Stablecoins versus The Power to Tax
Yes, the old saying is true: The power to tax is the power to destroy.
But you know what else the power to tax is? It’s the power to run a decent monetary policy.
If you’re looking for a monetary system that offers low, stable rates of inflation, you’ll be looking for a system that has both a stable supply of money and a stable demand for that same money. You need both for stability—not just one. And a government’s power to tax—to use the threat of force to extract wealth from a nation’s citizens—can help solve both problems.
If I’m right about this, that means that stablecoins—cryptocurrencies that try to hold a constant value, usually 1:1 against the U.S. dollar—have a critical weakness compared to government-run money. Stablecoins are trying to use peaceful, market-driven, voluntary investments to accomplish what governments can do with the threat of force.
Do notice the “can” in that last sentence: I’m only claiming it’s possible for governments to use their powers to run a safe, low-inflation monetary system. But in a world with almost 200 nations, there’s a good chance that at least a couple will do it right for decades at a time—indeed, maybe quite a few are doing so right now. And in that case, there’ll always be a few decent candidates for “global reserve currency” that elites can turn to when looking for safety amid the world’s financial storms.
How, exactly, is the power to tax so central to stable money? Let’s see:
The traditional big worry about government currency—and here I’ll just talk about fiat currency, ones that aren’t backed by promise of gold, silver, or Bitcoin redemption at a fixed rate—is that governments will run up big debts and pay them off with some form of “the printing press,” literal or electronic. When your Deutschmark, Peso, or Franc-denominated debts get too high, and if the government doesn't want to raise taxes or cut spending to start paying down that debt, it can always just print more currency to pay the bills. That yields our old friend, hyperinflation.
Usually, governments are more subtle about it when hyperinflating to pay off a debt--financial obfuscation is always a growth industry during a government debt crisis—but the story ends up the same regardless: a big boost in the supply of government-created money that helps the government pay its bills.
But you know what? Hyperinflation just doesn’t happen all that often. Yes, you’ll have one or two a decade, usually in small economies, and that’s terrible for the people who live there. But most countries have their inflation under decent control—and things have improved significantly since the 1990s, when less-developed countries averaged 100% inflation per year. Today, even amid the remains of post-Covid inflation, the average inflation rate in poorer economies is 8.5%, and 4.6% in the rich countries. It’s not zero, and it’s not the official 2% that lots of rich nations use, but hyperinflation it is not.
Government-created money, on average, is working out fine and has for decades. I think that’s partly because global elites paid attention to two Nobel Laureates: Milton Friedman and Thomas Sargent. Friedman famously said “Inflation is always and everywhere a monetary phenomenon,” thus turning away the core blame for inflation from unions and bankers and one-time bad supply shocks and toward the government.
Sargent, drawing on both the history and the theory of hyperinflation, pushed higher up the chain of causation and wrote in the 1980s that “Persistent high inflation is always and everywhere a fiscal phenomenon.” Friedman said money growth is the problem and Sargent agreed—and then pointed us toward why governments print that extra money. Friedman was saying smoking causes lung cancer and so Sargent asked us “So how do we get people to stop smoking?”
And while it’s hard to be sure about why policy improves, within a decade of Sargent hammering home the importance of solid long-run deficit control in preventing high inflation, dozens more countries massively improved their control over inflation. Yes, the Asian Financial Crisis of the 90s led to a high inflation in a few countries, but again, nations learned from that crisis and so when the Global Financial Crisis rolled around in 2008, many predicted a hyperinflation that never happened. Almost every country got at least that much right—and now it’s clear that the world is getting better at running fiat currencies.
So far, I’m mostly showing that the misuse of the power of tax can cause trouble—I haven’t really shown how it can solve problems for fiat currencies. To get there, we need to look at demand for money:
As Penn State economist Neil Wallace showed in 1981 and as Bitcoin maxis have learned in the real world since then, simply having a fixed supply of currency isn’t enough to guarantee stable prices—you need a reason for people to need your nation’s money. There are well over a hundred separate currencies in the world, but in many countries, elites and a lot of the masses have multiple ways to pay—you might be able to buy a house or a business or a share of stock with dollars, for instance, rather than the local currency. So what drives demand for the local money, when there are options?
This is the same problem faced by every stablecoin—there are so many out there, why pick one over another? And with stablecoins as with national currencies, not everyone has an option, but a lot of big-money heavyweights do have options—and their choices move the market. So making sure that big-money heavyweights trust your money will be a big driver of your stablecoin’s—or your fiat currency’s—success. And that success looks a lot like high and stable demand.
Neil Wallace showed that one way to stabilize demand for fiat currency is to offer a fixed exchange rate between your nation’s money and some more-trusted currency—backed by the taxing power of the state. The most reliable way for a small nation to prove to the world that it can maintain the value of its currency is to have a big pile of wealth, backed by a believable promise that it will convert its national currency into that wealth at a fixed rate for anyone who asks. Neo-Sweden says that 1 Neo-Krona is worth 2 US dollars? I’ll believe Neo-Sweden’s promise if it’s got a huge pile of U.S. dollars and a trustworthy government that seems to care about the opinion of global financial elites.
The second most reliable way to prove an exchange rate will stay stable: A strong national credit rating. You don’t need a big pile of U.S. dollars if everyone in the world believes you can instantly go out and borrow a big pile of U.S. dollars. That’s why strong national credit ratings are a strong signal of a trustworthy monetary system: Because a strong credit rating is a sign that one can borrow in a financial panic to solve the financial panic. And a strong credit rating for a government means more than a strong credit rating for a firm, even for a massive financial firm—because everyone knows that the government’s credit rating is backed, in part, by the threat of force, either to cut payments that need cutting or to raise taxes that need raising.
No stablecoin can beat that superpower—the power to raise taxes and the power to cut spending while—usually at least—being able to keep the economic engines firing fairly efficiently. Yes, a stablecoin project facing a run on its coin might be able to borrow from banks or other crypto projects to hold the peg, and it might cut salaries or expenses for a while, but ultimately that's nothing compared to the power of the IRS, or the ability of Congress to slash Medicaid spending.
Of course, just because somebody has a superpower doesn’t mean the person will use that power or use it for good—for every Superman there’s a Zod. But most fiat currencies have used that power for good for decades now, amid multiple crises. And the world’s global reserve currency, the U.S. dollar, is run by a government that for all of its failings still is a low-tax country by rich-nation standards, a nation without a VAT, a nation with only a modest welfare state that should probably shrink still further in a fiscal crisis. So even with its massive post-Covid debt, the U.S. is still in a place where it could still borrow its way out of a big run on the dollar.
What does this mean for stablecoin market share? It means that one plausible space for stablecoin success is in competing against currencies that face genuine risks of big, massive failure—not of likely 10% inflation but of low-risk, even tail-risk currency crises. That’ll often be in nations with weak credit ratings, countries that will face a tough time borrowing their way out of a financial panic. And it’ll mean reminding users that while even the best-run, safest stablecoins—like the ones rated B+ and above by Bluechip--aren’t riskless, they at least aren’t the same risks faced by lower-quality fiat currencies. Stablecoins offer people living with risky currencies a chance to diversify their currency risk—to avoid putting all their cash in the same basket.
No, stablecoins can’t tax their way out of a crisis—but yes, stablecoins can serve as a unique form of shelter in the storm.