Bitcoin Combines Ph.D-Level Computer Science With Sub-Kindergarten-Level Monetary Understanding
April 18, 2013
(This item originally appeared at Forbes.com on April 18, 2013.)
A “currency” is like “art”: it is anything that we use as “currency.” At times, cigarettes and small candies have served as currency. Tobacco was a currency in colonial Virginia. In Ancient Greece, iron pots and tripods once served as a sort of currency. Ancient Chinese used gardening tools as currency.
Some people use bitcoin as a means for transactions in goods and services, so it is, for them, a currency.
But is it a good currency?
The Bitcoin project is an odd combination of very advanced, Ph.D-level computer science, regarding encryption and record-keeping, and very primitive, sub-kindergarten-level monetary understanding.
What do we want from a currency? What are the characteristics of an ideal currency, and how do we manifest those in a practical, real-life system?
I think it is easy to see, today, that cigarettes, candies, iron pots and gardening tools are not ideal for use as currency.
Today, there are two basic ideals: one is a currency that is as stable, reliable, predictable, and inert as possible — a universal constant of commerce. The other ideal is a currency that you can actively manage to produce certain economic effects, or other government policy goals.
Bitcoin does not serve either of these functions. It is certainly not stable, reliable, predictable and inert. Nor is it a suitable platform for active economic management.
In practice, the first ideal, or the “Classical” ideal — of a stable and inert currency — was most often realized through a gold standard system. The second ideal, or “Mercantilist” ideal — of an actively-managed currency — is realized as today’s floating fiat currencies.
In both of these cases, the base money supply is adjusted, on a daily basis, to attain the policy goal. In the case of a gold standard system, the base money supply is adjusted via an automatic mechanism similar to a currency board, such that the currency’s value maintains its defined parity relationship with gold bullion.
In the case of the floating fiat currency, the base money supply is adjusted on a daily basis to achieve whatever economy-fiddling monetary distortion goals the currency managers have.
In the case of Bitcoin, the monetary base is not adjusted at all. It grows steadily. According to Wikipedia, at present, 25 new bitcoins are introduced every ten minutes. This will be halved in 2017, and halved again every four years until a hard limit of 21 million bitcoins is reached in 2140.
Obviously, there is no daily adjustment system here — not a gold standard-type system, or a floating-fiat type system. When supply is inflexible, then the value of the currency depends almost entirely upon demand. The value of the currency can vary wildly, depending on demand, just as the value of Impressionist paintings, vintage baseball cards, rare stamps, or other collectibles can vary.
In the period 1775-1900, as the United States grew from a small experiment into a world power, the demand for U.S. dollars increased immensely. The gold standard system of the time naturally adjusted for this increase in demand, by increasing the supply of base money, such that the value of the dollar maintained its gold parity at 23.20 troy grains of gold per dollar, or $20.67/oz.
The number of dollars in existence increased by 163 times, from $12 million to $1,954 million. During this period, the amount of gold in the world increased by 3.4 times due to mining production.
Bitcoin today is quite similar to Milton Friedman’s calls for a Constitutional Amendment to increase the money supply by some fixed rate, typically around 3% per year. The result of this would be about the same as Bitcoin today, which is to say: total chaos.
Milton Friedman’s monetary understanding, alas, was not very good.
The most interesting thing about Bitcoin is not that it is a good alternative currency — as a currency, it is garbage — but that it illustrates the great enthusiasm people have today for some kind of alternative to the monopoly floating fiat currencies imposed upon us by tyrannical governments.
Also, Bitcoin has introduced a number of computer science approaches that could be helpful in the creation of a truly useful alternative currency.
Actually, we have many currency alternatives today. Any country’s currency, among the hundred-plus now available, could be potentially used as an alternative currency in the United States or elsewhere.
The problem is, these other currencies — the Philippine peso, Malawian kwacha, Cambodian riek or Syrian pound — are also fiat junk, no better than dollars or euros. Much the same is true of the hundreds of “community currencies” in existence in the United States, which are basically dollar adjuncts, or worse.
The best alternative currency would be one based on gold — a currency that reflects the Classical ideal of a universal constant of commerce, rather than the Mercantilist ideal of government economic manipulation expressed in today’s fiat currencies.
That would be a truly useful alternative. Bitcoin, alas, is just another failed experiment.