What exactly do central banks do in order to be able to maintain the stability of national currencies such as the US Dollar, the Euro or the Yen?

The majority of humans throughout the world nowadays organize in complex social structures made up of millions of people. These macro-organizations adopt the political form called “country” in most cases in order to dominate a territory and to distinguish themselves socially and culturally from one another. Each country, also, usually creates a currency that serves as the axis of all its economic activity. The United States prints and distributes dollars. Europeans issue new euros frequently and inject them into the global economy. And, likewise, Japan does the same by periodically creating new yens and handling them to other banks. There exist many coins. All are issued under the same pattern.

In ancient times, a precious metal such as gold or silver was used as a means of exchange. In those epochs, then, money was a “commodity”. A gold coin contained within itself the substance that gave value to it: the material from which it was made, the same gold. At present, the money that is used in the world is not made of a “intrinsically” valuable material. Nor does present money represent an amount of gold that exists in a bank or in a reserve. The value of modern money is based on somewhat imaginary approximate estimates made by the central banks of each country and also on the political vision of the individuals who print and manipulate each currency.

Over the past few years, we have all heard of cases of hyperinflation. An extremely striking example has been the case of Zimbabwe. Its inflation has been verified since the beginning of the decade of 2000. In the wake of hyperinflation, in this country, an intense process of confiscation of agricultural land that passed into the hands of powerful elites, was observed. Another effect has been that the country refused to pay the debts to the International Monetary Fund. The currency fell to historic lows. Zimbabwe’s annual inflation rate ascended to 89.7 billion per cent in 2008. Citizens were, thus, accustomed to having prices two or three times more expensive every single day. The loss of value of the currency hurt the population every day. In the end the printing of the Zimbabwean dollar had to stop. Now international currencies are used.

Zimbabwe is just one case. There are many other cases such as Greece, Venezuela or Argentina. All are well-known cases of hyperinflation that serve to understand why, in no country in the world, no national currency is stable. Stability is a myth even for users of cryptocurrencies who, for example, use the term “stablecoin” to refer to currencies that have the same monetary value as some official national currency such as the US Dollar, the Euro or the Japanese Yen. But it is a mistake to think that to be pegged to these official currencies makes a coin stable. National currencies are not stable just as global prices of products and services are not stable. The reason is that, in many ways, a currency is just another product whose prices are subject to the natural fluctuations of social psychology. Currencies can be seen also as services. Either if one sees them as products or services, the result is the same: their value is unstable.

Who is in charge of providing stability to official currencies like US-Dollars, Euros or Yens?

In order to answer this question, we must first clarify a vital point: the semantics behind the concept of “stability”. If one wants to buy a new car or a full Bitcoin, in both cases, one interprets the value of the automobile or the value of the 1 Bitcoin, as stable, if and only if the price in dollars –or in Euros or Yens— remains the same during a certain period of time. What does “stability” mean, however, in the case of national currencies? They always seem stable if one does not compare them with another meta-currency. Since in the minds of most people there is no meta-currency above the dollar or above the Euro or the Yen, then these currencies may seem stable. However, they are not. These currencies show as much instability in their value as cars or as Bitcoins do. The problem is with which meta-unit one should value national currencies. Usually when you want to buy these currencies, you pay with your labor force or with products or services.

Having stated this aspect of the idea of “stability”, it is easier to answer the question about who does the job of maintaining the stability of national currencies, because we now comprehend that “stability” implies conservation of purchasing power. Central banks are responsible for maintaining the value of the currencies of each country. That is, for example, in the case of the United States, the Federal Reserve has the responsibility to give stability to the US-Dollar. And that means that this institution has a duty before the citizens to protect the wealth of the people and to work so that the purchasing power of the dollar does not fall. It should not happen, then, that the prices of things increase uncontrollably if the Federal Reserve does its job. In the case of Europe and Japan – the other two mere examples in this article – this work is carried out by the European Central Bank and the Central Bank of Japan.

Users and enthusiasts of cryptocurrencies utilize two verbs that are antonyms to each other: HODL and DUMP. To hodl means retaining an asset or currency for a long time usually because one trusts that the value will go up. To dump implies the opposite, to get rid of a coin or an asset, because one has lost faith and one believes that the price will fall. Well, in the markets of the official currencies of each country, one can see hodling and dumping. When people are feeling faith in the future of the dollar, they engage in hodling. And when people believe that the dollar does not look promising anymore, these people will tend to do dump dollars. Some ways to practice hodling can be to save money in the bank or to lock it up in a fund. Some ways to carry out dumping would be to buy land or to flee to other assets as stocks. In recent years it has become very popular to migrate towards cryptocurrencies as a form of dumping official currencies. There are people, then, that prefer to hodl Bitcoin by dumping official dollars, euros or yens.

What exactly do central banks do in order to be able to maintain the stability of national currencies such as the US Dollar, the Euro or the Yen?

The most elementary function that a central bank fulfills is not as difficult as some specialists want to think. There are two words that synthesize the work of these banks in two very basic concepts: monetize and demonetize. This may sound complicated, but in reality, it only means printing more currency and injecting the currency into the market or, on the contrary, taking out of circulation a portion of the official currency that is being used. Crypto users know these concepts very well. In the microcosmos of cryptocurrencies, these two concepts are usually referred to as “to mint coins” and “to burn coins”. The meaning of monetization and demonetization corresponds to the same financial practices of minting coins and burning coins. Central banks control the issuance and destruction of the currency. Directors in charge of the banks make decisions related to these two mechanisms to control humanly the fluctuations in the purchasing power of the currencies of each country.

Dollar bill, all seeing eye zoomed in.

Why, then, do even the most powerful currencies in the world, such as the US-Dollar, the Euro or the Yen, seem to be weaker and weaker each year? Why do users of these currencies feel poorer every day?

If you travel to the United States, to Europe or to Japan, and you ask the specialists in banking and finance “why did the official currency of Zimbabwe lose so much value until it died?”, Most likely you will hear first a long explanation on historical and political processes. In the end these specialists are going to tell you that the main reason is that in Zimbabwe there was a lot of “printing too much money and giving it away”. This has actually not been a secret. Most analysts agree that Zimbabwe’s politicians, in order to maintain their political power, manipulated the Reserve Bank of Zimbabwe. Actually a huge amount of evidence shows that the government ordered its central bank to keep on printing more and more money to give it to political allies. In the end, as it has to be, since money is subject to the natural laws of supply and demand, an obscene level of hyperinflated supply made the currency totally worthless. Nobody wanted to take or to hodl Zimbabwean dollars.

Basically one can assume that, if the fiat money that we all buy by paying for it with our workforce or with our products and services, is losing purchasing power, then, the mechanisms of stability control are not working. In other words, central banks are not working to protect citizens. This fact forces us to think about old financial models. Even after the Second World War, each dollar represented a quantity of gold stored inside the Federal Reserve. Also, to some extent, in present times, something tangible should be backing each dollar, each euro and each Japanese yen. Exclusively in the theoretical realm, it is believed that the supply of money coincides with the total value of all the goods and services available in an economy. Nevertheless, of course no central bank knows how much wealth its economy has. So national currencies are currently not supported by real wealth accounting. Rather, there seems to be a lot of political considerations in deciding the new printing of money.

It seems logical to conclude, therefore, that the central banks of each country affect all the prices of products and services, and have the opportunity to manipulate the inflation-deflation cycles. If the Federal Reserve of the United States prints new dollars because the banks and the companies need more liquid, immediately after monetizing this new capital, all the dollars that the people are hodling, become less valuable. On the contrary, if the Federal Reserve burns US-Dollars, then dollar users around the globe may be able to buy more products or services with their dollars. Sociological studies indicate that people perceive a continuous unstoppable process of inflation occurring in all of the supposedly stable official currencies. This means that central banks are not working in favor of hodlers and that these official currencies are not stable at all.

In fact, the so-called stable currencies issued by regular governments are inflationary assets. “Inflation” is a dynamic process that implies negative instability and that a central bank, deliberately, prints too many bills and coins causing that the prices of all goods and services increase at a proportionate level. If one year ago, you could buy two US-Dollars by the price of one cup of hot coffee and right now, by the same price, you buy three dollars, this means your dollars are cheaper. Negative volatility is killing the price of your dollars. People around the world are complaining about this type of phenomenon affecting most of the widely used official currencies issued by legal countries.

If one keeps in mind the fact that when a person A buys a cup of coffee from a person B, actually B is executing a purchasing transaction too — in other words, if we realize B is buying money from person A — the chaotic instability of US Dollars, Euros and Yens becomes fully visible. In general, it is important that all citizens of the world understand this basic principle and that, through knowledge, we open our eyes. If the countries of the world continue to print frantically more and more or their national money, logically, we are all to expect that the purchasing power of world’s currencies will continue to precipitate towards an abysm. The only people who benefit for the new money printed are the one on the top of the pyramid. It is for this reason that each new generation, in most countries, tends to be poorer than the previous generation.

Grandparents could have farms and infinite independence. Parents of the last generation had a little wealth and comfort but no farms and much less independence. The last generation, however, faces the danger of being poor and not having any independence at all. The whole system is based, although, on minting or burning new money. If one analyzes well all this historical process in which each generation is poorer, modern capitalism based on central banks looks more and more like a Ponzi scheme and not as a real scientific system. Maybe we should never have abandoned the gold standard in the past. At least gold can not be created and destroyed for political reasons. A new hope that recent impoverished generations have invented is, undoubtedly, Bitcoin. BTC is borderless electronic money that can not be created or destroyed according to the speculations of central banks. It’s open, decentralized and censorship-resistant sound money controlled only by the laws of Math. It is totally deflationary. No government can control it. Its limited supply seems to transform it into a new sort of modern electronic gold. Bitcoin could be the money of the future.