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Across North America, Europe, Asia and beyond, central banks are increasingly entertaining radical new methods to shore up skyrocketing public liabilities and debts, particularly in developed countries now wrestling with rapidly aging demographic trends.
These methods include currency-diluting measures, such as quantitative easing (QE), mass accumulation of government securities by central banks, and negative interest rates. Use of these tools by central banks dramatically increases the risk of government debt default, or debt monetization, and subsequent rapid inflation or hyperinflation (see: Argentina, Turkey, Venezuela).
Very recently, even mainstream Keynesians seem to be preparing central bankers for the prospect of the benign-sounding yet radical economic/currency model known as Modern Monetary Theory (MMT).
As key ideas from Modern Monetary Theory (MMT) become increasingly mainstream, it is worthwhile to consider the consequences of the government essentially printing money to finance its deficits. Recent history offers a number of lessons about what can go wrong when these ideas are put into practice, but a close look at Argentina in particular demonstrates the results of 50 years of chronic fiscal deficit spending, including hyperinflation, sovereign debt defaults and a high poverty rate.
If the proponents of MMT prevail, investors, consumers and lenders could gradually abandon rapidly inflating and unstable fiat currencies for a more reliable alternative store of value and means of transacting, such as cryptocurrencies like Bitcoin. Many cryptocurrencies, like Bitcoin itself, are finite (i.e., there is a fixed number of Bitcoin in existence) and cannot be controlled, created or diluted by a single government or organization, which makes them ideal for storing value and performing transactions. And unlike gold, cryptocurrencies can be transmitted electronically.
Simultaneously, as the traditional financial and banking system becomes increasingly chaotic as a result of potentially unstable fiat currencies, it is likely that alternative forms of business financing – factoring, supply chain financing, asset-based lending and revenue-based lending by private lenders (driven by new fintech models) – will flourish.
Together, private fintech lending paired with private cryptocurrencies are poised to revolutionize the commercial lending sector, as Europe, the United States, Canada, Japan, China and South American central banks push investors to lose confidence in their ability to shore up the value of traditional fiat currencies (USD, CAD, Euro, etc.)
- Factoring – the sale of invoices at a discount to a factoring company – is a form of financing that would thrive in an economy that relies on cryptocurrency.
- Use of blockchain technologies in commercial finance can increase transparency, facilitate legal international money transfers, lower the cost of moving money across borders, and in some cases – if regulatory bodies can keep up with the pace of the changes – eventually make money laundering more difficult.
Former Federal Reserve Chairman Alan Greenspan once famously said that the U.S. government could never default because it could “always print money to pay its debt.” That premise is one of the core tenets of what is known as Modern Monetary Theory (MMT), an unorthodox offshoot of traditional economics that states that government spending is not constrained by tax revenue or borrowing. However, traditional economic theory recognizes that an increased money supply will lead to inflation, which will erode the value of existing investments and cause dangerous imbalances in the financial system.
Recent months have seen a resurgence of MMT proponents. Congresswoman Alexandria Ocasio-Cortez said that MMT should be a “larger part of conversation” when it comes to financing the Green New Deal, free education and healthcare. Bernie Sanders’ senior economic advisor, Professor Stephanie Kelton, is another proponent who argues in her upcoming book that deficits “can be used to sustain life and build a more just economy that works for the many and not just the few.”
What exactly is MMT?
At its core, MMT suggests that large deficits can be paid for by printing money, i.e., that governments can spend freely because they can always create more money. Therefore, government spending is only limited by the inflation created when the money supply is increased. MMT is a synthesis of ideas from various economists, including German economist Georg Friedrich Knapp and British economist and diplomat Alfred Mitchell-Innes.
The United States can pay any debt it has because we can always print money to do that,” said former Federal Reserve Chairman Alan Greenspan.
Even without democratic socialists such as Ocasio-Cortez and Sanders taking power, the U.S. may already be going down the path toward MMT. The country ended the 2019 fiscal year with a deficit of $984 billion, up 26% from the previous year. It is estimated to exceed $1 trillion in 2020 as the result of a multi-billion-dollar increase in government spending.
In addition, the Federal Reserve has recently begun another round of quantitative easing (QE), despite its denial that that is what its market operations amount to. ‘QE Infinity’ (no-limits quantitative easing) dovetails nicely with MMT, inasmuch as the government continues to “print money” (i.e., arbitrarily increases its balance sheet by quite literally adding zeros within a spreadsheet field) to buy securities from the market, such as bonds and stocks, in an effort to drive down long-term interest rates, which is intended to boost private investment spending.
As of November 18, 2019 the Federal Reserve held just over $4 trillion in assets on its balance sheet, up from $3.77 trillion on August 26, 2019. If the Fed buys $60 billion worth of Treasury bills per month through the end of the second quarter of 2020, its assets will expand to $4.48 trillion, on par with December 2017. The balance sheet is likely to keep expanding for as long as growth remains stagnant.
What happens when deficits are monetized?
To understand the consequences of monetizing deficits, let us examine the example of Argentina. The article “What Should Modern Monetary Theory Learn From Argentina?” by Nicolas Cachanosky summarizes the issue well:
“Can governments run large fiscal deficits financed with new money without generating significant inflation? The experience of Argentina calls this view into doubt. As shown in the figure below, Argentina has had a chronic fiscal deficit for the last 50 years…
Like MMT advocates, Argentinian policy makers seem to think that deficits don’t matter and, by implication, that the budget constraint is not really binding. What are some of the effects of this deficit policy? There have been at least four sovereign-debt defaults … A serious crisis, known as the “Rodrigazo,” arguably contributed to the social environment that led to the military government… between and 1983. Argentina experienced hyperinflation in the late 1980s and early 1990s and a great depression in 2001. It has experienced stagflation since 2011. In fact, other than the 1990s, when it had a currency board, Argentina has suffered high inflation rates over the entire period. Meanwhile, the poverty rate (which fiscal deficits are intended to reduce) remains high.”
The Fed’s assets are projected to hit close to $4.5 trillion by June 2020 if it continues to buy securities at the current rate. Eventually, it may find it hard to stop printing money for deficit spending, which could lead to devaluation and inflation.”
If MMT-inspired policies in the U.S. have similar consequences to the ones in Argentina, then we can expect to see a flight away from fiat currency towards a more stable currency, such as Bitcoin and other finite cryptocurrencies. In Argentina— where inflation is currently above 50%—the volume of Bitcoin trading in the second week of November reached an all-time high of 19.8 million Argentine pesos (0.33 million in U.S. dollars), an increase of 139% over the same period last year.
Bitcoin has value because of the attached payment system, as well as its features, such as the prevention of double-spending, that have been proven to work over time.”
Zimbabwe is another example of economic problems leading to increased cryptocurrency use. Zimbabwe’s economy is suffering from hyperinflation, thanks to MMT-like policies, and the government has “banned the use of foreign currencies for settlement of local transactions.” These conditions have led to a dramatic increase in the use of cryptocurrency for both personal and business transactions.
If the U.S. is also affected by hyperinflation and recession, it is reasonable to imagine that people will increase their use of cryptocurrencies. In addition, people will turn to alternative forms of financing, as traditional loan systems break down within an increasingly chaotic financial system driven by hyperinflation. Instead of traditional loans, people will look to short-term financing backed by assets, such as private lending and factoring. Private asset-backed loans are based on a company’s existing inventories, while factoring is the sale of a company’s outstanding invoices at a discount to a third party, such as a factoring company or a bank.
In Argentina one can already observe these shifts through the increased use of Ripio, a cryptocurrency and payment system that recently raised $37 million in an initial coin offering (ICO). The payment system matches individual lenders and borrowers across the globe using Ethereum smart contracts.
Why does cryptocurrency have value?
According to Bitcoin advocate Jeffrey A. Tucker’s article “What Gave Bitcoin Its Value?”, a number of factors contribute to Bitcoin’s value:
”[Bitcoin’s value] is not embedded in the currency unit but rather in the brilliant and innovative payment system on which bitcoin lives. If it were possible for the blockchain to be somehow separated from bitcoin (and, really, this is not possible), the value of the currency would instantly fall to zero.”
Blockchain is a ledger of transactions which is located online and allows secure transfer of “non-repeatable bits of information from one person to any other person anywhere in the world.” No one person or organization controls the underlying blockchain, so it would be impossible for a government to simply “print” more bitcoin, like they do with U.S. dollars.
The U.S. deficit is set to exceed $1 trillion by 2020 due to a multi-billion-dollar increase in government spending.”
Unlike the U.S. dollar, which loses purchasing power with every passing year, the values of major cryptocurrencies such as Bitcoin continue to increase over time. When Bitcoin first came out in January 2009 its value was zero. By October that year, “$1 equaled 1,309.03 Bitcoin,” according to Tucker. Now, it has risen in value to $7,500.
The rapid appreciation in value was the result of Bitcoin early adopters verifying that the first cryptocurrency does what it was created to do, which is to prevent double-spending.
Bitcoin and similar cryptocurrencies:
- Exclude intermediaries in the transfer of “title-based information” through peer-to-peer (P2P), timestamped networks.
- Verify transactions by using cryptography instead of trust.
- Record transactions in an online ledger (blockchain) that allows “secure transfer” of information.
- Use “voluntary CPU power” to confirm the transactions.
What are the implications of more widespread cryptocurrency use?
As fiat currencies become less valuable, an increasing number of U.S. businesses will look to transact business in cryptocurrency. In addition, an increasingly chaotic and unstable traditional financial system will drive businesses to seek out alternative forms of lending, such as asset-backed loans and factoring.
The main consequences for businesses will include
- Cryptocurrency payment systems: Traditional payment systems based on fiat currencies, such as Visa and Interac, will be replaced by new payment systems based on cryptocurrencies.
- Cryptocurrency lending instruments: A number of startups already offer cryptocurrency loans to North American consumers. As the use of cryptocurrency proliferates, we can expect to see more companies offering working capital solutions utilizing cryptocurrencies.
- Invoice factoring on the blockchain: Factoring transactions could move onto the blockchain, which would eliminate the possibility of double invoicing and reduce fraud. In addition, the P2P nature of blockchain transactions would lower the barriers to entry for both buyers and sellers, thereby dramatically increasing the size of the factoring market.
- Smart contracts: Smart contracts can be used for both blockchain factoring and cryptocurrency loans to reduce transaction costs and lower time-to-funding.
- Facilitation of cross-border transactions: Companies all over the world will be able to find the liquidity they need using the global market.
The U.S. deficit is on track to reach $1 trillion in 2020 as the result of a multi-billion-dollar increase in government spending. Despite the increasing deficit, the U.S. government does not show a willingness to cut spending. In addition, the Federal Reserve continues to expand its balance sheet through quantitative easing. Both of these policies lead to hyperinflation and an unstable financial system, and the growing support for Modern Monetary Theory can only worsen these conditions. The consequences of these fiscal and monetary policies, as seen in the cases of Argentina and Zimbabwe, are disastrous, and include hyperinflation, recession and financial instability.
As a result, investors, businesses and consumers will shift away from the U.S. dollar and towards alternative forms of payment, such as cryptocurrency. Bitcoin in particular will increase in popularity because of its payment system and a track record of stability, including the proven ability to avoid double-spending. As the reliance on cryptocurrency increases, a shift away from the traditional financial system will occur and private lending and factoring will become more prominent. We will see that these alternative lending systems dovetail well with cryptocurrency, blockchain technology and smart contracts, which will increase the rate of their adoption by businesses.
Crypto Factors is a U.S. and Canadian working capital provider that offers factoring and asset-based working capital solutions, among other services. Contact us today to get started.
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