By CJL P.H.D.
So you’re thinking about investing in crypto. In this post we will explore the reasons why this is a bad idea. If you’re already invested in crypto, and you’re convinced it’s a great idea and that people on Looserounds have no idea what they’re talking about with such things, then just save yourself some time and stop reading.
With that out of the way, why shouldn’t you invest in bitcoin? Let’s start with the reasons why people think they should invest in bitcoin. People usually say something like crypto is going to be the “money” of the future and we need to get in on the ground floor. But what is money? At this point you need to go read R.A. Radford’s “Economic Organization of a P.O.W. Camp.” The Wikipedia article has a link to the article itself: (https://en.wikipedia.org/wiki/Richard_A._Radford)
But basically (as any of you who have taken an intro macroeconomics course should know), the textbook definition of money is anything that simultaneously performs 3 functions:
1. Store of value – you can save this item and be reasonably certain you can spend it later
2. Medium of exchange – people actually use it to exchange things with to avoid barter and the “double coincidence of wants” problem. In short, if you’re a cattle rancher who needs shoes, good luck unless you find a cobbler who wants a cow and you’re willing to exchange a cow for a pair of shoes. (Radford explains how complex services and a credit system spontaneously emerge once a medium of exchange appears)
3. Unit of account – people post prices in this item as a measure of value
All 3 have to exist at the same time. If one of these fail, then this item fails as money, and something else will dominate. Historically salt, gold, seashells, etc have been used, as they have all at one point in time met these 3 conditions in at least one specific economy. Usually there’s one thing in an economy that performs these functions better than other things.
How would bitcoin fit in?
1. Can you store value with bitcoin? A simple look at bitcoin prices (in USD, btw) over time suggests that this is one of the least stable items in history. I’m pretty certain that by whatever measure you pick, you’ll find that the North Korean won is substantially more stable than bitcoin. People who aren’t interested in speculating would be loathe to exchange their hard-earned (at least sometimes nowadays) dollars into bitcoin and risk losing everything in a crypto crash.
2. Do people use bitcoin to exchange things? Actually, yes–it sorta works there, but then people are also more likely to use other things, especially when buying legal things.
3. Do people post prices in bitcoin? No. Why? See #1 above–it’s too unstable for anyone to know what 0.0035 BTC means as a price today, much less next week.
So crypto is unlikely to end up as the new “money.” A better argument is that crypto is a decent hedge against inflation. Admittedly, there are a handful of similarities between Weimar Germany 100 years ago and the U.S. today. So maybe there’s a reasonable chance we’ll see inflation tick up, and inflation can be at least partially explained by a central bank running the printing press with reckless abandon. With crypto, there is only a limited supply (21 million bitcoin, for example), so there is no printing press, right?(not true for Doge coin though-ST)
This is true of gold as well, and gold is a much more stable hedge against inflation than bitcoin, but this raises another question. Why isn’t gold still being used as money? As Radford explains with cigarettes, its because gold is deflationary. If the economy is growing, but we still have the same supply of gold, then prices (in terms of gold) will actually fall. Think about it. We have less gold for every item we produce as a nation. While your first thought may be that this isn’t a bad thing, it’s actually pretty horrible. What happens is that people figure out that the purchasing power of gold increases over time. So rather than invest in business activity (i.e., buying stocks), people hoard gold. Then there’s even less gold in the economy and prices (in terms of gold) rise even more. In a 100% gold standard, it’s a feedback loop that takes all the gold out of the economy, then it destroys our credit system and pretty soon the shoeless cattle rancher is back to looking for a cobbler who wants a cow.
Gold is deflationary. There’s a reason we used a fractional reserve system (i.e., more paper gold than actual gold). It was to stave off deflation in a growing economy. This deflation exacerbated the Great Depression and arguably helped ignite World War II. The book to read is Lords of Finance: The Bankers Who Broke the World, by Liaquat Ahamed. It’s fascinating and written to be accessible to the layman. I also suggest you check out the “Free Silver” debates of the late 1800s/early 1900s, when the average American was surprisingly much more “in-tune” with basic ideas of monetary economics than the average American today.
So if gold is deflationary, so it will be with bitcoin… …or will it? There are always new forms of crypto (maybe think of them as types of fractional bitcoin currency). Any new “coin” will compete for a limited supply of resources to be spent on crypto, eventually leading to a drop in value. As we’ve already seen, bitcoin prices also have dropped at times fast enough to surprise a Zimbabwean who lived through their currency fiasco 15 years ago. It’s simply too unstable to know which will happen for sure, and in the absence of any central authority, that brings us to our third objection… Do you really think the monetary authorities, who use monetary policy (i.e., the printing press, interest rates, and other tools) to manage the economy will allow bitcoin to be used, and give up their ability to “stimulate” the economy? Remember we did pass the Gold Reserve Act in 1934 that made holding gold bullion a federal crime, specifically because the authorities had to maintain control over the money supply. But this time is different, and they’ll just let bitcoin take over? Right…