I just came across a column from British financial commentator Liam Halligan that is one of the most terrifying things I’ve read in a while. It is nominally about the rise of Bitcoin, a recently invented “stateless” digital currency—but it is really about the decline of the big, traditional state-backed fiat currencies, most particularly the dollar and the euro.
These are parallel developments. It is only the collapse of traditional currencies that makes Bitcoin seem like a reasonable alternative.
Halligan sketches out what the guardians of the European and American financial systems are doing to their currencies.
While America’s quantitative easing is meant to be “tapering soon,” in Western Europe the funny-money dials have just been turned up.
Since Western QE began in late 2008, the Federal Reserve has tripled its balance sheet, creating virtual money and using it to buy Treasuries and corporate toxic debt. In Britain, we’ve been even more enthusiastic QE-ers, with the Bank of England presiding over a jaw-dropping four-fold expansion of base money, much of it channeled through the gilts market.
Eurozone policymakers, largely on Germany’s insistence, have used QE less than their Anglo-Saxon counterparts, rather more quietly and via more circuitous routes…. Yet the [European Central Bank] has still engineered a doubling of its balance sheet over the last five years.
Why is this helping Bitcoin? For only one reason: “Unlike ‘fiat currencies’ controlled by governments, which can be issued endlessly, an upper limit of Bitcoins is built into the software. Only 21 million can ever be ‘mined.'” Thus, Bitcoin is “an incredibly sophisticated response to the ongoing problem of deliberate currency debasement by governments in some of the world’s largest economies.”
As I wrote on Twitter, “You know we’re in trouble when Bitcoin starts to make sense.”
And boy are we in trouble. Bitcoin has no business being taken seriously as an alternative currency—except when the world’s major fiat currencies are in danger of spiraling into worthlessness.
Bitcoin is a particularly interesting case because of its basic similarity to fiat money: it has no value except what is agreed upon by social consensus. It has value only because it is arbitrarily accepted as having value. But it differs from government-backed fiat money in two respects. First, it is voluntary, adopted as payment by choice rather than by legal decree. Second—and this is the crux of the matter—the quantity of Bitcoins is inherently limited.
It is limited in two ways. Bitcoins cannot simply be printed at whim; they must be “mined” through a complicated process that involves doing the big mathematical calculations required to keep the Bitcoin monetary system running. A unit of Bitcoin currency is really just a long numeric code. Since spending a Bitcoin just consists of typing a series of numbers (or scanning a QR code), the obvious challenge is to prevent double-spending, i.e., punching in the same set of numbers again and again for repeated purchases. To prevent this, a mathematical code must be generated and propagated across the Internet to create a public ledger of transactions and keep them from being repeated. That’s the ingenious thing about the Bitcoin system: if you provide the computing power to generate these mathematical codes and maintain the system’s ledger, you are automatically rewarded with the issuance of new Bitcoins in your name.
This is intended to simulate the process of mining gold. One of the reasons gold money used to serve as a stable store of value is that no one can bring more of it into the system without investing their own time, money, and effort to dig it up out of the ground. This provides an automatic regulation on the money supply. If the supply of gold doesn’t expand quickly enough to keep up with economic growth, then its purchasing power rises, increasing the incentive to mine more of it and thereby increase the supply of money. If the supply of gold increases too rapidly, that reduces its purchasing power, at which point some mining operations become unprofitable and production drops, an automatic brake on inflation. There is no inherent upper limit to the supply of gold; if push comes to shove, we can always mine the asteroids. But finding new sources of gold becomes increasingly more expensive, putting a practical limit on how much of it can be added to the system.
The same thing applies to Bitcoin: the value of Bitcoins is tied to the expense of the computing power required to create them. But note that Bitcoins are merely a simulation of gold money. When gold is used as money, some of its value comes from its use as a medium of exchange, and even when it isn’t used as money, part of its value comes from its status as a hedge against inflation. But beneath that, gold is valuable in itself as a rare metal highly in demand for industrial and ornamental uses. Bitcoins, by contrast, have no underlying value. When you mine an ounce of gold, that is a process of production, of bringing a new economic good into existence. When you “mine” a Bitcoin, you are getting points for playing a mathematical game, and as with any other game, the points have no value outside the context of the game.
You can think of Bitcoins as a computer simulation of gold money, imitating the outward form of a gold standard system but without the substance. It’s the soul of fiat money, combined with the monetary mathematics of gold. Which makes it a very interesting combination indeed.
Bitcoin is the brainchild of an unknown mathematical genius who published the blueprints for the system under a pseudonym. And it functions with the precision of a scientific experiment. By creating something that has the basic characteristic of fiat currency, but which cannot be debased on whim, it tests the value of having a currency of limited quantity. Or to put things differently: it tests the destructiveness of having an unlimited quantity of money, as in the prevailing central banking system. The extent to which investors and purchasers flee into the limited fiat money of Bitcoin is the extent to which they are fleeing out of the unlimited fiat money which our central bankers are vigorously debasing.
That is why the rise of Bitcoin is so terrifying. The rise of Bitcoin is a measure of the collapse of money.
And yet, if we can learn the right lessons from Bitcoin, we can figure out how to end the disastrous unlimited expansion of the fiat currencies. Halligan points to a paper published by the Chicago Fed speculating that governments could issue their own Bitcoin-style currencies, built on the same principles: “the Fed can now envisage a time when nations themselves attempt to rely on cyber-currencies, which cannot be debased, in a kind of gold standard throwback.” But why does the gold standard have to make a comeback in such an odd, artificial, halfway version?
I guess it makes sense that a hybrid between fiat money and a gold-stand simulation would have some appeal as a halfway house for recovering quantitative easers. But if Bitcoin helps us realize the value of a non-debaseable currency, perhaps it can eventually help us to go all the way to monetary sobriety and return to a currency based on something other than arbitrary social consensus.