Several months ago, one of my company’s engineers told me about Bitcoin. It wasn’t the first time that I had heard about the concept, but it was the first time that somebody I knew actually bought some.
Did I say some? What I meant to say is that he bought a crapload of Bitcoins. They were worth about $9 each when he acquired them, and he decided to drop a healthy $5,000 on his roll of digital bullion.
Today, even as he has sold a small percentage, his holdings are worth close to $100,000 — a very nice return for a guy in his mid-20s. He is skeptical about selling them, but he does like the idea of buying a house.
So, now that he has demonstrated a 4,000 percent IRR on his investment, I should probably concede that he was right, and that Bitcoin is the real deal… I shall — of course — do no such thing.
Instead, I will re-iterate exactly what I thought several thousand-percentage points ago: Bitcoin is ridiculous, and there is no reason why someone should buy them.
“But, Bryan, a Bitcoin is a perfectly legitimate currency…”
Yes, a Bitcoin fits many of the theoretical definitions of a currency. And if you had just completed your fourth day of Economics 101 coursework, then you would feel pretty great about yourself right now.
As any Economics professor will remind you, there is nothing particularly clever about the characteristics of money. It needs to be a portable, divisible, easily recognized form of exchange that is universally accepted by merchants and service providers.
Gold, shells, beads, etc. have all been used as currency in past years. And, it’s also true that more and more merchants have begun to accept Bitcoins.
End of story, right? Well, no, not really. There are several other key facets of a currency that need to be taken into account in the modern day.
First off, we have the matter of inflation. People who don’t understand economies think that inflation is bad. The old yapping men on FoxNews sure hate inflation! If you earn $100 and put it in the bank, then inflation acts as a sort of virtual tax on your money. It’s worth less and less each day.
But, once you get past that basic description of inflation, you realize that inflation is actually a good thing. Because the opposite of inflation is something far more terrifying and sinister: deflation. There are few acts of devastation — wrought by God or man — that can compare to the horrors of deflation.
Deflation creates what we in Silicon Valley like to call a “death spiral.” It begins when money borrowers — you know, entrepreneurs, home buyers, and other people who take risk in order to achieve greater things in life — first smell deflation. Imagine if John Q. Entrepreneur borrows $1 million to open a cool coffee shop in the Mission. Things are going great. But then, deflation kicks in…
Now, that cup of coffee that used to cost $3.75 has to go down in price. Everything is going down in price. So, John lowers it to $2.75. Then he lowers it go $1.75. But his debt is still fixed at $1 million. And when the price of a cup of coffee falls to one nickel — just like in Grandpa’s day — then John says “screw it, I give up.”
And John closes his coffee shop, because back when he borrowed that $1 million to open the coffee shop, he thought he was going to make $3.75 per transaction.
And now John has defaulted on his debt. Just like thousands of other San Franciscans. My condo would not be worth paying the mortgage on any longer, since my salary has deflated too. And my fancy new Soma condo is now only worth $100,000 in recently-deflated dollars, so why pay that $2 million mortgage? I won’t. I’m out!
And when all of us walk out on our debts, who is left holding the bag?
That’s right — pension funds and old people who buy bonds. Too bad for Grandpa. Maybe he shouldn’t have complained about prices going up so much!
As it turns out, Bitcoin guarantees that deflation must occur. In the year 2140, the money supply will freeze at 21 million Bitcoins in existence. Decades up to that point, the supply of Bitcoins will basically stagnate.
But does this mean that Bitcions will necessarily experience deflation? Well, yes it does. If people actually use it, then it will deflate.
Because if you are not increasing the money supply of a currency, then any increase in productivity will lead to deflation. Simply stated, there is an increasing amount of goods and services chasing a flat supply of money… this means that each coin is worth more than before.
And that is a bad thing.
“But, Bryan, doesn’t the price increase of Bitcoins disprove you?”
No, it proves my point exactly.
Sure, if you are someone like my engineer friend who is sitting on a bunch of coins, then the price increase is really great.
But what if you had actually used your Bitcoins in a complex financial transaction, rather than just sitting on them? What if you had bought a home for 100,000 Bitcoins, and you planned to pay it back over the next thirty years? Yikes! You are screwed.
Bitcoins have proven one thing so far this month… you do not want to buy or sell anything denominated in Bitcoins.
And as long as Bitcoins have no prayer of being used in complex financial transactions, then they are more of a curiosity than they are a currency. They are a talking point, not an action point.
Just wait until the media’s little fascination with Bitcoins comes to an end. Then, once they serve no financial purpose whatsoever, then things will get interesting.
“But, Bryan, our government causes all sorts of currency problems, aren’t we safer with a non-manipulated currency?”
No, we are safer with a currency that is managed by a government that can manipulate that currency.
For all the complaints about Ben Bernanke (the man who manages America’s currency), he has done a great job of preventing deflation and other economic hardships that would come with it.
Europe is the counter-example. They don’t have a way of centrally controlling their currency, because there are too many proverbial cooks in the kitchen. Getting 17 countries to agree on anything is impossible, which is why their problems are so much more severe than ours. Countries like Greece and Spain are in trouble primarily because they can’t lower the prices of their (comparatively weak) goods and services. Thus, they are not competitive on a global scale. They need to weaken their currencies via inflation, but other countries (like Germany) won’t let them.
Spain is a country that ran a budget surplus prior to the Great Recession. They were careful with their spending — much more careful than America. Now their unemployment rate sits at 27 percent, and it’s all thanks to a non-manipulated currency.
That’s right — reckless government spending and terrible financial habits are not nearly as bad as a non-manipulated currency. Spain was a model government with healthy spending habits… but their currency has ruined everything.
And as for Japan?
Their Prime Minister recently decided to inflate away the Yen. Now the Yen is worth much less, and all of those Sony and Toyota products are cheap again to us Americans. Now we don’t have to buy the Korean equivalents (Samsung and Kia).
The result is that their stock market is booming like nothing we’ve seen before.
Wait, you thought that Sony became irrelevant because of poor product innovation? No, that’s ridiculous. Samsung and LG are equally lame in their inability to innovate, but they just have a weaker currency. So when they rip off Apple, they do it for cheap, and everybody loves their cheap Korean products.
Japan finally gets this…about ten years too late. But they get it. Yes, this whole currency thing is more than meets the eye.
“But, Bryan, all this government stuff feels sketchy, like we are having a currency war…”
We sure are having a currency war. And the only way to prevent it from spinning out of control is to make all countries participate in it — to make all countries fear the never-ending nature of it.
Back in the Cold War, there was a concept called MAD, or “Mutually Assured Destruction,” and it really leveled the playing field. When every major country had nuclear weapons, then people really calmed the hell down when it came to nuclear threats. Bomb us, and we bomb you.
It is only by having a world where all currency can be manipulated that we can avoid a situation where it happens perpetually. After all, which is more realistic — a world where all nuclear weapons are eliminated, or one in which every major country has them, and thus nobody ever uses them?
The latter is more realistic.
Bitcoin is like the idealistic country that doesn’t need nuclear weapons. It doesn’t need inflation or manipulation. It doesn’t need any of that crap. And it doesn’t need to exist within the confines of reality, evidently.
And, while we are on the topic of armies and war and nukes, let me make another point about currency…
It’s really nice when your currency is backed by a huge military. Like the United States Military. After all, the first and most fundamental role of government is to defend your property. That’s why we put up with taxes — because it’s better than anarchy, a circumstance that would lead to hooligans stealing our homes (and all other possessions) at gunpoint.
Is Bitcoin backed by a military? No, it is not.
So, when China manipulates their currency, and we get upset about it, we probably won’t do anything because we fear their giant military and arsenal of nukes. But, it’s unlikely that the engineers behind Bitcoin can provide the same intimidation tactics.
“But, Bryan, we were having so much fun with Bitcoin being in the news. Can’t you stop raining on our parade?”
Sure, I can stop raining on your parade. I’ll stop right now.
But please get back to doing your real job, which is to help engineer amazing products that change the world through innovation, convenience, and problem solving.
And stop trying to be an economist. You’re not an economist. You are a software engineer. I don’t want you practicing medicine or law either.
[Illustration by Hallie Bateman]