This past week on Bloomberg Television, I referred to bitcoin as "a fraud decorated with technology." The fraud comes about because the exchange of a fiat legal dollar for a token, to use the kind description adopted by the Securities and Exchange Commission, seems unfair and frankly incomplete. But since the dollar itself is a product of government fiat, the subject seems open to debate.
The fact that a growing crowd of people have decided to speculate in this modern day version of tulip bulbs does not alter the unfairness of the exchange. Our friend Jim Rickards recently squared off against four bitcoin proponents (a contest that hardly seems fair), but left them stumped when he reminded them that bitcoin displays the same “autoserial correlation” that was the tipoff in Madoff case.
But more to the point, the arrival of bitcoin heralds the culmination of a process of shrinkage in the value of what we rather pathetically call “money.” In 1862, when the Union led by Abraham Lincoln enacted the legal tender laws, it broke the limits on government spending and began a slow slide for the American Republic towards insolvency.
On February 25, 1862, Congress passed the Legal Tender Act to finance the Civil War. It allowed the federal government for the first time to print paper money, that was not backed by an equal amount of gold or silver. Congress authorized the sale of $150 million in paper currency which soon became known as “greenbacks.”
Congress required Americans to accept these pieces of paper adorned by dead Presidents “in payment of taxes, internal duties, excises, debts, and demands of every kind,” but significantly not customs duties for imports.
The significance of this act of Congress was to provide a way for the government to expand the currency without relation to whether it was backed by metal or even taxes. The emergency which enabled this act of theft was a war, a reality that goes back to the Greeks and Romans. “Thus under the exigencies of war,” wrote Senator Robert Byrd, “the nation gained a uniform currency to meet the demands of an expanding economy.”
Well, sort of. The nation gained a flexible currency that traded down to a sharp discount vs gold and silver during the Civil War, but rebounded thereafter. Yet in real, purchasing power terms the greenback steadily has lost value since the 1860s. Through WWI and the creation of the Federal Reserve System in 1913, then the Depression and FDR’s confiscation of gold held by individuals, the fiat monopoly of the US government has grown. And since the Depression and WWII through to today, the dollar has lost roughly 95% of its original value in real, purchasing power terms.
Many other nations have legal tender laws, a feature of the modern administrative state. Yet as the public debt of the US and other industrial nations has grown, an unease has affected many people when it comes to the future of the Republic and the dollar. Think Neo in The Matrix. Americans are forced by law to use dollars as a means of exchange and a unit of account, but it has largely lost any utility as a store of value.
Indeed, negative interest rates and quantitative easing are merely the latest manifestations of the ability of the state to tax its people of value via the shrinking dollar. Nations have fiscal deficits and trade deficits, but the biggest shortfall is credibility. When you look at the growth of the federal debt and the Fed’s willingness to monetize public debt via open market purchases, it is reasonable to conclude that we will all one day drown in a sea of worthless fiat dollars.
Into this yawning gulf of integrity comes bitcoin, a new era vehicle for speculation and larceny that derives its legitimacy from the fact that it is not sponsored by one of the indebted administrative states. The folks at BNP Paribas noted recently that the future of bitcoin is limited because it lacks a lender of last resort, but isn’t that the point? Right?
Bitcoin is a “currency” that was designed to go ever up in value, to grow rather than shrink compared to fiat currencies. The lack of a short market or the ability to borrow the crypto currency is part of the clever design by the mysterious founder that strongly biases the market to move ever higher, albeit with spasmodic episodes of price collapses.
As the value of bitcoin expressed in fiat currencies rises, so too does the cost of clearing and the rewards to the “miners” who validate each trade. Bitcoin looses efficiency as it goes up in value. And as the crowd of people seeking access to the limited supply of bitcoin grows, the price increases.
But at the end of the day, the key flaw that blocks the bitcoin game from becoming a functional means of exchange or unit of account is the lack of an efficient way to move from the crypto currency to dollars or other legal tender currencies accepted by the payments system. There are plenty of proposals on how to fix this, but the key issue seems to be the volatility. As and when a solution occurs, however, the crypto world will threaten the fiat system. China’s new Emperor Xi Jinping understands this reality very well and has taken steps to ensure that bitcoin is tightly under the control of China’s communist rulers.
While many people suppose that bitcoin is a threat to banks and the banking system, in fact the true threat is political. If bitcoin were to ever grow large enough to present a viable alternative to the world of fiat legal tender dollars, the threat to America’s government monopoly over money would require a political reaction akin to FDR’s seizure of gold -- in the name of self preservation. Compared to FDR's seizure of gold held by individuals, President Nixon closing the gold window forty years later was mere formality.
Fortunately, the quirky aspects of the bitcoin model that push the price ever higher, and with rising volatility, make it unlikely that it will achieve such broad adoption. But it sure is fun to watch. Yet ultimately the success of bitcoin is a pretty grim commentary on the prospects for the world of dollars and euros and yen, which are all tied to nation states that are well down the road to insolvency and default. And yes, robbing people via inflation is a form of default.
Or as one banker commented in 1862 when the legal tender laws were enacted: “By common consent of the nations, gold and silver are the only true measure of value. These metals were prepared by the Almighty for this very purpose.”