I have been reading alot about BitCoin lately and it has led me to a series of questions that make my head hurt. I am far from the expert on BitCoin, but I will try to briefly summarize the premise. An anonymous individual or small group of individuals created a standard/protocol for a new form of money on a peer-to-peer network that is not controlled by any government or central bank. Servers plug away at algorithms to “mine” for BitCoins and new BitCoins are released every ten minutes. The miners are rewarded in BitCoins and maintain transaction logs which keep the whole system running in a distributed but organized state. The total number of BitCoins that will ever be released will be limited to 21 million. BitCoins are actually traded in secondary markets for real currencies. Since BitCoins exist outside of governments and banks; it can be used for international money transfers with no fees, used by tin hat conspiracists that do not want to have bank accounts, and/or they are the perfect currency for trading for all kinds of illegal things since user identities can remain anonymous.
Until February of this year, BitCoins have traded for less than $25 USD per coin. Suddenly, the price of BitCoins have spiked to over $200 per coin in the span of two months. There are all kinds of arguments for why BitCoins are or are not a bubble. One of the arguments for BitCoins rapid appreciation is that there will always be a limited supply. This argument is eerily similar to the argument for gold or the gold standard. Except, as Warren Buffett likes to point out, gold doesn’t do anything. It has no intrinsic value except that we, as a species, have decided that gold is good. Even though gold is a finite resource with no intrinsic value, it is still there. Although centuries of alchemists attempted to turn lead into gold, no one was ever successful at it. However, there is nothing to stop a new protocol from being established and thereby minting BotCoins or BitPoints or whatever. All mining computers are essentially creating strings of numbers that are then stored in transaction logs. These numbers have no value except, like gold, the value we decide to give it.
Just as I was trying to get my head around why anyone would buy BitCoins, I started thinking about fiat money. Once upon a time, the currency of the United States was on the gold standard and dollars were redeemable for some fraction of gold. Since carrying around bars, or even flecks of gold in vials, would be a huge pain in the ass, gold was placed in vaults in Fort Knox, Kentucky and kept under armed guard. The US Mint then printed out paper money that served as a proxy for the gold sitting in Fort Knox. No one really saw the gold but everyone believed that it did exist. People went about their lives trading paper dollars that represented gold up until President Nixon took us off the gold standard.
To “gold bugs”, or people who really like the idea of the gold standard, August 13, 1971 was a very bad day in America. We left the gold standard and ushered in a few decades worth of high inflation. The gold bugs would point to this and say, “See? I told you.” Except the period of higher than average inflation was then followed by two decades of relative price stability which supposedly ushered in a new paradigm of economics and was called “The Great Moderation”. That is until 2007 when the shit hit the fan. Then gold bugs came out and said, “See? I told you.” Except the data shows that tying a currency to gold doesn’t stabilize prices either.
Gold keeps prices stable! Oh wait, it doesn't...
So, if we are not on the gold standard, what do we have? We have a money supply controlled by the Federal Reserve. The purpose of the Federal Reserve is to create asset bubbles. I’m kidding, but it seems like that is the net result. The Federal Reserve controls the money supply and now that we are not on the gold standard, the money supply is literally money printed by the US mint. Except, just like gold a hundred years ago, I rarely deal with physical money. I get paid electronically. I purchase goods and services on credit cards and then pay those bills electronically.
As far as I know, there are transfers of physical bundles of cash between various banks as money goes in and out of my account and that is why BitCoins sort of make sense. Since BitCoins are purely digital, why go through all the bother of moving worthless money around? Why not move equally worthless bits around? Further, BitCoins are not controlled by a central bank and there are plenty of central bankers around the world who are not fans of Ben Bernanke at the moment. Since 2008, our central bank has literally been creating money out of thin air and then calling it “quantitative easing” or QE because saying, “I’m going to print money out of thin air,” sounds stupid. The purpose of QE was to fight deflation because to economists, the only thing worse than inflation is deflation. By and large it has worked.
Printing money is going to cause hyperinflation! Well... TBD
I noticed in Australia that the exchange rate of the Australian Dollar against the US Dollar is a point of national pride. When the AUD broke through parity, it was celebrated. The US played the role of the sucker to perfection, bowing our heads in shame as our dollar fell. Except... the dollar falling in the foreign exchange markets had no effect on an American who was not travelling. Suddenly our exports and labor costs got lower internationally and that has helped to bring back some American jobs. Meanwhile, in Australia, the already high labor costs got even higher. Tourism got cost prohibitive as people such as myself took a look around and said, “Holy fuck this place is expensive.” The one area that should have got better for the average Aussie, purchasing imports (and almost everything is imported) didn’t budge because the retailers collude and price fix, but to combat this Australians are slowly learning of this new invention called “the Internet” where goods can be purchased overseas online and shipped to their homes which, of course, has the local retailers crying, “Foul!”
Now, a few years later, instead of celebrating the high Australian Dollar, the high dollar is being blamed for a lot of the economies ills. Central bankers around the world have caught on to the US secret of trying to make their currency worth less. Today, it’s a game of if you can’t beat ‘em join ‘em, except we, the United States, got a five year head start on the game.
I hate to delve into tinfoil hat wearing conspiracy theory waters, but, the way the Federal Reserve has handled things the last few decades makes me realize that some of the anger towards Wall Street is well deserved. Most of the GDP growth at the beginning of the ‘00s was illusionary (Australia, per always, is behind the times but will soon find out). Big investment firms made horribly bad decisions and created derivatives that didn’t really benefit anyone except themselves. When things were good, they kept the money. When things got bad, they got bail outs at 100 cents on the dollar. To many, myself included, Wall Street does not produce anything. For an industry that does not produce anything, they are wildly overcompensated. Because they are overcompensated, they have a ton of influence. It seems that the financial sector is controlling, or at least, influencing the most important aspect of our government - the money supply. As much as I love capitalism, the status quo isn’t working.
So what’s the answer? In an ideal system, the reward for entrepreneurship should still exist. I don’t begrudge the Bill Gates, Steve Jobs, and Mark Zuckerbergs of the world (to name a random few) who created new companies and led to the employment of millions of people. Their entrepreneurship was a huge benefit to the entire nation and produced real gains in a sustainable manner. This type of behavior needs to continue lest we become a society without innovators and dreamers who come along and disrupt everything. At the same time, I would like to see an end to the class warfare where people begrudge the “1%”. I would like to see a system where whenever an entrepreneur succeeds at creating something that can be sold and exported, everyone wins. I would like us all to have a little skin in the game. I was thinking about this for a long time when I randomly mentioned it to my friend, Juan. Out of the blue, Juan thought about it for less than a minute and responded, “The money supply needs to be tied to GDP which is the problem with the gold standard as it does not increase or reward increased productivity.”
I was dumbfounded. I had been thinking about this for years and Juan answered the problem, shrugged his shoulders, and then went back to work. It seemed so obvious, but there had to be problems, right? The biggest issue I had was that the GDP numbers for the US in the mid ‘00s looked phenomenal. Except there were no productivity gains or innovation. It was nothing more than an illusory sugar high funded by consumer debt from a housing bubble that was about to implode and take the entire economy down with it. Rewarding short term quarter to quarter measurements could lead to a desperate desire to keep propping up asset bubbles which are little more than Ponzi schemes (are you listening Australia????). I was stumped again as it seemed that Juan had figured it out and I had just poked a hole in it.
Then I did a little research on GDP and discovered it was created by Simon Kuznets for a US Congress report in 1934. Except he explicitly warned not to use this new fangled measure to determine a country’s welfare.
Kuznets was very aware of the limitations going so far as to say:
“The valuable capacity of the human mind to simplify a complex situation in a compact characterization becomes dangerous when not controlled in terms of definitely stated criteria. With quantitative measurements especially, the definiteness of the result suggests, often misleadingly, a precision and simplicity in the outlines of the object measured. Measurements of national income are subject to this type of illusion and resulting abuse, especially since they deal with matters that are the center of conflict of opposing social groups where the effectiveness of an argument is often contingent upon oversimplification. [...]” (God bless wikipedia)
Or paraphrasing, the concept of GDP is really hard to measure and by measuring it people are going to try to manipulate the criteria or mechanism for calculating it in ways that cannot be predicted and this will be disastrous. I have worked at Microsoft long enough to see what happens when someone creates a KPI and Mr. Kuznets is very right. Regardless, the world ignored him and adopted the formula:
GDP = private consumption + gross investment + government spending + (exports - imports)
At first look, the only thing needed to consistently increase GDP is to encourage private consumption and government spending and that’s working out pretty well for China right now, but it’s not sustainable. The fix to the formula that has the potential to solve the economic equivalent to life, the universe, and everything was provided by Professor Steve Keen.
I first learned of the professor when I took an interest in the Australian housing market. Professor Keen’s voice seemed to be the only one in agreement with me that all was not fine. It turns out that he has famously predicted a housing crash of 40% and lost a bet to a member of Australia’s vast and powerful housing special interest group. In the loss of the wager, it is important to note that the professor stated a loss of 40% in REAL terms, not nominal and his specified timeline was much longer than when he paid it off. I would also like to note that almost all housing gains are in nominal terms and most people don’t know the difference between real and nominal. Although Dr. Keen paid off the wager and lost all credibility, he stipulated the reason he lost was due to massive government intervention that completely distorted the market. Again, I agree.
The good professor went on to publish a book, “Debunking Economics”, which provides a pretty strong case that economics is a pseudo-science and that it’s biggest problem is that modern day economists ignore debt. Since economists ignore it, that is why they are always wrong. Professor Keen is so intensely disliked in his native Australia that even though he is a tenured professor, his university is doing away with the entire economics department just to get rid of him. Anyway, with a stroke of the pencil, he fixed the GDP calculation to subtract out the change in debt. If this formula had been used in the mid ‘00s in the US, we would see a much different GDP number as the private consumption would have been cancelled out by the increased debt. Problem solved!
Modern economics has been based on the idea of money changing hands in exchange for goods and/or services. This idea has to continue, yet implementations such as the gold standard, fiat currency, or BitCoins are not working. The gold standard or BitCoins are finite and do not reward productivity gains. Fiat currency puts power in the hands of a few and have been behind the epic boom and bust cycles we have been experiencing over the last few decades.As much as I initially was flabbergasted by BitCoins, they have inspired me in a way. Power can be taken away from the few and democratized. If the right measurements are in place, the system can exist and be self correcting. The proposed system still rewards risks, entrepreneurship, and innovation but still lets everyone win during periods of increased productivity. It seems insane; but no more insane than trading worthless pieces of paper, bars of metal with no real purpose, strings of numbers, or hoarding land in a country that has nothing but land (are you listening, Australia???). My proposal may not be perfect, but I think with some more eyes and brains on it, the answer may be revealed.
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