Digital money like Bitcoin has become expensive and prominent, perhaps because people think such forms of “money” are superior to “regular money.”
Don’t think you may adequately protect yourself against the current East-West deadly combination of inflation and recession by using digital currencies such as Bitcoin instead of normal money.
The unwise trust that digital currencies are safe, or protective, extends to national governments, since some of them (El Salvador declared that Bitcoin has legal-tender powers) have built into their official financial structures such Ponzi devices.
Solid data are hard to get, but it is widely believed that Bitcoin use is greatest in Asia, most particularly in India. Wisely, China makes Bitcoin use illegal, although such a law, at the moment, is difficult to enforce at a general level. Canada, the US, the UK and others have not made Bitcoin illegal – yet.
Don’t get me wrong: I support the general idea of private money. Government-run banks have a self-interest in creating inflation. An inflated currency makes it more easy for a government to pay its debts. An inflated currency allows a government to tax its citizens by a sort of back door.
Citizens find they cannot remove from the markets as much “stuff” as they did in the past. This makes room in the market for government to take away “stuff.” If the government-run bank issues money, the government may use that money, usually paper money, to pay its debts. Private banks do not have such power. Such power requires a monopoly position for key financial products and functions.
Although in East and West during the 19th and early 20th centuries there were significant economic woes, the fact that private banks during that time issued their own banknotes, based on and guaranteed by various combinations of customer/banker mutual trust, interbank lending and mutual support networks, deep capital reserves, and the banks’ own holdings of gold and silver, the banking system itself was not easily made to be, and practically speaking could not permanently be, the fundamental source of runaway inflation/recession combinations.
Because the members of private bank support networks were motivated by their individual and collective realization that crooked members of the group who issued banknotes in excess endangered all members of the support group, such groups developed self-policing entities, usually centered on clearing houses.
And because there was no topmost governing authority of the system of all banks comprising any one currency group having total monopoly power over the entire financial network, massive/inflationary increases in any national money stock rarely took place.
When problems did arise, there was almost always a government factor at their heart, such as during the American Civil War. Things change only and until individual national governments set up monopoly paper-money schemes (combined with rules against private banknote issuance and the passage of “legal tender” laws claiming that only government-issued money is fully legitimate).
Such monopoly power extended to rule-making that forbade the use of foreign money, forbade the use of privately held stocks of gold or silver, and required that banks hold their liquid reserves in some form of government-issued paper rather than gold or silver.
These government money-monopolies were controlled by politicians hiding behind central-banker masks whose wearers claimed that they had joined the financial “party” in order to control the punch bowl.
More often than not, it was they who spiked the system, not for the good of all, but quite often for the good of some, and frequently producing a painful morning-after headache for all. (See the review of the collection of essays titled The Fluttering Veil: Essays on Monetary Disequilibrium by Leland B Yeager; edited and with an introduction by George Selin, which appeared in The Cato Journal Volume 18 No 1, 1998.)
I am a member of the minority (growing) of economists who prefer to put their trust in the private banking tradition rather than the central-banking alternative. But by no means does it follow that Bitcoin-type digital currencies are preferable to either (truly) private or government-operated central banks.
You can’t hide
Yet digital currencies have taken root, sometimes with government support, and sometimes despite it, around the world. One reason may be the quite possibly mistaken belief that trading in funds (as if such “funds” were in the same family as stocks or bonds) and using digital “money” as means of payment or stores of value/units of account could be kept invisible to tax and regulatory entities of the typical national government, East or West.
Don’t you believe it. I sure don’t.
Think about it. Inquiring minds in government offices need not develop super-clever ways to penetrate the fog of computer tricks used to conceal the “back track” of, say, a sum of “money” used by you but being investigated and discussed in a courtroom proceeding at which you and the tax authority are present.
All the prosecuting lawyer for the tax-collection side need do is ask the question: “Do you conduct any of your affairs with the use of any type of digital ‘funds’?” The punishments for perjury are generally more severe than those for tax evasion. Your sweaty palms and red face will give you away at that moment.
And if you get away with it for the time being, you will be forever haunted by the idea that someday, somehow, tax hounds will hack into even the most cleverly designed (for example) Bitcoin concealment scheme.
Madoffs and Minotaurs
Moreover, and more to the point, financial faith placed in digital currency of any standard design is badly misplaced. Placing a value on “money” such as (for example) Bitcoin is placing trust in a Ponzi scheme, albeit a cleverly designed one.
Articles warning against digital currency too often get lost in the weeds of a discussion of blockchains and server networks. I will content myself by cutting to the center of the thing.
Because Bitcoin is a Ponzi scheme, it not only cannot protect against inflation/recessions, it aggravates the problem.
The false complexity of Bitcoin-like schemes reminds me of the maze of financial entities, like the 23 money-managing giants (at least that many; see the court records made public after his trial) whose job was to feed billions of dollars into the maw of Bernie Madoff, who, like the Minotaur of old, feasted at the labyrinthian network’s center.
That is, he feasted until a combination of snitches and Theseus-like investigators cut their way to the center. Madoff died in prison in 2021, serving only part of the 150-year term to which he was condemned in 2009.
Bitcoins have value in the same way Madoff’s investments made profit: Money coming in was used to pay dividends and, when necessary, pay off money going out of his “investment funds.” He took a cut out of the middle.
The mysterious complexities that protect Bitcoin, such as blockchains and myriad servers, will one day fail by way of innovative attack (Theseus went in and out of the Minotaur’s lair, helped by a ball of string supplied by Ariadne; Alexander the Great didn’t bother to unravel the Gordian Knot: A sword stroke was sufficient).
We know one thing about the chaos that attends bubble-busting moments that set off recessions: At such times the financial market’s general rule of diversity and covariance (some prices are always going up, while simultaneously other prices are going down) fails utterly. Everything goes one way: down. No portfolio mixing of uppers with downers will work.
Bitcoin will be no exception. Even “good” investments (like a house to live in, or a farm with rich, fertile soil) will go begging for buyers because everyone has lost (nearly) everything. Bitcoins all the worse, since, like all Ponzi assets, they depend on the greater-fool theory: Buy at almost any price, since tomorrow a greater fool will pay even more.
Bitcoin suffers from Gertrude Stein’s concise remark: “There’s no there there.”
Stein was born in 1874, and her bon mot was published in 1933. I intend her no ageist slight when I say, when applied to the financial operations I here discuss, her advice has a grandmother’s simplicity and wisdom: Bitcoins do not represent any underlying value whatsoever. Even pure paper money, when published by a government, is “backed up” by that government’s taxing power.
(Such power may become negligible at crisis time, but it exists in theory.)
I do not claim that China’s regulatory authorities have in mind an obligation to protect capitalistic trading markets along with the sort of speculators who might have ridden the roller-coaster of Bitcoin from its officially recorded low of US$72 in 2013 (some say it was worth only 9 cents in 2010) to its high (November 10, 2021) of $68,000 a unit. (Price today is $44,400+.)
But it may be remarkable (or ironic or unexpected) to note that China, in contrast with its capitalist competitors, seems to better recognize and act to offset the inherent instability that digital currency may add to investment markets.
Tom Velk is a libertarian-leaning American economist who writes and lives in Montreal, Canada. He has served as visiting professor at the Board of Governors of the US Federal Reserve system, at the US Congress and as the chairman of the North American Studies program at McGill University and a professor in that university’s Economics Department.