Dodo

Photo: Ballista/wikimedia

UK Chancellor George Osborne and Bank of England Governor Mervin King last week announced another round of fiscal and monetary stimulus measures, including steps to ease the funding for banks and allow them to extend more loans.

If these measures were hoped to instil confidence they must be classified as a failure. We have lived through quite a few years of unprecedented and fairly persistent monetary accommodation and occasional rounds of QE by now, and I doubt that yet another dose of the same medicine will cause great excitement. Furthermore, observers must get confused as to what our most pressing problems really are. Have we not had a real banking crisis in the UK in 2008 because banks were over-extended and in desperate need of balance sheet repair? Is a period of deleveraging and a rebuilding of capital ratios not urgently required and unavoidable? Let’s not forget that the government is still a majority-owner of RBS and holds a large chunk of Lloyds-TSB. If banks are still on life-support from the taxpayer and the central bank, is it wise to already prod them to expand their balance sheets again and create more credit to ‘stimulate’ growth?

The same confusion exists on fiscal policy. Is the Greece crisis not a stark warning to all other sovereign borrowers out there, which are equally and without exception on a slippery slope toward fiscal Armageddon, that it is high time for drastic reduction in spending and fundamental fiscal reform? If the Bank of England or the government assume any of the risk of the latest additional credit measures, then the taxpayer is on the hook.

None of this will instil confidence, not in the economy and not in the banks, and certainly not in politics. UK newspaper ‘The Independent’ headlined: “King pushes the panic button”, which I consider a pretty apt description.

Banks are parastatal dinosaurs

One thing is now clear to even the most casual observer: banks are not capitalist businesses. In their present incarnation they have little to do with the free market and no place in it. They are constantly oscillating between two positions: One moment, they are a state protectorate, in desperate need of support from the state printing press or unlimited taxpayer funds, as, in the absence of such support, we are supposedly faced with the dreaded social fallout of complete financial collapse; the next moment they are a convenient tool for state policy, simply to be fed with ample bank reserves and enticed with low interest rates to create yet more cheap credit and help manufacture some artificial growth spurt. Either the banks are the permanent welfare queens of the fiat money systems, or convenient policy levers for the macro-economic central planners. In any case, capitalist businesses look different.

Central banks and modern fiat money banks are quite simply a blot on the capitalist system. In order for capitalism to operate smoothly they will ultimately have to be removed. I believe that the underlying logic of capitalism will work in that direction. Personally, I believe that trying to ‘reform’ the present system is a waste of time and energy. It is particularly unbecoming for libertarians as they run the risk of getting infected with the strains of statism that run through the system. Let’s replace this system with something better. With a market-based monetary system.

When and how exactly the present system will end, nobody can say. I believe we are in the final inning. Around the world, all major central banks have now established zero or near-zero interest rates and are using their own balance sheets in a desperate attempt to avoid their highly geared banking systems from contracting or potentially collapsing. If you think that this is all just temporary and that it will be smoothly unwound when the economy finally ‘recovers’, then you are probably on some strong medication, or have been listening for too long to the mainstream economists who are, in the majority, happy to function as apologists for the present system.

I still believe that chances are we will, at some point, get the full throttle, foot-on-the pedal monetary overkill, the ultimate Ueber-QE that will push the system over the edge. This will be the moment when central bankers discover – and discover the hard way – that their ability to print their fiat money may well be unlimited but that the public’s confidence in this fiat money certainly is not. The whole system will blow up in some hyperinflationary fireball, which has been the end of most previous experiments with complete fiat money systems, all others having ended with a voluntary return to commodity money before the public had lost complete faith in the system. And the prospect for a voluntary and official return to a gold standard seems slim at present. However, this is not the topic of this essay.

The future of money

I am often asked what will come next after the present system collapsed? Will we have to go back to barter? – No. Obviously, a modern capitalist economy needs a functioning monetary system. My hope is that from the ashes of the current system a new monetary system arises that is entirely private and not run by states – and that does not have the unholy state-bank alliance at its core, an alliance that exists in opposition to everything that the free market stands for. Nobody can say what this new system will look like precisely. Its shape and features will ultimately be decided by the market. In this field, as in others, there are few limits to human inventiveness and ingenuity. But we can already make a few conceptual points about such a system, and we should contemplate working on such a system now while the old system is in its death throes.

A private gold ‘standard’…

Free market monetary systems, in which the supply of money is outside political control, are likely to be systems in which money proper is a commodity of limited and fairly inelastic supply. It seems improbable that a completely free market would grant any private entity the right to produce (paper or electronic) money at will and without limit. The present system is unusual in this respect and it is evidently not a free market solution. Neither is it sustainable.

The obvious candidates are gold and silver, which have functioned as money for thousands of years. We could envision a modern system at whose centre are private companies that offer gold and silver storage, probably in a variety of jurisdictions (Zurich, London, Hong Kong, Vancouver). Around this core of stored monetary metal a financial system is built that uses the latest information and payment technology to facilitate the easy, secure and cheap transfer of ownership in this base money between whoever chooses to participate in this system (Yes, there would be credit cards and wire transfers, and internet or mobile phone payments. There would, however, be no FOMC meetings, no Bank of England governor writing letters to the Chancellor, and no monetary policy!).

Are these gold and silver storage companies banks? — Well, they could become banks. In fact, this is how our present banking system started out. But there are important differences about which I will say a few things later. In any case this would be hard, international, private and apolitical money. This would be capitalist money.

…or Bitcoin

Another solution would be private virtual money, such as Bitcoin.

Bitcoin is immaterial money, internet money. It is software.

Bitcoin can be thought off as a cryptographic commodity. Individual Bitcoins can be created through a process that is called ‘mining’. It involves considerable computing power, and the complex algorithm at the core of Bitcoin makes the creation of additional Bitcons more difficult (and thus more expensive) the more Bitcoins are already in existence. The overall supply of Bitcoins is limited to 21 million units. Again, this is fixed by the algorithm at the core of it, which cannot be altered.

Thus, creating Bitcoin money is entirely private but not costless and not unlimited. Most people will, of course, never ‘mine’ Bitcoins, just as under the gold standard most people didn’t mine gold. People will acquire Bitcoins through trade, by exchanging goods and services for Bitcoins, then using the Bitcoins for other transactions.

Bitcoin is hard money. Its supply is inelastic and not under the control of any issuing authority. It is international and truly capitalist ‘money’ – of course this assumes that the public is willing to use it as money.

There are naturally a number of questions surrounding Bitcoin that cannot be covered in this essay: Is it safe? Can the algorithm be changed or corrupted and Bitcoins thus be counterfeited? Are the virtual “wallets” in which the Bitcoins are stored safe? – These are questions for the computer security expert or cryptographer, and I am neither. My argument is conceptual. My goal is not to analyze Bitcoin as such but to speculate on the consequences of a virtual commodity currency, which I consider feasible in principle, and I simply assume – for the sake of the argument – that Bitcoin is already the solution. Whether that is indeed the case, I cannot say. And it is – again – for the market to decide.

There is one question for the economist, however: Could Bitcoin become widely accepted as money? Would this not contradict Mises’ regression theorem, which states that no form of money can come into existence as a ready medium of exchange; that whatever the monetary substance (or non-substance), it must have had some other commodity-use prior to its first use as money. My counterargument here is the following: the analogy is to the banknote, which started life not as a commodity but as a payment device, i.e. a claim on money proper which was gold or silver at the time. Banknotes were initially used as a more convenient way to transfer ownership in gold or silver. Once banknotes circulated widely and were generally accepted as media of exchange in trade, the gold-backing could be dropped and banknotes still circulated as money. They had become money in their own right.

Similarly, Bitcoin can be thought off, initially, as payment technology, as a cheap and convenient device to transfer ownership in state paper money. (Bitcoins can presently be exchanged for paper money at various exchanges.) But as the supply of Bitcoins is restricted while the supply of state paper money constantly expands, the exchange-value of Bitcoins is bound to go up. And at some stage, Bitcoin could begin to trade as money proper.

A monetary system built on hard, international and apolitical money, whether in form of a private gold-system or Bitcoin, would be a truly capitalist system, a system that facilitates the free and voluntary exchange between private individuals and corporations within and across borders, a system that is stable and outside of political control. It would have many advantages for the money user but there would be little role for present-day banks, which goes to show to what extent banks have become a creature of the present state-fiat money system and all its inconsistencies.

Banks profit from money creation

Banks conduct fractional-reserve banking (FRB), which means they take deposits that are supposed to be safe and liquid and therefore pay the depositor little interest, and use them to fund loans that are illiquid and risky and thus pay the bank high interest. Through the process of fractional-reserve banking, banks expand the supply of money in the economy; they become money producers, which is, of course, profitable. Many mainstream economists welcome FRB as a way to expand money and credit and ‘stimulate’ extra growth but as the Currency School in Britain in the 19th century and in particular the Austrian School under Mises and Hayek in the early 20th century have argued convincingly (and as I explain in detail in Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary) this process is not only risky for the individual banks it is destabilizing for the overall economy. It must cause boom-bust cycles.

It cannot be excluded that banks could conduct FRB even on the basis of a private system of gold-money or Bitcoin. However, in the absence of a backstop by way of a central bank that functions as a lender-of-last resort the scope for FRB would be very limited, indeed. It would be too dangerous for banks to lower their reserve ratios (at least to fairly low levels) as that would increase the risk of a bank-run.

I am sometimes told that I am too critical of the central banks and the state, and that I should direct my ire toward the ‘greedy’ ‘private’ banks, for it is the ‘private’ banks that create all the money out there through FRB. Of course, they do. But FRB is only possible on the scale it has been conducted over recent decades because the banks are supported – and even actively encouraged – in their FRB activities by a lender-of-last resort central bank, in particular as the central bank today has full and unlimited control over fiat money bank reserves. Under a system of hard money (gold or Bitcoin), even if the banks themselves started their own lender-of-last resort central bank, that entity could not create more gold reserves or Bitcoin reserves and thus provide unlimited support to the banks.

FRB is particularly unlikely to develop in a Bitcoin economy, as there is no need for a depository, for safe-keeping and storage services, and for any services that involve the transfer of the monetary system’s raw material (be it gold or state paper tickets) into other, more convenient forms of media of exchange, such as electronic money that can facilitate transactions over great distances. The owner of Bitcoin has an account that is similar to his email account. He manages it himself and he stores his Bitcoin himself. And Bitcoin is money that is already readily usable for any transaction, anywhere in the world, simply via the internet. The bank as intermediary is being bypassed. The Bitcoin user takes direct control of his money. He can access his Bitcoins everywhere, simply via the SIM card in his smartphone.

The tremendous growth in FRB was made possible by the difficulty of transacting securely over long distances with physical gold or physical paper tickets. This created a powerful incentive to place the physical money with banks, and once the physical money was in the banks it became ‘reserves’ to be used for the creation of additional monetary assets.

Channeling true savings into investment is very important, but remember that FRB is something entirely different. It involves the creation of money and credit without any real, voluntary saving to back it. FRB is not only not needed, it is destabilizing for the overall economy. Under gold standard conditions, it created business cycles. Under the system of unlimited fiat money and lender-of-last-resort central banks, it created the super-cycle, which is now in its painful endgame.

Banks make money from payment systems

When I recently made arrangements for a trip to Africa I dealt directly with local tour operators there, which, today, can be done easily and cheaply with the help of email, the internet and skype. Yet, when it came to paying the African tour operators I had to go through a process that has not changed much from the 1950s. Not only were British and African banks involved, but also correspondence banks in New York. This took time and, of course, cost money in form of additional fees.

Imagine we could have used gold or Bitcoin! The payment would have been as easy and fast as all the email-communication that preceded it. There would have been no exchange rates and little fees (maybe in the case of gold) or no fees (in the case of Bitcoin).

Another example: Last year I gave a webinar at the Ludwig von Mises Institute (LvMI). The LvMI is located in Auburn, Alabama, I did the seminar from my home in London, the LvMI’s technology officer sat in Taiwan, and the seminar attendants were spread all over the world. All of this is now possible – cheaply, quickly and conveniently – thanks to technology. Yet, when the LvMI paid me a fee it had to go through a few banks – again, correspondence banks in New York – it took quite some time and it incurred additional costs. And the fee from LvMI was paid in a currency that I cannot use directly in my home country.

Banks make money from monetary nationalism

Future economic historians will pity us for having worked under a strange and inefficient global patchwork of local paper currencies – and for having naively believed that this represented the pinnacle of modern capitalism. Today, every government wants to have its own local paper money and its own local central bank, and run its own monetary policy (of course, on the basis of perfectly elastic local fiat money). This is naturally a great impediment to international trade and the free flow of capital.

If I want to spend the money I got from the LvMI and spend it where I live (in Britain), I have to exchange the LvMI’s dollars for pounds. I can only do that if I find someone who is willing to take the opposite side of that transaction, someone who is willing to sell pounds for dollars. The existence of numerous monies necessarily re-introduces an element of partial barter into money-based commerce. Sure, the 24-hour, multi-trillion-dollar a day fx market can accommodate me, and do so quickly and cheaply, but this market is only a second-best solution, a highly developed make-shift to cope as best as possible with the inefficiencies of monetary nationalism. The better, most efficient and capitalist solution would be to use the same medium of exchange around the world. The gold standard was a much superior monetary system in this respect. Moving from the international gold standard to a system of a multitude of state-managed paper currencies meant economic regression, not progress.

One hundred years ago, you could take the train from London to Moscow and use the same gold coins all along the way for payment. There was no need to change your money even once. (Incidentally, neither did you need a passport!)

The notion of the ‘national economy’ that needs a ‘national currency’ was always a fiction. So was the idea that economies work better if money, interest rates and exchange rates are carefully manipulated by local bureaucrats. (This fiction is still spread by many economists who make a living off this system.) The biggest problem with monetary policy is that there is such a thing as monetary policy. But in today’s increasingly globalized world, these fictions are entirely untenable. Capitalism transcends borders, and what it needs to flourish is simply hard, apolitical and thus international money. Money that is a proper tool for voluntary human interaction and cooperation and not a tool for politics.

Banks benefit from the present monetary segregation. They profit from constantly exchanging one paper money for another and from trading foreign exchange. Non-financial companies that operate internationally are inevitably forced to speculate in currency markets or to pay for expensive hedging strategies (again paying the banks for providing them).

Banks make money from speculation

There is, of course, nothing wrong with speculation in a free market. However, in a truly free market there would be few opportunities for speculation. Today the heavy involvement of the state in financial markets, the existence of numerous paper currencies, all managed for domestic political purposes, and the constant volatility that is generated by monetary and fiscal policy create outsized opportunities for speculation. Additionally, the easy money that central banks provide so generously to prop up their over-extended FRB-industry is used by many banks to speculate in financial assets themselves, often by anticipating and front-running the next move of the monetary authorities with which these banks have such close relationships. And to a considerable degree, banks pass the cheap money from the central banks on to their hedge fund clients.

Remember that immediately after the Lehman collapse, investment banks Goldman Sachs and Morgan Stanley, which previously had shun deposit and retail banking but have always been heavily involved in securities trading, quickly obtained banking licenses in order to benefit from the safety-net the state provides its own fiat-money-deposit banks.

Banks channel savings into investment

Yes, to some degree they still do this, and this is indeed an important function of financial intermediaries. However, asset managers can do the same thing, and they do it without mixing this services with FRB and money-creation. In general, the asset management industry is much more transparent about how it allocates its clients’ assets, it has a clear fiduciary responsibility for these assets, and it cannot use them as ‘reserves’. In the gold or Bitcoin economy of the future, you will, of course, be free to allocate some of your money to asset managers who mange investments for you.

Conclusion

Have I been too harsh on the banks? – Maybe. The bankers, in their defense, will say that they are not the source of all these inefficiencies, that they simply help their clients deal with the inefficiencies of a state-designed and politicized monetary system – and that they reap legitimate rewards for the help they provide. – Fair enough. To some degree that may be true. But it is very clear that the size, the business models, the sources of profitability, and the problems of modern banks are uniquely and intimately linked to the present, fully elastic paper money system. As I tried to show, even if the paper money system was meant to last – and it certainly is not – the forces of capitalism, the constant search for better, more efficient and durable solutions, coupled with technological progress, would put enormous market pressures on the present banking industry in the years to come in any case. But given that our present system is not the outcome of market forces to begin with, that a system of fully elastic, local state monies is not necessary, that it is suboptimal, inefficient, unstable, and unsustainable, and that it is already in its endgame, I have little doubt that modern banks will go the way of the dodo. They are to the next few decades what the steel and coal industries were to the decades from 1960 to 1990. They are parastatal dinosaurs, joined at the hip with the bureaucracy and politics, bloated and dependent on cheap money and state subsidy for survival. They are ripe for the taking.

The demise of the paper money system will offer great opportunities for a new breed of money entrepreneurs. In that role, I could see gold storage companies, payment technology companies, Bitcoin service providers and asset management companies. If some of these join forces, the opportunities should be great. The world is ready for an alternative monetary system, and when the present system collapses under the weight of its own inconsistencies, there would be something there to take its place.

The present fiat money economy is ripe for some Schumpeterian ‘creative destruction’.

In the meantime, the debasement of paper money continues.

 

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45 Responses to The death of banks – and the future of money

  1. David Goldstone says:

    Just occasionally one reads an article that expresses one’s own thoughts but in a far better and clearer way. This is one such article!

  2. Peter Surda says:

    Great post as usual Detlev, just one minor addition. Bitcoin also provides a ledger (book keeping), which normally requires banks. DeSoto (in critiquing Selgin I believe) mentions ledger offered by the bank as one of the factors causing demand for money substitutes.

  3. Paul Troon says:

    The strongest argument in favor of Bitcoin compared to precious metals is Executive Order 6102.

    A hybrid approach might make sense until the Bitcoin network has a longer track record.

    A private gold storage company, established in a safe jurisdiction, could accept Bitcoins for gold and redeem gold for Bitcoins. Unfortunately you would lose the advantages of Bitcoin’s low holding cost and safety from sovereign seizure.

    But what you gain would be reduced exposure to the long term risk of Bitcoins losing value and you would still be able to access your money quickly in a bank-free form that trades more easily than gold certificates from a private reserve.

    A first step might be to setup an exchange between something like the gold currency Pecunix and Bitcoin.

  4. [...] are a convenient tool for state policy, simply to be fed with ample bank reserves and enticed with low interest rates to create yet more cheap credit and help manufacture some artificial growth [...]

  5. Rod says:

    A global apolitical system can’t come soon enough. My concern is, though, what will happen is the current fiat money system will be replaced with one international fiat money, controlled by one world central bank. e.g. the IMF and SDRs. Given the state’s reluctance to give up power, isn’t that the more likely (and sad) outcome?

  6. [...] The German hard money guru looks beyond the forthcoming collapse of paper money, in an excellent piece. [...]

  7. Alister Cyril Blanc says:

    Mirror, Mirror on the Wall, When is the Next AIG to Fall? | Marc Faber
    http://www.youtube.com/watch?v=H0sS6a9RW2E

    Hoppe talks about “time-preference” , the length of time for which a person or group tries to order a plan amongst natures spontaneity. I wonder which group, if the world is crudely and probably without much sophistication divided up into Savers & Debtors, tends to plan more for the medium-long term? And is planning for the medium-long term always preferable to planning for the short-term? Doubtful, considering only the rarest of things seem to exist in an absolute state.

    More & more I sense mass psychology is weighted down with love and curiosity, pushing events into a surreal like enlightenment as intelligence becomes increasingly required and also easy to spot, thanks information circulating like never before.

    “The dearth of credit which marks the crisis is caused not by a contraction but by the abstention of further credit expansion”
    Ludwig von Mises

  8. [...] This article was previously published at Paper Money Collapse. [...]

  9. [...] death of banks – and the future of money by DETLEV SCHLICHTER on JUNE 20, 2012 · 8 COMMENTS Photo: Ballista/wikimedia UK Chancellor George Osborne and Bank of England Governor Mervin [...]

  10. [...] are a convenient tool for state policy, simply to be fed with ample bank reserves and enticed with low interest rates to create yet more cheap credit and help manufacture some artificial growth spurt.Either the [...]

  11. Christian Kruse says:

    Mr. Schlichter,

    There is a simpler answer to Bitcoin. Gold is seen as a better store of value than our western currencies but is not easily divisible and readily acceptable by merchants for daily purchases. The solution is a company or organization to facilitate transactions between gold and the local currency.

    This company or organization would:

    1) Accept gold deposits from customers and credit them in milligrams of gold.
    2) The customer is issued a debit card backed by the gold.
    3) The merchant would accept it just as it would any other credit/debit card.
    4) The merchant receives credit in their local currency just as they would from any debit/credit card.
    5) The company/organization would liquidate enough gold on a daily or weekly basis to pay merchants and debit each gold account in milligrams of gold, easily accounting for small purchases.

    I’d love to figure out a way to commercialize this type of business. I’m developing a PowerPoint presentation. E-mail me if you’d like to see it.

    • GoldMoney says:

      GoldMoney has already patented and implemented this:
      http://www.goldmoney.com/pay-with-gold.html

      • Christian Kruse says:

        Thanks for your post. As I see it, GoldMoney patents attempt to make gold a “currency” through a global exchange and accounting system. It apparently has run into regulatory issues because gold is not recognized internationally as a “currency”.

        What I am attempting to do is create a system, primarily within the existing system where all payments are made in local currency. This aspect more familiar to both client and merchant and would therefor be more widely accepted. Also, because the merchant receives his local currency, I’m not attempting to directly make gold money. Rather, it is a store of value and my system would merely facilitate just-in-time liquidation of small amounts of gold to back CURRENCY transactions.

        I believe this is an important distinction from GoldMoney but appreciate you pointing out their patents to me.

        Hope this is more clear than my original post.

    • Rune K. Svendsen says:

      Who would create this electronic, gold-backed currency? I think in any case you run into the issue of companies creating too much of the currency, thus making it only partially backed by gold.

      This is the crux of the issue. Any sort of backing is just a promise, similar to the period of fractional reserve banking where bank notes were convertible into specie.

      Bitcoin solves this problem. This is its purpose. It removes any need to trust any organization to deliver on a promise to “pay you back in gold”. Any paying back in gold is done by selling your Bitcoins for gold to an individual who holds gold and is in need of Bitcoins. There is no risk of default with Bitcoin, because it is not backed by anything. Its supply is limited and easily verifiable using a computer.

      Now I’m not saying Bitcoin itself is the future of digital money, but I believe a Bitcoin-like technology will be. Bitcoin is the very first distributed digital currency, and as with any first-of-a-kind technology there is room for improvement.

  12. Cryptoman says:

    Great article! A more extensive discussion of Mises’ regression theorem as it relates to Bitcoin can be found here:

    https://bitcointalk.org/index.php?topic=583.0

    Mr. Kruse, I like your idea, but how do you protect such a company or organization from centralized authority? I give you the e-gold example. There is also Pecunix, however, which remains in business.

  13. Ian Purton says:

    Looking at Christians posting above I could use the same arguments for Bitcoin with the benefit that nothing real has to be delivered.

    I run the site https://www.bitcoinary.com I’m hoping to create a community of Bitcoin traders world wide.

    I’m hoping that one day you’ll be able to transfer money Africa and other nations by using local people. Effectively a currency market without the banks and western union just transfers between real people.

  14. Rachael says:

    Bitcoin, maybe. Gold in a world of population expansion faster than the rate of discovery and recovery of new gold reserves? No way. Destined to failure and depression for the majority of the world.

    The important thing about money is to make sure the supply per person is as close to constant as possible. For thousands of years, that worked rather nicely with gold. Not anymore. In the early 20th Century the population started expanding faster than gold was being put into circulation and depression resulted.

    Bitcoin would work as long as a mechanism is built in to keep the money/population ratio stable (not expanding or contracting), so that long term investments make sense and a constantly strengthening form of exchange wasn’t constantly making repayment more difficult. Fractional Reserve Banking is a dumb idea for sure, and a quick way to destroy wealth at that, but so too is a money supply that constantly shrinks in relation to population growth…..

    • Ramon says:

      Gold is perfectly viable by functioning as a reference point. The real concern is counterparty risk of custodial entities. See Freegold.

      Bitcoin does not work like fiat, which requires 1:1 elasticity to maintain price stability. Instead, units are subdivided depending upon market demand for greater base money supply. The decimal point moves to the right with Bitcoin and gold rather than to the left in contemporary fiat.

      Gold cannot readily be subdivided to denominations less than the gram unit without counterparty risk. Bitcoin is presently limited to 8 orders of magnitude in divisibility expansion, but is theoretically unlimited with a fairly simple protocol update.

    • David Goldstone says:

      Rachael, why do you say that a fixed stock of money leads to failure and depression? And what has the population level got to do with anything? I’m sorry but I don’t understand. If the money stock is fixed but productivity improves over time (which is normal in a free market) then all that will happen is that stuff becomes cheaper. What is wrong with that?!

      • Jamie says:

        David,
        What about the oft-quoted problem that wages might be sticky downwards? If there’s a fixed amount of money, but a growing population, then wages would be forced downwards. If this is not allowed to happen because of the stickiness, then mass unemployment could ensue. The real world seems to suggest to me that wages are sticky downwards.

  15. Ramon says:

    This is one of the most enlightened Bitcoin & gold related articles in existence.

    Your suggestion of an inherited form of wealth is an excellent observation for the way Bitcoin has become valuable. Derivatives have been made used in the context of traditional financial instruments, so it only makes sense that it should be applied to currency itself.

    Mises’ regression theorem seems valid, but the definitions of certain assumptions it relies upon may be questionable. Is a commodity only physical, and can it be a conglomerate of multiple individual elements that are independently functional? Bitcoin is based in part on cryptographic methods which have arguably been used for a very long time. Cryptography could be considered a commodity tool.

    There is also the question of money arising from a social contract, yet the heart of Bitcoin is a protocol, or language; a sort of machine social convention. The system is functioning in ways that confound contemporary definitions.

    As for interaction with gold, there is interest in the ability to maintain direct ownership of wealth. Gold can be transported in a sense without it being moved by exchanging gold for bitcoins, traveling, then exchanging bitcoins for gold. Possession of fungible assets does not have to be relinquished to a custodial party at any point.

    • Myno says:

      I suspect that it is this ability of Bitcoin to bypass border inspectors that attracts “money launderers” and hence the government agents who pursue them. Garnering the attention of government agents is the first step to receiving statist intervention. Thus it is not far fetched to assume that Bitcoin or any clone would soon be outlawed or regulated (taxed) by any government that felt its financial shenanigans threatened by it.

      But can they track it? Dunno. If Bitcoin transactions are truly undetectable by authorities, then it is safe from scrutiny. But the attention Bitcoin gathers will rise in direct proportion to its market success. There’s “big money” at stake here, and hence LOTS of incentive on the part of the regulators.

      Just how hidden can a Bitcoin transaction remain, in the face of concerted active measures by technologically adept regulators to track it? On the answer to that question hinges its ultimate long term viability. If regulators achieve complete control over web nodes, able to filter all packet traffic, looking for signs of Bitcoin transactions, would they be able to find them? Could e.g. China do so now, given the kind of control they present have over their web routers?

      My point is that the regulators don’t need to be able to subvert a Bitcoin transaction. They only need to know that one has taken place. Then they can apply enough pressure on the participants to make it very unhealthy to use Bitcoins within their borders.

  16. Paul Grignon says:

    The fundamental mistake with money is the concept that it must be a LIMITED QUANTITY. This is a primitive leftover from the days when we had no technology for transferring value except by means of portable physical objects.

    That limitation was overcome long ago. But this unnecessary and outdated concept continues unquestioned.

    The other problem with money is that it is NOT a promise of redemption in real value. If it were, its value would be DEFINED BY ITS ACTUAL REDEMPTION and NOT by the quantity of it in circulation.

    Gold as money creates the first problem but not the second.
    BitCoin creates BOTH problems.

    Money should be A PROMISE OF SOMETHING SPECIFIC FROM SOMEONE SPECIFIC enforced by contract law. That is what makes money REAL. It represents the REAL VALUE of the actual things we will buy with it.

    http://paulgrignon.netfirms.com/MoneyasDebt/Incorrect_Diagnosis.pdf

    • Money is not a promise. It is a medium of exchange. It is simply the most fungible good. Of course, it works best if its quantity is limited. This is not at all a “primitive leftover”. This is economic logic. Repeat, money is NOT a promise. And it is certainly not a promise of anything “specific”.

      • Rune K. Svendsen says:

        Money is not a promise. It is a medium of exchange.

        Isn’t that the crux of the issue, really? Money is, and has been for the last couple hundred year, a promise. No one buys anything for physical gold or silver any more. During the gold standard – even during the classical gold standrd – we didn’t use physical metal to trade with each other, thus making its supply – at least in the short term – virtually unlimited. Ever since we stopped trading in physical bullion, money has been a promise. It might have been a promise to pay someone back in a physical commodity (gold, silver), but a promise nonetheless. A gold standard doesn’t solve this. Whenever we need to “back” a currency with something, it is a promise. This is where Bitcoin shares an important similarity with gold: it isn’t backed by anything, and is thus not a promise. Its supply is limited by its very nature, not by relying on money producers (or, really, producers of fiduciary media of exchange) to limit themselves because they know they have to deliver on their promise.

    • Adriano says:

      “The fundamental mistake with money is the concept that it must be a LIMITED QUANTITY. This is a primitive leftover from the days when we had no technology for transferring value except by means of portable physical objects.”

      Are you kidding!

      No “technology limitation” has ever prevented mankind from using something quite unlimited as money!
      Why not using leaves, stone chips or wood sticks as money? Why not using something that you can produce ‘out of thin air’?

      You could create a new form of money ‘out of thin air’ (like Bitcoin). Let us call it PG. You could create it scarce (but not too scarce) or relatively abundant (ex: 1 quintillion of PG, as no truck is needed for transport) because its purchasing power will be adjusted automatically by the market. You could even be able to convince the world population to use it as the only money.

      BUT, after that you got your PG accepted as money, could you keep producing it as you wish? Theoretically in UNLIMITED quantity?

      Yes, you could fool people for a while by saying you absolutely need to expand the supply of PG by a couple of trillions otherwise economic Armageddon would happen (sounds familiar?)! You could then probably go on with more rounds of “quantitative easing” with similar excuses. As it becomes no news anymore, at the following expansion of 1 trillion PG people will start thinking something like “… a trillion of what…”.

      BUT, what do you expect people to do once they realise you are simply producing unlimited quantity of PGs? They will simply stop using your PG as money and it will return to be just ‘thin air’!

      “Something” MUST be limited for it to be accepted as money.

      Not even Keynes or Friedman or the like would argue about this.
      How ‘flexible’ the supply has to be… this is a different discussion.

      To me, perfect money is no flexible at all! Even gold is not perfect in this sense.

  17. Edgar Swank says:

    I have tried Bitcoin, and found it highly volatile in relation to US Currency, and not widely accepted. However, there is already a bank that deals only in .999 silver coins, and (drum roll) it not only stores your silver coins, it PAYS INTEREST (Up to 7.25% on a 36-month contract) on term deposits. This is the Free Lakota Bank, on a sovereign Indian reservation in South Dakota.

  18. John Campbell says:

    This is a very interesting discussion and I need to find out a lot more about Bitcoin.

    How would Bitcoin work in the future with significant advances in computation – particularly quantum computing?

    Could this not alter the costs of executing the algorithm?

  19. Adriano says:

    Hi Detlev,

    have you read about the last report of the BIS?
    http://www.nytimes.com/2012/06/25/business/global/25iht-banks25.html

    “At its root the European crisis is a potential harbinger,” the report said, “a virulent and advanced convergence of the problems to be expected elsewhere if policy fails to break the vicious cycles generated by the global weaknesses we describe in this report — sectoral imbalances, excess leverage, public overindebtedness and overburdened central banks.”

    Apart from the usual call at “policy” to act, which is what created the problem in the first place… It seems written by you!

    Cheers Mate!

  20. [...] The death of banks – and the future of money [...]

  21. Adriano says:

    Hi Detlev,
    I know you don’t like forecasting, but what’s your take on the current situation?
    Can we say we are entering ‘panic mode’?

    Gold seems to hold pretty well considering that all the rest, apart from the dollar, is deflating. Gold market seems more cleaning up the mess with (inexistent) paper gold being sold while physical gold being hoard.
    We are gonna have surprise soon!

  22. Habib Kadiri says:

    Great article; was wondering what Detlev’s thoughts on peer-2-peer monetary exchange might be? With companies like ZOPA and Ratesetter springing up in the UK for example, might we have an unsung hero among the alternative solutions to banks?

  23. Lex says:

    Excellent article. I think that in future finance peer-to-peer finance will also play a role: online systems that allow users to transfer money in and loan it to businesses or individuals. In the UK peer-to-peer is offered by Zopa and Ratesetter and peer-to-business is provided by Funding Circle. I believe it is possible to earn around 8% gross AER with these sites, and around 6% net.

    What is interesting is that these sites do not benefit from a government guarantee like bank accounts – yet another unfair advantage to the crony capitalist banking system.

  24. Roland says:

    It is a very interesting article, but I now have one -for me- quite logical question:

    Wouldn’t it be a problem that a global currency (e.g. bitcoin) creates the same imbalances as we currently see in the eurozone crisis? The fact that the same money has the same value everywhere will cause countries which are less competitive to get into a vicious circle of debts and depression, just like we see in Greece (as far as I understand this stuff).

    So if I’m right, free currency exchange rates are indispensable because international differences in competitiveness can’t practically be solved by adjustment of wages and higher productivity only (which is especially difficult to do in an economic crisis).

    If so, bitcoin can’t have the same value everywhere and you will need different types of it? I’m not really into monetary policy but this is a big problem for a global currency as I see it.

    • worthchanging says:

      I was going to say a similar thing.
      If you are a country with rising living costs and wages (inflation) and a lot of exports, the FX mechanism will allow you to maintain the livelihood of your exporting companies. Would Jamaica – other things being equal – with the USD-pegged currency do any better than it does, in terms of employment?
      There are significant other concerns like foreign ccy-denominated govt debt which in case of depreciation is harder to drag.. but how is it pro-capitalist to lock ‘em all in and not allow the exporters (and the job markets) to benefit from flexible currencies?

  25. “The death of banks – and the future of money”, the death of banks is inevitable in the global econ. And well, the future of money is unpredictable I believe.
    Money gotta employed in the best economic manner: http://theglobalecon.com/printing-of-money/

  26. [...] “Trying to ‘reform’ the present system is a waste of time and energy. When and how exactly the present system will end, nobody can say. I believe we are in the final inning. Around the world, all major central banks have now established zero or near-zero interest rates and are using their own balance sheets in a desperate attempt to avoid their highly geared banking systems from contracting or potentially collapsing. If you think that this is all just temporary and that it will smoothly unwound when the economy finally ‘recovers,’ then you are probably on some strong medication, or have been listening for too long to the mainstream economists who are, in the majority, happy to function as apologists for the present system,” wrote Detlev Schlichter. [...]

    • Adem says:

      There is a solution to this pbleorm. If someone releases a new Bitcoin client (and miners) that run on only 1% of the available processing power, and gets more than 50% of the network to adopt this new client, then total electricity costs drop would drop hugely, and still the same amount of bitcoins would be generated. The demand for bitcoins sets the price, and the supply won’t change, so everybody profits. Yet we all choose our own success, which ultimately has negative consequences for everyone involved. That’s just not smart.You’re talking about lowering the cost to compute bitcoins. All it would take it one person using a non-crippled client to destroy the Nash equilibrium. Bitcoins are necessarily rare based on computing power, but I agree, if there was a way to make a new resource rare not based on computing power (but based on time, or something else), it would be much more efficient.

  27. [...] “Trying to ‘reform’ the present system is a waste of time and energy. When and how exactly the present system will end, nobody can say. I believe we are in the final inning. Around the world, all major central banks have now established zero or near-zero interest rates and are using their own balance sheets in a desperate attempt to avoid their highly geared banking systems from contracting or potentially collapsing. If you think that this is all just temporary and that it will smoothly unwound when the economy finally ‘recovers,’ then you are probably on some strong medication, or have been listening for too long to the mainstream economists who are, in the majority, happy to function as apologists for the present system,” wrote Detlev Schlichter. [...]

  28. Hi Detlev,

    I’d like you to look at this:

    http://independent.academia.edu/timebeatsglobal

    Would love your critique on this model as the future of money.

    Thanks,

    Frederick
    timebeatsglobal@gmail.com

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