This post was originally posted on January 2015. Now, 18 months later it’s time to revisit the facts:
Bitcoin’s price is on a downtrend, the dollar is strong, and even Microsoft’s adoption combined with a crumbling ruble isn’t picking up the slack. This past year’s decline has lead to some Bitcoin’s detractors calling it the worst investment in 2014, and if you invested in Bitcoin to speculate, it certainly was. However, none of this matters. Bitcoin can continue to decrease in price, but that won’t mean it has failed. Bitcoin has already succeeded. Even if it collapses completely, digital currency will still be the future. This is a topic I have touched on in the past, but it seems like there is a need to explain exactly why decentralized digital currency is superior to both the gold standard, and USD or other forms of fiat. To start, we must outline some of the pros and cons of the two “traditional” currency systems.
USD and Other Fiat Currency Systems VS Bitcoin
The move to a fiat currency is an easy one, as fiat is “simple”. A central bank issues the currency, they have a network of banks to handle the transactions, and there is no need for any storing, shipping, protecting, or auditing of a metal backing it. The word of the government, and acceptance of the currency for taxes, gives it value. However, as most know, this leads to other problems. Still, it has it’s benefits, which must be weighed against it’s problems. As USD is the most widely used fiat currency, it will be used as an example here. Not all fiat currency systems are exactly the same, but they share most of the same pros and cons.
Positive Aspects of USD
It is easy to transfer, store, and claim. There are not enough physical dollars in the world to cover the amount of USD that is “owned”, but if you prefer to have your cash in physical form, it only takes a trip to the bank to get it.
In theory, it should have the ability to inflate and deflate, as needed, to lessen the impact of economic problems, and accelerate the economy in times of growth. (whether that is pro or con depends on your viewpoint)
By not having gold tied to currency, it frees the metal to be used for commercial purposes.
Because it is not truly connected to anything physical, it should be very divisible, flexible, and digitally usable.
Prevents banks from collapsing due to high number of withdrawals when the demand for money is high. (Again, this is often stated as a pro, but it is very debated)
The process of creating fiat, and the system of loaning and debts that it uses, also creates the system needed to process transactions.
It is really difficult for me to objectively analyze the “positive” aspects of USD, and other fiat currencies. I do not agree with the logic behind many of it’s “advantages” as they seem based on accepting that debt and compound inflation are “good”. Of course, I am not an economist, but it just seems like a system aimed at creating short term benefits that later cause huge problems. The negative aspects are much easier to describe. As this politician puts it:
https://youtu.be/NeJpQQt_b8c
The power to control the creation of currency is concentrated in the hands of a small group of people. While many people that were previously, or are currently, involved with this process have good intentions, many do not. Lord Acton’s famous quote regarding papal infallibility fits here as well as it would fit any person or group that are given unrestricted authority and power,”Power tends to corrupt, and absolute power corrupts absolutely. Great men are almost always bad men…”
This one is the biggest problem in my eyes, as the data is readily available, and extremely clear: While the stated mission of the Federal Reserve and Treasury is to ensure a stable value and supply of money, this has not been the case. That would suggest working to create both inflation and deflation, at different times, in a constant balancing act, to mirror the market’s fluctuations. That would, basically, simulate a gold-backed currency, while also offering protection in times of serious economic instability, or recession, and curbing the creation, and growth, of bubbles.If that had actually happened, then the buying power of $1 would have remained relatively constant since the USD went fully fiat. That is how it was between 1800 and 1930. $1 in 1800 and $1 in 1930 were worth the same amount, according to the Consumer Price Index. (Since I started writing this article, the CPI chart provided here was removed. A copy is available here.) Between these times, the value of $1 fluctuated up and down slightly after 1800, then increased until the Civil War. During the Civil War, the value went down, but still above the 1800 level, then started to increase in value again until the lead up to World War 1, where the value started to go significantly down again.By 1934, when FDR signed the Gold Reserve Act, it was starting to increase in value once again. However, after the Gold Reserve Act was put into place, the value of the dollar has only went up 5 times: in 1938, 1939, 1949, 1955, and 2009. Every other year has experienced inflation, which has compounded so much that, at this point, $1 from 1934 = $17.37 today. The dollar is worth over 17 times less today, due to inflation. This is very easy to understand by looking at the cumulative CPI chart from 1800-2005 (I chose this one because it also shows yearly CPI. There are more up to date ones, but they do not look very different…just taller) The mainsteam economics of today, which generally support the actions of the Federal Reserve and Treasury, are based on a blend of neoclassical and Keynesian economics. However, it seems that they have all missed the message in one of John Maynard Keynes most famous quotes, though it is quite clear,”By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth.“
When attempting to control the money supply, periods of expansion and constriction of the money supply are needed. These periods are what cause the “booms” and “busts” we see so frequently. Through these booms and busts, those with large amounts of capital have the ability to benefit massively during the booms, increasing their wealth, as well as protect themselves during the busts. The average person, who does not have enough liquid capital, or cheap credit, to benefit from the boom is crushed during the bust, which generally causes an economic recession of some form. Coin Brief’s Evan Faggart has written extensively on these “business cycles“.
USD, or any fiat currency, is only backed by the word of a government, and debt. That can hold up in times of prosperity, but can result in hyperinflation or economic collapse if pushed too far.
While USD is currently the most used currency, at least in the business world, it’s departure from the gold standard leaves it vulnerable. On top of that, the compound inflation illustrated above is creating a wealth divide that is destroying any semblance of a “middle class”, while creating the illusion of economic growth via bigger numbers. A “record high” for the stock market does not mean much when that high point can be attributed almost completely to inflation.
In reality, the stock market should reach a “record high” every year that the economy is even remaining flat. Not reaching that would indicate that the economy is performing poorly compared to the previous period.
Bitcoin vs Gold – The Gold Standard
Bitcoin was founded on semi-Austrian economic, Libertarian ideas, and was meant to be something resembling a digital version of gold-backed cash. It has succeeded in many ways, with the exception of stable value, but that can only come with mainstream acceptance and time. Now, I know that there are many Austrian Economists, Libertarians, “Gold Bugs”, etc. that disagree with this, but when looking at the positive and negative points behind gold currency, or a gold-backed currency, there is certainly room for improvement.
