the new money before them. And the process goes on and on and gradually the new money ripples through the economy raising demand and prices of the next in line items.

The result? An increase in the supply of money benefits the early receivers being the government, the banks and their favoured debtors or contractors at the expense of the groups that receive the new money later or not at all. Those who receive the new money later on or not at all are left with the same or similar wealth, but they are now in an economy where the goods and services that they buy are more expensive.

This reality has been termed the Cantillion Effect. You can read more about it here. Evidence that it happens is provided below.

Concentration and redistribution of wealth

After the 2008 financial crisis, central banks decided to double down and inject a lot of new money into the system.

Earlier this year, the Wall Street Journal (wsj.com) published a number of charts showing where we are 10 years after the financial crisis and as expected, the charts show a growth in the wealth and income gap. By way of example, the below chart shows the “Distribution of wealth by wealth percentile” from 2007 to 2016: –

Ten years later, the top 1% of the population owns 15% more and the bottom 90% owns 25% less of the total wealth in the USA economy.

Further evidence of wealth concentration is provided by the below graph. It shows that the Bank of Japan now owns 80% of the total volume of Exchange Traded Funds (ETFs) trading on the Nikkei, up from less than 5% eight years ago.

Summary

Human time is scarce. We use our time to create value in exchange for money. One of the functions of a money is to store value into the future – it must preserve your purchasing power.

The central banking monetary system has seen a rapid expansion of the supply of government money. This does not serve the majority of the world’s population because it results in the transfer and concentration of wealth and reduced purchasing power for the majority. Government money is not functioning as a store of value for the majority of people.

The solution to the problem

Bitcoin and its native currency, bitcoin, is a replacement for central banking and government money. The way it solves the problem that many people face will be the subject of a future post.

In closing, I’d like to make one final observation. In 2016 Donald Trump was elected as the president of the USA and a majority of British voters supported leaving the European Union. For me, both of those events are evidence of the fact that people are looking for anything that’s different to what’s currently in place because what we’ve had hasn’t worked for so many people. Will more and more people continue to choose Bitcoin over the centralised monetary system that’s in place today? I can’t wait to find out.

Disclaimer: The comments, views, opinions and any forecasts of future events reflect the opinion of the quoted author, do not necessarily reflect the views of Switch or other professionals at Switch, are not guarantees of future events or results and are not intended to provide financial planning or investment advice.

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