Gold-Backed Stablecoins: Bridging the Gap Between Crypto- Gold (Part 3)

Bitcoin.me Educational Video by Three Piece Suit Productions LLC, Michael Adamo, Dan Donaldson is licensed under CC-BY-NC 4.0

The Benefits of Gold-Pegged Stablecoins?

Most of the white papers of the existing gold-tied stablecoins exalt the perks of digital currency backed by the world’s most enduring monetary commodity. Many claim the benefits of  1:1 token to gold-backing, low transaction fees, a safe-haven hedge against instability and inflation, low buy-in requirements, low transactional costs for people living in remote areas, and the positive aspects of combing blockchain technology (convenience, decentralization, and honest record keeping) with the enduring value proposition of gold. While all these qualities are maybe enticing, the best way to demonstrate the superiority of golden stablecoins would be to compare them to other similar alternatives. 

Standard Cryptocurrency vs. The Midas of Digital Money

The most notable difference between Bitcoin and a stablecoin like Tether Gold would be the value proposition. Jeffery Tucker was bold enough to claim that the use-value of Bitcoin was a combination of trust (immutable transaction and a public ledger )and a universally applicable payment system structure. Tucker’s interpretation of the Austrian Regression Theorem (p. 407) is audacious, but can a concurrent use-value be equated to a past use value? Such an inquiry may be obtusely pedantic. However, what if a form of money could not only have the trust of a blockchain and internationally fluid payment system conjoined with the storied prior use history of gold? This may very well prove to be a superior form of money.

Beyond the intrinsic value of a gold collateralized cryptocurrency, the price stability of gold is far superior to that of Bitcoin, the highest valued digital coin on the market. As previously mentioned uncollateralized cryptocurrencies are highly volatile( 81 percent annualized for Bitcoin), with wildly fluctuating values. Some commentators have claimed that established gold-backed stablecoins such as Pax Gold have a lower degree of volatility when compared to unbacked cryptocurrencies. However, the degree of price fluctuation can also be attributed to how the currency is managed by the firm holding the gold. It would be shrewd of consumers to look for purveyors of stablecoins offering full reserve (1:1) redemption policies or limits on the capacity (to avoid depreciation). Even if an institution has lower reserve requirements, judicially implementing option clauses to prevent bank runs can help maintain customer confidence. 

Gold-Backed Stablecoins and Gold ETF Funds

Gold Stablecoins are frequently compared to Gold ETF Funds which are the darling of derivatives markets. Despite the criticisms of experts, there are some advantages that gilded Stablecoins hold over ETFs. Gold ETFs are essentially investment funds possessing gold-related assets. One key attribute distinguishing ETFs from their blockchain-based cousins is the fact that “..most ETFs, upon redemption, do not pay out by providing the precious metal; they instead provide an investor with a cash equivalent..”. In terms of liquidity, this may be a bit more simplified than cashing out a share of a gold-backed stablecoin token, as most stablecoins redeem in gold specie. However, if the point is to obtain money of “high intrinsic” value, the ETFs have to trade easy liquid for lesser money (fiat currency), in return. It would be dishonest not to bring up that gold-tied stablecoins do have counterparty risks, but that is a chance anyone takes with any third party holding precious commodities in their care. 

ETFs are purely intended to function as a speculative asset, while in contrast, the smooth settlement and distributed ledger and nationally agnostic nature of blockchain structure make tokens like Pax Gold or Tether Gold better suited for use as a medium of exchange. In all honesty, this will probably best bet for re-establishing a gold standard in the post-Bretton Woods era. The political interests of Federal Reserve officials, banks, and politicians are too embedded in the empty promises of easy money policies of the post-2008 U.S. Monetary regime. The temptation lurks for utilizing Quantitative Easing, bent beyond purely macroeconomic objectives (full employment, price stability), to fund the ends of fiscal policy. (Fiscal QE). The temptation of gesturing such a powerful bargaining chip such as open purse strings would make the idea of a fixed money supply more of an obstacle than a virtue. The number of people who stand to benefit from the current monetary policy of using collateralized debt as money makes a gold standard wide-eyed opium dream. Any transition to gold-backed currency; must come from a private currency; no government would ever revert to such a barbarous relic. It doesn’t matter even if the “End the Fed” crowd gets Ron Paul or Dave Smith in the Whitehouse, a meat grinder of the political process will drown out any monetary reforms. 

The Benefits Over Physical Gold

Beyond the benefits of tokenized gold lending itself as a medium of exchange from blockchain technology, it is worth noting that most transactions are now digital. The ease, portability, and divisibility of a digital version of gold are hard to beat; versus lugging around cumbersome bars or pressed coins or employing costly storage solutions. Like ETF exchanges, gold exchanges or reputable storage facilities may not be accessible in rural areas. There is an affordability factor; instead of buying by the gram, ounce, bar, or coin, investors can purchase a fraction of a coin for as little as $1. They are reducing the logistical and monetary costs of investing in gold. 

Bootleggers & Baptists: XLV- Baptists, Economists, Careers, & QE

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What is Quantitative Easing?

Quantitative easing (QE) is the controversial and unconventional monetary policy tool first introduced in the United States in 2008 [1]; as a countermeasure to the Great Recession. The practice of Quantitative easing (QE) is where a central bank purchases long-term government securities, corporate bonds, mortgage-backed securities, and other assets from banking institutions with newly created money. The ultimate goal is to boost the money supply encouraging lending in a sluggish economy by lowering interest rates. The Federal Reserve’s strategies for managing interest rates are divided into pre and post-financial crisis eras. Before 2008 how the Federal Reserve maintained interest rates were different (operating under a corridor system). Per the New York Federal Reserve:

Before October 2008, the Federal Open Market Committee (FOMC) communicated the stance of monetary policy by announcing a target for the federal funds rate. The Fed would then use open market operations to make small adjustments to the supply of reserves so that the effective federal funds rate (EFFR) would print close to the target set by the FOMC. This type of implementation regime that relies on reserve scarcity is often referred to as a corridor system (as explained in this article). Under this framework, depository institutions, or banks, were incentivized to hold as few reserves as possible since they did not earn interest on their Fed account balances. Reserve balances that banks held in their Fed accounts added up to a very small amount, as can be seen in the next chart. The banking system operated with aggregate reserve scarcity and relied on the redistribution of reserves in an active interbank market.

https://libertystreeteconomics.newyorkfed.org/2022/01/how-the-federal-reserves-monetary-policy-implementation-framework-has-evolved/

Amid a phase of quantitative easing, the Federal Reserve injects massive quantities of money into the economy through large-scale asset purchases on the open market, increasing the risk of interest rates becoming too low. In the post-crisis, the Fed has opted to implement a Floor System, where the central bank pays interest on excess reserves (IOER) for funds held by member banks at the Feder Reserve beyond the mandate reserve requirements. Procedurally assists with stabilizing the interest rate (Fed funds rate) even when the Fed pumps vast amounts of liquidity into the economy. The excess money held by Fed-associated financial institutions acts like an interest rate floor; through paying on IOERs the opportunity cost of holding money is eliminated. Effectively, maintaining the target interest rate. The Fed’s convoluted attempt to skirt the Law of Supply and Demand, the Federal Reserve, nothing more than an attempt to have its cake-and-it-too (avoiding a liquidity trap and concurrently stimulating the loans market).

The Baptists and Economists of QE:

The monetary establishment expresses that QE is a necessary and effective policy instrument. The promoting of this interventionist policy has created fertile ground for Bootlegger and Baptists (1983) coalition dynamics. Much of this pro-QE sentiment is perpetuated by the research of Federal Reserve economists. It is hard to pinpoint clear Baptists in the pro-QE coalition, several parties that benefit from defending the practice.

In some instances, politicians who champion QE could be viewed as Baptists, arguing for it as means of stabilizing the economy. However, politicians stand to benefit from the unorthodox monetary policy in the form of Fiscal QE (coined by George Selgin), directing the money created through QE to non-macro-economic objectives (e.g. funding the Green New Deal through QE). There is the potential of politicians assuming the role of “pure” Bootleggers and Dual Role Actors. But while QE could be used to “achieve” macro stability (full employment, etc.) and other extraneous policy goals, it operates as a double-edged sword. It is important to note that the inflation rate is a metric that matters to the voting public. Inflation has become a focal point in political discourse and is politicized (p.129-163) [2]. The next logical possibility for  Baptists would-be journalists. However,  their position on QE is “mixed”. Some outlets like to diagram the pros and cons, others are outright hostile, and some echo the positive sentiments acting as a mouthpiece for the Fed.

There is one faction in the QE advocacy coalition that unquestionably fits the definition of Bootleggers, the economists employed by the Federal Reserve. In the book Money and the Rule of Law (2021) Boettke, Salter, and Smith detail the numerous incentive problems facing Federal Reserve officials armed with “constrained digression” (CH 3; p.58-94). Pollical pressures asides; there are other reasons why favoring QE would be appealing (p.67-70), but also substantial internal pressures as well. The authors expound upon the impact of “bureaucratic inertia” on the central banks; like any other center of governance, there is a bias towards maintaining the status quo (p.64). After approximately fourteen years and four rounds of QE, the policy has become normalized. Initially, QE was an aberration in American monetary policy [3]. Favoring QE in 2022 is an example of institutional inertia, but not during QE1 (2008).

However, the obtuse and obstinate inflexibility of the sluggish nature of the Fed is far from the most troubling rationale for unwaveringly defending QE. That would manifest itself in the form of promotion opportunities. We need to consider that the Federal Reserve is one of the largest employers of economists in the United States (p.64), urging researchers to conform to internal norms of the Fed. (p.65). One paper that beautifully describes the incentives of the career concerns of Federal Reserve economists was Fifty Shades of QE: Comparing Findings of Central Bankers and Academics (2020; revised 2021). In their NBER paper, Fabo, Oková, Kempf, & Pástor found that central bankers are more likely to describe QE in sanguine terms in their research when compared to unaffiliated academics (p.15). Fabo et al. found that there was some evidence that:

“…One possible mechanism is career concerns. In principle, bank management could make promotion decisions in a way that encourages bank employees to assess the bank’s policies favorably… (p.18).

“… We find that the interaction between the effect on output and Seniority is positive and significant. A one standard deviation increase in Seniority raises the sensitivity of career outcomes to the estimated effect on output by about 50%… (p.21).

“..These could involve concerns about the bank’s reputation and, for very senior researchers, concerns about their reputation. Like career concerns, reputation concerns reflect researchers’ incentives because in both cases, a researcher derives a private benefit from reaching a particular research outcome. We have no evidence on the potential contribution of reputation concerns to our results…” (p.25).

We must not interpret this correlation between the promotion of senior economists and research validating the “positive” effects of QE as these actors intentionally manipulate the results. In the absence of sufficient evidence; making such an assessment is made in bad faith, but there is most likely a third variable connecting these outcomes. For example, Fabo et al. describe the potential of economics who end up working for the Fed having priors that make them more apt to favor interventionist monetary policy (p.4 & 25). They even explore the possibility of researchers inadvertently selecting modeling techniques that would make QE appear to be more effective (p.2 & 17).

Footnotes:

1. The initial introduction of quantitative easing in the US in 2008 was dubbed QE1. In March 2020, the US Federal Reserve initiated its fourth round of QE (QE4).
2. In Boom-and-Bust Banking (2012) (ed. David Beckworth), Scott Sumner argues for adjusting monetary policy to  NGDP targeting versus inflation targeting. A stance also advocated by David Beckworth. Sumner explains how inflation targeting is more politically appealing than a Nominal GDP target. After all, inflation is very salient, especially if you are old enough to remember stagflation. Side note, the author of this blog post was born in the late-1980s but is an avid fan of economic history.
3. The policy of Quantitative easing developed in Japan in the early-2000’s and was subsequently implemented in the United States nearly a decade later.

College: The Opportunity Cost Not Worth Subsidizing

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Despite all of the arguments for attend college, earning a college degree is not without risks.  Not every degree holds the same amount of salability on the job market.  Clearly a degree in engineering will have more utility than a Bachelors in Gender Studies. The opportunity cost of the time spent in college needs to be considered. The student actively forgoes opportunity for hands-on job training when they elect to attend college. Mirroring the costs of an unpaid apprenticeship detailed by the near forgotten French Economist Richard Cantillon (1680-1734) in his seminal work An Essay on Economic Theory.

If his father has him taught a trade, he loses his assistance during the time of his apprenticeship and is obligated to clothe him and to pay the expenses of his apprenticeship for many years. The son is thus dependent on his father and his labor brings in no advantage for several years. The [working] life of man is estimated at only 10 or 12 years, and as several are lost in learning a trade, most of which in England require seven years of apprenticeship, a plowman would never be willing to have a trade taught to his son if the artisans did not earn more than the plowmen……. The professionals themselves do not make all their children learn their own trade: there would be too many of them for the needs of a city or a state and many would not find enough work. However, the work is naturally better paid than that of plowmen. (p.41-42).

While the dynamics are not identical to a student attending college in the 21^st century, however, there are some striking parallels. Both practices are assumed to function as an investment in a young person’s human capital. A trade off forgoing income for the present, with the anticipation that this will yield higher potential wages in the future. However, based upon Cantillon’s depiction of 18^th century of apprenticeships parents were more entuned to the practical results of their child’s job training. Due to the large costs of losing help on the farm parents were more  likely to consider their child’s aptitudes and the present concentration of skilled labors on the job market. The current “college for all” initiatives have left out an important piece of information out the factual argument for promotion greater college attendance, not all college degrees are equal. On average graduates holding a degree relating to the medical or STEM fields stand to make more money than those who majored in the humanities. This fact is frequently omitted in the onslaught of appeals encouraging young people to attend college. Creating the false impression that an engineering degree is on equal footing with a degree in sociology.

The pragmatic concern of  parents during the 18^th century of an over saturated job market has disappeared. Witlessly parents are now pushing their kids to go college not for the sake of obtaining skills, but for acquiring credentials. Meaning that a college degree has turned into a signaling mechanism for employers. It’s an easy metric for qualifying potential candidates and effectively avoiding the  the legal complexities of  employment contingent intelligence testing (Griggs v. Duke Power Company). To a certain extent this signaling model for attaining college diplomas has backfired. As the number of people procuring 4-year degrees increases, invariably like another commodity its value depreciates on the market. Embodying the very essence of the most well know law in economics, the Law of supply and Demand. As the quantity of a good increase its market value  (quantified in money) decreases. The current glut of college educated participants in the workforce is exemplified by the statistics that 41 percent of all recent graduates are underemployed. Recent graduates that are underemployed are five times more likely to remain underemployed five years after graduation. The overall employment rate of college graduates has decreased from 1989 to 2019. Retention rates for 4-year institutions reached an all-time high of 81 percent in 2017. In 1900 only 27,410 students earned a bachelor’s degree. This number ballooned 4.2 million by  1940. That number has increased to 99.5 million. Demonstrating the vast proliferation of Americans with college degrees since the turn if the 20^th century.  Considering nearly 40 percent of all Americans have a four-year degree does it still hold the same value on the job market? Clearly not. This is evident when observing the statistics relating to underemployment.

The decreasing value of a 4-year degree has distorted the signaling function of  a bachelor’s degree. This precipitous decline in value is the result of credential debasement. The depreciation of college degrees has resulted from a two-pronged debasement of these ubiquitous form of credentialing.  The first form of debasement that is afflicting college credentials is an increase in the quantity of degrees. Which is analogous to the introduction of more money into the economy through fiscal and semi-fiscal qualitative easing. Based upon the Law of Supply and Demand the greater the quantity of a commodity, the lesser the value. This debasement is exacerbated by federal subsidies for higher ed, government scholarships, and government loans. These policies eliminate the financial barriers for entering college, the result being more students obtaining degrees.  On the surface, this sounds like a good thing. However, with an increase in the number of Americans holding degrees the “purchasing power” of a bachelor’s degree is greatly diminished. Leaving many graduates with no choice but to take jobs that do not require a degree.  Even most positions in an office environment working in sales or customer service do not require any college (or shouldn’t). This phenomena is particular jarring when you consider that 29 % of flight attendants, 17 % of hotel clerks, and 23.5 % of amusement park attendants hold 4-year degrees.

While the first form of debasement is a quantitative debasement of college credentials, the second variety is a qualitative depreciation.  Paralleling the currency debasement practices in ancient Rome. Gradually the silver content in Roman coins was replaced by higher concentrations of copper significantly reducing the real value of the coins, while nominal value remained the same.  The qualitative debasement of academic standards is a metric that is difficult to empirical prove.  However, many experts who believe that higher ed has been “dumbed down” utilize a lot of correlative measures to defend this assertion. Some theorists have cited a decline in SAT reading scores have being indicative of falling standards for college admissions. This talking point is far from the most damning piece of evidence supporting the claim of a dip in academic rigor. Students on average spending 400-900 hours a year on course work. In contrast, a fulltime work devotes 1,8000-2,000 hours annual to their job.  Despite the paucity of time dedicate to their studies students are currently earning higher grades than their parents or grandparent ever did. Back in 1940 the average GPA of a college student was 2.5, now it hovers around 3.1. While it would be unwise to infer causation from correlation, it wouldn’t be foolish to at least notice pattern.

Beyond the hordes of misguided parents and High School guidance counselors  urging students to go to College there is another force pushing them in this direction, public policy.  In recent years, many politicians various forms of “free college” or “student loan forgiveness” as part of their policy platform. Even some Republicans have incorporated moderate compromises to the “free college” proposals. For example, Arizona governor Doug Ducey signed (AZ SB1453) a bill that allows community colleges to offer bachelor’s programs. This measure may seem minor, it helps further debase 4-year degrees. Allowing community colleges to provide bachelor’s degrees acts as a subsidy, by artificially lowering the cost of a 4-year degree. There is a substantial difference in the cost of tuition between junior and senior colleges. Such initiatives encourage more prospective students to attend college, pushing the 4-year degree closer to being the new defacto high school diploma.