on bitcoin

Businessmen, they drink my wine
Plowmen dig my earth
None of them along the line
Know what any of it is worth
— Bob Dylan, All Along the Watchtower
A cynic is a man who knows the price of everything and the value of nothing
— Oscar Wilde
If he were alive today, Oscar Wilde would say that a cynic is a man who knows the price of Bitcoin. You cannot drink a Bitcoin. You cannot plant crops on Bitcoin. Its intrinsic value is nothing.
Social construction of value
Economic value is socially constructed. Is the value of land in San Francisco high because of what you can grow on that land? No, its value is high because our society has organized itself in such a way that people are willing to pay a lot to live and locate firms in San Francisco, and everyone expects that people will continue to be willing to pay a lot to live and locate firms there in the future.
A barrel of crude oil is a “hard asset.” Even if you are not in the oil business, you can trade barrels of crude oil in markets for the exchange of commodities. But the value of crude oil is not intrinsic. A few hundred years ago, before the invention of engines that could use oil as fuel, the value of crude oil was zero. Some day, if solar power becomes cheap enough, the value of crude oil may once again be close to zero. Meanwhile, the price of crude fluctuates, depending on the current state of supply and demand as well as expectations for supply and demand conditions in the future.
In short, the value of crude oil is socially constructed. It depends on the state of technology, crude oil’s role in other economic activity, government policy, and expectations about the future configuration of the market for energy.
Bitcoin vs. the American Dollar
The value of a Bitcoin today depends on what we expect other people to expect it to be worth tomorrow. It is a consensual hallucination.
The value of the American dollar is also a consensual hallucination. A dollar is worth what is today because of what we expect it to be worth tomorrow.
However, compared with Bitcoin, the dollar’s value is more solidly grounded in social behavior. Many people around the world believe in dollars, have arranged our habits around dollars, readily accept dollars as payment, and make payments in dollars. Of these people, there are many (including me) who do not believe in Bitcoin, have not built habits around Bitcoin, do not accept Bitcoin as payment, and do not make payment in Bitcoin.
One can imagine a scenario in which the dollar’s value disappears. This has happened in other countries during hyperinflations. These occur when a government finds itself with more obligations to its creditors and its employees than it can fund with tax revenue, and at the same time investors lose confidence in its ability to take on any additional debt and meet its obligations. At that point, government officials may see no option other than to print money in order to pay its bills. As people realize that this is happening, they drive down the value of money by charging higher prices. This forces the government to print even more money, leading more people to try to avoid holding money, which raises prices even faster. Eventually, this vicious cycle drives prices close to infinity and the value of money close to zero.
It is possible that speculators in Bitcoin are betting that the U.S. government will some day have to resort to hyperinflation. But even though I believe that we are headed toward an eventual fiscal crisis and that this will create much political strife, I do not think that politicians will attempt to wipe out our government obligations with hyperinflation. And even if I did expect politicians to crank up the monetary printing presses, I would do my hedging by buying up crude oil rather than by holding Bitcoin.
The lesson for economics
The point of this essay is not to knock Bitcoin. I could have written this essay without mentioning Bitcoin at all. One excuse for bringing up Bitcoin is that it is fun to troll the Bitcoin cultists. But the main excuse is that Bitcoin is such an outstanding example of the point that I am trying to make, which is that value is socially constructed, as opposed to residing intrinsically in resources or produced goods.
Imagine that you suddenly became marooned on a tropical island, completely cut off from the rest of the world. What would be valuable to you? Not Bitcoin. Not dollars. Not your cell phone. Not your shares of stock in Google and Amazon. Not your college degree.
On the deserted island, bananas would be valuable. Coconuts would be valuable. Fresh water would be valuable. Wood for a fire would be valuable. The time that you spend gathering food, digging a well for water, tending to a fire, and building shelter would be valuable.
In a primitive setting, it is plausible to treat value as intrinsic. What matters about the stuff around you is whether it can be used to meet basic needs for food and shelter.
Our modern society is not primitive. We are highly specialized. We satisfy our basic needs in a stunning variety of ways, and we also consume many goods and services that go beyond meeting our most basic needs. People vary in their needs and desires, so that our consumption baskets differ from one another.
The more complex the economy becomes, the more difficult it is to associate value with intrinsic characteristics. We have to discard the notion that the value of land comes from the quality of its soil, that the value of a corporation comes from its physical plant and equipment, or that the wealth of a country comes from its natural resources.
Labor theory of value
Economists and business journalists avidly discuss “productivity” and “living standards.” Labor productivity by its very definition is the ratio of output to labor time. Living standards typically are defined as the goods and services that one can enjoy with the wages of a typical year’s work.
These concepts of productivity and living standards rest implicitly on a labor theory of value. These terms treat labor time as the fundamental unit of intrinsic value.
But the labor theory of value is not at all suited to describing a complex economy. In our highly specialized economy, labor is not homogeneous. Moreover, most labor is used not to produce output but instead helps in an indirect way to prepare for final production.
Two hundred years ago any able-bodied person could have been trained to work in an apple orchard or a cotton field. Under such circumstances, farm hands will tend to have very similar levels of productivity. Farmhand labor is approximately homogeneous.
In a classic assembly-line factory, workers are treated as identical. If one worker is out sick, the foreman can put someone else in that worker’s place with little or no difference in results. In that setting, labor is homogeneous.
But most of us are not farmhands or assemblers in factories. Our labor is not generic. You cannot replace an accountant or a surgeon with a worker you find on a street corner.
Economists often talk about salary differentials between college-educated workers and workers with only a high-school education. But these classifications are inadequate. On average, college-educated workers earn higher salaries. But a trained plumber may have more marketable skills than someone with a BA in psychology. More generally, differences within educational categories are far larger than average differences across them.
In short, labor is not homogeneous. Workers with different skills produce different types of output, so trying to compare productivity is like trying to compare apples and oranges.
Work that produces output only indirectly
Another important problem with the labor theory of value is that most workers do not produce final output. Instead, most workers are engaged in “intermediate labor” that is prior to final labor. Our connection to output is very indirect.
— If you work on an assembly line making farm machinery, then you are not producing food, but you are producing equipment that can be used to help farm workers to produce food.
— If you are a white-collar worker in a corporation that makes farm machinery, then you are providing capabilities that ultimately help the corporation’s assembly-line workers produce equipment that can be used to help farm workers to produce food.
— If you work on accounting software used by the corporation, then you are indirectly helping accountants provide information to other white-collar workers in the corporation that produces farm equipment that helps farm workers to produce food.
Many of us engage in labor that has only a vague, indirect effect on final output. How can our productivity be calculated? Think about the jobs that you have held in the last ten years. Is there a meaningful way to talk about widgets-per-hour in these jobs?
Social construction of value at higher levels
The broader view that one takes of the economy, the more it becomes evident that value is socially constructed. Consider the value of management skills in the retail book business. Twenty years ago, management in book retailing meant deciding where to place stores in shopping centers, deciding which books to stock, and creating displays that attracted customers. But now, Amazon has instead made the management of software teams crucial for its book retail business. What we mean today by “management in book retail” is different from what it used to mean.
Economic textbooks describe business leaders as if their job were to aggregate machines and homogeneous workers to produce output. Sixty years ago, this might have been a fair approximation. At that time, many large firms had been started and were being run by men without much formal education, relying instead on experience and grit.
But today, business strategy is more complex. Getting the most out of highly-skilled employees is more challenging. Making the best use of computer technology requires a careful analysis of how new developments affect the business environment.
In short, at present firms derive their value less from their investment in tangible machinery and more from the strategic decisions that their managers make and the internal leadership that managers provide. This makes stock prices and management compensation more socially constructed, dependent on the evolution of strategic decision-making in the external environment and on the approach to internal organizational development rather than on intrinsic properties of resources.
When we look at differences across nations, or even at regional variation within a nation, we see social construction once again. What matters are the legal systems, government policies, social norms, and cultural habits that prevail in different areas. If you have an idea for a new Internet-based business, you are better off trying to develop it in Silicon Valley than in Venezuela. Where laws and policies are conducive to commerce and to business formation, we tend to see greater longevity, less hunger, cleaner air, higher levels of education, and other indices of human development than we see in nations that make it difficult to start businesses or to sustain commercial activities.
New economic thinking
The bottom line is that we need new economic thinking that avoids the trap of treating value as intrinsic. For further reading on this topic, I recommend Invisible Wealth, which I co-authored with Nick Schulz several years ago, and Capitalism without Capital, by Jonathan Haskel and Stian Westlake, a book which just recently appeared.