On Crypto, Paul Krugman Exposes Himself…

If you need confirmation that Paul Krugman is Dean of the Stupidest Men on the Face of the Earth, look no further than his discussion of crypto-currencies. It is hard to know where to start with this, there is so much claptrap here. And if you’re wondering why I adopt such a strident tone, I am just mirroring Krugman. If you don’t believe me, I’ll just work backwards from his foaming at the mouth.

Could I be wrong? Of course. But if you want to argue that I’m wrong, please answer the question, what problem does cryptocurrency solve? Don’t just try to shout down the skeptics with a mixture of technobabble and libertarian derp.

(Derp: foolishness; stupidity. Krugman could have just settled for either… But no… So as a libertarian, I shall consider myself free to adopt his tone in the following diatribe.)

And now, working backwards…

Cryptocurrencies, by contrast, have no backstop, no tether to reality.

This is only true if you believe math is not reality. But to explain this, I am going to have to disabuse you of a more fundamental error: conflating Blockchain as a form of technology with crytpo currencies. A Blockchain is essentially a distributed aggregation of bank statements. (It can be much more, but that is another topic.) Take your bank statement and simply imagine the personally identifiable information and bank information is replaced with a single string of characters. The term “Digital Wallet” is used to segregate transactions which apply to one person, and a “Wallet ID” is that string of characters that takes the place of personal information.

Instead of relying on regulatory authorities to adequately do their job, Blockchains establish consensus as to the true record of transactions by relying on people devoting computing resources to validating each “block” (transaction). A crypto-coin (if the intended use is ‘horizontal’ across multiple markets) or a crypto-token (for ‘vertical’ use within one market) is the incentive to provide these resources. And if the Blockchain in question is designed to set a mathematical hard limit to the number of coins/tokens issued, the value of those coins/tokens then becomes mainly a function of that math.

You do not understand this because you do not even understand the utility of gold as a store of value. Gold does not have value because people arbitrarily say it does; people say it has value because it does not react with the oxygen in the atmosphere — it does not rust. The value of monetary metals is a function of their weight. If that weight dissipates due to oxidation, the metal proves inadequte as a store of value. Gold and silver both are the longest recognized adequate store of value for precisely this reason.

So when we look at a crypto-currency to store value we look first at whether it resists natural dissipation. Since it is not a metal, we do not have to worry about rust. I can already hear the objection: the volatility in the price of a Bitcoin proves it is not a stable store of value. This is a non-sequitur. The volatility in Bitcoin is a function of fiat monetary policy forcing financial markets to reach (into the crypto space) for yield.

If you like, fiat currencies have underlying value because men with guns say they do. And this means that their value isn’t a bubble that can collapse if people lose faith.

Really, now. Please try to convince the folks in Venezuela that this is true. They are ruled by men with guns, and their Bolivar is useless as a currency. The validity of this premise is clearly a function of the behavior of the government. And that is why what is said immediately prior is nonsense:

In normal life, people don’t worry about where the value of green pieces of paper bearing portraits of dead presidents comes from: we accept dollar notes because other people will accept dollar notes. Yet the value of a dollar doesn’t come entirely from self-fulfilling expectations: ultimately, it’s backstopped by the fact that the U.S. government will accept dollars as payment of tax liabilities — liabilities it’s able to enforce because it’s a government.

Your arrogance here is magnificent. People who worry about the value of their dollars are not evidently not “normal.” This must be because “the government” guarantees the value of the dollar by accepting only it for the payment of taxes. But seeing as those taxes are levied to pay the costs of government, if prices rise as a result of a dollar which is losing its purchasing power, the cost of government goes up and taxes with it. Apparently you believe it is not “normal” to worry about taxation increasingly reducing one’s ability to otherwise transact in the economy as one wishes.

This is where the discussion could really take an interesting direction. I’ll take the following up in more detail shortly. If you are given to Thomas Hobbes’ ideas about government, the State is the most significant unit of society, and the individual exists for the benefit of the State — which is to say to feed its ever-increasing appetite for money in the form of taxes. If you follow John Locke, however — as did our Founding Fathers — the individual is the most significant unit of society and the State exists for the benefit of the individual — to secure her natural rights to, among other things, pursue her own happiness.

For those who believe the latter of these two options, “normal” people most certainly do worry about the value of their money. And they realize that value is “debased” when their government puts excessive demands on the money supply and then engages in excessive money printing in order to maintain those claims.

Clearly, cryptocurrencies are in effect competing for some of the same [illegal] business: very few people are using Bitcoin to pay their bills, but some people are using it to buy drugs, subvert elections, and so on.

What is “clear” is how little you really know about crypto-currencies. “Ripple” — a crypto-token — is competing with SWIFT to be the foundation of inter-bank settlements. These settlements will still be tied to a reserve fiat currency, but by converting to Ripple and using its Blockchain, a great deal of the friction in the SWIFT system — and especially its lack of security — is addressed. Numerous other vertical markets are being served by their own “tokens” for the same reason. It reduces transactional friction (as opposed to your badly outdated understanding based solely on Bitcoin). That this reduction can be exploited for illegal purposes is — once again — not a function of the technology, but of human nature. And we do not ban something that benefits people because others might misuse those benefits — unless, of course, there is some other purpose afoot…

Banknotes worked because people knew something about the banks that issued them, and these banks had an incentive to preserve their reputation. Governments have occasionally abused the privilege of creating fiat money, but for the most part governments and central banks exercise restraint, again because they care about their reputations.

Your capacity for convenient lapses in memory is even more magnificent than your arrogance. I expressly recall listening to Ben Bernanke before the financial crisis telling Congress that “reputational risk” restrained the banking sector from excessive issuance of credit and excessive speculation (mainly with that same credit). What a fantasy that turned out to be! When government depends on the issuance of public credits to stay in power, and banks rely on the issuing of those same credits to make a profit, the idea that either “care[s] about their reputations” is laughable.

If you are interested in the origins of political campaign cash, look no further than the fees and commissions made trading in U.S. Treasury bonds in the secondary market. It’s a wonderfully elegant money laundering scheme: The Legislature gets elected making promises it cannot keep. The Executive (Treasury) papers over the falsehoods by issuing bonds. Banks make a profit by buying and then facilitating trade in these bonds… and then shovels some of those profits into legislative campaign coffers so they can get re-elected by making promises they cannot keep… If there is no other lesson to be learned from the financial crisis, it is the inevitability of the government/banking axis “abusing the privilege of creating fiat money.”

Bear in mind that conventional money generally does its job quite well. Transaction costs are low. The purchasing power of a dollar a year from now is highly predictable — orders of magnitude more predictable than that of a Bitcoin. Using a bank account means trusting a bank, but by and large banks justify that trust, far more so than the firms that hold cryptocurrency tokens. So why change to a form of money that works far less well?

Yes, indeed, the [loss of] purchasing power of a dollar is highly predictable — which, in addition to the fantasy of reputational risk as a restraint on the money supply, is why Blockchain technology was developed to begin with. But much more to the point is this matter of trust. Take the time to watch “The Big Short” and then say with a straight face that “banks justify [that] trust.” Your academic colleague Jeffrey Sachs thinks otherwise:

I believe we have a crisis of values that is extremely deep, because the regulations and the legal structures need reform. But I meet a lot of these people on Wall Street on a regular basis right now. I’m going to put it very bluntly. I regard the moral environment as pathological. And I’m talking about the human interactions that I have. I’ve not seen anything like this, not felt it so palpably. These people are out to make billions of dollars and nothing should stop them from that. They have no responsibility to pay taxes. They have no responsibility to their clients. They have no responsibility to people, counterparties in transactions. They are tough, greedy, aggressive, and feel absolutely out of control, you know, in a quite literal sense. And they have gamed the system to a remarkable extent, and they have a docile president, a docile White House, and a docile regulatory system that absolutely can’t find its voice. It’s terrified of these companies.

No, professor Krugman, Wall Street does not deserve our trust. Neither does the Federal Reserve or the government. They forfeited it a decade ago. And no, we are not the government and the government is not us. The Constitution does not begin with “We the Government.” And no, if we withdraw our trust and confidence (that bell has already been rung) from what I will call “legacy banking” it will not be economic Armageddon… It will be the Blockchain. If you had even a remote understanding of how the computer is actually used in the modern economy, you would get this — and you wouldn’t even need a degree nor that shiny Nobel Prize of yours.

And no, this is not libertarian “derp.” It is history:

In the run-up to the English Civil Wars, King Charles I sought to establish a more uniform church order by appointing bishops over the Church of Scotland. It is hard for us today to appreciate how “church order” and “social order” were one and the same back then. The issue of Blockchain technology and crypto-currencies is, first and foremost, a debate about the social order — and therefore a debate about money rather than merely currency.

Returning to the discussion on Hobbes and Locke, the question arises: Is the social order to be determined by individuals who associate organically and freely? Or is it to be determined by the State? There are decent arguments for both. (And if you were honest, intelligent, and mature enough to recognize this, we could be taking on very different and much more constructive tones.) A libertarian like myself will insist that the State will never have enough information to order society in such as way as to “promote the general welfare.” Of the two options, the aggregate good is far better served by the former.

But if you believe the State to be the most significant unit of society, and is best suited to determine the social order, how is this effected? The anwer: Money. Those who control the money supply determine the social order.

The story of King Charles I and the First and Second Bishops’ Wars bears this out. In the First Bishops’ War, neither the English nor the Scots were all that interested in fighting. A stalemate ensued and a Parliament was called. But the Parliament ended up not agreeing to the king’s proposals, and further sought redress for economic grievances (read: taxation). The king abolished the Parliament and sought to raise an army to impose his will (church/social order) on Scotland.

Only this time the Crown did not have the money to pay its soldiers. So the king confiscated the gold in the Royal Mint — which belonged to English merchants — as a forced loan. Before going on, it is important to note recent noise about requiring Americans to have retirement accounts conveniently invested in U.S. Treasury Bonds (euphemistically called “conservative investments”)… which is just another way of confiscating money as a forced loan. And after 17 years at war with no culturally or historically credible end-state in sight, the parallels are stark and eerie.

To separate themselves from this nonsense, after being repaid, the merchants began depositing their gold with trusted goldsmiths. They received a receipt in return, which upon presentation, would be converted back to gold. Before long, however, these receipts proved useful as a medium of exchange; paper money was born. This worked very well — because the receipts were “as good as gold.”

Your reading of this history is conveniently narrow. The move to paper money was about much more than “transaction costs and tethering.” The English merchants did not want any part of the Crown’s recidivist war-mongering. You treat fractional-reserve banking as a welcomed innovation. The truth is these erstwhile “trusted” goldsmiths realized not all receipts would be redeemed at once, and thus started issuing “extra” receipts in secret and lending them out at interest. It was originally done on the sly, because once you realize there isn’t enough gold to redeem all circulating receipts — well — no one wants to be next in line holding a worthless receipt after the last of the gold is redeemed. This does not discredit the idea of fractional reserve banking. But it does discredit the idea that an axis of government and banks can be trusted to restrain themselves with respect to those fractional reserves.

Recall the possibility of being the “the next one in line when the last of the gold is redeemed:” Between the U.S. government and the banks, led by the Federal Reserve, massive amounts of credit were created to fight the Vietnam War and the War on Poverty at the same time. This credit became part of the money supply and it became clear to countries holding dollars in reserve that the U.S. did not have the gold reserves to redeem the quantity of dollars in the economy at $35/ounce. A run on U.S. gold ensued, only to be stopped by Richard Nixon’s “closing the gold window” in 1971.

The debate, though, over the role of money in determining the social order is not really a debate about “the gold standard.” It is about having some form of “rule” from outside the government/banking axis imposed upon it. This would be called “rules-based monetary policy” and John Taylor has proposed the widely understood “Taylor Rule” as an option. A gold standard is nothing but the simplest form of rules-based monetary policy, the rule being: US$1 = x oz. gold.

You have asked what problem crypto-currencies are supposed to solve: It’s simple: an unrestrained money supply.

Libertarians like me believe a very simple proposition: In a representative democracy you cannot have a “free” market and an “unrestrained” money supply at the same time. Amazingly, this is nothing new. It is the same debate Thomas Jefferson had with Alexander Hamilton about the very nature of banking. A restrained money supply is simply the sine qua non (“that without which”) of free markets. Your parroting of “reputational risk” as an alternative is laughable in light of the financial crisis.

Finally, your observation about how little commerce is actually conducted with Bitcoin is irrelevant; it is highly unlikely Bitcoin will ever be a transactional currency. But as Ripple as a crypto-token is proving vis-a-vis (legacy) SWIFT, a “vertical” crypto-token for inter-bank settlements (“vertical” meaning it has no real use outside of inter-bank settlements) bears with it the possibility of even replacing (legacy) Special Drawing Rights. And if this is the case, the Blockchain not only threatens to replace the utility of legacy domestic banking, but of the legacy International Monetary Fund itself.

The real promise in the crypto space is the ability to test the utility of “industry-vertical” crypto-tokens as an analog to “political-vertical” national currencies. With national fiat currencies floating against each other in value, an incentive is created to speculate on potential arbitrage between and among them. When a currency is “shorted” (as George Soros famously did with the British Pound Sterling) everyone who uses the currency gets hurt. Thus the degree to which we get hurt by speculation in “political-vertical” national currencies can be lessened by lessening the degree to which we depend on them.

At this point, the same can be said of crypto; an incentive exists to speculate on arbitrage among them. The answer to this problem is the same as it would be for national fiat currencies — a tie to deposits of gold and/or silver (and other Noble metals as well). Only in the crypto space we do not have the problem of politicians needing an unrestrained money supply to stay in power. Various industries can conduct commerce using an industry-vertical token, and can scale the supply of that token as that vertical market’s growth requires — without hurting everyone else by subtracting from their purchasing power.

This actually has the promise of “repealing and replacing” Gresham’s Law (bad money drives out good) with the exact opposite. Good, vertical-token, gold-deposit restrained, money can reduce our dependence on bad, self-serving government/banking axis fiat money.

And none of this requires we abandon cash, which is clearly your Hobbesian/Progressive/Statist dream. It simply means money once again (as it was with the English merchants and their trusted goldsmiths) will be a utility emerging organically from the needs of the people who use it, and not from the need of the “Crown” to dictate upon them their preferred social order. Which is to say we get to decide the degree to which we wish to employ the respective utilities of crypto-currencies and cash. And as the “good” of crypto pushes out the “bad” of fiat, government will finally get the memo and start accepting payment of taxes with crypto— perhaps in a vertical token created for just that purpose.

And that, then, will be the end of the “Crown’s” (the political ruling class’) motivations for how they appoint the “Bishops” of the Temple of the So-called Free Market — aka Central Banking.

That outcome — all by itself — is worth the initial friction as Blockchain technology develops. Most of our parents never knew life without electricity. My children have never known life without the Internet and social media. My grandchildren will never know life without the Blockchain.

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I am a charter member of the pocket-protector set, but old enough to make fun of them and otherwise have a healthy skepticism of tech. https://goo.gl/2z5Snr

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