Bitcoin and Gold: Hard-Cap Currencies During Financial Crisis

What would happen to Bitcoin economy amid the financial crisis caused by the coronavirus? Right now, we don’t have a definite answer. However, we can get insights on how Bitcoin may perform during financial crisis by looking at a proxy: gold.

Bitcoin has earned a name of “digital gold”, mostly due to its low issuance supply schedule and a hard cap of 21 million Bitcoins. In turn, theory on how a gold-based economy would perform during an external shock like the current global pandemic provides us a look at a future Bitcoin economy.

Both Bitcoin and gold gained in price after news about the U.S. Federal Reserve distributing an indeterminate amount of aid to the private market in order to counter the financial crisis. In terms of supply, both assets are unchanged while the Fed desperately tries to outrace COVID-19.

On March 23, the central bank stated:

“The Federal Reserve will continue to purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions.”

Such a policy may raise inflation concerns, as infinite supply decreases the value of the U.S. dollar. What would an alternative look like? What would the macroeconomic story be in a world where Bitcoin or gold dominate as a medium of exchange?

Gold during financial crisis

For one, the value of a gold-based money would not be prone to artificial inflation, according to Mark Thornton, Austrian economist at the Ludwig von Mises Institute. (From the other hand, mainstream economists are concerned that central bankers will have far fewer opportunities to curb financial collapse).Like any market, gold’s value is defined jointly by supply and demand but it is naturally limited to the amount supplied in a given year. On average,the amount of gold mined annually hovers about 2% of its total known supply.

Indeed, the price of gold has increased in recent years mostly because gold is priced in dollar terms, Thornton maintained. As the amount of dollars on the market increases, the same happens to the gold’s price.

In addition, gold — a safe-haven asset — is used as a hedge on inflation in financial crisis situations such as the current one. In the long run, Bitcoin enthusiasts like Messari co-founder Dan McArdle believe that Bitcoin’s conservative features will bring it long-term value similar to that of gold, which will mean similar performance during financial crisis.

For Austrian economists like Thornton, gold’s value comes down to the economic theory first outlined in Principles of Economics (1871) by Austrian school founder Carl Menger. In short, Menger postulated that everyone determines value subjectively while a society creates a price one can buy or sell on the open market.

Gold’s value is readily demonstrated by is use as a store of value, especially during financial crises or recessions.

Thornton stated:

“The supply schedule for gold is relatively stable. The quantity of gold supplied is a response to the demand for gold and its price.”

A gold-based economy

But what is the difference between gold-based economy and our present-day one? A stable medium of exchange would make people be more responsible with their money, said Roy Sebag, co-founder of precious metal custodian Goldmoney.

This responsibility would lead to two outcomes: A stable money supply would make it difficult to pile up big corporate debts, decreasing the threats of a 2008-style financial crisis. But it would also help distribute wealth across the economy more efficiently than current systems do, Sebag maintained.

First, Sebag noted that a fiat-based system which is known to inflate the currency to hedge against business fails leads to companies taking out too much debt. (Think about commercial airlines buying back stocks in heady times as opposed to investing in their services, which may be regarded as a moral hazard.) Sebag stated his point can be readily sen on Capitol Hill today — where Congress is considering a multitrillion-dollar stimulus package with protections for companies like Boeing.

Sebag said:

“Under a gold monetary standard, leveraging a balance sheet in any circumstance is a risky proposition.”

There would be a place for failures — but they would not become this massive in the first place. “Failure happens often and resilience becomes the integral ingredient in defining prosperity,” Sebag said of what a gold-based system would look like.

Second, if people were able to plan financially on long time frames, then retirees would not have problems in every economic turmoil. Sebag went as far as to claim the elderly would accelerate the economy during a recession, not be crushed by it.

Indeed, the Dow Jones Industrial Average has lost more than 30% since its peak in February 2019. Many people see their retirement plans underwater.

A gold economy, according to Sebag, would allow people to build plans for the future with a central metric: the interest rate.

Historically, Sebag said the natural interest rate — meaning the cost of future money when not set by a government — kept at about 5% level. Compare this to the rate-by-decree coming out of the Federal Reserve and periodic percentage drops: It’s difficult to plan for the future when you can’t predict the price of your assets in six months.

Two extremes

A Bitcoin economy is laughably far away from a mainstream adoption — even more so than a gold-based economy. Bitcoin’s market cap is below $200 billion while the Dow reached as high as $8 trillion in December 2019. Gold’s current market cap is about $9 trillion.

Yet, a savings-based economy such as gold or Bitcoin would be more attractive during financial crisis.

Thornton noted:

“In a gold-based economy without interest rate manipulation, taxes and so forth, people would have much more savings and far less debt. But now, with the Fed and paper money inflation, we have very little savings and gargantuan debt.”