The empire may think that Satoshi and his followers are on shaky ground, but the emperors and their courtiers should look to their $280 trillion tower of debt, which is beginning to teeter. Their own fortunes may go down with it. Governments and investors everywhere should welcome the explosion of creativity in crypto, preparing a new financial system of the world for the moment when the fiat currency piñata bursts at last.
CHAPTER 22
The Bitcoin Flaw
Mike Kendall, nearly six feet, five inches tall, had to slouch at his physical to make it under the Air Force’s six-foot-four maximum height for pilots. Lean, sandy-haired, gimlet-eyed, he now flies Airbus 321s for American Airlines, and for the last twenty years his avocation has been studying money from an altitude of thirty-five thousand feet or so.
His blog is titled “Man on the Margin.” Up there amid the clouds for many hours a day, he is necessarily concerned with maps, metrics, standards, and ground states. Acutely conscious of the correlations and deviations between maps and territories, measurements and mirages, he doesn’t want his guideposts to shift, let alone collapse, while he is aloft in space and time.
Entrepreneurs, also “aloft in space and time,” depend on maps and metrics to guide their investments and companies. Space registers the geographical span of enterprise horizontally across the world; time projects the vertical dimension that takes the economy into the future. Money is a central metric to both, exchange rates mediating cross-border transactions, and interest rates guiding movement through time. When the signs and signals of time and space are muddled by government interventions or by arbitrary “caps” or controls, trade can founder, and the horizons of investment shrink in both dimensions.
In scrutinizing this problem, Kendall first became fascinated with Isaac Newton’s system of the world—his perdurable gold standard as the exemplary money—and then became intrigued by Satoshi’s bitcoin as an imitation of gold. To understand the prospects for bitcoin and the other cryptocurrencies and tokens, it is necessary to grasp the centrality of gold.
Gold resolved both the horizontal and vertical enigmas of money. As a universal index of value, it muted the volatile shifts and shuffles of exchange rates. As an unchanging standard, it made interest rates a reliable guide for entrepreneurs making commitments in the darkness of time.
The gold standard thus provided maps and metrics that enabled entrepreneurs to act confidently across time and space. They were assured that in an ever-changing and insecure world the monetary measuring sticks would not change when they brought their products in for a landing in the marketplace.
Although some people think that miners will exhaust the gold supply in the future, there is scant evidence of that. As futurists contemplate mining meteors or the oceans and ocean floors, slag heaps and the moon, the likelihood of a hard cap on gold seems fanciful. The market issues its own judgment on this point, revealing no sign of “peak gold.” The existing supply of 187 kilotons of gold is split evenly between financial and decorative uses. Any shortages will merely cause a shift between these two applications.
Although mining has increased the supply of gold by between 1.5 and 2.5 percent a year for centuries, the stock of gold is huge compared with its flow. The amount of gold in inventory is vastly greater than its annual rate of new production, making gold peculiarly resistant to supply shocks.
Big new gold finds, from South America in the sixteenth century to South Africa in the nineteenth, have had a relatively small effect on prices. Accumulated supplies can shift between gold’s two main uses as money and jewelry. Money is liquid jewelry; jewelry is crystalized money. Raw bullion can be converted into baubles, and jewelry can be melted into coins, according to the needs of the economy registered by the price of gold. Mining output responds far more slowly.
If technological breakthroughs could drastically expand gold production, gold as a metric would give way and its real price would plunge. But across millennia of scientific advance and metallurgical discovery, gold has remained stable. Compensating for the improvement in mining technology has been the increasing difficulty of extraction from ever deeper and more attenuated lodes.
As I explained in the Scandal of Money, this rough cancellation of technical progress makes the price of gold a function of the time it takes to extract it.1 In a world full of subjective human passions and greed, hungers and desires, time is the one economic factor that is indisputably objective. Thus, time lends objective substance to the movements of money.
Money is essentially a measure of the inexorable scarcity of time in economics. Imagine a world of barter. The rates of exchange between apples and houses, for example, would be determined by the differential time periods needed to produce an incremental unit. As a barter economy becomes a commercial economy, these common time factors become manifested in money.
Now we live in a global economy in which myriad goods and services are exchanged in unfathomable patterns in time and space. To mediate the tradeoffs and priorities of economic choice, money must be scarce. What remains scarce when all else becomes abundant is time. Stable money confers a harmonic cadence on the dance of economic activity; without it, the dancers plunge into chaos and cacophony.
As King Midas discovered, gold (and all candidates to be real money) is not wealth itself but a metric of wealth. While some gold advocates—including me in years past—have insisted that its slow but steady 2 percent rate of growth assures an expanding supply of money in tune with economic growth, Nathan Lewis says we are “idiotic.” He correctly shows that under a gold standard, the money supply has virtually nothing to do with the gold supply:
I like to take the example of the United States. In 1775, the total amount of currency in circulation (primarily gold and silver coins) was an estimated $12 million. In 1900, it was $1,954 million—an increase of 163X!
During this time period, the amount of gold in the world increased by about 3.4 times, due to mining production.
Obviously, the two have nothing at all to do with one another. . . .
For example, between 1880 and 1900, the monetary base in Italy actually shrank by 4.8%. However, the monetary base in the U.S. grew by 81% over those same years. Both used gold standard systems. So, [under a gold standard], the “money supply” not only has no relation to gold mining production, but two countries can have wildly different outcomes during the same time period.2
Since gold does not deteriorate, all the 187,000 tons of gold mined over the centuries remains available for use as money. Maintaining neutrality in time and space, gold is neither inflationary nor deflationary. It penalizes neither creditors nor debtors. It is a measuring stick and unit of account for the world’s goods and services.
Despite the near unanimous rejection of the gold standard by respectable economists, central banks around the globe have been building up their holdings of gold. While the learned debate, rational actors in the market practice a de facto gold standard. My response to such contradictions has been to consult airline pilots and other auto-didacts such as Nathan Lewis and Steve Forbes more than university scholars. The response of scores of thousands of millennial investors has been to buy bitcoins and other crypto-assets. The question is whether any of these devices can fill the historical role of gold.
Satoshi believed that his mining algorithm was mimicking gold. In the Scandal of Money, I accepted this claim. Bitcoin did laboriously cancel out the advance of technology through its ten-minute mining cycles and lottery process. In 2017, however, I began paying close attention to Mike Kendall, who was drilling down into the economic model of bitcoin as a possible successor to the gold standard. I sent him a pre-publication draft of Saifedean Ammous’s book The Bitcoin Standard,3 which presented bitcoin as a satisfactory replacement for the gold standard. Ammous, who combines economic and financial sophistication with a degree in engineering, has studied bitcoin and gold for the past seven years.
Denouncing “the siren song of con artists and court jester econom
ists,” Ammous declares, “Contrary to the most egregiously erroneous and central tenet of the state theory of money, it was not government that decreed gold as money, rather it is only by holding gold that governments could even issue any form of money at all.”4
Proceeding to bitcoin, he asserts: “Nakamoto invented digital scarcity . . . a digital good that is scarce and cannot be reproduced infinitely . . . a digital good whose transfer stops it from being owned by the sender. . . .
“The limit on the quantity we can produce of any good is never its prevalence on the planet, but the effort and time dedicated to producing it. With its absolute scarcity,” writes Ammous, “bitcoin is highly salable across time.”
Kendall was impressed. But as he probed, he found a fundamental flaw: the belief that the money supply can and should be determined by the supply of bitcoin or gold—in other words, that gold (or bitcoin mimicking gold) should serve not only as a measuring stick or unit of account but as the actual medium for all exchanges.
Such monolithic money was also the error of Murray Rothbard, an idiosyncratic exponent of Austrian theory who believed that any authentic gold standard must have 100 percent gold backing. He did not even believe in fractional reserve banking, intrinsic to the role of banks, which necessarily mediates between savers seeking safety and liquidity and entrepreneurs destroying it through long-term investments. The value of liquid savings is necessarily dependent on the achievements of illiquid and long-term enterprise. There is no way to avoid the maturity mismatch between savings and investments except by abolishing capitalism.
In the same way, bitcoin and other cryptocurrencies cannot become significant moneys without systems to intermediate between savers and investors. Money cannot be simply a smart contract. It entails continual acts of intelligent discretion in the provision of loans and investments responding to changes in markets and technologies, while in Hayek’s words, “The gold standard force[s] governments to control the quantity of money in such a manner as to keep its value constant.”5 Cameron Harwick of George Mason University makes the crucial point that bitcoin cannot succeed as a smart contract; it must be complemented by an entrepreneurial banking function:
If the main source of Bitcoin’s volatility is volatile demand, we can expect the issue and circulation of bitcoin-redeemable liabilities to stabilize the demand for (and therefore the value of) Bitcoin by allowing fluctuations to be borne by changes in the supply of liabilities rather than by the price level or the volume of transactions.6
A currency cannot be put on autopilot; it needs oracles to channel it to the most promising entrepreneurial uses.
Kendall concludes: “The difference in the monetary Classical economics [of the gold standard] and Rothbard’s economics is that Classical economics has been put into effect. It has a three-hundred-year history of monetary success with a gold standard. By contrast, Rothbard’s monetary view has never been put in effect, but actually has an opportunity to prove its viability with bitcoin. Bitcoin with its absolutely limited supply defines the Rothbardian system.
“However, there’s a reason why the world has not adopted a Rothbardian monetary system up until now. It won’t work, and bitcoin as designed will not last as a functional currency.”
As Kendall drilled more deeply into bitcoin, he became increasingly alarmed at what he found. “While Satoshi was beyond brilliant in creating the blockchain as the basis for bitcoin, Satoshi had no understanding of currency as a unit of account. By limiting bitcoin’s supply to 21 million units over a 131-year period, Satoshi designed bitcoin as a deflationary currency. . . . Because of its deflationary design, bitcoin is used more as a volatile investment bet” than as a measuring stick or unit of account.
As Ammous points out: “The reason Satoshi chose 100 million units per Bitcoin was that the total global money supply at the time was around $21 trillion, and he wanted the smallest unit of Bitcoin to be equivalent to one cent in case the entire world economy were to switch to using Bitcoin. . . . [If that had happened in 2009], each Satoshi would be worth one U.S. dollar cent and each Bitcoin would have been worth around $1 million.”
In his Craig Wright costume, “Satoshi” believes that nearly all past gold standards were deeply defective. As recently as the Bitcoin Investment Conference of October 2015, Wright averred that 100 percent gold backing is required for a valid gold standard. The “gold-exchange standard up until the ’30s,” he says, was not a true gold standard because it wasn’t based on 100 percent gold.
As Kendall observes, “For the same reason you can’t have a 100 percent gold standard—there’s not enough gold for our vast international economy and it would be highly deflationary—bitcoin’s fixed limit is also highly deflationary and unworkable. To come to this conclusion Wright has to ignore, or not understand, the combined three-hundred-year history of the British, American, and international gold standards and their proven success.”
I agreed that money’s most crucial role is as a unit of account, a measuring stick of value, that makes possible transactions across time and space. But I had assumed that bitcoin’s rate of growth over the current century would accommodate the needs of the economy for a stable measuring stick.
What I missed in comparing bitcoin and gold was that bitcoin is the transactions medium itself rather than a stable metric for the valuation of fiat monies. For gold, transactions are incidental; for bitcoin, transactions are the key point. Bitcoin, unlike gold, must therefore increase in either volume or value if the system is to succeed.
In debates with Steve Forbes, I strongly resisted his insight that though bitcoin could serve for transactions and as a store of value, it could not perform the central role of a currency as a unit of account and a measuring stick. I said just wait—gold and bitcoin will converge. It seemed to me that bitcoin resembles gold, slowly growing, perhaps a bit deflationary, but as I said in Scandal of Money, not so deflationary as to cause more than a slight gradient in favor of savers. This bias is favorable to growth.
As Ammous puts it, “Prosperity only happens when there is no easy way for people to produce money, and instead they have to produce useful things.”7
Who cares what happens in 2140, when Satoshi’s algorithm ordains a halt in bitcoin mining? I’m seventy-eight years old! We’re in a crisis now, with debt and other government liabilities mounting to over $100 trillion in the United States alone, bigger than the gross world product of $78 trillion, and with global debt at $257 trillion. I deemed a slight deflationary bias a reasonable corrective to the engorgement of debt that currently afflicts the world economy, with debts piling up far beyond the growth rates of gross world product.
Confirming Forbes’s insight, however, Kendall demonstrated beyond cavil that bitcoin, as now constituted, cannot be a currency. Currencies create value by measuring it. The price of bitcoin changes with demand. You could respond that the price of the dollar also changes with demand. As I show in the Scandal of Money, that has been mostly true since 1971, and such fluctuations are the Achilles’ heel of the dollar as a long-term currency.
“No other basic unit of measure,” says Kendall—whether it’s the second, the meter, the ampere, or the kilogram—“changes in value with demand. They are standards” based on physical constants. If money is a measuring stick, it cannot respond to demand.
“If bitcoin cannot fulfill the required roles of currency, its long-term utility as a currency is nil. . . . Bitcoin would disappear into the ether from which it came. . . . Because bitcoin has limited its supply to a fixed amount that is already mostly realized it will have a short shelf-life as a functional currency.”8 Kendall points out that other cryptocurrencies are following in bitcoin’s deflationary footsteps with their mining algorithms.
Comparing their rates of issue, Kendall shows that bitcoin little resembles gold. If bitcoin mimicked the 1.6 percent rate of growth of gold production during the past one hundred years, the current number of bitcoins—16,651,130—would swell to 116 million units by
Satoshi’s closing date in 2140, far more than his stipulated 21 million. If bitcoin matched gold’s higher historical growth rate of 2.5 percent, it would reach 347,119,614 units. As Kendall concludes, the limit of 21 million total bitcoin units “is highly deflationary over time and unworkable.”
If people believe in the scheme, most of the world’s wealth might flow to bitcoin in periodic buying panics like the tulip mania, South Sea Bubble, and other derangements catalogued in 1841 by Charles Mackay in Extraordinary Popular Delusions and the Madness of Crowds.9 This outcome might be gratifying to current bitcoin holders, but it would obviously lead to government interventions, confiscations, crashes, and other reactions that would end this otherwise redemptive human project.
Satoshi’s scheme is asymptotic with the time model of money, slowly stopping the passage of time and cutting it off in 2140. That to Kendall is like removing the landing strip while he is in the air. Time, however, goes on forever at its unalterable pace.
This bitcoin flaw represents a huge opportunity for other cryptocurrencies. But few of them to date—in the embryonic “stable coin” movement—reflect any notion of a currency as a measuring stick. Kendall observes: “Ether’s value is determined by its supply and demand, which is determined by its mining algorithms, which are determined by tech geeks without any real understanding of currency as a unit of account.” Vitalik Buterin should take notice.
Craig Wright still proclaims “bitcoin as the solution to everything.” He remains a “bitcoin maximalist.” But the fact is that bitcoin cannot fulfill its basic role as a currency. Its historical fate is to provide a haven from maniacal governments and central banks and a harbor for a great innovation, the blockchain.
CHAPTER 23
The Great Unbundling
Life After Google Page 25