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An (admittedly naïve) answer to the Bitcoin Bubble

Posted on July 20, 2018 by Siddharth Jamad  | Academics | Blog

The most important economic event in history—that is, if there is such a thing—is The Great Depression. The economic collapse of the 1930s, in challenging the monetarist assumption that markets are self-correcting, necessitated an economic institution that supervised and managed crises. And so, the central banks.

There is no robust definition of a central bank. Yet, among economists, it is generally accepted that a central bank is a bankers’ bank. It sits at the top of the hierarchy of financial institutions, and its aim is to secure monetary stability in an economy. It achieves this by pursuing an appropriate monetary policy. And, the fact that it is a monopoly currency-printing agent which also exercises a significant influence over interest rates, makes it capable of slowing down and speeding up an economy in the ways that it does. But, what if central banks weren’t the sole controllers of money supply? The Bitcoin bubble throws the exact same question at us.

Bitcoin, whose stock price has got, well, most of the investors excited, threatens the global financial system not only as a currency, but also as an asset (i.e. as a stock). Though it brands itself as a “currency”, it fails the very definition of money. Sure, it is a medium of exchange, but, owing to the considerable volatility in its price (in terms of fiat currency), it fails to be a store of value. Moreover, it accomplishes no useful function in addition to those of digital currencies. On the contrary, it has some severe shortcomings—it is decentralised and its transactions are anonymous. This supports the mushrooming of a parallel black economy, as the recent reports have already confirmed. In addition, central banks have little to no control over the supply of Bitcoin. This implies dilution of their influence over price stability and exchange rates. Therefore, owing to its economic drawbacks, Bitcoin “can never (and should never) become a permanent part of our financial system,” (Robert Shiller). And so, to prevent any more investment from being sucked down the Bitcoin stock, I, as the RBI, would burst this asset bubble at the earliest. Because, as Keynes argues, “the market can stay irrational longer than you can stay solvent.”

I would place a ban on transfer of money from bank accounts to Bitcoin accounts. This move directly targets the “currency” problem. As for the “asset” problem, I would turn to the Bagehot principle: lend without limit, to solvent firms, against good collateral, at 'high rates'. Reasonably higher interest rates would make loans banks’ “self-liquidating assets”. In other words, people would not use loans for speculative trading, as is the case with Bitcoin stock, since the cost of doing so would be higher than before. On the other hand, “against good collateral” would ensure that only creditworthy entities, whose solvency can “take a hit”, would borrow money for investing. This would also protect banks, who would have the collateral to turn to should the bubble burst and investors turn bankrupt. And, although the economy as a whole would suffer some deflation, or, as must be the case with India, “disinflation” (a welcome side-effect?), it can be restored to equilibrium with moderate rounds of quantitative easing once the bubble bursts, and the misaligned asset markets in general correct themselves.

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