The past two weeks have had me very very confused. Every Tuesday and Thursday I sit in FNCE 101 (intermediate macroeconomics) attempting to understand how interest rates affect the GDP, why taxes may not shift consumption, and why Bernanke says it’s great to run a current account deficit. The trouble is I’m a skeptic, and for the past couple of weeks I haven’t believed half of what I am being taught. What I haven’t been able to grasp so far is why GDP even matters, how it’s okay for the US to run what looks like a ponzi scheme, and why productivity seems to have such a contrived definition. Those last three points will be included in future posts as I begin this series of reflections on economics, and share my opinions as to what really matters. If you have at all felt confused about what macroeconomic mumbo jumbo means, I invite you to read along; and if you aren’t confused, I still hope you’ll read this article and then properly explain economics to me.
To begin, I want to talk about money because that is where the root of all my problems started. Everything is always priced in terms of dollars; it is the unit of economics. When we discuss the economists’ universal fetish (EUF), otherwise known as gross domestic product (GDP), we speak about it in terms of dollars, real or nominal. The fact that real and nominal are not the same, should key people off to the fact that something spooky is going on. GDP is meant to convey economic growth and is a measure of the production of goods and services. Goods and services are real tangible things that have utility i.e. they help increase people’s satisfaction. When we discuss them in the aggregate we use money because that is how we compare their values. The thing is money has no intrinsic value other than the fact that we use it as an intermediate. The term fiat currency is especially apt because dollars, pounds, yen, etc. are literally fiats, that is they are arbitrary commands coming from an authoritative body that said, “Thou must pay me thine taxes in dollars,” (complete anachronism). Since taxes had to be paid in fiat, and the government expected people to accept that fiat when it wanted goods and services, the currency became the new means of exchange.
As an aside, to all those who declare that money and currency are different because money (i.e. gold and silver) is a store of value while currency is not, enjoy paying for your tea parties and first edition Atlas Shrugged hardcovers with gold bullion. For the most part, gold and silver have historically been no different than greenbacks in that their only value was being pretty to look at and difficult to dig out of the ground. You couldn’t eat them or make anything particularly useful out of them (or at least create nothing more useful than could be made out of another material). In reality, they had very little utility, and so I would argue very little intrinsic value.
Going even further, I believe that the dollar is not a value itself, but an equals sign. What I mean by this is that a currency functions as a statement of equality which say for example $1 equals 4 gum balls equals 6 large eggs equals 2.04 seconds of Amy Gutmann’s “labor” (in 2015 dollars assuming a 2000 hour workweek). When we speak about a GDP we are discussing all of the goods and services that are produced in a country in a year. That is, we mean all of the stuff that we do for each other, or give to each other in a year. We can call it $18 trillion or 42 quadrillion AmitCoins©, but the point of the number is to say that I made more stuff than you did, or I made more stuff this year than I did last year. The issue with this is that it is loosely a measure of how much you made (for real GDP) but there is no measure of quality, and more than that, all we are really measuring is the utilization of visible dollars as a medium of exchange.
The value of money is the value of trade conducted with that money. Someone is going to tell me I am wrong, but I posit that in theory the value of a unit of currency is loosely equal to the trade conducted through that currency /circulating supply of the currency. The purpose of a currency is to mediate transactions of goods and services, and each unit of currency is an entitlement to a good or service. If nobody is using the currency for transactions, or the amount of goods and services being exchanged (i.e. economic activity) is decreasing, then the value of the currency decreases. If more notes of the currency exist, the value of the currency decreases because each unit it is now a smaller fraction of the overall amount of money in action. However, if some of that money is not being used at all, then it does not necessarily cause an appreciable dip in value because it is effectively not part of the money supply since it cannot be transacted with.
So after all that buildup, here comes Bitcoin, i.e. a digital currency. First two comments: 1. the IRS considering Bitcoin property is stupid, 2. Jamie Dimon is an idiot (sort of). Bitcoin is really not that different from a dollar or a pound. It is a way for people to conduct transactions, and its value stems from how much transacting people want to do with its circulating supply. Since, like a dollar, it has no intrinsic value, i.e. I can’t farm it for food, utilize it it to build something, or use it to enable a service (sort of), Bitcoin is not, and should not be considered property; it’s money. Bitcoin derives value from the fact that people like to use it for making exchanges. In the beginning I believe there were five main segments using it:
Techno geeks: These evangelists saw an technological breakthrough that was unlike anything they had seen before, and were inspired by this new system.
Decentralists (Anarchists?): These people railed against the idea of the Fed running the world, and wanted something pure of central bank taint. Decentralists generally believe dispersing data across a network, versus having a central node, inherently makes a system more secure. Plus, they generally mistrust any institution with the power of maintaining a network by itself.
Cool Kids: These followers didn’t understand how blockchains work whatsoever, but wanted to be part of the in crowd and look like trendsetters.
Smugglers: These people saw a great way to buy drugs without the government monitoring them.
Free marketers (Tax Evaders): These people wanted to avoid taxes, and send money internationally without restriction.
The issue today is that many of those initial groups (outside of the smugglers) were not very actively exchanging the bitcoins for goods and services, or at least exchanging it for another fiat to represent goods and services. Added to that mess entered all of the investors (i.e. speculators) who saw bitcoins as high-alpha penny stocks, and miners who thought they found the next gold rush. Where Dimon may have a point is that Bitcoin is not actually being used to trade very much. People are treating this as if it’s a stock, but a stock is a share of a company that has earnings and will eventually pay those earnings out to you. Bitcoin is never going to pay anyone anything, it’s a string of numbers that says that let’s people trade with each other.
Bitcoin’s integral strength lies in the fact that it makes trade really easy, but if people do not start using it to pay for things, it will continue to be volatile and the price eventually will drop. Right now Bitcoin is propped up by wishfulness mixed with its de facto use as the crypto dollar or reserve currency against which most other crypto is priced. Once it is used as a proper means of exchange, the price will stabilize because nobody wants to hear that today gasoline is .001 BTC and tomorrow it is .002 BTC. Business becomes impossible to conduct when price swings create that much uncertainty and instability, so the currency stops trading. The only other option is that, like gold, it becomes a hedge against the dollar, but given its volatility, due to a lack of use as a medium for value exchange, I do not see that happening.
If the general public, however, sees that Bitcoin is a great medium for exchange, and stops fearing digital currencies, which may eventually replace paper money, the price of Bitcoin will soar due to its limited supply.
Unlike Bitcoin, Ethereum actually does have some intrinsic value since many things can be made from it. In some sense, Ethereum is essentially a commodity like steel because different smart contracts can be built with it. Thus unlike Bitcoin, Ethereum ideally sources its value from the demand in all of the applications being built on top of it. Computer processing of Ethereum-based smart contracts, any transactions that occur on the Ethereum network, have gas prices that are paid in Ethereum, so as long as people want to build and use ERC20 tokens Ethereum will have a commodity value. Ethereum holds a fiat-style monopoly on transactions within its network which is why its value is tied strongly to the value of the overall network, including the sume of ERC20 tokens. The issue is that Ethereum too is over speculated (by people like me), and is oftentimes being treated as a security, which it isn’t. The potential downfall for Ethereum, is that it is being used to create hundreds of illegal securities through ICOs as founders decide to avoid SEC regulations and institutional investors by going straight to the gamblers trying to get rich quick (also me).
If good products and companies are built on Ethereum, its value will soar, but if ICOs devolve into scams and governments decide to ban them completely, Ethereum is doomed.
Let me know if you (dis)agree.