Feynman diagrams are a way of understanding state interactions and changes in subatomic particles. In this post, I use simple diagrams to understate state interactions between different types of money. The title of is inspired by Michael Crichton's explanation of how he coined the phrase "Gell-Mann Amnesia" as I wrote about before: Name dropping a famous physicist bestows gravitas. So now that I have your attention (if not respect), let's draw some diagrams.
Current era
The picture that is worth a thousand words. If you understand this picture no need to read this post.
Gold Standard
But to put into historical context, here's what the picture looked like in the late 19th and early 20th centuries.
Post-Bretton Woods
And here's the world that evolved in the mid 20th century.
In the original Bretton Woods agreement, from 1945-1971 the major currencies continued to be theoretically pegged to gold. But that was increasingly theoretical. Ordinary citizens did not have automatic convertibility. Eventually, convertibility stopped completely in 1971. So that's what I'm showing here.
Legend
In each of these diagrams,
- Solid lines represents easily exchangeable value.
- Dashed lines represents flows with barriers e.g. currency controls.
- The direction of the arrows represents where value "wants" to flow
What determines the directions? Two principles
- Inflation: people prefer strong money to weak money. Strong in the basic sense of future purchasing power for real goods and services. Of course all else is not equal, so sometimes a weaker currency is required as a means of exchange.
- Permission: all else being equal, people prefer money that they can use without permission. Of course all else is not equal, for example physical cash is great for permissionlessness. But it's not the best for long distance exchange or storage.
Hard/soft and strong/weak currencies
"Hard currency" traditionally meant the money is made of, or directly convertible to, gold, silver, or some other hard to produce commodity. The natural scarcity provides inflation resistance. This link faded in the 20th century, but it still persists in for example central banks gold reserves, which help "back" the value of their currencies. But there is no guaranteed convertibility. It is money by fiat.
The US Dollar for example is no longer a hard currency in the traditional sense. The scarcity is not given by nature, but rather by monetary policy (i.e. politics), which in practice is almost always inflationary. In the last 80 years, there have only been 2 years in which the US CPI change was negative. 2% inflation used to be the target. Now the target is creeping up to 3%. Everyone expects one dollar will buy less stuff on average in the future than it does today. We are now so deep into the post-hard currency world that nobody even expects to keep savings in dollars. The very idea seems quaint. Bury dollar bills in your backyard? Your mattress? It is accepted that to store money for the future, you have to invest it. And of course investing is work. As Bitcoiners like to say, with fiat you have to work twice for your money, once to earn it and again continuously to keep it.
But the USD is strong compared to the many weak fiat currencies at the bottom. Everyone expects these units will lose value faster than dollars. Instead of 2-4% being normal, it's more like 15-30%. Most people at the bottom would rather hold USD than their local weak currency. This all sounds strange if you are part of the 1B people currently living in the rich countries. But for the other 7 billion people in the world this is a very familiar story.
The arrows show the direction in which money "wants" to flow to store value. But of course, local fiat is required as a means of exchange, either by convenience or by law. And you have currency controls, international transfer difficulties, and other friction represented, as shown by the dashed lines.
Stablecoins
The key feature of stablecoins is allowing people currently locked-in to weak currencies to access the strongest fiat currencies with relatively low friction.
Reminds me of the situation with long distance phone calls in the early 2000s. An international phone call could cost 10x more from poor countries to rich countries than vice-versa. This gave rise to "call-back" services, where you would use VOIP and the web to bridge the call via two separate calls originating in the rich country, allowing people in poor countries to make international calls at the same low price as people in rich countries. (I was actually a partner in a project called africalling.com that did that circa 2005). Then eventually, bandwidth became so cheap that voice calls just became another type of data on the internet, and now everyone uses messaging apps like Whatsapp, Telegram or Signal, etc. No one even thinks about long distance phone calls per minute.
Stablecoins and CBDCs
Stablecoins are like the call-back services. They allow people in poor countries to use rich country money. Local currencies are like the old third world phone monopolies A lot of sweat and tears will be spilled trying to stop international stablecoins. CBDCs ("central bank digital currencies") will be touted as the national alternatives. But once users have access to the stronger money with low friction, why would they prefer the weaker money? So it's just the same old game as with current fiat, but the playing field is now slightly more tilted in favor of the individual users. As people around the world gain access to USD stablecoins, they will experience the ability to buy from suppliers and sell to customers in other countries. The ability to travel and use their money in other countries. If you are part of the 1B people in rich countries, this is something you take for granted. But for the other 7B people this is a huge deal. Like being in Africa and being able to make a voice call to someone in another country in 2005!
USD Stablecoins demand
Now if there are many equally accessible stablecoins tied to different fiat units, there is no reason to use the second strongest units. Everyone will just use the USD stablecoins. Which means not just the weak, but also the other "strong" currencies, like the Euro or Yen etc will become less relevant. Even the Chinese Yuan, which you would think would have strong demand since everyone imports from China, is going to be less desirable because the Chinese recipient will gladly accept USD knowing that everyone else does. In a friction-less fiat world, USD is the Schelling point.
Stablecoins as USD turbo-supply
On the supply side, the mechanism is self-reinforcing. USD stable coins are backed by US government debt. When they issue $1 of a stablecoin, the issuer takes $1 from the buyer and uses it to buy $1 of treasuries. The coin then circulates indefinitely with the value remaining pegged based on the belief that it can always be redeemed for a real $1.
And that peg is solid. Because
- the US government will never do a hard default where it simply refuses to pay back that $1 of debt. Why? Because it can always do a soft default: print another $1 out of thin air and pay the debt with it. It is fiat money, remember? Of course you can only do this if the debt is denominated in the currency that you print, so this is more true of the dollar than other currencies, because of it's unique historical position (world reserve currency, petro-dollar, euro-dollar, etc.). And from a stablecoin perspective, a soft default is a no-op. As long as they keep short duration treasuries, the stablecoin issuer can legitimaely maintain the peg at $1 per coin.
- the stablecoin issuer meanwhile is happily buying $1 and issuing $1 of tokens maintaining the peg, and they get to keep the interest on the debt. At 4% per year, and $200B of USDT issued, Tether could make $8B a year while maintaining a 1:1 peg. Of course they could also be fraudulent and not maintain the peg, but that would be irrational. Why jeopardize a legit $8B profit by stealing from your customers?
This makes stablecoin issuers large buyers of US government debt. Which is convenient for the US government as additional demand for treasuries makes it easier to continue running a deficit. And stablecoins also make the USD more dominant internationally at the expense of all the other fiat currencies, It reinforces the "dollar milkshake theory". The US was already in a position to suck up a lot of international demand for safe debt, now stablecoins provide more straws for it to drink the milkshake. So the US government has very good reasons to support USD stablecoins.
If the US government is like an engine pushing the dollar out into the world, the stablecoin acts like a turbo which takes the exhaust from an engine and pumps it back in to increase power.
Don't get me wrong a soft default is still bad as it implies high inflation. But "nothing stops this train", to quote Lyn Alden. All fiat currencies are heading for higher inflation. However, in the short to medium term, the dollar, via stablecoins, will dominate even more than it does currently.
Bitcoin
But just like in our long distance phone call story, there's a final twist. Back to our basic principles of inflation and permission.
First, as those 7B people use the ladder of stablecoins to climb up from the flooded basement of weak fiat to the ground floor of strong fiat, they will start thinking what the 1B already on the ground floor are starting to think now. The ground floor is sinking too! This magical token which saved me from double digit inflation and allowed me to transact with the whole world, when I save, it doesn't even pay me interest! It's like a bank account with 0% savings interest rate. Adjusted for inflation it is minus 3% per year. Can i do better?
Second, stablecoins are not entirely permissionless. They have lower friction than traditional fiat rails but at the end of the day, a USD stablecoin issuer will still obey the US government, since their main asset is US treasury bills. (The Iranian government recently bought $500M of USDT. Grab your popcorn). Can you use something that has even less risk of confiscation?
The answer to both of these is of course Bitcoin. It may take a long time but Bitcoin will do to fiat (both traditional and stablecoins) what voice messaging apps did to long distance phone calls.
