Bitcoin

by Dominic Frisby

  But these reforms, together with America’s involvement in the Vietnam War, cost money. The US began printing dollars – many more dollars than its gold supply could back. This would lead to a run on America’s gold by other nations, and in 1971 the US abandoned the gold standard for good and joined the rest of the world under a fiat money system.

  There are many, particularly on the political left, who think the large state model the right one. There are others, particularly in the libertarian area of the political spectrum, who don’t. Wherever you stand, the large state model is only possible – if not inevitable – when government controls money. If money becomes independent, then a government struggles to fund itself.

  A word about the great obfuscation that is inflation – and how it causes the wealth gap

  Inflation once meant ‘an increase in the supply of money and credit leading to higher prices’. Deflation meant the opposite – ‘a decrease in the supply of money and credit leading to lower prices’. These meanings have, however, been distorted over time, so that inflation is now ‘rising prices’ and deflation ‘falling prices’. It may not seem important – meanings of words change all the time – but it is.

  The official method of measuring inflation, the Consumer Price Index (CPI), tracks the prices of things we commonly use – food, clothing, transport, energy and so on. From 1989 to now CPI has averaged just under 3% in both the UK and the US. But the amount of money circulating has grown at an average rate of 11.5% per year over the same period.

  Money supply has also grown faster than the economy. In 1971 in the UK, there was £31 billion in circulation. Now there are just under £2,100 billion (£2.1 trillion). That is a 67-fold increase. Are we 67 times richer? A few people are. But most of us aren’t. Similarly, the US has seen $800 billion become $16 trillion – a 20-fold increase.

  Research by think tank Positive Money shows that only about 10% of newly created money goes into the kind of consumer goods tracked by CPI. So all CPI does is measure the effects of about 10% of money creation. What’s more, many of the goods tracked by CPI face the deflationary pressures of competition and improved productivity. For example, computers and other mass-processed goods tend to fall in price.

  Positive Money’s research also demonstrates that 13% of newly created money has gone into real businesses that create jobs and boost economic growth; 37% into financial markets and 40% into residential and commercial property. Is it any wonder the financial and real estate sectors have grown so disproportionately large? That’s where the money’s gone.

  The trusted tool to deal with inflation is to raise interest rates. The effect of higher rates is that money costs more to borrow and people borrow less. So, the cost of assets that people use borrowed money to buy – houses and financial assets, especially – tends to fall.

  But the last thing a government wants on its watch, particularly if an election is looming, is falling house prices or a falling stock market. Where possible, it will not want to raise rates. So how handy it is to have an official measure that ‘proves’ that inflation is low – especially one that ignores 77% of new money supply.

  But the manipulation of money has unseen consequences. It actually causes the wealth gap.

  Government printing of money, even with quantitative easing, is not quite as willy-nilly as some would have you believe. Banks actually create more money than governments. ‘The majority of money in the modern economy is created by commercial banks making loans,’ says the Bank of England.173 About 96% of the money in fact – in both the US and the UK.

  Electronic banking, which began in the 1980s and replaced the cash- and cheque-based economy, has made it possible for banks to do this – facilitated by the decision to ignore money-supply growth in measures of inflation.

  The social consequence of this has been for the financial sector to grow disproportionately large and influential – for banks to have become ‘too big to fail’. More and more people have been drawn to this sector where they can get some kind of exposure to new money creation. But elsewhere, perfectly innocent people lose out because of it. This is from Life After the State:

  Imagine a tiny economy. There are 20 people in it. Of these, ten each have $1 in cash, so there is $10 in the entire economy. The other ten people each have a house – these are the only assets in the economy and are each priced at $1. People quite happily buy and sell these houses for $1 each. If more houses appear in this economy, but the amount of money stays finite, the cost of houses will fall. But let us assume for now no new houses enter the economy.

  One person – Mr King – is suddenly able to magically create another $10 from nowhere. He decides to go out and spend some of this new money. He buys a house for $1, which the vendor is happy to sell because, based on the knowledge the vendor has, that is the fair market price. Except that it isn ’ t because there is no longer $10 in the economy, but $20. At $1 the vendor has sold his house too cheap – and he has received devalued money in exchange.

  Mr King then decides to outbid the others and offers $1.50 for another house. This vendor is delighted, sells, probably feeling rather clever, and makes off with $1.50, but even he has sold his house too cheap. Mr King, meanwhile, is developing a nice little property empire. The other vendors hear houses are now trading for $1.50 and now expect that price, which Mr King is happy to pay. In other words, house prices are gradually rising to reflect the new money in circulation.

  There are some big losers in this process – the people who each had $1. The purchasing power of their money is now no longer enough to buy the house they were previously able to buy. Ultimately, their purchasing power will halve because there is twice as much money in circulation. They haven ’ t acted imprudently in any way – they haven ’ t even acted – yet they are made poorer by this process of other people creating new money.

  What about the people owning houses? How have they done? Eventually, houses prices in this economy will rise to $2 – there are ten houses and $20 in circulation. The price of their houses should rise to reflect this extra money in circulation, so – as long as they didn ’ t sell – they come out even. They might think they are richer because their house now costs $20, but this is a delusion: it is the same house. They have just survived the inflation, nothing more. If, however, they were one of the early vendors who sold for $1 or $1.50, now they cannot afford to buy back the house they previously sold. They are ‘ priced out ’ and poorer.

  Meanwhile, Mr King has done extremely well. He benefits, of course, as the recipient of a load of newly created money. But he was also able to buy houses for $1 and $1.50, before they rose in price to reflect the new money in circulation, so, with his houses now valued at $2, he profits from the asset-price inflation too. Wealth, which was originally spread evenly through our tiny economy, has insidiously transferred from cash-holders and those who sold their houses early to Mr King.

  As a consequence of this process not only has wealth transferred, but those operating in our tiny economy no longer focus on making things. Instead they look for signs of future money creation and speculate on those signs, because there is more money to be made that way. 174

  The process is continuous and relentless. Economists call it the Cantillon effect, after the 18th-century French-Irish economist, Richard Cantillon.

  If you own the assets or if you operate in the sectors that benefit from all this newly created money – the financial sector and, in the case of the UK, the London property in which it mostly lives – you make spectacular gains. But if you don’t own these assets – and most young people don’t – you get left behind, and the wealth gap gets bigger.

  We are constantly told that hard work pays. If you start out with nothing, the way to better your lot is to work hard. But significantly bettering your lot is not so easy these days because wages have not kept up with the increase in the money supply.

  In the US wages have gone from around $6,000 per annum in 1971 to $44,000 today.175 So, while the money
supply in the US has increased by 2,000%, wages have increased by 750%. The inequality in the UK is greater. Money supply has increased by 6,700%, wages by just 1,250%.176 Wages, in short, have failed to keep up with inflation.

  In addition, you are also taxed heavily on your wages – and the harder you work, the more you are taxed.

  At the same time, many of the assets you might want to buy are rising in price and getting further out of reach. Those that own the assets you want to buy are not taxed on their gains, unless they actually sell – and capital gains tax is lower than income tax.

  The result is a system in which labour is penalized, and capital and assets are not. Inflation and income tax between them actually increase the wealth gap.

  Many families now find themselves having to work longer hours, with both spouses in the workplace, taking on larger debts and having fewer children just to maintain an ordinary middle-class lifestyle. Many of their children face unprecedented levels of debt and, in many places, will never be able to buy a house.

  What is happening is an insidious transfer of wealth from those that don’t own the right assets or operate in the right sectors to those that do. This process will not stop until inflation is measured accurately and honestly and until taxation is reformed.

  Forget property – money is theft.

  Why Bitcoin is libertarian Utopia

  There are four ways a government funds its activities.

  The first is through taxation – income tax, property tax, road tax, sales tax, corporation tax, import duties and so on. Income tax is by far the largest earner – about 40% of government revenue in the US and 30% in the UK (50% if you include National Insurance). It is easy to collect because it is levied at source. Add to taxation various rents and income from its activities and the sale of assets.

  The second way a government funds itself is through debt. Government borrows money through the bond markets.

  The third is by actually creating money – printing it and creating it by other means such as quantitative easing.

  The fourth is by manipulating money – inflation. We have just seen how insidious this is.

  Let’s be idealistic for a moment and imagine that Bitcoin and other independent monies become the globally preferred means to make and receive payment. I do not see this as at all likely in the short term. But in the longer term, I do – and the implications are enormous.

  In a flash, the ability for a government to fund itself through the manipulation of money disappears. You can’t obfuscate bitcoin supply – inflation is transparent. You can’t ‘quantitatively ease’ bitcoins. Governments – without a very aggressive and potentially impractical bitcoin confiscation scheme – will struggle to use your bitcoins to bail themselves out. Deficit spending becomes impossible – you can’t spend bitcoins you don’t have. Central and private banks can’t create bitcoins when it suits them, and governments can’t print bitcoins (they’d have to compete to mine coins along with everyone else).

  It all means you don’t have to pay the price for the mistakes of governments and banks. They do. They will have to act more prudently or go under.

  If it can’t fund itself though the manipulation or printing of money, a government would have to rely more on borrowing. But even that option is not as appealing as it once was. A government can no longer devalue its debt through inflation or the suppression of interest rates. With no control over money, government borrowing rates would have to increase to cover for the very real risk of default.

  So, government will find itself forced to live off its tax revenue. But, again, Bitcoin could also change the way we are taxed.

  If workers are paid in bitcoins, income tax will become much harder to levy at source. Many people will do what corporations and the self-employed already do – try to find legitimate ways – and in some cases illegitimate ways – to reduce the amount of tax they have to pay. And if governments demand too much tax, people look for ways to avoid it – it will be no different with Bitcoin. It will mean greater state resources are required to stop evaders and avoiders. An investigation might not be worth the cost for the amount it levies. This, of course, raises all sorts of moral issues.

  But taxation, in its current form, will be harder to enforce and more costly to levy. In all probability, we’ll move towards the taxation of consumption and assets, rather than labour – a land value tax, even (see the footnote for more on land value tax177).

  Charles Hoskinson, CEO of Ethereum – dubbed ‘Bitcoin 2.0’ – says to me:

  I think it’s going to go to a national sales tax. If you’re a business you’re going to probably have a physical footprint because you have warehouses, you have to store products, you have a store front, you have to register with the government. If you’re an Internet business, maybe then you can live 100% in the cloud. But let’s say for the sake of the argument you have to have a physical presence, then it’s easy for the government to levy upon business standards like sales tax.

  While it’s going to become increasingly more difficult to know how much money people are making, it’s still going to be relatively easy for governments to collect sales tax on businesses and keep businesses in compliance because businesses are not in the habit of evading income tax or evading sales taxes. So I think we’re probably going to see a larger transition towards a national sales tax and a reduction, either in legislation or in feasibility, of income tax.

  Why is Bitcoin libertarian Utopia? Libertarians tend be of the view that most government action, even if well intended, has negative consequences. Losing control of money means that, suddenly, governments are more limited in what they can do. There might be fewer wars, there might also be less state welfare. That’s a frightening thought for many, but the libertarian view is that welfare would be both cheaper, more effective and more widespread if the state stayed out of it.

  But it’s not just that Bitcoin limits government. It also has the potential to redistribute wealth. A deflationary system of money means savers are rewarded rather than debtors – a paradigm shift in the way things work. A society that transparently taxes consumption rather than production means labour is rewarded rather than penalized. A money that is free of banks means people can bypass banking systems. The huge concentrations of money and power that have found their way into the financial sector can finally be diluted. There is no insidious transfer of wealth to ‘Mr King’.

  Suddenly the enormous cost of the state – and your government is the most expensive purchase you will ever make – is lightened. Being taxed less and compensated for their labour in a currency with increasing purchasing power means workers really do have a chance to better their lot.

  As Satoshi said, Bitcoin is ‘very attractive to the libertarian viewpoint if we can explain it properly’.178 Ain’t it so.

  8

  How Bitcoin will Change the World

  Bitcoin is the beginning of something great: a currency without a government, something necessary and imperative.

  Nassim Taleb, author and statistician

  My stepfather’s parents, who were Jewish, fled Germany in 1936. Luckily for them, they had gold – and they used some of it to bribe their way out. That same gold had protected them during the madness of the Weimar hyperinflation 14 years earlier.

  Wanting to get as far as possible from the dangers they perceived in Europe, they went to South Africa. The last of the gold they had managed to smuggle out of Germany helped them to get started in their new life there.

  They had two children. Some years later, one of them, my stepfather, would also find himself wanting to ‘get out’. He decided he didn’t like what was happening in South Africa and in the 1970s became determined to leave. However, there were capital controls in those days. He could go, but he couldn’t take his money with him.

  The way he got round the problem, like his parents before him, was with gold. He bought 60 Krugerrands (about $80,000 in today’s money) and got on a flight to London. Those 60 Krugers were
enough to get him started in his new life in the UK.

  But he had to take considerable risk. He could have lost those Krugers, or they might have been stolen or confiscated. There was also the possibility he would be caught and charged with smuggling.

  In the 1970s there were capital controls across the West. Until 1979 in the UK you had to get permission to take more than £25 – less than 50 dollars – abroad.179 Those controls may not exist to anything like the same extent now, but they do exist elsewhere.

  China, for example, is the world’s second-largest economy, yet individuals may not withdraw more than $50,000 per annum from the country.

  The banking crisis in Cyprus in 2013 saw capital controls introduced there. Currently, cash withdrawals are limited to €300 a day, the cashing of cheques is banned and large cash transfers are vetted. Accounts with over €100,000 saw funds confiscated. Capital controls now seem to be being imposed in the Ukraine due to its current instability.

  Reports suggest nationals are finding it harder and harder to get their money out of Spain and other parts of impoverished Southern Europe, and the insolvency of Spain’s banks makes another banking crisis in the region look probable. The investment bank JP Morgan has declared it is ‘inevitable that capital controls and a capital freeze will be imposed’180 in Southern Europe; senior employees tell me many of their current strategies are based on this inevitability.

  Where there is an economic or political crisis, capital controls often follow. Innocent people are made to pay for the profligacies of their banks, their financial system or their governments.

  Bitcoin has been dubbed ‘money without government’ and ‘money without borders’. You can send money to another country as easily as you can an email, and nearly as instantly. There is no need to smuggle 60 Krugerrands in your pocket if you’re fleeing an oppressive regime.