What Bitcoin shows us about how money works
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Just because it's easy to understand doesn't mean it's correct.
For example, the US money supply more than doubled in the last 10 years, yet the value of a dollar has not halved.
M0 quadrupled in 10 years: https://imgur.com/a/L9mDx
M1 tripled: https://imgur.com/a/AaLNS
M2 doubled: https://imgur.com/a/0RGeQ
Money doesn't work like shares of stock, where a two-for-one split makes each share worth half as much.
Velocity, yield curves, economic growth and exchange rates all get to vote.
If you double the number of dollars "in circulation", it also matters which economic actors hold those extra dollars.
US money supply more than doubled, but the balance in most people's bank accounts and wallets didn't double. The doubling went to actors who didn't spend it, driving velocity down.
This stuff is complicated with many variables. Unfortunately the "easy to understand" version doesn't explain what happens in the real world.
Note that this was done in response to the velocity going down for reasons unrelated to the money supply, and largely because the government completely dropped the ball on fiscal stimulus so the central bank was left pushing the one lever it has, even though the circumstances were such that that lever was obviously not well suited to move the economy in the intended direction.
Presumably the demand and market forces have changed for the dollar in that time. If the central bank doubled the supply in one day, don't you think that would have an (approximately) halving impact on the value?
1) Nominal GDP = Money Spent
2) Nominal GDP = Price Level * Real GDP
3) Money Spent = Money Supply * Velocity
Therefore
4) Price Level * Real GDP = Money Supply * Velocity
So if supply doubles but velocity halves while real GDP remains constant, then there's no effect on prices.
Economists call this "pushing on a string".
The Federal Reserve increases the money supply when it buys securities like Treasury bonds and collateralized mortgages.
This puts more money in the hands of banks, brokers, and wealthy investors who used to own Treasury bonds and collateralized mortgages and now they own money instead.
Banks, brokerages and wealthy investors don't spend money as fast as regular people do. The money sits idle in savings and bank reserves.
That drives the velocity of money down as supply increases, and it's exactly what happened over the last 10 years: https://imgur.com/a/dtVJq
As M2 supply doubled, velocity dropped a lot. That's why the value of a dollar didn't halve even though the supply doubled, tripled, or quadrupled depending how you measure it.
EDIT: oops didn't see OP already clarified.
Monetary policy increases the money supply itself through the exchange of money for treasury bonds and relies on banks to distribute this "new" money, while fiscal policy redistributes money that already exists (previously collected through taxes) and gives it to active businesses through government purchases rather than to bond holding institutions.
That's basically fiscal policy, and was not implemented much after the initial Obama stimulus (or not at all in Europe, really, due to all the austerity rhetoric by very serious people).
if they doubled the money supply, evenly distributed it AND those new dollars were all spent at the same velocity then the expected price increase would certainly happen.
distribution & velocity are huge.
the ability of the new dollars to debase the old dollars only happens when they are spent into the economy.
the first parties to get and spend the new dollars receive the benefit side of inflation/price increases.
these bankers and economists will try to take credit for anything that has a positive twist to it, statistically speaking, but dont be fooled the central banks have very few tools and common sense + gut instinct is your friend when you're living underneath a government instituting financial repression (macroprudental policy).
Yes. We all know a lot of people with mortgages, student debt, and credit card debt, who if suddenly given a government handout that would double their savings, would immediately pay off their debts. But I can't claim that all debts would be paid.
> Would people be able to, considering the overall price increases?
Of course people would be able to pay off their current balance if you hand them money. What do price increases have to do with this? Prices may go up (or may not), but your current balance on your mortgage and your credit card bill do not. And if people anticipate interest rates going up, that motivates them to pay it off sooner rather than later. But note that there is a lot of fixed-rate debt out there (like mortgages) not affected by interest rate hikes.
> And if so, how long until they’re in debt again because they can’t keep up with increased prices (since they spent their printed money to pay their debt?)
You keep assuming that prices would go up. Prices are determined by supply and demand. It has been claimed on this thread that prices will go up exactly 2x, but this claim has not been substantiated whatsoever. One potential mechanism for this would be a substantial increase in aggregate demand, as a result of the handout, but much of the money would go into paying off debt instead. This is called "debt deflation". So prices might not go up nearly as much as you are claiming they would.
Less obvious is the strong dampening effect that industrial slack has on inflation. Printing more dollars can mean more cars get shifted off the lot instead of the same cars going for a higher price.
In any case -- what matters is that the inflation index of note is wrong in the same exact way every week.
This isn't the nature of economics, it's the nature of numbers. My masters' thesis is about simulating certain physical systems. There we stipulate G=1 and get the fuck on with the real work.
M0 doubling over ten years is not surprising if the underlying wealth that it measures also doubled, and doubling in ten years is on the right order of magnitude.
Of course, there are also other factors at play, so it would be unlikely to map exactly to the inverse of supply, but as a good rough first order approximation, it works OK.
Implying ceteris paribus -- all else held constant. Historical observations are generally not controlled experiments, as we only have one path through time.
OK, so walk us through it. What are the mechanics that transmit the money supply increase to wages and prices?
If the money supply instantly doubled by magically changing Treasury bonds and collateralized mortgages into cash, what would happen?
Cash balances would go up for banks, brokerages and wealthy investors but cash balances would stay the same for most people who don't own these securities.
Would that cause an instant doubling of wages and prices throughout the economy? Or would banks, brokerages and wealthy investors just hold on to their new, bigger balances?
This isn't really about timing, since even if the money supply instantly doubled, you'd probably see velocity instantly cut nearly in half.
You read the original comment differently than I did. I assumed some magical doubling, as if every dollar bill in someone's pocket duplicated itself.
If you want to play "What If?" I guess we need to figure out if we're magically erasing everyone's memory of their previous holdings. If not, the world would go a bit crazy. Journalists would report it, we'd learn about the existence of magic, etc. So, I guess we'll need to assume that the magic doubling also makes people forget what they had before.
Let's see ... there might be a bit of a wealth effect [0], but if we're saying people don't remember their old balances, would they really perceive themselves as wealthier? This question is just too nonsensical to really pursue. It could be a fun thought experiment, but it's hit the point where I'd rather get some work done instead.
1. The US dollar has intrinsic value. That intrinsic value is that the US government accepts it as payment for taxes. Regardless of what currency you conduct your business in, the USG accepts its cut only in dollars. That creates intrinsic demand for dollars, and links that intrinsic demand directly to the US GDP.
2. Bitcoin also has intrinsic value. That intrinsic value stems from transaction fees. It costs bitcoin to move bitcoin. International value-transfer is a service that has been around for a long time, and there is a market in it, so we can derive its value (or at the very least, that its value is non-zero) from the existence of demand for that service. Global value transfer has value, the Bitcoin network offers that service, and accepts payment only in Bitcoin. That is intrinsic value.
3. "Yes, this check could fail, but that possibility is still better than Bitcoin’s complete absence of any check on inflation." Bitcoin's core problem is not inflation. It's deflation. A fixed-supply currency is likely to suffer from deflationary spirals and subsequent crashes. I suppose you could call those crashes 'inflation', but that's not generally how the word is used.
4. "So here lies the fundamental difference between the dollar and Bitcoin: The supply of bitcoin is fixed, but the demand is beholden to uncontrollable market forces and speculator whims. That means that unlike the dollar, the value of BTC can never be stable, because there is no means regulate the supply to keep the value consistent from moment to moment.". Yes, that is the standard econ. argument in favor of central banks. It's not a new idea. But the actual evidence for its truth is surprisingly weak. Economies existed long before central banks, and indeed, they did have boom and bust cycles. However, it's not all that clear the central banks have really helped matters much, despite what they would like to think. Now, i'm not a total skeptic of central banking. I think its possible that they're adding some value, but i'm skeptical that it's as much as they think, and that the economy wouldn't find a way to function smoothly without them.
That can be argued to be an abstract utility for the US Dollar, but it is not an argument for the value (or "intrinsic value", whatever that means) of the US dollar in that the value of it is what determines the tax obligation. That is, if I own taxes on a non-USD transaction (say capital gains for BTC sales), the amount of those taxes is dependent on the value of USD. There's no forcing function -- if USD is valuable, I owe fewer dollars, if USD is cheap then I owe more dollars. There's no net demand.
To summarize -- tax obligations create no net demand for USD, thus are not a factor in the value of USD.
The exception to this is things like fees and (in the short-term) specific value taxes (like property taxes). These are not a significant factor in US government revenue, so I think we can safely discount them, although many municipalities rely on them to a greater degree.
I don't understand why this tired old meme keeps getting circulated -- it makes me want to write an angry letter to David Graeber. I think it's an interesting thesis for the origin of money, as early taxes were more like fees, tariffs, and tolls rather than ad valorum, and serves as a useful counterpoint to the Mises regression theorem, but stating it as a fact for the current state of things rather than a historical vestige requires a gross misinterpretation of the facts.
In what sense is there no "net demand"? There is a fixed (at any given time) amount of USD in circulation. People will need that USD to pay taxes. That is the demand side. Where is the supply side to make it net zero?
Assume for the moment that the number of USD in circulation is fixed. (Presumably we agree that if the government prints or retires currency they can change the value of USD, so let's remove that as a factor). For the sake of argument let's say there are 10^13 USD at all times.
Every year America produces some amount of real income. Let's just call that 1 A, measured relative to some fixed basket of goods. And let's say the government collects .2A in taxes.
Now, you are saying that the value of USD is not constrained by this situation. Suppose that almost everyone switches to cryptocurrency and 1USD = 10^-16 A. Then at tax time Americans have to come up with 0.2A=2x10^15 USD which is 200x more than actually exist. So people will need more USD than they have and will have to bid the price up.
Thus, given a fixed money supply and that the government doesn't literally instantly spend every tax dollar, there is a floor on the value of the USD proportional to total tax collection (and thus to the size of the economy being taxed).
In this context, not a specific technical use, my best understanding of intrinsic would be the value of something apart from any external forces or interest (extrinsic value). The intrinsic value of gold comes from its usefulness as a material, or from its attractiveness, not from the fact that it is accepted as a means of exchange. The fact that a US Dollar is accepted by the US Government for payment of legal debts is an extrinsic factor, just as its general usefulness for exchange of goods in the market is extrinsic. Intrinsically it has as much value as any other pretty piece of paper.
However I can see that there is a worthy distinction to be drawn about US dollar vs. Bitcoin in the recognition of the former by the US government and other parties. I just don't see intrinsic as the best descriptor for that quality.
Two things were not addressed though, which I think have a bigger impact than the things he mentions:
1 - scalability (e.g. transactions per second) of the bitcoin block chain is abysmally low. So low in fact, that today’s society would crumble on it as it currently exists;
2 - credit markets are not addressed. How do you loan money in a bitcoin world? Our society is built upon credit transactions, from buying houses to wasting money on gadgets with credit cards. If debt cannot be issued, then it will never amount to more than second place. Perhaps a medium of exchange for the Zimbabwe’s of the world, but not supplanting a modernized country’s currency.
[edited for spelling typo]
For instance, if you borrow in USD,you generally have to put it somewhere (like a bank) who can loan it out again. How do you let two different people use a single bitcoin? You need to do that for Fractional-reserve banking.
I’d reference this as a longer example of what I’m talking about: http://thismatter.com/money/banking/money-supply-money-multi...
2) Why wouldn't debt work? Wouldn't loans come from the pool of currency held by the creditor?
Fiat is better as a standard of value because an institution controls its quantity precisely to keep inflation in check (in other word, keep money supply in line with goods and services produced).
One thing the article doesn't mention is that a country's taxes need to be paid in that country's fiat. That's another source of value for fiat (which cryptocurrencies don't have).
Saying the gold standard didn't work after central banks printed far more than their gold reserves (i.e. effectively went off the gold standard) is like saying vaccinations don't work after people stop getting vaccinated and start getting sick again. It would be more correct to say that parties responsible for maintaining the gold standard (the central banks) failed and therefore "don't really work".
I would explain how the opposite is not true but people a lot more knowledgeable on the subject have written volumes.
"A sudden random jolt downward in bitcoin price prompts many people to try to sell it and worsen the situation,"
This sentence makes no sense because the "bitcoin price" is actually the BTC/USD ratio. You can trade in other ways.
My final, roll-on-the-floor-laughing moment was the description of dollar as a measure of utility:
"If the utility measured by a single dollar fluctuated a lot, that would mean that the number in your bank account would suddenly miscount the utility of all the work that filled it"
This happens every single day. Every government and bank in the world devalues your current bank account (aka inflation), so that you have to work harder (ie, increase your utility) to receive the same benefit.
"If you’re not willing to have a fluctuating bank account, BTC does not make transactions easier. It forces you to make more transactions."
That's precisely why government provided currencies are also worthless! All of us are running around like chickens without their head, hoping to get 'more money' just to survive! Currency is enslavement IMHO.
This is actually wrong. Money really consists of 2 things: 1) Government debt 2) Private bank credit
The Fed only controls the amount of bank reserves, which is a function of: 1) Policy (federal funds rate target, reserve requirements) 2) Demand for reserves from private banks
The fed cannot create or destroy money, because money as we know is either a balance in a bank account, coins, or notes. The fed's operations are always either neutral towards bank account balances, or swap physical currency (coins or notes) for bank account balances.
The government creates money by spending it into existence, and destroys money by collecting revenue. Private banks create money by lending it out, and destroy money when loans are paid off.
Research is currently ongoing in stable coins like https://makerdao.com/ In the following decades we will just begin to understand what it means to have decentralised and programmable value. Perhaps we won't use ANY currency in the future and the value of everything will be dynamic and personalised. Say, someone with low tolerance for risk will see more stable prices but slightly higher. Expressed in currency "minutes of watching TV".
Anything really is possible.
Talk about a strawman, nobody believes that. Gold (or any form of money) derives its value from being a commonly accepted medium of exchange.
Now, a few years later, BTC is blessed by regulators. The next phase of world domination is for the governance model of Bitcoin to start to seem far better than fiat governance models. This is just a matter of time.
Goldbugs / conspiracy theorists have a line of argument where they describe all the fiat currencies that have ultimately experienced corruption and hyper-inflation. So I think it's fair to say that running a fiat currency successfully for more than 500 years is something that is unprecedented in the history of the world.
So over a long time horizon this makes Bitcoin extremely interesting. It's not a question of whether 1 BTC will one day be worth millions of USD, it's a question of when. There is a good chance it will be hundreds of years from now if at all.
Much financial risk is in fact sovereign risk in one form or another. This doesn't mean it's rational to hoard gold or BTC, but for entities that have a long-term view of their own future, it makes sense to care a little bit and to diversify.
Even if 10% of the long-term entities diversify into Bitcoin, that alone will drive the price up substantially. It's far too soon for that to have happened.
We are also entering an era where politics are once again a bit part of international exchange, which adds additional sovereign risk for many areas of international business and financial planning.
But Bitcoin faces the same kinds of risks as governments for corruption, mismanagement, etc. The genius of it is that the governance model makes it a lot harder for one party to really control what happens with it.
And they are, practically in all the cases wrong. What we see is in history is a mismanagement of the real economy or external factors affecting the currency. They confound the symptom with the cause.
When the 'real' economy goes wrong, never mind if you have bit-coins, or whatever. In a desert, a bag with a million dollars buy you nothing. Of course, you can make a case for gold or similar because it could make easy run away to another place, but that it's not the argument they are pushing normally.
I think this is the aspect of it that applies to Bitcoin. All of the steps along the road to hyper-inflation in a fiat currency may be quite reasonable and may constitute the smartest move using the available tools.
There is also the question of whether currencies should be tied to governments. The risks that (frequent) government failures pose to one of the core purposes of money (storing value) are not costless. Society bears the costs of those risks even though they are hard to measure.
Of course many of the same problems could apply equally (or more) to Bitcoin depending on how the governance process proceeds.
Even with a fixed qty; uncovered exploits, technological breakthroughs, change in crypto trends (aka a move to another platform), or change in society could halt an increase of value.
Technically the same is true of gold. Even with out a massive change in qty, something as simple as a better gold like alloy for jewelry, an alternative for electronics, or a sudden cultural aversion to gold ownership could reduce the value.
That's actually an indisputable fact.
The Chinese managed it for a hundred years or so back in the day, we're on year 46 since The Nixon Shock.
There is no historic trend in which Bitcoin has become "very expensive" to hold long term, especially when compared to other long term asset classes. This fact is due to the price sitting at the top of its value, historically. Large fluctuations in other asset classes may also hold this property, which means it's a common issue with asset speculation, not Bitcoin itself.
This is not to say that Bitcoin's value will not decrease at a future date. It likely will.
This entire article's argument has been heard before. Bitcoin isn't money. It can be used as a currency, but its nature is much, much more than that.
I think people forget that there is a lot of value to a censorship resistant currency.
Before Bitcoin was worth hundreds or thousands of dollars it was being used in the black market at whatever rate it was floating at. That rate is a non zero value. There is no other way, other than another crypto currency, to do business in these black market places.
Now blow that out exponentially to places like China where your money isn't exactly your money. Or places where its ok to seize someones property, depending on whose in power.
This then starts to give you an idea that even when the bubble crashes we will still have Bitcoin.
This seems like the crux of the argument of the difference between the dollar and Bitcoin in the author's view. To me though this statement doesn't make sense and is very misleading, and someone please correct me if I'm wrong. The Fed CANNOT just keep burning dollars because they don't have all the dollars. Individuals hold those dollars. Yes, if individuals just started burning their dollars the value of the dollar would adjust to the "right" amount, but who in their right mind would burn their money for the greater good? In light of this, the Fed doesn't at all seem like a "check" on inflation or deflation. The dollar is still subject to the same supply and demand properties of Bitcoin.
But I still don't see how it differentiates BTC from USD. Because issuing any debt in the first place would inflate the value. So then when you stop issuing debt, the value would get deflated to what it would have been originally. I think this is how the Fed tries to control deflation as well. They print more money, not to distribute it but just so that they can hold it and burn it when they need to control inflation. Either way, both of these scenarios seems like a wash to me. You're just making money so that you can destroy it later.
The only argument I can see here is the idea of having 'wiggle room' within the money supply. In essence a way to control the irrational volatility of the market. If everyone is screaming sell sell sell!, the Fed has a limited amount of room to destroy some money and calm people down before panic takes over. BTC doesn't have that. But even this seems to me like a much weaker 'check' than the author suggests.
If the Fed wants to inflate the currency they print more and 'give' it to banks who create even more on top of this and if they want to deflate the currency they can simply change the minimum reserve value so less money is created out of thin air by the banks. Totally oversimplifying here but that's the general idea.
Anything short of 100% reserve banking and you have illusionary money in existence that gets spent just as well as a paper bill but with no actual paper bill backing it.