I am intrigued by the Bitcoin experiment – the attempt to launch a virtual currency as an alternative to the current global patchwork of local state fiat monies. Bitcoin has recently been hotly debated in the online community and among libertarians, and has now aroused the interest of the mainstream media and the political establishment. Bitcoin’s challenges seem to be mainly operational – related to computer and internet security and cryptography, which is of paramount importance to the Bitcoin project. These are areas in which I am no expert by any stretch of the imagination. But many of Bitcoin’s monetary properties strike me indeed as highly interesting and commendable, and I am somewhat surprised by the indifference or even hostility Bitcoin has encountered from many free-market ‘Austrians’.
I cannot presently see it challenge gold, and after some recent setbacks – again, mainly of an operational nature – I am not even sure it will survive, but in terms of pure monetary economics it has considerable advantages over state fiat money, many characteristics of gold – and potentially even some unique advantages. The concepts and ideas behind Bitcoin cannot easily be dismissed.
Before I try and evaluate Bitcoin, let’s put this story into the broader context. Please bear with me for a moment as all of the following does indeed relate to the Bitcoin project.
The decline of state paper money
We are presently living in the twilight of the fiat money era. The twentieth century was the century of statism, of big state ideologies, such as communism, socialism, fascism, and, since the end of World War 2 and certainly since the fall of communism in 1989, of global social democracy — the combination of nominal capitalism (nominally private ownership of the means of production and moderately free trade) combined with a highly interventionist state apparatus legitimized by the concept of majority rule.
All the big state ideologies of the first half of the twentieth century (and I include here the ‘fascism lite’ of 1930s New Deal America) were hostile to gold. If the state was to create a better world and fulfil the historic mission of the class, the race, or the nation, its activities couldn’t be restricted with the straitjacket of a gold standard. The Bolsheviks confiscated all gold after the revolution, so did Roosevelt during the depression in 1933. Maybe nothing signifies the end of the classical liberal era of the nineteenth century more than the demonetization of gold, and the Nazi economist Werner Daitz was not just speaking for his fascist masters but reflected widespread ideology when he declared:
“In future, gold will play no role as a basis for the European currencies, because a currency does not depend on what it is covered by, but rather it is dependent on the value which is given it by the state, or in this case by the economic order which is controlled by the state.”
The modern social democratic state has largely maintained the concept of complete state control over money via its territorial monopoly on paper money creation. Historically, state paper money was introduced – openly and unashamedly – as a tool to fund the state, predominantly for the purpose of warfare. Of course, the modern client state has to argue somewhat differently. Conveniently, modern macroeconomics has, in the twentieth century, come up with a number of ultimately dubious theories for how the national economy – obviously a political fiction – can be made to perform better through the clever manipulation of the national money supply and the administrative setting of national interest rates by the central bank, in which the national monopoly power of money creation is vested. Bizarrely, in the latter part of the twentieth century, even self-styled “free market” economists have found ways to make peace with the concept of state money (Milton Friedman).
This system is not only suboptimal it is in fact unsustainable – even if those who are in charge of the fiat money franchise do exactly as they say they would. The system’s Achilles heel is the very elasticity of the money supply that today’s mainstream doesn’t tire of touting as its main advantage: “No dreadful deflation and we can always ‘stimulate’ the economy!”
The fallout from decades of ongoing and essentially unconstrained paper money production is now accumulating all around us – unsustainable debt levels, overleveraged and weak banks, and distorted asset prices globally. The crisis is at the moment still unfolding in slow motion, although I reckon things are about to accelerate soon.
Gold – the eternal money
What comes after the collapse?
My short answer is, I don’t know.
It is one thing to show conclusively that something cannot work and must collapse, but it is logically quite a different thing to predict what will come after the collapse.
Gold has been a monetary asset throughout practically all of human civilisation, in all cultures, and is presently still regarded the number one monetary asset the world over.
Importantly, the supply of gold is essentially inelastic. Nobody can quickly and cheaply expand the supply of gold. Again, contrary to currently widespread fallacies, this is a distinct advantage for gold’s use as a monetary asset, not a disadvantage.
But, I am often being asked, are alternatives feasible? Well, who is to say that human ingenuity will not come up with new ideas and revolutionary solutions? However, gold – a commodity of limited and essentially inflexible supply – can deliver all that a medium of exchange ever can deliver. I see little need to come up with something new.
The Cyber-money promise
“I’ve seen the future and it will be
I’ve seen the future and it works”
The Future, by Prince
Bitcoin is a digitally created, completely decentralized currency that only exists in cyberspace, created and sustained by the computers connected on the world-wide-web to form the Bitcoin network. It is a peer-to-peer payment system that allows digitally signed transactions. It does not have a centralized issuer and there is no central authority controlling it.
Allegedly, Bitcoin transactions cannot be traced and accounts cannot be frozen. The system cannot be shut down or destroyed. (Again my knowledge of computer technology and cryptography is too limited to pass judgement on any of these claims.)
Significantly, according to this Wiki entry, “there is a limited controlled expansion of the monetary base hardcoded in the Bitcoin software, but it is predictable and known to all parties in advance.” At each moment, every user is able to not only see how many Bitcoins he or she owns but also how many Bitcoins are in existence in total. Ultimately, only 21 million currency units can be created.
The process of Bitcoin creation is called “mining” (hear, hear!), and is conducted by computers supporting the Bitcoin network. As I understand it, Bitcoin mining involves considerable computing power and is supposedly designed in such a way, that the supply of Bitcoins only increases moderately over time, until it reaches a limit – the said 21 million units determined by the underlying algorithm – at which point the supply of Bitcoin is essentially fixed. Of course, as with gold or paper money, most people who use Bitcoins are never involved in “mining” it but get hold of it by trading with others.
The appeal of Bitcoin and its advantages over paper money are instantly apparent. Bitcoin is inelastic money and as such closer to gold. There is no central authority that issues it according to political expedience or, if we are willing to be more charitable, to what its economic advisors tell it is in the “national interest”. It cannot be used to bail out the banks, fund the government, raise money for a war, defraud the savers and protect the debtors. It cannot be used to create asset bubbles and artificial growth spurts that make the politicians look good for a while but end in painful recessions. Again, just like gold. If widely accepted as a medium of exchange – and that’s a big ‘if’ – it could become a store of value, unlike state paper money, which is always and everywhere a political tool and is issued for the purpose of ongoing debasement – with grave consequences for the entire economy.
And just like gold, Bitcoin is international money. It can facilitate transactions between two parties in entirely different political jurisdictions. Few people today appreciate just how anachronistic local state fiat monies are in a world of increasingly global trade. Just look at state paper money notes with their national symbols printed on them, usually living monarchs or dead presidents. Paper money is tied to the state but economic relationships increasingly transcend borders.
Today we have, of course, the foreign exchange market to deal with the inefficiency of the global patchwork of territorial state monies as well as we can. But the fx market – big, liquid and impressive as it may appear to most observers – is a makeshift, a second best solution to cope with the inefficiencies of monetary nationalism. If you earn money in the UK but want to spend it in the United States, you still have to find somebody to take the opposite side of that transaction – the fx market helps you find that somebody. Nevertheless, local money monopolies re-introduce an element of barter into the global money economy -suboptimal indeed.
What is the “Austrian” position?
There has been criticism of Bitcoin from an unusual corner. Some “austro-libertarians” have dismissed it on the basis that it could not be proper money because it was not backed by something of intrinsic non-monetary value (see here and here). I think this notion is based on a misunderstanding of Austrian monetary theory.
Carl Menger, the founding father of the Austrian School of Economics, explained 140 years ago that in the transition from a barter economy to a money-economy a good can only attain the status of medium of exchange if it has previously – prior to its very first use as money – already obtained some value on the basis of its status as a commodity. In other words, money couldn’t have come into existence by the state (or anybody else for that matter) declaring otherwise worthless pieces of paper (or bits on a computer hard-drive) money.
However, once the good (whatever it is) has attained the status of monetary asset and is accepted as such by the trading public, its price (or the purchasing power of this money) is then mainly determined by the demand for money, and no longer by its remaining use in industry. The gold price has skyrocket in recent years not because of any rising demand for gold in industrial application but because of its use as a monetary asset. I expect the gold price to go much higher as our paper money system approaches disintegration and collapse. Gold has value as a monetary asset and a store of value simply because others consider it a monetary asset and a store of value. If it were to lose that status its price would plummet, and it would then be of little consolation that the price wouldn’t go to zero because there would still be some demand for gold as a pure industrial commodity.
Value is bestowed on a monetary asset by the trading public that use it as money, not by its alternative employment in industry or, as Daitz and other statists thought, by the state.
To put it differently, our paper money system is not doomed to failure because paper money or electronic money is not backed by anything of “real” value – a redundant term in Austrian economics anyway – but because it will ultimately get over-issued and the public will lose confidence in it. Those in charge of the present paper money franchise are already boxed in a corner. They do not want to allow a painful cleansing of the accumulated dislocations, which means they have to keep creating ever more money. The endgame is fast approaching.
The problem I see with Bitcoin is on the operational level. Whether it is really as secure, indestructible and untraceable as promised is simply very difficult to ascertain for anybody who is not an expert in computing and cryptography. By contrast, gold is an established store of value, has a long history as a monetary asset, and it has the advantage that I can touch it and lock it away in my safe.
However, here is precisely an aspect of Bitcoin that is so intriguing: The big concern for those who protect themselves from the approaching currency disaster by buying gold is that governments will confiscate gold, ban its use or tax it heavily. The history of state paper money has – sadly – also been the history of government interference with the gold market. The state has a strong interest in defending its paper money monopoly – a source of considerable power for as long as it lasts (which usually is not very long). Few people are aware that Roosevelt confiscated all privately held gold in the United States by executive order in 1933, and that restrictions on private ownership existed for all Americans until 1974! Questions such as how to store your gold, in which country to hold it (as a rule, usually not your home country), and in which form, are paramount among gold investors.
As the present crisis intensifies and morphs into a full-fledged paper money crisis, state interventions into financial markets will greatly intensify. With its paper money monopoly disintegrating, the state will increasingly resemble a fatally wounded man, becoming desperate and aggressive. Interference with the gold market and capital controls are highly likely. The writing is on the wall everywhere.
Against this bleak prospect, the Bitcoin promise – if, in fact, it can be kept – that an international financial system is feasible that allows parties to interact freely and voluntarily without state oversight, intervention and the threat of confiscation through taxation and inflation, is indeed significant.
I do not presently own any Bitcoin, nor have I ever owned any. I am invested in gold, which I consider the essential self-defense asset and the price of which I expect to go much higher when measured in state paper money. But I will continue to monitor the Bitcoin experiment with interest and a considerable degree of sympathy.
In the meantime, the debasement of paper money continues.