The Power of the Reserve

The following thoughts were inspired by Principles for Dealing with the Changing World Order by Ray Dalio as well as conversations with fellow members of Dartmouth Blockchain. Ray's insightful book went into much greater detail than I could in this essay. If you are interested in learning more about the cycles of world order, read that.

If you are interested in learning more about Bitcoin, check out the plethora of content on YouTube and read the whitepaper.

My fellow members at Dartmouth Blockchain and I love to discuss these topics, so please get in touch any time to chat on ideas, theses, disagreements, etc.

“We are like ants, preoccupied with our jobs of carrying crumbs in our very brief lifetimes instead of having a broader perspective of the big-picture patterns and cycles” (Dalio 8). In Principles for Dealing with the Changing World Order, Ray Dalio outlines the continuous cycles that humanity has progressed through for millenia. In this brief essay, I will outline two key concepts that Ray goes into great depth about: the debt cycle and the global reserve currency. I will then analyze how Bitcoin as a decentralized, deflationary currency can help to solve some of the problems that derive from these two concepts.

The debt cycle often occurs when countries become rich then greedy and take on massive debt, often paying for consumption items/agendas that do not raise productivity or income; rich countries then print more money to pay for the debt. However, while they are taking on this debt, countries often become less productive because of the riches they have accumulated. This causes internal (national) and external (global) instability, eventually causing a collapse in the current power and reserve currency, and the cycle starts again. Inside this big cycle are smaller cycles of intense, often bloody, internal and external conflict until a new power dynamic is reached.

Bitcoin, as a decentralized reserve currency, could put an end to the vicissitudes of reserve currencies that cause mass conflict. Powerful countries would need to become smarter when considering debt burdens because they would not be able to print their way out of these burdens without destroying real wealth (purchasing power, etc). In the current fiat money system, governments are able to drive themselves into exorbitant debt because, in the short term, they can finance these expenses with the creation of more fiat currency. This works while the country’s economic output is increasing rapidly, but it is not sustainable in the long term. When this system of currency creation is no longer sustainable and inflation has destroyed purchasing power, economies collapse and countries fall into disrepair, often violently (e.g. Greece in 2010 and Venezuela in 2017). Bitcoin, fixed at 21,000,000 total coins, cannot be printed by any centralized government, and the network can be updated and upgraded by miners to allow it to be productive and steady in an era of quantum computing. This allows it to be stable yet innovative and not controlled by any centralized actor or actors. If Bitcoin were the global reserve currency and all currencies had to be backed by Bitcoin, countries would not be able to finance irresponsible financial activity because more Bitcoin cannot be created and instead must be earned or purchased.

In Principles for Dealing with the Changing World Order, Ray Dalio explains the rise and fall of three great empires and reserve currencies over the past five hundred years. He begins with the Dutch, who rose to prominence through their ingenuity with trade and shipbuilding as well as their invention of capitalism and the modern stock market to fund the Dutch East India Company. Eventually, the Dutch became gluttonous and lazy and began to outsource their shipbuilding to the English who then mastered and improved on the trade to establish their colonizing empire and overtake the Dutch as the world power. England’s status as the leading world power ended after World War II with the Bretton Woods order when the United States became the new world power and has remained since.

However, the United States has a high debt burden and relatively low expected real growth over the next ten years (1.1% per year) (Dalio 514). China, on the other hand, has a relatively low debt burden and high expected real growth over the next ten years (4.3% per year) (Dalio 518). Because of this, as well as China’s increased focus on education and infrastructure-building globally, the next shift in the world order is seeming inevitable. While the Chinese renminbi does not have significant adoption as a global reserve currency, the United States dollar has lost over 11% of its value since 2020 as of this writing in July of 2022, making it significantly less stable as the leading reserve currency. This could lead the renminbi to gain an eventual completion of the classic power cycle if it can stabilize before the dollar. It is unlikely that the United States would hand over its positions of leading world power without a fight, meaning more global conflict and suffering.

The reigns of the three great powers over the past five hundred years (the Dutch, British, and American) have all been marked by housing the global reserve currency. The Dutch were the world leading power from the mid-sixteenth to late-seventeenth centuries. Not coincidentally, the Dutch guilder was the global reserve currency for much of the seventeenth and eighteenth centuries, until the British had become the dominant global power and established a new global reserve: the sterling. The sterling held global reserve currency status until the Bretton Woods Conference of 1945, where it was determined that the US dollar would be the global reserve currency, and the US became the top global power.

This is all to say that whoever has the global reserve currency is the leading power, and the cycles caused by reserve currencies have caused mass conflict and suffering for centuries. If Bitcoin were to be adopted as a global reserve, countries may be forced to seek greater stability around spending and debt accumulation instead of accumulating loads of debt that then must be fought over or defaulted on once the reserve currency has become too inflated.

However, as Ray Dalio explains, the global reserve currency must be both a medium of exchange and a storehold of wealth (Dalio 277). Currently, Bitcoin is viewed and often labeled as “digital gold.” Gold has historically been a stable store of value but a poor medium of exchange. Regardless of its recent price swings, Bitcoin has proven to be a dependable store of value due to its scarcity and durability. However, like gold, it too is a poor medium of exchange due to its long finality times (how long a transaction takes to settle) and high gas fees (fees needed to complete a transaction to reward those who maintain the network and verify transactions).

Because the Bitcoin network currently lacks that second key aspect of global reserve currencies, one could argue that it could not act as a global reserve. However, Bitcoin maxis and blockchain-enthusiasts from around the globe are fiercely persistent and have proven their problem-solving abilities time and again. The Lighting Network is a current potential solution being built on top of Bitcoin to solve the issues of slow finality times and high gas fees. This is one of many scaling solutions being built and tested on top of and around Bitcoin. If these scaling solutions prove viable and achieve mass adoption through Bitcoin’s already strong network effect, Bitcoin will have the two components necessary to act as a global reserve currency.

To have power over one’s self, one must have sovereignty over one’s wealth. Bitcoin offers this through its decentralized, deflationary currency. The swings in global reserve currencies of history have caused mass conflict and suffering. A true decentralized global reserve currency may be the solution.

- Charlie, July 2022