Bitcoins, gold and pyrite

Bitcoins and gold may have some speculative value but as a solution to economic problems or as a form of money they are on a par with pyrite

As I understand bitcoins their main feature is that the supply of them is intended to be finite.  This will make them great for speculators but as a form of money they come with the same problem as gold and that is that the amount of money in an economy needs to be flexible.  Through history there have been a number of situations where authorities have tried to limit the money, sometimes by trying to force a gold standard, and the result has been serious depression.  I wonder if bitcoins were invented in part because gold is in limited supply.

circleBitcoinProbably the increasing interest in  bitcoins is a psychological reaction to economic uncertainty and fears of hyperinflation which would wipe out the savings and pensions of a lot of people.  Given that the economic crisis is based on problems in the resource base gold and bitcoins may not be useful.  A better hedge would be a market garden.

Another feature of bitcoins is that they can be used online anonymously .  This makes them great for illegal transactions.   No wonder some regulators are saying bitcoins should come under their jurisdiction.

So far as I can see the main use of bitcoins is for speculation.

The gold standard, money and stability

Thanks to a Republican senator and the dynamics of that party we are hearing calls for a return to the monetary gold standard.

I see this as a reaction to economic events most people don’t understand and the fact even fewer understand how money works in the economy.  We look for explanations which relieve ourselves of responsiblity.  Therefore the economic crisis is the fault of former president Nixon who took the United States off the gold standard in August 1971.

In these uncertain economic times we are looking for stability and what can be more stable and solid than gold.   Never mind that since 1971 there have been major fluctuations in the price of gold and there were economic problems before then.  Going back onto the gold standard in search of stability would probably introduce even more instability into the economy.

We start this analysis with the formula

MV=PQ
where:

M= the money supply
V= the velcoity at which money changes hands
P= the price level
Q= the total of goods and services produced in the economy.

Some people doubt the validity of this formula but to me it appears to have a lot of logic and common sense.  It is an important tool for understanding the the financial world connects with the physical economy.   The important thing is that if any one item goes up or down then something else also has to change.

Probably most of the people who want a return to the gold standard are concerned about inflation which treatens to wipe out their savings.

If we were to go back onto the gold standard that would in effect be trying to hold M steady.

Thus if the Q were to go up or down then either the V or the P would have to go up or down.  It it would most likely be the P then we would have inflation or deflation when what we really want is price stability.  Going back to the gold standard would probably increase instability.

But the gold standard people are right to focus on changes in the M in the equation.  The thing is that for there to be price stability the M has to be easily variable and that takes us to my favorite topic – how we create money.

Let’s not go into that now.  Let’s just say that the way we create money is a Ponzi scheme which works only when there is economic growth, an increasing M, and that my essay “LETS go to market: dealing with the economic crisis” proposes another way of creating money which would be easily variable.

 

If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

Milton Friedman and Money Mischief

I have just finished reading Money Mischief, Episodes in monetary history by Milton Friedman published about 20 years ago.

Friedman is remembered for his interest in the economics of money and banking. However, I have two concerns about omissions from this book.  The first is that he places too little emphasis on the T or Q in the quantity theory formula and the second is that he has missed the significance of interest in the creation of money.

Any discussion of money in economics has to include the formula MV=PT because this shows how the real and financial sides of the economy are connected.  This formula states that the stock of money times the velocity with which it changes hands is equal to a price index times the total of transactions or the quantity of goods and services exchanged.

Friedman uses this formula to support a claim that inflation is purely a monetary thing.  Prices go up when there is too much money in the economy and governments control the total amount of money.

My concern is that he does not appear to recognize the potential of T (or Q) to disrupt the economy.

In the chapter on money he suggests T could go down because workers are “paying less attention to their work and more to the stock ticker.”  A few pages later he states: “What happens to output depends on real factors: the enterprise, ingenuity and industry of the people; the extent of thrift; the structure of industry and government; the relations among nations; and so on.”

He may be excused on the grounds that throughout recorded economic history downward changes in T have not been an obvious problem.

However, there is some evidence that the resource base is now being depleted, or at least the most easily extractable, of the resources are gone.  This is certainly going to impact on the T in the formula.  Other things which could impact the formula are climate change, natural disasters or disease epidemics.

MY second concern relates to the role of interest in the creation of money.  Friedman didn’t see this and I have not come across any other economist who has recognized it.

During the 20th century there was a change in the nature of money from that based on a commodity (gold or silver) to money based on fractional reserves and credit.  (For a more detailed discussion of fractional reserve money and its problems, please see my essay “LETS go to market.”)

So long as money was based on gold the total supply was limited by the amount of gold and could be increased only as more gold was dug out of the ground.  If you look at the formula it is easily seen that this could cause problems in a growing economy.

With the switch to fractional reserve money the problem became reversed.  Now there is the potential for too much money to be available.

One of the differences between commodity money and fractional reserve money is that with the latter as new money is created the creators (the banks) demand that interest be paid on that new money.  I see this as a  built n force requiring that even more money be created to pay interest.  I see this as a sort of Ponzi scheme which from time to time collapses into a financial crisis.

Friedman provides a different take on why the money supply is increasing.  “Whatever may have been true for money linked to silver and gold, with today’s paper money it is governments and governments alone that can produce excessive monetary growth, and hence inflation.”

I have to take issue with him.  Fractional reserve money is not paper. It is entries in the computers of the banks.  Governments are involved in its creation when their bonds are purchased by central banks.  It might be good for governments to stop issuing bonds but I am not sure it is fair to blame them for inflation.

However we create money, the formula makes it clear that if the goal is price stability the money supply or its velocity must be easily variable.

International banking and money as a commodity

The Economist this week has an article about international banks and the problems of their retreating to their home markets.

The big problem here is that we treat money as a commodity when it really should be an intangible token which represents the goods and services produced by an economy.

Money represents purchasing power and gives its holder command over goods and the services of people.  International financial transactions should then represent and match exchanges of goods and services between different countries.

Historically we have mostly used gold, a commodity with limited usefulness, as the token.

By treating money as a commodity we have given it a value of its own and made transactions that do not match the exchange of goods and services.  This has made the financial system complicated, convoluted and chaotic.  It is no wonder there are lots of problems.

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