Blockchains, debt and globalisation: the limits to central banking in the 21st century
The global monetary system is currently subject to three major trends: high public and private debts, increasing globalisation and the emergence of blockchain technology. Models of economies as complex systems formed by individuals acting on the basis of their psychology and social position suggest it is unlikely central banks will be able to control the money supply to meet their objectives in the face of these trends. Central banks are likely to return to their original function of maintaining financial stability and acting as banker to the government.
The role of central banks is to control the money supply and influence the economy for political ends. These political ends may be financial stability, controlled inflation, strong GDP growth, low unemployment, a particular exchange rate, it really depends on the political zeitgeist. The central bank expands the supply of money or decreases the supply of money in an attempt to get people to change their buying and selling behaviour so as to obtain an economic outcome the government wishes to see.
We’ve in the past years heard much about how the European Central Bank, Federal Reserve and other Central Banks have had increasing difficulties in obtaining the desired outcomes of monetary expansion in response to the ongoing crisis of growth in the European Union and United States. They have been charging interest on their loans at historic lows (hovering around 0%) and only now are beginning to increase these rates most tentatively. They even engaged in money printing on a scale unprecedented in developed economies in liberal democracies, dressed up in the jargon of quantitative easing.
There is a deeper question emerging now of whether Central Banks will be able to continue to control the money supply for political ends into the 21st century in the face of three major trends in the monetary system. Will Central Banks be able to maintain their ability to control the money supply for political ends in the face of substantial levels of private and public debt, increasingly globalised money markets and the rise of blockchain technology?
The short answer? Probably not, except in a most restricted manner. Central Banks in the 21st century will, in all likelihood, will be largely confined to the original tasks of maintaining financial stability and acting as banker to the government. Why?
The role of substitutability
To answer our question we require more than the traditional ISLM model, for the very structure of the system the ISLM is based on is being disrupted. There is no competition between currencies in the model, there are no inter-temporal considerations of debt, and the Mundell-Fleming model which accounts for international capital flows is quite unstable. Further, the question is ultimately of a behavioural-psychological one: will peoplerespond to the actions of Central Banks in the 21st century in such a way as to obtain the outcomes the government wants? To answer this question we require a model with a structure the nature of the economy as it exists, and one which accounts for economic psychology.
Such a model has been developed at the University of Queensland of economies as complex evolving networks formed by individuals acting on the basis of their psychology and social position. It has been applied to the effect localised changes such as the change of the money supply by the central bank will have on the broader economy, and this helps us to frame our answer to the question.
The three big trends in monetary systems affect the ability of Central Banks to attain their objectives because of the effect they will have on substitutability.
The provisions which govern whether an increase or decrease in the money supply will diffuse across economic networks and cause an expansion or contraction of credit and expenditure depend critically on whether the Central Bank can attain a state of substitutability. I’ve written at some length about this critical point of economic theory elsewhere, but here it applies to whether the Central Banks’ changing of the money supply can cause people to think, given their personal knowledge, that the outcomes they may expect to follow their holding to the status quo in their behaviour will be roughly equivalent in preferability as expanding or contracting credit or expenditure.
The three major trends in the monetary system make it less likely that this will be the case in the 21st century, and therefore less likely central banks will be able to affect the behavioural change by which they obtain their objectives through control of the money supply.
High public and private debt
Take first global levels of private debt especially, but also public debt. These are staggeringly large. These make it increasingly unlikely that a state of substitutability will exist between status quo behaviour and especially an expansion of credit or expenditure. This effect is fairly asymmetric (these same debts will make it quite easy indeed to engineer a contraction of credit or expenditure ceteris paribus), but it is potent.
To expand credit and expenditure when one has high levels of debt on one’s balance sheet (public or private) relative to a status quo is somewhere between sheer stupidity and current government policy. To do so is to court the distinct possibility of bankruptcy. Even in the United States where this hasn’t quite the same ruinous social consequences as in the rest of the world, this is hardly of equivalent preferability to avoiding the necessity for liquidation or administration by maintaining current habits of credit extension and expenditure, or at least inviting it to a lesser extent.
In a world of high private and public debt, a state of substitutability does not exist between the status quo and increasing credit or expenditure, and this impedes the ability of the Central Bank to affect diffusion of behavioural change across economic networks. In the 21st century, a century which seems without a massive liquidation unlikely to be one without staggeringly high levels of debt, Central Banks will find it increasingly difficult to obtain their objectives by control of the money supply.
Globalisation of money markets
Now take the increasing globalisation of the monetary system. This makes it increasingly likely that the Central Bank will be unable to engineer a state of substitutability between the status quo and a contraction of expenditure and credit. Again this effect is asymmetric but it is potent.
The Central Bank no longer operates in an economy where funds obtained all but exclusively in the currency it controls. Increasingly and despite a brief reset during the Global Financial Crisis, global capital markets are moving ever closer toward perfect integration. Funds can be obtained from any part of the globe and exchanged between currencies in a global exchange market.
Not only do contractionary monetary policies make obtaining foreign funds more attractive for scarcity reasons, they tend to make the obtaining of foreign funds cheaper by causing an appreciation of the exchange rate. If the Central Bank wishes to change behaviour, it will need to contract the money supply to a much greater extent to obtain the point of substitutability between the status quo and the contraction of credit and expenditure. This is because there has been an increase in the availability of substitutes for own-currency funding which makes the point of substitutability between the status quo and obtaining more foreign funding more easy to attain.
It has become and will increasingly become easier to reach a point of substitutability between the status quo in funding sources and seeking alternatives in global markets which allow the status quo of credit and expenditure to be maintained in response to Central Bank control of the money supply. This has made it and will increasingly make it more difficult to make maintaining the status quo of credit and expenditure less preferable than contracting them. Therefore it has become and will increasingly become more difficult for the Central Bank to engineer a state of substitutability between the status quo and a contraction of credit and expenditure.
In a world of globalised money markets it is more difficult for the Central Bank to engineer a state of substitutability between the status quo and the contraction of credit and expenditure necessary for the diffusion of behavioural change across economic networks due to the availability of funding substitutes which might support that status quo. The actions of any one Central Bank get “lost in the mix” if you like. In the 21st century, a century which seems unlikely to be one of closed national money markets, central banks will find it increasingly difficult to obtain their political ends by control of the money supply.
The emergence of blockchain
Finally now take the emergence of blockchain technology. We needn’t concern ourselves especially with the technical aspects of the software. All we need to know to assess its impact on Central Banking is that the blockchain gives us a way of keeping a book. Each and every person has a copy of this book called “the blockchain” on their computer, and the code in which it is written includes a method for updating the book upon which everyone can agree but which, and this is vital, does not require external validation. The bookkeeping process is entirely decentralised.
The applications of this technology haven’t yet been fully explored, but the earliest application was to use the book (“the blockchain”) as a way of writing down and keeping track of how much money everyone has. The money, the earliest form, was no national currency, it was a new currency called Bitcoin.
The salient features of “cryptocurrencies” like Bitcoin are these. The blockchain technology underlying them makes them capable of being entirely decentralised, under the control of no one individual, by virtue of everyone keeping a copy of the book in which currency holdings are written down and everyone agreeing to the manner of its updating. Despite this, the cryptographic properties of the blockchain mean that the whole book is entirely anonymised unless someone’s private “key” to deciphering the parts of the book recording their transactions is known. They are fast as well, with all transactions typically being settled within minutes where some international transactions can take days. Moreover, the code supporting their keeping and updating can be written in such a manner as to increase the money supply in whatever manner desired, usually a monetarist fashion (steadily increasing at a predetermined, fixed rate).
Within the confines of the cryptocurrency at least, it is possible to maintain near-complete anonymity, it is virtually impossible for any one party to control the currency, and to trade in a currency with a very stable overall supply. They are, up to programming bugs and the possibility of backdoors, intensely attractive as currencies. They are likely increasingly attractive for the reason in particular that they are extremely difficult to manipulate.
Cryptocurrencies as a means of payment have come a long way since Laszlo Hanyecz bought two pizzas for 10,000 bitcoins. At the time of writing (5th of September 2017), the exchange rate for Bitcoin was such that these two pizzas were now worth approximately 46 million USD. They are no longer the province of blackmarket transactions, they are increasingly becoming mainstream, especially as a manner of settling transactions which in ordinary currency are subject to significant regulation and bureaucracy. They are quite possibly the new safe haven asset for holding wealth, akin to gold and silver. We can see this in the steady increase prices and volumes traded especially of Bitcoin.
Cryptocurrencies are increasingly a medium of exchange, they are a more solid store of value than national currencies for their value is not subject to the control of an external party in addition to the market, and they are even becoming more widely accepted as a unit of account. They are a new, increasingly attractive form of money.
This has the effect of introducing yet more competition into the global money market. This competition takes the form of a safe, secure, anonymous currency whose value is not subject to the control of political governments. It makes it yet more difficult for Central Banks to control the economy by engineering a state of substitutability between status quo and expansion/contraction of credit and expenditure because of the existence of an alternative funding source and store of value which only becomes a better substitute the less stable are national currencies. It is more difficult to engineer an expansion or contraction of credit and expenditure by manipulating a supply of money which is increasingly less used for credit and expenditure.
Is there a future for Central Banks?
In the 21st century, a century of high debt, globalised money systems and the rise of blockchains, it is unlikely that central banks will be able to control the money supply to obtain political ends. Is this the end of Central Banks?
Probably not. Central Banks emerged in a global environment not totally dissimilar to that of the modern era, only much slower. Central Banks emerged at a time of great competition between currencies, high debts and a fairly global financial market. It’s just that their role then wasn’t to control the macroeconomy. Their job was to act as banker to the government, and a little later to act as guarantor of financial stability by using their capital to extend credit to institutions short of liquidity.
It was only in the last century in particular that Central Banks were tasked with the additional objectives of engineering the macroeconomy in a manner pleasing to the political government. And in point of fact, we know that they have always struggled with this task, for their manner of operation is not direct. They effect the broader economy by the diffusion of behavioural change throughout economic networks. It’s a matter of psychology whether they will be successful in this endeavour.
What we have seen here is that we can increasingly expect the psychology which allows central banks to influence the economy to break down. The ability of the Central Bank to engineer a state of substitutability between the expansion or contraction of credit and expenditure by a change in the money supply is likely to break down in the face of high private and public debts, globalised money markets and the rise of blockchains.
In the 21st century, a century difficult to imagine without these attributes, it will be increasingly difficult for Central Banks to control the money supply to obtain political ends. This does not mean the end of Central Banks, but it does mean they will probably return to their original purpose of maintaining financial stability and acting as banker to the government. Central Banking in the 21st century is likely to consist of a return to roots.