Bitcoin mirth [UPDATED]

@RichardWooding sent me a link to a Wired story about a new Bitcoin wallet app for Android. I think Richard has figured I’d enjoy taking a few pot shots at this based on my past posts on bitcoins.

The article is fairly balanced, indicating the recent (and trust me on this, ongoing) problems with BitCoins. The idea of the app is fairly neat, using camera, display and barcodes to effect transactions. Then I read:

“Right now, Bitcoin appeals mostly to the hacker types,” said Android developer Brandon Iles, the app’s creator. “Down the line, though, it could gain traction between friends. There’s an advantage over credit card companies because there’s no fees involved in the transaction.”

Now this is a quote so I can hardly blame the journo, but the utter blindness of those involved with Bitcoin continues to astound me.

Yes, it may be easier to transfer bitcoins between friends than credit card transactions. However, after the transfer one of the parties is left with bitcoins that still need to be converted to something useful. Like real money perhaps. Bitcoins aren’t a unit of account, they aren’t a store of value and they are a means of transacting outside of a tiny handful of people who think it’s cool.

Bitcoin is a speculative fad.

But again, the worst thing that could ever happen is that it could actually become “money” since it shackles monetary policy (in a not dissimilar way to how the gold standard magnified the Great Depression and how not being on the gold standard made our current problems easier to deal with (pdf)). A hint – we produce more goods all the time, a limited currency means deflation, which is bad for economies (see Japan over the last, uh, 20 years?) and limits policy responses to economic downturns.

I’ve blogged about Bitcoins being a terrible idea before (and here and here too)

Update:  Thanks to @RiaanSingh for a link to an article from the economist magazine’s website asking whether economists agree with the excitement expressed by geeks for Bitcoins.  Unsurprisingly, they give the same message and the same flaws as I’ve expressed (albeit far more eloquently and with better pictures).  However, while they go as far to state that Bitcoins will likely lead to deflation, they don’t go far enough in outlining the dangers of deflation for an economy.

As an aside, US average hourly wage decreased according to the latest employment statistics (pdf) (see page 3). This in the face of many talking heads freaking out about inflation and what loose monetary policy has done. US Long term interest rates are still barely above 3%.  So yes, inflation in the US should not be first priority – jobs jobs jobs is what is needed.  (An easier job in the US since this is still primarily cyclical unemployment rather than South Africa’s more-difficult-to-fix structural unemployment.)

Published by David Kirk

The opinions expressed on this site are those of the author and other commenters and are not necessarily those of his employer or any other organisation. David Kirk runs Milliman’s actuarial consulting practice in Africa. He is an actuary and is the creator of New Business Margin on Revenue. He specialises in risk and capital management, regulatory change and insurance strategy . He also has extensive experience in embedded value reporting, insurance-related IFRS and share option valuation.

15 replies on “Bitcoin mirth [UPDATED]”

  1. It is just as much a unit of account as much as a bank account. They are a store of value as well. The idea that the great depression was magnified by the gold standard was a myth, and china’s lost decade as well was caused by other issues. A limited money supply is a good thing. Just stop reading the propaganda from the economists who are on the federal reserves payroll and you will be fine.

    1. It’s not a unit of account because it’s of too limited use and is too unstable and, well, nobody uses it as a unit of account.

      They are not a store of value because it’s too unstable.

      Did you read the link (one of many by well respected, established economists, who have, you know, studied economics) explaining how gold standard currency resulted in contraction of the money supply, further decreasing consumer demand and increasing the debt burden by balance-sheet constrained debtors without a commensurate increase in spending by creditors? Whether you read Milton Friedman or Keynes, the message is the same here.

      China didn’t have a “lost decade”. Japan did, and it’s now much longer than a decade and is very much a result of low demand arising from deflation and real interest rates that promote saving against consumption.
      I don’t read any of the economists with the current Federal Reserve, although Bernanke did have some good research out on the Great Depression before he joined.

      So Steven, I’m curious to know which economic models you are applying to show that a world economy with a finite currency is a good thing? In many ways your comment is exactly the problem I’m trying to draw attention to – people with good intentions (no argument here) but without any knowledge or understanding of how money, monetary policy, macroeconomics and overall economic policy, latch onto the warm fuzzy idea of Bitcoins because it feels like a good idea. The bad news is that what feels like a good idea is often a really bad idea as soon as the problems become complex.

      It’s taken us hundreds of years of deep thinking and analysis to understand a small amount of how free market economies work. I don’t know why you think your gut feel is better than any of this.

      1. @David Kirk: Seems you subscribe to the idea that you can solve debt with more debt. You like the idea that you can print your way out of trouble. You think that government can solve all economic problems. Your misguided thoughts and your ilk are what got the world into the huge mess its in.

        1. I feel really bad about lowering mortgage standards and fraudulently granting loans without proper information. I kick myself for having created exotic financial instruments and then persuading rating agencies to mis-rate them. If only I hadn’t convinced George Bush to offer huge tax breaks to the rich, the US budget deficit would be manageable and a little deficit spending on top of automatic stabilisers would help the US through the recession.

          I wonder, am I also responsible for the Great Depression or Japanese lost decade (plus) through deflationary pressures through inappropriate monetary policy?

          For all the feel-good buzzwords and slogans many use, the real solutions are based in analysis, sound models and economics. The current fallacy that “too much debt” got is into the mess we’re in is blind to the more complex issues, the issues that are more difficult to understand.

          The US deficit is a problem and it does need to be solved. However, the more pressing issues now are employment before more cyclical unemployment turns into structural unemployment. For every Dollar of debt, there must also be a Dollar of asset to the person to whom the money is owed. The problem isn’t with debt per se, but rather with the distribution of debt.

          If bitcoins have any place it’s as a minor transaction means for the paranoid. As an actual currency in wide use, the deflationary pressures increase the real burden of debt pushing economies every further away from full employment.

  2. The banks sure made a mess, however the US Gov made a huge mistake in buying up all the toxic debt. If the banks had been left to fail, the pain would have been great, thats certain, but nowhere near whats awaiting us.

    The amount of tax revenue never has and never will, no matter what, equal the debt. The “huge tax cuts for the rich” are so miniscule in terms of the overall debt that its naive to believe raising taxes could balance the deficit. Additionally the US Gov and indeed all goverments worldwide are not engaging in “a little” deficit spending – they are cranking the presses as hard and fast as they can. The mainstream view is that just a little bit more is needed. How much is enough for Keynesian’s ? 1 trillion, 100 trillion ? Why not print 1 quadrillion and hand it out to every man, woman and child ? Surely that would do it ?

    Those whole love debt, fear deflation as it makes debt more expensive but at what what cost to our children ? Cheaper debt now so that our kids can pay 10 million for a small car in 2025 ? Is it your contention that monetary policy in Japan is weak and MORE money should have been printed to avert the lost decades ?

    You are confusing the symptoms with the root cause. Unemployment is one such symptom of the debt problem. Unemployment is totally structural in the US and here in SA. SA has the additional weight around its neck of inflexible labour law and powerful unions. It all starts with the debt and all other “complex” issues are as a result. The challenge with the debt is that no-one is taking the other side voluntarily. Its being forced onto us all by corrupt polititians only intent on being re-elected and their crony bankers. All the massive money printing (QE, POMO, TARP etc) in the US, and of course Europe, is going into either buying toxic assets, funding banks for making very bad choices or propping up bankrupt nations like Greece. Once the debt becomes un-repayable when rates rise, and it will, its Joe Average, who is going to pick up the bill.

    Bitcoins are not backed by anything tangible, just like the Dollar or Rand Fiat. They do have however a limit on how many will circulate. Current Fiat can be printed into existence at will. Bitcoin would have done better to tie itself to Gold.

    In any event its not deflationary pressures which is causing unemployment, its the systemic purging after the last central banker induced bubble since 2003 and large fears in the small to medium business sector who for many reasons cannot and will not hire. A bubble which central bankers and governments are desperate to re-blow. Unfortunately for them, their attempts are being observed by the one true marker and real money : GOLD.

    1. Study the Great Depression and you’ll see exactly what massive bank failures, tight monetary policy, a gold standard and deflation do to an economy. You’re confusing deficit spending with quantitative easing. You are focussing on a very limited component of the money supply and using the tired analogy of “cranking the presses” showing a lack of understanding of what money is in an economy.

      Economists knew that the $700bn stimulus package was too small from the moment it was announced – it’s easy enough to calculate what the shortfall in demand was an it was always clear that that would be insufficient. I don’t know where you get your argument that it’s just about more and more spending. The economy is not some mythical, magical creation but a very complex, sensitive system.

      The tax cuts for the rich are not miniscule – due to income inequality in the US, those tax cuts affected a large amount of tax revenue.

      The actual bail-out funds are small compared to the impact of automatic stabilisers (unemployment benefits and lower tax revenues through unemployment and lower corporate profits) and the spending on the various wars. Further, the decline in GDP has pushed up the ratio of Debt/GDP significantly, which is not a question of debt but a question of economic growth. If we have deflation, nobody is encouraged to spend – money will be kept because it automatically increases in value. If nobody spends, nobody can earn. You and I would both soon be out of work. Your solution would be catastrophic for employment and welfare.

      You say that unemployment in the US is structural, but without explaining why. The US doesn’t have pockets of unemployment with other sectors experiencing full employment (as structural unemployment does, since there cannot be a mismatch in every geographic area, every industry of the US). Debt can’t cause structural unemployment since structural unemployment is a mismatch between skills supplied and skills demanded, exacerbated by wage stickiness.

      Wages declined in the last BLS report. Wages are declining, which makes us a hairs-breadth away from deflation and you’re worried about inflation?

      You talk about structural unemployment in South Africa, but somehow forget to talk about physical and human capital, about the education and skills we need to employ our citizens productively, high transport costs and those who are almost unemployable through decades of unemployment. At what point in our history did debt cause our structural unemployment problems? Was it the years when we ran budget surpluses perhaps?

      Long-term borrowing rates in the US are about 3% – short term rates are basically zero even with the prospect of debt-ceiling-inspired-default. So you say “nobody is voluntarily taking the other side” but in truth that’s exactly what is happening. Investors are lending to the US as much as the US wants to borrow at record LOW levels of interest.

      My contention is that Japan fell into a liquidity trap and should have combined additional quantitative easing with more significant fiscal stimulus and a commitment to modest inflation in the medium term (say, 4%) to discourage hoarding of cash and encourage spending in the economy. Japan also had to deal with the re-emergence of China and the competitive threats from Taiwan and Korea but they experienced more pain than was necessary.

      What is true to say is that because of our fractional reserving system and generally free capital flows, an increase in debt and strong capital inflows can be a warning sign for financial crisis. This doesn’t make all levels of debt “bad” and it doesn’t mean that additional deficit spending can reduce balance sheet constrains and ultimately lead to great economic growth and less public debt in the long run. Destroying the economy is one sure-fire way to make the debt to GDP levels skyrocket.

      Finally, your advice is to just let all the banks fail? Businesses that depend on financing to fund working capital would close. Banks that couldn’t roll over medium term debt would fail. Those employees would lose their income and spend less, default on their loans. With low spending, other businesses will fail. And so on. Your solution is the single most dangerous economic idea that could be implemented – and those who have studied economics and performed research in this area all agree with that conclusion.

      Boosting employment and demand, weakening balance sheet constrains through modest inflation and government spending will lead to economic growth and an ultimate restoration of public debt to sustainable levels. Wallowing in a liquidity trap and repeating all the mistakes of the Great Depression will not help.

    2. For completeness I should note that Sishq replied to the above, but the post was rejected as spam by Akismet, perhaps partly because large chunks of it were copied and pasted off the web. If I wanted to know what Aristotle thought of money (I don’t because his appreciation of economics and money is a little out of date) then I would read up the same tired theories all over the web. Sishq points to the deflation in the US in the mid 1800s and asks why it didn’t lead to a depression – well, it did.

      Sishq also holds onto the fantasy that hold has “intrinsic value” – you can’t eat it and it has only limited industrial uses. The “intrinsic value” there is no more than scarcity.

      The interesting thing about the Great Depression and the gold standard is not only do almost all economists agree with the theory of how sticking to the gold standard and shrinking money supply in the face of losses of gold reserves damaged the economy, there is also a great built-in experiment. As countries in turn abandoned the gold standard, so was the order of their recovery. This is a great summary paper outlining some of the mechanisms of the great Depresison, the gold standard, international trade and monetary policy with a good reference list.

      Sishq refers to the debunked theory of “real balance effect” without description of why there is no evidence for this in Japan’s case.

      Finally, Sishq ends with the curious comment:

      Here’s the deal….

      1. You cannot save a village by destroying it.
      2. You cannot save capitalism by destroying it.
      3. You cannot save a free market when you don’t have one in the first place.

      Didn’t quite know what it meant – then I found that it was written by at least one person before, Mike “Mish” Shedlock. Shedlock is also quoted as saying “95% of Russian banks defaulted in 1998 and an economic boom followed”, which is also simply not true and also repeated verbatim by Sishq (without referencing it) as supporting evidence. Only a small number of banks were allowed to fail and still the economy contracted by nearly 6%.

      It’s bad enough failing to see the numerous errors in logic and historical fact, but blatantly copying and pasting from places all around the web is disappointing.

  3. You still fail to answer many of my questions and its apparent that your theories and mainstream economists have no answer to them because they do not fit into ivory tower thought. Its clear that the current crisis has been created by governments and governments and mainstream economists have zero clue what do do about it. All they can do is print money and tout bogus theory.

    I challenge you to deny that the economic situation is getting worse !

    1. You keep saying “it’s clear”, but you don’t provide valid reasons why.

      If you actually read my blog and my posts you’ll see that I don’t think policy reactions have been right at all! The thing is, governments are not doing what is prescribed by the economists who’s models work. Don’t judge my policy views by the current situation – I don’t think the policy responses have been correct.

    1. Interesting article, thanks for the link. Dalio doesn’t support your arguments though. He does support many of mine. But why we are using a single hedge fund manager as the “owner of the truth” is beyond me.

      Firstly, as a hedge fund manager, Dalio is actually part of the leverage / deleverage cycle. Not blaming him, just pointing out the irony.
      Secondly, Dalio is a hedge fund manager making calls on investable assets (currencies and bonds in particular). He isn’t talking about what is best for the economy or for employment so this article, while interesting, is really a bit of an aside. His views on potential, future, currency and bond market problems from future money supply increases do not equate to “economic collapse by early 2013” and is silent on economic growth, employment and welfare. This is a pretty fundamental point

      Dalio states quite clearly that he views reflation, currency devaluation and government intervention as helping recover from the recession and crisis

      the financial deleveraging causes a financial crisis that causes an economic crisis. . . . This continues until there is a reflation, a currency devaluation and government guarantees of the efficacy of key financial intermediaries.

      He isn’t calling for mass bank failures and “purging of the system”.

      Dalio believes countries unable to manage their money supply due to currency pegs / participation in the Euro will face more severe recession as well. Can’t and “won’t” manage money supply amount to the same thing here.

      Other developed countries, particularly those tied to the euro and thus to the European Central Bank, don’t have the option of printing money and are destined to undergo “classic depressions,” Dalio said

      Dalio, according to this article anyway, has been long US treasuries. Hardly the position of someone who is concerned about inflation.
      Peter Schiff, another doyen of the Austrians, has famously been horribly wrong in most of his economic predictions since 2008 and is on record as saying his clients have lost money. Again, I don’t place too much weight on this because he’s a hedge fund manager not a policy economist. (I was going to find some links, but it only takes a 2 minute google to find plenty of evidence of Schiff’s incorrect predictions.) But it does show that picking a particular hedge fund manager who has made some successful predictions is no guarantee that the predictions will continue to be correct. Did I mention that Dalio’s predictions are more in line with my views than yours in any case?

      Dalio does not support your views.

  4. Fascinating debate. Curious to understand what the conclusion is. I see David why you have you positions, and I agree, we cannot afford a collapse. But I do have concerns that its not sustainable for the governments of the world continue to “print themselves out of trouble”. The cycle of demand for goods has slowed down – things just don’t need replacing as often any more. Where is the demand going to come from to drive the spend that is essential to use the increased liquidity that us there to save the economy? Disclaimer – I don’t profess to understand anything about economics. Just curious and concerned.

    1. Now that’s a perfectly sensible position I can get behind – printing money does nothing to change structural problems, promote innovation or growth in economic capacity. I also believe that medium term there is plenty to suggest that mostly-free-market policies will allow businesses to create value and drive the economy in the long run – so I’m not so worried about the long-term prospects of the global economy. Our own South Africa is a different issue – we have massive structural problems that urgently need to get fixed.

      Back to the US – the point around fiscal stimulus and liquidity is not about changing economic capacity, but rather to push the economy closer towards full employment. The very unfortunate reality is that debt levels are high – much higher than anybody would like. These arose from running deficit budgets in good times rather than paying down the debt in good times to keep more power dry for the inevitable busts. The US actually had a great history of doing this, until the Reagan-Bush-Bush tax cuts and spending, including necessary/unnecessary (you pick) wars. The Clinton era gave us budget surpluses and an economic boom – exactly the way it should be. Tuck away money in the good times, pay down the debt so government can promote full employment in the tough times. (A sad comparison is how South Africa increases welfare payments at every opportunity rather than focussing on fixing education, skills, transport, regulatory red tape etc. because they’re more popular political options.)

      But, we have the economy and the deficit we have. And the lesser of two evils is dealing with more stimulus and debt in the short term, but with a clear path for return to balanced (and surplus!) budgets in the medium term when unemployment isn’t catastrophic. See my next post (next couple days probably) for a couple charts and figures showing exactly how awful the situation in the US is. The negative impact of debt will be higher if the policies adopted kill off any remaining economic growth and put more people in the unemployment queues. That’s a path to recreate the Great Depression in spite of all we have learnt since it.

      Thanks for the comment Jon – I’m only not gentle when guys who have read one random internet post too many have “all the answers” based on long-repudiated stories, manufactured statistics and red-bull-infused zeal.

  5. Now we are getting somewhere. I cant agree however that fiscal stimulus and liquidity in the US has anything to do with unemployment. Its solely to rescue the big banks who are the masters in charge.

    Quick question and not meant to antagonise you as I see I have done enough of that already :

    If gold has no intrinsic value and no place in society and very little industrial use, why is it currently at $1600 an ounce when in 2001 Gold was $268 an ounce ?

    1. Sishq, you’ve got to give in. You haven’t made a single point that isn’t trivially refuted but persist in making statement after statement. It doesn’t matter how many times you state your hypothesis about it all being the evil banks, you’re just creating a permanent record here of how you can’t back up your views.

      I’m not going to bother answering your question on gold, except to say two things. Firstly, where did I say “gold has no place in society”? I’ve said more than enough here already (!) without you putting words in my mouth. Secondly, US Dollars have no intrinsic value, yet you can buy anything with them. Intrinsic value != perceived value. I’m not saying there is a bubble in the gold market (I don’t know) but you might find it interesting to read up on the Dutch Tulip Crisis to see how prices, perceived value and intrinsic value are not identical concepts.

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