From time to time something odd happens to the gold price – it goes down. This is usually a shock to the advocates of anti-fiat money who’ve been squirreling away the shiny stuff against the inevitable day when nation states collapse. They get quite cross when they discover that the said nation states may in fact be flogging their gold at historically high prices and driving the price down. Apparently the thought that countries might resist collapsing hadn’t occurred to the gold bugs.
In the meantime we’re seen the rise of Bitcoin, one of a number of cryptocurrencies that offer freedom from central regulation. Bitcoin and its ilk isn’t backed by anything, which makes it more than ordinarily a punt on the perverse willingness of people to believe in ephemera. And that, of course, is simply another case of history repeating itself. Have we learned the lesson?
Sing For Your Gold
Fiat money requires regulation to ensure it can’t be minted by shady characters in back-rooms with a handy photocopier. Back in the good old days of the Gold Standard cash was backed by reserves of gold, which had the effect of limiting the money supply to how much of the stuff hairy Americans with gruff singing voices could physically dig up (perhaps I should point out that my entire knowledge of the Gold Rush comes from Paint Your Wagon – a film musical starring Lee Marvin and Clint Eastwood: two fine actors not generally known for their musicality). This had two effects – firstly it limited inflationary pressures because expanding the money supply was hard and secondly it limited economic expansion, for largely the same reason.
As the electoral franchise was extended to the middle classes in the developed world they demanded more growth and, eventually, governments gave up on gold supply restricted money and started printing the stuff in order to keep people happy and get re-elected. That’s had good and bad consequences – economic growth driven by technological innovation has been truly remarkable over the last century, but inflation has regularly destroyed the value of peoples’ savings – great if you’re earning, less so if you’re not.
In this post gold world fiat money is backed by the ability of governments to raise taxes – an innovation first introduced by the Dutch and then picked up by the English, who discovered that reliably repaying your debts instead of periodically defaulting had the effect of driving down the interest rates required. English military success over the 17th and 18th centuries was largely driven by the country’s ability to collect taxes and borrow at half the rates of its competitors: the Napoleonic wars were won more in the City of London than in the mud of Waterloo: see Going Dutch, the Benefits of Sound Money.
But there’s a large group of people who aren’t happy with this floating currency nonsense, and who aren’t at all comfortable with governments controlling cash. Neither are they happy with the idea that cash is being digitized and that electronic payments are traceable. They would like a currency that isn’t controlled by nations and that is essentially invisible to them. Of course, they should be careful what they wish for – Greece is a current test case in the theory as tax revenues on invisible earnings have undermined the economy to the point where it’s all but vanished in a puff of ouzo.
Enter Bitcoin – a peer-to-peer cryptocurrency invented by an anonymous programmer which isn’t backed by anything other than belief and which is probably unforgeable as long as a bare majority of the people using the stuff can be trusted. Bitcoin is built on a technology called blockchain, used to create a decentralized ledger where all Bitcoin transactions are linked in a chain of cryptographically protected records, with each successive transaction dependent on the records that went before. To fake a transaction you need to fake the successor ones, and as they're being continuously created this is as close to impossible as you can imagine.
The number of Bitcoins that can ever be minted is deliberately limited by the protocols developed, so in some ways it’s analogous to gold. It’s not an accident that the process for creating Bitcoins is called mining. No doubt there are digital alchemists out there attempting to turn mere base bits into golden Bitcoins as we speak.
Before we dismiss Bitcoin and its many cryptocurrency imitators as some kind of economic sideshow it’s worth considering what backs the value of its physical analogue. Gold has no intrinsic value – it can be used to create jewelry, and minute amounts are using in electronic circuitry, but you can’t eat it or build things with it and it doesn't provide an income. Normal cash has many properties. It’s a store of value, it’s a means of exchange and it’s fungible (see Dirty Money: There is Accounting for Taste). Gold is a rubbish currency on those grounds, as anyone who’s ever lugged a bag of the stuff around with them can testify.
Essentially the belief that gold has an intrinsic value is entirely psychological. If I believe that you’ll take my gold in exchange for goods and services then it works. If that belief fails I’m left with a mound of shiny, heavy and hard to transport disks – an issue we looked at in Salience is Golden. So apart from the physical attractiveness it’s not entirely clear what the difference is between gold and Bitcoin, other than that gold has a near three thousand year history of being treated as money, going back to King Croesus of the Lydians in what is now Western Turkey – and Bitcoin doesn’t.
Lost in Translation
In fact as a means of exchange Bitcoin probably isn’t scalable – the blockchain is an unwieldy tool in a retail payment system, where you need rapid confirmation that the recipient has received the funds – but that doesn’t mean that some variation of the principle won’t work. Cryptocurrencies are not about to fade away. But increasingly they are likely to be regulated.
The unregulated and essential anarchic nature of the Bitcoin universe was underlined when Mt. Gox, one of the major Bitcoin exchanges, went bust in 2013 because someone stole all its Bitcoins. It’s as if someone wandered into Fort Knox and walked out with all of its gold. And just as traceable.
Regulating Stable Doors?
Regulators have started to take notice of cryptocurrencies, which is probably a sure sign that they’re too late. But as cryptocurrency volumes grow they become an increasing threat to money supplies and, of course, to the ability of countries to track payments and raise revenues. As always in these cases the spectre of terrorists and paedophiles is waved around to justify government interference in private enterprise, but the truth is more prosaic – in a world dominated by states whose existence depends on taxation they will always seek to control the source and the flow of funds.
The Bank of England is now looking at the possibility of issuing cryptocurrency, implicitly acknowledging that the technology works in its One Bank Research Agenda:
While existing private digital currencies have economic flaws which make them volatile, the distributed ledger technology that their payment systems rely on may have considerable promise. This raises the question of whether central banks should themselves make use of such technology to issue digital currencies.
The acceptance that cryptocurrencies work is a double-edged sword – because as soon as they become economically significant then governments will seek to regulate. And while Bitcoin et al may be essentially anonymous that anonymity is limited in practice to the ability to move the currency into real-world, productive assets – so simply criminalizing anonymous use of the system will be enough to drive it underground where, presumably, only terrorists and paedophiles will want to make use of it: a self-fulfilling prophesy if there ever was one.
The Future of Money
Be clear, however esoteric Bitcoin may seem cryptocurrencies and their underlying technologies are not fads that are going to disappear. But the willingness of users to suspend disbelief in the face of its lack of underlying intrinsic value can be destroyed if governments take it upon themselves to make turning Bitcoin into physical assets nigh on impossible. And they can, just as Richard Nixon did in 1971 when he suspended the convertibility of dollars in gold and broke up the post-war Breton Woods agreement.
Money is only useful if it can be used to buy real things or assets that generate income. As yet many of those things are still in the physical dimension and regulators can control that exchange, and if cryptocurrency becomes economically significant they'll seek to do so. Ironically, that will probably be the stamp of approval Bitcoin and co need to achieve widespread acceptance. But, of course, if you truly believe the end of days is upon us you probably want to store gold under your bed, rather than Bitcoins; analogies (tenuous or otherwise) just won't buy you food and shotgun cartridges when you really need them.