Opinion

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.

Comments
37 comments so far | RSS Comments RSS

Well written and thought out. However, please allow me some remarks:

1) Notwithstanding its great quality, your post takes another ‘either or’ perspective. I would rather welcome a post that theorizes on a world where both bitcoin and national currencies co-exist. Is this really impossible? What has to be done to create a win-win situation?

2) You are certainly right in saying that it is better for the ecomomy to have a flexible money supply. But should the state of an economy really be the single most important measure for humankind? Who is the better human: the one who goes shopping to keep the economy going or the one who tries to save our natural resources for our children?

Thanks for your opinion in advance

Posted by ocmone | Report as abusive
 

Well written and thought out. However, please allow me some remarks:

1) Notwithstanding its great quality, your post takes another ‘either or’ perspective. I would rather welcome a post that theorizes on a world where both bitcoin and national currencies co-exist. Is this really impossible? What has to be done to create a win-win situation?

2) You are certainly right in saying that it is better for the ecomomy to have a flexible money supply. But should the state of an economy really be the single most important measure for humankind? Who is the better human: the one who goes shopping to keep the economy going or the one who tries to save our natural resources for our children?

Thanks for your opinion in advance

Posted by ocmone | Report as abusive
 

So, your solution to having printed too much money is to let “the government” print even more money.

I don’t buy it.

Creating money from thin air does not produce wealth, rather, it robs savers and discourages investment into production capacity.

When Bitcoin prevails, the ability for the central bankers to enrich themselves and their chosen few (cronies) by running the proverbial printing presses will be gone. That’s what originally attracted me to Bitcoin.

Your entire rant sounds like a contrived fear tactic to me. For example, if gold is so bad, why do central banks own so much of it? Sounds hypocritical to me: “We’ll trade in gold. You common people use these slips of printed cloth that we’re able to devalue…”

Posted by crw92129 | Report as abusive
 

It’s fun watching Bitcoin demonstrate, in the real world, that the “deflationary spiral” is at best highly exaggerated, and at worst is but a fallacy. Not only do people spend Bitcoin, even though they think it may be worth more in the future, but in fact the entire Bitcoin economy is becoming increasingly dynamic and active since it started.

An objective observer will notice a world of profound growth and innovation… though it runs counter to popular economic doctrine.

Posted by evoorhees | Report as abusive
 

It is incumbent for the Edward to research the topic before judging, for it is only what a reasonable person would do.

As Edward points out Bitcoin is deflationary. However, due to not understanding the technology he has not realised a solution has already been presented.

Historical approaches required creating more money, which creates inflation. Bitcoin avoids this pitfall via infinite divisibility. Liquidity is provided without diluting existing holders. This requires most economists to “think outside the square”. Please do so.

It does no credit to Edward that money printing has widened the Gini coefficient the world over. Debt based fiat is an imperfect solution. It awards seniority over meritocracy, on a permanent basis.

It is sad that economists comment on the supposed ignorance of others from a position of ignorance themselves.

Posted by Lloydie | Report as abusive
 

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
 

This article starts off with saying that he can’t judge whether Bitcoin represents a technological breakthrough. You cannot evaluate Bitcoin is you don’t understand the breakthrough which is a decentralized consensus system. While Bitcoin can be used to achieve some political goals, like the Internet, it is not a political thing, it is a software tool that can be used for many purposes. You also discuss Bitcoin as an either/or scenario but it will be a choice among many things. Banks, currencies, and governments won’t collapse simply because Bitcoin exists. discussing a world where Bitcoin is a dominant currency is an interesting discussion but it has to be taken in the context of the technological advance that it provides.

Posted by Milly-Bitcoin | 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
 

“I cannot judge whether bitcoin represents a technological breakthrough”

And that is the first fail, which is why you came to the wrong conclusion. A proper examination of the protocol will have revealed to you that liquidity problems associated with hard money can be resolved. How? Read the paper and do some RESEARCH.

Posted by Lloydie | Report as abusive
 

I agree with blaqfather above.
In addition:
a) I think the currency aspect of BTC is best seen as a commodity exchange. The BTC codes are like prime numbers in the sense that they are there to be discovered.
b) A financial infrastructure based on BTC (read commodity) will eventually lead to a trust model anyway. People will not be keeping their lifes savings on a flash disk. Secure datacenters will be banks, much as today’s retail banks are just dressed up secure datacenters.
c) BTC therefore presents the *opportunity* to actually return to a gold standard, and central banks should look to BTC, or cryptocurrency, as an alternative to SDR in a global banking union, because a return to physical gold is not feasible.
d) Finally, BTC is not just a currency. It is also a settlement system. It is also an escrow system. It offers the ability to tie together exchange of promises with exchange of currency using multi-party cryptography instead of trust.

Posted by FrankSz | 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
 

@paintcan
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
 

@paintcan

The internet is global, bitcoins are on the internet. There is not much more to say about why it is not just a token currency heard among small town merchants. Overstock.com is accepting bitcoins, eBay, Amazon, and Google are soon to follow.

Your questions regarding the counterfeiting are not unfounded. However, even knowing the ins and outs of computer technology and programming, that will not help a hacker create their own bitcoins. The protocol is based on a public ledger which has record of every bitcoin in existence. The only way for a criminal to obtain bitcoins is by hacking into your account which is no different from a bank robber holding a bank at gunpoint.

Posted by mitchwhite5 | 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
 

@baroque-quest
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
 

@baroque-quest
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
 

Currencies are not declared.
Bitcoin is not independent of government. That is a myth.
An article based on a rare event “monetary dystopia” can only describe a rare outcome.
Governments are hardly social guardians. That’s the perception of someone in Govt.
Gold can be easily hacked. Just cook the books on a gold EFT and there you go…

Bitcoin has no borders, no central authority. Bitcoin lets anyone make their own deposits and withdrawals into their own backed up wallet, sans fees or tellers.

The world has many currencies. Bitcoin is ideal as a world currency living and breathing in the multi-billion member social networks.

But, most of all, its software. The most relevant question was neither mentioned or addressed in the article. All software evolves. What is Bitcoin going to become? that is the relevant question.

Posted by JamesD112 | Report as abusive
 

In my humble opinion, establishment bootlickers are very hostile to bitcoin because it doesn’t yet give them an opportunity to manipulate the money supply. The existing system is good for corrupt people because the Fed can dole out massive sums of money to favored banks first.

I don’t find the author’s argument, what little of it that exists, convincing at all. Governments are ostensibly the pre-eminent social guardians, but in reality is the most destructive organization that currently exists.

Posted by purplegap | Report as abusive
 

Usually appreciate Hadas intellectual rigor. Appears he’s talking to something different this time.

“I cannot judge whether bitcoin represents a technological breakthrough”

Very first sentence therefore disqualifies you from any further definitive statements. To wit: I cannot judge whether the wheel represents a technological breakthrough as I can easily run faster over these rocks than I can push this stupid wagon I made.

“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.”

It’s impossible to be confident in any rational sense of what WILL happen in the future – yes, even death and taxes. That is simply fact. By saying otherwise does not make it so. Innovation is about true intellectual curiosity and the foundation of innovation is intellectual open-mindedness and passion for fixing what is broken.

Clearly, the current model is broken. Go innovators. Make the world a better place as usual.

What follows in Hadas’s narrative is just absurd in terms of cogent logic. Just a sample:

“The ultimate “elsewhere” is always the government, which can create new funds out of thin air.”

Nothing is ever ‘always’. And it’s obviously absurd to posit that governments can ‘always’ create new funds out of thin air. Hadas states this as fact to somehow claim as truth in support of an argument. Governments clearly CANNOT always do anything if those governed decide otherwise. Who’s ignoring history?

“Government rescues are not ideal, but better than any known alternative.”

Really? Not intellectually rigorous. Or thoughtful. Or even true. How about functional government where society-crushing ‘rescues’ are even needed. Come on. Where’s the rigor?

“In a bitcoin or growcoin world, the government would have nothing to offer. Frequent bank runs and financial panics would be unavoidable.”

God. No need to say anything here. See above logic.

“Charitably, the popular interest in bitcoin can be interpreted as a sign of ignorance of economic history.”

Charitably this is absurd. ‘Can be interpreted as a’ parakeet too. More opinion proffered as fact. Not fact. Only intellectually honest statement, I don’t know what will become of bit whatever coin, but it’s considerably more fair to state that fiat ‘coins’ will eventually fail. Simply because THEY ALWAYS HAVE for basically the same reasons. And not because of ‘crops’. Math is fact. Not opinion disingenuously representing itself as the ‘popular interest’.

“More realistically, it is a sad statement of a loss of faith in a monetary system which has not worked as well as promised.”

Sad? It’s called a market. It’s called the collective free will of thinking people. Please. Rigor.

“Unfortunately, bitcoin is no more than a high-tech version of an even worse system.”

Yea. Just like the wheel.

Posted by TheNeutralParty | 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
 

I would like to raise a question – if the demurrage currency of Silvio Gesell and others could work as a digital currency.

Posted by Galilee | Report as abusive
 

Huh?

Posted by TheNeutralParty | Report as abusive
 

What’s wrong with competition from BitCoin that makes transactions cheaper? Isn’t that the nature of the capitalistic market? The problem with this article is that it assumes that BitCoin is going to take over the world – it’s not. But crypto currency is going to change the world. There might be a future crypto currency that evolves from BitCoin into an ideal, but we’re not there yet. Interest in BitCoin is hardly ‘a sign of ignorance’ – rather an article judging something new which disturbs the current world order as a complete replacement of modern currency – that’s definitely a sign of ignorance.

Posted by JoeCalifornia | 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
 

@blaqfather

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.

You don’t remember leaving the gold standard unless you’re at least ninety years old. What the U.S. left during the Nixon Administration was the gold window, which operated for purpose of the foreign exchange markets, not the domestic economy.

Posted by BenJohannson | Report as abusive
 

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Posted by Anonymous | Report as abusive
 

Great article.

Posted by TheNeutralParty | Report as abusive
 

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