30 Dec 2013

A Bit of Silliness

Bitcoin, Krugman, Tyler Cowen 26 Comments

Something is really screwy with all of this cryptocurrency discussion. I feel as if a bunch of academics are “proving” that spaceflight is impossible.

To take but one example, Tyler Cowen has a long post saying that Bitcoin will collapse in price, where his argument seems to rely on one (or both) of the following premises:

(A) People would rather work for quarters than dollar bills, because you get more quarters per hour of labor.

(B) Somebody would sell me something for $400 knowing that it would be guaranteed to quickly rise (within a day or two) to $500.

I’m not saying Tyler is dumb. On the contrary, it would take someone really really sharp to write a long post resting on one (or both) of the above premises.

Last thing: I am NOT a cheerleader for Bitcoin. I am merely acting as a defense attorney, batting back what seem to me to be specious objections. (Plus Krugman says Bitcoin is evil, so there ya go.)

26 Responses to “A Bit of Silliness”

  1. Brent says:

    Tyler’s post doesn’t make sense. It’s too late here, but there is something wrong with arguing that the price of the competing ‘coins’ will be continuously driven lower because they are (always?) expected to go higher. Something’s got to give.

  2. Major_Freedom says:

    Murphy, isn’t it tragic that you have to make the disclaimer about not cheerleading for Bitcoin when you make these types of arguments?

    It’s almost as if you have experience in this, being accused of wanting to impose a gold standard on everyone just because you defended gold as money against those who are just making incorrect claims about it.

  3. Yancey Ward says:

    Glad it wasn’t just me. I have a lot of respect for Cowen’s intellect, but that blog post seemed to be one fallacy stacked upon another, and I am someone who thinks Bitcoin will probably end up worthless at some point in my lifetime.

  4. David R. Henderson says:

    Bob, I didn’t find Tyler’s argument totally persuasive, but can you tell me where he’s making the equivalent of statement A?

    • Yancey Ward says:

      David, isn’t (A) really the essential meaning of the following:

      “For purposes of argument, let’s say that a year from now Bitcoin is priced at $500. Then you want some Bitcoin, let’s say to buy some drugs. And you find someone willing to sell you Bitcoin for about $500.

      But then the QuitCoin company comes along, with its algorithm, offering to sell you QuitCoin for $400. Will you ever accept such an offer? Well, QuitCoin is “cheaper,” but of course it may buy you less on the other side of the transaction as well.”

      The buyer of the Bitcoin want $500 of buying power this instant, not a “coin” per se.

      • Major_Freedom says:

        “but of course it may buy you less on the other side of the transaction as well.”

        That’s the key passage. It may buy you less. He’s implicitly suggesting a conversion rate of Bitcoins to Quitcoins like dollars to quarters.

    • Bob Murphy says:

      David, Yancey is right. Tyler is saying that if I want to buy $500 worth of drugs using a cryptocurrency, I can either buy a stable $500 worth of Bitcoin, or I can buy $400 worth of an alternative that will quickly appreciate to $500.

      Yet the way Tyler said it’s “cheaper” and then qualified it, made it sound as if the “cheaper” thing were a legitimate plus in its favor, that might perhaps be offset by other factors. As opposed to, a factor that really isn’t relevant at all. E.g. nobody would say, “Should you buy your coffee with dollars or Mexican pesos? Well, Mexican pesos are cheaper, though of course that might affect how many pounds of coffee you end up getting on the other side.” Wouldn’t that be a weird thing to write?

      • David R. Henderson says:

        Got it. Thanks, Yancey and Bob.

  5. Major_Freedom says:

    I think a good way of constructing a general framework to understand whether the Bitcoin industry is in a “bubble”, is to use good old fashioned ABCT.

    We can start by asking the following questions:

    1. Is the production of Bitcoins being propped up “artificially” by unsustainable inflation and credit expansion from the Federal Reserve System? Specifically, is the production of Bitcoins expanding on account of “artificially” low interest rates, where individual investors and consumers are being misled as to the actually supply of savings available to finish the Bitcoin project?

    2. Once consumer prices rise to a point that triggers the Fed to tighten, and malinvestments are revealed, will Bitcoins be one of them? Will the production of Bitcoins currently taking place become unprofitable due to a relative reallocation of spending?

    I am not certain either way.

    On the one hand, the main reason Bitcoins started in the first place, was to be able to trade in a currency that won’t be arbitrarily inflated. In this sense, it is reasonable to conclude that Bitcoins are indeed a “bubble”, because the reason why they exist at all, is because of inflation and credit expansion.

    On the other hand, even if we assume that the Fed tightens in the future, and malinvestments are revealed, the coding inherent in Bitcoins is that the production of them will continue on towards 21 million. Sure, the production might slow down due to many Bitcoin miners losing their “day jobs”, but I don’t expect the production to decline significantly like housing declined, or like the dot com startups declined. So in this sense, Bitcoins are not going to go through a large correction and as such are not really in a bubble right now.

    I don’t know where it will go.

    • Major_Freedom says:

      One of the confusing factors in all of this is the pervasive habit of thinking about the value of all things in terms of dollars. If Bitcoins are going to be a money, then we’re going to have to start thinking about the value of things in terms of Bitcoins, including dollars.

      So if we see a meteoric rise in the dollar price of a Bitcoin, we should view that as the value of dollars precipitously declining in terms of Bitcoins. It takes more dollars to buy a Bitcoin the same way it takes more and more electronics to buy dollars.

      If the dollar price of Bitcoins falls, then we should be viewing that as a dollar boom. If the dollar price of Bitcoins rises, then we should be viewing that as a dollar bust.

      Bitcoins are a medium of exchange, and so Tyler’s assertion that Bitcoins are in a bubble because the dollars price has risen so much, is implicitly denying Bitcoins are a medium of exchange. He’s still thinking in terms of dollars. Would he say the same thing with the Venezuela currency vis a vis the dollar? Would he say that the dollar is in a bubble because the Venezeula currency price of a dollar is rising so fast? If not, why do it with Bitcoins?

      • Matt G says:

        The dollar is still the world’s money. Bubbles are viewed in terms of the dollar. We can talk about the market capitalization of Bitcoin, but no one talks about the market capitalization of dollars.

        Limited use as money notwithstanding, it seems pretty clear that today Bitcoin is still a speculative asset. Most of its value is derived from the belief that it will become a widespread medium of exchange.

        Thought experiment: tomorrow the dollar collapses – would you rather be holding Bitcoins or Euros? Which one has the more stable prices for real goods and services, ample gold reserves with which to defend itself, and can practically be used to buy real things?

        People will stop talking about Bitcoin as being a speculative bubble once it is “normal” to make purchases in Bitcoins. To do this it will need to see massive growth in its use for real transactions. Personally, I think the dollar is so fragile that any significant threat such as this would be enough to tip it over before Bitcoin has the chance to grow to the point where it can compete with the Euro as the successor medium of exchange.

        Additionally, from a normative standpoint, I’m actually more comfortable with the ECB or even the Fed managing the money than I am with the possibility of Satoshi Nakamoto single-handedly crashing the world economy because he had a bad day. I can’t see people with real wealth buying in to such a top-heavy system.

    • Matt M (Dude Where's My Freedom) says:

      “because the reason why they exist at all, is because of inflation and credit expansion.”

      I don’t think that’s necessarily true. That’s A reason, and maybe the most important reason, but it’s not the ONLY reason. Plenty of people continue to use Bitcoin because it’s an anonymous payment system (or at least much closer to anonymous than a credit card ever will be) or because it’s easy to use (provided you’ve found a vendor that accepts it).

      • Major_Freedom says:

        You’re right, that was too strong.

        I should have said the main reason, or one reason.

      • Tel says:

        And Bitcoin tends to have lower fees than credit cards, and no charge-backs (which makes the vendors happy).

  6. Blackadder says:

    Something is really screwy with all of this cryptocurrency discussion. I feel as if a bunch of academics are “proving” that spaceflight is impossible.

    I’ve had the same thought. In his ‘Bitcoin is Evil’ post, for example, Krugman says: “So far almost all of the Bitcoin discussion has been positive economics — can this actually work? And I have to say that I’m still deeply unconvinced.”

    I had to stop and scratch my head after reading that. I mean, we know that Bitcoin can work because it does work. People are using Bitcoin as a medium of exchange and as a store of value. If you want to argue that they are stupid to do so, fine. But that’s a separate argument. It’s one thing to say in 1998 that the Internet won’t have a big impact on the economy; it’s quite another to say in 1998 that the Internet is impossible.

    • Matt M (Dude Where's My Freedom) says:

      Maybe if Bitcoin enthusiasts promised to wander around with guns and force people to pay in and accept bitcoin, Krugman would be more convinced of its ability to “work”

      Make no mistake, that is his major objection here. Bitcoin does not rely on force, therefore it cannot possibly be any good.

      • Blackadder says:

        Bitcoin does not rely on force, therefore it cannot possibly be any good.

        This is meant as a slam, but I think Krugman would agree. One of the key features of U.S. dollars is that you have to have them to pay taxes to the U.S. government. So as long as that’s true, there’s always going to be some demand for U.S. dollars.

        By contrast, it’s not clear that Bitcoin has any non-monetary value. So it’s not entirely clear why people would want to accept it, any more than they would accept MurphyBucks, or some other made up currency. In fact, a lot of Austrians were initially skeptical of Bitcoin for precisely this reason.

    • Major_Freedom says:

      I’m with you on that point, but I’m guessing that he’s thinking “can this actually work” really means “will this continue to work?”

      Deep down, I mean way in the recesses of his mind, he really really means “Will governments fail stop people from using them, through threatening them with violence if they do not stop? I’m not convinced, because the government is a rockstar when it comes to compulsion.”

    • Silas Barta says:

      Just today I was getting lectures from people about how Bitcoin has a “chicken and egg” problem yet to solve in terms of getting it accepted by being valuable and vice versa.

      Kinda like the one it solved two years ago when the only thing you could buy with it was alpaca socks?

      • Major_Freedom says:

        Are you still mining Bitcoins? Or have costs exceeded the benefits for us regular non-supercomputer folk?

        • Silas Barta says:

          Stopped a while ago, even before my tell all. You need specialized hardware now to be profitable.

  7. Tel says:

    There would surely be fundamental store of value in any device that consistently annoys Paul Krugman.

    I predict that Western governments will get together and outlaw cryptocurrency, I also predict that people will keep using it even when it is outlawed (after all, drugs are outlawed and we know how well that worked).

    Also, there will be new cryptocurrencies coming along, in fact there already are, Bitcoin is merely the biggest network (and hence the most valuable). Probably new and improved features will encourage people to move onto something else (eventually) but it’s not trivial to outdo an existing network.

    • Matt M (Dude Where's My Freedom) says:

      “Probably new and improved features will encourage people to move onto something else (eventually) but it’s not trivial to outdo an existing network.”

      Indeed. Look at all the newer social networks with “better features” that have failed to put a dent into Facebook’s market share. A large userbase is a feature in and of itself, and for many potential customers, the single most important feature by far.

      It doesn’t matter how much “better” Google Plus is if none of your friends are on it. And it won’t matter how much “better” any bitcoin alternatives are if nobody accepts it as payment.

      • Tel says:

        Facebook has only been around for a few years, look how fast MySpace got trashed. Anyhow, twitter sold better on the share market (God knows why, but someone thinks it’s good).

        Each new generation wants to do something different to their elder brothers and sisters, especially they want something different from their parents. I’ve seen it in programming a dozen times: perl is older and the syntax is easier and there are more libraries but a whole bunch of bright young things rushed out and insisted on using python just so they could get the opportunity to rewrite all those libraries. It will happen with Bitcoin as well, cycles are roughly every 10 years.

  8. nl7 says:

    We already have a concept for the integration of today’s value and tomorrow’s future value, it’s the net present value. So Tyler’s expected situation only holds to the extent that you find enough people making errors estimating the value (and appreciation) of currency, or there is no functioning market in the currency that would enforce the law of one price. Rubes are not a stable foundation for the predicted equilibrium, and the idea that large numbers of merchants would switch to a fly by night currency without some institutional third party quoting a spot price is unrealistic. So all these currencies would either be too small to change things or too well traded to have mismatched prices.

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