Can Bitcoin Become Money?
A familiar question that Frank Shostak recently raised, so at Liberty Chat I gave my usual answer:
The reason Mises needed to supplement his theoretical explanation of the purchasing power of money with his historical “regression theorem” was simply to protect the explanation from charges of infinite regress. In other words, since Mises was explaining today’s purchasing power of money (ultimately) by reference to its purchasing power yesterday, Mises needed to come up with a way to stop the explanation at some finite point in the past. He did this by saying at some point, the monies gold and silver (or other commodity monies) were mere commodities in a system of barter. Economists already knew how to explain relative prices in a barter world, so Mises could stop, having completely explained the purchasing power of money in a logically coherent way.
We can give a similar explanation for Bitcoin. We can trace back its purchasing power until the point at which Bitcoin was invented. Certain people really did sell pizzas and other goods against bitcoins in the first transactions. Why did they do so? I don’t know; ask them. But the point is, they did do so. That gave everybody an objective frame of reference for the market value of bitcoins, which then snowballed to the present day.
In closing, let me be clear that I am not necessarily predicting that Bitcoin will one day be used by billions of people as a primary money. Rather, I am merely arguing that the argument against Bitcoin citing Misesian monetary theory—such as Shostak recently used—doesn’t work.
The Final Nail in the Coffin: MPK Is Not *Sufficient* For Interest, Either
For those who really want to understand what all the fuss is about capital & interest, you need to get a cup of coffee, perhaps even a piece of paper and pencil, and spend 20 minutes reading my latest Mises Canada post. You know I don’t often ask these things of you, but this is really tough stuff and it takes a while to free your mind from its shackles.
In this latest post, what I’ve done is tweak my bird economy to show that even if there are physically productive nets which augment output, and even if everybody gets paid his or marginal product, the rate of return on financial capital can still be zero. An excerpt:
Suppose our hypothetical economy only last for 10 periods, and that everybody has perfect foresight of what’s coming. This time, however, the “bird catch” steadily declines each period, in order to perfectly offset the natural “time preference” in people’s subjective preferences. Thus, in equilibrium, a bird in period 1 trades for a bird in period 2, which trades for a bird in period 3, etc. Yes, *other things equal* people would prefer a present bird to a future bird, but other things aren’t equal: There is going to be very little bird consumption occurring in period 10, so a worker even way back in period 1 would be willing to trade away one of his present birds in order to obtain an airtight claim to someone else’s bird to be delivered in period 10.
Now then, the other wrinkle in our hypothetical economy is that a few workers start out in period 1 in possession of nets. A worker with a net can always catch 1 bird per hour more, than a worker who just uses his bare hands. (It’s true that over time it gets more difficult to catch birds per hour of labor, but workers also get more adept at handling the nets. The advantage of having a net in your possession is always 1 extra bird per hour, for periods 1, 2, …, 9, and 10.)
Notice that in this world, capital goods and labor contribute to total output. (When we explained that the real interest rate on birds would be exactly 0% because of the declining bird catch per period, we had already taken into account the fact that workers would be using the nets optimally.) We are assuming standard competitive markets, meaning that each worker earns the marginal product of his labor. The owners of the nets also earn the marginal product of their capital goods: Either they use the nets themselves and reap the extra output, or they rent the net to another person who then hands over the surplus above what that person would have caught with his bare hands. Either way, the earnings of the net owners are 1 bird/hour of usage.
Finally, to keep the math simple, suppose that all the workers just work for 10 hours each period. (If you want, you can suppose that there is only a 10-hour window each period when the birds fly low to the ground. Or, you can assume that the workers’ preferences for leisure just happen to yield the result that everybody always optimally choose to work exactly 10 hours each period, all things considered.) What can we say about the earnings of the capitalists, i.e. the owners of the nets?
Well, it’s clear that the owners of the nets will receive a flow of “real bird income” of 10 birds per period. If they want, the capitalists can thus eat 10 birds per period more than the workers who only have their raw labor power to generate an income. Now in Piketty’s preferred framework where we calculate a distribution of “national income” between “labor and capital” or between “the workers and the capitalists,” clearly we should say that the capitalists are getting some of the output, while the workers are getting the rest. According to Piketty, the share of income going to the capitalists is the real return to capitalr multiplied by the stockpile of capital β. (Remember he uses the formula α = rXβ.) Since the result is positive–we know the owners of the nets are getting birds each period, while the workers aren’t retaining the full catch–it must be the case that the real rate of return on capital is positive.
Oops, except that it isn’t. If we calculate the market price of the nets in each period, we can see that their owners earn a zero return.
It’s easiest to work backwards. At the end of period 10, the market price of the nets will be 0 birds; nobody would trade even a single bird to buy the net from an owner, because the world ends in period 10.
At the end of period 9, people know that a net still has one period left to contribute to physical output. This contribution will be 10 birds (accruing one period in the future). But since (in this contrived example) we’ve adjusted things on purpose to get birds trading at par across time periods, that means a “bird-in-period-9″ has the same market value–trades one-for-one against–claims to a “bird-in-period-10.” Thus, the market price of the net in period 9 is “10 present birds.” In other words, the owner of a net could sell it outright in period 9 to someone who would hand over 10 birds that could be eaten on the spot.
At the end of period 8, similar logic shows that the spot market price of the net must be 20 birds immediately available. At the end of period 7, the market price of the net will be 30 birds, etc. etc., and at the end of period 1 the market price of the net will be 90 birds. Also note that at the beginning of period 1–which is equivalent to the “end of period 0″ before time begins–the net has the full value of 100 birds, which will be its lifetime contribution to physical output.
Now then, suppose the owner of a net asks his accountant to calculate the rate of return on his financial capital from period to period. What will the answer be?
The accountant will say, “At the beginning of period 1, your net had a market value of 100 birds. During that period, you rented it out to earn a gross return of 10 birds. However, even though the net was physically in perfect condition when the worker gave it back to you after his shift, by the end of period 1 the market price of the net had fallen to 90 birds. Thus your total wealth went from 100 birds at the start of the period, to 10+90 = 100 birds at the end of the period. You just treaded water financially speaking; you converted the form of your wealth from being 100% concentrated in a net to being 90% in a net and 10% in a stockpile of birds. But your total wealth–measured in market value–didn’t go up. Your rate of return was zero.”
If you go to the link, you’ll also see I included a quote from Mises on this stuff. I figured if it’s Mises Canada then Bohm-Bawerk shouldn’t be getting all the love.
Heterodox Economists School Krugman on His Flim-Flam Econ
Wow, I thought I was hard on the guy… In the debate over Thomas Piketty’s book on Capital, many of the heterodox leftist economists are coming out of the woodwork to complain. Specifically, the problem is that Piketty relies on the mainstream notion that interest in a market economy is determined by the “marginal product of capital,” just as wages are determined by the “marginal product of labor.”
This is totally muddled, as the great Austrian economist Böhm-Bawerk showed in the late 1800s. But interestingly, leftist economists such as Joan Robinson brought up a similar critique during the Cambridge Capital Controversy of the 1960s.
In any event, Krugman has been carrying water for Piketty, defending him from all onslaughts. This has led the heterodox leftist economists to go after Krugman.
(1) In this post, Thomas Palley attacks the “flimflam” defense of mainstream economic theory offered by Paul Krugman and Simon Wren-Lewis. My favorite part (all bold in this post is from me):
Krugman’s freshwater – saltwater characterization is profoundly misleading regarding the intellectual state of mainstream economics. Whereas the freshwater metaphor makes sense, the saltwater metaphor does not. The true saltwater school is the now eviscerated Cambridge (UK) School of economics that was home to the likes of Joan Robinson and Nicholas Kaldor. The MIT School is better described as brackish (or even putrid) water.
(2) Then in this post Lars Syll takes Krugman to task because he (Krugman) foolishly wrote:
[KRUGMAN:] And what’s going on here, I think, is a fairly desperate attempt to claim that the Great Recession and its aftermath somehow prove that Joan Robinson and Nicholas Kaldor were right in the Cambridge controversies of the 1960s. It’s a huge non sequitur, even if you think they were indeed right (which you shouldn’t.) But that’s what seems to be happening.
Perhaps somewhat in shock–I know I was very surprised at the flippancy with which Krugman dismissed the Cambridge debate–Syll provides two quotes from mainstream, neoclassical economists who were eyewitnesses to the controversy. The first is from Paul Samuelson who conceded that the Cambridge UK critics had made a good point: “Pathology illuminates healthy physiology. Pasinetti, Morishima, Bruno-Burmeister-Sheshinski, Garegnani merit our gratitude for demonstrating that reswitching is a logical possibility in any technology, indecomposable or decomposable.”
Then Syll quotes from Edwin Burmeister who explained:
It is important, for the record, to recognize that key participants in the debate openly admitted their mistakes. Samuelson’s seventh edition of Economics was purged of errors. Levhari and Samuelson published a paper which began, ‘We wish to make it clear for the record that the nonreswitching theorem associated with us is definitely false’ … Leland Yeager and I jointly published a note acknowledging his earlier error and attempting to resolve the conflict between our theoretical perspectives … However, the damage had been done, and Cambridge, UK, ‘declared victory’: Levhari was wrong, Samuelson was wrong, Solow was wrong, MIT was wrong and therefore neoclassical economics was wrong. As a result there are some groups of economists who have abandoned neoclassical economics for their own refinements of classical economics. In the United States, on the other hand, mainstream economics goes on as if the controversy had never occurred. Macroeconomics textbooks discuss ‘capital’ as if it were a well-defined concept — which it is not, except in a very special one-capital-good world (or under other unrealistically restrictive conditions). The problems of heterogeneous capital goods have also been ignored in the ‘rational expectations revolution’ and in virtually all econometric work.
This is admittedly a very technical area; in this article I try to explain the “reswitching debate” in layman’s terms. But my point in this present post is to show how much Krugman simply bluffs. It is clear from Piketty’s 3-page description and Krugman’s glib dismissal that neither man really understands what happened during the Cambridge capital controversy. In a heated discussion of a 600+ page book devoted to capital and income distribution, that is a very serious weakness.
Showing Problem With Piketty Using Neoclassical Models
I am an Austrian economist. My understanding of capital & interest comes (originally) from Mises, but then it was refined in grad school when I studied Bohm-Bawerk, Fetter, and Fisher.
In case I haven’t been clear: One doesn’t need to be an Austrian to understand what’s wrong with Piketty’s conceptual remarks about capital & interest income. The reason I personally can “see” this is because of my background with the Austrian School, but a true student of the history of economic thought and neoclassical theory (which includes Paul Samuelson but not Paul Krugman) would understand the problem with Piketty’s remarks. So here are some links:
==> Nick Rowe has a great post today walking through standard two-good diagrams with PPFs and indifference curves, to show that interest is not “determined” by the marginal (physical) product of capital. This is standard stuff from Irving Fisher.
==> If you understand formal notation and modeling (like the Solow growth model), then check out the appendix (starts on page 178) to my dissertation. I show that in general, the equilibrium real rate of interest is not equal to the derivative of the production function with respect to K. It’s only under very special conditions that the general formula reduces to “r=MPK.”
==> Finally, go look at Paul Samuelson’s referee reports on my two journal articles where I fleshed out the appendix. I took Bohm-Bawerk’s verbal analysis and put it into a neoclassical model. I showed “with math” that Bohm-Bawerk was right and the naive productivity theory was wrong. As you will see, Samuelson had some quibbles with the conclusions I drew etc. (in particular he denied that some authors were advancing a “naive” theory), but he told them to publish the papers (which they did).
Let me say something in closing: Thomas Piketty isn’t stupid. He is aware of some of these issues. But it’s like the classical economists who adhered to a labor- or cost theory of value. Adam Smith understood full well that if you spent 10 hours making a mud pie, nobody would buy it. Yet it is still correct to say “the labor theory of value is utterly muddled” and to use simple thought experiments to get people to see why it’s utterly muddled.
A Question for the Piketty Defenders on National Income Accounting and Interest
OK Kevin Donoghue manages to escape the trap I had set for Piketty, much as Luke Skywalker–nursing his mangled arm–fled Vader at the end of The Empire Strikes Back.
To refresh your memories: Piketty clearly had argued that if the “marginal productivity of capital” (and from his discussion it was clear that this was a technological state of affairs, having to do with physical facts) is zero, then the return to capital r is also zero, meaning that in any period the income flowing to capital must be zero.
So I set out to show the problem with this framework. I specified a thought experiment in which all production is “due” to labor in an economic sense, and where there is clearly no physical contribution of capital goods or other forms of wealth (such as land). Nonetheless, I showed how someone in possession of a stockpile of consumption goods in period 1 could trade them intertemporally in order to obtain a perpetual flow of real consumption, which was obviously coming out of the catch that the workers were physically producing each period.
So, in response, Kevin Donoghue gave the best reply on behalf of Piketty: “Actually I’m pretty sure Piketty would simply say: loans (whether payable in money or birds) are not net wealth. I owe you 5 birds, payable next spring; an asset in your books, a liability in mine. In aggregate, Beta = 0.”
As I said, *that’s* a defensible response. It moves us forward one step in this debate (as opposed to the people trying to argue that Piketty doesn’t think “interest” counts as income to capital, or claiming that Piketty never meant that the marginal product of capital had anything to do with the rate of return on capital).
Now I could grapple with Donoghue’s response in the terms of my thought experiment, but instead I want to turn it back to the defenders of Piketty: You show me a paradigmatic example of what would count in the national income statistics as “net interest income” flowing to the capitalists. As always with these things, try to keep the example as simple as possible; boil it down to the essence of what you think “net interest income” really is, if you’re denying that my example shows a portion of total national income going to capitalists.
(NOTE: The purists can of course bite my head off for even “playing this game.” That’s fine, you’re right that there are problems with the very idea of GDP etc. But I’m doing baby steps here. I want to show the believers in the naive productivity theory of interest that their worldview leads to internal contradictions; I don’t need to replace their whole economic framework to do that.)
Bookkeeping: More Commentary From Others on Piketty
This post is mostly so I don’t lose these links…
==> George Cooper is a blogger after my own heart. He comes up with a fable of a kingdom trying to show why Piketty’s approach confuses cause and effect. However, I think Cooper leaves out one loose end when valuing his capital stock etc.; his approach is a bit too mechanical and Ricardian for me. But you could plug in some subjective preferences to round out his story, I believe.
==> Piketty and co-author’s QJE paper in which they lay out the technical discussion. In the section on conceptual framework, they do get into the issues of a two-good model and how the capital/income ratio can rise because of a capital gain where the market price of capital goods vis-a-vis consumption goods increases, not because of physical growth in the stockpile of capital goods.
==> To his credit, Brad DeLong acknowledges the apparent contradiction between Summers (worrying about persistently low r and permanent secular stagnation) and Piketty (worrying about persistently high r and growing income inequality). DeLong solves the problem by saying there are different rs. (HT2 a reader in the comments at an earlier post here.) How convenient…
A Fleshed Out Example Showing Problems With Piketty
[UPDATE: Note that I clarified the thought experiment to make sure it’s obvious that all physical production is due to labor in an economic sense.]
At Mises Canada I elaborate on an example showing Piketty’s approach is flawed even on its own terms. First I’ll refresh your memory about Piketty’s framework:
Technology naturally plays a key role. If capital is of no use as a factor of production, then by definition its marginal productivity is zero. In the abstract, one can easily imagine a society in which capital is of no use in the production process: no investment can increase the productivity of farmland, no tool or machine can increase output, and having a roof over one’s head adds nothing to well-being compared with sleeping outdoors. Yet capital might still play an important role in such a society as a pure store of value: for example, people might choose to accumulate piles of food (assuming that conditions allow for such storage) in anticipation of a possible future famine or perhaps for purely aesthetic reasons (adding piles of jewels and other ornaments to the food piles, perhaps). In the abstract, nothing prevents us from imagining a society in which the capital/income ratio β is quite high but the return on capital r is strictly zero. In that case, the share of capital in national income, α = rXβ, would also be zero. In such a society, all of national income and output would go to labor. [Thomas Piketty, pp. 212-213]
And now an excerpt of my response to show why this doesn’t work:
[I]magine a world where there are no physical capital goods, machinery, or tools of any kind. Further, land and other natural resources do not contribute to production in any way that can be appropriated by humans.
In this strange world, the only way people can eat is that workers can jump up and grab (edible) birds as they fly overhead. These birds are the sole source of consumption in this economy. However, there is no advantage to standing in one spot versus another; the likelihood of catching a bird is the same on any particular plot of land.
Notice that in this odd scenario, we have satisfied Piketty’s requirements: Technologically speaking, there is no role for capital goods or physical wealth of any kind to contribute to production. Human labor is the sole source of consumption. Therefore, Piketty would conclude that 100% of GDP every period must be attributable entirely to wages, with the capitalists earning 0% of GDP in the form of capital income (whether in the form of interest, dividends, profit, etc.).
Yet hang on. This isn’t correct. Even within the confines of Piketty’s thought experiment, it’s possible that someone in period 1 accumulates a stockpile of the birds, let’s say equal to 50% of that period’s total catch. [UPDATE: Just to clarify what I had in mind, further assume that the reason this person in period 1 catches so many birds is that he figured out a good technique. Then, in subsequent periods, the other workers copy his technique. At any time, the constraint on catching more birds is how much time a person is willing to put into it. Thus there are no rents accruing to those who captured scarce natural resources; production is entirely attributable to the expenditure of scarce labor.] Thus β which is “capital/income” is 50% of GDP in Piketty’s framework. Now since (by construction) there is no way this stockpile of birds can contribute physically to more output, Piketty wants us to conclude that the real return on capital (i.e. the real interest rate) is zero, so that α = rXβ which is “capital’s share of income” is also zero.
But this isn’t necessarily correct, and the possibility of a counterexample shows that Piketty’s framework is wrong. If we suppose that everybody expects the flow of birds to increase steadily over time, and we further suppose that people have subjective preferences in which there is diminishing marginal utility from consuming additional birds in each period, then in equilibrium we will see a premium placed on present consumption versus future consumption. That is, someone will be able to sell a bird in period 1 for a claim to more than one bird in period 2.
For example, suppose the capitalist who starts out in period 1 with the stockpile of birds is able to sell them for claims to twice as many birds available in period 2. This will be physically possible and in everybody’s interest if the “bird catch” grows enough from period to period. Then the real interest rate in this economy is 100% per year.
If you want specific numbers, imagine in period 1 the total bird catch is 100 birds, and one really lucky worker happened to nab 50 of them. So he starts out period 1 with a “capital stock” of 50% of GDP. Then in period 2 maybe the total bird catch jumps to 200 birds and it’s more evenly distributed among the workers, and moreover everybody saw this coming. So in period 1, the workers who were really hungry might agree to pay 100% on a loan from the rich capitalist. He lends out his 50 birds, then next period out of the catch of 200 total, the other workers pay him back 100 birds.
Thus, a macroeconomist looking at period 2 would say GDP was 200 birds, and the “interest income” of the capitalist was 50 birds (because of the total 100 birds given to him, 50 was interest, the other 50 was payback of principal). Piketty would be forced to say that the entire output of 200 birds went to labor in period 2, because capital has no physical contribution to output. Yet it seems undeniable that from an accounting standpoint, the capitalist earned 50 birds in “real” interest income, meaning that the workers must have only earned 150 of the birds in terms of wages.
Whether r < g or r > g, We Need Much Bigger Government
I was toying with this idea but hadn’t had time to go document my claims. But now Nick Rowe is saying the same thing, so I’ll let him put his head out there. Anyway here’s the claim:
(1) A few months ago, Krugman was agreeing with Larry Summers that we were stuck in a period of secular stagnation. For various reasons, the market-clearing real rate of interest would be so low that we needed to either permanently boost (price) inflation and/or enact permanent fiscal stimulus programs in order to ensure full employment. Nick summarizes the problem as r < g. (2) Now with Piketty's book, Krugman et al. are agreeing that we are entering a period where r > g and it will only get worse over time. This shows why we need a worldwide tax on wealth.
OK kids: Fair or unfair? For sure claim (2) is right, but is it correct to characterize the worries over secular stagnation as “r < g"?
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