Edward Hadas

Bitcoin repeats gold-standard errors

By Edward Hadas
January 22, 2014

I cannot judge whether bitcoin represents a technological breakthrough, but I am confident that the pseudo-currency’s popularity shows widespread economic amnesia. If bitcoin ever became a real currency, it would suffer from the crippling problems of the gold standard.

The underlying problem is the belief that the electronic token’s independence from the government is a good thing. This libertarian notion could hardly be more wrong. Money is a common good for the whole society, and in the contemporary world governments are the pre-eminent social guardians.

It is true that under dire circumstances people might have to resort to an inferior monetary substitute. If a government collapsed or totally trashed the monetary system, then some privately issued money could be the least bad alternative. In such apocalyptic times, though, a software protocol which relies on secure electronic communications would not be first choice. Gold, which is tangible and not subject to hacking, is more plausible. So are old baseball cards.

But for the sake of argument, assume that bitcoin or something like it did actually become the leading currency in a monetary dystopia. People would learn soon enough why non-government money works badly.

Deflation is an obvious issue. Price declines are inevitable when a finite supply of bitcoin money, a feature of the software, meets an expanding supply of purchased goods and services. That would be uncomfortable. Consumers might delay purchases as they wait for prices to fall, workers might chafe at regular annual wage cuts, and creditors would be even worse off.

But in itself, deflation does not discredit non-government money. People and banks could adjust to the new monetary reality, as the Japanese have to the country’s 0.3 percent average annual decline in consumer prices since 1998. Alternatively, a different non-deflationary electronic currency could be created; one which added steadily to the supply of money. If the addition was in line with GDP growth, prices and wages could be roughly flat in normal times.

Yet times are not always normal, and neither bitcoin nor some putative “growcoin” – nor any sort of limited-supply money – can cope with unexpected bad news. Historians of money know the story well. Before governments started to issue money purely by fiat, the supply of money was limited by the supply of gold or silver, supplemented by public or private notes which were theoretically backed by some valuable asset. Whenever people decided to hoard their hard currency and reject paper notes, there was trouble.

The spur to the monetary fear might be war, crop failure or a bust financial institution. Whatever the cause, the sudden increase in caution automatically created a sudden decrease in the money for spending. The economic theorists of hard money said that wages and prices would also fall automatically, so the shrunken supply of currency would still be adequate to keep the economy running. In practice, the adjustment was always much too slow. Goods became unaffordable, unemployment rose and production fell.

John Maynard Keynes called it the paradox of thrift. The British economist was analysing the Great Depression of the 1930s, the last big money-prodded general decline. Keynes taught, and the world learned, that governments could and should counter bad news by ensuring that there was always enough money available to keep spending constant.

As the slow recovery from the 2008 recession shows, the policies haven’t always worked perfectly. But they could not work at all in a bitcoin economy, because there would be no authority which could decide how much new money to print. Indeed, the knowledge that governments could not create new bitcoins in a crisis would only increase thrift. Just as in the 19th century, a little bit of bad news would spawn a large economic crisis.

The problem would be worse now than then, because the economy relies so much more on bank-created credit. Whether banks use dollars, euros or bitcoins, they lend out most of their deposits. The loans increase the supply of spendable money, because the loaned sum is added to the total while the deposits which fund the loans are not subtracted.

The arrangement is always potentially unstable. If the borrowers cannot repay too many of the loans or if depositors want to withdraw their money too fast, the bank may fall short of funds. A failure, and an ensuing panic, can only be avoided if banks can find cash elsewhere.

The ultimate “elsewhere” is always the government, which can create new funds out of thin air. Government rescues are not ideal, but better than any known alternative. In a bitcoin or growcoin world, the government would have nothing to offer. Frequent bank runs and financial panics would be unavoidable.

Charitably, the popular interest in bitcoin can be interpreted as a sign of ignorance of economic history. More realistically, it is a sad statement of a loss of faith in a monetary system which has not worked as well as promised. Unfortunately, bitcoin is no more than a high-tech version of an even worse system.

19 comments so far | RSS Comments RSS

Ok lets get started. Even though I have the flu today, and am not feeling well physically, I can still return to refute almost all of this hogwash written by someone who obviously does not know anything about Bitcoin. The gold standard was an error ? What planet are you on ? Tricky Dick Nixon took away the gold standard from The American Dollars, I remember the day it happened. It was the worst mistake in a slew of governmental errors, including running up an 18 Trillion dollar debt on the country’s charge card, and starting a completely useless, Trillion Dollar War in Iraq, while borrowing more money from China, to name a few. ( There’s more. ) A 1 dollar bill costs the same to print as a 100 dollar bill. ( It’s an assigned value ) What exactly is backing the US fiat dollars now ? The answer is simple trust and the ability to borrow. How is an 18 trillion dollar deficit a tangible asset ? ? ? Does inflation exist in your little governmental office ? Talk to the people of Greece about how stable their fiat dollars became recently. The gold standard was ” crippling ? ” If you people at Reuters actually believe the nonsense in this article above, it’s time to stop hiring these bank oriented hacks, to describe malarky. ( I work for free. )

Posted by blaqfather | Report as abusive

All the ” policies ” from 2008 worked perfectly ? Sure, banks and corporations that were ” Too Big To Fail ” got huge bail outs. Sure that would work, then why don’t you tell me why the FDIC still has NOT ENOUGH MONEY for large scale bank failures ? What’s to stop another housing bubble from happening ? I watched while mortgage companies bet on mortgages one month, and one month later, bet against them. Are there any ” policies ” to prevent that from happening again ?? What Keynes did, was give the government the ability to write a blank check, and fill out the value later. This was a mistake of utmost proportion, and it is the reason we now have a ‘buy now and pay later’ society.

Posted by blaqfather | Report as abusive

He is not incorrect. Bitcoin was designed to be deflationary. It was also designed not to be the primary currency, but a supplementary currency to serve as a hedge against too much loss of value in government-regulated fiat currencies. It’s an experiment that will run for as long as people have faith in it, and in a way, it’s a pure ‘free market’ experiment.

Some alternative coins, like PPCoin, are designed to inflate at a moderate pace of approximately 1 percent per year, and without a cap on the total.

Posted by Burns0011 | Report as abusive

You logic is sound. Governments (central banks) can do ill with money supply but they can also help the economy. However, you swim upstream in the timing of your article. The pain of 2008 is still fresh in everyone’s minds, bitcoin prices are at an all time high and the day after your last article that ‘no-one accepts bitcoin’ Overstock.com (Amazon subsidiary) announced it would accept bitcoin.

Posted by BidnisMan | Report as abusive

Your article ignores something else with fiat money supply. When the banks extend further loans without further deposits (fractional lending) they seemingly extend the credit to the ultra-credit worthy only – i.e. the 0.1% and the corporation that made them so. With the hypothetical situation of bitcoin as the international currency there may be less wealth in total but there there will not be a natural perpetuation of the 0.1% super rich.

Posted by BidnisMan | Report as abusive

At last, after a night of pure physical sickness, I have come back to put the cigar in the mouth of this wooden indian here, by saying ; ” The people who own Bitcoins are scattered throughout the world. They come from all walks of life, some rich, some not so rich, some from China, some from Europe, some from South America, and some are Americans. To say that all these people are ‘ anti – government ‘ is purely ridiculous.”

Posted by blaqfather | Report as abusive

At last, after a night of pure physical sickness, I have come back to put the cigar in the mouth of this wooden indian here, by saying ; ” The people who own Bitcoins are scattered throughout the world. They come from all walks of life, some rich, some not so rich, some from China, some from Europe, some from South America, and some are Americans. To say that all these people are ‘ anti – government ‘ is purely ridiculous.”

Posted by blaqfather | Report as abusive

Without government backing how could bitcoins be anything more than the token currency you occasionally hear about among small town merchants?

What about the question of counterfeiting? It might be easy for people who know the ins and outs of computer technology and programing?

Posted by paintcan | Report as abusive

Fiat money is controlled by the shadow government. The central bank’s devaluation of my US dollar asset by trillions every year will come to an end when I insist in keeping my cash reserves in crypto coin. The crypto coin market will stabilize, it continues to grow day after day. That we remove bankers from the world is a very good thing.

Posted by UScitizentoo | Report as abusive

When people realize that they can get paid in crypto coin instead of a constantly devalued dollar, the US dollar will be a dead man walking.

Posted by UScitizentoo | Report as abusive

@USCitizentoo – Why should crypto coin be any more stable than a government backed currency? The value of the bitcoin still has to be compared to the mainstream currency and there isn’t much reason why they shouldn’t move together? Prices don’t depend on what they are paid in?

Posted by paintcan | Report as abusive

1) Crypto coin cannot be devalued by a central bank single authority. Did you vote to have the US dollar devalued by trillions yearly? I didn’t. Therefore by that measure alone it is more stable. (2) The value of a crypto coin is directly proportional to it’s utility. In that regard crytpo coin has far more utility than a paper dollar bill. For example a crypto coin has a public ledger (accountability), and can be traded anywhere without restrictions by governments or banks (accessibility). (3) Crypto coin is a new paradigm. There can be no explanation of it in the old paradigms. It is simply the democratization of money.

Posted by UScitizentoo | Report as abusive

Netizens seem to think Bitcoin can be both investment and currency, but by doing so it becomes neither. Why was gold a currency for so long? Because it was uncommon and had a fixed price. If Bitcoin was to be a serious currency, it should have had its value set to the average of a basket of currencies. Right now Bitcoin remains merely a curiosity with no intrinsic value.

Posted by baroque-quest | Report as abusive

Gold had a fixed price? It’s somehow misleading – while golden coin almost supposedly always cost it’s weight in gold, from our ‘fiat’ POV ‘value’ of that coin fluctuated a lot as prices were not fixed. Notion of ‘eternal’ value compared to current money was from generally lower speed of economics these times – and that foreign-minted coins were as good as local ones (though since High Middle Ages governments took trouble to lower usage of foreign ones).
As for inflation – did you ever heard words ‘debased coin’? Gov’ts in trouble added other -cheaper- metals like silver etc.
BTW silver was used for lesser-value coins and it’s funny to note that ‘Groschen’ coin went from “Denarius Grossus” with very high value to current derigatory word meaning “coin of smallest value possible” (‘cept Poland where it IS coin of lowest denomination,’grosz’).

Posted by chyron | Report as abusive

@chyron “Gold had a fixed price?”

Yes, $35 an ounce for a long time; research “Bretton Woods system.” The actual price could not vary much because one needed to find a large deposit and extract it before the supply of gold could increase; this took time.

This stands in stark contrast to Bitcoin which has doubled or halved in price in a single day, but you and the other Bitcoiners continue to bleat about deflation / debasement. I’ll take deflation / debasement over halving any day. And yes, gold has skyrocketed in price, but never to the extent that Bitcoin did and only because of shills like Glenn Beck.

Not to mention how hackers have created bots to “mine” Bitcoins. Yeah, that’s real stable.

Posted by baroque-quest | Report as abusive

Bretton-Wood was other way around – it was USD with fixed value of 1/35 ounce of gold and was figue leaf over pushing USD as THE international money.
Afair it was doomed the moment France and others offered USA to exchange their (french and german) USDs for gold.

Posted by chyron | Report as abusive

Since the big depression 1930 the economical system has changed. The balance between sellers and buyers has changed as well. Nowadays huge corporations dominate the markets counting on the dependency of their customers. Some of these bigger sellers certainly have a good time during a period of deflation.

Posted by seafloor | Report as abusive

Edward, you quite aptly make the argument from the standard positions, however it is one that makes sense only in a society committed to arbitrary value being ascribed to any individual human being and inherent inequality in the weighting of value. such philosophy and position affects any means of currency, whether wampum shells, shillings, gold, bit coin, unicorn eyelashes, etc.

Posted by NIkiV | Report as abusive

While the article raises valid points, I don’t think there will ever be a “bitcoin economy”. The dollar and other fiat currencies aren’t going away.

For that reason, I don’t think bitcoin should be compared to existing state managed currency. It should be compared to other “fixed” commodities like gold. Gold fluctuates, but in the long run it only goes up in price compared to fiat currencies. This is because all currencies experience inflation caused by a steady introduction of new money.

I think electronic currencies (there are many) will be used for trading where electronic transactions present a problem. The obvious example are criminal enterprises, tax evasion, and money laundering. But not everything is sinister even in that category. Say the Red Cross wants to send money to a children’s hospital in North Korea. Banking transactions are monitored and will be seized by their government. So they might use bitcoin instead. Government is not always the good guy.

Posted by markcwells | Report as abusive

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/