The argument for Bitcoin money is as it stands now, but there are many components that could be questioned.
This opinion editorial is by Taimur Ahmad (a Stanford University graduate student) and focuses on energy, environment policy, and international politics.
Note from the Author: This is part one of a trilogy.
Part 1 introduces Bitcoin and evaluates Bitcoin as an inflation hedge. Part 2 dives deeper into the concept.
Part 2 examines the current fiat system and how money is created. It also discusses the supply of money.
Part 3 focuses on the history and relationship of money to society and state, inflation in the Global South and the progressive case against/for Bitcoin as money.
Bitcoin As Money: Progressivism, Neoclassical Economics, And Alternatives Part I
Prologue
Once upon a time, I heard a story that inspired me to understand money. It's something like this:
Imagine a tourist visiting a small rural town to stay at the inn. They are required to deposit 100 diamonds as a damage deposit. The owner of the inn discovers that the tourist had fled town and left behind 100 diamonds. The owner is thrilled to receive a 100-diamond bonus, as it seems unlikely that the tourist will return. The owner goes to the local bakery and pays off his debt with this extra money. The baker then proceeds to pay off his debt with the local mechanic. The tailor is then paid off by the mechanic.
However, this is not a happy ending. The same tourist returns the next week to retrieve some of his luggage. Now, the inn owner feels bad about not having the deposit, and freed from the obligation to pay the bakery's debt, he decides to remind him of the 100 diamonds and give them back. Nonchalantly accepting them, the tourist then crushed them under his feet.
It's a simple story but it is difficult to understand. Many questions arise: If everyone in the town was indebted to one another, why can't they just cancel it (coordination problem). Why was the town paying IOUs to each other for services, but the tourist had to pay money (trust issue)? Why did no one check whether the diamonds were real, and could they have even if they wanted (standardization/quality problem)? Is it really important that the diamonds were not real (what is money now)?
"The purpose for studying economics it to learn how to not be deceived economists." — Joan Robinson
Introduction
To borrow from Adam Tooze, we are currently in the middle of a multi-crisis. Modern society is, as clichéd as it may sound, at a pivot point on multiple fronts. The foundations on which the last few decades have been built are constantly shifting, whether it's the global economic system — China and the U.S. playing complementary roles as producers and consumers respectively — or the geopolitical order — globalization within a multipolar world — and even the ecological ecosystem — cheap fossil fuels that fuel mass consumption —
This largely stable system is quickly falling apart, even though it has many benefits, including low inflation, global supply chain, trust, and a lot more. Now is the right time to ask fundamental, big questions that we've been too scared or distracted to answer for so long.
This is all about the idea of money. This does not necessarily refer to wealth, although that is the topic of many conversations in modern society. But, I am referring to the idea of money. Our main concern is usually who has the most money (wealth), how to get more, and how fair is the distribution. This discourse assumes that money is almost inert, almost a sacrilegious thing, that is constantly being moved about.
However, in the last few years, debt and inflation have been more prominent topics in mainstream discourse. Questions around money as a concept have received increasing attention.
- What is money?
- It is where did it come from?
- Who is it controlled?
- What is the difference between money and non-money?
- Is it possible for it to change?
Modern Monetary Theory (MMT), and alternative currencies (mostly Bitcoin) have been the dominant ideas in this discussion. This article will focus on the former and analyze the arguments that underpin the Bitcoin standard. It is a theory that Bitcoin should replace fiat currency. What are the potential pitfalls? And what other roles could Bitcoin play? I will also critique neoclassical economists, which is the basis of much of the arguments that the Bitcoin standard relies on.
Why Bitcoin? Why Bitcoin? Bitcoin is the only decentralized cryptocurrency that doesn't have a premine and has no fixed rules. There are many questionable and speculative projects in the digital asset market, but Bitcoin is a truly innovative technology. Bitcoin is unique because of its proof-of-work mining algorithm. This mechanism often gets attacked for its energy use. I wrote against it and explained how BTC mining can help clean energy.
For clarity's sake, I will only be focusing on Bitcoin as a monetary asset and analyzing arguments from the "progressive” wing of Bitcoiners. The majority of this article will focus on the monetary system in Western nations, with a few exceptions.
This essay will be long and sometimes meandering. Let me give you a brief summary of my thoughts. Bitcoin as money isn't possible because it is not an endogenous entity that can programmatically be fixed. Similar to this, money can't be assigned moralistic virtues (e.g. sound, fair, etc.) This is a misinterpretation of money. My argument is that money can be understood as a social phenomenon. It is created out of and sometimes representing socioeconomic relationships, power structures, and other factors. Not vice versa, the material reality of the world creates monetary systems. This has been true for centuries. Money is always in flux. It must be flexible enough to absorb complex economic movements and adapt to the unique dynamics of each society. Money cannot be separated from the legal and political institutions that create property rights, market, etc. We must change the current broken monetary system — which I also agree is flawed — by focusing on the ideology framework and institutions that create society, so that we can use existing tools to achieve better ends.
Disclaimer: I own bitcoin.
Critique of the Current Monetary Systems
The following argument is made by Bitcoin standard supporters:
The government's control over the money supply has resulted in a wide range of inequality and the devaluation the currency. This is due to the Cantillon effect, which is responsible for economic distortion and growing inequality. Because they have access to more money, the Cantillon effect favors those closest to the center of power.
The lack of transparency and accountability in the monetary system can have ripple effects on the entire socioeconomic system. This includes a decrease in purchasing power and a reduction of saving capacity. To counter the widespread effects of this corrupt system, which has led to a weak currency, a programmatic asset is needed that has low entry barriers, fixed rules of issuance and no governing body.
Before I can begin to evaluate these arguments, it's important to understand the larger socioeconomical and political context in which this movement is occurring. There has been a lot of empirical evidence over the past 50 years that shows real wages have stagnated despite rising productivity. Inequality has been increasing faster, the economy has become more financialized, which has benefited the rich and asset owners. Financial entities have been involved with corrupt and criminal activities, and the Global South has been in economic turmoil due to high inflation, defaults and other effects of a global financial system. The neoliberal system is unequal, oppressive, and duplicitous.
Political structures have also been in decline over the same time, with many democratic countries falling prey to the state-capture of the elite. This has left little room for political reform and accountability. While there are many Bitcoin supporters who are wealthy, the majority of Bitcoin advocates can be described as people who are "left behind" or recognize the absurdity of the current system, and are looking for a way to get out.
This is why there are an increasing number "progressives", loosely defined as people who argue for equality and justice, who are pro-Bitcoin. The question of "what's money?" and the fairness of our financial system have been largely absent from mainstream discourse for decades. They were buried under Econ-101 fallacies and kept to a few ideological echo chambers. These questions are now mainstream again as history swings back towards populism. However, there is a shortage of experts who can adequately be sympathetic to and respond coherently to people's concerns.
It is therefore important to understand the origins of the Bitcoin standard narrative and not dismiss it outright. However, it is also crucial to recognize that many people who are skeptical of the current system have a lot in common, at least at the first principles level. Only by engaging in discussion beyond that level can we raise our collective consciousness to a level that allows us to make change possible.
Is a Bitcoin Standard the Answer?
This question will be addressed at different levels. I'll attempt to address it from operational perspectives such as Bitcoin as an inflation hedge to conceptual ones like the separation of money & The State.
Bitcoin as an Inflation Hedge
This argument is well-known in the Bitcoin community. It covers many features that are important to Bitcoiners, such as protection from loss of purchasing power and currency devaluation. The standard argument was that Bitcoin was a hedge against inflation because its price rises (by orders-of-magnitudes) under the inflationary monetary system. This seemed odd because many risk assets performed well during this time, but they are not considered inflation hedges. This claim was not tested because developed economies operated under a secular low inflation policy.
Importantly, Bitcoin's prices have risen over the past year, and its price has plummeted. The argument changed to "Bitcoin's hedge against monetary inflation." This means that it doesn’t hedge against an increase in the price for goods and services, but against the "devaluation currency through money printing."
Source: Raoul Pal’s Twitter
This argument is also unique for many reasons. I'll explain each one in detail.
- Again, it relies on the assertion that Bitcoin is a unique "hedge" asset and not just a risk-on investment. This is similar to other high beta assets that have performed well during periods of increasing liquidity.
- It is based on the monetarist theory of an increase in the money supply that directly and immediately leads to an increase price (if not, why bother to care about the money supply at all).
- It is a misinterpretation of M2, money printing, as well as where the money comes from.
1. Bitcoin: Is it a risk-on asset?
Steven Lubka, a podcast host, stated that Bitcoin is a hedge against inflation that has been caused by excessive monetary expansion. However, this was not the case when the inflation was supply-side. This, he correctly pointed out, is what the current situation is. He responds to criticisms that other risk-on assets go up during periods monetary expansion. He writes that Bitcoin rises more than other assets, and that only Bitcoin should serve as a hedge since it is "just cash" while other assets do not.
The extent to which an asset's value goes up should not be considered a hedge, as long as it is positively related to the price for goods and services. I would argue that price moving up too much — although this is subjective — can make an asset go from being a hedge to speculative. While his assertion that stocks are subject to idiosyncratic risk such as bad management decisions or high debt loads, which makes them distinct from Bitcoin, other factors like "risk of obsolescence" and "other real-world problems," to quote him directly, also apply to Bitcoin.
Many other charts show that Bitcoin is strongly linked to tech stocks and the equity markets in general. It is clear that Bitcoin's price action is driven by global liquidity changes, especially U.S. liquidity. This is because it determines how far investors will push back. Bitcoin does not play a similar role in times of crisis like now when USD and other safe haven assets are performing well.
There is no reason to believe that Bitcoin trades differently from a liquidity wave-risk-on asset, so it shouldn't be treated any different, just because. This relationship could change in the future, but that is up to the market.
2. What is Inflation?
The Bitcoiner argument is crucial that you understand that an increase in currency supply causes currency devaluation. This means that you can purchase less goods and services because of higher prices. This argument is difficult to understand because inflation definitions are constantly changing. Some people think it's simply an increase in price of goods or services (CPI). This seems intuitive because this is what consumers are most interested in and concerned about. Another definition of inflation is an increase of the money supply , as some refer to it — regardless how this affects the price of goods or services. However, this should eventually lead to price increases . This is Milton Friedman's quote, which I think has been meme-ified:
Inflation can only be created by an increase in money's quantity faster than the output.
Let's now try to understand it. Non-monetary factors like supply chain issues and price increases are not inflation. Inflation is when the money supply expands. Price increases are caused by an increase in money supply. Steve Lubka's argument about Bitcoin as a hedge against inflation, or at least the current supply-chain-induced high prices, is correct. Note: Although his work is well-articulated, many other people in the space make similar claims.
We won't argue the effects of supply chain and other physical restrictions on prices. Let's instead focus on the second statement. What is the point of a change to the money supply if it is not tied to changes in prices? It doesn't matter when or how asymmetrically they occur. Below is a chart that shows the annual percentage change in CPI and money supply.
Data source : St. Louis Fed; Center for Financial Stability
Technical Note: M2 is a smaller measure of money supply that M4, because it does not include liquid money substitutes. The opaque financial system in the United States limits the ability to accurately estimate the wide money supply. However, the Federal Reserve in the U.S. provides M2 data only as the broadest measure. The Divisia M2 is used here because it provides a more methodologically sound estimation (by applying weights to different types money) than the Federal Reserve's simple-sum average approach (regardless, Divisia's M2 data is very closely aligned). Leasing and loans are a measure bank credit. As banks create money by lending rather than recycling savings, I will explain this later.
The chart shows that the correlation between money supply changes and CPI is very weak. The rate at which money supply has changed is increasing, while inflation is declining from the mid-1990s to the early 2000s. Inflation was rising, but money supply was decreasing in the 2000s. Post-2008 is perhaps the most notable because it was the beginning of quantitative easing, when central banks' balance sheets grew at incredible rates but developed economies failed to achieve their inflation targets.
Another possible argument is that inflation can also be found in stocks and real estate, which have risen higher over most of the period. Although there is a strong correlation between stock market appreciation and M2, it is not inflation. Stock market appreciation does not affect consumers' purchasing power and therefore does not need a hedge. Is there inequality due to distributional issues? Absolutely. For now, I will focus solely on the inflation narrative. It's difficult to include housing prices as inflation, since real estate is an important investment vehicle (which is a serious structural problem).
There is no evidence to support the claim that an increase of M2 will lead to an increase CPI. (I am mainly focusing on developed countries and will later address the issue of inflation in the Global South). Japan wouldn't be stuck in low inflation despite its Bank of Japan balance sheets expanding over the past several decades. Because of rising energy prices and disruptions in supply chains, the current inflationary cycle is being caused by Europe's high dependence on Russian gas. This is why Europe is experiencing higher inflation than other countries.
Sidenote: Peter McCormack's reaction to Jeff Snider making a similar case about M2 and Inflation on the What Bitcoin Did podcast was fascinating. Peter commented on how the situation made sense, but was so contrary to the dominant narrative.
Let's not forget the details, even if we accept the monetarist theory to be correct. The key equation is MV = Q.
M: Money supply.
V: Velocity of money.
P: prices.
Q: Quantity of goods and services.
These M2-based charts and analyses do not show how money velocity changes. Consider 2020 as an example. Many predicted hyperinflation ahead of 2020, as the M2 money supply grew higher due to the government's fiscal and monetary responses. However, while M2 increased by 25% in 2020, the velocity money fell by 18%. Even if you accept the monetarist theory as true, the dynamics of the money supply and inflation are much more complex than that.
Source: https://fred.stlouisfed.org
Source: https://fred.stlouisfed.org
For those who bring up the Webster dictionary definition for inflation in the early 20th Century as an increase of money supply, I would say that the change in money supply under a gold standard was something entirely different from what it is today. (addressed below). Friedman's claim is fundamental to the Bitcoiner argument and is therefore a fact. Higher prices are when there is more money to chase the same goods. However, this does not necessarily mean that an increase in money supply will cause an increase in prices. Additional liquidity can unlock extra capacity, increase productivity, and expand the use deflationary technology. This is the central argument for MMT (trigger warning). MMT argues that fiscal spending can be targeted to increase capacity. It does this by focusing on the "reserve army" of unemployed, as Marx called them, and making them work, rather than treating them like sacrificial lambs on the neoclassical altar.
This brings us to the end. It's difficult to see how inflation can be different from an increase in CPI. If the mantra that monetary expansion leads inflation is false, what's the point of Bitcoin as a "hedge" against such expansion? What is the hedge against?
While there are many issues in how CPI is measured, I can admit that price changes occur due to a variety of factors on both the demand-side as well as supply-side. Powell, Yellen and Greenspan have all noted this fact, while heterodox economists have been arguing it for decades. It is difficult to reduce inflation to monetary expansion. This raises questions about whether Bitcoin can be used as a hedge against inflation, if it doesn't protect value when CPI is rising, or if this idea of hedging against money expansion is just chicanery.
Part 2 explains the current fiat system and how money is created (it's still not all government's fault), as well as what Bitcoin could be lacking in terms of money.
Taimur Ahmad contributed this guest post. These opinions are not necessarily those of BTC, Inc., or Bitcoin Magazine.
—————————————————————————————————————————————————————————————–
By: Taimur Ahmad
Title: A Criticism Of The Current Bitcoin As Money Narrative
Sourced From: bitcoinmagazine.com/markets/criticism-of-bitcoin-as-money-narrative
Published Date: Fri, 02 Sep 2022 00:00:00 GMT
Leave a Reply