I cannot judge whether Bitcoin represents a technological breakthrough, but I am confident that the pseudocurrency’s popularity shows widespread economic amnesia. If Bitcoin ever became a real currency, it would suffer from the crippling problems of the gold standard.
The underlying problem is the belief that Bitcoin’s independence from government is a good thing. This libertarian notion could hardly be more wrong. Money is a common good for the whole society, and in the contemporary world governments are the pre-eminent social guardians.
It is true that under dire circumstances people might have to resort to an inferior monetary substitute. If a government collapsed or totally trashed the monetary system, then some privately issued money could be the least bad alternative. In such apocalyptic times, though, a software protocol that relies on secure electronic communications would not be first choice. Gold, which is tangible and not subject to hacking, is more plausible. So are old baseball cards.
But for the sake of argument, assume that Bitcoin or something like it did actually become the leading currency in a monetary dystopia. People would learn soon enough why nongovernment money works badly.
Deflation is an obvious issue. Price declines are inevitable when a finite supply of Bitcoin money, a feature of the software, meets an expanding supply of purchased goods and services. That would be uncomfortable. Consumers might delay purchases as they wait for prices to fall, workers might chafe at regular annual wage cuts, and creditors would be even worse off.
But in itself, deflation does not discredit nongovernment money. People and banks could adjust to the new monetary reality, as the Japanese have to the country’s 0.3 percent average annual decline in consumer prices since 1998. Alternatively, a different nondeflationary electronic currency could be created; one which added steadily to the supply of money. If the addition was in line with gross domestic product growth, prices and wages could be roughly flat in normal times.
Yet times are not always normal, and neither Bitcoin nor some putative “growcoin†â€" nor any sort of limited-supply money - can cope with unexpected bad news. Historians of money know the story well. Before governments started to issue money purely by fiat, the supply of money was limited by the supply of gold or silver, supplemented by public or private notes that were theoretically backed by some valuable asset. Whenever people decided to hoard their hard currency and reject paper notes, there was trouble.
The spur to the monetary fear might be war, crop failure or a busted financial institution. Whatever the cause, the sudden increase in caution automatically created a sudden decrease in the money for spending. The economic theorists of hard money said that wages and prices would also fall automatically, so the shrunken supply of currency would still be adequate to keep the economy running. In practice, the adjustment was always much too slow. Goods became unaffordable, unemployment rose and production fell.
The British economist John Maynard Keynes called it the paradox of thrift. He was analyzing the Great Depression of the 1930s, the last big money-prodded general decline. Keynes taught, and the world learned, that governments could and should counter bad news by ensuring that there was always enough money available to keep spending constant.
As the slow recovery from the 2008 recession shows, the policies have not always worked perfectly. But they could not work at all in a Bitcoin economy, because there would be no authority that could decide how much new money to print. Indeed, the knowledge that governments could not create new Bitcoins in a crisis would only increase thrift. Just as in the 19th century, a little bit of bad news would spawn a large economic crisis.
The problem would be worse now than then, because the economy relies so much more on bank-created credit. Whether banks use dollars, euros or Bitcoins, they lend out most of their deposits. The loans increase the supply of spendable money, because the lent sum is added to the total while the deposits that fund the loans are not subtracted.
The arrangement is always potentially unstable. If the borrowers cannot repay too many of the loans or if depositors want to withdraw their money too fast, the bank may fall short of funds. A failure, and an ensuing panic, can only be avoided if banks can find cash elsewhere.
The ultimate “elsewhere†is always the government, which can create new funds out of thin air. Government rescues are not ideal, but better than any known alternative. In a Bitcoin or growcoin world, the government would have nothing to offer. Frequent bank runs and financial panics would be unavoidable.
Charitably, the popular interest in Bitcoin can be interpreted as a sign of ignorance of economic history. More realistically, it is a sad statement of a loss of faith in a monetary system that has not worked as well as promised. Unfortunately, Bitcoin is no more than a high-tech version of an even worse system.
Edward Hadas is economics editor at Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.
