Useful for deepening your understanding of money, its origin, and the central role of bitcoin in a future monetary paradigm. This crisp, short book is a genuine gift, and I've already made a note to reread it about a year from now to re-groove the ideas in it.
Notes:
* Considering money in "layers" as a prism for understanding our monetary system: a pyramid of layers going all the way up to base layer money or "layer one" money.
* Gold (the first layer one money) moves toward being traded non-physically: in the form of deposit slips representing the underlying gold. And those deposit slips become a type of money that can be used for exchange. Further, this is much easier than physically carrying/moving/exchanging the underlying gold itself.
* Solving the problem of needing a unified form of money, one that was less debaseable than other forms, developing the first money market in Antwerp in 1531, where there could be price discovery for various second layer money forms.
* The Antwerp bourse: merchants from around the world would come there to have final settlement, of many different types of loans, of many types of globally traded products. This was a transition of our understanding of cash moving from metal to paper, using paper money-based mechanisms of discounting and IOU/note issuance. The discounting of notes gave rise to an illustration of the time value of money, also credit risk.
* Antwerp kind of gives an indication of the success a "crypto city/country" (Miami, or El Salvador) might have if it embraced an Antwerp or a Florence model with true hard money.
* The development of promissory notes, a promise to pay the bearer the value on a piece of paper. These were direct predecessors to what we consider paper cash today, currency notes. By far the most valuable medium of exchange so far. Secondary market of these paper assets, arbitraged by interest rate.
* A few steps involved in the birth of central banking in Amsterdam: starting with what was the first joint stock company (The Dutch East India Company), the Amsterdam bourse was created by the Dutch East India company in order to trade shares in itself and facilitate a secondary market of its own shares. Next, The Bank of Amsterdam banned the holding and transacting of first layer money (all merchants and citizens had to give up their gold and silver coinage) and issued "deposits" at the Bank in exchange for these coins (!). The bank thereby monopolizes issuance of second layer money by eliminating public access to first layer money, while creating (actually stealing) that wealth by holding that coinage and issuing notes against it. (!!) The guilder then became essentially the world reserve currency for the 17th and 18th Centuries.
* The birth of the Bank of England, issuer of the world's next reserve currency. Goldsmiths fulfilled all the major roles of "banking" in England (such as it was then) around the time of the 1688 "Glorious Revolution." The need to finance war eventually drove the English crown to replace this decentralized system by capturing the role of "sole actor" between the first layer (gold) and the second layer of money.
* The English government borrowed money by issuing debt. Then, in 1694, the Bank of England was created with the express role to purchase this government debt, and then use it as an "asset" (basically collateral) to capitalize the bank itself. The bank could then make loans in second layer money which were capitalized by the English government debt. (!) This was more or less the same mechanism used by the bank of Amsterdam, except done in a friendlier way: rather than unilaterally banning private holding of gold and coinage, England actually allowed these competing forms of money to continue to exist in private hands.
* England struggles initially with bimetalism, using both silver and gold as backing. But then Sir Isaac Newton arrives at an exchange value between gold and silver which favored gold's valuation relative to silver, this gradually led to silver no longer being used as money in England--perhaps accidentally or premeditated.
* The introduction of a third layer of money: bills of exchange, payable in English pounds, which sat upon a backing of gold. These are private sector promises to pay second layer money in English pounds. "Liabilities of the private sector therefore exist on the third layer of money."
* The bank of England was initially chartered in 1694 with several 11-year expirations/renewals, then in 1742 it became a de facto monopoly over note issuance in England, then in 1844 the Bank became permanent and no longer subject to charter renewals.
* On the elasticity and fragility of first, second and third layer money. Bank of England notes are "elastic" because they are fractionally reserved (there's more second layer money than gold reserves backing it), and the supply can increase or decrease depending on lending by the Bank (and the banking system overall). This elasticity gets compounded further when private sector participants issue deposits that promise to pay out in Bank of England notes, and those deposits themselves are only fractionally reserved (third layer money fractionally reserved by second layer money, which is already fractionally reserved by gold/first layer money).
* As you get farther from the apex of the pyramid (where gold is in this example) fragility grows. Now we can see how the bank of England dealt with financial panics, or the act of people "scrambling up the money pyramid."
* For example, see the 1797 bursting of a land bubble in the United States: The bank of England suspended gold convertibility for its Bank of England notes or two decades.
* See Walter Bagehot's book Lombard Street: "In a panic, the holders of the ultimate Bank reserve should lend to all that bring good securities quickly, freely, and readily." Basically this introduces the idea of a "lender of last resort."
* Next followed the successor global reserve currency: the US dollar. The United States Federal Reserve System formalized a three-layered monetary system, with sanctioned private sector banks permitted to create third layer monetary instruments on their balance sheets.
* First, a discussion of early American money: there was a lack of coins from Europe, thus other first layer money had to be created for exchange: wampum in New York, tobacco in southern colonies (tobacco as a first layer money even had a second layer: notes promising the delivery of pounds of tobacco). Although imperfect, these examples showed that many things can serve as money, and do so successfully for decades.
* Gradually more foreign gold and silver coins started circulating throughout the colonies, including the Spanish silver dollar, later to be standardized as a (roughly) 15:1 gold/silver exchange rate. A bimetal standard.
* Note also there was much less trust among Americans of the idea of a central bank administering their currency, it was seen as the antithesis of limited government and led to a great deal of political vitriol in the early history of the USA.
* See also the US Civil War financing tool, the "greenback," which was not backed by any precious metal at all, a pure fiat money by which the Union financed its war effort.
* Then the Gold Standard Act of 1900 fixed the US dollar at 1.5g of gold (or 23 grains) and eliminated silver from its monetary role.
* The panic of 1907 which was an indirect result of the San Francisco earthquake: The Bank of England increased interest rates to attract capital away from the dollar in the face of capital outflows from insurers in England to pay out insurance claims in California. This is the crisis that J.P. Morgan "stepped in to save" because the USA at that time did not have a lender of last resort.
* [Note that this author is considerably more orthodox and considerably less conspiracy-based in his thinking compared to the author of
The Creature From Jekyll Island regarding the monetary history of the USA and the birth of the USA's Federal Reserve!]
* The passage of the Federal Reserve System in December of 1913.
* What exactly are "reserves"? It implies a safety mechanism, something to help in the case of a crisis. The US Federal Reserve would issue second layer money, in other words dollar bills, but the real asset, the real monetary construct we need to understand here is the difference between retail money, or dollar bills, and wholesale money, which is fed reserves--the latter is money made available on deposit in banks throughout the banking system. In other words "wholesale money" would be available to the banking system as a rescue mechanism.
* Initially the Fed was required to maintain a gold coverage ratio of at least 35% against second layer liabilities. At its founding, gold represented 84% of Federal reserve assets. Today it's less than 1%.
* Very quickly the original intent of the Federal Reserve was changed because of World War I: in order to finance the war effort the Federal reserve was permitted to purchase US Treasuries. This had tremendous implications for the dollar pyramid: US Treasuries thus joined gold on the first layer of money, and by 1918 the Fed's gold coverage ratio fell from 84% to less than 40% (!) and half the assets of the Fed were holdings of US government bonds. This is the first major step towards retiring gold as a layer one asset.
* 1929 crash, followed by the Depression, and the US government's forced seizure of all American citizens' gold holdings (1933's f*cking infamous "Executive Order 6102") followed by a spontaneous devaluation of the US dollar in gold terms by the Federal Reserve (1934).
* FDIC created as a mechanism to assuage depositors' fears of bank counterparty risk. The insurance levels were tiny, $5k per account only, but it was sufficient to limit peoples' desire to flee to second layer money en masse.
* The problem of Eurodollars (dollars on deposit in foreign banks--and away from the Fed's purview and control): "The monetary ambiguity of international banks issuing USD."
* "The dollar emerged as the cleanest dirty shirt in the laundry of global currencies."
* The Treasury repo market: a bank holding treasuries can borrow against them (and thus create more dollars), also a similar mechanism used for eurodollar creation, this results in the Fed losing track of precisely how many dollars are in existence; the dollar money supply had lost all measurability.
* 2007 and the great financial crisis: starts with the discussion of money market funds/short-term paper. Note that truly large investors (like major companies and the cash they hold on their corporate balance sheets) can't actually use paper (second layer) currency because the sums are too large to permit transacting in paper fiat, thus "cash" today means "cash-like monetary instruments that are safe." Money market funds bring a type of fragility to the financial system.
* [For finance geeks only] Re the section on the Long Term Capital Management debacle, note the author makes a factual error here: "At the time of the LTCM bailout, the market value of all the world's derivatives was $3 trillion. To compare, the total supply of us treasuries was also about $3 trillion. By 2007, the total supply of us treasuries increased to $4 trillion but the market value of derivatives outstanding increased to $11 trillion." This is a basic (and very common!) error typically involving two types of mistakes:
1) double-counting and
2) confusing the "market value" of an option/derivative (the price you'd have to pay to buy or close out the position) with the "notional value" (the value of the underlying asset).
For example, the price of an option could be a couple dollars, but the price of the underlying stock (think of this as the "notional capital" that could come under control of the option holder under certain circumstances) could be tens or hundreds of dollars; likewise the "value" of an interest rate swap is almost always a tiny fraction of the underlying "notional capital" involved used to derive the swapped interest payments between counterparties (a fixed/floating interest rate swap of a tens of millions of dollars would involve notional capital of perhaps hundreds of millions, even billions, of dollars). Regarding double-counting: the value of derivatives is typically over-counted by a factor of 2x because for every derivative there's a counterparty on the other side of that same contract holding a mark on his balance sheet, but the "cost" of the actual derivative nets these two counterparties against each other. The truth is, nobody really knows how much derivative exposure there really is out there but the "$11 trillion" number bandied about is likely multiples higher than the true exposure. $11 trillion sounds big and scary, but it fails a fact check.
* Dec 12, 2007: BNP Paribas freezes cash withdrawals after a rise in LIBOR, triggering "an ascent up the dollar pyramid." The Fed suddenly finds itself the lender of last resort outside the US, providing liquidity to European banks. The entire international monetary system becomes dependent on the Fed as a lender of "only" resort.
* Lehman Brothers' BK caused a "break the buck" moment at many money market funds due to holdings in Lehman Brothers commercial paper. A mere 3 cent drop from par to 97 cents.
* "Climbing the dollar pyramid" is a really good phrase.
* The Fed's response was called "quantitative easing" but we can just call it secondary money creation.
* Additional examples of the Fed stepping in to provide liquidity:
- September 2019: the Fed stepped in to backstop a dislocation in the Treasury repo market
- March 2020: several Fed moves to backstop markets due to the COVID panic.
* [If were a central banker in any country, I'd be looking for a way to hive off my exposure to the US Fed and the banking system so heavily dependent on it. Kind of analogous to being a power company interconnected with a national grid that is fragile. See for example El Salvador that wanted to offer an alternative to a dollar-based system by incorporating Bitcoin in their economy and their country's Central Bank reserves.]
* Despite all this the dollar is more deeply entrenched in the international monetary system than ever before.
* Dollars now travel around on the second and third layer of money, but US Treasuries are the only thing that acts as first-layer money in the dollar pyramid. [Pretty good deal that your own country's debt--seemingly no matter the relative quantity of it--is the thing people most want to hold!]
* Renaissance of money and the creation of Bitcoin: October 31st, 2008. As of September 2020 there are approximately 100 million holders of Bitcoin. Slightly more than 1% of the world's population. Instead of dismissing it we must ask why it has amassed such a groundswell of attention and market value.
* Bitcoin as a new first layer money, with its own monetary pyramid.
* Good review here of the central ideas behind Bitcoin the technology, how to use it, and how to think about a globally distributed payment and settlement infrastructure controlled by no one, and viewable and verifiable by all at any time, as well as a breakdown of some of the common FUDs (e.g., you can't use it to buy coffee).
* Bitcoin bull case:
- Neutral
- No leader with too much influence
- Holders cannot be coerced or blackmailed
- Untinkerability
- Peer-to-peer, outside of financial institutions
- Easily transferable
- Mimics gold as a first layer counterparty free money, but with easier transfer and verification
* Three helpful metaphors for Bitcoin: gold, land, and email:
- Gold is a counterparty-free asset
- Land is a (more or less) fixed quantity that is highly divisible, and
- Email is a simple system that works whether or not we understand how it works, where email addresses that can be shared with anybody but only the password holder can access received messages.
* We can liken Bitcoin's price to a land grab of prime real estate. "Once people finally understand the Renaissance of money taking place, the fear of missing out will become overwhelming."
* "Bitcoin is used most crucially by people [who] prefer a neutral, counterparty-free way to store money."
* "The root problem with conventional currency is all the trust that's required to make it work. The Central Bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trust to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve."
--Satoshi Nakamoto
* See also Hal Finney's quote about "Bitcoin-backed banks" creating second-layer payment systems on top of the slow moving Bitcoin itself. Incredibly forward-looking.
* "Owning physical": the act of owning precious metal (or any commodity, really) in physical form instead of in ETF/certificate form, which are only IOUs/promises to pay. This makes for an acute distinction between first- and second-layer gold. Physical = counterparty free.
* Cold storage versus storing your Bitcoin online in a hot wallet. Fidelity Digital Assets, launched in 2018. With the introduction of large Bitcoin custodians, many customers will not own first-layer BTC, and they will not hold the private keys themselves, the custodian will. "Not your keys not your coins."
* The criticism that most businesses don't accept Bitcoin as a form of payment: this is a feature not a bug: it's the whole point! Bitcoin can be used to purchase the most important commodity of all: money, in any currency you choose.
* Customer balances on bitcoin exchanges were the initial form of second layer bitcoin. Some exchanges would build stellar reputations and would have full BTC reserves against all deposits, others would not and would default on customer balances (Mt. Gox, etc).
* February 2011: the tech blog Slashdot posted an article about Bitcoin reaching dollar parity.
* Silk road ironically becomes the solution to its own FUD that "only criminals use it": "After law enforcement agencies started monitoring the Bitcoin ledger, Bitcoin was no longer the ideal currency for criminal activity, rather far from it. This disassociation boosted the legitimacy of Bitcoin in a pivotal way."
* "In 2014 the IRS determined that ownership of Bitcoin was to be treated as property and gains realized in USD terms were subject to capital gains taxes. This was an admission by the US government that owning Bitcoin was an unmistakable form of property like real estate or physical gold and should be taxed as such."
* Note the resilience of Bitcoin surviving and continuing to grow even after three separate 80% declines in price. "Bubbles don't burst three times in a decade and come back stronger each resurgence."
* Stablecoins as a second-layer asset. JPM launched a stablecoin in 2020, JPM Coin. (??? I didn't know this.)
* CME launch of BTC futures in 2017.
* CBDCs: competing second-layer monetary instruments issued by central banks, although no one quite knows how these will be constructed or the impact they'll have. The ability to give people digital "helicopter money" directly. It blurs the line between central bank monetary policy and legislative branch fiscal policy. Also could be a mechanism to auto-install a universal basic income system. (Note also the pejorative for CBDCs: government surveillance tokens, or inflationary surveillance tokens).
* CBDCs could also be an existential threat to the banking sector because the public uses third-layer Bank deposits as its primary form of money, CBDCs could disintermediate this. Also, digital currency going directly to citizens would change the concept of monetary policy and potentially disintermediate banks' role in the creation of the money supply--the central bank would interact directly with the people. So each Central Bank has to decide whether to have a "retail" CBDC that goes directly to citizens or a "wholesale" CBDC that goes directly into the banking system.
* China having certain problems in this domain because it does not have liquid capital market for its currency, nor for its government debt, and because it has capital controls and does not even have freely trading currency. China is attempting to internationalize its currency, but they are unable to and probably will be unable to for a long time: no currency can be a world reserve currency if it can't freely move in and out of a given country. Note also China's penchant (maybe fetish is a better word?) for surveillance would make accepting a global Chinese GBTC unattractive.
* "The underlying thesis of this book is that BTC will stand alone on the first layer of money in the future." And he quotes Taleb here (ironic, now that Taleb hates Bitcoin): "The resilient resists shocks and stays the same; the antifragile gets better."
* "Bitcoin is antifragile because it thrives off global monetary disorder within the dollar pyramid and is resilient to the threats, slander, and legislation from dismissive bureaucratic entities."
* Atomic swaps: this is the author's phrase for smart contracts on a layer above the Bitcoin settlement layer, the last piece of the puzzle... He thinks all government digital currencies will have to be swappable or "smart contract compatible" with Bitcoin, will experience price discovery in Bitcoin terms and Bitcoin will be the apex monetary layer for everything in the future. I wonder what this author would think about Stacks/STX?
* "...money and the state don't necessarily mix anymore. To many, the entire concept of government money is becoming obsolete..."
* Referring back to "Bitcoin Banks": In this future banks would have live capital ratios visible to everyone all the time instead of heavily window-dressed static quarterly reporting like current banking financial earnings reports.
* People will simultaneously hold an assortment of digital currencies:
- Bitcoin for neutrality,
- CBDC and/or local currency for paying taxes or collecting benefits,
- Stablecoins for earning interest.
* Many people will rely on second-layer CBDCs and do away with third-layer bank deposits altogether. "A growing number of people will survive exclusively on non-government cryptocurrencies like BTC and never subject themselves to counterparty risk."
To read:
Walter Bagehot: Lombard Street: A Description of the Money Market
Andreas Antonopolous: Mastering Bitcoin
Nik Bhatia: The Time Value of Bitcoin
Richard Ehrenberg: Capital and Finance In the Age of the Renaissance (1928)
Jane Gleeson-White: Double Entry: How the Merchants of Venice Created Modern Finance
Richard Goldthwaite: The Economy of Renaissance Florence
Thomas Jefferson: Notes On the Establishment of a Money Unit, and of a Coinage for the United States (1784)
Perry Mehrling: The New Lombard Street: How the Fed Became the Dealer of Last Resort
Nakamoto Institute: The Complete Satoshi