Professor Zhu Jiaming: Digital currency has become an indispensable factor in understanding the modern economy

This article was published on March 29, 2020, on Mars Finance, by Zhu Jiaming.

In order to deeply interpret the impact of digital currency on the domestic and even global macroeconomic system, and to reasonably forecast the future development trends of digital currency and propose corresponding suggestions, on March 27, the Digital Asset Research Institute, Hengqin Smart Finance Research Institute, and Zero One Finance·Zero One Think Tank jointly held an online closed-door seminar titled "The Impact and Outlook of Digital Currency on Macroeconomics."

At this seminar, renowned economist and chairman of the Academic and Technical Committee of the Digital Asset Research Institute, Zhu Jiaming, pointed out that digital currency has become an indispensable factor in understanding the modern economy. Currently, although the scale of digital currency is limited and it is still in the early stages of development, the emergence, development, and expanding influence of digital currency have already disrupted, and even changed, the past logic between interest rates, savings and investment, monetary liquidity preference, and money supply, and will gradually and rapidly erode the foundational models of aggregate demand and aggregate supply, leading to a trend of ineffectiveness in traditional monetary policy.

The following is a transcript of the speech:

Hello everyone, thank you to all the friends and participants. My topic today is "The Ideas on the Impact of Digital Currency on Macroeconomics," and I hope to discuss and think with you about the impact of digital currency on macroeconomics and what issues need our attention and consideration.

1. New Combinations in Macroeconomics Caused by Digital Currency

First of all, the emergence and development of digital currency and the digital economy have led to changes in the structure of monetary economy and macroeconomics. With digital currency, the monetary system has undergone structural changes, resulting in a classification of traditional currency and digital currency; similarly, due to the digital economy, macroeconomics has also experienced structural changes, leading to a classification of traditional economy and digital economy. Thus, an unprecedented recombination has formed between monetary economy and macroeconomics.

Here is a diagram divided into four types: one is digital currency and digital economy, two is digital currency and traditional economy, three is traditional currency and digital economy, and four is traditional currency and traditional economy.

It should be noted that when we discuss the role and impact of digital currency in macroeconomics, we basically still maintain the "dichotomy" from traditional economic theory, or rather, we implicitly use dichotomous thinking to explain the relationship between monetary economy and macroeconomics. According to the so-called "dichotomy," monetary economy and real economy are different economic categories, and only by separating the two can we discuss the monetary economy, the real economy, and the relationship between them.

Now, we do not need to touch on controversial issues such as how to define digital currency, the composition of digital currency, or digital currency regulation. However, this does not prevent us from emphasizing this idea: no matter how small its scale or how weak its current influence, as long as digital currency becomes a fait accompli, its comprehensive impact on macroeconomics has already begun, leading to a "deconstruction" and "reconstruction" of the monetary economic system and even the macroeconomic structure, forming the new combination model described above.

This process is very much like a chemical reaction phenomenon. According to the usual explanation of chemical reactions: when a new element enters, it will erode and affect the entire system, causing original molecules to break into atoms, and the process of atoms rearranging to form new substances is the chemical reaction process. Digital currency has led to the "splitting" of traditional monetary economy, or the "alienation" of the traditional monetary system, thus changing the traditional macroeconomic structure; this monetary system and this macroeconomic structure are no longer the same as that monetary system and this macroeconomic structure. Therefore, unlike before the birth of Bitcoin in 2008, when discussing monetary economy now, we can no longer exclude the role of digital currency. Similarly, when discussing the real economy or the actual economy, we cannot ignore the existence of the digital economy. We need to incorporate "chemical awareness," "mixed awareness," and "cross-awareness" into our understanding of the relationship between digital economy and macroeconomics.

2. Digital Currency Changes the Monetary Economic System

Now, let’s delve into how digital currency changes the monetary economic system, emphasizing the following points:

First, the comparative advantages of digital currency and traditional currency.

(1) Diversification of issuance rights. The issuance of fiat currency is based on its authority, while digital currency does not pursue authority, thus it is diverse.

(2) Incredibly low costs; when everyone can create digital currency based on blockchain, its cost is naturally very low.

(3) Digital currency transcends sovereignty.

(4) Technology-driven.

The evolution of traditional currency is linked to human civilization and economy, forming a historical pattern, hence the classic saying that currency is the sum of social relations. Digital currency, on the other hand, is the result of the comprehensive development of science and technology, and is the only type of currency in human history created and driven by science and technology.

(5) The market value, variety, and regional expansion capabilities of digital currency.

(6) The circulation speed of digital currency.

Second, digital currency promotes the arrival of a zero-interest and negative-interest era. With the emergence of digital currency, capital will no longer be scarce in the future, and the classic notion of capital may head towards extinction. Government public investment, public consumption, and public goods will increase significantly. The reasoning is simple: the disappearance of capital is due to the cost of monetary resources that could originally become capital tending towards zero. After the introduction of digital currency, the supply is theoretically unlimited. It can even be argued that because of the combination of monetary demand and digital currency, the function of interest rates will no longer exist.

Third, digital currency naturally transcends the so-called "liquidity trap." In terms of private digital currency, its functions are simpler compared to traditional currency, with a wide variety, and it is difficult to link with the "interest rates" of traditional currency. Therefore, there is almost no demand elasticity for any single digital currency or unlimited demand elasticity for digital currency. In terms of fiat digital currency, compared to traditional currency, it has inherent transparency and is difficult to convert into "speculative" currency demand.

Fourth, digital currency ultimately leads to the failure of the IS-LM model. In the vast field of economics, there are countless models. However, the IS-LM model is undoubtedly one of the most profound and practical. British economist Hicks proposed the IS-LM model in 1938, based on Keynesian economics, ingeniously linking monetary economy and real economy. In 1949, American economist Hansen modified Hicks's IS-LM model. IS discusses the relationship between savings and investment, while LM discusses the relationship between money preference and money supply. Whether IS or LM, both are ultimately constrained by interest rates. Now, more than eighty years have passed since 1938, and more than seventy years since 1949; the monetary economy, real economy, and their relationship have all changed significantly. Especially the past logical relationships between interest rates and investment, and between money preference and money supply have been completely disrupted. The penetration of digital currency into the traditional monetary system and macroeconomics has accelerated the failure of the IS-LM model.

On the left is Hicks (John R. Hicks, 1904-1989); on the right is Hansen (Alvin Hansen, 1887-1975).

3. Digital Currency Fully Erodes the Foundation of the Aggregate Demand-Aggregate Supply Model (AD-AS)

Digital currency will fully erode the foundational model of aggregate demand and aggregate supply, mainly reflected in the following aspects: the Pigovian effect, the Keynesian revolution, the Mundell-Fleming model, and traditional international trade models.

First, the Pigovian effect. Research in the Chinese economics community has always been insufficient. Pigou greatly enriched macroeconomics with his theoretical and ideological contributions to wealth, welfare, industry, employment, and institutional comparisons. The most influential aspect of Pigou in macroeconomics is the "Pigovian effect," which describes how a declining price level is conducive to stimulating economic growth, achieving full employment, and creating wealth effects. Now, the correlation characteristics between price levels and consumption, and financial assets have changed. Even entering a low inflation phase does not necessarily lead to a "Pigovian effect."

The sensitivity of price levels to wealth has now undergone a serious separation, with no direct correlation between stock market fluctuations and price levels, or the correlation is becoming smaller. Digital currency and the digital economy have exacerbated this trend.

Second, the Keynesian revolution. In the second half of the 20th century, no economist's influence could surpass that of Keynes, and even to this day. Keynesian economics, represented by "The General Theory," was published in 1936 in response to the Great Depression that had just occurred, and thus Keynesian economics was once referred to as "depression economics." The "effective demand" theory proposed by Keynes expanded macroeconomic total demand theory by increasing investment to expand employment. However, with the advent of the digital economy and information age, the correlation between investment and employment has been continuously weakened.

Third, the Mundell-Fleming model. The core idea of this model is that under conditions of complete capital mobility, a floating exchange rate system has significant and effective impacts on the macroeconomics of various countries. However, what we see is that the intervention of countries and central banks in the exchange rate system is becoming more common, coupled with increased restrictions on the free flow of capital, macroeconomics is increasingly constrained by government influence. Because digital currencies, such as Bitcoin, have the inherent characteristic of transcending sovereignty, there are no so-called restrictions of exchange rate systems. Of course, fiat digital currencies, especially central bank digital currencies, still seem to be constrained by exchange rate frameworks. Regardless, digital currencies will have profound and lasting impacts on existing exchange rate systems and mechanisms.

Fourth, traditional international trade. In general economics textbooks, there is a formula for aggregate demand: AD = C + I + G + (X - M). Among them, international trade, represented by exports minus imports (X - M), is an important component of aggregate demand. At least due to the advent of the internet revolution and the information age, the formation of globalized industrial chains and value chains, and the rise of service trade, traditional trade is being transformed, thereby affecting the macroeconomic landscape of various countries. It is now almost clear that digital currency and the digital economy will further change the structure of international trade itself, while also affecting the position of international trade in macroeconomics.

In summary, from a global perspective, the economic systems, macroeconomic structures, and mechanisms that support macroeconomics, especially the policy systems of government influence and intervention in macroeconomics, are facing an unprecedented new situation. Of course, we cannot attribute these changes solely to the emergence and development of digital currency and the digital economy; it would be premature to draw such a conclusion. However, digital currency and the digital economy undoubtedly reveal a potential new trend.

4. Digital Currency as an Alternative Path for Economic Recovery

Finally, let’s talk about how digital currency may provide an alternative path for changing the normalization of economic crises and achieving a relatively long-term economic recovery. The birth of digital currency:

(1) Changes the way of investment. It mainly changes the form of capital, the status of capital, and the subjects of capital. This is reflected in the comprehensive reform of the relationship between interest and capital, and capital and investment models.

(2) Changes the industrial structure. The main feature is the development of non-real economies, including the digital economy, information economy, and conceptual economy.

(3) Changes the employment model. Self-employment, cooperative economy, and sharing economy will gradually become mainstream.

(4) Changes the economic organization. The traditional company model will decline, leading to smaller enterprises and diversified entrepreneurial models.

In summary of these four aspects, I hope to convey the idea and concept that digital currency has become an extremely important factor or element in understanding modern economics, whether macro or micro, and should not be underestimated in terms of its real and long-term impact on original monetary theory and the real economy. This is something that mainstream economists in the world have not adequately estimated, and it has influenced government macroeconomic policy systems. Taking monetary policy as an example, since 2008, the impact of loose monetary policy on macroeconomics has weakened, and even the lowest interest rates, including zero and negative interest rates, have been ineffective in stimulating the economy, leading to a comprehensive failure of monetary policy. After the global spread of the COVID-19 virus began in March 2020, the effectiveness of monetary policy has become even more pronounced. This is a historically significant phenomenon worth noting.

Finally, these are my immature views shared today. Thank you all, and I hope to hear your criticisms, guidance, and comments.