Gold, Bitcoin (Digital Gold), Price-Stable Coins and Economic Freedom
In his 1966 article, ‘Gold and Economic Freedom’, former 5-term chairman of the Federal Reserve Alan Greenspan wrote about the history of money and how gold has become the best money.
“Whether the single medium is gold, silver, seashells, cattle, or tobacco is optional, depending on the context and development of a given economy. In fact, all have been employed, at various times, as media of exchange. Even in the present century, two major commodities, gold and silver, have been used as international media of exchange, with gold becoming the predominant one. Gold, having both artistic and functional uses and being relatively scarce, has significant advantages over all other media of exchange. […] If all goods and services were to be paid for in gold, large payments would be difficult to execute and this would tend to limit the extent of a society’s divisions of labor and specialization. Thus a logical extension of the creation of a medium of exchange is the development of a banking system and credit instruments (bank notes and deposits) which act as a substitute for, but are convertible into, gold.”
Greenspan then writes a summary of monetary history including how the gold standard was replaced by a mixed gold standard and ultimately by fiat system orchestrated by central banks. He then ends with this famous quote:
“Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.”
The article is a concise trumpeting of gold as real money along with a critique of the statists that disparage it. Later in his career Greenspan must have experienced much cognitive dissonance in order to eventually end up the Federal Reserve chair.
If, according to Greenspan, gold is an international media of exchange that protect property rights, what is Bitcoin?
What has Greenspan said about Bitcoin?
One of the first public quotes about Bitcoin made by Greenspan appears to be in a 2013 interview where Greenspan said:
“It [bitcroin] has to have intrinsic value. You have to really stretch your imagination to infer what the intrinsic value of bitcoin is. I haven’t been able to do it. Maybe somebody else can”
However, years later during the 2017 bubble that peaked in 2018, Greenspan compared Bitcoin to other fiat currencies including the revolutionary continental and the greenback during the American civil war. When asked if bitcoin would ultimately be worthless Greenspan explained that it depends on how the network manages the quantity brought into the market. In the same segment, Greenspan also said:
“Bitcoin is a really fascinating example of how human beings create value or estimate or judge value and it’s not always rational. You cannot tell me that you can create, out of nothing, something which has a medium of exchange value. It is not a rational currency in that sense. But that does not mean it will not trade, because so long as people believe, they can sell it to somebody else or unload it on somebody else that’s all you need to create a market. And look, human beings buy all sorts of things that aren’t worth anything but they do it anyway. People gamble in casinos when the odds are against them! It has never stopped anybody.”
In his comments, Greenspan is engaged in his usual ‘fed speak’. That is, he is playing the two-handed economist “on the one hand X, on the other hand Y”. However, with these statements, Greenspan admits that it doesn’t matter what the medium of exchange is so long as people have confidence. After all, Greenspan admits that people will even use sea-shells or cigarettes to exchange value.
In other words, despite the FUD headline “Greenspan compares bitcoin to Colonial American currency that eventually became worthless”, Greenspan is actually being very careful not to be seen as supporting or opposing Bitcoin. And it stands that since Greenspan still believes what he wrote in his 1966 paper, as confirmed by his later books and talks including a 2014 interview for the Council on Foreign Relations – that gold reigns supreme. Given that Bitcoin has proven it too has the ability to protect property rights and act as a medium of exchange, Greenspan would approve.
Bitcoin is Digital Gold
Let’s rewind here a bit. Cryptocurrency implies something far more fleeting than digital gold. So why do people make the claim that Bitcoin is digital gold? Bitcoin’s store of value property has been its most dominant characteristic. That is, it has so far been an excellent inflation hedge something which gold bugs say is one of gold’s greatest use-cases.
In 2017, the Bitcoin community had something similar to a religious schism which divides the original Bitcoin community to this day. The resulting fork of Bitcoin, known as Bitcoin Cash (aka BCash) was driven by Jihan Wu, owner of an integrated mining manufacturer, developers like Bitcoin Unlimited and billionaire ideologues like Roger Ver who for various reasons (including possible financial incentives such as ASICBoost) have taken the words “A Peer-to-Peer Electronic Cash System” quite literally. Their solution, bigger blocks, would have allowed Bitcoin to process more transactions per second cheaply at the long-term cost of having a larger blockchain file.
Prior to this debacle, many in the bitcoin community had been suspicious of the New York Agreement which they felt never represented large parts of the community including many Bitcoin Core developers. Some radicals even advocated for a User Activated Soft Fork to force the miners to accept a Segregated Witness upgrade. They pointed out what Satoshi wrote in the whitepaper is not gospel and that the most important property of Bitcoin, apart from censorship resistance created by a very decentralized network of miners and nodes, was that Bitcoin remains a store of value - akin to Digital Gold. They criticized the ‘big blockers’ for risking nodal centralization that big blocks could lead to. In the end, the community stayed with Bitcoin and chose decentralization and stability of the network (store of value) in the long-term over cheap transactions (medium of exchange) in the short-term. They further reasoned that Bitcoin would soon have the Lightning Network, a second layer solution, and this would eventually result in cheaper transactions.
As Tone Vays, one of the leaders of the UASF revolt tweeted - “I will never consider ANY other #Blockchain as a store of value other than #Bitcoin”. Bitcoin is digital gold not because of its price volatility, but because it has now endured nearly a decade of protocol stability. As the Paris Bitcoin Meetup’s moto reiterates “Fluctuat Nec Mergitur”.
<Insert chart of historic inflation of Gold>
Conclusion from these charts, Bitcoin may be too deflationary.
The Rule of 72
Introductory finance teaches us about the rule of 72. According to this rule, we can quickly see how many years it will take for an investment to double at a given compound rate. Similarly, it can also be used to demonstrate how inflation can eat away at savings.
In many countries including European countries, the retirement age is set at 65 year old. People can usually expect to live an additional 15 and 25 years beyond this retirement and should be financially prepared to do so. This implies that someone with a pension of $4,000 per month will feel very little difference in their purchasing power with an inflation rate of 1.0% as it would take 72 years to erode their payments in real terms so that it would decline to $2,000 per month in real terms. However, an inflation rate averaging 6.0% would be quite catastrophic as it would mean that if the person lived an additional 25 years, they would have experienced their payments shrink to $2,000 and then to $1,000 in real terms. $4000 per month, or $48,000 per year is a reasonably comfortable pension for a Canadian
A ‘natural’ rate of Inflation
As a supporter of Bitcoin, I was attracted by its disinflationary (a term often confounded with deflationary) supply. I learned that at some point the total supply would peak at 21,000,000 and that this in some ways represented how gold mining could play out where at some point, all the gold that can be mined has been mined but that this is way out in the future and for now, the increase in the gold supply every year has averaged between 1 and 2% per year so far for hundreds of years.
Assuming real rates of interest are positive, 1-2% inflation that remains relatively stable over time ensures that savings are properly incentivized without causing noticeable declines in savings.
Lies, Damned lies and Inflation Statistics
Many readers at this point will ask: hasn’t the inflation rate remained at 1-2% in most developed countries? This is hard to say exactly. Firstly, there are many factors at play (just think about the usual demographics, regulatory, macro-economic trends) and there are many ways to measure inflation.
One well-respected source, John Williams, disagrees with the assertion that inflation has been stable. Using analytic techniques, John re-constructs the government statistics to reveal a different view of US inflation. The graphs show the official CPI statistics compared with 1990 and 1980-based measures of CPI. That is, CPI calculations prior to major revisions in how the CPI is calculated. The conclusion that seems to emerge is that inflation is significantly higher than the government suggests. At the time of writing the article, inflation certainly feels like it’s higher than 2% but might not be as high as 10%. What most people agree with is that goods in demand (food, energy, medical services, college tuitions) appear to be rising significantly whereas goods that are not essential like many electronics have tended to suppress inflation. Despite the criticisms, his work definitely reinforces the idea that CPI is only a measure of inflation and this measure’s parameters are being adjusted by a centralized institution.
Hot Link here: Official vs. SGS 1990-Based Alternate
Hot Link here: Official vs. SGS 1980-Based Alternate
What is the optimal inflation amount?
In a previous article we advocated the need for a decentralized price-stable currency to accelerate Bitcoin adoption. We pointed out that Bitcoin is digital gold and that a stable currency backed by Bitcoin could track an asset like the US dollar.
A price-stable currency could in its initial phases be pegged to the US dollar. However, at some point inflation would return to the US dollar as measured by CPI. For this reason, a plan to manage this currency peg would be necessary. Here are some possible solutions.
Fixed supply inflation rate. This implies that some value could be algorithmically assigned to increase supply by 1.5% each year.
Variable supply inflation rate. This implies that some value could be managed by a DAO
Oracle-based inflation rate. This implies that an oracle system (essentially a smart contract) could interface with the real world to determine what inflation is based on a measure like the CPI.
Inflation rule-set or an oracle to collect price data? but that this may be a long-term solution to the problem as trustless oracles may take some time to design but that if they could be trusted to scrape internet data for price change to help determine monetary policy.
Price-stable cryptocurrencies have been described as the ‘holy grail’ of cryptocurrency. This is because they are an ideal that has not yet been achieved. That is, a price-stable cryptocurrency could mimic the world’s reserve currencies for example the US dollar. In the short-term these currencies would track the reserve currencies effectively eliminating the need for central banks while reducing volatility. The best of these currencies would also need a mechanism for creating stability by eliminating runaway inflation risk. This is because even an inflation rate that appears relatively low has a way of eating savings. Furthermore, it would be important for these price-stable cryptocurrencies to be decentralized or ‘backed’ by assets like a digital gold which ensures stability.
- This will keep the Keynesians who preach about spending and ensuring inflation is higher
- This will ensure a new paradigm where Central Banks have been replaced by a DAO that competes with other stable coins for the best policy.
- Conclusion: The best policy will be a very low inflation rate. And this number should remain very low i.e. 1.5% or less (long-term inflation of gold). Not in the actual price rise of goods or services, but in the increase in supply
Price-Stable tokens may help with the revolution. Updating Greenspan’s quote:
Deficit spending is simply a scheme for the confiscation of wealth. Bitcoin stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the Bitcoin Network.
- Note that when doing the actual calculation, do not divide by %. For example, when dividing by 2%, use the number 2 and not 0.02 or 2%.