quotes:

"Most people are in arrested development and cannot use logic." Jacob.
"Competition and capitalism are hated to-day because of their tendency to destroy poverty and privilege." William Hutt
"America is unique in that our economy is totally dependent on global charity." Peter Schiff

Wednesday, June 22, 2011

Bitcoin Takes a Beating

Have a look at this

The webpage is Libertarian news, with a picture of Murray Rothbard on the bannerhead.
And they let an article sneak in called "The Economics Of Bitcoin – How Bitcoins Act As Money."

The article goes on to explain how bitcoins are as good as gold. Both gold and bitcoins are scarce, are fungible [one piece of gold is the same as another], are divisible into smaller pieces, and are recognizable. Plus bitcoin has all kinds of advantages gold doesn't, which we won't go into here.

Gold, the article tells us, has only one insignificant little detail of an advantage over bitcoin, hardly worth mentioning really. You can make jewelry out of gold. But so what, right? Let's quote the article in full, emphasis mine:

It is important to note that anything which meets the criteria I just listed can act as a money.  People do not care in the slightest that gold can be turned into artistic jewelry pieces in their decision making process about why they are holding gold as a store of value.
The fact that gold can be turned into artistic pieces simply provides a reassuring alternative use for gold if people decided that gold is no longer of monetary value.  So this way I know that if people stop buying gold as a store of wealth, I’ll still be able to sell my gold to a jewelry shop at a tiny fraction of its current value if it came down to it.  But this reassurance that gold will always have some tiny fraction of value to jewelers in no way influences the reasons why people use gold as a money and why gold has a market determined value of nearly 1600 dollars today.
Because Bitcoins have no other use besides acting as trade facilitators, they have no such reassurances of minimal value – but this fact is totally irrelevant from a monetary perspective, just as it is totally irrelevant from the perspective of gold.
All that matters as far as the money market in Bitcoins is concerned is that they have all of the aforementioned properties that make gold a money – which they do.  Thus, Bitcoins can act in exactly the same capacity as a store of wealth as gold. 

Sounds very convincing no? After all, does anyone really think all that gold in Fort  Knox, if it is still there, will ever be turned into jewelry? The thought is ludicrous, right? So just because gold might be worth a few pennies as a trinket doesn't really give it an advantage over bitcoins. Gold is valuable because it is money, not because it makes a good nose ring. That's the article's argument.
What woman would want this? Really.


But alas, dear reader, the article is either misinformed or trying to dupe you.
To understand why, let's sit for a while at the feet of the master, Ludwig von Mises, with my snarky comments to make it palatable. This is from Human Action, Chapter 17.

As soon as an economic good is demanded not only by those who want to use it for consumption or production, but also by people who want to keep it as a medium of exchange and to give it away at need in a later act of exchange, the demand for it increases. A new employment for this good has emerged and creates an additional demand for it. As with every other economic good, such an additional demand brings about a rise in its value in exchange, i.e., in the quantity of other goods which are offered for its acquisition. The amount of other goods which can be obtained in giving away a medium of exchange, its "price" as expressed in terms of various goods and services, is in part determined by the demand of those who want to acquire it as a medium of exchange. If people stop using the good in question as a medium of exchange, this additional specific demand disappears and the "price" drops concomitantly.

We'll use gold as an example of what he means. The caveman liked gold because it made pretty trinkets. This didn't mean much, really, and he certainly would not pay $1,600 an ounce for it. But as time went on, and people started using gold as money, then that very fact that it was money made it more valuable. It's the law of supply and demand at work. Increase the demand for gold, since more people want it now that it is used as money, and you increase its price.

Thus the demand for a medium of exchange is the composite of two partial demands: the demand displayed by the intention to use it in consumption and production and that displayed by the intention to use it as a medium of exchange.[7] With regard to modern metallic money one speaks of the industrial demand and of the monetary demand. The value in exchange (purchasing power) of a medium of exchange is the resultant of the cumulative effect of both partial demands.

In other words, the reason people want a gold coin, when it is used as money, and what determines what they are willing to give in exchange for a gold coin, is the two uses it has, as jewelry and as money.

Simple enough so far, and totally in agreement with the bitcoin article.

Now the extent of that part of the demand for a medium of exchange which is displayed on account of its service as a medium of exchange depends on its value in exchange. This fact raises difficulties which many economists considered insoluble so that they abstained from following farther along this line of reasoning. It is illogical, they said, to explain the purchasing power of money by reference to the demand for money, and the demand for money by reference to its purchasing power.

Translated into English, he is asking a simple question. Let's put aside the jewelry aspect of gold, and concentrate only on its value as money. People want gold because it has purchasing power, and it has purchasing power because people want it. In a Logic classroom, that kind of thinking would get an F. It's called circular reasoning, like the guy who drinks too much to forget his problems, and the problem he's trying to forget is that he drinks too much.

So bottom line, if we knock off a dime for its value as jewelry, how on Earth did a gold coin ever get to have the ability to buy $1,600 worth of groceries? Because people want it so badly? Well, why do they want it so badly? Because it can buy $1,600 worth of groceries? Circular reasoning.

Mises did not originate the question, but he did come up with the answer.
Before we see what he says, let us take note that right here is where the bitcoin people want to end the discussion.

They will say, "Great question, Ludwig. Just have to chalk it up as one of life's mysteries. But whatever the answer, that answer probably applies to bitcoins as much as to gold. Maybe both bitcoins and gold have no answer to that highly theoretical parlor game quiz, but who cares? Bottom line, gold works in the real world despite some ivory tower paradox, and bitcoins can, too."

On to the answer. Mises leads us through the intricate looking reasoning step by step:
The difficulty is, however, merely apparent. The purchasing power [p. 409] which we explain by referring to the extent of specific demand is not the same purchasing power the height of which determines this specific demand. The problem is to conceive the determination of the purchasing power of the immediate future, of the impending moment. For the solution of this problem we refer to the purchasing power of the immediate past, of the moment just passed. These are two distinct magnitudes. It is erroneous to object to our theorem, which may be called the regression theorem, that it moves in a vicious circle.[8]

In English, people are willing to accept gold coins and give in exchange $1,600 worth of groceries today, because they saw that yesterday they could get $1,600 worth of goodies with a gold coin. People want gold today because yesterday they saw they can buy a lot of stuff with it.

This would apply to bitcoins as well, of course. People will pay $17 for a bitcoin today because they saw that yesterday they could spend it and get $17 worth of stuff.

But, say the critics, this is tantamount to merely pushing back the problem. For now one must still explain the determination of yesterday's purchasing power. If one explains this in the same way by referring to the purchasing power of the day before yesterday and so on, one slips into a regressus in infinitum. This reasoning, they assert, is certainly not a complete and logically satisfactory solution of the problem involved. 

In other words, it's worth $1.600 today because that's what you could get with it yesterday. But what about yesterday? You can't go back and back to the beginning of time, right?

What these critics fail to see is that the regression does not go back endlessly. It reaches a point at which the explanation is completed and no further question remains unanswered. If we trace the purchasing power of money back step by step, we finally arrive at the point at which the service of the good concerned as a medium of exchange begins. At this point yesterday's exchange value is exclusively determined by the nonmonetary --industrial--demand which is displayed only by those who want to use this good for other employments than that of a medium of exchange.


In other words, if you go back far enough, you get to the day when gold was useful as jewellery only, worth say a dime. Until someone realized people are happy to take gold coins valued at a dime apiece. What have they got to lose? That's what the gold is worth for jewellery, anyway. And from there, as gold coins became more popular as money, they started becoming worth more than a dime.

And this is where bitcoins achieve their fail. Unlike gold, no matter how far back you go, bitcoins were never worth anything intrinsically. There was never a reason for bitcoins to suddenly become worth a dime, or any other price. They are totally useless as jewellery, or anything else. So that there is no reason people should accept them as being worth a dime, much less $33.

One may ask, then how come they were traded on certain websites at $33 a bitcoin? P.T. Barnum provided the answer. There's a sucker born every minute. A small handful of people decided to speculate in bitcoins and bought them at whatever silly price they thought was worth it. But bitcoins were never generally accepted at any price but zero. They have no reason to be.

The Brooklyn Bridge, on sale now.

20 comments:

  1. Thanks for insightful post. Frankly thanks to you I finally understood regression theorem :)

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  2. Could bitcoins become money if bitcoin represented "promise to deliver some amount of computational resources (hard disk space, cpu or gpu time)" (and this new architecture would have api that could be used to take advantage of this computational resources using for example map/reduce-type algoritm for cpu/gpu time, and some sort cloud for storage) instead of "proof that energy was spent"?

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  3. I do not know the meaning of many of the words you used. But the rule of thumb is this.

    To be money, a person has to have a clear answer to the question "What's in it for me if I have this thing, besides maybe passing it off to another sucker?"

    With a gold coin, the answer is "I have some gold, which I want." With a US dollar, the answer used to be, "I am now able to present this paper at a bank and get a gold coin." Nowadays, the answer is "I can give this paper to the IRS and they won't bother me for a while."

    If the answer for bitcoin is "You will have the right to use some hard disk space on some cloud computer," that's fine. If the answer is you get a kiss from Lady Gaga, that's OK, too. You are getting something.

    Then comes the next hurdle. The something has to be so desirable that 90% of the country will want it. Also, 90% of the people will have to trust that having the bitcoin guarentees getting the something; that there is no fraud involved.

    That's off the top of my head. The books on the subject spell out what other conditions a thing needs to be accepted as money.

    The point of the blog was to point out that bitcoin lacks the very first essential of money, that having it in your hand means you will get something you want.

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  4. "With a gold coin, the answer is "I have some gold, which I want.""

    Not quite. I don't have any non-trade related use for gold for instance. Only a minority want gold for non-trade related use currently. Similarly, a minority of early bitcoin adopters wanted to hold bitcoin for 'geek cred'--also a non-trade related use. So there's no problem here, by your reasoning.

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  5. bitbutter said...

    "With a gold coin, the answer is "I have some gold, which I want.""

    Not quite. I don't have any non-trade related use for gold for instance. Only a minority want gold for non-trade related use currently.


    You might be right. The question only has to be answered when the thing is first starting to be used as money.

    As I explained many times in the comments on an article here [called bitcoin yet again, in simple language this time], a few geeks is not a large enough population to count. Even all the bit coin users alive today is not enough.

    I'll repost the comment right here for your convenience:

    If you and your kid sister set up a system of paying each other for lollipops with tarot cards, that doesn't make tarot cards money, right? And why not? Because money has to be something accepted
    1. by a whole community
    2. in exchange for anything and everything.
    That's what medium of exchange means.

    When everything has a price in tarot cards, for a large group of people, not just a few close friends, then they can be legitimately called money.

    Bitcoin is not money yet, because there is no community, even if we call a group of people connected by computers a community, who will buy and sell everything for bitcoins.bitbutter said...

    "With a gold coin, the answer is "I have some gold, which I want.""

    Not quite. I don't have any non-trade related use for gold for instance. Only a minority want gold for non-trade related use currently.


    You might be right. The question only has to be answered when the thing is first starting to be used as money.

    As I explained many times in the comments on an article here [called bitcoin yet again, in simple language this time], a few geeks is not a large enough population to count. Even all the bit coin users alive today is not enough.

    I'll repost the comment right here for your convenience:

    If you and your kid sister set up a system of paying each other for lollipops with tarot cards, that doesn't make tarot cards money, right? And why not? Because money has to be something accepted
    1. by a whole community
    2. in exchange for anything and everything.
    That's what medium of exchange means.

    When everything has a price in tarot cards, for a large group of people, not just a few close friends, then they can be legitimately called money.

    Bitcoin is not money yet, because there is no community, even if we call a group of people connected by computers a community, who will buy and sell everything for bitcoins.

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  6. Nice post great information, The Fed’s recent campaign to raise interest rates has certainty been supportive of the dollar. But one has to ask at this late stage: How much higher can the Fed raise rates without tipping the U.S. economy into a recession and can our economy handle a recession at this point in our history?

    We are a nation of debtors who have literally piled up debt in the last few decades, particularly within the last 16 years. You will recall that I address our astronomical debt in almost every newsletter. Again, I remind you that, excluding unfunded liabilities, our debt currently exceeds $40 trillion (corporate, personal, and government), and 65% of that debt has been created since 1990. This has put tremendous pressure on the dollar.

    us gold coins

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  7. Our theories of money and economics have been changing and will continue to do so. The continued existence of Bitcoin, along with hundreds of other currencies that violate the theory you explain above should be evidence that reality may not agree with Mises' theory. The value accomplished through a medium of exchange is the ability to account for the production of value of individual people, along with the subsequent ability to exchange that value. There are time bank currencies that trade units of work valued in hours, the "unit" is no more than a means of record keeping. Obviously you cant take your "unit" of hours and turn back the clock in your kitchen. But you can use it as an abstraction and exchange it for someone else's time.

    There is a new currency in Greece called TEM which is literally nothing more than an accounting ledger of things that have been traded, and the number of TEM (based on a limited supply) either parties willingly agreed to exchange them for. As long as the ledger is secure, accurate, and consistent it can perform the operations as a medium of exchange indefinitely. In fact its working far better than the Euro where it's being used.

    What Mises' theory suggests is that without first having use in some physical sense it cant have use as a medium of exchange. So its value as a medium of exchange can only be achieved through a 2 step process of believing it has value somewhere else first... but seeing the currency value before some other use is somehow impossible...

    Sounds like a logical contradiction to me. That would imply that the value attributed to it as a medium of exchange isn't real, unless it has a tiny prerequisite value for some other less useful purpose. The purpose of money is to account for value produced and then to trade that value as accurately as possible. This can be done with a pen and a sheet of paper. Societies throughout history have used thousands of different methods successfully. The brilliance of gold and silver was that they were INDEPENDENT mediums. You didn't have to trust anyone else because you had a physical abstraction of the value you produced that was widely accepted, accurate, and secure.

    Money only needs to operate as an abstraction of value. Nothing more and nothing less. I can point to countless currencies that operate exactly this way, time bank currencies, airline miles, Linden dollars, WOW gold, TEM, barter ledgers, the US dollar, the Euro, and so on and so forth. Not all of these currencies work spectacularly and many are being manipulated and/or destroyed by the institutions that control them, but the system of money as an abstraction is not only successful, but already far more dominant then any system trading a medium with any physically useful properties.

    Either you have misrepresented Mises' Theory in this blog post, or it is simply incorrect. An independent and secure accounting for value is all that's necessary to create "money." Society proved this long before Bitcoin came around.

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    Replies
    1. 1. Have you actually read the articles?

      2. Do you think the law of gravity has been changing and will continue to do so?

      3. Bitcoin is not a currency. It is not generally accepted. The US dollar does not violate the regression theorem. Read Mises [in the link provided in the first article] for his discussion of fiat currency. Those hundreds of currencies that you think violate the theorem either are not generally accepted [= you cannot go into your local shopping mall and buy everything there with bitcoin or whatever] or someone has legally bound himself to exchange those things on demand for dollars, which nobody has done for bitcoins.

      4. Please lay out the contradiction in the form of a syllogism so we can see what you are talking about. Hint: You can't do it. There is no contradiction.

      The value attributed to it as a medium of exchange is real, if it exists. But the theorem says it will never exist unless it first has intrinsic value. No contradiction there. Read the first article.

      5."Money only needs to operate as an abstraction of value. Nothing more and nothing less." No. You forgot one critical little thing. It has to be generally accepted. For example, if you start printing Monopoly money and go to the store with it, explaining to the grocer how it is an abstraction of value, and that is all it needs to be, nothing more and nothing less, you won't get very far.

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  8. Hi, thanks for explaining, I did not see it that way previously. It is very well written.

    Just one Idea that i would like your opinion on. It can be difficult to take your gold and give it to someone else. Its heavy, its visible, someone else can intercept the delivery, government can come and take it from you, bla bla...
    Now I am definitely not smart enough to even express myself properly, but would it possible to see the value in Bitcoin in the way its protected in your wallet? What about the way how all nodes work together to deliver Bitcoin as securely as possible?
    I am just asking because I already saw people using they're "wealth" in Bitcoin in "jevelry" like style. For instance I saw a subscription like div (what u see on forums when person make a comment - under line is his subscription) that looked kinda nice and had automatically updated the value, how much of Bitcoins he has in related wallet.

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    Replies
    1. see the eighth link on intrinsic value.

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  9. Dave: Could the inherent properties of BitCoins (anonymous, global) themselves not be considered to be useful enough to get the ball rolling? Scarcity and transferability are excellent characteristics of money and from what I have read BitCoins seem to do quite well on the black market because of their (perceived) anonymity in addition to being easily transferable and (realistically) impossible to forge. I also have a gripe with your application of the term "Generally accepted". Money only has to be accepted by the parties involved or interested in it; it is why one currency is worthless in another country.

    Concrete example of my point: Let's say I want a smartphone, and I have pesos in my pocket. It does not matter that smartphones are produced in a country which does not trade in pesos, since there are stores which will happily exchange pesos for smartphones. This process can be extended and applied infinitely to more localized or obscure currencies, until, finally, you get get classic trading with goods; I may not even have pesos but know someone who does. I can work for him in exchange for a smartphone and thus never even have to touch fiat currency although several kinds of it are probably used in the chain between me and the factory workers and owners who produced it.

    I admit I am not an economist nor have I read your entire series of posts yet, but I wanted to make these arguments and get your input on it. Thanks for making these posts btw, it's an interesting phenomenon =)

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    Replies
    1. Yw Glader. All your q's are answered in the other articles.

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  10. Your theory seems based on an assumption that is wrong.

    "There was never a reason for bitcoins to suddenly become worth a dime"

    Protecting oneself from identity theft and therefore limiting risks while purchasing is worth more than a dime.

    Paying in a hard currency is a cumbersome, costly and still a risky task if you don't want to risk a traditional electronic transfer of any kind is worth more than a dime.

    Not paying fee's to the the 1% is worth more than a dime.

    For just those reasons above, a Bitcoin has value.

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    Replies
    1. Riz,
      You have to reread the article. We are talking about intrinsic value, not the advantages it has when used as money.

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  11. 1. Gold as jewelry has a intrinsic value but not bitcoin?, it is at-least a fun way to exchange something to some, who will decide if something has a intrinsic for all?

    2. gold-jewelry is also of not of value to all or may not be in future, do you think Gold as medium of exchange will disappear then?

    3. I think regression theorem describes how it can be bootstrapped, but does it mean if bootstrapped it needs the original cause to sustain?

    4. Bitcoin seems to be working as medium of exchange for now for some, which according to you should not happen at-least for even that subset, isn't that a contradiction, till when we should wait for your proof to materialize , N years?
    Isn't it true for all those N years?


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  12. "And this is where bitcoins achieve their fail. Unlike gold, no matter how far back you go, bitcoins were never worth anything intrinsically."

    Value is a subjective property, so if someone finds something valuable, for whatever reason, it is valuable (to him)! This person does not need to argument or explain why he finds something valuable, it is simply his opinion. This also holds for gold. Therefore there is no such thing as intrinsic value of gold, because it is a subjective value. We don't know the reasons and we cannot know the reasons why people ever valued gold. Maybe people like wearing gold because it is valued so much by others which makes it also suitable for a general mean-of-exchange.

    Maybe Satoshi valued bitcoins initially as a nice toy or experiment for a programmer, but this is still not intrinsic value. Maybe the first cavemen valued gold because they liked the color, who cares!

    Valuing something as a mean-of-exchange is a property determined collectively by supply and demand. Properties like scarcity and un-counterfeitable, durability etc. are probably more important because we have, based on history, a reasonable good picture of (bad) human nature.

    In a society where everyone can be trusted or are robots we could use anything as money.

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    Replies
    1. My blog has moved to smilingdavesblog.wordpress.com

      There's an article there called Bitcoin All in One Place that has a response to your points about value being subjective etc.

      TY for commenting.

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  13. Bitcoin's regression ends at the point where someone agreed to deliver 2 pizzas for 10,000 bitcoin. Just because they thought, why not? That set a price. The rest was history.

    When reality disagrees with theory, either the theory is wrong, or you're applying it incorrectly.

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    Replies
    1. My blog has moved to smilingdavesblog.wordpress.com

      There's an article there called Bitcoin All in One Place that has a response to your point about one person is enough to set a price.

      TY for commenting.

      Delete