“On a long enough timeline, the survival rate for everyone drops to zero.”

– Tyler Durden, from Chuck Palahniuk’s book Fight Club

The establishment’s favorite macroeconomist, Paul Krugman, has finally taken a public stance on cryptocurrency. Though his scathing assessment is predictable, daresay justified, there is something missing from Krugman’s commentary. There are deep structural issues that plague the long term viability of the United States dollar. And though the dollar is the world’s reserve currency, there’s no telling how long the party will go on.

Krugman starts with a flurry of body blows. The Nobel Prize winner correctly notes that cryptocurrencies generally don’t serve as a reliable store of value, they aren’t a common medium of exchange, and they aren’t by any stretch of the imagination a standard unit of account. Unless of course you are extorting a company with ransomware or dealing narcotics.

In other words, cryptocurrencies don’t satisfy the basic features of money required for mainstream economic activity. Such that, as things stand now, they are more of a commodity than money, and a fiat commodity at that—literally conjured up out of thin air by inspired software engineers using a wide array of cryptographic primitives and internet protocols to track ownership and implement transactions.

Krugman then goes so far as to designate cryptocurrencies as a kind of natural Ponzi scheme, in that they maintain the veneer of profitable investments so long as new buyers, encouraged by the success of early investors and a veritable deluge of marketing hype, continue to bid up asset prices. Speculative bubbles are the usual end result, leaving wreckage in their wake when the music stops.

Your author would tend to agree with Krugman regarding the above. However, he’s not telling readers the whole story. It is as though he is happy to shred the upstart monetary challengers but is far more demure when it comes to facing down the reigning heavyweight champ. In that sense the cryptocurrency mavens have a valid critique of the American monetary system: There are solid reasons for wanting to escape dollar hegemony, reasons that experts like Krugman usually don’t talk about.

Money for Nothing

Given that money is a store of value, it is tempting to think of dollars like a tangible commodity. But in practice dollars are born out of debt. This can be counterintuitive until the mechanics are spelled out. Walking through the actual process of money creation, as it’s executed by the Federal Reserve’s Open Market Operations, is clarifying.

The central bank of the United States (the Federal Reserve, or Fed) runs a trading desk where it buys and sells debt instruments. Things like U.S. Treasury bonds, mortgage-backed securities, and agency debt. Money is created when large institutional banks sell their debt instruments to the Fed. After taking possession of such assets the Fed digitally credits the account of the seller with an appropriate amount of Federal Reserve Notes (also known as dollars) which manifest as a bookkeeping entry on a server somewhere.

In plain English, the Fed buys financial assets from banks using money that it creates out of thin air and then the Fed merely bumps up the account balances of the banks via the money that it just created. It is as if the Fed had a license to print money, though strictly speaking printing hard currency is the purview of the United State Treasury. The Fed creates and destroys money by jiggering electronic account balances.

It has been this way since 1971, when President Richard Nixon left the gold standard. The U.S. government no longer links the dollar to precious metals. Nixon’s actions 50 years ago made the dollar into a fiat currency. It’s paper. There’s nothing tangible backing it. Nothing except the assertion that “this note is legal tender for all debts, public and private.”

When the Federal Reserve buys debt instruments it increases the amount of money in circulation. The large institutional banks take their cash and put it to work. Over time this devalues the money supply and prices rise. Economists euphemistically refer to this as inflation. Since there’s more money out there chasing goods and services, money becomes less scarce and therefore worth less. In the aftermath of the First World War John Maynard Keynes offered a prescient warning about where money creation can lead if government officials get carried away:

By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

A few years after Keynes made this fateful statement, the Weimar Republic nearly drove the German economy off a cliff through hyperinflation. Savings were wiped out across the board. There were food shortages as the price of raw materials shot up. People burned money to stay warm.

Uncle Sam’s Ponzi Scheme

Things really start to come into focus once compound interest enters the picture. Because, just like any bank, the Federal Reserve doesn’t loan cash out for free. Oh no, the Fed expects to be paid back in full along with accrued interest on top of the original principal. That’s normally what happens when buying fixed-income securities. But if the principal is returned back to the Federal Reserve, in its entirety, where does the money come from to pay off the interest?

The answer is—a drumroll, please—more debt. In particular, additional debt instruments must be purchased by the Federal Reserve to feed enough money into the economy to service interest on existing debt. And naturally the money used to buy those additional financial assets must likewise eventually be repaid with interest. And so on, ad infinitum.

By design, total debt must always increase over time. This makes inflation a core feature of the banking infrastructure because money is born out of debt. Therefore prices will continue to rise (or in certain cases stock prices will continue to rise) by some percentage because the supply of cash, fueled by equivalent amounts of debt, must always grow to pay off the interest on existing debt.

This Can Only End in Tears

Mathematically speaking, this is a recipe for debt that grows exponentially, doubling in size over specific intervals of time as all exponential functions do. The only hope of keeping up this sort of infinitely growing debt is to develop the economy at a similar rate. Make more stuff to pay off more debt.

This, dear reader, is where the whole economic paradigm runs smack into the laws of physics. Infinite growth is a losing proposition on a finite planet. Limited resources put an upper bound on gross domestic product. As with every Ponzi scheme, things inevitably come to a crashing halt.

Thomas Malthus wrote about this kind of scenario at length. As did Charles Darwin.

Krugman may tar cryptocurrency as a Ponzi scheme but he’s conspicuously silent on the larger fraud being perpetrated by the Federal Reserve. The people in charge have created an immense black hole of debt that quietly steals wealth as it consumes everything around it to stay on the exponential curve. Can you guess what happens when nations are forced to sacrifice prosperity on the altar of economic growth while at the same time competing with each other for dwindling strategic resources? What happens when the struggle for basic commodities becomes existential and leaders have their backs to the wall?

Bill Blunden is an independent investigator focusing on information security, anti-forensics, and institutional analysis. He is the author of several books, including The Rootkit Arsenal and Behold a Pale Farce: Cyberwar, Threat Inflation, and the Malware-Industrial Complex. Bill is the lead investigator at Below Gotham Labs.