What Crypto's Failures Reveal About Money's Future

Katie: Legend has it that in 1929, right before the stock market crash, Joseph Kennedy Sr. was getting his shoes shined. The raggedy boy shining his shoes starts chatting up Kennedy about the stock market, and he offered him a stock tip. Now the myth goes that Kennedy was like, "Oh, this poor shoeshine boy is giving me stock tips. Yeah, we're at the top. I'm going to sell." And that's how he preserved his fortune through the stock market crash and Great Depression.

Now, the story has never been corroborated anywhere with truly historical chops, but when I first heard it, I couldn't help but notice the similarities between a stock tip from a shoeshine boy and the more recent headlines about Justin Bieber buying a monkey JPG for millions of dollars. Shouldn't more of us have been tipped off that we had officially entered bullshit territory? But as with most bubbles, it's hard to think clearly in the midst of the run-up. So whether you're talking about Bored Apes or tulip mania or shitcoins, groupthink is an innate part of human psychology, which can tell us a lot about investor behavior.

Welcome back to The Money with Katie Show, Rich Girls and Boys. I'm your host, Katie Gatti Tassin, and today we are talking about the rise and fall of crypto and what it says about the future of money. What I don't want today to be is a crypto technology explainer, because frankly, that is less interesting to me, and I imagine to you, than an exploration of the narratives that landed us here and the obstacles that crypto's promises purport to solve. Those narratives include the fundamental promises of permissionless payment systems, why we may or may not need them, and what might be coming next.

Much of what we're going to discuss today is abstract and paradoxical, because when we typically think about how money functions at a macro level, we tend to apply the laws of the micro to it. We treat government budgets like household budgets. We think of taxation as something that lowers our purchasing power, and we probably don't give much thought on a daily basis to how we are exchanging our labor for goods and services. There are probably going to be moments in this episode where you're gonna go, "Wait, what?" and need to rewind by 15 or 30 seconds, because that's exactly how I felt when I was doing the preliminary research for this episode, and I'm going to be invoking a lot of work from experts in the fields of wealth management, monetary policy, and more. So all that to say, we are heading into some heady stuff and we are on this ride together. So let's begin with the briefest of histories of how crypto rapidly rose, and then equally rapidly fell.

Despite being around since 2009, by 2021, crypto was all you heard about. "It's the future. It's going to the moon! The blockchain is going to cure your acne and save us all. Fiat is dead." But by 2022, and I warned you the history was brief, the party was ending. The stock market began declining in January, as the costs of goods started rising, and the asset that was supposed to be an inflation hedge started deflating at the exact moment it was supposed to hold strong. And now in 2023, things are real quiet on the western front. As a video from The Economist put it, "The financial revolution crypto promised us seems further away than ever. So what gives?" At this point, 25 out of 45 of the world's largest economies have partially or completely banned cryptocurrency. And from where I'm sitting, it sure looks like this movement has stalled. But to understand how cryptocurrency entered the scene at all, we have to zoom out and look at a much longer timeline. We'll be right back after a quick break.

So what set the stage for crypto? Well, we started seeing narratives in the second half of the 20th century that described free markets as "efficient" and therefore impervious to improvement by government action. Robert Shiller writes in his book, Narrative Economics, "These narratives in turn led to a public reaction against regulation. There are of course legitimate criticisms of regulation as practiced then, but those criticisms were usually not powerfully viral. Viral narratives need some personality and story. One such narrative involved movie star Ronald Reagan." Maybe you've heard of him? Reagan...I don't know. Concerns about regulation interfering with free markets, or the idea that a free market would exist perfectly in nature if untouched by any sort of government intervention, created some pretty fertile soil for the cryptocurrency movement. Then in the 1990s there was this hot new thing called the internet. You'd go into your house's computer room, you'd boot up your 200-pound beige monstrosity, listen to 15 minutes of beep boop Mozart, and then voila, you were on the web. Pretty exciting, right?

I remember my first experiences with the internet in the early 2000s looking up pictures of Dylan and Cole Sprouse. Swoon. And leaving angsty away messages on AIM, but unbeknownst to 10-year-old Katie, the group known as the Cypherpunks were more worried about how the internet was going to impact people's privacy. And part of their work birthed a mission to develop a secure peer-to-peer payment system. To them, the appeal was that it would reduce the government's ability to surveil or control economic activity. That seems like a relatively innocuous statement, right? Like, "Ah, we don't want the government to control our economic activity." Fine. Think about that sentiment for a moment in our current political climate, or maybe I should say the climate since the 2016 election. The overall concept aligns with this very populist approach to money, which assumes that the elites who run things don't care about everyday people's concerns, which is so hot right now.

But what I found myself wondering as I dug into this backstory was, is this a legitimate quote unquote "problem"? Do we have real reason to believe that less government intervention in economic activity would solve the problems, the very real problems, that we are facing? And, my friends, this is where things start to get really interesting. Because the state of cryptocurrency technology today is problematic—it's slow, it's clunky, it's environmentally inefficient, but technology can evolve rapidly. I believe it's likely someone or a group of someones are going to solve that problem, but does their ability to solve the problem mean that it's a problem worth solving? Because it's hard to separate the crypto space and its theories from criticisms of monetary policy. You can't read a pro-crypto piece without encountering the phrases "the Fed" or "money printing" ad nauseam.

Now, initially I took these claims at face value. I was like, "Yeah, those damned old men at the Fed won't take their finger off the button that adds more money and it's making things worse." But then I got a little bit curious about monetary policy. So I read a book called The Lords of Easy Money by Christopher Leonard, which was, to put it mildly, a less than flattering portrayal of our central bank. Still, the ideology crypto relies on, that hard money is the answer, is positioned as a solution to the problem of a central bank. As you'll hear in this interview quote that I pulled from a really fantastic conversation involving Mike Green of Simplify Asset Management, the idea that hard money, aka money that has a limited fixed supply like gold or bitcoin, unlike the US dollar, is the answer to our current woes is dubious.

Mike Green: I look at the nonsense around the bitcoin commentary. "We want the hardest money." Who does that benefit? It doesn't benefit those who want to participate in the economy, those who are willing to exchange their human capital for financial income that they can then use to increase their consumption or save for future retirement. Hard money benefits those who already have wealth.

Katie: From that perspective, it sounds like hard money or a fixed supply would be an economic disincentive for productive economic output. Now, to be very clear, that's not to say that the status quo, namely an economy based on the US dollar, does not also mostly benefit those who already have capital versus those who are willing to labor. So from where I'm sitting, it's not that the concerns the cryptocurrency movement is trying to address are invalid, just that their solution might not be the right solution.

So let's talk about fiat currency. Crypto advocates often criticize fiat currency, and when I first heard the word "fiat" more in the first six months of 2021 than in the previous 27 years of my life, the first few times I actually thought they were talking about those little Italian cars, but what it actually means is backed by a sovereign state.

So what is fiat currency? What do people mean when they say there's no inherent value or that it's made up? Well, this is probably because in the United States, our money used to be pegged to the price of something specific, like gold, and that makes people nervous. The diversions from that, also known as the US leaving the Bretton Woods system, it made people a little uneasy. But I see a few issues with that too. Namely, why is gold inherently valuable? Sure, it's something found in nature in limited supply. But have you ever once needed gold to survive? If everything went to shit, would you suddenly be roaming your neighborhood with a band of cannibals hunting for gold? If anything, we should peg the price of money to toilet paper, because we know that's actually the commodity that everyone wants during a crisis.

Moreover, what happens if they suddenly discover way more of it in some unexplored part of the world? Would the money supply suddenly expand as a result? It feels arbitrary to me, too. What really gives fiat currency value beyond the fact that we all agree it has value is taxation. Now, stick with me, because this is probably going to be one of those moments where you're going to be hitting rewind. The US dollars in your wallet and in your bank account have value because you have to pay your taxes with them. Taxation creates the demand for fiat currency. Taxes do not necessarily need to be paid in money, right? They could be settled with Kohl's Cash or expired Chili's gift cards or any number of things. But if the state requires you to pay taxes in dollars, you always have to make sure you're going to have some dollars at hand when you need to pay them. It doesn't matter if you're paying capital gains taxes on crypto itself, you need to be able to convert those gains to US dollars to settle your debt with the government. Now, this creates demand for money and gives it value. Here's Mike Green explaining a little bit further.

Mike Green: The taxes ultimately create the capacity to spend, because they create the demand for the currency that you're spending. By introducing taxes, you are creating a liability for each member of society to a differing degree that they have to obtain the government's currency in order to settle that obligation. So what that means is when the government hands out welfare checks or when the government pays soldiers, that there is demand for that currency that they have paid them in. So you need the taxes, but the reason that you need the taxes is not because that's where the government is actually getting the money from, but that's what's creating the demand for the money. And this is actually one of the really troubling aspects that we've gone through as we continually lower taxes, is I would suggest that part of the reason that we experience many of the problems that we're experiencing is a function of us saying, "You know what? Let's reduce the demand for the US dollar."

Katie: So in that quote, you basically heard him saying that taxes aren't important because that's necessarily where the government is getting its money from, but because it's what creates the demand for the currency, and because the government can force you to pay your taxes through, well, violence and imprisonment, there's really no getting around it, you know, death and taxes. You may have picked up on that and thought, "Then wait, where are they getting the money from? Why are we always running a deficit? Why can the government spend more than it's taking in, but it's frowned upon when I do it?" My friends, we have entered the monetary policy portion of this episode, so strap in, because we're going to be talking about central banks, another concept in our society that the crypto ideology believes is the source of our problems. But is a central bank a problem that needs solving? Would we actually be better off without one? We'll answer that question after a quick break.

So why does the central bank exist? Let's explain why it exists and the purpose it's supposed to serve. So the central bank, also known as the Fed in the US, headed up by our boy Jerome Powell, has a monopoly on how much money can be created and circulated. It manages monetary policy, it sets interest rates for lending. It regulates the banking industry and is also the lender of last resort or the banker's bank, aka the provider of liquidity when no other institution can be. It exists to prevent economic crashes and to keep markets stable. Back in 1837, there was a panic, aptly named The Panic of 1837. There were dramatic drops in cotton and land prices, which led to a drop in lending, which led investors to withdraw their money from banks. And in the 80 years that followed, panics and depressions happened frequently, until Congress passed the Federal Reserve Act to prevent future panics. So historically, economies are much more volatile without central banks. Now, that's not to say they don't have their problems, just that their total absence tends to cause more trouble than their existence.

So to reiterate, the Federal Reserve is the US's central bank. Now today, the Fed has three goals. They want to maximize employment, they want to keep prices stable, and they want to manage interest rates to influence lending. Now, here's a real mindfuck. The central bank itself, the aforementioned Fed, is decentralized in the sense that it is made up of 12 different banks that control 12 different districts. Each reserve bank has a board of nine directors, and part of the reason the central bank is controversial to the general public is because of the secrecy around what it does and the vast amount of power that it holds. In that sense, I think of it as both a private and public institution. And hey, being skeptical of any institution that holds a lot of power is a good thing. It's not all sunshine and rainbows in J-Pow town. Here's another great Mike Green quote, which I'm including because even though it is a little complicated, it highlights the ways in which our current system, or rather the monetary policy that shapes our system, is flawed and potentially not sustainable.

Mike Green: So your real policy is a function of creating demand. That's the idea behind interest rates is that it's a way to create demand for your currency. If you raise interest rates, it makes it more attractive for individuals around the world to hold assets denominated in your currency, effectively parking the funds, freezing them up. That's how monetary policy contributes. This is a secondary view of monetary policy, which is that by lowering interest rates, you're encouraging economic activity. We began using interest rate cuts to create the collateral to drive the price of bonds higher. Again, what we thought we were doing is stimulating economic activity, but the evidence is very clear that it hasn't done that. All it's driven is greater and greater financialization. More and more collateral is then being borrowed against.

Katie: When we examine these competing theories, it becomes obvious that there's a fundamental misalignment of ideals. On one hand, it seems as though historically speaking, central banks have helped keep things on track. Proponents of a crypto overhaul see it differently. They believe these banks are to blame for our economic woes, and to be explicit about it, it's not like there's any one true right answer. I'm presenting my findings and where I have personally landed, but that's not to say one is inherently right or the other is wrong, or that I am wrong and they are right or vice versa. They are both imperfect competing ideologies about how best to structure a society's means of storing and trading value, and a lot of it is theoretical.

So one person who's doing interesting controversial work in this arena is Stephanie Kelton. She's the author of The Deficit Myth. Now, she's an economist who has contributed to the body of academic research known as Modern Monetary Theory, or MMT. In the simplest terms, her work suggests that limits on money are not real. I would love to take that approach in my personal life, but it doesn't work that way for me. But she believes it doesn't make sense to impose limits that do not actually exist, that the limits are always going to be arbitrary. Now, her work rests on one fundamental theory: A government budget does not work like a household budget because the government and people are on opposite sides of the ledger.

Stephanie Kelton: A government deficit becomes a financial surplus when we look at it from another perspective. When the government spends more than it taxes away from us, it makes a financial contribution to some other part of the economy. Their red ink is our black ink. When you look at it this way, it becomes clear that every deficit is good for someone. The question is for whom, and what are those deficits being used to accomplish? It matters how the money is spent and who ends up with the resulting surplus.

Katie: That is to say, a debit from the government is like a credit to its citizens, that the red ink of government spending when working correctly should be seen as an investment in a society, but that what the money is being spent on matters. And this is where I think a lot of citizens get pissed off, because they see the amount of money the government's spending and they disagree with what it's being spent on. We don't want to invest our deficit money into huge windfalls for billionaires and corporations. No, we want it to go toward things like infrastructure and healthcare and education and childcare and things that are probably going to benefit the general populace. That investment makes the country and its economy stronger. All of these investments require investing in people because these fields are not run by automatons. They're run by people who require training.

The problem, as I see it, is that much of government spending ends up in the wrong hands. So we as laypeople who manage our household budgets look at that and we think, see, the solution is spending less, and I would suggest, and I think Stephanie would suggest, that maybe the solution might be spending differently. We just had the shortest recession in US history after a major, major economic crisis, because a lot of our government investment during the pandemic went to good use in the form of PPP loans, direct payments to citizens, child tax credits that lifted 3 million kids out of poverty. Now, it wasn't perfect. There was definitely fraud. There was abuse of the programs. There was waste, right?

But much of the money ended up in the hands of citizens who needed it, and as for the inflation we faced in the aftermath, it's easy to make the connection between government pandemic spending and inflation, but it's likely there's something a little more complicated happening there. Supply chain disruption from a pandemic that shut down the world and ground everything to a halt for months, and after all, the inflation was global. It was not specific to the United States. Kelton's perspective is that being responsible doesn't mean running government finances like a household. The challenge is not finding the money, as the central bank can always create more of that, she says, but rather finding the productive capacity.

Stephanie Kelton: Instead of asking, "How will we pay for it?," Congress should be asking, "How will we resource it?" To answer that question, think of people, factories, equipment, and raw materials like wood and iron. If we're going to build high-speed rail, fix crumbling infrastructure, and green our economy, then we'll need concrete, steel, and lumber. We'll need construction workers, architects, and engineers. We'll need companies that can fill thousands of orders for solar panels, EV charging stations, and electric school buses. If our economy has the productive capacity to quickly supply all of those things, then we can easily resource it. Or take healthcare or free college. Paying the bills to expand Medicare to include dental vision and hearing is easy. The challenge is making sure we have enough dentists, optometrists, and audiologists to treat everyone who needs care.

Katie: And that's where investment in people training, reaching full employment in society, that's the piece of the puzzle that brings us back to square one, because that does require spending money on the right things. Could it be that part of the frustration fueling the crypto-adjacent desire for a complete lack of government involvement in money stems from the fact that the current system seems to be tilted to favor a certain class of people rather than the scruffy libertarian masses and Gucci sweatshirt-wearing crypto bros? That they think removing the system itself will solve the problem, when in reality that would likely just throw everything into more chaos, as we've observed in the unregulated crypto space over the last couple of years? Is permissionless money or total lack of regulation actually the answer, or is it just an inspiring narrative that doesn't actually work in practice? For example, Robert Shiller writes about a narrative that drove the 1932 stock market bottom in his book, Narrative Economics.

This idea that modern industry could now produce more goods than people would ever want to buy, leading to an inevitable and persistent surplus, that there'd be too much stuff available, no one would ever want to buy all that stuff, and things would become chaotic as a result. Now, obviously, we know that so far, a hundred years later, that has not been the case. Surplus of goods is not the problem that we face. In fact, we are having the opposite issue. Compelling narratives don't necessarily translate to practical execution in real life, and that goes for all of the theories that we're discussing today.

So coming back to cryptocurrency, what does this mean for its future, and the future of money more generally? In spite of its more recent downfall, some believe that the real value of the cryptocurrency technology isn't that it's going to replace money that we're transacting with, but that it's going to power a new version of the internet called Web 3.0. Their theory is that your data would be stored on the blockchain rather than by third-party companies like Alphabet, Apple, or Meta, who currently own and monetize your data.

This vision of the world means you would own your data rather than the companies who operate the sites you're visiting, which creates a more decentralized democratic internet. Part of this belief system means that users would have to pay for the sites they're using rather than paying through, handing over their behavioral data to advertisers. And remember, all the data on the blockchain is public, which means you won't see someone's name, necessarily, but your data would be public, decentralized information. The downside to that, and the current challenge, is that nobody is responsible for it. If someone hacks in, something breaks, nobody is accountable for the security. Whereas we saw how Facebook had to bear responsibility for their role in Russian interference in the election. So there's no such accountable party in a decentralized version of the web.

Though my gut instinct during the crypto run-up was that things were going to end badly, I do think that there's a case for suspicion, that we might be seeing a replay of the early dotcom crash. The people who believed that the internet was the future weren't wrong. They were just early. It wasn't quite there yet. Some early attempts like pets.com, they missed the mark, but it didn't mean an interconnected network accessible from anywhere was going away. I don't think we've seen the end of the crypto craze. I'm just not sure that the original vision for crypto is the one that's actually going to come to pass. And I have to admit, I did relish a little bit the schadenfreude of the 2022 meltdown, because I was so tired of being told to "have fun staying poor" or being mocked for my antiquated reliance on fiat currency, that it was a bit of a welcome relief to exit bullshit land.

But while I'm not sure what the future of cryptocurrency holds, what I do feel confident in is the fact that trading my US dollars for shares of companies that are creating real value domestically and on the global scale will continue to be valuable for the rest of my lifetime. So we can argue all day long about whether or not the value of a US dollar is real, but it's almost unquestionable that the companies I can buy equity in with those dollars are. As long as Vanguard accepts payment in US dollars, I'm good.

That's all for this week. I will see you next week, same time, same place on The Money with Katie Show. Our show is a production of Morning Brew and is produced by Henah Velez and me, Katie Gatti Tassin, with our audio engineering and sound design from Nick Torres. Devin Emery is our chief content officer, and additional fact checking comes from Kate Brandt.