In the three-way race between the monetary properties in gold, bitcoin, and fiat, our favorite orange system usually occupies a blessed middle ground between fiat and gold — in some sense incorporating the best of both worlds:
- Fiat doesn’t have market-governed supply; there is no marginal cost to its production and no constraints on its creation, which is what contribute to its abuse and instability. But it's cheap and "efficient" and doesn't have non-monetary demand that can interfere with its role as money.
- Gold has nature-constrained supply, making its issuance subject to shocks of discovery and techniques for its extraction, and its industrial and decorative use on the demand side can mess with its monetary role.
Like fiat, bitcoin has no nonmonetary shock vectors (this is what monetary economists refer to as not having intrinsic value). Like gold, it uses competitive energy expenditures to constrain its production, but in bitcoin's case, not really since it has a perfectly predictable and predetermined supply schedule.
Because bitcoin’s supply cannot adjust to changes in its purchasing power, its long-run and short-run purchasing power becomes unanchored — a property it shares with fiat, though in the opposite direction: bitcoin has no top because fiat has no bottom, etc. Its supply is “completely free from surprising exogenous changes,” as monetary economist Larry White wrote in his excellent book Better Money: Gold, Fiat, or Bitcoin? 1
Gold has one property that, to most macroeconomists at least, make it super to bitcoin: The price level under gold is mean reverting. Informationally efficient and very convenient. Because gold miners adjust production (or sources of nonmonetary gold, their holding) in accordance with the purchasing power of gold, its supply expands when prices are falling — since the mined gold is more valuable. With more monetary quantity available in the future, this brings prices back up again.
Conversely, gold production contracts when prices are rising, which brings them back down.
The price level under a gold standard thus becomes self-correcting, causing stable prices over decades and sometimes centuries. (British prices were roughly the same on the eve of World War I as they were before the Napoleonic wars a century earlier.)
The process is slow and unpredictable, and under historical gold standards aggregate prices could be higher or lower during long periods of time — often coinciding with monetary shocks like new mines from the New World or fiscal ones like kings waging wars.
Under fiat, with credible monetary policy and competent, knowledgeable central bankers committed to a 2% target — yes yes, this is an impossible unicorn, I know, but we’re playing blackboard economics here — we get short-run prices that consumers and businesses can deal with.
- If what costs $100 today will cost $102 this time next year, I know my wages must rise by 2% to maintain my standard of living; if my bank and I both know that the real value of my mortgage debt will be 2% lower next year and 2% lower still the year after, we can comfortably factor that into our interest rates today.
- Either party gets shafted only when experienced inflation diverges from what is announced by the central banker. Since real-world central bankers reliably mess up — as opposed to omnipotent and omniscient angels — no market participant can have a remotely accurate price-level view for 10, 20, or 50 years into the future; the errors compound, making price level predictability over medium-to-long horizons garbage. 2
Because unstable monetary demand and unyielding supply makes the bitcoin purchasing price undetermined in both long and short run, most economists — including Larry White — ultimately favor gold as the world's money (or, if they're sufficiently wonky and credulous, fiat, given that an ideally operating fiat regime can mimic a gold standard, 3.
This is basically the best economic case an honest, serious, and well-meaning critic can levy against bitcoin: the price level is unanchored.
I'm not persuaded that this is such a devastating flaw 4. Indexation efforts are underdeveloped; we can learn to live with more (short-run) unpredictability in aggregate prices; the "harm" is all on the upside. Plus, feasibility:
"The bitcoin revolution doesn’t take an Act of Parliament, or convincing those least likely to appreciate the harm of current monetary policy; it merely takes individuals to opt out, to vote with their feet."
Takeaway: Bitcoin is different from both gold and fiat, its macroeconomic effects and dynamics completely different from both.
It's not the case that bitcoin is merely digital version of gold. It comes with a different set of properties, leading to different macroeconomic outcomes.
That's today's little money lesson.
Peace,
J