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June 24, 2016

Future Scenarios: Digital Currencies as the Medium of Commerce

Digital Currency

This is a ‘Future Scenarios’ post where we break down a conceptual future scenario and ask ‘what if.’  The idea is to challenge the political narratives surrounding economic development, whereby all forecasts are built on constant, linear growth, and the continuous expansion of the industrial economy without any real thought to emergent social, cultural and environmental constraints. By challenging these narratives that exist, Future Scenarios emerge that shed light on new models for growth and economic development. 

What if the global economy goes into a major recession and takes down municipalities, incentivizing citizens to hoard money and grinding the velocity of money in local economies to a halt?

In our inaugural Future Scenarios post ‘Villes to Villages and the Breakdown of Global Hub Cities,’ we talked about what could happen if global hub cities start to decompose and how the advent of future cities could result. As a next step in the thought chain around cities, we are going to construct a potential Future Scenario where the global economy goes into a major recession and cripples local economies because of the lack of confidence and capital exchange between citizens.

We will weave together the pieces of this scenario based on historical research of periods of financial turmoil and look at what modern factors make this Future Scenario far more likely to occur than central planners would like to admit. We will then look at how the emergence of the digital ether could become a catalyst to rebuild confidence and deploy capital in the form of a digital currency tethered to the blockchain.

Fundamentally, the problem with central planning forecasts in the modern era is that they are woefully inaccurate and assume constant, linear growth over the short, medium and long-term, despite the fact that a recession happens almost every decade. With levels of debt reaching historic levels for both public states and private citizens, and interest rates plumbing to ultra-lows, there are no bullets left in the gun of central planners who use the old-world playbook. That’s why this Future Scenario looks at solutions through the eyes of the everyday person and identifies a solution that can be implemented ubiquitously in cities around the world.

Depression Scrips

The idea that a city could plunge into financial abyss, crashing confidence and causing people to hoard money in the process, is not without historical precedent. It has happened regularly throughout the previous centuries. The most recent historical example was the creation of ‘Depression Scrips’ during the Great Depression in the ’20s and ’30s.

LongBranch NJ-One Dollar

Martin Armstrong, also known as ‘The Forecaster,‘ is one of the world’s greatest historians about the global economy and financial markets. According to Mr. Armstrong, multiple private currencies were created my Municipal governments during the 1929 Crisis:

“Another best kept secret of the Great Depression I have included in the upcoming book on the Great Depression & the Sovereign Debt Crisis of 1931, is the fact that there were vast amounts of private currency being issued at that time because of hoarding and bank failures.How Do Empires Die – Armstrong Economics

These currencies were called ‘Scrips’ and acted as a way to ignite the local economy in the face of a collapse in confidence in both the local and national economies:

Thus, the use of “scrip” during the 1930’s was not a new idea in the United States. During other earlier financial crises such as the Panic of 1837, the Civil War years, and the Panics of 1873, 1893 and especially 1907, many different kinds of private emergency fiat currency had been issued.” How Do Empires Die – Armstrong Economics

the-great-depression

Is it possible that the same conditions that created these panics in previous centuries exist today?

Bank Failures and Hoarding

Even after the systemic shock of 2008, many people still hold their money in banks. A lot of this faith presumably has to do with the fact that governments back ‘Too Big To Fail’ Banks, which many people interpret as a strong signal that their money will be safe even if the bank fails. But there are a few reasons that logic is fragile:

  • globally, the banks are highly interconnected – what happens if many banks fail at once?
  • many sovereign states, especially in places like Europe, are highly leveraged and are themselves suspect of being creditworthy – what happens if a sovereign state is deemed non-creditworthy?

Essentially, the banks and national governments function as one entity since the 2008 Financial Crisis. Despite the fact that banks are run privately and shareholders profit, losses are backed by the government and taxpayers; with many banks leveraged more than 25 to 1, a simple wipeout of 4% of the assets on their balance sheet takes down the whole entity. If losses are socialized and banks don’t have enough capital to guarantee losses, politicians must play a much larger role than one would expect in a free-market economy. In a large-scale crisis, like we saw in 2008, the State steps in to guarantee the Banks and that helps stabilize the financial system, paving the way for an economic recovery.  At that time, nobody would have ever thought it was feasible for sovereign states in major nations to fail – now everything is different.

Now the financial stability of the state is in question. We have seen examples of this at a small scale in recent years, first with Cyprus in 2013 and then in Greece in 2015. The solution in Cyprus was to backstop the banks via a ‘bail-in,‘ where the average depositor with over €100,000 in their account lost about 60% of their savings.  In Greece, the solution was for the ECB (European Central Bank) to backstop the state via the EU’s Emergency Liquidity Assistance (ELA) by injecting money into Greek Banks in exchange for an austerity package to be administered by the Troika. During this time period, Greek Banks were shut down and citizens were limited to €60 in withdrawals daily.

 

Cyprus Bank Bail In

In both these scenarios, the Eurozone and its officials sanctioned the action – a bail-in in Cyprus and a bank recapitalization in Greece – and provided the financial backstopping. But it came at a massive price in both cases:

Yet Christos Savvides, managing director of an advertising agency in Nicosia, the once booming capital, does not have the luxury of forgetting. Daily reminders include the rows of downtown shops that once sold luxury clothing brands but now stand empty. At one defunct auto dealership, a Renault Laguna sedan, in a thick layer of dust, is still on display behind dirty windows.” As Cyprus Recovers, Deep Scars Remain

The underlying assumption behind both decisions, which were essentially political in nature, was that it was in the best interest of the citizens to remain in the Eurozone for the long-term. The brinksmanship between Greek officials and Eurozone bureaucrats centred around the Euro and the possibility of Greece exiting the Euro. The colorful Yanis Varoufakis, who acted as Finance Minister for Greece during the Crisis, had drawn up a plan for exiting the Euro:

…the outspoken politician admitted that a small team under his control had devised a parallel payment system. The secret scheme would have eased the way to the return of the nation’s former currency, the drachma.” Greece Crisis: Yanis Varoufakis admits ‘contingency plan’ for euro exit

The actions of the Eurozone politicians and the national governments in the respective countries prevented panic, restored confidence, and helped stabilize the financial system. But it came at the cost of sovereignty. And, as we can see above, it also cost the local economies and the citizens within those economies greatly. The lack of sovereignty and the inability to stimulate new businesses, combine to paralyze a nation:

“Cyprus, too, has managed to survive, and by some measures is doing better than expected. But the economic situation remains dire. Unemployment, though falling from a peak of 16.6 percent in December, is still above 16 percent. The economy shrank 0.7 percent in the fourth quarter of 2014, compared with the previous quarter, the worst performance in the European Union. And more than half the outstanding bank loans in Cyprus are classified as nonperforming — a legacy of the crisis and a huge obstacle to growth.” As Cyprus Recovers, Deep Scars Remain

epa03495744 A woman walks past a shop which recently cleared its stock on Nicosia's Makarios Avenue, once the commercial heart of the Cypriot capital, 04 December 2012. Cyprus has been in recession for the past year, and in June the island sought financial aid from the IMF and the EU to help counter the impact of its banking sector's exposure to Greece. Cypriot President Demetris Christofias was to discuss terms of the bailout in a public address later Tuesday, 04 December 2012. EPA/KATIA CHRISTODOULOU

Which brings us back to the point. There are similarities to the conditions that were in place in the 20s and 30s during the Great Depression.  The ECB and Eurozone planners have been unable to stimulate the economy in a notable fashion, while national governments have pledged their allegiance to the EU at all costs. Local economies suffer dramatically, and without new systems to stimulate commercial activity, such as that of a Depression Scrip, citizens’ economic prospects will further diminish and many will drift towards poverty. The stakes will continue to get bigger in the EU, as now we Italian Banks are flashing warning signs.

“Forget Brexit or Grexit, €360bn of bad loans within a fragmented Italian banking sector could be the biggest threat of all.Quiet crisis: why battle to prop up Italy’s banks is vital to EU stability

Thus, it’s not crazy to expect to see bank failures and hoarding start to occur in exactly the same way it did during the Great Depression.

Chaos Theory > Digital Currencies 

“Chaos theory is the field of study in mathematics that studies the behavior and condition of dynamical systems that are highly sensitive to initial conditions—a response popularly referred to as the butterfly effect.” Wikipedia

The butterfly effect is when ‘small causes can have large affects’ leading to scenarios where future behavior is fully determined by initial conditions. The result is chaos (from a physics perspective).

The name, coined by Edward Lorenz for the effect which had been known long before, is derived from the metaphorical example of the details of a hurricane (exact time of formation, exact path taken) being influenced by minor perturbations such as the flapping of the wings of a distant butterfly several weeks earlier.” Wikipedia

The difference between then and now is that we have the technology, the blockchain specifically. The question surrounding digital currencies since the inception of bitcoin in 2008, has been: what will the killer app be for bitcoin, or any other digital currency for that matter?

The term ‘killer app’ generally assumes that we live in an iPhone utopia where we don’t need to use technology to solve hardcore world problems, but can just sit and wait for a mass of consumers to latch onto something like Facebook or Angry Birds. For the citizens of Cyprus and Greece, having a digital currency to store value and transact would have solved their problems during their respective crises.

As the butterfly begins to flap its wings around the banking system and state currencies, the hurricane starts to pick up pace around cities and local economies. If we look at what the ‘Depression Scrips’ achieved, it was to restore confidence and increase the velocity of money so that citizens were spending, creating jobs and opportunities in the process. The Wörgl Experiment, for example, began in Austria in 1932. With conditions desperate in this small town due to many families living in poverty and only 40,000 Austrian Schillings in the municipality’s bank account, not enough money to do anything, the mayor deposited the money in a local savings bank, issued the Scrip as a stamp, and paid people to do the first project that needed to be done:

Because a stamp needed to be applied each month (at 1% of face value), everybody who was paid with the stamp scrip made sure he or she was spending it quickly, automatically providing work for others” The Wörgl Experiment

The system worked and many other projects were undertaken after this to create employment and better the town. This system was able to create 12 – 14 times more employment than normal Shillings circulated in parallel. The idea eventually became so popular more than 200 townships wanted to copy the idea; however, the central bank ultimately panicked and the powers that be shut down The Worgl in 1933.

worgl_money_front

Digital currencies are being designed now so that an entity – a state, a municipality, a business, a community – can create their own digital currency. Take Colu for example, a company based out of Israel that enables entities to create and manage their own digital currency. Any municipality or state could take the Colu technology and create a digital currency to help stimulate local commerce, and track the results in the process:

“Local currencies have a broad range of positive effects on local economies, says Meiri. By keeping the money in the area, local currencies have positive effects on local economies: they support small and medium-sized businesses, increasing economic growth and creating jobs. “It also helps to build deeper connections between locals, which in turn leads to increased social capital and community involvement. Colu’s technology allows for this model to be scalable globally.” The Blockchain Could Give a Big Boost to Local Economies

The company is currently doing a project with the government in Barbados to create ‘digital dollars’ on the blockchain. This may be the beginning of a global movement towards digital currencies becoming the dominant medium of commerce for local economies. In the case of Barbados, this would be a state-backed, ‘centralized’ solution. Bitcoin and other digital currencies such as Ether, are ‘decentralized’ and have no central controlling party. There are strong applications for both, depending on the type of commerce, but with an increasing loss of confidence in the banking system and the state, those who are designing a solution to increase velocity of money and catalyze local commerce can learn lessons from the Wörgl Experiment in the 30s, where the power of the money was put in the citizens’ hands.

An Opportunity Beckons

Back to the core question.

What if the global economy goes into a major recession and takes down municipalities, incentivizing citizens to hoard money and grinding the velocity of money in local economies to a halt?

There are many indications that we could go into a global recession in the near-term, mainly:

  • the Commodity rout continues
  • China is in a precarious situation
  • bond yields are collapsing across the EU and have gone negative in major economies
  • inflation is non-existent, QE has done nothing to stimulate the Main Street economy
  • #Brexit! and the corresponding ripple effects across the EU

As we have explored above, when these conditions are in place, things can spin out of control for national economies and municipalities. When these situations happen, people tend to hoard money and the velocity of money in a local economy collapses, as was the case in the 20s and 30s Great Depression. There is no doubt, from a Future Scenarios perspective, that the above is possible.

As bad as it may sound, with the recent explosion of blockchain and the looming potential of digital currencies, there are new tools in the toolbox that give local actors the power to engage citizens and stimulate commercial activity. The desire of the state to maintain control and the banks to monopolize the money supply can only be upheld when the economy is strong, as soon as it turns down and centralized solutions fail, local governments and their citizens need to look for new opportunities that are built to be sustainable, economically viable and even fun!

Digital currencies check all these boxes. The advent of blockchain is not a trend, but a social revolution that empowers people to control more of their financial destiny; therefore, anything built on the blockchain will be sustainable. Since many of the people who designed digital currencies were driven to do so by the events of the 2008 Crisis, they are also designed to be economically viable. In the case of bitcoin, it has a deflationary design (fixed supply) so that people are incentivized to spend them, at least in theory anyways. Other digital currencies will employ their own economic models depending on their political/economic theories. And finally, digital currencies will be fun. They create engagement and enable new ways for people to transact with the businesses they love. While many are still not ready for mass-market adoption, there are many tools already that enable merchants to accept digital currencies and instantly convert them back to the local currency, meaning that local merchants will not need any clunky apparatus or advanced administrative systems just to accept them.  Systems can be deployed quickly and upheld for the long-term, enabling for an adaptive response in the event that certain factors change.

 

Decentralized Villes

The key to any city’s economy is to maintain resiliency and ensure the velocity of money remains high regardless of the cycle in the global economy. If this Future Scenario does occur, both cities and states will obviously be required to take action. But for cities, a modern-day Scrip playbook built on the back of a digital currency would enable a quick and innovative solution to be tested in the local economy. Unlike many other digital currencies in the last decade, which were managed by clunky coupons or mediocre digital apps, today’s digital currencies being built on the blockchain are engineered using sophisticated math protocols and economic theories, making them ideal for stimulating commercial activity.

In this way, cities can start to ‘decentralize’ themselves from state powers and build economic models that work counter-cyclically to major recessions, giving those responsible for their citizens’ well-being the ammo they need to reignite commerce and prevent hoarding and/or a collapse of confidence in the face of challenging financial conditions. Nobody wants to wake up in a city and see jobless youth on the street, shops boarded up or nobody transacting – by analyzing Future Scenarios, such as this one, tools can be implemented ahead of time to ensure that no matter what, life goes on and businesses blossom.

allez-y!