Triggers of Economic Crises
We are supposed to learn from our past mistakes, as individuals, and as a global society. The past is full of mistakes that can teach us a wealth of lessons. Several economic crises have taken place in the last century that give us an indication as to what can go wrong. It is important that we learn about what triggered these crises so that we can avoid making the same mistakes.
The Great Depression
The Great Depression hit the United States at the end of the 1920’s. The crash took place for a variety of reasons, some of which are now well understood triggers of economic crises. One of those triggers is how quickly, and aggressively the banking sector was growing in the 1920’s. The 20’s were known as the Roaring Twenties. During this time, many new inventions and technologies were created. Naturally, people want to buy them. In order to buy them, many people went into debt, and borrowed money they didn’t have. Eventually the countries debt caught up to them, triggering a crash in the market. The problem that we’re highlighting here, is the overextension of credit.
The 2008 Financial Crisis
The next most well known economic crises, perhaps more well known due to its recency, is the 2008 financial crisis. This crisis is near and dear to the hearts of everyone in the cryptosphere because it was this crisis that triggered the birth of Bitcoin. The 2008 financial crash began because of bad loans made out to people that couldn’t afford them. Secondary markets were exposed to the failure of the loans, as people were betting on the success of the American housing market. The crisis eventually sent ripples to all corners of the globe. The issue with the 2008 financial crash was that banks, both at the state and federal level were giving out loans to just about anyone and everyone who asked. What this comes down to, is an overextension of credit.
The Common Thread
As you can no doubt tell, the common thread between the two largest economic crisis of our time, was an overextension of credit. People could obtain larger than reasonable loans, to live too far outside their means. Therefore, we as a society need to be on the lookout when our financial institutions get too laze-faire with loaning money. Of course, there are other reasons for economic crisis, although they’re almost all related to supply and demand in some way shape or form. We explore more crises in depth on Episode 8 of the Go Full Crypto Podcast.
How to Solve the Problem
How exactly do you solve a financial crisis? It is typically the job of the central banks, or federal reserve to make sure the economy is stable. What happens in a crypto based economy where there is no central regulatory entity?
The Approach of Central Banks
Central banks have two levers that they are able to pull in order to regulate the economy.
Central banks can print money to stimulate the economy
Central banks can manipulate interest rates in order to make it more/less appealing to loan money
To be clear, the job of the central banks/federal reserve is to make sure the economy is on track. Their job is not to make sure they don’t hyperinflate the national currency. However, they must be aware that this is a possibility. By hyperinflating the currency, they could completely throw the economy out of wack, and fail at their primary job. In the latest two economic crises, (2008 and 2020), the federal reserve opted to reduce interest rates, and inject a large amount of money into the system. It is my belief that the economy is simply to large and complex to be properly managed by humans. Even if we have the best intentions, we inevitably end up making mistakes. What we really need to be avoiding is an overextension of credit. When interest rates drop, this makes credit seem more appealing. When we print money, and drop interest rates, it is time to prepare for another economic crisis.
The Approach of Bitcoin
Bitcoin and other cryptocurrencies have opted to remove as much human influence from systems of money. In my estimation, this is for the reason that I’ve pointed out above. Humans are subject to error, we make mistakes, we cannot help it, nor should we be blamed if we make a mistake in earnest. Take Bitcoin for example, its monetary policy is much simpler when compared to the monetary supply of every country on earth. Cap the supply at 21 million bitcoin, and leak the supply in slowly over the course of 130 years. If you’re interested in learning about the monetary policy of bitcoin, check out Episode 5 of the Go Full Crypto Podcast.
With bitcoin, there are no interest rates, or loans. Bitcoin is an extremely simple accounting system that just tracks where the bitcoin is in the system. It does a perfect job of this. Therefore we don’t have the same set of concerns for overextending our credit system if it is based on bitcoin. If we were to find ourselves in a credit crisis from loaning out too much bitcoin, we wouldn’t be able to print more bitcoin in order to dig ourselves out of the hole. This fact may prompt us to be a little bit more careful with the levers of our financial system.