On Bitcoin, Gold and Monetary Policy

This negative article on bitcoin indirectly brought together a few disparate thoughts for me. The article's position/bias is clear - the digital currency, which has grown significantly vs. the dollar  is a speculatively bubble:

(source)

What is even more interesting, however, is the set of comments which mostly defend bitcoin. These online comments, to me, show exactly the misconceptions which drives bitcoin, gold and many arguments about US monetary policy. Let us begin!

1) Misconception: Bitcoin is a valid and perhaps best currency because it is not manipulated, transparent and free from government control.

It is true that there is no government control and transactions are automatically tracked. What about manipulation? There may be no group trying to set a price, but the alternative is a currency that changes by 100%+ in a year. Is that what currencies are? A reminder: typical characteristics of a currency include 1) medium of exchange 2) unit of account and 3) store of value. The first two could arguable, but the store of value? While the currency has been gaining versus G10 currencies, its volatility could easily swing the other way by double digit % points.

Finally - no manipulation or adjustment also means no flexibility. There is a set formula that grows the supply until a specified limit in the future. Why that limit? If there are 100 dollars in circulation for 100 people now, and still 100 dollars for 500 people later, what will happen? Deflation. <- this, incidentally, makes a consistent price rise nearly rational, as deflation is literally designed into the system. As a result, speculation will override traditional usage (why sell goods via bitcoin when bitcoin will rise in value the next day?) Assuming more goods are sold/bought using bitcoin system, bitcoin value will rise - the result is what we see today, where most bitcoin usage is actually speculation vs. use in commerce.

This reflexive (ref: Soros) rally is self-reinforcing and may indeed reach new heights for sometime. However, bitcoin's ultimate usefulness is supposed to be its use as legitimate currency, which in my opinion will ironically be a smaller and smaller part of bitcoin usage as the currency rises. So, bitcoin gains in value are self-reinforcing in the short run but ultimately self-defeating in the long run (perhaps an apt definition of a bubble). If bitcoin mania continues and commercial usage lowers, there may very well come a point when the crowd discovers that they hold more money than there are goods possibly to buy it with.

2) Misconception: Gold is a great alternative to the US dollar as well because it is not manipulated and is a hard asset. Gold prices are indeed not at the whim of the Federal Reserve, but can be influenced by non-stable factors as well -after all, isn't the gold supply determined by how much gold is mined? Buffett noted that all the gold in the world could fit inside a baseball infield (when melted down to pure gold, etc.). If one miner such as Barrick Gold finds a large deposit that would add 5%, 10% to the supply (exaggeration), is that addition to the money supply warranted?

This actually happened in the 16th century Spain, where gold from the New World led to inflation. Yes, gold - like any other currency - can lead to inflation. The point is this - the usefulness of gold as a currency is of stability, not because you can see/touch it.

3)
Misconception: US dollar and most other currencies are fiat, not based
off anything tangible and are therefore prone to manipulation, excessive
printing by governments/politicians, and ultimately lead to 
fiscal/monetary instability.

The history of government printing can be bleak to review. Liaquat Ahamed's "Lords of Finance" shows how excessive money printing leads to inflation, using the real life example of the Weimar Republic after WWI.

The problem with "fiat" money (money that has no direct asset backing) is not that it is fiat, but that it is money. Any currency depends on the confidence of those using it - in this case, this confidence is based on the (taxing) power of the United States Government. Indeed, the US dollar is an implicit bet on the country's stability and well-being going forward. So the question is, do you have more faith in a gold bar or the United States?

As for monetary stability, the US money supply is indeed being manipulated. Is that always a bad thing? Are markets always self-correcting? One only has to look to pre-Fed panics (1907, others) to recognize that panics are an inherent part of the world economy. The question, as always, is the trade-off between intervention now vs. costs later. Both have consequences.


A discussion of current monetary policy may never be complete and may be as political as academic, but using the fiat currency system critique as a sledgehammer is far from correct.
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The upside to
this is that it continues to demonstrate that the market is far from
efficient. More specifically, the level of ignorant vitriol directed at
the Fed, the US dollar and economy means that the vanilla long equity
trade remains viable. I hope to not be ensnared by my own ignorance,
however, and will continually reevaluate the above.

From The Big Short/Tolstoy:

"The most difficult subjects can be explained to the slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of a doubt,what is laid before him." —Leo Tolstoy,1897 [ix]"