Could Bitcoin Affect Emerging Market Monetary Policy?

Federal Reserve Bank of St. Louis Vice President, Dr. David Andolfatto, is optimistic about Bitcoin, as an alternative currency could impose limitations on the ability of governments to raise revenue through money creation.

“In some countries”, the former professor says, “the ability for a central bank to print money is a significant source of revenue for the government. It’s not the case in the U.S. or developed countries. But in underdeveloped countries, where you don’t have a well-developed tax system, and still a relatively large fraction of the population living in the countryside, an alternative to collecting taxes is through the inflation tax. That is, to print money”.

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Dr. Andolfatto, who posts his thoughts on the Macromania blog, doesn’t take a qualitative position on the inflation tax. “If a government does it to build a hospital for sick children, it’s arguably a good thing,” he points out. “If it does it for military hardware for evil friends, it’s probably bad. Either way, if a government finds itself fiscally constrained, it’s going to want to start printing money at a faster and faster rate. 10 percent in the first year, then 20 percent a year, 30 percent, and so on. At those rates, it becomes costly to hold cash because it’s losing its purchasing power very rapidly”.

In such circumstances, people tend to seek out money substitutes or alternative currencies like gold, the US dollar or bitcoin. Recent examples include places like Zimbabwe and Venezuela.

“What people do in high inflationary and hyperinflationary circumstances is seek alternative or competing currencies,” Dr. Andolfatto tells Bitcoin.com. “This could be the U.S. dollar, gold and things like that. Governments and central banks often then impose currency restrictions, maybe by implementing laws keeping people from opening USD denominated bank accounts.”

It’s not so easy, however, for a money printing central bank to stymie capital inflows into digital currency.

“Enter Bitcoin, where any kid with a phone and access to the internet can now access this alternative cryptocurrency not under jurisdiction of any government, because it’s accessible through the internet,” the Vice President explains. “The only way a government could really crack down on it is through draconian measures, essentially shutting down the internet in the country or confiscating everyone’s personal devices.”

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Provided a government doesn’t go so far, Dr. Andolfatto believes Bitcoin could promote central bank moderation in fiscally strained countries.

“You can see how this competing currency might impose some sort of discipline on a central bank in the future if Bitcoin becomes more popular, and is more widely used in, say, a country like Venezuela,” he says. “This potentially precludes the ability of a central bank and government to over-inflate the currency.”

This alternative currency could have implications for central bank policies in other jurisdictions in the developing world, according to Dr. Andolfatto, whose interests are in banking, money and payment systems.

“You’ve always seen competing currencies emerge, the only difference is this one is digital and through the internet,” he notes. “To the extent that Bitcoin is available, to the extent bitcoin has zero inflation, people are going to be asking themselves, ‘Why should I accept this bolivar for my labor and goods when the bolivar is depreciating at a quick rate? Why don’t I just accept bitcoin with my phone and payment address?’ In that matter, the population substitutes out the domestic currency, the bolivar in this case, and starts to ignore it. It becomes valueless or is driven out of circulation and the economy switches to bitcoin or some other substitute.”

So, if no one wants the bolivar, Venezuela’s ability to extract an inflation tax then goes to zero. “[A government’s] ability to acquire goods and services by printing money depends on people accepting money,” Dr. Andolfatto elucidates. “If no one accepts bolivars, only bitcoins, then the central bank and government are going to be out of luck”.

He adds: “If central bank and government understand the threat of this currency substitution, they are not likely to increase inflation rate. They will keep the inflation rate lower than it otherwise would have been, and will be able to extract less inflation tax revenue because people could dump the bolivar and substitute with bitcoin”.

Dr. Andolfatto, notably, doesn’t believe Bitcoin represents an entirely new phenomenon altogether.

“Central banks have been under threat of currency competition since the beginning of [central banking history],” he tells Bitcoin.com. “Currency competition is arguably a good thing. It’s been a good thing. There is nothing to prevent anyone from paying someone in pesos here in the U.S. The same is true for bitcoin. And bitcoin is a de facto foreign currency as far as central banks are concerned.”

Why do you use bitcoin? Let us know in the comments below.

Images courtesy of Shutterstock, St. Louis Public Radio, 

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