Which financial assets a central bank should buy and sell is hardly a novel question. Historically, the US Federal Reserve has focused on shorter-term Treasury securities, but quantitative easing had the Fed buying mortgage securities and quality commercial paper in vast quantities. Central banks often hold gold and foreign currencies.
Separately, the US government maintains reserves of critical commodities, such as its Strategic Petroleum Reserve. The Treasury also holds forex reserves and SDRs, and many foreign governments go further and have extensive sovereign wealth funds that include equities, natural resources (Canada has its own strategic reserve for maple syrup) and other assets.
Enter Bitcoin. Senator Cynthia Lummis of Wyoming has introduced a bill to have the Treasury create a $67 billion stockpile of the cryptocurrency and Republican presidential candidate Donald Trump supports the idea, saying it would be “a permanent national asset to benefit all Americans.”
The bill may not be a serious piece of legislation—it’s unlikely to pass—but it raises a big question: Under what circumstances can governmental purchases of cryptocurrency be justified?
It is not a hypothetical. Jersey City’s pension fund plans to invest in Bitcoin, as Wisconsin already has. It may well be that these plans are pandering to crypto holders and putting taxpayers’ money at unacceptable risk.
Yet, if respectable private entities are investing in Bitcoin, as indeed is the case with current financial ETFs, the “separation of state and Bitcoin” is unlikely to last forever.
To see one version of the case for government purchases of Bitcoin, consider Argentina, where past hyperinflation has made both dollars and Bitcoin very popular. Inflation rates are declining under President Javier Milei, but Argentina’s currency future will probably still feature both currencies. Milei even suggested as much recently.
El Salvador is another case in point. The country already is fully dollarized, and President Nayib Bukele has been taking steps to encourage crypto use and investment.
So far his intended crypto revolution has not taken off, but the country does offer highly favourable terms for crypto users and investors. If crypto rises in importance, some of that financial activity may take place in El Salvador, if only for regulatory reasons.
In short, there might be a number of governments that use dollars and crypto as a significant part of their natural monetary base, along with the domestic currency (if it still exists). In fact, the more dollarization spreads, the more the demand for crypto and Bitcoin may rise.
Many countries are aware of the advantages to using the dollar, but they may also come to see crypto as a useful tool that weakens the ability of the US government to apply financial sanctions.
The end result may be more dollarization—but with crypto as a complementary back-up financial system. Crypto also could give those countries more elastic money supplies, in case they find Fed policy too tight for their economy.
To get back to domestic US concerns: If crypto and the dollar are complements internationally, the US government might want to encourage crypto as a way to expand the reach of the dollar. The dollar truly would become further entrenched as the global reserve currency, boosting possible levels of US consumption.
To continue this line of reasoning, it’s useful to ask what Washington could do to encourage the use of crypto. If the Fed or Treasury bought and held a modest amount of Bitcoin, as they might a lower-tier foreign currency, that would help legitimize the asset in the eyes of global financial markets. The longer-run effect could be to boost the demand for American dollars as well.
Even in this scenario, the case for government crypto purchases is not ironclad. One caveat is that the government might buy so much crypto that it becomes a major force in setting its price.
Crypto-holding voters could then push the government to boost or maintain their portfolio values, much as homeowners often support zoning regulations or the mortgage deduction. Crypto markets would become politicized.
There is also the worry that too tight a government embrace might make crypto innovators hesitant and too conservative. It is not always good for innovation to have government as a major customer. That’s a reason to might hope that any public-sector investment in Bitcoin is modest.
No matter what, the separation of government and crypto will eventually come to an end. My suggestion is that any change be made slowly, modestly and as far removed from politics as possible. ©bloomberg
