Money has gone digitalMoney has gone digital. Less than 3% of currency these days is in the form of cash (coins or paper bills). I still struggle to understand bitcoin, but I have slowly come to realize that what I don't fully understand are the technological aspects of bitcoin. To understand bitcoin, you must first understand blockchain. To understand blockchain, you need to know about open-source coding, algorithms and cryptography, then you need to know about hashing and CPUs in order to understand what "mining for bitcoins" means (although I get that "mining" means solving a math puzzle and allowing transactions to use your computer). However, these lacunae in our technological knowledge notwithstanding, bitcoin is just like any other digital currency (keeping in mind that the US dollar, for example, is already 97% digital) with only one truly significant difference. Every example of money that we accept without much thought is managed and manipulated by a central bank--bitcoin is not.
Countries and companies preparing their own digital currencyMost countries have their own currencies--197 countries use 164 different national currencies worldwide--but there are only eight [small] countries without a central bank. The Financial Post reported a few days ago that last year Stephen Murchison did a presentation to the Bank of Canada on "whether or not the bank should issue its own digital money." China is preparing the launch of its own digital currency. Facebook is planning the release of Libra, its own digital money. The FP article reports that :
Switzerland’s central bank started exploring the use of digital currencies for trading. Sweden and Singapore both have research efforts underway. [ . . . .] JPMorgan is already using a digital coin and Vanguard is testing a blockchain-based currency trading system.Although these reports create the impression of a definite distinction between digital and non-digital currencies; to reiterate, most of the money we use today is already digital. Since this currency must be encrypted in order to transit over the internet, it can also be described as cryptocurrency. What distinguishes bitcoin from the crypto, digital money that we accept unquestioningly into our lives is that bitcoin has no central bank.
Facebook, China and even JPMorgan provide a central bank to manage their digital currencies. We Canadians who have been accepting Canadian Tire money since the 1950s should be at ease with corporations' producing their own money, and recognize that a company (the Canadian Tire Corporation in this case) can be a central bank. The question bitcoin raises is: "Do we need central banks?"
Central Banks: God or the Devil?Central banks are either God or the Devil depending on your perspective. Few issues are more likely to spur conspiracy theories than discussions of central banks. The claim that the Rothchild family has slowly taken over the central banks of the world regularly gets viral play. Depending on your perspective the US Federal Reserve (the US central bank) either saved the American economy from total collapse in 2008 with 100s of billions in bailouts, or it protected the interests of wealthy bankers at the expense of American sub-prime mortgage holders. Central banks are either a cabal of fat-cat bankers taking care of themselves, or they are altruistic, public-spirited individuals dedicated to serving the interests and welfare of their countries' citizens. Individuals with connections to a central bank have insider knowledge not only of monetary policy but of the financial systems and decisions of their home countries. These financial gurus tend to be in the wealthiest 1% of the 1%--which arouses suspicion. On the other hand, they help to control inflation and unemployment by decreasing or increasing the money supply, cooling down or heating up the economy. We barely note their existence until there is a major screw up, as there was in 2008.
What's the difference between the new money and the old money?The average citizen doesn't understand bitcoin because the average citizen doesn't understand money. I speak from the perspective of an average citizen. Even though I have done two posts on the subject (What Is Money? & How Is Money Created) and I am an accredited professional in understanding works of imagination, I still struggle to grasp that money, that thing which hard-core realists consider the bedrock of modern existence and survival, what we get up and go to work for, and worry about going to bed, can be such an airy-fairy, shrouded-in-mystery product of imagination.
How the Bank of Canada creates moneyI credit this Parliament of Canada website with providing a clear and succinct description of "how the Bank of Canada creates money for the federal government." The article also provides "Information about how private commercial banks create money." The first step is perhaps the most confusing. The Government of Canada produces bonds and treasury bills, which the Bank of Canada sells to private banks and other financial institutions, but the Bank of Canada also buys 20% of the bonds produced by the Government. This first step is confusing because to the uninitiated (like me) the assumption is that the Bank of Canada is part of the Government of Canada, so it sounds like Canada is buying and selling to itself. The process would seem to make more sense if the Bank of Canada was a private company, separate from the Government. In fact, the Royal Bank of Canada was first created as a private enterprise in 1934 but was nationalized in 1938.
However, in the current Canadian case:
Since the Bank of Canada is a Crown corporation wholly owned by the federal government, the Bank's purchase of newly issued securities from the federal government can be considered an internal transaction. By recording new and equal amounts on the asset and liability sides of its balance sheet, the Bank of Canada creates money through a few keystrokes. The federal government can spend the newly created bank deposits in the Canadian economy if it wishes.The entire process seems like a game of "let's pretend." "Let's pretend" you are a bank and I borrow some money from you, then I deposit the money I borrowed from you in your bank. There is no limit to how much money I can borrow from you, and it doesn't matter if you think I'm a good, reliable client or not. When I spend the money I have deposited in your bank, you take the money out of my account. Of course, you will never ask me to repay the money I've borrowed from your bank. Later, when I have depleted my account, I will just borrow some more money from you. In more adult language:
. . . the Bank of Canada's purchase of government securities at auction means that the Bank records the value of the securities as a new asset on its balance sheet, and it simultaneously records the proceeds of sale of the securities as a deposit in the Government of Canada's account at the Bank [. . . ]. No paper evidence of a bond, treasury bill or cash is exchanged between the Government of Canada and the Bank of Canada in these transactions. Rather, the transactions consist entirely of digital accounting entries.
Most of the Money in the Economy is Created by Private BanksIn the game of "let's pretend," the Bank of Canada only buys 20% of the Canadian government's loans, the other 80% is purchased by private banks and investment firms.
Private commercial banks also create money – when they purchase newly issued government securities as primary dealers at auctions – by making digital accounting entries on their own balance sheets. The asset side is augmented to reflect the purchase of new securities, and the liability side is augmented to reflect a new deposit in the federal government's account with the bank. However, it is important to note that money is also created within the private banking system every time the banks extend a new loan, such as a home mortgage or a business loan. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money [. . .]. Most of the money in the economy is, in fact, created within the private banking system.
As just described, with a click of the mouse, private banks have an asset (money in their accounts) and an equal debt owed to the Bank of Canada. Why do private banks buy or even want Canadian government debt? The answer has many names (some of which I have dealt with in What Is Money? & How Is Money Created) such as "leverage" or "the fractal banking system." The parliamentary website describes the system as "[t]he limiting rules, known as 'capital constraints,' [ . . .]." What each of these expressions is telling us is that when you go to a bank to take out a mortgage, or a car loan, or an education loan, or if you use your bank's credit card to buy a cup of coffee, you are creating money. The money does not exist until you spend it, and when you spend it you have created an asset--money in the bank's bank account.