Original title: The "Digital Gold" Fallacy, or Why Bitcoin Can’t Save the U.S. Dollar
Original Author: George Selgin
Original Source: https://www.cato.org/blog/digital-gold-fallacy-or-why-bitcoin-cant-save-us-dollar-1
Translation: Tom, Mars Finance
Editor's Note
George Selgin is a senior researcher and honorary director at the Cato Institute's Center for Monetary and Financial Alternatives and an honorary professor of economics at the University of Georgia. His research covers a wide range of topics in monetary economics, including monetary history, macroeconomic theory, and the history of monetary thought.
Selgin is one of the founders of the modern free banking school, inspired by F.A. Hayek's writings on monetary denationalization and currency choice, and he co-founded this school with Kevin Dowd and Lawrence H. White.
The Cato Institute is a libertarian think tank based in the U.S. dedicated to promoting the ideas of limiting government power, protecting individual freedoms, and supporting market economies. The Cato Institute is funded by major Republican donor Charles Koch.
Here is the main content:
"Digital Gold" Fallacy: Why Bitcoin Can't Save the U.S. Dollar
This summer, there was a significant turning point in the story of bitcoin. Bitcoin was initially seen as a revolutionary, grassroots alternative to traditional fiat currencies, including the dollar. However, this turning point transformed bitcoin's role from being opposed to the dollar to strengthening the dollar's position as the most popular medium of exchange globally.
Although this new perspective had earlier sprouts, it gained widespread attention at the Bitcoin 2024 conference in July this year. Many attendees at the conference, including presidential candidate Robert F. Kennedy Jr. and Donald Trump, voiced this viewpoint.
Like the story of Goldilocks and the Three Bears, these proposals come in three different sizes. Trump's proposal is the most conservative, suggesting that the federal government use its existing 210,000 bitcoins—most of which were confiscated by law enforcement—as the "core" of a "strategic national bitcoin reserve," claiming that this move would "benefit all Americans."
Kennedy's plan—the "Big Bear" proposal—suggests that, based on Trump's "core" proposal, the Treasury would add 550 bitcoins daily until it holds at least 4 million bitcoins, exceeding more than one-fifth of the current circulating total. According to Kennedy, his plan would make the value of bitcoins held by the U.S. Treasury, based on current market prices, exceed its gold reserves, thereby placing the U.S. in a "dominant position that no other country could replace."
Finally, the "Mama Bear" proposal was put forth by Wyoming Senator Cynthia Lummis after Trump's keynote address. Her proposal is for the U.S. Treasury to establish a "bitcoin strategic reserve" that includes the purchase of 1 million bitcoins over five years. Unlike other proposals, Lummis's plan has been reflected in actual legislation, namely the (BITCOIN Act of 2024), which she introduced a few days after the Nashville conference. One of the aims of the bill is to "strengthen the dollar's position in the global financial system."
If only politicians are proposing to establish an official U.S. bitcoin reserve, it might be seen as an opportunistic act to leverage bitcoin's popularity for electoral support. However, based on the applause garnered by the three proposals at the Nashville conference and the comments afterward, regardless of whether Satoshi himself would support these proposals, many bitcoin supporters firmly believe that the proposed bitcoin reserve will indeed benefit the dollar and the overall U.S. economy.
Politicians are not the only ones calling for the U.S. government to join the bitcoin trend. In a recent report (Digital Gold: Assessing America's Strategic Bitcoin Reserve), the Bitcoin Policy Institute also recommended that the U.S. establish a bitcoin strategic reserve as a unique complement to "traditional reserve assets like gold and treasury bonds," to help ensure "the continued dominance of the dollar."
Why do we need reserve assets?
So, is it time to bid farewell to the bitcoin "terminator" dollar and welcome the bitcoin "supercharger" dollar?
Or is it not entirely? Some argue that establishing an official bitcoin reserve would enhance the dollar, which differs from viewing bitcoin as a strategic commodity like oil and silicon chips, or hoping the U.S. government would include bitcoin in its sovereign wealth fund. While calls for a strategic bitcoin reserve often conflate these different arguments, this article focuses solely on the argument for "currency reserves." Would accumulating bitcoin really "supercharge" the dollar? Can strategic bitcoin reserves be compared to the role of gold reserves in the U.S. or elsewhere? Does the dollar really need "supercharging" to maintain its global status?
To answer these questions, it is essential to understand the general role of non-national reserves in supporting today's fiat currency system, especially the role of the dollar. Official reserve assets are financial assets held by fiscal or monetary authorities that cannot be created by these authorities themselves. Today, these assets are typically foreign exchange (including foreign currencies themselves, as well as bank deposits and securities denominated in foreign currencies) and gold. According to the International Monetary Fund (IMF) statistics from mid-2024, global monetary and fiscal authorities hold a total of $12.347 trillion in foreign exchange assets and 29,030 tons of gold, valued at approximately $2.2 trillion.
Why do governments need to hold reserves? During the commodity currency era, central banks and commercial banks needed to hold reserves of currency commodities to meet redemption requests from clients and other banks. When many countries' monetary systems were based on the same standard commodity, such as the gold standard before the Great Depression, reserves were also needed to cover international payment deficits, meaning that a country's net outflow of foreign capital contrasted positively with its current account income (exports minus imports and net foreign remittances).
In today's irredeemable fiat currency system, reserve assets are clearly no longer used to redeem liabilities of central or commercial banks. Deposits in commercial banks are essentially a claim on central bank currency, or central bank reserve credits in interbank settlements. As long as countries are willing to let their currencies float freely, they can eliminate international balance of payments deficits through exchange rate adjustments without having to use foreign exchange reserves.
However, in reality, even countries that issue their own fiat currencies often seek to peg the value of their currency to another country's currency. For instance, small open economies often choose to peg their currency to that of their major trading partners to avoid exchange rate risks for traders. In this case, foreign exchange becomes necessary again to cover international payment deficits. Other countries wish to limit fluctuations in their own currency's exchange rate; that is, they tend to use "managed float" or "dirty float" rates rather than fixed or freely floating rates. These countries must also hold a certain amount of foreign currency as reserves.
On the other hand, gold reserves are no longer used to settle international accounts. However, they still account for about 15% of global reserve assets. The main reason is that gold is a good hedge against exchange rate or "currency" risk, which monetary authorities face due to holding foreign exchange reserves. When gold is stored as bullion in the home country rather than in foreign custody, it also avoids the political risks that foreign exchange reserves might face, namely the risk that foreign governments may freeze or expropriate reserve currencies.
But as we will see, the holding of most of the world's official gold reserves has no better reason than inertia. These reserves include the 8,133 tons of gold held by the U.S.—about two-sevenths of the global total—almost all accumulated from the time when the U.S. was still on the gold standard.
The Dollar as a Global Reserve Asset
Despite the global foreign exchange reserves including currencies from many countries, the share of the dollar far exceeds that of other currencies, accounting for about 58% of total reserves. The euro follows closely with a share of 20%. As shown in the figure below, a few currencies—yen, pound, Australian dollar, Canadian dollar, and Swiss franc—account for the remaining majority. Other currencies, if used as reserves, account for only a negligible portion.
Currency Shares in Global Foreign Exchange Reserves
The dollar's dominance is not mysterious. According to recent comments from the Brookings Institution, the dollar still accounts for 58% of all cross-currency payments, meaning that 58% of international payments between non-eurozone countries use the dollar. Additionally, 64% of global debt is also denominated in dollars, including about $13 trillion in dollar credit flowing to non-bank borrowers outside the U.S. This data also explains why many foreign governments prefer to peg their currencies to the dollar or at least limit exchange rate fluctuations, even though doing so forces them to hold large amounts of dollar reserves.
If the dollar's position is so solid, why would anyone think it needs strengthening? This viewpoint stems from the fact that since the late 1990s, the dollar's share of global reserve assets has declined by 12 percentage points. If this decline were accompanied by an increase in the shares of the euro, yen, or even the pound (the only other serious competitor), and if this trend might continue, it could ultimately threaten the dollar's reserve currency status. If this decline reflects a decrease in the volume of trade denominated in dollars, it might suggest a diminishing popularity of the dollar as a medium of exchange. However, this is not the case. The dollar's decline has not been supplanted by competitors like the euro or yen, but has come from various "non-traditional" reserve currencies, including the Canadian dollar, renminbi, and gold. Moreover, this decline is not due to more trade being priced in non-traditional currencies or gold—cross-border renminbi payments are far less than dollar payments—but due to other reasons, including the U.S. government's "weaponization" of the dollar, namely freezing or seizing foreign governments' dollar reserves held in U.S. financial institutions or those cooperating with the U.S.
Clearly, establishing a strategic bitcoin reserve would not mitigate the risk of foreign governments facing the seizure of their dollar reserves. Perhaps less obviously, such reserves would not provide any support or enhance the popularity of the dollar's value.
U.S. Reserve Assets
As of October 2024, the U.S. Treasury and Federal Reserve System hold $245 billion in reserve assets. In addition to foreign exchange (over $37 billion, of which about two-thirds is euros and the rest is yen) and 8,133 tons of gold (valued at approximately $11.041 billion based on the official gold price of $42.22 per ounce, and about $691 billion based on current market prices), these reserve assets also include the U.S.'s reserve position in the International Monetary Fund (approximately $29 billion) and its special drawing rights (SDRs) allocated by the IMF (less than $170 billion).
From this total, the accumulation of U.S. reserve assets places it in the "second tier" of the world. Although the U.S. is the largest economy globally, this total reserve ranks only 15th in the world, behind countries like Hong Kong, Singapore, and Italy.
Although this original ranking is not particularly impressive, it greatly exaggerates the U.S. government's emphasis on these assets because it accounts for IMF reserves and SDRs, which together account for over 80% of U.S. reserve assets. While the Treasury and the Federal Reserve jointly decide how much foreign exchange and gold to hold, the U.S.'s IMF reserve position and SDR reserves are determined by IMF rules. For example, the IMF periodically sets the total SDR allocation for all its members, which is then distributed according to each member's quota in the fund.
The U.S.'s large SDR reserves primarily reflect the IMF's recent allocation of $660 billion in SDRs (approximately $890 billion) and the U.S.'s 17.42% share of IMF quotas. The U.S.'s IMF reserve position is also a mandatory amount, representing a portion of each IMF member's mandatory contribution to the fund. Excluding SDR reserves and IMF reserve positions from the reserves of various countries, the U.S. ranking drops to 45th, below Vietnam, Romania, Colombia, and Qatar! As we will see, due to its reliance on the U.S.'s vast gold reserves, even with this ranking, the importance of the U.S.'s international reserve assets is exaggerated, because unlike the gold held by most central banks, the U.S.'s gold reserves (which, by the way, belong to the Treasury rather than the Federal Reserve) have no strategic significance.
The U.S.'s reserve assets, especially its foreign exchange reserves, are so insignificant that they reflect the unique position of the dollar as the most freely floating currency: other governments may peg their currencies to the dollar, whether tightly or loosely; but for the U.S. government, maintaining these links has mostly been, and for a considerable time has been, the problem of other governments.
The U.S. government is able to universally allow its currency to float, which is part of the "excess privilege" it enjoys due to the dollar's status as both a national and global medium of exchange. As I mentioned earlier, about 58% of international trade is denominated in dollars, which also corresponds to the dollar's share of global official foreign exchange reserves. Beyond the U.S., many countries use the dollar as their domestic currency. The global demand for the dollar, whether official or in the private sector, means that the U.S. government does not need to borrow in other currencies, and the dollar's freely floating status also eliminates the need for foreign currency to pay for U.S. imbalances.
Foreign Exchange Stabilization Fund: A Less Successful Precedent
The dollar's status means that the U.S. government does not actually need to hold foreign exchange. Since the collapse of the Bretton Woods system in 1973, the U.S. has had no obligation to participate in the maintenance of any international fixed exchange rate regime. Although the Federal Reserve has long been authorized to buy and sell foreign exchange, its functions, as stipulated by the (Federal Reserve Act), aimed at promoting "maximum employment, stable prices, and moderate long-term interest rates," do not involve stabilizing or regulating exchange rates.
Even before the collapse of the Bretton Woods system, the responsibility for dollar exchange rate policy was primarily held by the U.S. Treasury, with the Federal Reserve assisting under the Treasury's functions (the foreign exchange market operations jointly managed by the Treasury and the Federal Reserve reflect a rough balance of national foreign exchange reserves). This arrangement can be traced back to the Gold Reserve Act passed in January 1934, which required the Federal Reserve to transfer its gold reserves to the Treasury in exchange for gold "certificates," anticipating that the official valuation of gold would adjust from $20.67 per ounce to $35 per ounce, a price that remained until December 1972, when it was increased to $38. (A few months later, it was raised again, until the current $42.22 per ounce.) In this exchange, the Treasury made a nominal profit of $2.8 billion, of which $2 billion was used to establish the "Exchange Stabilization Fund" (ESF) with the goal of "stabilizing the dollar's exchange rate." Importantly, the ESF is not subject to congressional appropriation processes and is exclusively controlled by the Treasury Secretary.
In the book "Digital Gold," the Bitcoin Policy Institute partially supports the argument for establishing a strategic bitcoin reserve based on the precedent of the ESF. They argue that the "ESF" provides a tool to stabilize currency markets during periods of exchange rate volatility, helping to ensure that the dollar maintains its value relative to other currencies. This allows the U.S. to intervene in the foreign exchange market, mitigating speculative attacks and preventing sharp devaluations or appreciations that could disrupt trade balances or financial stability.
However, although the ESF was indeed established to "stabilize the dollar exchange rate," its interventions in the exchange rate market have been quite limited since 1995, and it has not intervened since March 2011. Why? First, as we have seen, since the dollar began floating in March 1973, foreign exchange operations have become unnecessary—this fact was formally (if somewhat late) confirmed by legislation passed in 1976 that removed provisions about stabilizing the dollar's value from the Gold Reserve Act and instead shifted the ESF's function to undertake "operations necessary to meet U.S. obligations in the International Monetary Fund."
Although the FRED chart below shows that from the late 1970s to the mid-1990s, the ESF frequently used its newly acquired, more ambiguous functions to intervene in the foreign exchange market, after 1980, most of its interventions aimed to weaken rather than strengthen the dollar. However, whether these interventions had a lasting impact on the dollar's exchange rate is questionable, as the scale of interventions relative to the size of the market is too small, and even large-scale interventions can only have lasting effects if the Federal Reserve allows the Treasury's exchange rate objectives to dictate overall monetary policy.
U.S. Foreign Exchange Market Interventions: 1973-2011
The Federal Reserve did not make such a compromise. Instead, the Federal Reserve's determination to combat inflation in the 1980s excluded any form of compromise. Therefore, by the 1990s, U.S. government interventions in exchange rates were primarily made "in a spirit of cooperation," such as interventions to fulfill its commitments made in the 1985 and 1987 (Plaza Accord) and (Louvre Accord), rather than pursuing any U.S. government exchange rate objectives.
Since the mid-1990s, even these "cooperative" interventions have become rare: the U.S. intervened in 1998 to support the yen, in 2000 to support the euro, and in 2011 to stabilize the Japanese economy after the earthquake and tsunami. However, there has been no further intervention since then. In 2013, the U.S. participated in a G7 agreement to focus its monetary and fiscal policies on domestic objectives rather than exchange rate targets, and it seems that the likelihood of changing this stance is lower than ever. Far from serving any strategic purpose, the U.S. foreign exchange reserves are more of a leftover asset from past interventions.
Nevertheless, as expected, these developments did not lead to the complete "death" of the ESF. Before giving up attempts to influence the dollar's exchange rate with other major currencies, the Treasury found another use for it: to assist underdeveloped countries, particularly in Latin America.
The ESF's charter, its ambiguous post-Bretton Woods functions, and its ability to "monetize" SDRs and foreign exchange reserves (i.e., to temporarily convert them into dollars within a short time frame) allow it to make large short-term emergency loans without congressional approval. By the 1990s, such loans had become the main task of the ESF. Because the ESF typically lends by "exchanging" dollars and foreign currencies, they fit the definition of foreign exchange operations. However, stabilizing exchange rates is not the primary purpose of these loans and, in many cases, is not a purpose at all.
Congress's negative view of the Treasury using the ESF as a "backdoor" source for foreign aid is not surprising. In 1995, Bill Clinton used the ESF to provide a $20 billion aid package to Mexico. Subsequently, Congress attempted but failed to significantly reduce the ESF's ability to exchange dollars for foreign exchange.
Thus, although the foreign exchange stabilization fund has not stabilized exchange rates, it has maintained its funding capabilities. As a result, the status of the dollar and the international credit of the U.S. are hardly affected, even though the U.S. has not systematically accumulated large amounts of foreign exchange reserves.
Gold Heritage
If the U.S. government does not need foreign exchange, does it still need gold? According to the Bitcoin Policy Institute, in addition to being "historically a significant part of the U.S. global financial strategy, supporting confidence in the dollar, and serving as a hedge against inflation or monetary crises," U.S. gold reserves also act as "a last resort financial asset that can be quickly remonetized in extreme circumstances, providing the U.S. with a historically reliable source of liquidity to address severe financial or geopolitical challenges that disrupt the global monetary order." Lastly, gold reserves also enable the government to "subtly influence the precious metals market and ensure price stability during periods of monetary or geopolitical turbulence."
There are clearly counterarguments to these claims about the benefits of U.S. gold reserves. Regarding support for the dollar, "historically" plays a key role here: since the dollar's decoupling from gold in 1971, the dollar's value no longer depends on the Treasury's gold reserves. (The value of a freely floating fiat currency, like bitcoin, is determined by market demand and supply rather than by the assets held by its creator.) Regarding the liquidity of gold: nothing is more "liquid" than the dollar itself, as the U.S. can create dollars without relying on gold. Regarding helping the precious metals market: in this regard, gold reserves do indeed have an impact. But the question is, why should the government support the gold market, other than allowing gold miners and investors to profit at the expense of others?
The current gold reserves of the U.S. Treasury are far from being intentionally acquired for some strategic purpose, but rather are a legacy from when the dollar was devalued in January 1934, at a time when the U.S. was considered a unique safe haven for gold. As shown in the FRED chart below, between the passage of the (Gold Reserve Act) and the 1950s, the U.S.'s gold reserves increased more than sixfold—if not regretfully for officials, it could be said to be passive—reaching a peak of over 20,000 tons. In the 1950s, especially after the Bretton Woods system came into effect in 1958, the flow of gold reserves reversed.
When Nixon closed the gold window in August 1971, U.S. gold reserves were less than 8,700 tons. Since then, despite having no apparent use, their quantity has changed very little. However, there are no laws preventing the Treasury from selling its gold as long as it repays the Federal Reserve for the corresponding nominal value of the gold certificates it holds. In fact, the Treasury sold about 491 tons of gold in the late 1970s to take advantage of record gold prices at that time. However, when a proposal was made in June 2011 to sell more gold to address that year's debt ceiling crisis, the Federal Reserve publicly opposed the plan, arguing that it could disrupt the gold market and affect "broader financial markets." Similar considerations have seemingly prevented the U.S. government from selling gold.
U.S. Gold Reserves, 1934-2018
Who needs another unnecessary reserve asset?
Although the U.S. government has consistently resisted the idea of reducing its gold reserves, it has never considered the possibility of increasing them. After all, if the 8,133 tons of gold stored now at Fort Knox and elsewhere are merely relics of the gold standard and Bretton Woods era, then suggesting that the U.S. should buy more gold is like proposing that humans should grow tails because we have a coccyx.
So, what about a strategic bitcoin reserve? If the U.S. government's vast gold reserves have no reason to exist solely due to inertia, then it has no reason to acquire bitcoins. (A "suboptimal" argument posits that adding bitcoin to its asset mix could reduce risks associated with gold reserves—this argument's flaw is that bitcoin is not a particularly good hedge against gold.) In other words, the only reason is to "influence the market in less subtle ways," particularly by driving up the price of bitcoin.
And—let's be honest—while some bitcoin enthusiasts may sincerely believe that a strategic bitcoin reserve would enhance the dollar's strength, many others support this idea not out of concern for the dollar's future, but because they expect it to make them richer, indifferent to the costs borne by others.
