
What Bitcoin shows us about how money works - tbabb
http://www.bzarg.com/p/what-bitcoin-shows-us-about-how-money-works/
======
panarky
_> It’s pretty easy to understand that if the government were to suddenly
double the number of dollars in circulation, the value of a dollar would go
down by approximately half._

Just because it's easy to understand doesn't mean it's correct.

For example, the US money supply more than doubled in the last 10 years, yet
the value of a dollar has not halved.

M0 quadrupled in 10 years:
[https://imgur.com/a/L9mDx](https://imgur.com/a/L9mDx)

M1 tripled: [https://imgur.com/a/AaLNS](https://imgur.com/a/AaLNS)

M2 doubled: [https://imgur.com/a/0RGeQ](https://imgur.com/a/0RGeQ)

Money doesn't work like shares of stock, where a two-for-one split makes each
share worth half as much.

Velocity, yield curves, economic growth and exchange rates all get to vote.

If you double the number of dollars "in circulation", it also matters which
economic actors hold those extra dollars.

US money supply more than doubled, but the balance in most people's bank
accounts and wallets didn't double. The doubling went to actors who didn't
spend it, driving velocity down.

This stuff is complicated with many variables. Unfortunately the "easy to
understand" version doesn't explain what happens in the real world.

~~~
tbabb
> M0 quadrupled in 10 years:
> [https://imgur.com/a/L9mDx](https://imgur.com/a/L9mDx)

Presumably the demand and market forces have changed for the dollar in that
time. If the central bank doubled the supply in one day, don't you think that
would have an (approximately) halving impact on the value?

~~~
panarky
Here's a way to think about it using simple identities.

1) Nominal GDP = Money Spent

2) Nominal GDP = Price Level * Real GDP

3) Money Spent = Money Supply * Velocity

Therefore

4) Price Level * Real GDP = Money Supply * Velocity

So if supply doubles but velocity halves while real GDP remains constant, then
there's no effect on prices.

Economists call this "pushing on a string".

The Federal Reserve increases the money supply when it buys securities like
Treasury bonds and collateralized mortgages.

This puts more money in the hands of banks, brokers, and wealthy investors who
used to own Treasury bonds and collateralized mortgages and now they own money
instead.

Banks, brokerages and wealthy investors don't spend money as fast as regular
people do. The money sits idle in savings and bank reserves.

That drives the velocity of money down as supply increases, and it's exactly
what happened over the last 10 years:
[https://imgur.com/a/dtVJq](https://imgur.com/a/dtVJq)

As M2 supply doubled, velocity dropped a lot. That's why the value of a dollar
didn't halve even though the supply doubled, tripled, or quadrupled depending
how you measure it.

~~~
meri_dian
So if the Fed was somehow able to increase money supply by getting money into
the hands of the average consumer rather than wealthy individual and
institutional bond holders, monetary policy would be more effective?

~~~
jganetsk
Monetary policy is just not that effective, overall. The Fed is not putting
money into anyone's hands. It's just making bank balance sheets replace
higher-interest paying asserts (Treasury bonds) with lower-interest paying
assets (bank reserves) in the hopes that more lending will happen. But it
won't. Fiscal policy is necessary.
[http://neweconomicperspectives.org/2012/01/mmp-
blog-31-funct...](http://neweconomicperspectives.org/2012/01/mmp-
blog-31-functional-finance-monetary.html)

~~~
meri_dian
But that's not an answer to my question. I'm asking if - regardless of how
policy is being executed now - money were distributed throughout the economy,
would that accomplish the goals of monetary policy more effectively than the
way it is traditionally carried out?

~~~
ultraluminous
It does answer your question - what you're misundestanding is that
"distributing money throughout the economy" is _fiscal_ policy, not _monetary_
policy. That's what the OP meant by "fiscal policy is necessary" and "the
government dropped the ball on fiscal policy". The Federal Reserve, as a body,
and monetary policy in general by extension, does not posses the tools to
enact fiscal policies.

EDIT: oops didn't see OP already clarified.

~~~
meri_dian
But monetary policy is also injecting money into the economy. Both fiscal and
monetary do this, but differ in two ways: the nature of the money injected and
the way the injection is performed.

Monetary policy increases the money supply itself through the exchange of
money for treasury bonds and relies on banks to distribute this "new" money,
while fiscal policy redistributes money that already exists (previously
collected through taxes) and gives it to active businesses through government
purchases rather than to bond holding institutions.

~~~
jganetsk
The interpretation that banks distribute that money is wrong. Banks don't lend
out reserves:
[https://www.kreditopferhilfe.net/docs/S_and_P__Repeat_After_...](https://www.kreditopferhilfe.net/docs/S_and_P__Repeat_After_Me_8_14_13.pdf)

------
darawk
Overall I like the article, but a few points of disagreement:

1\. The US dollar has intrinsic value. That intrinsic value is that the US
government accepts it as payment for taxes. Regardless of what currency you
conduct your business in, the USG accepts its cut only in dollars. That
creates intrinsic demand for dollars, and links that intrinsic demand directly
to the US GDP.

2\. Bitcoin also has intrinsic value. That intrinsic value stems from
transaction fees. It costs bitcoin to move bitcoin. International value-
transfer is a service that has been around for a long time, and there is a
market in it, so we can derive its value (or at the very least, that its value
is non-zero) from the existence of demand for that service. Global value
transfer has value, the Bitcoin network offers that service, and accepts
payment only in Bitcoin. That is intrinsic value.

3\. "Yes, this check could fail, but that possibility is still better than
Bitcoin’s complete absence of any check on inflation." Bitcoin's core problem
is not inflation. It's deflation. A fixed-supply currency is likely to suffer
from deflationary spirals and subsequent crashes. I suppose you could call
those crashes 'inflation', but that's not generally how the word is used.

4\. "So here lies the fundamental difference between the dollar and Bitcoin:
The supply of bitcoin is fixed, but the demand is beholden to uncontrollable
market forces and speculator whims. That means that unlike the dollar, the
value of BTC can never be stable, because there is no means regulate the
supply to keep the value consistent from moment to moment.". Yes, that is the
standard econ. argument in favor of central banks. It's not a new idea. But
the actual evidence for its truth is surprisingly weak. Economies existed long
before central banks, and indeed, they did have boom and bust cycles. However,
it's not all that clear the central banks have really helped matters much,
despite what they would like to think. Now, i'm not a total skeptic of central
banking. I think its possible that they're adding some value, but i'm
skeptical that it's as much as they think, and that the economy wouldn't find
a way to function smoothly without them.

~~~
andrewla
> That intrinsic value is that the US government accepts it as payment for
> taxes

That can be argued to be an abstract utility for the US Dollar, but it is not
an argument for the value (or "intrinsic value", whatever that means) of the
US dollar in that the value of it is what determines the tax obligation. That
is, if I own taxes on a non-USD transaction (say capital gains for BTC sales),
the amount of those taxes is dependent on the value of USD. There's no forcing
function -- if USD is valuable, I owe fewer dollars, if USD is cheap then I
owe more dollars. There's no net demand.

To summarize -- tax obligations create no net demand for USD, thus are not a
factor in the value of USD.

The exception to this is things like fees and (in the short-term) specific
value taxes (like property taxes). These are not a significant factor in US
government revenue, so I think we can safely discount them, although many
municipalities rely on them to a greater degree.

I don't understand why this tired old meme keeps getting circulated -- it
makes me want to write an angry letter to David Graeber. I think it's an
interesting thesis for the origin of money, as early taxes were more like
fees, tariffs, and tolls rather than ad valorum, and serves as a useful
counterpoint to the Mises regression theorem, but stating it as a fact for the
current state of things rather than a historical vestige requires a gross
misinterpretation of the facts.

~~~
voidmain
I really think you have this wrong. At the least, you need a better defense of
your position.

Assume for the moment that the number of USD in circulation is fixed.
(Presumably we agree that if the government prints or retires currency they
can change the value of USD, so let's remove that as a factor). For the sake
of argument let's say there are 10^13 USD at all times.

Every year America produces some amount of real income. Let's just call that 1
A, measured relative to some fixed basket of goods. And let's say the
government collects .2A in taxes.

Now, you are saying that the value of USD is not constrained by this
situation. Suppose that almost everyone switches to cryptocurrency and 1USD =
10^-16 A. Then at tax time Americans have to come up with 0.2A=2x10^15 USD
which is 200x more than actually exist. So people will need more USD than they
have and will _have to_ bid the price up.

Thus, given a fixed money supply and that the government doesn't literally
instantly spend every tax dollar, there is a floor on the value of the USD
proportional to total tax collection (and thus to the size of the economy
being taxed).

~~~
voidmain
To add some real world numbers: it seems that federal, state, and local taxes
total about 40% of the $18.6 trillion GDP, or $7.4 trillion per year. The
broad money supply M2 is about $13.8 trillion. So more than half of all the
USD in existence anywhere need to be handed to US governments every year! If
the value of the USD were to fall precipitously, this fraction would go _up_.
It seems crazy to think that this doesn't bound the value of the dollar.

------
MR4D
Good article.

Two things were not addressed though, which I think have a bigger impact than
the things he mentions:

1 - scalability (e.g. transactions per second) of the bitcoin block chain is
abysmally low. So low in fact, that today’s society would crumble on it as it
currently exists;

2 - credit markets are not addressed. How do you loan money in a bitcoin
world? Our society is built upon credit transactions, from buying houses to
wasting money on gadgets with credit cards. If debt cannot be issued, then it
will never amount to more than second place. Perhaps a medium of exchange for
the Zimbabwe’s of the world, but not supplanting a modernized country’s
currency.

[edited for spelling typo]

~~~
danield9tqh
Debt can absolutely be issued with Bitcoin. What's to stop someone from
saying, here I'll give you 1 BTC today if you give it back to me tomorrow? The
reason you've probably heard that debt cannot be issued in Bitcoin is because
debt cannot be issued in a 'safe' way. In other words if I give someone 1 BTC
today, I can't be sure that they will give it back to me tomorrow. But that's
just the nature of debt and has nothing to do with Bitcoin.

~~~
MR4D
Sure, you can do that, but that’s not how the modern world works. And it can’t
create enough debt.

For instance, if you borrow in USD,you generally have to put it somewhere
(like a bank) who can loan it out again. How do you let two different people
use a single bitcoin? You need to do that for Fractional-reserve banking.

I’d reference this as a longer example of what I’m talking about:
[http://thismatter.com/money/banking/money-supply-money-
multi...](http://thismatter.com/money/banking/money-supply-money-
multiplier.htm)

------
FabHK
Good points.

Fiat is better as a standard of value because an institution controls its
quantity precisely to keep inflation in check (in other word, keep money
supply in line with goods and services produced).

One thing the article doesn't mention is that a country's taxes need to be
paid in that country's fiat. That's another source of value for fiat (which
cryptocurrencies don't have).

------
stevedekorte
"What about the gold standard? Well, it didn’t really work."

Saying the gold standard didn't work after central banks printed far more than
their gold reserves (i.e. effectively went off the gold standard) is like
saying vaccinations don't work after people stop getting vaccinated and start
getting sick again. It would be more correct to say that parties responsible
for maintaining the gold standard (the central banks) failed and therefore
"don't really work".

~~~
jganetsk
The gold standard doesn't work because it's deflationary. The Eurozone
effectively functions as a gold standard. And now we are re-learning why the
gold standard is bad when we look at the impact austerity has had on the Greek
financial crisis.

~~~
UncleEntity
There's nothing inherently bad about deflation, the US economy was basically
deflationary for the whole of the 19th century and did just fine.

I would explain how the opposite is not true but people a lot more
knowledgeable on the subject have written volumes.

~~~
faint_coder
If you say so, you don't know anything about macroeconomics, and John Maynard
Keynes' thrift paradox. Money MUST BE printed, because players that use it
(people and businesses) _GROW_ over time! Did you heard that Facebook ALONE in
2014 generated almost $400,000,000,000.00 in economic activity? How that would
haven been possible if we had the same USD volume supply of 1930? How
derivatives, futures contracts, options contracts, options writing would be
possible with a fixed USD volume at 1930's levels?! What you say is absurd,
for modern economies. Please, read some more books on those topics. Thank you.

------
option_greek
I can now see how internet didn't make sense to Bill gates and IPhone was a
passing fad to Steve balmer. I think the existing players get a sort of tunnel
vision when they get in contact with disruptive technologies. Either way, we
will know in a few years :).

------
arghbleargh
I find a lot to agree with in this article, and it explains it pretty well,
but the part about the Federal Reserve is a bit too simplistic. The value of
money is determined by a complex interplay of factors, including government
spending/taxation and international trade. The Federal Reserve has only
limited influence on it via manipulation of interest rates. Nevertheless, the
main point stands: the strength of fiat currency lies in the implied _social_
contract that measures will be taken to ensure your savings today are not
worthless tomorrow.

------
cmroanirgo
Lol. Although many good and seemingly well-reasoned arguments, the author
forgot that you can only place a _value_ on something if it is traded for
something else. (eg BTC to USD, or chickens to potatoes). It is the _ratio_
that gives the _value_ and also depends on _what side_ of the trade you're on.

"A sudden random jolt downward in bitcoin price prompts many people to try to
sell it and worsen the situation,"

This sentence makes no sense because the "bitcoin price" is actually the
BTC/USD ratio. You _can_ trade in other ways.

My final, roll-on-the-floor-laughing moment was the description of _dollar as
a measure of utility_ :

"If the utility measured by a single dollar fluctuated a lot, that would mean
that the number in your bank account would suddenly miscount the utility of
all the work that filled it"

This happens every single day. Every government and bank in the world devalues
your current bank account (aka inflation), so that you have to work harder
(ie, increase your utility) to receive the same benefit.

"If you’re not willing to have a fluctuating bank account, BTC does not make
transactions easier. It forces you to make more transactions."

That's precisely why government provided currencies are also worthless! All of
us are running around like chickens without their head, hoping to get 'more
money' just to survive! Currency is enslavement IMHO.

~~~
ypeterholmes
Well said. I was also struck by the author's core argument- that Bitcoin will
never be stable because nobody can manipulate its value. Seems to me the
opposite is true; the fact that nobody can directly manipulate supply will
provide the type of stability our current fiat currency sorely lacks.

~~~
xapata
Did you forget the discussion of Bretton Woods? When you can't alter supply,
it might be temporarily stable, but you have catastrophic shocks. Calm before
the storm, and all that.

------
jganetsk
> Demand for dollars is (like anything) organic and capricious, but the supply
> is directly controlled by the Fed.

This is actually wrong. Money really consists of 2 things: 1) Government debt
2) Private bank credit

The Fed only controls the amount of bank reserves, which is a function of: 1)
Policy (federal funds rate target, reserve requirements) 2) Demand for
reserves from private banks

The fed cannot create or destroy money, because money as we know is either a
balance in a bank account, coins, or notes. The fed's operations are always
either neutral towards bank account balances, or swap physical currency (coins
or notes) for bank account balances.

The government creates money by spending it into existence, and destroys money
by collecting revenue. Private banks create money by lending it out, and
destroy money when loans are paid off.

------
Agebor
I agree with the conclusion about bitcoin, but it's very ignorant to just
dismiss all current and future cryptocurrencies and assume it's not possible
to replace fiat currency.

Research is currently ongoing in stable coins like
[https://makerdao.com/](https://makerdao.com/) In the following decades we
will just begin to understand what it means to have decentralised and
programmable value. Perhaps we won't use ANY currency in the future and the
value of everything will be dynamic and personalised. Say, someone with low
tolerance for risk will see more stable prices but slightly higher. Expressed
in currency "minutes of watching TV".

Anything really is possible.

------
gima
Hmm. Reads a lot like the video series on "The History of Paper Money by Extra
Credits":
[https://www.youtube.com/watch?v=-nZkP2b-4vo](https://www.youtube.com/watch?v=-nZkP2b-4vo)

------
UncleEntity
> Essentially, the gold standard commits a fallacy by assuming that the value
> of money comes from the commodity that backs it.

Talk about a strawman, nobody believes that. Gold (or any form of money)
derives its value from being a commonly accepted medium of exchange.

------
githubcomyottu
You could say there has been a massive deflation in Bitcoin since 2010. I
prefer to say the Pizza price has inflated to $92.499.925,00/Pizza (5000 BTC).

------
bitconion
well, also gold is yellow and shiny, not like bitcoin. the author is somewhere
in the middle between abstractions and direct analogies. of course "intrinsic
value" has no math definition. so one can manipulate words around it and
bitcoin and gold etc

------
zxy_xyz
ELI5 how bitcoin works anyone? I'm curious but not willing to deep dive atm.

~~~
allemagne
[https://www.youtube.com/watch?v=bBC-
nXj3Ng4](https://www.youtube.com/watch?v=bBC-nXj3Ng4)

------
jonnycomputer
and not a single mention of taxes in the article as a source of demand for a
currency. Roughly, the US collects about $3.3 trillion in tax every year, and
the US states another $700 billion.

------
grandalf
These are all good points except for the idea that it won't be used like
normal money. The speculative environment and price volatility resulting from
that, is all by design. The mining incentive creates a "boom" environment to
help bootstrap the currency.

Now, a few years later, BTC is blessed by regulators. The next phase of world
domination is for the governance model of Bitcoin to start to seem far better
than fiat governance models. This is just a matter of time.

~~~
blowski
That seems like wishful thinking. You might end up in being correct, but I've
yet to see firm evidence that suggests that will be the case.

~~~
psyc
How often does one get "firm evidence" about how future human affairs unfold?

~~~
blowski
We quite often get firm evidence, and the evidence turns out to be wrong. But
I'm a sceptic, which is why I never bought any Bitcoins for $1 in 2012.

~~~
grandalf
I have no idea whether that will happen, just trying to express what I think
the rational case is for investing in Bitcoin today.

Goldbugs / conspiracy theorists have a line of argument where they describe
all the fiat currencies that have ultimately experienced corruption and hyper-
inflation. So I think it's fair to say that running a fiat currency
successfully for more than 500 years is something that is unprecedented in the
history of the world.

So over a long time horizon this makes Bitcoin extremely interesting. It's not
a question of whether 1 BTC will one day be worth millions of USD, it's a
question of when. There is a good chance it will be hundreds of years from now
if at all.

Much financial risk is in fact sovereign risk in one form or another. This
doesn't mean it's rational to hoard gold or BTC, but for entities that have a
long-term view of their own future, it makes sense to care a little bit and to
diversify.

Even if 10% of the long-term entities diversify into Bitcoin, that alone will
drive the price up substantially. It's far too soon for that to have happened.

We are also entering an era where politics are once again a bit part of
international exchange, which adds additional sovereign risk for many areas of
international business and financial planning.

But Bitcoin faces the same kinds of risks as governments for corruption,
mismanagement, etc. The genius of it is that the governance model makes it a
lot harder for one party to really control what happens with it.

~~~
RobertoG
>"Goldbugs / conspiracy theorists have a line of argument where they describe
all the fiat currencies that have ultimately experienced corruption and hyper-
inflation"

And they are, practically in all the cases wrong. What we see is in history is
a mismanagement of the real economy or external factors affecting the
currency. They confound the symptom with the cause.

When the 'real' economy goes wrong, never mind if you have bit-coins, or
whatever. In a desert, a bag with a million dollars buy you nothing. Of
course, you can make a case for gold or similar because it could make easy run
away to another place, but that it's not the argument they are pushing
normally.

~~~
grandalf
> Of course, you can make a case for gold or similar because it could make
> easy run away to another place, but that it's not the argument they are
> pushing normally.

I think this is the aspect of it that applies to Bitcoin. All of the steps
along the road to hyper-inflation in a fiat currency may be quite reasonable
and may constitute the smartest move using the available tools.

There is also the question of whether currencies should be tied to
governments. The risks that (frequent) government failures pose to one of the
core purposes of money (storing value) are not costless. Society bears the
costs of those risks even though they are hard to measure.

Of course many of the same problems could apply equally (or more) to Bitcoin
depending on how the governance process proceeds.

------
kordlessagain
> As we can see from everything above, holding BTC will tend to be very
> expensive, as large fluctuations can cut your savings in half without
> warning.

There is no historic trend in which Bitcoin has become "very expensive" to
hold long term, especially when compared to other long term asset classes.
This fact is due to the price sitting at the top of its value, historically.
Large fluctuations in other asset classes may also hold this property, which
means it's a common issue with asset speculation, not Bitcoin itself.

This is not to say that Bitcoin's value will not decrease at a future date. It
likely will.

This entire article's argument has been heard before. Bitcoin isn't money. It
can be used as a currency, but its nature is much, much more than that.

------
wintom
>"A bitcoin is a number, and that number has no utility outside of its ability
to be accepted by someone else. Unlike gold, the the minimum value of a
bitcoin is zero— its value if everyone stops believing it works. This is one
reason why a bitcoin is a risky way to hold assets."

I think people forget that there is a lot of value to a censorship resistant
currency.

Before Bitcoin was worth hundreds or thousands of dollars it was being used in
the black market at whatever rate it was floating at. That rate is a non zero
value. There is no other way, other than another crypto currency, to do
business in these black market places.

Now blow that out exponentially to places like China where your money isn't
exactly your money. Or places where its ok to seize someones property,
depending on whose in power.

This then starts to give you an idea that even when the bubble crashes we will
still have Bitcoin.

~~~
AstralStorm
Bitcoin wallet can be seized and the transactions are traceable and public, so
a sufficiently determined actor can figure out who has it and how much. Then
enforce their cut with violence.

~~~
maxfurman
I would quibble with this, depending on how we define "seized". My
understanding is that your coins cannot be transferred unless the transaction
is signed by your private key. So, authorities could seize the computer that
has the private key on it, or, as you say, use violence against a known
individual, but they have no way in-network to take your wallet. Compare this
with the central banking system where governments can and do force banks to
freeze or hand over their customers' assets.

~~~
nugget
The NSA was able to infect air gapped Iranian computers 100 ft underground
that only a handful of individuals had access to. I doubt any hot wallets are
really out of Government reach given enough time and attention. A cold wallet
with offline multi sig - more likely.

------
danield9tqh
> Even if demand for the dollar plummeted, the Fed could in principle keep
> burning money until a dollar is scarce enough to be worth the “right” amount

This seems like the crux of the argument of the difference between the dollar
and Bitcoin in the author's view. To me though this statement doesn't make
sense and is very misleading, and someone please correct me if I'm wrong. The
Fed CANNOT just keep burning dollars because they don't have all the dollars.
Individuals hold those dollars. Yes, if individuals just started burning their
dollars the value of the dollar would adjust to the "right" amount, but who in
their right mind would burn their money for the greater good? In light of
this, the Fed doesn't at all seem like a "check" on inflation or deflation.
The dollar is still subject to the same supply and demand properties of
Bitcoin.

~~~
osrec
"Burning dollars" can be done in other ways. For example, the powers that be
can issue less debt going forward, which would shrink the money supply.

~~~
danield9tqh
This makes sense to me, that's something I hadn't thought of so thanks for
sharing.

But I still don't see how it differentiates BTC from USD. Because issuing any
debt in the first place would inflate the value. So then when you stop issuing
debt, the value would get deflated to what it would have been originally. I
think this is how the Fed tries to control deflation as well. They print more
money, not to distribute it but just so that they can hold it and burn it when
they need to control inflation. Either way, both of these scenarios seems like
a wash to me. You're just making money so that you can destroy it later.

The only argument I can see here is the idea of having 'wiggle room' within
the money supply. In essence a way to control the irrational volatility of the
market. If everyone is screaming sell sell sell!, the Fed has a limited amount
of room to destroy some money and calm people down before panic takes over.
BTC doesn't have that. But even this seems to me like a much weaker 'check'
than the author suggests.

~~~
UncleEntity
Most of the money in existence doesn't actually exist, it is an illusion
created through fractional reserve banking.

If the Fed wants to inflate the currency they print more and 'give' it to
banks who create even more on top of this and if they want to deflate the
currency they can simply change the minimum reserve value so less money is
created out of thin air by the banks. Totally oversimplifying here but that's
the general idea.

Anything short of 100% reserve banking and you have illusionary money in
existence that gets spent just as well as a paper bill but with no actual
paper bill backing it.

