2 - The Evolution of Monetary Policy

welcome to bankless where we explore the frontier of internet money and internet finance this is how to get started how to get better how to front run the opportunity this is ryan sean adams i'm here with david hoffman and we're here to help you become more bankless hey david how's it going this is episode two hey ryan yeah this is gonna be a good one uh another really foundational episode that's really gonna set us up for some really awesome topics into the future talking all day about monetary policy the history of money

and where these two big crypto economic systems bitcoin and ethereum fit in the world of monetary policy so we're going to talk about ether and we're going to talk about bitcoin and how their monetary policy compares and contrasts and once again this is going to be an episode that appeals to everybody so this is all skill levels we're going to pause the episode and define things where it makes sense we want this to be approachable and open to everybody but before we dig in i want to tell you

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portfolio summary at your fingertips so check it out xeron.io they support a number of different wallets that you'll easily be able to sign in with and see your crypto portfolio so let's kick things off david with this question uh what is money yeah what a great question money is something that we are never really discussing actually like what it is like when somebody says what is money like they will pull out like a dollar bill from their wallet is that really money i i it's the money we use but it's not really the right answer so money is a

thing that comes out of the need to exchange so before there was money there were people that were producing goods that they needed to swap for other goods in order to have the goods that they don't produce so if you're like an apple farmer and you need a new pair of shoes you need to swap the thing that you produce apples for the thing that you don't produce with your shoes but sometimes like the shoe producer doesn't want apples or at least not as many apples as you have to sell them for your shoes and so what money is

is this other good it's this good that people adopt emergently to use so that they can trade the asset that they produce for the asset that they want money is this substrate good that all other goods go through in order to be able to exchange goods with all other people so it really money comes out of a demand for exchange you remember that uh the definition we did last episode of of protocol kind of a set of rules that's that's socially accepted and broadly

used to accomplish something i think money is very much a protocol as you said it's a it's this substrate for value exchange but it only works because we all agree that the thing that we are exchanging or the thing that we use as a unit of account or the thing that we are storing our value in is money we all have to agree on it so why can't anything just be money you know why can't i use uh monopoly money as money why can't i use

tokens from an arcade is money is there some special quality that money has yeah and you touched on it a little bit where money is something that we all agree to use so if you come to the market with your monopoly money and say hey can i buy this thing people are going to be like well no because you don't have the actual money the real money uh and so the choice of how humans have how humans have chosen money over time is a really interesting story that i think we're gonna touch on a little bit here the first and foremost requirement is that you are using the money that

everyone else is using can you can fashion your own money uh but that doesn't mean that other people use it money is the thing that everyone uses uh and and some monies are better than others we won't we wouldn't ever use something that decays as money and so that's why we've seen stuff like precious metals which don't decay uh being used as money over things organic like like cattle or apples like those are bad monies because they die so money is something that needs to persist across time so that it doesn't lose its

value and so that's that's kind of one of the basic tenets of money is that time shouldn't matter for it it's going to be money tomorrow because if it isn't money tomorrow well then you're going to get rid of it today and then that reduces its moneyness so i think economists call the quality that you're talking about the quality of durability it has to be money has to be durable across a time we can't use you know fruit as money it would decay it would rot away and it would be no good in the future as

money wouldn't be a good store value so we have to pick some sort of item that is as durable across time but but it seems to me uh there are some other qualities of money too right um we can't pick something that is uh easy to produce uh and that can be found everywhere there has to be some level of uh scarcity to money wouldn't you say and this is relevant to how money is a useful thing to act as a price tool uh

so if if i have my apples and you have a cow how do we actually measure how many apples equals one cow it's not really something that's possible especially when in the market there are hundreds of different goods and so the fact that money has inbuilt scarcity is this thing that allows us to be this meter stick of value that's what that's what one unit of money really is it's a it's a measurement of how valuable something is that's why money often has you know different denominations like one dollar

five dollar ten dollars like this is like one inch one foot one mile it's different measurements for how valuable something is and you can't have those measurements without scarcity because scarcity is the thing that you measure against you know there is there there is a only a finite amount of gold in the world and gold has historically been the money that we have used the most and so when we trade a cow for a gold you're trading a cow for one for a very specific percentage of all

the world's gold yeah it's really interesting you know i've heard it said there's only enough gold in the world to fit in an olympic sized swimming pool at least above ground gold a gold that we could use uh so there there is a scarce amount uh and you talked about that that ability to um divide the money into into specific units um economists call that fungibility it's sort of a fancy word for it so it has to be scarce it has to be a fungible it has to be durable

and lots of different monies have been used you know shells wampum stone tablets on islands but gold has has been a very popular money throughout history and i think it's because it it it has all of those uh qualities and um societies that have adopted gold it's a stronger money tech than societies that have adopted something like shells and so if you're a society and you have shells on the beach

um as money and another society comes and you know they have the ability to kind of find shells far quicker than you they can inflate your money supply and essentially destroy your society's money technology um and they can use their money technology gold to essentially drive out your bad money so there's this concept called gresham's law where good money drives out bad so that means when a better money a better money technology enters a society it will

drive out the the worse uh money because people will keep the better money uh they won't spend it they'll store that they'll hoard it and they'll spend the bad money and this happens in all sorts of societies you can see it happening even today in argentina where good money the us dollar is driving up the the bad money argentine pesos and people want to keep good money they want to they want to store it um so it's it's kind of a timeless um sort of

attribute it's a timeless i guess societal meme that we've developed this this meme of money but there have been some consistent attributes that um all money has has really provided for and uh contained so that that first type of money that gold money that um we sort of settled upon uh throughout throughout history in the 1600s and 1700s that is a specific type of money that's a commodity money those are probably some of gold's strengths the things that

we mentioned but what would you say are some of gold's weaknesses as a commodity money gold's biggest weakness is that it's it's big and heavy and you know carrying around gold is is difficult and so you either carry it in your pocket and then if you want to carry a lot of it like it weighs you down and it becomes impossible and if you want to save it in your home in your place of residence well then then you have to leave your home at some point it becomes unguarded so the more gold you have the more

commodity money you have the more it actually is required to protect it uh so if you have a sufficient amount of gold it starts to become you know you start to become incentivized to you know hire somebody to secure it and so this is kind of where the early banks came from out of a demand to need to safely and securely store your gold and so you are giving your your money to someone else you're depositing it into a bank so that uh they can store it for you uh and that's kind of one of the biggest weaknesses of gold that has

been turned in from you know a small drink in the armor to a fatal flaw of gold because now as a result of this you know over you know 4 000 years of using gold as money gold has converged upon the biggest banks in the world which are the central banks and so as a result of this weakness no one has gold in their house anymore and all the central banks have it deposited deposited in their bank uh and so this has really shifted who has control over the money from you

know the individuals who used to keep it in their pocket to the banks that have like the vast majority of the world's gold something like 80 plus percent of gold is located in central banks we talk about wells fargo as sort of an arc type of a bank on this podcast a lot and their logo is actually a um like a wagon a wells fargo wagon that was you know the the old-timey equivalent of a brink's truck you know that that's what kind of carried the gold around from one physical bank location to another

and i think that this quality that you're talking about has led to massive centralization of gold and has has led to the banking structure as we know it and so this commodity era that we're talking about this um this gold era um you know has has indeed produced the banking the the roots of the banking uh structure that that we see today but i want to pause and define maybe commodity

money a little bit more for us so commodity money has this monetary value aspect in that we use it as money but but commodity money isn't it also used outside of money so you can use gold and other things like you know we used to use gold in in dental work as an example gold can be used in in jewelry uh can you talk more about that aspect of usage

is it is it important for a money to have some sort of commodity utility outside of being a money yeah so gold is used in industry for a bunch of different reasons like as fake teeth like you said but also in wires electronics for data communication the idea of commodity money is that this thing is some tool that is usable in industry as a as a resource so commodities are typically things that are one-time use assets like

wheat or coffee or energy like the oil in a barrel these are these are things that are one-time use that produce something something useful for you like you can take wheat in industry and turn it into bread you can take oil and you can turn it into like locomotion to move your car your train your boat and so commodity money has a specific component of it that is useful in the industry now this actually turns to a big debate especially among the austrians where they think that any

money that has some sort of commodity industrial use case actually makes the money worse because what money is supposed to be is the commoditiness of it the utility of it is as the substrate and so any time the money is used for something other than money it actually weakens it like the the good that is supposed to be money is the or the utility value of the money is the fact that you can exchange it for anything anywhere of equal value yeah you just

said austrian uh right there david and you know i want to want to talk about what what you mean by that so you're not talking about austria the country right you're you're talking about something else what do you mean by austrians yeah so there is this school of thought that are is often called austrian economics and it's something that the bitcoin community has really rallied behind and it's the austrian world is a is a gold money world the opposite of a fiat money if you're an austrian you believe that

no one should be managing the monetary supply you believe that the federal reserve and their manipulation of interest rates which turns into the manipulation of the total money supply is a net negative for the world at large and humans should actually be the people that are organically deciding what money is and how to value it and having some central body that that manipulates people's choices via interest rates is a is a net negative the opposite of an offscreen is a

keynesian somebody that believes that the active management of the money monetary supply is a good tool to balance the economy in good times and bad times when the coronavirus has just triggered the fed to reduce interest rates by half a percent which means that there's going to be a little bit more money in the total economy which means people are going to spend more they're going to engage in trade more and it's going to boost the economy a little bit and some people think that's good it's it's how we got out of the 08 crisis

but austrian economics think austrian economists think that the whole reason why the 08 crash happened in the first place is that because the fed is irresponsibly managing the money in ways that that no one should have the control over so it's a really interesting debate and it's one of the things that's at the central core of cryptocurrency and cryptocurrency monetary policy wait so what are you have you picked aside are you austrian are you keynesian i tend to lean austrian uh i i don't go full austrian i don't think anyone should go full austrian but i

think their arguments are pretty compelling and that's reflected in in the crypto world at large i think the reasons why these crypto assets are valuable is because in the design of bitcoin and ethereum is inherently austrian beliefs where these things the the monetary policy of these things is determined by a computer protocol not a group of 12 people behind closed doors that no one elected and we'll get into this a little bit more in the episode but i i think if you

go to any one end of the spectrum you're definitely wrong so a balance of being able to manage the money supply while also having it mostly out of the hands of humans is a pretty good answer i think i resonate with that particularly about the balance and i think um we have veered the balance in a in the wrong direction so the teeter-totter is is completely skewed towards um the fiat money uh the keynesian perspective and it's becoming uh more and more keynesian

as the years as the years go by the 2008 crisis prompted government intervention central bank intervention uh that we haven't ever seen before new economic tools like quantitative easing which we don't have to define here but these new tools central banks haven't plot deployed are really untested so we're in uncharted waters in in keynesian country and uh there's really no backup to the current system that we have which is which is a

bit what the bankless and the crypto system provides is is backup a parallel universe um in case the keynesian system goes wrong and the keynesian system can definitely go wrong uh look just look at what happened in venezuela they the government tried to print their way out of a crisis and it ended up just digging the crisis even deeper the ability to freely print money is very dangerous the ability to the ability to freely

print money is very dangerous even the most responsible humans fall to the temptations of printing money austrian economics says why even have the ability to be tempted by this power let's just have a money that no one can have the control over let's remove the temptation and i and i think that's fair and a good illustration as to how dangerous money printing can become operation bernhard was a plan that the nazis in world war ii were going to were thinking about doing to the british economy uh their their plan was to drop

billions and billions of british banknotes that would effectively be money they were going to just drop a bunch of money on top of britain and it was going to hyperinflate the british monetary system what they were going to do is they were just going to drop so much money on top of britain so much fake money that it was just going to destroy the economy the value of the money would be worthless and so it kind of illustrates that the ability to print money it is a weapon of mass destruction it really takes a lot of faith in these like 12 people behind closed doors that they are

not going to you know press the hyperinflation button so we've talked about commodity money and gold being a representative of that but the centralization that we were talking about earlier led towards a different type of money something that we might call representative money and maybe that's best embodied in the us dollar so can you talk about kind of the the origins of the dollar and how it was originally backed in this representative

money era so when you are working in your field and you are producing a bunch of wheat you need a place to store that and so what you do is you go to a granary or some some store of the local economy's assets and then you put in your wheat into the the store and then whoever's managing this gives you some thing in return as a credit like a piece of paper you speak clay tablets and this thing that you got this piece of paper or this note that you got back was a

credit for whatever you deposited which means that you can go about your day do whatever you want you can come back to that that bank that granary and you can give them that piece of paper and then receive your whatever you deposit it back now it can actually be something different that you it can be a different bunch of wheat or a different basket of apples it doesn't matter because you deposited 10 apples and so you get 10 apples back that's what the note that you were given says but you can also take this note elsewhere in the world and you can give

it to somebody else and so you can go to the local blacksmith and say i would like a sword i deposited 100 apples and you can go get 100 apples worth of stuff out of that same bank and if you could take this piece of paper you'll you can make me a sword and that's the very beginnings of what we call fiat money or or paper money where the the bank where people are depositing all their value gives people a receipt of that deposit which is much more efficiently communicated as a piece of paper with

writing on it and that receipt is able to be given out to the rest of the world because it's just much more efficient instead of having to carry your gold everywhere just carry a piece of paper that says that you own gold and you can give that to anyone and that is the new money that is the the paper issued money and that's kind of where that humans created and or engineered their own money rather than uh emergently selecting gold they said okay well we'll use gold as deposits but we're going to use this paper money which is a receipt

for that gold and we're going to use this money out in in the world and this is the genesis of banks this is how banks came to be in the first place yeah absolutely so we we kind of moved from from commodity money where everything is gold to the banks have to store the gold and so what they do is they issue notes pieces of paper ious for the gold that they're keeping and these ious become an early form of fiat we might not call it fiat yet just maybe fiat

light but it's really representative money because each of these notes represent a dollar that you can go to any bank uh in in the cu in your country to or maybe across the globe and get that gold out and so this representative money these pieces of paper uh become the money that circulates in the system and that representative money system uh really lasted into the into the 1800s and early 1900s

until something happened which is uh bretton woods do you want to talk about bretton woods and the next era of money bretton woods was this event after world war ii where all of the remaining powers in the world came together in bretton woods new hampshire in order to decide what the international monetary policy should be after the breakdown of the world in world war ii uh and so every economist from all over the world decided came to you know the same room and just hashed out what the world is

going to be and there's a famous fight between john maynard keynes from keynes economics economist that we talked about earlier and and harry dexter white uh keynes is from britain harry dexter white is from the united states it's a really interesting story there's a planet money episode that i'm going to link in the show notes that walks you through this but basically what happens is at the end of bretton woods it's decided that the us dollar is going to be the dominant currency across the whole world and the reason for that is because the american

economy is largely untouched uh there was no actual fighting in world war ii inside the united states and because places like britain and france had paid united states all of their gold to supply them with supplies in the early part of the war the united states had all the gold in their vaults they had the gold in their central bank and so the united states really had the leverage here they said well you know our bank has all the gold so our banks paper money note receipts that we issue

aka the dollar is going to be the the currency of the world and that was the resulting decision of bretton woods that the united states dollar is going to be the currency for the world now at this time one dollar was always backed by a bunch of gold and so if if other countries in the world had a bunch of dollars they could come bring that to the window at the central bank and they could exchange that dollars for gold and so that's the the dollar at this point it still represents its value in gold there's a hard peg of 35 dollars to one ounce of

gold that the united states central bank promised to uphold as you may know now that door that window is closed they no longer accept 35 for any amount of gold to anyone yeah so let's talk about that so so you know but first like the quick recap we had gold commodity money that's centralized into these banks and turned into ious for the gold that's representative money but still there there were many forms of these ious each of the countries had

their own gold reserves but after world war ii that further centralized into u.s control because it turned out that the us bank had the power had all of the gold uh and their currency the us dollar could be the representative money uh for the world and that was determined by a small group of people uh in uh in that bretton woods meeting that you mentioned but it's still representative money so the us dollar

was backed by some measure of commensurate gold in um fort knox and the various places the u.s government stores its gold reserves until until something else happened uh so can you talk about the the next event where we move from representative money to a full-on fiat money system yeah and this to me is just so telling that humans do not belong behind the driving wheel of money this this is the big argument for

why no one should be in charge of what money is or how it works so bretton woods was in the 40s post-world war ii and in the 70s we go to war with vietnam it's a very expensive war and frankly the united states doesn't have the funds to really keep it up even though for some reason we want to continue with this war and so what nixon does is he starts printing money so the way that we finance this war is through printing money the us government starts to spend

money it doesn't have and this is where inflation comes from the increase of the monetary supply of the us dollar goes up which means that every other us dollar goes down remember money is a measuring stick it's a measuring stick of value and the value of the world doesn't go up when you print more money it just makes actual money go down in value what money printing does is it just allows whoever has the ability to print money to take

money from everyone else and put it in or take value i should say from everyone else and give it to themselves so they're printing money david uh the us government is printing their us dollars without the ability to print gold to back those dollars is that right that's totally right and that's that's the fundamental flaw of human generated monetary systems the austrian economist belief is that if someone has the ability to print money then they will print money because of incentives the the world is all about incentives

and if you give the ability to for someone to print money they are automatically incentivized to do so because i mean wouldn't wouldn't you do that ryan if you had a little money printer in your house like i would i would print some money every single day i would go out and i would print a hundred dollars and buy a nice steak lunch and i would do that repeatedly no one should have that power no one should have their own personal money tree where they're just continuing to grow it so so okay so so what happens then so the us is printing money wouldn't wouldn't that cause the u.s dollar to inflate people

realize that uh wow this these dollars aren't actually backed by anything um they're worth a lot less than they should be and so the us dollar inflates becomes worth less over time like what happened there right so the the window at the federal reserve allows for the exchange of 35 dollars for an ounce of gold when the us government decided to print more money well then there is going to be more dollars than there was in the central bank and this starts to upset a lot of european countries they're saying

well you know the the dollars that we have in our banks are becoming uh worth less and so we're going to go and take these dollars to the federal reserve and swap them out for gold and so during the in the middle of the vietnam war the very expensive war the supply of gold in the central banks was was being withdrawn it was being withdrawn from other countries because other countries didn't want to hold the dollars and so this goes back to what you said earlier where people will always leave the bad money for the good

money and when the central bank was printing a bunch of money during the 70s they were making the dollar bad money and they were incentivizing everyone to swap out their dollars for the good money which is gold but nixon was having none of it so in 1972 he closed down the gold window he said there's no more exchange for us dollars and we essentially defaulted on our commitment to have our dollars swapped out for gold and we did this because we had the power to that's what happens when the dollar was at the center point of the world