Saturday, June 15, 2019

Good Money, Bad Money -- And How Bitcoin Fits In

Let us start with talking about bad money, by which I mean the US dollar, the euro, the Japanese yen, the Chinese renminbi, the British pound, the Swiss franc, and basically all official currencies.

They all represent fiat money. The term fiat is derived from the Latin word fiat and means “so be it.” Fiat money is “coercive money,” or “money forced upon the people.”

There are three major characteristics of fiat money:

  1. The state (or its agent, the central bank) has a monopoly on money production.
  2. Fiat money is produced through bank credit expansion; it is literally created out of thin air.
  3. Fiat money is intrinsically valueless. It is just brightly colored paper and intangible bits and bytes that can be produced at any time and in any amount deemed politically expedient.

Just in passing, I would like to let you know that fiat money has not come into this world naturally. States have worked long and hard to replace commodity money in the form of gold and silver with their own fiat money.

The final blow to commodity money came on August 15, 1971: US President Richard Nixon announced that the US dollar would no longer be convertible into gold. This very decision (which I like to call the greatest monetary expropriation in modern history) effectively put the world on a fiat money regime.

Against this backdrop, it may not come as a surprise that fiat money suffers from economic and ethical deficiencies.

First, fiat money is inflationary. Its buying power dwindles over time, and history has shown that this entropy is almost as irreversible as gravity.

Second, fiat money enriches a chosen few at the expense of many others. The first receivers to get a hold of the new money benefit to the detriment of latecomers.

As the state expands and sprouts like weeds in an untended garden, fiat money strangles—even destroys—individual freedom and liberty.

Third, fiat money fosters speculative bubbles and capital misallocations that culminate in crises. This is why economies boom and bust.

Fourth, fiat money lures states, banks, consumers, and firms into the pitfall trap of excessive debt. Sooner or later, borrowers find themselves in a deep hole with no way out.

Fifth, fiat money feeds big government. And as the state expands and sprouts like weeds in an untended garden, this outgrowth strangles—even destroys—individual freedom and liberty.

I have spoken enough about bad money. Let us talk about good money.

What is good money? To answer this question, we just have to think about how a free market in money works.

Here, people are free to decide which kind of money they would like to use, and they also have the freedom to cater to the needs of fellow people seeking good money. Money has emerged from a commodity and spontaneously from the free the market: no state or no central bank was needed in the process.

The outcome of a free market in money will be good money simply because people will demand, out of self-interest, good money—not bad money. This is actually what sound monetary theory would tell us. Money has emerged from a commodity and spontaneously from the free the market: no state or no central bank was needed in the process.

To qualify as good money, the “thing” or good in question must have specific properties. It must be scarce, homogeneous, divisible, durable, transportable, mintable, etc. Gold and silver meet these requirements par excellence, and this is why they were chosen as the universally accepted means of payment whenever people were free to choose.

How does Bitcoin fit in?

I would argue that from a monetary theory point of view, Bitcoin qualifies as a good money candidate. It has emerged from the free market through the voluntary actions of all participants involved, respecting individual freedom and private property rights.

I would also argue that Bitcoin complies with the regression theorem and thus provides the crypto unit with a necessary requirement to potentially become money. The key question, therefore, is whether Bitcoin will stand a chance in challenging and outcompeting official fiat currencies or gold money. Let us think about this in further detail.

One exciting feature of Bitcoin is that its quantity is limited to 21 million units. This hard cap means that at some point, the quantity of Bitcoin will not grow any further. If the quantity of money is constant and the economy expands, prices for goods and services will fall.

Would that be a problem for money users or the economy? No, it would not. Firms can still be successful if prices decline. Their profits result from the spread between revenues and costs. If goods prices fall (in nominal terms), firms just have to make sure that revenues keep exceeding costs.

Consumers would be pleased to see the prices of goods fall. Their money becomes more valuable. They can reduce their cash balances and increase spending.

But wait: would consumers not refrain from buying goods if and when prices can be expected to fall over time? Imagine a car costs $50,000 today and only $40,000 in a year. If I need the car right now (because my old one has broken down), I would have to buy a new one right away, I would not and could not wait.

The general answer is this: People make their decision to buy now or later based on discounted marginal utility. The marginal utility of buying the car for $50,000 ranks lower on people’s value scale than paying only $40,000. But the car available forThere is no reason to fear that the economy will come to a standstill if and when the prices of goods decline over time.

$40,000 is not for sale now but in a year. When it comes to decision-making, people will, therefore, discount the marginal utility of purchasing the good for $40,000 in a year using their individual time preference rate.

They will then compare the result with the marginal utility of buying the good now for $50,000. If the discounted marginal utility of buying the car for $40,000 in a year is lower than the marginal utility of buying at $50,000 now, people buy now. If it is higher, they will postpone their purchase.

The important point is: There is no reason to fear that the economy will come to a standstill if and when the prices of goods decline over time. Money that has a limited quantity, such as Bitcoin, would work just fine!

Let me stress something fundamentally important here: The quantity of money in an economy does not have to grow to make increases in production and employment possible. The sole function of money is exchange, and so a rise in its quantity does not make an economy richer; it does not bring about any social benefit.

All an increase in the quantity of money does is lower the purchasing power of one money unit compared to a situation in which the quantity of money has not been increased.

We just heard that in a Bitcoin money regime, we would have to expect price deflation. What would that do to the credit market? As the prices of goods fall, holding money becomes more profitable.

If, for instance, prices fall by three percent per year, the purchasing power of money increases by three percent. In this case, I would not exchange my money for a T-Bill that yields only, say, two percent per year.

In an economy where there is a constant quantity of money, the credit market will remain relatively small. 

To make me part with my money, a borrower would have to offer me a return on the investment that is higher than the increase in the purchasing power of money. Borrowers would be careful taking up debt because they know that in times of stress, they will not be bailed out by an inflationary monetary policy.

Therefore, it is likely that in an economy where there is a constant quantity of money, the credit market will remain relatively small—especially compared to the debt pyramid that comes with today’s fiat money regime.

At the same time, firms retaining earnings and issuing equity for funding would be much more commonplace. People would invest their life savings in company stock rather than debt (be it issued by banks, governments, or corporations).

What about the market interest rate in a world in which price deflation occurs? We know that in a free market, the nominal interest rate cannot drop below zero. This is easy to understand: if I lend $100 to you for one year at, say, minus 5 percent per annum, you would have to return $95 in one year.

Of course, any lender (who is not out of his mind) would politely reject this kind of deal. They would be better off just holding on to cash and would not lend at a negative interest rate. I cannot go into detail here but will simply say that in a free money market, the market clearing interest rate is determined by people’s time preference. Time preference is always and everywhere positive, and so is its manifestation, the originary interest rate. In other words: the interest rate would not and cannot fall to zero, let alone into negative territory.

So far, I have argued that the limited quantity of Bitcoin does not stand in the way of the crypto unit becoming money. However, some aspects appear to be disadvantageous for Bitcoin's aspirations to become money.

From the current state of technical capabilities, distributed ledger technology is unlikely to be put to widespread use in retail and large value payments. Currently, there are around 360.000 Bitcoin transactions per day, and given its current configuration, the Bitcoin network is presumably running at full capacity. This is not enough. For instance, in Germany alone there is an average of around 75 million transactions per business day!

Where to store your private cryptographic keys?  Offline, secure, and immune to electromagnetic fields.

What is more, Bitcoin transaction costs vary widely. For instance, in July 2016, it cost around $.08 for a transaction mined on the block (data recorded in files) in the next 10 minutes. In December 2017, it cost more than $37. Currently, the price is around $4. High and volatile transaction costs might discourage the use of Bitcoin from the viewpoint of many people and institutions.

Another aspect is finality. Financial transactions require a point in time from which they can be taken as valid. However, not all DLT (distributed ledger transaction) consensus mechanisms offer this. The “proof of work” protocol, for instance, merely provides a probabilistic finality (due to the creation of forks).

What about safety? Progress has been made in Bitcoin safekeeping (think of, for instance, cold storage wallets). However, vulnerabilities remain, as scams and thefts at even the largest and most sophisticated crypto exchanges prove.

A central issue in this context is where to store your private cryptographic keys. They need to be stored offline (so they cannot be hacked), and the place of storage must the secured (to prevent theft) and immune to electromagnetic fields (otherwise the stored codes could be destroyed).

For professional investors, this is a challenge. They might need a bunker storage solution, but this could turn out to be quite inconvenient. How does one get access to private keys quickly and at low costs?

Bitcoin was developed for peer-to-peer (P2P) exchange without any intermediation. But would people really want a monetary and financial system without any middleman? For some payments, you may not need intermediation (e.g. to buy a book).

For others, you may wish to involve an intermediary. Imagine you mistakenly send 100 Bitcoins instead of just one. How would you get it back? Who is going to help you out in a P2P world without any intermediation? The answer is nobody, and nobody would help you if your wallet got hacked.

To support economic progress and a sophisticated monetary sphere, a currency must be compatible with some form of financial intermediation.

What about more sophisticated financial transactions like borrowing and lending? It is hard to imagine that this can be done in an anonymous and trustless regime as envisaged by the Bitcoin protocol. Interestingly enough, many Bitcoin owners seem to keep their coins on crypto exchanges, which control the private keys of the Bitcoins. Obviously, people trust some intermediaries in the Bitcoin space, actively demanding the services supplied by these “middlemen.”

This observation points us toward a rather important but unfortunately often neglected issue: To support economic progress and a sophisticated monetary sphere, a currency must be compatible with some form of financial intermediation. Otherwise, it will be difficult to compete effectively with existing fiat currencies, which offer money users many convenient intermediary services.

How would an intermediation structure look in a free market of money? For the sake of illustration, let us review the workings of a digitalized gold money system.

Let us say Mr. Miller owns one ounce of gold (31,1034 … grams). It is recorded on the asset side of his private balance sheet.

For greater convenience, he deposits 10 grams of gold with a money warehouse, which offers security, storage, and settlement services.

The 10 grams of gold are credited on Mr. Miller’s account with the money warehouse, and the accounting unit is gold gram.

In return, Mr. Miller gets a digital gold gram certificate (which may be called a money certificate) documenting that he owns 10 grams of gold deposited with the money warehouse.

In a free market of money, you would not only have money warehouses but also institutions specialized in credit, hedging, pooling risks, insurance, etc.

The digital gold gram certificate serves as a means of payment, and it can be redeemed into gold at any time at par with the money warehouse.

Now there is a steel company that wants to raise money by issuing a bond. Mr. Miller wishes to earn some return, so he decides to exchange his digital gold gram certificate against the bond. In Mr. Miller's balance sheet, the digital money certificate is replaced by the bond. The steel company records the digital gold gram certificate as an asset on the left side of its balance sheet and a liability on the right side of its balance sheet. Now the steel company can spend the money on input factors, salaries, rents, etc.

In addition to this “direct credit transaction,” a digitalized gold money also facilitates all sorts of “indirect credit transactions,” as well as all kinds of transactions in stock and bond markets, derivative and commodity markets, M&A markets, and so on.

In fact, in a free market of money, you would not only have money warehouses (offering safekeeping and settlement services for money proper) but also institutions specialized in credit, hedging, pooling risks, insurance, etc.

Of course, we could imagine Bitcoin, rather than gold, being "base money," and digital Bitcoin certificates, rather than digital gold certificates, being used as a means of payment. Either way, intermediation would work just fine, and unhampered competition would effectively prevent the practice of money warehouses operating on fractional reserves.

However, with the need for an intermediation structure, it is hard to see how the monetary system—whether Bitcoin or gold serves as “base money”—could escape the repression of the state. Under intermediation, it is no longer possible to have transfers of any kind confined to the purely virtual realm; States might no longer be in a position to stamp out cryptocurrencies, but they will increase the hurdles preventing money candidates.

transfers would have a point of reference in the real world where the state has become overwhelmingly powerful.

While states might no longer be in a position to stamp out cryptocurrencies, they can and actually will do everything in their power to increase the hurdles preventing money candidates—be they cryptocurrencies or precious metals—from replacing fiat currencies.

For instance, states impose VAT and capital gains taxes and restrictive regulations on potential money candidates, and they bestow the privilege of legal tender status on their own fiat currency. All of these are hostile to the idea of good money.

The emergence of cryptocurrencies has given great impetus to the search for better money. As paradoxical as it sounds, it is the state that is one of the greatest allies of Bitcoin in particular or any other crypto unit in general. If there were no state (as we know it today), we would undoubtedly have a free money market. People would be free to decide what money they would choose. No one would have to hide. In a genuinely free market of money, it would be far from a done deal that Bitcoin would outcompete digitalized gold money.

The world is as it is, however, so I would like to conclude by saying that technological progress is just one aspect of making the emergence of good money possible. The other aspect is to inform the public at large that fiat money is bad money, that good money is possible, and that it is advantageous for them, and that all it takes is a free market in money unimpeded by the state.

Technology alone might not do the trick of putting an end to the tyranny of fiat monies—it also requires people to actively invoke their right to self-determination in monetary affairs.


This talk was given at the Value of Bitcoin Conference in Munich, 3 June 2019.

Deutsche Bundesbank (2017), Distributed-Ledger-Technologien im Zahlungsverkehr und in der Wertpapierabwicklung: Potenziale und Risiken, Monthly Report, September, pp. 35 – 50.

Harwick, C. (2016), Cryptocurrency and the Problem of Intermediation, The Independent Review, v. 20, n. 4, Spring, pp. 569 – 588.

Herbener, J. ed. (2011), The Pure Time Preference Theory of Interest. Auburn, Ala.: Ludwig von Mises Institute.

Hülsmann, J. G. (2008), The Ethics of Money Production, Auburn, Ala.: Ludwig von Mises Institute.

Mises, L. v. (1998), Human Action: A Treatise on Economics. The Scholar’s Edition. Auburn, Ala.: Ludwig von Mises Institute.

Mises, L. v. (1953), Theory of Money and Credit. New Haven, Yale University Press.

Polleit, T. (2017), Die Blockchain-Disruption: Geld, Bitcoin und Digitalisiertes Goldgeld, Ludwig von Mises Institut Deutschland, 20 December.

Polleit, T. (2014), Geldreform: Vom schlechten Staatsgeld zum guten Marktgeld, FinanzbuchVerlag, München.

Reik, T. (2019), Bitcoin Revisited, Sprott Insights, 29 May.

Rothbard, M. N. (2009), Man, Economy, and State. The Scholar’s Edition. Auburn, Ala.: Ludwig von Mises Institute, Auburn, US Alabama.

Rothbard, M. N. (2008), The Mystery of Banking, 2nd Edition, Ludwig von Mises Institute, Auburn, US Ala-bama.

Thorsten Polleit
Thorsten Polleit

Thorsten Polleit, Chief Economist of Degussa, Honorary Professor at the University of Bayreuth, and Partner of Polleit & Riechert Investment Management.

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Tuesday, May 28, 2019

Why Principles Matter

Paraphrasing the English journalist and philosopher G. K. Chesterton, New Testament scholar N.T. Wright wrote:

The purpose of an open mind… is like the purpose of an open mouth: that it might be shut again on something solid. Yes, we must be free to ask questions. But when we hear a good answer we must be prepared to recognize it as such, and not be so keen on keeping all the questions open that we shy away from an answer because we so like having an open mind. That is the way to intellectual, as well as spiritual, starvation.

So much for the Cult of the Open Mind, which in its purest essence is nothing more than the admission that one has lived a life without learning a thing or arriving at a conclusion.

In one form or another, I hear people suggest that an “open mind” is somehow superior to possessing an opinion or embracing a principle. The only times that’s true, in my view, are when an opinion or a principle is knee-jerk, poorly considered, illogical, untrue, or unfounded.

Does the sun come up in the east or in the west? It’s not a sign of wisdom to claim your mind is open on the matter and then wait around to see what happens each morning.

Opinions and principles are connected, or at least they ought to be. Principles are foundational, and opinions are based at least in part upon them. So think of principles as first, opinions second. Principles are rule sets, guidelines, fundamental truths. They include axioms, morals, ideals, laws of nature and human behavior, and even the bedrock physical principles of the universe. You have an opinion on something because somewhere along the way you’ve adopted, consciously or subconsciously, a principle or two. Another word for principle is conviction.

This doesn’t mean that one’s principles must necessarily never change. When truth or new evidence (not simply the prevailing winds) suggest it strongly enough, we should change them. In that sense, I suppose, our minds should always be “open,” but that’s no reason to sit on the fence in the meantime.

To date, our senses and the information they gather inform us convincingly that vegetables are good for our health. We act—and consume—accordingly. No one in his right mind would say that he’s so open to the contrary view that vegetables might someday be found to be bad for us that he’s not going to take a chance and eat some now. So we embrace the principle that vegetables are good so far as we presently know. We eat them and then form opinions as to which ones are more pleasing to our palates.

“If you don’t believe in something, you’ll fall for anything.”

The above examples come from the physical sciences, where evidence and proof seem to be, at least for the moment, objective and indisputable. It’s in the social sciences that things get fuzzier and more subjective. But even there, a thinking person seeks principles to lead him logically to opinions as well as conclusions.

Though some might view principles negatively as a sign of rigidity, ideology, or closed-mindedness, that’s often just a way of dismissing another person’s principles while holding fast to our own. Most people instinctively admire someone who seems to believe in something!

The comedian Groucho Marx once facetiously declared, “Those are my principles. If you don’t like them (pause), I have others!” We may chuckle at that, but we don’t admire it. It’s just a funny way of saying, “I really don’t have any principles,” or “I’ll have whatever principles you want me to have, and I’ll dump them the moment somebody else wants me to have different ones.”

I don’t know who first said it, but whoever it was should get a medal for observing that “If you don’t believe in something, you’ll fall for anything.”

Many people are cynical about politics because it’s the graveyard of principles. Rick Becker, a friend and member of the North Dakota House of Representatives, is one of the rare politicians who says what he means, means what he says, and votes that way. On my podcast, I recently asked him what it is about politics that sabotages men and women of principle.

If you dodge and weave so you can claim to have an “open mind,” you’ve simply demonstrated how empty your mind really is.

I expected Rick to cite a litany of temptations the political process dangles in front of good but unsuspecting people. Instead, he offered a more penetrating insight: “Politics brings out what’s already in you.” In other words, in the pressure cooker of politics, the principles you thought somebody had turned out to be little more than temporary conveniences that were easily replaceable by a stronger desire to be popular, rich, or re-elected.

To be principled is more than just uttering platitudes or high-sounding maxims. To be principled means you put your actions where your mouth is. It’s a sign of good character. To be unprincipled should never be a compliment. If you dodge and weave to avoid principles so you can claim to have an “open mind,” you’ve simply demonstrated how empty your mind really is. And perhaps your soul, as well.

I believe that being a principled person is so important that it’s one of the two or three things I would most want to be remembered for someday. Long after anybody remembers the houses you've lived in, the jobs you've held, or even the names of your children, it would be over-the-moon if they could proclaim, “Now there was a principled man. He identified what he thought was right and true, connected the dots, and lived his life accordingly.”

I’d like to suggest here a useful exercise in self-examination. Put some time aside to write down some principles you earnestly believe in. Of course, if you worship at the Altar of the Open Mind, you can write them in the palm of one hand and still have room to spare. But if you’re honest, and if you’ve learned anything in your years, you’ll be amazed at how many tablets you can fill. Look carefully at the list to see if you’ve got some glaring contradictions, and if you do, resolve them. Think about what risks you might be willing to take or the losses you might be willing to endure to stick to each principle.

For example, one of my principles is “Humans should be free so long as each does no harm to another.” That’s one I think I’d risk everything for. Another principle I believe in is “Because my yard is a public reflection of my care for property, I want it to always look good. But I’m not going to bankrupt myself keeping it watered if I live in Death Valley.”

(FYI, here are a few more principles to consider.)

Socrates supposedly advised, “Know thyself.” I can’t think of a better way to do that than this very exercise.

Keep your list where you can pull it out and give it some attention from time to time. Judge how well your actions comport with what you listed. Share some or all of your list with your children; they will know and appreciate and remember you so much more for it.

Stanley Baldwin, one of Britain’s more forgettable prime ministers, once declared, “I would rather be an opportunist and float than go to the bottom with my principles around my neck.” We still aren’t sure what his principles were, which is a big reason he remains forgettable.

Open your mind to the importance of principle. It just may be what the world remembers you for.

Lawrence W. Reed
Lawrence W. Reed

Lawrence W. Reed is President Emeritus and Humphreys Family Senior Fellow at the Foundation for Economic Education and author of Real Heroes: Incredible True Stories of Courage, Character, and Conviction and Excuse Me, Professor: Challenging the Myths of Progressivism. Follow on Twitter and Like on Facebook.

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Wednesday, May 15, 2019

The US Is 5 Years Away from a National Debt Death Spiral. Here's Why.

According to the U.S. Treasury Department’s Office of Debt Management, the U.S. government is just five years away from the point where every new dollar it borrows from the public will go toward funding interest payments on the national debt.

That is the main takeaway from the Debt Management Office’s Fiscal Year 2019 Q1 Report, which featured the Office of Management and Budget’s latest projection of the U.S. government’s borrowing from the public, shown in the chart below:

FY2019Q1 OMB's Projection of Borrowing from the Public

ZeroHedge explains the significance of what the chart shows as the Primary Deficit, indicated as the blue portion of the bars in the chart, swings from positive to negative beginning in 2024:

As part of today’s Treasury Presentation to the Treasury Borrowing Advisory Committee, there is a chart showing the Office Of Debt Management’s forecast for annual US debt issuance, broken down between its three component uses of funds: Primary Deficit, Net Interest Expense, and “Other.”

That chart is troubling because while in 2019 and 2020 surging US interest expense is roughly matched by the other deficit components in the US budget, these gradually taper off by 2024, and in fact in 2025 become a source of budget surplus (we won’t be holding our breath). But what is the real red flag is that starting in 2024, when the primary deficit drops to zero according to the latest projections, all US debt issuance will be used to fund the US net interest expense, which depending on the prevailing interest rate between now and then will be anywhere between $700 billion and $1.2 trillion or more.

In short: in the stylized cycle of the US “Minsky Moment”, the US will enter the penultimate, Ponzi Finance, phase – the one in which all the new debt issuance is used to fund only interest on the debt – some time around in 2024.

Net interest on the national debt has become one of the fastest growing segments of federal spending. When the national debt reaches the point where all newly borrowed dollars must be used to pay this mandatory expenditure, the U.S. government will have passed the event horizon that marks the boundary of the national debt death spiral.

Cities and territories in the United States that have crossed that crisis point have either gone through bankruptcy proceedings or their equivalent, or they have implemented major fiscal reforms that reversed their fiscal deterioration, wherein the best-case scenarios, they acted to restrain the growth of their previously out-of-control spending to restore their fiscal health.

There’s an old saying that applies for the U.S. government’s looming fiscal situation: “If something cannot go on forever, it will stop.” It’s only ever a question of how painful it will be when it does.

This article is republished with permission from the Independent Institute. 

Craig Eyermann
Craig Eyermann

Craig Eyermann is a Research Fellow at the Independent Institute.

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