A Neo-Gold Standard: Exploring the Effects of a Weak Coalition of Central Banks Inflation Targeting Bitcoin
The purpose of this writing is to influence the managers (and also advisors of managers) of the various major centrally banked currencies of the world to consider entering a loose coalition whereby they each eventually inflation (value) target bitcoin. It is also an attempt to present the argument at a level accessible to someone only vaguely familiar with economic theory with the hope that public support for the policy of mandated value targeting to bitcoin grows large enough to be decreed fiat.
The basic idea is somewhat novel, in the sense that bitcoin is new, but not altogether new-effectively achieving a situation analogous to when much of the world might have functioned on the actual gold standard (rather than a similar de facto standard).
Judging by an overview of price volatility bitcoin might not seem like an optimal value standard to peg a national based currency on, however, we will inquire into the nature of bitcoin’s market valuation and how an increase in the quality of centrally banked money might favorably affect the stability of bitcoin as an international value standard.
We can consider a future possibility of “well-managed” centrally banked money targeted to bitcoin’s market valuation. This money would necessarily be value stable versus any other currencies that are also successfully value targeting bitcoin. This opens the possibility for the creation of useful monetary unit-a metric of which we should call a “Nash”.
Since value differs depending on subjective viewpoints such as locally versus internationally an impossibility arises in regard to the creation of a stable unit of value. This problem, termed the subjective theory of value, is avoided by not creating a stable unit of value over time per se, but rather by inciting relative stability of value between all major currencies in relation to bitcoin. This paradigm solves an important conflict perpetuating problem (namely currency based economic warfare) while craftily avoiding the paradox that arises when conceiving of an objectively stable unit of value.
I close the argument with the suggestion that central banks, acting in their own self interest of preservation, and central bankers acting out of the same, will in fact learn to better manage their supplied units of currency by targeting stability in relation to bitcoin-if they don’t they will lose their customers to the free market value competition bitcoin and emerging crypto-currency technology has created.
The Problem of A Deflationary Supply Restricted E-Currency
A good place to start an inquiry into the optimal use case of bitcoin is George Selgin’s essay “Synthetic Commodity Money” where he expounds on the new possibility of a money that has an externally controlled supply rate such that it is not politically manipulable. Bitcoin is one consideration and example of a synthetic commodity money. Selgin also gives the example of the Swiss dinar which effectively became synthetic commodity money when the issuance was cut off to those that were relying on its purchasing power:
“Prior to the 1990 Gulf War, Iraq’s official currency consisted of paper dinars printed in the U.K using Swiss-engraved plates. During the war, sanctions imposed on Iraq prevented it from importing more of these notes. Hussein’s government in turn chose after the war to decry its former currency, issuing so-called “Saddam” dinars in its place. Saddam dinars were subsequently issued on an enormous scale, both officially and by counterfeiters, for whom the poor-quality notes were an easy target, causing it to depreciate rapidly. But Swiss dinars, as the old notes came to be known, continued to circulate in the northern, Kurdish regions of Iraq; and they, in contrast, held a remarkably stable purchasing power and exchange rate relative to U.S. dollar despite gradually deteriorating from constant use.”
It is quite a counterargument to those that would suggest bitcoin’s value would decline if a major government or multiple major governments “forbid” and banned its use as a money and a store of wealth (whether that is possible or not isn’t important for this point). Banning a money with a restricted supply that is still considered useful does not necessarily degrade its value. Seglin concludes:
“With regard to viability, the episode shows that “intrinsically useless” notes can continue to function as money, even though their use as such is, not only officially unrecognized, but officially condemned.”
This suggests bitcoin is destined to exist and play role in the future of our global financial system. The more governments resist the effects of its market valuation and make laws against the use of it the more they might find the price increases accordingly. From a state perspective this suggests it’s a matter of national economic stability to consider the effects of bitcoin as a synthetic commodity money.
Bitcoin, however, does have an interesting limitation that Selgin introduces us to in “Bitcoin: Problems and Prospects”:
“Part of the bad news is that there’s no reason to suppose that either the purchasing power of Bitcoins or the total volume of Bitcoin spending or “nominal income” would be stable. Today of course it’s evident that the value of a Bitcoin fluctuates a great deal. But “value” here refers to the Bitcoin-dollar exchange rate. In a Bitcoin economy the only sort of stability that would matter would be that of Bitcoins’ value relative to goods.”
Most bitcoin enthusiasts don’t like to admit this is a problem, that bitcoin isn’t the ideal money (lowercase) that economists and central bankers have been thinking of and searching for (targeting). Such a money’s supply would need to be able to expand and contract (more on this in a later section). Selgin continues:
“In such an economy the real demand for Bitcoins would also be more stable than it is today, with speculative demand (as opposed to demand for making payments) playing a much less important role than it does now. For that reason Bitcoins’ purchasing power in a fully “Bitcoined” economy would almost certainly be considerably less volatile than the present Bitcoin-dollar rate. So it’s a mistake to assume that the instability of Bitcoin as money would mirror or resemble the instability that it has today as an aspiring money only.
It doesn’t follow, however, that either Bitcoins’ purchasing power or the volume of Bitcoin-denominated payments will be stable enough to make Bitcoins anyone’s idea of a sound money. Because it makes no allowances for changes in the real demand for Bitcoins, whatever their source, the strict “protocol” that regulates the supply of Bitcoins — a protocol that raises Bitcoin “mining” costs in response to changes in mining activity and technology, but without regard to Bitcoins’ purchasing power — would allow fluctuations in the pure transactions demand for Bitcoins to continue to influence their purchasing power.”
Selgin makes an important point here about the driving force of bitcoin’s market valuation, that it is very related to the demand for bitcoins. In a later section I will show that is an important limitation in which he might have missed the “brilliance” of. For now we can see Selgin conceives of a more optimal issuance schedule that we might hope bitcoin could have:
“The supply of such a “smart” cybercurrency would therefore remain beyond the power of anyone to manipulate, yet would also be “elastic” in a macro-economically desirable way. You really couldn’t ask for anything much better.”
He also references FA Hayek’s essay “Denationalization of Money” and specifically points out a folly in the comparison to today’s circumstances:
“The rub, though, is that Hayek took for granted that competition among different “fiat” currency issuers would favor those offering currencies with the most purchasing power, while forcing others out of business. It all sounds reasonable if you’re talking to economists because economists tend to treat stability of purchasing power as proof of a currency’s soundness. The problem is that it doesn’t at all follow that consumers of currency, that is, those actually deciding which currencies to accept in exchange and to hold among other assets, aren’t inclined to adopt a similar, macroeconomic perspective. They will, first of all, favor (as has now been stressed many times) a currency with a wide network of users over one with a narrower network, ceteris paribus.”
We might counter this point, however, with a reference to John Nash’s “Ideal Money” in which he describes the possibility of a money that arises to be out of the hands of the ordinary citizen. Such a higher powered money might somehow (I hope to explain how in this essay) serve the general public even though they might not particularly use such a money:
“In a large state like one of the “great democracies” it is reasonable to say that the people should be able, in principle, to decide on the form of a money (like a “public utility”) that they should be served by, even though most of the actual volume of the use of the money would be out of the hands of the great majority of the people.”
The following sections we will re-explore what Selgin explored and hope to inspire the inquiry into a slightly different approach to the possibility bitcoin offers in regard to stabilizing the global economy, in order “..to consider alternative synthetic commodity arrangements that might promote overall macroeconomic stability despite continued reliance upon base money itself as the economy’s only form of circulating currency. “
The Important Similarity Between Bitcoin And Gold
The usefulness of gold as an inflation hedge is cruxed on a phenomenon that is well explained by Nash in the Southern Economic Journal entry entitled “Ideal Money”. Nash points out that it is not the actually rarity of gold that makes it scarce but that natural throttle created by the increased costs of digging deeper:
“It is a coincidental fact that the inherent nature of mining and mining technology makes it possible for the prices of certain commodities that are produced as a result of the devotion of labor and capital to the effort of mining to increase less (or decrease more) than might be expected. There is a “dimension paradox”: Agricultural products are produced by using the two-dimensional resource of the earth surface, so the “disappearing frontier” creates a limitation. In contrast, some mining, particularly for elemental metals, can essentially be done in three dimensions, although, of course, there are increasing costs for deep digging. So, really there is lots and lots of gold, silver, platinum, tungsten, and so forth out there and more can be found by digging deeper.”
Bitcoin has a stable scheduled supply much like the production of gold, but the mechanism by which this is achieved is slightly dissimilar than gold. Bitcoin’s algorithm is such that it adjusts the difficulty requirement of creating new blocks (and new bitcoins) proportionally to the aggregate mining power of the network:
“Bitcoins are created each time a user discovers a new block. The rate of block creation is adjusted every 2016 blocks to aim for a constant two week adjustment period (equivalent to 6 per hour.)”
If more mining power enters the network the difficulty increases and adjusts so that the supply rate of new bitcoins is still effectively steady. If mining bitcoin was expected to be very profitable, many new miners would be expected to arise, and then the difficulty would increase, thus curbing the excessive profits to be made (because more energy must be expended and paid for to mine for bitcoins). This has a special implications on how and why we might value bitcoin.
The result, provided there is no significant demand otherwise for bitcoin (such as explained in the following section), would be a commodity mined at a fairly predictable rate which can therefore have a fairly predictable value. The price in this regard, with no other special consideration, is ultimately a discovery of the cost to mine bitcoin, which as we have noted, is targeted for stability.
In this case there is no implicit reason to scale bitcoin in regard to its transactional throughput as is often argued. That it cannot compete with visa, because it has only a 7 tx/s base layer capability, does not harm the stability or predictability of its value proposition. In fact in the essay “Money, Blockchains, and Social Scalability” Nick Szabo describes the computational limitation of the network as the crux of the brilliant insight Satoshi used to secure the network:
“That is what proof-of-work and broadcast-replication are about: greatly sacrificing computational scalability in order to improve social scalability. That is Satoshi’s brilliant tradeoff. It is brilliant because humans are far more expensive than computers and that gap widens further each year.”
It is yet to be proved that bitcoin will scale to be a highly transactable and low fee medium that functions like an ideal “e-cash”, but for the important and relevant consideration we value gold for, Satoshi is effectively the first successful alchemist to create gold out of math-Newton would certainly be impressed.
The next section will deal with the assumption being made here, that bitcoin might not have a significant role as a crisis hedge for savings in the future.
The Value of Bitcoin is Related to the Value of Centrally Banked Money
Satoshi Nakamoto said the “The price of any commodity tends to gravitate toward the production cost.”. But this isn’t perfectly true at least from the short term perspective. In his essay, “The Monetary Value of Liquid Commodities”, Nick Szabo explains that certain store of value commodities gain prices that are valued well beyond their cost of production especially at times of global monetary instability:
“Another way of putting this is that, when currencies become unreliable as a store of value, commodities take on part of that monetary role. Both oil and gold increase in value by performing this monetary function better than the currency against which they are being traded, better than credit instruments denominated in that currency, and even better, in the short term, than stocks of companies that do business primarily in that currency. The joint movements in oil and gold reflect their value, relative to the currency they are priced in, performing the monetary function of a store of value. Global supplies and industrial demands for minerals are far less volatile than the change in their value in this monetary role. It’s the logical emergence of money from barter, but this emergence goes on everyday that liquid commodities act as a better store of value than the currency in which they are priced. Contrariwise, as the currency becomes a better store of value than the commodity, these commodities move back down towards just being commodities valued only for their consumption. Thus their exaggerated moves, both upward and downward, in reaction to changing expectations of future increases or decreases in money”
Szabo explains that we can observe this phenomenon when oil and gold move in tandem with each other (rather than in separate price directions which would rather indicate a change in the supply or demand of one or both of the commodities).
He goes on to show this effect with simulations on the effects of inflation in different scenarios of monetary instability in his writing “Simulations of Inflation Expectations and Oil prices”. If bitcoin were to be targeted as a new gold standard, and provided bitcoin threatens to serve as a deflationary safe haven from inflationary fiat, we would expect the result of such targeting to remove some of the otherwise implied upward pressure on bitcoin’s price. Thus the trend we should expect is asymptotic stability.
There still might be some implied secular deflation which is in fact not only not a problem but in complete alignment with George Selgin’s view on what the value trend of an optimally managed currency should have from a domestic purchasing point of view.
A Challenge: Can Bitcoin Be Ideal Money Without an Elastic Supply?
In an open letter style essay, “A Challenge to the Bitcoin Community” Selgin starts the following inquiry:
“I wish to accomplish that end by challenging Bitcoin fans to propose means by which one might combine the same advantages as Bitcoin presently offers with a mining or production protocol that, instead of adjusting mining rewards so as to achieve some predetermined output rate and limit, adjusts them so as to automatically alter the rate of coin production as needed to achieve some other objective”.
He is effectively tying the concept of an algorithmically issued money to his concept of a money supply based on the factors of production. This is fairly straightforward to understand.
We learn from FA Hayek (a distinguished austrian school economist Selgin also refers to) in his essay “The Use Of Knowledge in Society” that in an optimal setting prices act as market signals which tell the markets which commodities are in how much demand:
…that the values of the factors of production do not depend solely on the valuation of the consumers’ goods but also on the conditions of supply of the various factors of production. Only to a mind to which all these facts were simultaneously known would the answer necessarily follow from the facts given to it. The practical problem, however, arises precisely because these facts are never so given to a single mind, and because, in consequence, it is necessary that in the solution of the problem knowledge should be used that is dispersed among many people.
It is in this connection that what I have called the “economic calculus” proper helps us, at least by analogy, to see how this problem can be solved, and in fact is being solved, by the price system.
….a coordinated utilization of resources based on an equally divided knowledge has become possible.
If a government therefore tries to inflation control in relation to a domestic price index they curb the favorable effects of this pricing system. If we think of a year in which crops die out, and therefore food is scarce, we should expect and want the price of food to reflect this scarcity (this can be understood in tandem with a point made in the next section that suggests advancements in technology should allow the prices of commodities to fall proportionally ceteris paribus).
Selgin also explains well that money itself has a demand for its use and existence and a central banks can choose to either fulfil that demand or not fulfill it. If they under-fulfill the demand for money that there will be a shortage of it and prices will fall in an undesirable way ie not from a favorable change in the production factors of the those goods such as advancement in technology. Conversely, if the demand is overmet, and there is too much money created, then this will cause the prices of goods to rise, but not from a decline in production or scarcity of goods. From an international point of view it is being argued that each of the over and under management of the supply would cause a decrease in international valuation in comparison to a standard metric of value (such as observed in times with an actual gold standard).
Selgin’s challenge of creating an e-money in which the supply is elastically related to the production factors was also addressed by John Nash who observed that such a money would necessarily be need to be regularly adjusted:
“We can see that times could change, especially if a “miracle energy source” were found, and thus if a good ICPI is constructed, it should not be expected to be valid as initially defined for all eternity. It would instead be appropriate for it to be regularly re-adjusted depending on how the patterns of international trade would actually evolve.”
This returns us to the problem in the first place, removing politically based instability in our economies:
“Here, evidently, politicians in control of the authority behind standards could corrupt the continuity of a good standard, but depending on how things were fundamentally arranged, the probabilities of serious damage through political corruption might becomes as small as the probabilities that the values of the standard meter and kilogram will be corrupted through the actions of politicians.”
He is speaking here of his concept called an ICPI which stands for “Industrial Price Consumption Index” which is a theoretical notion of an optimal basket of commodities used as a basis for value in the same way this essay argues bitcoin should be used. It is relevant to note that Nash didn’t propose the actual politically born index and instead suggested a possible scenario could arise where there is international stability of value in comparison with two currencies and that this type of gravity could occur without such a political component being necessary:
“It seems possible and not unlikely, however, that if two states evolve towards having currencies of more stable value as measured locally by national CPI indices that then also these distinct currencies would tend to evolve towards more stable comparative relations of value.
Then the limiting or “asymptotic” result of such an evolutionary trend would be in effect “ideal money” but this as a result achieved without the adoption of anything like an ICPI index as a basis for the standard of value.”
Nash suggests, the setup for this circumstances is the introduction of a “good” but not necessarily “Ideal” international money. This money would act as type of catalyst provided it has certain apolitical quality:
“I think of the possibility that a good sort of international currency might EVOLVE before the time when an official establishment might occur.”
“…my personal view is that a practical global money might most favorably evolve through the development first of a few regional currencies of truly good quality. And then the “integration” or “coordination” of those into a global currency would become just a technical problem. (Here I am thinking of a politically neutral form of a technological utility rather than of a money which might, for example, be used to exert pressures in a conflict situation comparable to “the cold war”.)”
The significant insight here is easy to miss but perfectly captured in this quote from Ideal Money, “To be quite respectable, in a Gresham-advised sense, money needs only to be AS GOOD as other material commodities that might be hoarded. It seems Nash, Szabo Satoshi, and Selgin each see a limitation in bitcoin-giving it an elastic supply creates a political lever for manipulation. Nash, however, paints the picture of a possible purpose for a version of e-money that is limited in this way.
That is to say bitcoin cannot be Ideal Money by the definition of a money that has a fluctuating supply in order to keep prices stable (or secularly deflating like Selgin correctly recommends). It is not, however, limited in the ability to be tailored to perform the monetary function as an inflation hedge like gold has historically served as.
The brilliance of Satoshi it seems is that while different people spent many years trying to solve the last problem of issuing an stateless e-currency (with an optimized supply schedule), Satoshi turned the problem around and realized that the project can never scale (on the base layer) and this can be the crux of its value mechanism.
From this view its functions is far more important to consider as a digital gold than it is as a circulating currency. And in this sense it is perfect in its design.
Avoiding the Problem of Subjective Value
The subjective theory of value is an admission that an objective unit of value is impossible since value differs depending on social factors as well as time and space. What is valuable to someone might have a different value to someone else. And what is valuable to someone in one circumstance might have a different value to that same person in a different circumstance.
The proposal for Ideal Money does not seek to create this kind of stable value metric. Instead it can be thought of as a proposal for value stable of each major currency in relation to each other. This is quite a reasonable suggest which doesn’t pose the idea that item X that is worth Y bitcoins today will be worth Y bitcoins in 10 years. In fact it should be quite natural, given a growing and more efficient economy, that money would buy more X in the future since the costs of production would decline based on technological advance (and competition in the markets would therefore pass some of that gain onto the customers).
The purchasing power of the domestic managed money would fluctuate with the circumstances of the local economy while remaining stable from an international evaluation point of view.
Congressional Admission of the Relationship Between Bitcoin and FED Inflation Targeting
If bitcoin continues to expand its network it is foreseeable that central banks would, regardless if they considered the truth of it, be forced to adjust their monetary policy actions based on the effects of the competition. This is explained in a Congressional Research report on bitcoin:
At Bitcoin’s current scale of use, it is likely too small to significantly affect the Fed’s ability to conduct monetary policy and achieve those three goals.
However, if the scale of use were to grow substantially larger, there could be reason for some concern. Conceptually, Bitcoin could have an impact on the conduct of monetary policy to the extent that it would (1) substantially affect the quantity of money or (2) influence the velocity (rate of circulation) of money through the economy by reducing the demand for dollars.
Regarding the velocity of money, if the increase in the use of Bitcoin leads to a decrease in need for holding dollars, it would increase the dollar’s velocity of circulation and tend to increase the money supply associated with any given amount of base money (currency in circulation plus bank reserves held with the Fed).
In this case, for the Fed to maintain the same degree of monetary accommodation, it would need to undertake a compensating tightening of monetary policy. At a minimum, a substantial use of Bitcoins could make the measurement of velocity more uncertain, and judging the appropriate stance of monetary policy uncertain.
Also, a substantial decrease in the use of dollars would also tend to reduce the size of the Fed’s balance sheet and introduce another factor into its consideration of how to affect short-term interest rates (the instrument for implementing monetary policy).
However, the Fed’s ability to conduct monetary policy rests on its ability to increase or decrease the reserves of the banking system through open market operations. So long as there is a sizable demand by banks for liquid dollar-denominated reserves, the Fed would likely continue to be able to influence interest rates and conduct monetary policy.
Because the value of bitcoin is inversely tied to the quality of our traditional money system the co-operative effort of each nation optimally managing the “wellness” of their respective currencies will bring each of the currencies into a state of equilibrium in relation to the value of bitcoin. That is to say the concept of having truly Ideal Money, which is effectively the global value stabilization of our major currencies, could quite plausibly be expected to be brought about in the very near future (perhaps 2 or 3 years or more or less). The proposal then is that citizenry asks that their government’s mandate Ideal Money, money ultimately (asymptotically) pegged to bitcoin’s value, and to declare this endeavour and definition of money “well-managed” by fiat.
“The price of any commodity tends to gravitate toward the production cost.”, Satoshi Nakamoto https://bitcointalk.org/index.php?topic=57.msg415#msg415
Money, Blockchains, And Social Scalability, Nick Szabo http://unenumerated.blogspot.com/2017/02/money-blockchains-and-social-scalability.html
The Monetary Value Of Liquid Commodities, Nick Szabo http://unenumerated.blogspot.ca/2008/03/monetary-value-of-liquid-commodities.html
Simulations Of Inflation Expectations And Oil Prices, Nick Szabo http://unenumerated.blogspot.ca/2008/07/simulation-of-inflation-expectations.html
Synthtic Commodity Money, George Selgin https://object.cato.org/sites/cato.org/files/articles/synthetic-commodity-money.pdf
Bitcoin Problems and Prospects, George Selgin https://www.hillsdale.edu/wp-content/uploads/2016/02/FMF-2014-Bitcoin-Problems-and-Prospects.pdf
The Use Of Knowledge in Society, FA Hayek http://www.econlib.org/library/Essays/hykKnw1.html
Ideal Money John F. Nash, Jr.
Southern Economic Journal
Various talks and writings entitled Ideal Money and Asymptotically Ideal Money, John Nash
Bitcoin: Questions, Answers, and Analysis of Legal Issues-https://fas.org/sgp/crs/misc/R43339.pdf