Lessons of Modern Monetary Theory: The Failed Disruption of Cryptocurrencies
Updated: Dec 31, 2020
After scrolling through the latest FT articles looking for a new subject to write on, I came across the FT reading list and decided to start reading The Deficit Myth by Stephanie Kelton. The book focuses on Modern Monetary Theory (MMT) and how to build a better economy. I started thinking about other areas you could apply these principles in financial markets and that’s when I thought of cryptocurrencies such as bitcoin and why they have not taken off and offered the disruptive challenge to your ‘standard’ fiat currencies like that of the US Dollar (USD) or Great British Pound (GBP). Following a similar format to my previous entry, I will explain the basic theory, market trends and how the theory could offer an explanation.
Modern Monetary Theory
MMT begins by stating the national currency, such as GBP, is controlled by the UK government. The government acts as a monopoly issuer, with all other parties acting as a currency user, including businesses and households. In order to maintain ‘monetary sovereignty’ a country must not tie its currency to a scarce resource such as gold and must not borrow in foreign currency (Kelton, 2020).
A typical household would have to raise money prior to spending it and this analogy is often used when discussing government fiscal deficits. However, a government with monetary sovereignty is not constrained in the same way as currency users (i.e. households) and does not have to raise money through taxation and borrowing prior to spending. This may sound counterintuitive unless you think about the origination of the GBP notes in your wallet. The first notes must have been issued into the economy, via fiscal expenditure, prior to individuals, households or firms paying taxes. This idea was first proposed by Warren Mosler in the 1990s.
The UK government as the sole supplier of GBP does not require GBP from the population in taxes or borrowing. The government has need of real goods and services, but the only way to incentivise production is to create obligations for currency users in the form of taxation. If this is not met then provisions can be restricted in the form of schools, infrastructure and hospitals. In order to pay the taxes, individuals, households and firms must all raise the funds, by contributing to building the economy. This process operates in perpetuity with the government collecting and redistributing cash.
Cryptocurrencies are defined as a digital asset secured by cryptography. They are decentralised on blockchain networks on a distributed ledger. As they are not issued by a central authority they are supposedly immune to interference and manipulation from governments (Frankenfield, 2020).
There are many different cryptocurrencies, including Bitcoin and Ethereum. They are famed for their volatile exchange rates into fiat currency. As the currencies are not supported by real underlying assets they are subject to the full market forces of supply and demand. The currencies have often been used as a speculative investment rather than as the medium of exchange they were originally designed for. Bitcoin for example reached a high of £15,899 in December 2017 before crashing to £2,614 in December 2018 and recovering to £7,303 today (Coinbase, 2020).
Why have Cryptocurrencies Flopped?
This offers some insight into why cryptocurrencies have not challenged the traditional fiat currencies as many expected. There is a break in the chain. Although cryptocurrencies are deemed to have value, as demonstrated by the non-zero exchange rates into fiat currencies, individuals, households and firms simply have no need to hold them without tax obligations or similar essential fees. Imagine if tomorrow the government announced all taxes are to be paid in Bitcoin or Ethereum. This would start the metaphorical engine, bringing the cryptocurrencies to life. They would then be used and accepted widely. You would be able to pay for your weekly shop, a tank of petrol and perhaps your next holiday all using cryptocurrencies.
Some may argue the whole point of cryptocurrencies is to be decentralised and avoid central banks at all costs. However maybe there is something in the DNA of a currency that means it must be associated with such structures in order to hold value and because of this they will never truly be valued. This makes me think back to the Wolf of Wall Street film when Jordan Belfort is asking his colleagues to sell him a pen. At first thought you would want to try explaining the benefits of the pen and why it would be a good purchase, however we soon learn that the answer is to create urgency and demand rather to make the sale. Brad then steps up to ask Jordan if he could write his name on a napkin, but without a pen Jordan cannot complete the task so has no other option but to purchase the pen. In this analogy Jordan writing his name symbolises the necessity of taxation and the pen represents the currency.
Coinbase, 2020. Bitcoin price. [Online] Available at: https://www.coinbase.com/price/bitcoin [Accessed 12 July 2020].
Frankenfield, J., 2020. Cryptocurrency. [Online] Available at: https://www.investopedia.com/terms/c/cryptocurrency.asp [Accessed 12 July 2020].
Kelton, S., 2020. The Deficit Myth - Modern Monetary Theory and Building A Better Economy. London: John Murray.