It’s a mistake to read too much into short-term fluctuations in Bitcoin’s value.
On the contrary. Short-term fluctuations in value tell you everything you need to know about Bitcoin. It tells you that as a medium of exchange it is an utter failure. Who wants to undertake daily transactions in a currency whose value gyrates wildly?
Pointer from Tyler Cowen.
The same thing could happen to the dollar, although it won’t.
As a thought-experiment, imagine that everyone developed amnesia overnight about the dollar price of everything. They wake up having to quote prices in dollars. Do you think that anyone would have any clue what to charge in dollars today without knowing what prices were yesterday? Under the amnesia scenario, Americans would pick some other currency to use for ordinary business. Heck, they would be happier taking rubles than dollars, if rubles had some history to them. In the amnesia thought-experiment, the dollar would become like a Bitcoin–a crazy, speculative oddity that nobody would use for daily transactions.
This thought-experiment, which makes perfect sense to me, runs counter to everything economists teach about monetary theory. In standard monetary theory, nobody has to remember anything. Each new day, whether you start with a blank slate or not, the market will grind out the relative prices of everything, and then the dollar prices will be determined by the quantity of dollars in circulation.
Monetary theory wants to make dollar prices precisely determinate. My perspective is that money and prices are consensual hallucinations. We would prefer that prices not be volatile. We conduct our daily business as if most prices were not volatile, and this becomes a self-fulfilling belief. Except when it doesn’t. When we don’t trust that most prices will remain stable, our behavior becomes radically different.
When the same thing happens to the dollar isn’t that what we call a financial crisis?
Doesn’t this predict that no one should ever be able to introduce a new currency? Because when you introduce a new currency you need to figure out a price for everything. What makes it relatively tractable to introduce a currency is that you only have a single new if important price, the exchange rate between that currency and the next best alternative. I’m sure that exchange rate volatility among newly introduced currencies is high but there are plenty of volatile and long lasting currencies — right? All you need is a big non-tradable sector and volatile exports to get that. Is bitcoin that much worse than owning Brazilian Reals? Eritrean nakfas?
There are now tens of thousands of Bitcoin transactions every day, and the trend is upward. As a medium of exchange, Bitcoin seems to work. Holding Bitcoins is a job for brave speculators, for the reason you mentioned.
Not really. Mostly, Bitcoin is used as an intermediary transmission system.
What people do is hold digital dollars in regular bank accounts, and when they want to conduct a Bitcoin transaction, the buyer thinks about the price in terms of dollars (whether it’s quoted in Bitcoin or not), and then converts that amount of dollars to Bitcoin, executes the transfer, and then the seller immediately converts it back into dollars.
That’s not a medium of exchange. That’s basically like using a debit card at Amazon (actually Overstock is a better example, since they have a good Bitcoin service that does exactly what I’m describing). The consumer doesn’t care about all the many steps and gears in the giant financial black box that have a net effect of moving the same number of dollars from his bank account into Amazon’s account.
The main reason to use Bitcoin is slightly lower transactions fees and making it more slightly more costly and difficulty (but by no means impossible) for the government to watch what you are doing.
The Silk Road takedowns were just the beginning. Watch what happens to Bitcoin when DOJ starts bringing charges against the buyers too, given that they seized all the records. Which they have already said they plan to do within a year or so.
I agree with your assessment of money and prices as a consensual hallucinations. And yet we use it as a precise unit of measure, not just to facilitate market exchanges, but to make important policy conclusions.
Much of economics is built on the idea that money can be used as a precise unit of measure.
I wonder how important the whole giant set of formal, medium-and-long term, dollar-denominated liabilities, claims, and offers is in keeping this vast network social expectations stable.
I suppose one could be abstract and say that all prices, even for expendable goods sold for current consumption, are really just ‘re-callable bids’ that one usually expects to be kept open at the stated terms for a short time.
But I think it’s the set of longer term ‘priced claims’ (dollar denominated liabilities) that helps guide everyone’s expectations and molds the kind of prices they’ll offer for trades in goods and services.
A financial crisis happens when there is some kind of information shock occurs that creates a giant gap between corrected and revised expectations and the expectations that were embedded in all those long-term priced claims.
The real economy of PSST already can adjust only so fast until the rediscovery process has time to work, but the nominal economy of all those frozen legal obligations has much more friction and higher rationalization costs, along with all the delays and time it takes to resolve anything in our legal system.
It’s not just about sticky wages either. It would lead one to expect that the Modigliani–Miller theorem is false because its assumptions of low costs and delays does not hold, and instead, there are huge differences between financing in equity vs debt.
1) I’d say that yesterday’s prices contain the information needed to determine today’s prices. We recalculate each day (sort of, when we have to, but then sometimes (like in Zimbabwe) more than 1/day), based on the information which includes the price of everything. But deleting the history of prices you deleted information. People don’t have any idea what the actual volume of dollars is, or demand for dollars.
2) You’re precisely wrong about Bitcoin. It’s very strong as a medium of exchange. It’s the medium of account it’s not very good at.
Except for people who value anonymity extremely highly, Bitcoin is a poor medium of exchange due to its cryptographic underpinning. By requiring an ever-increasing amount of digital arithmetic just to make a transaction official, it demands an environmentally hostile arms race featuring well-financed intermediaries who take a cut of each transaction. Subtract the anonymity and extreme power burn, and you get something that acts like traditional merchant exchanges, banks or credit cards.
The Austrians have been having heated discussions of Bitcoin in this regard, framed in terms of Mises’ Regression Theorem. Daniel Sanchez and Bob Murphy come to mind, specifically. I am honestly surprised this hasn’t been mentioned yet.
So perhaps demographics leads to the worldwide decline in inflation? Older people are more set in their ways and less likely to tolerate a change in prices.