El Salvador’s crypto experiment could redefine government’s economic role

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If you pick up one of those books people buy to prove they are smarter than others, one of the questions you find there (or in consulting case interviews) is why are most barns painted red. The answer is that red paint is the cheapest. You then ask why. And that’s when you get to show how smart you are (more on that later).

On an unrelated note, it you are a fan of Rick and Morty (and I recommend that you are), you’d have been exposed to the Central Finite Curve that Rick used to wall off universes where he was the smartest creature in them from those where he wasn’t. Yet we see him nearly outsmarted by a Morty President at the Citadel of Ricks. How did a Morty smarter than the Resident Rick get there? Could he have leaked in from a Smart-Morty universe? DenofGeek.com speculates that this could just have been chance. In an infinite bundling of infinite universes, life finds its way, a-la Jurassic Park.

Life finds its way. In any evolutionary system with enough inputs and enough iteration opportunities, every conceivable option will eventually find its existence. Even one in which Bitcoin is the defacto currency of the world.

Bitcoin Vs Gold

So what will make that happen? I’m trying to educate myself through this note, so crypto-purists may take objection to some of my conclusions. But essentially, currency has two forms. It is either fiat (literally: declaration; an authority imbues value to a currency which imparts it the value) or pegged to something of underlying value (say the gold or silver standard). In our debates on whether Crypto is the future, we are essentially asking ourselves whether or not we will migrate back from a fiat currency to a value pegged one. It’s just that value would be pegged to Bitcoin, and not to gold, which has underlying value.

On that though: crypto futurists argue that there is no underlying value to gold either. It has value because it’s rare; and because people decide it has value. Back to red barns: the reason red paint is cheap is because iron is one of the most stable and hence most abundant elements in the universe. Fusion in stars leads to progressively heavier substances, from helium to carbon all the way to iron. Once we get to iron, fusion stops. How do we get gold then? Well – it is one of the most difficult substances our universe produces. Violently ejected as debris when a neutron star (the densest kind) collides with another, or a black hole, our entire gold reserve is literally star-dust. Bitcoin is rare too. Satoshi set this limit to 21 million, of which about 18 million have been mined. I’d argue the stars banging together process is harder. And gold has practical applications, particularly in high precision electronics.

Economic role of  a government

El Salvador’s move is an economic experiment at a global scale. It could redefine what we think of as the role of the government in an economy. The core thesis of their argument is that the level of control exercised by central governments and banks on their national economies – through monetary and fiscal policy – is unwarranted. But as economists, the best levers we have to control an economy (and hence, to protect it from unanticipated shocks) are the monetary and fiscal policy levers we have.

It gets more interesting. Globally, the currency supply to GDP ratio is about 10%. El Salvador bought 400 bitcoins before the experiment started – or about $22m worth. Their GDP is about $27bn. If Bitcoin is truly the El Salvadorian currency, the currency to GDP ratio is about 0.07% – minuscule by any standards. What would that mean for transactions? Will that drive down prices (as happens when monetary supply is limited), or contract the GDP? Will it drive the price of bitcoin up (unlikely, as El Salvador’s reserves are minuscule). Or will people find a way around the Bitcoin fiat and find other ways to transact?

Or will something entirely different happen – something we can’t predict? We could have hardly predicted that a government will voluntarily give up its currency. But in a world where Jurassic Park rules apply, life does find its way. Someone had to be the first to go and start this experiment. The key question is: what will be the lessons from this experiment? Will this be a blinding light of obviousness for our future? Will it unleash monsters we can scarily imagine? Or will this be a mutation that doesn’t fit in our world and goes extinct? Time will tell.

Thank you, El Salvador, for volunteering for this experiment.

(The author is the Managing Director of Bexley Advisors; views expressed are personal)