Bitcoin, Gold, and the Quantity of Money

Monetary Metals's picture

by Keith Weiner


The popular view today is based on the linear Quantity Theory of Money. It seems to be common sense. If more units of a currency are issued, then the value of each unit should fall. Many people may not think of it in explicit terms, but the idea is that the value of one unit of a currency is 1/N, where N is the total money supply. If you double the money supply, then you halve the value of each currency unit.

Inflation, according to this view, is either the cause—the increase in the money supply itself. Or it’s the effect—rising prices. The Keynesians hold that inflation is good, and the Monetarists basically agree, though they quibble that the rate should be limited. The Austrians universally think inflation is bad.

The Quantity Theory is not based in reality. One should think of this theory like the Lamarckian theory of evolution.[1]

Lamarck asserted that changes to an animal’s body—e.g. its tail is cut off—can be passed on to its offspring. At the time, this theory may have seemed only common sense, and it was very convenient, if not tempting. The same is true with the Quantity Theory of Money. It is convenient, seems like common sense, tempting—and wrong.

The Fed has been inflicting Quantitative Easing on us for five years. There are many negative effects, but rising prices, today, is at best debatable. Certainly, even where prices have risen, the increase is not nearly proportional to the increase in the money supply. Advocates of the theory explain this by saying that the money hasn’t entered the economy, it’s sitting on bank balance sheets. However, money is always on bank balance sheets in a debt-based system, so this answer is not satisfying.

Enter, bitcoin, a cryptography-based currency and technology developed by someone with the pseudonym Satoshi Nakamoto. It has been designed to have a limited rate of growth in the total quantity of currency, up to a predefined cap. There can never be more than 21M bitcoins. The Quantity Theory says that this will make prices of goods measured in bitcoins stable.

One problem with this theory is that the real costs in terms of land, capital, and labor to produce things is steadily falling. Every productive enterprise is constantly seeking to drive cost out of production. If a currency had a constant value, then prices in terms of this currency would be falling.

As we shall see below, the value of bitcoin will be anything but constant. Without a mechanism for responding to increased market demand by creating more currency, there is a fatal flaw.

In the real world, when prices appear to be stable it is not because anything is static or unmoving. It is because there is constant arbitrage. Arbitrage is the act of straddling a spread. If one thing becomes more valuable relative to something else, then someone will take the arbitrage. For example, if the price of eggs in a city downtown rises relative to the price of eggs in a farm town 50 miles away, then someone will buy eggs in the farm town and sell them in the city. This will lift the price in the farm town and depress the price in the city center, until there is not much of a gap any more.

To continue with the analogy on to another point, what happens if the price of eggs in the farm town is higher than the price in the city? This arbitrage is one-way. Distributors can only buy in the farm town and sell in the city; they do not distribute in the other direction.

There must be another arbitrage or arbitrages, if the farm-city egg spread is to remains stable. Indeed, there is. If the price of eggs gets cheap in the city, then consumers will prefer eggs to other foods.

In the body of a vertebrate, every joint is stabilized by a pair of muscles. Consider the upper arm. The biceps flexes it, and the triceps extends it. Muscles can only pull, but not push. There must be a second, opposing, muscle to move the joint in the opposite direction. This is analogous to arbitrage, as each arbitrage can only pull a spread tighter in one direction, but not push in the other.

No market is more important than the markets for money and credit.

So what happens when the price of money itself rises? In thinking about this question and the answer, you should not look at the dollar. The dollar is defective by design and does not work the way proper money ought to. The dollar is the product of fiat, not of a market. Everything about it is driven by forced wielded by the government.

It is more instructive to consider gold. Gold is produced by gold miners. They buy labor, oil, truck tires, machine parts, and they sell gold. As we saw above, they bid up these inputs and gold metal onto the market. The gap between the value of gold and the value of this broad swath across the major factors in the real economy is thus closed by the arbitrage of gold mining companies. This keeps the value of gold from becoming too high, or in other words allows gold to be produced in response to market demand.

What happens if market demand for gold drops? One reaction is that the jeweler and the artisan increase their activities. They tend to bid up gold metal, and sell jewelry and objets d’art onto the market. There is another kind of arbitrage, which is outside the scope of this article[2] but it’s worth mentioning. If the demand for gold metal drops, then the owners of gold, otherwise known as savers, can lend gold for interest. This tends to press down the bid on the rate of interest.

Now consider bitcoin. Bitcoin is not a fiat currency. No government forces anyone in any way to use it. However, bitcoin is irredeemable. That is, there is no agreement by anyone to redeem bitcoin in exchange for a defined quantity of gold, silver, or any real good. With its fixed quantity, there are no arbitrages regarding the value of bitcoin. So what does this mean? What will happen?

The value of bitcoin will be set entirely by speculators. In gold, there are numerous forces in reality—i.e. numerous arbitrages—that will keep the value of gold tied to the values of every other thing in the economic universe. The value of gold in a free market is the exact opposite of untethered and arbitrary. The value of gold cannot crash and it cannot shoot the moon.

Satoshi Nakamoto ignored these forces, and his design does not provide for them. The value of bitcoin is not tethered by the value of labor and capital. It was assumed to be sufficient that its quantity is fixed. It is the exact opposite of sufficient—a fatal flaw based on the Quantity Theory of Money, which is flawed to its core.

The speculators will use bitcoin as a toy to generate profits (as they already do). When the value of bitcoin is rising, it will be obvious. Everyone has a chart, and they can pile on. The value can rise much farther than anyone would expect. Eventually, the chart will show a topping pattern. Momentum will dry up. The speculators can see this too, and thus will begin a collapsing wave of bitcoin.

If a giant speculative spike occurred in food, the consequence is that poor people starve. When the price crashes, the consequence is that food producers will go bankrupt. As bad as this is, the consequences when the value of money spikes and crashes are incalculably worse. This is because every business, including food growers, depends on a stable currency.

To understand this, let’s ask the following question. If you take two bushels of corn and feed it to raise one chicken from egg to market, did you create or destroy wealth? Which has greater value, two bushels or one chicken? To answer, we use the common denominator of money. If Two bushels cost ½ ounce of silver and a chicken is 2 ounces of silver, then feeding the corn to the chick creates value.

Simple cases like this can be (and were, in the ancient world) resolved without money. Complex cases cannot be. If you borrow money to buy land, erect a building, buy machines and inventory, then hire people to manufacture computer chips, did you create or destroy wealth? This question cannot be answered without a stable unit of measure. It would not have been possible to answer it in the ancient world.

Businesses keep books to measure profit and loss. The very principle of bookkeeping depends on a constant value of the unit of account, the numeraire. When the value of the numeraire spikes and crashes, then business which produce wealth go can bankrupt. At the same time others, which destroy wealth, can grow larger, employing more people and more capital to scale up their wealth-destroying activities. This is occurring today on a massive scale.

Bitcoin may make a great speculation today, because its unique combination of technologies enables many transactions that would otherwise be impossible (due to government fiat). If you live in a country that does not recognize your right to freedom of speech, you can trade your local currency for bitcoin, pay Wordpress, and have your blog hosted safely outside your regime. There are many other kinds of legitimate transactions that are made possible by bitcoin.

Bitcoin would not work as the exclusive currency. Its unstable value is not suited to being used as the numeraire. For the same reason, it is not suitable for hoarding by wage earners. As I explain in In a Gold Standard, How are Interest Rates Set? it is the arbitrage between hoarding and saving (i.e. lending) that sets the floor under the rate of interest. If bitcoin is unsuitable for hoarding, then either it will not develop a lending market, or the lending market will not have a stable interest rate. A destabilized interest rate is the root cause of the ongoing global financial crisis.[3]

Bitcoin works well as a foil to fiat currencies. It makes it possible for people to conduct business that would otherwise be impossible. If enough people participate, then it becomes more difficult and more unpopular for governments to act to squelch those activities. It’s a pointed object lesson, showing people what is possible in a less-unfree market. Hopefully it will motivate them to clamor for more freedom.

Only gold serves as the objective measure of value necessary to act as the numeraire. It is no coincidence that the quantity of monetary gold is not fixed, but has elegant mechanisms to expand and contract in response to changing market demand.

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tip e. canoe's picture

deep thoughts from tradewithdave:

If you consider the 2 main Rothschild/Economist Magazine memes of 2013… “money as a technology” and “in gold we trust” then where is the “store of value” stored… in Moore’s Law or in Singapore? If money is a technology, then wouldn’t that be deflationary by 50% every 18 months? Then again if technological money is deflating by 50% every 18 months, what would gold be doing?

secretargentman's picture

I imagine there will be places you can swap gold / BTC for instant long-distance transfers of wealth. Long term stability of BTC value won't be an issue in that sort of scenario.

J S Bach's picture

I want to hear more discussion on this:  Aurum


A very cool concept.

fijisailor's picture

Coming soon to a more progressive sovereign nation.

don quixote's picture

I agree. Aurum is a wonderful concept. The currency IS the money.



silvermail's picture

If Bitcoin will be backed by gold at the Comex and LBMA, I will strongly support its development.
But at the moment, Bitcoin - it's just an attempt to create value out of nothing. That is - nothing, zero.

Matt's picture

What do you think the premium will be over physical gold? I suspect it will be triple digits - 100% to maybe 300%. Perhaps the increased utility will justify the premium.

michaelsuede's picture

"Without a mechanism for responding to increased market demand by creating more currency, there is a fatal flaw."


Keep telling yourself that.


Meanwhile, the rest of us who aren't blind and stupid will continue to see the value in a currency that has an absolute limit of supply while being inifinitely divisible.

silvermail's picture

"a currency that has an absolute limit of supply while being inifinitely divisible."

Here's your first statement contradicts your second statement. You're statement - this is nonsense in terms of elementary mathematics.

- Inflation inherently increases the amount of currency in circulation and makes the currency more cheaper against goods.
- The monetary reform that removes the extra zeros of paper currency (reduces the number of fractional parts of the money) makes currency more expensive
against goods.

So, Bitcoin - it's the same infinity of FRN, only in reverse.

madtechnician's picture

So, Gold - it's the same infinity of FRN, only in reverse.

silvermail's picture

You can not physically cut separate 0.0005 share parts  from one gram of gold. Or it will be very expensive and it is impossible for practical use.
But there is no difficulty, for do separate and for use 0.000000000000000001 parts from one Bitcoin.

madtechnician's picture

So what you are saying is that bitcoin is superior to gold because it's more easily divisible ?

silvermail's picture

Yes, bitcoin is by far superior opportunities of Gold for: unlimited possibility of manipulation and inflating bitcoin bubble.
Gold can not compete against bitcoin, as a means of deception.

Dick Buttkiss's picture

That's one reason, as Marc Andreessen recently pointed out:


A third fascinating use case for Bitcoin is micropayments, or ultrasmall payments. Micropayments have never been feasible, despite 20 years of attempts, because it is not cost effective to run small payments (think $1 and below, down to pennies or fractions of a penny) through the existing credit/debit and banking systems. The fee structure of those systems makes that nonviable.

All of a sudden, with Bitcoin, that’s trivially easy. Bitcoins have the nifty property of infinite divisibility: currently down to eight decimal places after the dot, but more in the future. So you can specify an arbitrarily small amount of money, like a thousandth of a penny, and send it to anyone in the world for free or near-free.

Think about content monetization, for example. One reason media businesses such as newspapers [note the article's publication venue] struggle to charge for content is because they need to charge either all (pay the entire subscription fee for all the content) or nothing (which then results in all those terrible banner ads everywhere on the web). All of a sudden, with Bitcoin, there is an economically viable way to charge arbitrarily small amounts of money per article, or per section, or per hour, or per video play, or per archive access, or per news alert.

teslaberry's picture

andreeesen is fucking tard. he is wrong, the micro payment idea has been explored na drejected. it costs 5 cents to process a bitcoin transaction in transaction fees. 

AND if it did not cost something------then the bitcoin network would be vulnerable to transaction spamming/ denial of service attack---overloading the network with 'free' fake .00001 penny transactions to jam up the legitimate transactions. 


i wouldn't say it's not good for micro payments. but it's not good for sending amounts of money less than 1 penny. sending 1 penny will cost you 5 cents. 


there's a point where the fraction of a money you want to send will not be worth 5 cents. it might be half a penny it might me 10 cents. i don't know...but at some point...micropayments don't work because they cost something. 

teslaberry's picture

the primary problem with any currency that cannot be expanded upon will of the king  is that you cannot use that currency for bailouts---because you never know when the bailout will be needed. 


bailouts are needed specifically to paper over massive credit implosions that occur at the very end of using every last bit of supply of existing 'hard' money to fill the leaky sieve of good capital that you call 'reserves'. 


gold can be inflated by mining more gold or monetizing silver, but it cannot be done so on a moments notice by the king---as needed for bailouts. it's time consuming.

crypto-currency can be inflated simply by legalizing the reserve status of new crypto-currencies. this can be done on a moments notice for bailouts.

to the extent bitcoin cannot be inflated OR susbsituted---then it is very much like gold, or even more time consuming to inflate ( the king essentially must kill tax and steal from people to get his bitcoins which won't 'inflate' the currency but still have the same end goal of making it amenable to his bailout programs.) 




chear leaders for bitcoin love it, but what political value does bitcoin serve and to whom?

the answer to that question reveals the underlying strengths and weaknesses of the currency---NOT some theoretical austrian economic argument about why 'honest' money is good deflationary money. 

Matt's picture

A historical solution to inflating the money supply when using gold and/or silver coins, is to simply dilute the purity of the coins. If you do it slowly enough over a long enough period, it can be fairly stable, until it suddenly collapses. This can take centuries, however, so for the current ruler, it is a viable strategy.

RaceToTheBottom's picture

This is fairly late in the game for such a stupid article on both Gold and Bitcoin.

Maybe he should have started with the three tenants of "money" and gone from there, rather than trying to forge new ground on his spiral to oblivion

silvermail's picture

Compare Gold with bitcoin, it's like comparing Sex with masturbation.

shovelhead's picture

We could all agree to use Pokemon cards as currency.

I declare Pikachu to be worth $100,000 fiats.


* will trade mint Harmon Killebrew rookie card for a Pikachu.


Matt's picture

You could certainly decree that, within your sovereign realm, pokemon cards are the only valid currency, and you could attempt to enforce a fixed exchange rate of your arbitrary choosing between those cards and each other, and between those cards and all other goods, services and currencies.

I think that real world observation of such systems suggests this is not a particularly effective, stable or efficient way for an economy to function. See Venezuala and Argentina as current examples.


silvermail's picture

"See Venezuala and Argentina as current examples".

May be better to look at China and Russia as current examples?

madtechnician's picture

If you could find another party which agreed with your price for that item , then you have reached consensus , problem is finding others to reach that consensus , with bitcoin that is happening right now .

frenzic's picture

heh right on sat800

frenzic's picture

this shit is getting stale

SAT 800's picture

this is getting very tiresome, couldn't we debate about what kind of cheese the moon is made out of now?

TheHound73's picture

I see about 50k BTC currently for sale across various exchanges.  "Unsuitable" or not, the rest of the 13 million coins are already being hoarded.

When a good part of worldwide business-to-business transactions are being powered by bitcoin, escrowed and hedged out the yinyang, speculators will have a lot less wiggle room to play in. Should be a couple more juicy bubbles before that time, though. 

silvermail's picture

I see BTC as zero bubble currently for sale across various exchanges.

fijisailor's picture

There will certainly be a new and more improved version of bitcoin in the near future if not already.

silvermail's picture

There will certainly be thousands a new and more improved versions of bitcoins in the near future if not already.
But the money will still only gold.

fijisailor's picture

I currently own .005 BTC.  Clearly I agree with you

spanish inquisition's picture

Gold is called money because its properties have made it a consistent barter exchange intermediary over time. 

Sufiy's picture

The US Crackdown On Bitcoin - The End Of The Amazing Bubble

 The only Bubble from 2013 left untouched so far is Bitcoin: after its crash postChinese ban and coordinated attack by the Central Banks Bitcoin has recovered its grounds and was trading close to $1000 range again. These days, with closing window for currency withdrawals from Bitcoin exchanges in China, DOJ has made its move. The most sexy attribution of Bitcoin - its supposed anonymity, will be used against it. As we have discussed before this anonymity is widely misunderstood and as Silk Road case demonstrates: All Transactions can be Reconstituted As An Evidence.    China bans Bitcoin and encourages its citizens to accumulate Gold. Central Banks all over the world are warning about the speculation danger related to Bitcoin. FED keeps very suspicious silence about its real stance about the FIAT alternative and after fighting Gold for 100 years it is a given that Bitcoin will be taken out once NSA will complete its job. Now Robert J. Shiller has joined our small crowd and called Bitcoin as it is:

"It is a bubble, there is no question about it.... It's just an amazing example of a bubble," the Business Insider quotes Shiller, talking to the World Economic Forum in Davos, Switzerland.

“I’m amazed by how people are so excited about it and I tell my students ‘no, it's not such a great idea’,"the economist said.

Skin666's picture

Bob Shiller claims Bitcoin is a bubble!


SELL SELL SELL all your bitcoin!!!



madtechnician's picture

Hey man , this is early days , it's not ending , it's only just beginning ..

silvermail's picture

Yes, this is only the beginning of bitcoin bubble. At the end of all the bubbles always burst, it certainly is not the end.

madtechnician's picture

The Fiat Debt bubble will burst first , once this has burst there will then be no reason for bitcoin to burst.

Skin666's picture

"Satoshi Nakamoto ignored these forces, and his design does not provide for them. The value of bitcoin is not tethered by the value of labor and capital. It was assumed to be sufficient that its quantity is fixed. It is the exact opposite of sufficient—a fatal flaw based on the Quantity Theory of Money, which is flawed to its core."


How many fucking times?! All value is subjective FFS!

Is the author still living in Karl Marx world of make believe, where all value is based on the Labour Theory of Value?!

This myth was dispelled by Menger, Jevons, and Walras in 1871 (The Marginalist Revolution)


Gold has no intrinsic value. It has subjective value as a store of weath and medium of exchange. Gold and silver, outside of the minds of humans, are worthless.

Subjective value is based on utility and scarcity, i.e Marginal Utility.

Bitcoin has far more utility than gold and silver as a medium of exchange. Gold and silver have far more utility than crypto as a store of value.


This was a bad article all round










silvermail's picture

"Gold and silver, outside of the minds of humans, are worthless."

On the festival of idiots, you can be the chairman of the jury!

TheReplacement's picture

Agreed on the quality of the article.

As for gold having no intrinsic value....  Suppose we each melt down our coins (btc and gold).  I can make a stabby thing and kill you with gold.  You can make a what exactly with btc?

How much btc goes into electronics, versus gold or even silver?

I can buy a gold ring and wear it.  Can you buy a btc ring and wear it?

I have a cavity.  Can I borrow enough btc with which to fill it?

I really need something to hold this paper down so the wind doesn't blow it away.  Would you mind putting a stack of btc on it to hold it?

I could continue but doubt there would be any intrinsic value in doing so.

Saro's picture

I can make rings out of gold, but I can't make rings out of bitcoins, therefore gold is valuable and bitcoins are not.
I can eat a steak, but I can't eat gold, therefore steak is valuable and gold is not.
I can talk to people across the world using a phone, but I can't talk to people across the world using a steak, therefore phones are valuable and steak is not.

Are you seeing the problem with your reasoning yet?  "I can use A for X, but not B for X, therefore B is valueless" ignores all other possible utilities of B.

I can send bitcoins instantly to any person, anywhere in the world, and no central authority can intervene or stop me.  In some cases, there isn't even a fee for that service.  That's a utility of Bitcoin, just like making electronics is a utility of gold.

madtechnician's picture

Bitcoin does have intrinsic value insofar as it can be used as a store of value , a high speed electronic medium of exchange which does not respect or acknowlege borders or interception.

Skin666's picture

The point I was trying to make is that nothing has intrinsic value. 'Intrinsic' is a bullshit concept beloved of Marx and other muddleheaded thinkers.


There is no such thing as intrinsic value. All value is subjective.


Imagine for a second that all of humanity is wiped out, and all that's left on this earth are animals. They have no reason or concsiousness like humans do. They do not place any value on anything, because they don't understand what value is.

Humans on the other hand have concsiousness and reason. They have subjectivity, and therefore can value materials based on their utility and scarcity. Value is in the mind of humans only.


Gold, silver, bitcoin all have subjective value due to their subjective properties to humans, but they have no intrinsic value.

Slamshizzlestein's picture

I'm pretty sure animals understand value. Explain how a dog hoards items or really any animal protects its young/food. Definitely value there.

Slamshizzlestein's picture

I'm pretty sure animals understand value. Explain how a dog hoards items or really any animal protects its young/food. Definitely value there.

silvermail's picture

Intrinsic value is determined at the moment of time, without any "buts" and "if ".
In your computer, kettle, refrigerator, air conditioning and so on, there is silver.
You can not do without catalysts of silver, for a big section of plastics.
Want to replace the Silver in bitcoin? Good luck you in the Stone Age.
Bitcoin can not exist without Silver anywhere except in your imagination.
But Silver can exist without ?itcoin, and without you personally, along with all your opinions and speculations about Silver.

madtechnician's picture

That's bullshit there are a lot of materials that have identical or improved properties to silver , only thing is they are more expensive. If the silver price passes the cost of these other materials then the alternative material will be used instead of silver. Silver is not a panacea in electronics , it is just cheaper than current alternative materials.