Tuesday, March 4, 2014

The Nature Of Money And Currency

Being an old fart, my education included a few items that are, let us say, no longer deemed suitable for dissemination to the impressionable young. However, had those young folks been exposed to a few of those items, quite a lot of our current miseries might well have been averted.

Two of those no-longer-chic items were the original definitions of money and currency:

money n: A medium of exchange and a store of value.
currency n: a proxy for money often employed in commercial intercourse.

Holding fast to those definitions make much else possible, including comprehension of the recent catastrophes that have afflicted those who placed their trust in Bitcoin.

Opinion about Bitcoin's prospects is sharply divided. This writer's faith in it appears unshaken, while this writer is much more skeptical. Both have points to make, but neither addresses the matter from the fundamental facts about money and currency:

  • What functions money must serve;
  • What properties conduce toward those ends;
  • What perils pertain to currencies that attempt to serve the functions of money.

Which will serve as the focus for today's tirade. Please forgive me if what follows seems too elementary to require discussion.

Money shares an important characteristic with language: it was a "crowdsourced" development. No one "invented" money; it evolved from the desires of ordinary people striving to live better, more secure lives.

The evolution of money from the barter system that underpins all voluntary exchange is itself a fascinating subject, but one too extended for a piece here at Liberty's Torch. (Yes, I'm a longwinded sort, but I try to respect my readers' patience. Really!) Suffice it to say that as markets grew more complex and human commerce extended over an ever larger region, various commodities were pressed into use as money, and over time were displaced by commodities that better served money's purposes. Before governments messed everything up for all of us, the predominant moneys of the world were gold and silver, with copper for the smallest of small change.

The salient characteristics of gold and silver are:

  1. They're easily recognizable;
  2. They cannot be counterfeited;
  3. They're durable over long periods of time;
  4. They're both uncommon and relatively stable in quantity;
  5. They're divisible into very small quantities without degradation;
  6. People value them for their intrinsic properties, rather than for legal reasons.

Those characteristics are the ones that make a commodity function well as money. Consider a few of the moneys that preceded the widespread adoption of gold and silver:

  • Tobacco degrades too swiftly;
  • Whiskey is too easily adulterated;
  • Corn is too commonplace, and of unstable quantity;
  • Buckskins lose their value by being divided into small pieces;
  • Big honking wheels of rock are not generally valued for their own sake, and make a hell of a lump in one's pocket, besides.

A society's choices about what will serve as money can be, and usually are, isolated from its choices about currencies. There have been many societies in which only one commodity was deemed money, yet several varieties of currency circulated in competition with one another. The most common currencies have been banknotes -- pull a Federal Reserve note out of your wallet if you need an example to study -- with small, largely worthless metallic slugs for small change. In modern economies we can also find more specialized currencies: bearer bonds and promissory notes. In an economy with a stable money, every unit of currency will represent some quantity of money, for which it can be exchanged in the proper circumstances.

A society's fiscal problems commence when people start to lose the distinction between money and currency.

We employ currencies in common transactions because they tend to be more convenient: easier to carry around. Also, when money is a physical commodity such as gold or silver, frequently handling money accelerates the process that wears it away or degrades it chemically. But a currency is not money and must not be treated as such; its intrinsic properties are not suitable for use as money:

  • It can be counterfeited;
  • It's likely to degrade far too swiftly;
  • If it's a governmental issue, it can be inflated;
  • A unit of currency cannot be divided (try that with a $100 bill);
  • It has no intrinsic value.

Indeed, the very properties that make currencies unsuitable as moneys are the reasons they become currencies in the first place -- especially when governments are involved.

Today, every government in the world produces a currency -- mostly paper notes -- that it proclaims to be legal tender: a payment applicable to goods, services, and debts that merchants, artisans, and creditors are required to accept, under penalty of law. However, no government ties its legal-tender currency to a commodity that can serve the functions of money. Every government issues as much of its currency as it pleases, according to its budgetary deficits and other obligations. The world economy, afloat on a sea of worthless paper and equally worthless digital records, is being steadily hollowed out from within by governmental deficit finance and the inflation used to fund it.

Which is why there's been such a resurgence of interest in gold and silver: not as moneys to be employed in common commerce, but as stores of value independent of the fluctuations and inflation that characterize governmental currencies.

Bitcoin, like the Federal Reserve notes in your wallet, is a currency. It cannot function as a money; it lacks the properties of money. The collapse of the Mt. Gox Bitcoin exchange has shaken the faith of many who thought they saw in Bitcoin a trustworthy alternative to governmental currencies. They failed to reckon with the many ways in which an entirely "virtual" currency can be compromised or undermined. The Mt. Gox disaster is only the first. There will be others.

Many astute and observant things have been said about money. Some of them are even true. For my money (sorry about that), the most piercing statement ever made about money occurred on the floor of the United States Senate, in 1912. The great financier J. P. Morgan had been asked to testify to that august body on monetary matters. This was the very first inquiry put to him:

Senator: Mr. Morgan, what is money?
J. P. Morgan: Gold is money, and nothing else is.

Morgan's understanding of the properties required of money was clear and unshakable.

For a poetic, emotionally charged oration on money, particularly about how it differs from currency, nothing can top Francisco D'Anconia's soliloquy in Atlas Shrugged. That speech is quoted in full here, but the pithiest portion follows:

    "Whenever destroyers appear among men, they start by destroying money, for money is men's protection and the base of a moral existence. Destroyers seize gold and leave to its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values. Gold was an objective value, an equivalent of wealth produced. Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked: 'Account overdrawn.'"

Food for thought.

1 comment:

Xealot said...

The Mt. Gox disaster is more complex than a lot of folks outside the Bitcoin community realize. First, I agree that Bitcoin is not money, it is currency. But it fulfills all properties of money except one: intrinsic value.

It is easy to recognize, cannot be counterfeited, the system is durable, they are not common, divisible to absurdly small amounts. But it isn't backed by anything. A Bitcoin itself is just numbers in a chain. Still, it has utility for transferring wealth and conducting business electronically -- it has several advantages in this respect (not the least of which is cutting the banks and their percentage out of the loop) when compared to traditional fiat.

Still, Gox shows a major flaw in the Bitcoin model. It is an ingenious peer-to-peer model, but it was not designed to be treated in a centralized manner. Holding small amounts of Bitcoin in your personal wallet is perfectly secure, for the effort to hack your computer or fork the blockchain (the only real ways to steal Bitcoin) to obtain whatever small amounts you may possess is impractical. However, when vast piles of Bitcoin are placed into centralized exchanges and online wallets, the temptation from people INSIDE the exchange (and I bet we will find it was an insider who stole from Gox) becomes too great.

Bitcoin doesn't have a recourse mechanism to deal with this situation. I stopped using centralized exchanges for my Bitcoin business some time ago because I realized that using them this way was something Bitcoin just wasn't designed to do -- in fact, it was designed for the express OPPOSITE purpose.

As a proxy -- a currency -- and a vehicle to transfer wealth or conduct electronic business, it is without peer. The individual may conduct transactions with other individuals (even on the other side of the Earth) free of regulation, paperwork and burdensome fees, in mere minutes. By allowing my webdesign business to accept Bitcoin payments, I have avoided fees and time issues associated with PayPal and Credit Card Merchant providers. Its unregulated nature has allowed me to make a tidy profit. Even Gox's collapse was profitable for me. It depressed the market for awhile and I was able to speculate a bit here and there, and turn a profit.

So, Bitcoin is useful and I do think it is here to stay. But at the same time, you are correct that it IS NOT money, and should not be used as such. Neither should it be treated the same as centralized fiat currency, because it categorically is not. Gox is proof enough of that.