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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.

Humans like categories. And for good reason – they make the world computable. Unfortunately, they can have the side effect of predigesting the world for us, so especially when it comes to concepts that are wholly or mostly abstract, we should be doubly on our guard against firm deliniations against what is “x” and what is “not x.”

More often, “x” is better used as an adjective and not a noun, not a class of thing but property that a thing can have more or less of or be more or less consonant with. JP Koning is a terrific advocate for this approach, as he explains why is blog is called “Moneyness:”

The second way to classify the world is to take everything out of these bins and ask the following sorts of questions: in what way are all of these things moneylike? How does the element of moneyness inhere in every valuable object? To what degree is some item more liquid than another? This second approach involves figuring out what set of rules determine an item’s moneyness and what set determines the rest of that item’s value (its non-moneyness).

Here’s an even easier way to think about the two methods. The first sort of monetary analysis uses nouns, the second uses adjectives. Money vs moneyness. When you use noun-based monetary analysis, you’re dealing in absolutes, either/or, and stern lines between items. When you use adjective-based monetary analysis, you’re establishing ranges, dealing in shades of gray, scales, and degrees.

Not only do I wholeheartedly endorse this approach re: understanding money, I think the methodology should be expanded to all kinds of other things. For example – a feature of much libertarian thought is trying to decide whether or not something is “coercive.” I’m not a libertarian, but I am emphatically not trying to concern troll when I suggest a better avenue to pursue is trying to weigh whether different things are more “coerce-y” than other things.

This brings us back to “savings” vs. “consumption,” or “investment,” or “consumer goods” vs. “capital.” I really don’t like these distinctions, because as useful as they have often been in the past in the present they can often sow more confusion than anything else. I suggest we instead look at different goods having different levels of “saveyness” or “capitalness” – some goods last longer, some have more uses, some increase future productivity more than others. This applies to both the consumer side as well as the good side – ie, is a certain consumer decision “saving” or “consuming,” as well as is a certain good “consumption” or “capital?”

Think of a Twinkie. Twinkies are an odd product; on the one hand, they are a cheap, delicious, unhealthy snack; on the other hand, they are (at least according to legend) practically immortal. So is buying a Twinkie consumption or saving? Does it depend when you eat it? And for those who will say “but Twinkies aren’t an investment, they bear no interest, they just sit there” – so does money under the mattress, and nobody thinks that isn’t saving. More interestingly, from the perspective of the economy, for the most part it doesn’t matter what you do with the Twinkie. Obviously in the aggregate, if people buy lots of Twinkies for “saving” purposes as opposed to “consumption” purposes there might be fewer loanable funds, but if you were deciding whether to buy a Twinkie, stuff it in the pantry, and eat it in a year, or simply stuff a dollar bill in the pantry to buy a Twinkie a year from now, you’d still be saving the same amount…right?

Or think about what goods are “consumption” and which are “capital.” Got it? OK – is roasted coffee a consumption good or capital? Fine, that’s probably an easy one – since it only has a single use, it probably gets counted as consumption even though it is manufactured and increases productivity. What about a Keurig machine? What about my beloved ekobrew that allows me to turn fancy whole bean roasted coffee into a Keruig-produced cup of hot java? Are these “consumption” or “capital” goods? Does it matter if I’m a worker at a firm or a sole proprietor? If Google had a giant coffee roasting and producing operation at the Googleplex as a perk for their employees we’d probably call the equipment they used to make the coffee “capital” – so is it merely a question of scale? If I buy it on Amazon, is it automatically “consumption?”

I think these conceptual questions are inevitable if we continue to rely on heuristical categories that don’t tell us much about modern life. Instead, any time we discuss a social production decision, we should instead ask ourselves questions – what does the good do? What inputs does it require to do what it does? How long does it last? How much does it increase productivity and happiness? How much maintenance does it require? What is it replacing or displacing, if anything? Asking these kinds of questions will tell us things about the nature of what we, as a society, are producing that are much more valuable than traditional delineations. For example, I think the United States, as a society, should be building more high-speed rail. High-speed rail is very “capital-y” – it lasts a long time and greatly increases productivity. I would be willing to trade substantial amounts of “consume-y” goods – candy bars, video games, new T-shirts – in favor of building more high-speed rail. Of course, the GDP calculation will show that as “G” and not “S/I” assuming it is built by the state – but it represents a social decision to produce more long-lasting, productivity enhancing, future-oriented stuff than it was before at the expense of more quickly-depleted, pleasure enhancing, present-oriented stuff. In the aggregate, that’s what “saving” is. It’s not a question of “more” or “less” but “what?” and “why?”
See also this book.

Something that occured to me recently (I think it was after reading this post by Freddie deBoer but I don’t quite recall) is that, in all the talk about the problems surrounding escalating aggregate student debt and average individual student debt loads, nobody has quite made the case that all student debt is really, really stupid. So I will:

Student debt is really, really stupid. Debt is an instrument by which to finance an acquisition. There are many of them; debt is one. It is, specifically, where you trade a portion of your future earnings for increased present consumption, usually because you are purchasing something which it would be beneficial to own now but would take a long time for you to save for. If you’re talking about an individual, think house and car; a firm, big capital investments.

Of course, since we haven’t invented time travel (and even if we had if giving money to your past self changes the future we might trap ourselves in an infinite loop) you are assisted in this process by an outside lender, usually a bank or bankish institution, who assess you a fee for borrowing this money. However, a fee doesn’t quite solve the big inherent problem in this model, which is "what if you don’t give the lender the money back" which is why we invented collateral, which in addition to being an excellent movie is the formal name for "if you can’t pay the bill the bank takes your [thing you borrowed the money to buy]" and assuming your legal system functions sufficiently well then you’ve got yourself a financial system.

However, education poses two major problems to this model. Firstly, there’s no collateral – once educated, your education cannot be reclaimed or clawed back. Secondly, there are massive positive externalities to education – a more educated workforce is more productive, more innovative, and produces higher quality goods and services for everyone to consume. And the big problem is that these mitigate in opposite directions, the former against having an education loan market at all even though the latter makes widespread education hugely desireable.

We’ve kludged this together with a network of subsidies, but that has produced the status quo which obviously sucks in many ways. So what we really ought to do is try to think of ways to get students educated without using a primarily debt-based market to make the whole thing work, or a radically-altered one.

Russ Roberts approvingly links to this diatribe from John Papola that is either very confused, attacking straw men, deliberately mendacious, or all of the above. Rather than engage it point-by-point, because I am tired and have better things to do, I will instead just start with the conclusion then go read a good book.

Of course economic growth is driven by production. Non-satiation is a key understanding of economics – that no matter how much people have, they will always want more (in some sense). Therefore, since the desire to consume is a constant the level of growth is almost definitionally a question of supply (though on a truly philosophical level, if humans did not experience want there would be no incentive to produce, but presumably that random mutation would be selected out). As long as we can continue to figure out how to make more, make better, and make more efficiently, consumers will demand the same.

But this is not the same question as what causes recessions. The reason that macro befuddles and confounds is that recessions are weirdOn the one hand, we have all these people who (as we just said, by definition) want more stuff; on the other hand, we have all these people who were making stuff yesterday and weren’t making stuff today. Here are some theories for what cause recessions:

1. A sudden and contagious plague of laziness.

2. A sudden and contagious plague of contentedness.

3. A sudden and contagious plague of confusion and stupidity.

These are idiot theories. None of them are remotely true. Yet recessions still happen. Which means that even though everyone who is consuming less would like to resume consuming what they were consuming and everyone who is producing less would like to resume producing what they were producing they can’t. For some reason.

That reason is, in a word, money. Why and how it’s money are complex and tricky questions, but there should be zero doubt that that is, in fact, the answer. And that means that recessions are about demand.

India is a really good example about how poor public policy and social organization can lead to unnecessary supply-side constraints that impoverish everyone. America is not India. We usually grow. When we don’t, it’s weird. It’s a malfunction.


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