One of the major issues in contemporary macroeconomics concerns monetary policy since the 2008 crisis. For many, if not most, of the major central banks, the conventional channels through which the money supply changes do not work anymore. For instance, by paying interest on reserves, the Federal Reserve has moved from adjusting the money supply to influencing the banks’ money demand. Some central banks have even maintained that money supply does not affect inflation anymore.
A few days ago, when it was announced that former Cato Institute president John Allison was under consideration for treasury secretary, Josh Barro of Business Insider dismissed the man as a “nutcase”. Why? Because Allison believes that the Federal Deposit Insurance Corporation (FDIC) generates a moral hazard that contributes to financial crises (a statement I agree with).
This slur irked one of the economists at Cato, George Selgin, who took to twitter to challenge Barro. In the exchange, at one point, Barro indicated that the desire of libertarians to return to the gold standard confirms the “nuttiness” of libertarians and the people at Cato.
And here, Barro allows me to make a comment on the gold standard. The sympathy towards the gold standard is not sympathy towards gold per se, but rather sympathy for reducing the capacity of governments to exercise discretion. Basically, each time you hear some academic economist mention the gold standard, what that economist means is rules-based monetary policy.
The gold standard era (1875-1914) was not an image of perfect monetary policy. It is not a lost paradise that we ought to strive to. However, the implicit rules imposed by the system did favor more stability that would have been the case with discretion during that era. In fact, the era of central banking with the Federal Reserve has not been that great relative to the gold standard era (and in the world of central banks, the Fed is pretty good). A lot of the scorn that the gold standard era has received had to do with regulatory policy towards banks (notably regarding restrictions on branch banking which forced more volatility) or with the role of changes in international demand for assets (see here). Thus, in spite of its many flaws, the gold standard was not that bad (but it was not* gold per se that was helpful – it was the shunning of discretion by governments).
To be sure, I do not favor a return to a gold standard era. What I do like, and what I think John Allison likes as well, is the return to rules-based monetary policy. Josh Barro should have been intellectually generous and understand this key distinction. By not making that distinction, of which he must be aware given his background, he debased the debate over monetary policy.
Last weekend, November 1st 2015, a Dutch television network broadcast a splendid documentary on Bitcoin entitled ‘The Bitcoin Gospel’ (Het Bitcoin Evangelie). It started off with Roger Ver, also known as Bitcoin Jesus in the Bitcoin community for his active promotions of the cryptocurrency, who is standing in his living room in Tokyo sending Bitcoins to the value of 100 Euros into the living rooms of the Dutch. The first person who scans the QR code of the ‘private key’ gets access to a Bitcoin wallet which holds 100 Euros worth of Bitcoins. At the moment of writing, that same amount of Bitcoin has more than doubled to 217.28 Euros. It is a powerful demonstration of how easy currency flows from one side of the planet to the other. If he would have made the transaction through the traditional way, it would have taken several days and it could have cost him up to 30 Euros. Using Bitcoins, he could send the money practically costless, and almost instantly without the need of any intermediaries.
You can watch the full documentary here:
If I could point out my two most favorite scenes, it would be the beginning scene (0:00 – 2:14) in which we can see Roger Ver’s impressive demonstration of Bitcoin transactions and the ending scene (43:43 – 48:24) where the myth making of its founder, Satoshi Nakamoto, is discussed and where an emotional and teary-eyed Roger Ver talks about the subversive nature of Bitcoins against political injustices.
The documentary however, also featured critics of the cryptocurrency – hence providing a balanced perspective of Bitcoins. Its main critic was Izabella Kaminska, a financial blogger at the Financial Times. She has offered several interesting critiques to which I would like to respond in this article.
1) The first critique that Kaminska offers is that Bitcoin prices are too volatile.
Kaminska reminds the viewers of the turbulent swings in Bitcoin prices. Indeed, if one would take a look at the price chart one would see that Bitcoin did rise 800 percent from $129.46 to $1,165.89 in the three month period from September to November 30 in 2013. Within the next four months, the price would plumb to $344.24. The value of Bitcoin is still extremely volatile – it has ranged between $184.32 and $481.51 in the year 2015.
In my opinion however, Bitcoin’s volatility is not necessarily deplorable. Its volatility is due to its small market and the experimental phase it is still in. The total market capital of Bitcoins currently stands at $5,676,100,709. It effectively means that only a small amount of money flows into or out of the market can already have huge implications for its price movements. It is therefore only natural that its price is still volatile. Volatility also offers prospects of possible gains, hence attracting more capital from investors. Total investments into Bitcoin related projects in 2015 is already more than double that for 2014. (Coindesk, 2015) The more investments are made into Bitcoin related projects, the greater the chance that Bitcoin will be widely accepted so that eventually in the long run products and services can be denominated in Bitcoins. Hopefully, this will make Bitcoins gain the same relatively low-volatility attribute of many fiat currencies.
2) Kaminska’s second critique is that buying Bitcoins does not benefit the economy as it is not loaned out to provide entrepreneurs with investment capital.
Kaminska contends that Bitcoins are simply sitting idly in people’s wallets – it has no interest, it has no yield, and she even claims that the persons who hold them believe that they have “a right to future income flows as if they are investing.” The statement that those who hold Bitcoins think that they have a right to future income flows is quite bold. Bitcoins are like any other investments in that they are always subjected to uncertainties. No serious investor believes that he has a right to profits. The Bitcoin investor is like an entrepreneur – he knows that he can only make a profit if he anticipates future conditions correctly. The notion that one should not hoard Bitcoins or cash or gold corresponds with the false notion that
“Unspent dollars means reduced sales, and as sales decline, profits drop, layoffs increase, and the total social income decreases, making less money available for consumption. Hoarding induces more hoarding as the economy sinks into a downward spiral.” (Smith, 2009)
What this notion does not take into account is that hoarding is an expression of people’s freedom to achieve personal goals or to deal with economic uncertainties. As George Ford Smith (2009) writes in ‘The Case for Hoarding’, the increased demand for money also makes prices fall. Those who are not hoarding are therefore actually benefitting from the decline in prices.
3) Kaminska’s third critique is that Bitcoin has transferred power from the existing elite to the new 1% of the Bitcoin economy, thereby going against the ‘democratization’ effects of Bitcoins that has been preached by its prononents.
In my view, it is only justified that those who have done the research into Bitcoins and who have taken the high risk to invest in new inventions also have a higher rate of return. Similarly, those who were pioneers by investing in Facebook or Microsoft during their inception period also deserve potentially higher rates of return as these companies were running higher risk of failures. If the first adopters of Bitcoins would not have had the opportunity to make enormous amounts of money, they would not have had investment incentives, it would not have got this successful and this critique of Kaminska would not even have been possible.
4) Kaminska had also argued that the Bitcoin community is extremely absolutist and driven by political ideology which is thrusted on everyone else.
She maintains that when she is paying for coffee she just wants the benefits of a working payment network and smooth transactions, not support for a certain political ideology. The idea that payment systems can be apolitical is an illusion. Governments have always had vested interests in the moneys of its citizens as its existence is entirely dependent on taxation and money creation. Any decision to meddle with the government’s schemes of taxation and manipulation of the money supply is hence always politically charged. It seems to me that she is holding an idealized view of our society if she believes that using USD does not support any political-economic system. Her statement that the Bitcoin community is thrusting their political ideology on everyone else is highly arguable as well. The government is an institution that holds the unjust power to determine which currency can serve as legal tender and which goods – including currencies – can be traded or should be outlawed. Unlike governments, the Bitcoin community does not hold the power to initiate force upon the people. It cannot thrust the adoption of the payment network on all citizens. Indeed, Bitcoin is a free market invention that allows, but not forces, anyone to join the payment network voluntarily.
Kaminska is right, when one uses Bitcoins one is supporting the libertarian political ideology. If one pays with Bitcoins, one is supporting a decentralized payment network through which transaction costs have virtually fallen to zero and through which it is much more difficult for governments and banks to track one’s financial transactions. The really relevant question however is not whether you are supporting a political ideology. The question that should be asked is: should we prefer to give our governments, and central banks the power to manipulate the value of our currency or should we prefer the separation of state and money?
Coindesk, (2015). State Of Bitcoin. Retrieved from http://www.coindesk.com/research/state-of-bitcoin-q3-2015/
Smith, G.F., (2009). The Case For Hoarding. The Free Market. Retrieved from https://mises.org/library/case-hoarding
Yesterday, September 26th of 2015, I attended the Reinvent Money event in Rotterdam, the Netherlands, that was organized by Paul Buitink. The goal of the event was to bring people together for a grand discussion on the future of our monetary system. This discussion on monetary reforms is totally necessary if one considers the current problems with the euro and Greece, banking scandals, the rise of bitcoin and the blockchain technology, and peer-to-peer lending.
The speakers list consisted of many prominent thinkers and activists who could share with a crowd that was mostly in favor of crypto-currencies their thoughts about the current monetary system and whether money should be reinvented.
Willem Middelkoop was the first speaker and talked about the Big Reset of the monetary system that is currently orchestrated by high level officials. Jakob de Haan, head of the research department at the Dutch Central Bank, was the second speaker and stated that he does not believe in an upcoming Big Reset. While defending central banks, he argued that central banks are necessary in order to stabilize the currency and he sees five aspects that central banks should fulfill:
- central bank independence;
- central bank transparency;
- using monetary policy instruments to stabilize the economy;
- banking supervision of not only independent commercial banks, but of the whole economy. In his opinion, the central bank should supervise the entire economic system instead of primarily addressing individual institutions;
- macro-prudential policies to avoid crises.
Other speakers included Max Keiser, Stacy Herbert, Vit Jedlicka (president of Liberland), Stephan Antonopoulos, Simon Dixon, Joris Luyendijk, Prof. Antal Lekety and some others. Some wanted to go back to a gold-based monetary system, others truly wanted to reinvent money through crypto-currencies, and a few wanted the system to stay as it is structurally. As a voluntaryist, I was quite disappointed that the pro-crypto-currency speakers saw it as a means to democratize society. I don’t fully understand what they mean with the word ‘democratize’ and how crypto-currencies could do that, but I’ve noticed that those speakers saw it as a means to make our political system more democratic. Maybe, they mean ‘anti-authoritarian’ as crypto-currencies would indeed limit the monetary powers of the government and the central bank. However, I’ve always understood it as a de-political money system that is disruptive enough to do away with the myth that government is needed at all to stabilize our currency, and hence that it would bring us closer toward a voluntaryist society – not toward a more democratic system. A democratic system, in my opinion, means a system in which the majority rules. Crypto-currencies give every individual the full ownership of their money. Thus taking personal financial affairs entirely outside the scope of government meddling, also if that government is democratically chosen.
After World War I, Germany had to pay reparations to the United Kingdom and France. Having sold off its gold, the German government had no specie with which to back its currency, the mark. Therefore Germany issued fiat money, not backed by anything. It was called the Papiermark, the paper mark.
With its economy in ruins, the German government printed more and more currency with which to pay its bills, and the German expansion of money became the world’s most famous example of hyperinflation.
The inflation induced alternative currencies in Germany. In 1922, the Roggenrentebank was established, issuing notes backed by rye grain. In 1923 several local governments issued small-denomination loan notes denominated in commodities such as rye, coal, and gold. The commodity front served as a price index relative to marks for the notes.
The inflation came to a halt with the replacement of the Papiermark with a new currency, the Rentenmark on October 15, 1923*. One Rentenmark could be exchanged for a trillion Papiermarks.
The Rentenmark was fronted by bonds indexed to amounts of gold. Since the US dollar was backed by gold then, the Rentenmark was thus also pegged to the US dollar at 4.2 RM to $1. To “back” a currency means to exchange it for a commodity at a fixed rate. It was not enough to merely index the units of the Rentenmark to gold. To become stabilized, the new currency needed to be fronted by a commodity that was actually used. That commodity was real estate.
The Deutschen Rentenbank, the central bank of Germany, established reserves that included industrial bonds as well as mortagages on Germany’s real estate. A currency is fronted when the issuer has collateral that it can deliver in exchange for indexed units of the money. Real estate rentals payable in Rentenmarks were fronts for the new German currency. “Rente,” derived from French, means income in German, such as a pension.
After having stabilized the money, the Rentenmark was replaced by the legal-tender Reichsmark in 1924 one-to-one, although Rentenmark notes continued to serve as money until 1948.
Previous attempts to front a currency with land value failed, because such frontage is insufficient. In France during the early 1700s, John Law’s bank issued money on the collateral of land in Louisiana, but that hypothetical land value did not constrain the over issue of the banks’ notes. Then during the French Revolution, the government issued “assignats” on the collateral of confiscated church land, but that too did not prevent the inflation of the money.
Land rent cannot “back” a currency, since there are no uniform units of land that can be exchanged for units of money. But land rent can be a “front” for money when taxes are payable in that currency, which helps give that money its value. But that alone does not prevent an excessive expansion of the money. To stabilize the currency, it also needs to be backed by or indexed to some commodity. And gold has been a common and suitable backing for paper and bank-account currency.
The German experience also shows that the gold backing does not require large amounts of gold. It is sufficient for stabilization that there is some credible limit to the expansion of the money. The Germans were lucky in 1923 in having monetary chiefs such as Hans Luther of the Finance Ministry, and Hjalmar Schacht, Commissioner for National Currency, who maintained the gold index by limiting the expansion of the new currency.
But as the experience of France, shows, it is risky to depend on the integrity of monetary chiefs. Permanent monetary stability requires a structure of money and banking that is self-correcting. That structure is best provided by free-market banking, in which the real money (outside money) is some commodity beyond the control of the banks, and the banks issue “inside money” or money substitutes backed by the real money. Competition and convertibility prevent inflation.
Any kind of tax can serve to help endow money with value, but a land-value tax offers the greatest frontage for currency, because in effect, LVT acts as a mortgage on land value, and the government can take over land when the tax is not paid. Unlike with taxes on income, nobody goes to prison for not paying a real estate tax, because the rent serves as a reliable collateral. Land rent can serve as collateral not just for real estate loans, but also for taxation, and for currencies. All countries can have “renten money” when they covert from market-hampering taxes on production to market-enhancing taxes on the economic surplus that is land rent.
* This was corrected from an earlier typo listing the year as 2013 instead of 1923.
Alex Tabarrok has a very flattering post at Marginal Revolution about my 2011 article, “Ben Bernanke versus Milton Friedman: The Federal Reserve’s Emergence as the U.S. Economy’s Central Planner.” It seems that the President of the Richmond Fed has independently just made a similar argument.