Bitcoin is NOT Money !!

Yes, bitcoin is fun.  But it’s not money.  It fails the most critical and basic test of “money.”  Along with many other people, we wish it could be money.  The problem is NOT that bitcoin exists only in electronic (or virtual) form.  The problem is also NOT that bitcoin is independent of governments and banks.  In fact, we love these properties!  We’ll say it again:  Bitcoin fails the most critical test of money.  To explain, we digress.

Role of Money

Let’s start at the beginning.  Every adult must acquire the survival necessities of food, shelter, and clothing.  The most direct means of acquisition is to grow one’s own food, build one’s own shelter, and make one’s own clothing.  Free people, however, choose otherwise.  Just as baking two pies is little more effort than baking one, production of food, shelter, and clothing admits vast economies of scale.  A farmer can double the size of her “garden” to feed two families rather than one without doubling her labor or investment in tools.  By doubling her production, the farmer will exchange the excess crops, perhaps, for the clothing and firewood that her neighbor provides.

The superior efficiency of this exchange, or “barter,” system is indisputable.  All participants in this barter system earn their necessities with less time and effort.  Direct barter is potentially manageable in small communities but suffers from the complexity of innumerable “exchange rates” among the barter items (e.g., vegetables, meat, clothing, livestock, lumber, barn construction, medical services, et cetera).  The establishment of money simplifies the barter system tremendously.  People exchange their goods and services for money that they use, in turn, to exchange for items they need from others.  Money becomes the pre-eminent barter item but has meaning only in its ability to facilitate free market exchange of goods and services.

Money is an extraordinarily simple and elegant solution to the barter exchange rate problem.  Further, the size and scope of the barter market increases astronomically due to our ability to save money for future years, borrow money for future repayment, and transmit money easily over long distances.  All human societies invent money, just as they discover fire, in their pursuit of survival and advancement.

Yet what particular barter item could serve as money?  The requirements “to save money for future years” and “transmit money easily over long distances” eliminate most candidates.  Crops and cattle, for instance, are of great value and some historical accounts consider them as early forms of money.  But they are not well suited as money.  The dominant money of the thousands of years of recorded history has consisted of coins of metals and alloys such as copper, bronze, silver, and gold.

The requirement that trumps all others is the certainty people have that whatever serves as money has enduring value.  A man will agree to accept copper coins for his bushels of wheat only if he is confident in the value of other goods he can purchase with the same coins – whether now or next year or within the same village or many days’ travel away.

Gold and Silver through the Millennia

What substance or physical item could possibly inspire such confidence simultaneously in almost all people?  What would all people agree has value “now” and will have significant value at all future times?  There is nothing tangible on Earth that can provide this certainty of value.  Surprisingly and with no strong explanation, however, the metals gold and silver are history’s best answers to these questions.

Gold, and to a lesser extent silver, has smitten human beings through all of recorded history and across a wide range of cultures.  No society rejects gold.  (Lenin may have said “we will make public toilets out of gold,” but neither he nor his successors in the Soviet Union followed through on this promise.)

The history is clear.  Human beings have always regarded gold and silver as “valuable.”  This persistence and confidence are precisely what one needs for viable money.  But there’s a counter-argument:  why should this work?  If a society bases its money on gold or silver and then, suddenly, a large fraction of the society realizes one “cannot eat” gold or silver and that there is no evident value other than “shiny and pretty,” what happens then?  The monetary system would fail.  But it has never happened.  There is no certainty gold or silver will always work as money, but the world has thousands of years of good experience.

Fiat Money

Earlier we stated that the dominant requirement for money is the people’s certainty of “enduring value.”  Yet we then expressed the view that there is nothing tangible on Earth with this certainty.  Gold and silver are merely the best candidates.

Fiat money consists of tokens such as coins or paper certificates with little or no inherent value that a government decrees has stated value.  The enduring value of such money, then, stems from the people’s confidence in the government to maintain the value and validity of the money.  One critical aspect of maintaining value of the otherwise worthless money is that the government mandates that businesses and people accept the fiat money in all payments.

Like many ideas in life, fiat money can certainly work as intended in one’s imagination.  If our employer pays us for our labor with colorful pieces of paper and we know we can exchange this paper for immediate or future purchases, then the money is functioning.  An evident risk is counterfeiting of the colorful paper, so the government must take pains to produce the paper money in a manner that is difficult to emulate.  The government will also create and enforce laws to forbid the counterfeiting.

Since fiat money has no intrinsic value, the citizen implicitly relies on government to maintain the money’s value relative to goods and services in an economy.  We don’t like fiat money – we see it as a disaster waiting to happen.  But at least fiat money has a premise:  “trust government to create and supervise money.”

Bitcoin has No Enduring Value

The big problem with bitcoin is that there will never be widespread, popular certainty that it has enduring value.  We may be able to buy food or clothing or pay our college tuition today with bitcoin, but what about tomorrow?  Proponents of bitcoin might argue that there’s a plan to cap the total bitcoin supply and such fixed supply should maintain stable bitcoin prices.  But why trust that arrangement?  Why trust the unknown and unaccountable group of people that manage bitcoin?  While there may be arguments for trust, public behavior does not derive from carefully parsed arguments.  There’s no stability if people need to think about their money and wonder why it has value.

Perhaps the “easy fix” to this problem is to get government to enforce (or compel or otherwise support) bitcoin somehow.  Yet the existential point of bitcoin is to move away from government control of money.

We’re not economists here at Financial PESTs!!  This is not an argument from the musty library of “Economic Theory.”  Good economists know that they don’t build the theories first and then expect people to follow them.  It works the other way.  Observe how free people pursue their own self- and communal interests.

(We excerpted portions of this essay from J. M. Pimbley and L. E. McDevitt, Banking on Failure at Lehman, to be published in 2014.)