2. We are used to money being created by the state.
Or rather, we are used to money being created
by banks on behalf of the state. The state has
no direct control over the quantity of money
created by the private sector on its behalf,
though it does influence that quantity through
monetary policy and, in these days of near-zero
interest rates, fiscal policy. But it does
guarantee it. Or rather, it used to.
3. Money created by the private sector on behalf of the
state always ends up in a bank, and once it is there it
is indistinguishable from money actually created by
the state (bank reserves and physical currency).
Private sector money and state money are “fungible”,
or as Izabella Kaminska puts it, “entangled“. Trying to
disentangle them is like unscrambling an omelet. So
we don’t try to. We simply accept that all of it is
equally valuable. Anything called a “dollar” and
sporting the symbol $ is fully backed by the US
government, however it was created – even actual
counterfeits if they escape detection.
4. But the implied cost to the state of guaranteeing the
value of all the money created by private sector
lending activity is enormous,as we discovered
when Lehman fell. So governments have been
attempting to limit that guarantee – for example
by capping the amount of private sector money
that can be converted to safe government money
(that’s what the depositor haircuts in Cyprus did),
or limiting the types of institution whose moneycreating they will guarantee. The trouble is that
far from making the system stronger and safer,
it’s actually making it riskier.
5. Since private-sector-created money is
indistinguishable from state-created money once it
gets into a bank, limiting the state guarantee makes
state-created money less safe. Saying “I’ll
guarantee this but I won’t guarantee that” when
“this” and “that” can’t be clearly distinguished
means that “this” can’t be trusted because it might
actually be “that”. It’s not unlike the UK’s ridiculous
legislation banning “dangerous dogs”, which relies
on identifying certain breeds of dog by means of
their physical characteristics.
6. This has resulted in the rescue centres being full of
Staffordshire bull terriers, which are not classified as
“dangerous” but look very much like the banned
American pit bull terriers. Trust in safe dogs has been
diminished because they look like dangerous ones.
So it is when the state removes the guarantee from
some forms of money: trust is diminished in other
forms that are still guaranteed.
7. This is where Bitcoin comes in. As state-guaranteed
money becomes less safe, the private sector is
trying to create alternatives. Bitcoin is gaining
credibility as a future currency because the state
is perceived as reneging on its implied pledge to
guarantee the safety of money. Zero interest rate
policy and QE, particularly, are seen as “theft”:
people blame the state, not the banks, for
negative returns because they believe the state
sets the price of money. If the state can’t be
trusted to honor its pledges, it is no surprise that
people look for alternatives outside the state
currency system.
8. Currencies have three functions: store of value, medium
of exchange and accounting unit. At the moment,
Bitcoin is principally a store of value. I disagree with
those who think that Bitcoin cannot be a store of value
because it has nothing physical backing it. Anything
that is intrinsically scarce and doesn’t decay can be a
store of value. Bitcoin, consisting as it does of digital
information with a hard limit on the number of units that
can be created, certainly meets these criteria. The
deliberate scarcity of Bitcoin makes it good for people
who want to invest in it as a store of value, because
(bubbles aside) it will appreciate over time, so they will
get richer simply by hanging on to it.
9. But it makes it much less satisfactory as a medium of
exchange. When money is deliberately kept scarce in
order to preserve the value of money savings over time,
the general price level in the economy tends to fall, which
is deflation.
For the economy to grow, people have to spend, which is
more likely if they expect prices to rise in the future –
obviously we don’t want them rising too much, but a little
bit of inflation does keep the economy moving. A safe
asset which gradually appreciates, so makes a good longterm investment, is not a good medium of exchange. The
design of Bitcoin therefore makes it more suitable as an
investment rather than a medium of exchange.
