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Kevin Drum, riffing off yesterday’s epic Mt. Gox and BTC implosion:

Bitcoin, after all, is the ultimate fiat currency: just a bunch of ones and zeroes on a computer with no intrinsic value. But so are all currencies. The difference is that it’s more obvious with Bitcoin because the entire enterprise is actively marketed as nothing more than algorithmically-created data. It’s one of their big selling points.

So that forces you to think about what the ultimate value of a Bitcoin can be. And if there isn’t any, then why do dollars and yen have value? Why do IOUs passed around in prison camps have value? Or babysitting chits? Once you figure out what ultimately underlies the value of these various fiat currencies, you’ve taken a big step toward understanding why some currencies are better than others and why playing games with the debt ceiling is so stupid.

Which reminds me that I wanted to knock down this whole notion of “fiat currencies” in the first place.

Money is a technology devised as a solution to a bundle of collective action problems centered around network effects and the transaction costs of exchange above a certain threshold of scope and scale. It works really, really well, but it has a few problems. A key problem (though not the only or, perhaps, even the most important of which) is the one of storing value – money is only useful if its value doesn’t fluctuate too much, too unpredictably, too soon. However, there are incentives for whomever issues the money (as well as counterfeiters) to take actions that result in just those kinds of fluctuations, as well as outside pressures that make such fluctuations more likely. Therefore, almost every money issuer ever has taken some sort of steps to regulate the value of its currency and the rate at which that value changes.

One solution to this was to make the money out of rare, durable, verifiable elements. One solution was to have private actors issue money and caveat emptor. One solution was to have a bunch of state technocrats issue paper redeemable for said elements. One solution was to have a bunch of state technocrats issue paper redeemable in more paper and pinky-swear not to allow the value of the currency to fluctuate. One solution was to create a self-perpetuating algorithm that fixed the supply of currency units. There were also other solutions.

I think trying to sort those and the myriad other solutions to the money problem into “fiat” and “backed” is as irrelevant as it is obscurant. In each of those schemes there are two identifiable foci from which value regulation derive and distinguish various schemes from each other:

-The algorithm – the rule governing the value path of the currency.

-The credibility – the likelihood of the currency following the value path promised by the algorithm, and the accountable party for those outcomes.

This makes actual, categorizable sense of the differences between various monetary regimes. The algorithm of a gold-standard is “the value of this currency will always be equal to a certain quantity of gold, and you can always exchange your paper for that quantity” and the credibility is in the issuer, whether it’s a private bank or the central bank. Nothing stops me from issuing a gold-backed currency tomorrow, but nobody would use it because my promise to redeem all the SquarelyBucks I’m issuing for shiny gold coins is, sadly, totally lacking credibility. The algorithm of a “fiat” currency is “the value of this currency will never decline by more than ~2% annually” and the credibility is in the issuer, in this case Janet Yellen, the FOMC, and the institutional apparatus in which they operate. The algorithm of Bitcoin is “the money stock will never exceed 21mm BTC” and the credibility is in the nature of the currency’s code which until recently seemed very well-designed to prevent counterfeiting.

The genius of Bitcoin is that it takes the algorithm out of human hands; the tragedy of Bitcoin is that its algorithm is stupid, for two reasons. The first was that Bitcoin’s algorithm was borne out of an ideology which believed that central banks inherently lacked credibility and that therefore central bank currency inflation, even hyperinflation, was not just possible but inevitable, especially in light of the various Federal Reserve responses to recent economic shocks. This ideology is wrong:


TIPS Spread

The second reason is that there are better algorithms even if you believe in that (wrong) ideology. A good example would be “one BTC will always equal one 2009 USD no matter what happens to the value of USD over time.” This, of course, is way more complicated than the BTC algorithm as a coding matter, because it would have to either trust CPI or another inflation measure or somehow routinely update an internal proprietary index based on accessible price data, a tricky thing to do into perpetuity. If someone wanted to program and release that cryptocurrency, BTW, it would be a fantastic economic experiment. But that’s not BTC, which instead fixed its money supply, and lacking any private or public chartalistic price anchor allowing for large, unpredictable, rapid fluctuation in its value, thus defeating the purpose of money itself.

I hereby therefore petition that we suspend all discussion of “fiat” currencies and “backed” currencies and instead discuss rules and credibility.

(Thanks to Mike Sproul and Nick Rowe for kicking this around with me in the comments of this post)


So I’m listening to the latest Planet Money, re: Bitcoin, and lately I’ve also been listening to FT’s Hard Currency podcast, and I’ve just got to say: foreign exchange markets are really, really weird. And there’s a reason for that – unlike other asset markets, the point of currencies is not to become more valuable, ceteris paribus. Usually, if your currency becomes more valuable it is a signal that good things are happening in the relevant political unit (if there is one), but the direction of causality here is important. Stocks are supposed to become more valuable, as are bonds, etc. But currencies are supposed to be stable. They are supposed to make all the other stuff in the economy possible.

So it’s odd to hear things like "which currency had a good year?" or "I’m long that currency" or other things like that. Forex traders serve an extremely valuable role in ensuring exchange rates reflect social information, but the mindset that leads to is in-and-of-itself a strange one. If Japanese folks decided to buy more Swiss chocolate and Americans decided to buy exactly the same amount less, the Swiss franc would appreciate against the yen and depreciate against the dollar and then the dollar would appreciate against the yen to exactly the amount that would forestall arbitrage and then Swiss and American consumers might decide to buy more Japanese stuff than they did before and so on and so forth until you get to "general equilibrium" (whatever that is) but the whole point is that if the central banks were targeting, oh, say, the level of nominal gross domestic product, none of these secular changes in consumer preferences (unless they were really huge) would have any effect on the overall level of economic output in any of these countries.

The fact that some currency goes up or down against another doesn’t really tell you anything about relative levels of inflation or prosperity. So there’s no underlying normative preference for one direction in exchange rate fluctation over another. I’m going to Turkey and Germany in September, so I really hope the dollar appreciates against the euro and the lira between now and then but if in October I get hired by a company that exports a lot to Germany then boy do I hope the dollar depreciates againts the euro. But there’s no reason to prefer one over the other from the standpoint of the overall national interest unless you’re super-dependent on a certain kind of international trade pattern.

Also, I realize I’m pretty down on Bitcoin generally on this blog, so I should say – certain things about Bitcoin are awesome, and I’m certain that whatever money looks like in 10-20 years, it will look more like Bitcoin then it does today. I’m just down on Bitcoin specifically due to Bitcoin-specific issues of trust and governance. I’d gladly use Bitcoins to transact, but I’d also gladly use Paypal or Square and be certain that the ~225 USD I sold my Pebble watch for last week can still be exchanged for the same basket of goods next week or next month or even next year, more or less. If I wanted or had to transact in BTC I’d want to get in and out of having any position in the currency ASAP, but somebody has to hold them and those people either need BTC for transaction-specific reasons or are speculating. I want to be able to hold my money (or deposits denominated in money) for long periods of time without having to feel like I have a position (although I of course do). You’ve got to have some liquidity so if the value of your currency is pretty stable it’s pretty easy to just hold cash or deposits.

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Ryan Cooper says this about Bitcoin:

…there is no human judgment whatsoever on the size of the bitcoin money supply, because it is all determined by prearranged mathematical formulas. This solves the problem of the currency being destroyed by the government, but at the cost of an inherent vulnerability to deflation and boom-and-bust panics, as we’re seeing today. (I strongly suspect some Wall Street types are making out like bandits at this very moment.) The only way to solve the panic problem is with a trusted central bank that credibly promises to intervene to prevent excessive inflation or deflation, thereby short-circuiting the self-fulfilling cycle. Again, this is impossible with Bitcoin.

Which is correct! But asks the question – what is the point of Bitcoin?

Money is three things – a medium of account, a medium of exchange, and a store of value. Let’s say USD:BTC is a random walk with unknown parameters. Is Bitcoin money?

The fact that, at any given moment, the USD:BTC has deviated stochastically from its prior value should not impact Bitcoin’s usefulness as a medium of exchange. Much has been written about the cleverness of Bitcoin’s code and structure; this makes it a very useful way to make secure exchanges.

But what about a medium of account? If Bitcoin’s value is random (and, presumably, fluctuating quite wildly), that doesn’t mean it can’t be a medium of account; it just won’t be a very useful one. Something that was 3BTC today will be 30BTC tomorrow and 0.000003 BTC next week. You could certainly keep track of USD:BTC and "translate" a Bitcoin ledger into dollars, but that only goes to prove that usefulness as a long-term medium of account has something to do with…

"Store of value." The thing about Bitcoin is that it is not solely a platform for secure exchange; once an exchange is made, one party or another is holding some number of Bitcoins. In fact, since there is no Bitcoin finance, at any given point individuals are holding all the Bitcoins in the world. And, if the price can fluctuate wildly between exchanges, it is a terrible store of value. Something you sold for 5 BTC yesterday could be worth 50 or 0.5 BTC today, and you haven’t had a chance to change your BTC for something more stable – or, if you have, the next guy got screwed.

So, to be money-er, Bitcoin really could use some sort of exchange rage regulation. The problem is…who? Even in the Cryptonomicon scenario, you’d have to trust the authority regulating the currency. And why would you? They may not have any power to buy back the currency if inflation is overheating, and no power to inject new money unless there is demand for it. The central bank of a country, back by laws and institutions and police and armies, have the power to compel money demand chartally; they have regulated banks that must maintain reserves at the central bank; they have deposit insurance; they have foreign reserves; they have gold; they have all kinds of things that allow them to back currency with trust, because they back trust with the state.

Point being, that in this modern age non-state currencies without intrinsic value are destined to either fail or be severly limited in their broader utility, especially to folks who want to engage in legal transcations.


In one of those "let’s defy common wisdom/sense!" kind of things, Matt Levine of Dealbreaker says something badly in need of correction:

1. You were shorting a thing that you were selling to your customers! This is what drove Congress bonkers. But that’s what selling is. If you have 20 apples and sell me 15, you now have fewer apples, and I have more. If apple prices decline, I am worse off, and you are relatively protected. Banks, which are always long some risks and short some others, don’t see zero as a particularly interesting point on this continuum – if you have 20 apples and sell me 30, and apple prices decline, you make money, but that’s different only in degree, not in kind, from selling me 15 and reducing your risk to 5.

This is silly. Let’s say I’m an apple farmer. And let’s say I love apples. Like, really love apples. For breakfast I have apples. For lunch – more apples. Dinner is apples. Dessert is an apple tart. Me, my spouse, my kids – we are all fiends for apples.

But if I have a worthwhile apple farm I am a) still going to have way, way more apples then my family could eat, and b) still need other stuff I can’t grow from the ground. Ergo, I’m going to want to swap some apples for other stuff – farm equipment, energy, an iPad, etc (or for currency that can be swapped for that stuff). But this doesn’t make me an apple speculator. It’s really about diminishing marginal returns and economies of scale. The apple is worth objectively more to someone who has zero apples and wants an apple then it is to someone who has 100,000 apples and can only eat 40,000.

But let’s say I found an apple with a bomb in it. I could bury it or try to defuse. I could alert the authorities to the situation. Or I could sell you the apple, neglect to mention the strong likelihood that it will explode, then make a huge bet with someone else that by day’s end you’ll be in the ICU with third-degree burns. That’s not capitalism, that’s being a giant asshole, and that’s really what people are accusing Goldman Sachs of here.

Now I’m going to go eat an apple.

In reading about the fascinating-and-inane-in-equal-measure experiment in private money called “Bitcoin,” I found this post by Timothy Lee, which contained a passage that I found very clarifying:

So one of Bitcoin’s key selling points—a permanently fixed supply—is basically illusory. The supply of Bitcoins, like the supply of every other currency, will be controlled by the fallible human beings who run the banking system. We already have an electronic currency whose quantity is controlled by a cartel of banks. If you’re a libertarian, you might think the lack of government regulation is an advantage for Bitcoin, but it strikes me as highly improbable that the world’s governments would leave the Bitcoin central bank unregulated. So I don’t see any major advantages over the fiat money we’ve already got.

In fact, from a small-d democratic standpoint, once you’ve reached this point of analysis the Federal Reserve System is actually superior because its leaders are appointed and confirmed by elected officials, thus implementing at least some democratic accountability.

But I’m not sure that matters to a lot of self-described libertarians. There is a view, famoulsy summarized by a misquoted Margaret Thatcher, that says “there is no such thing as society. There are individual men and women, and there are families.” In this view, there are individuals and there are those things that intrude on the right of individuals, and the latter is pretty much malicious in every instance.

But there is also a view that there is very much a thing called society, built of networks and relationships, fundamentally rooted in interdependence, and impossible to reduce to the sum of its parts. In this view the entirety of the society produces a certain amount of wealth in goods and services, and how those goods and services are produced and allocated should be determined by institutions elected by society in an accountable and fair and transparent way. This is not to say there is no such thing as individual rights, property rights, etc, but that those who happen for one reason or another to be the lucky few to control the flow and distribution of capitol shouldn’t be the only ones to determine its destination.

And these views are mostly incompatible, though in practice there are some practical areas of agreement (mostly around the necessity of public security and contract enforcement). But it does seem that libertarianism, to the extent that it denies the right of democratically-elected institutions to acquire any meaningful power beyond policing and border defense, doesn’t really lead to any kind of meaningful democratic empowerment.

But if you don’t believe that those who possess capitol have a sacred right to accumulate as much of it as they can, you will probably be more inclined to agree with Abraham Lincoln:

Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed. Labor is the superior of capital, and deserves much the higher consideration.


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