Bitcoin Triples Again; Thoughts on Money and Freedom

Much is being written and talked about when it comes to Bitcoin these days. Smartmoney writes The Bitcoin Triples Again:

The world’s fastest-gaining currency has tripled in price again. Last week, SmartMoney.com reported that the Bitcoin had exploded from an exchange rate near zero to more than $10 in about a year, making it one of the top-returning assets of any kind. On Wednesday the currency topped $30.

I myself don’t know much about Bitcoin yet, but what I do know that most people who write about it have little to no clue about the concept and the history of money.

A money is a medium of exchange. Under free competition in the realm of media of exchange, those goods that are most desired by consumers to fulfill this role will outstrip others in this process, just as they do in any other field where demands are to be fulfilled.

It is only through government fiat and intervention that the money market has been turned into a centrally controlled and directed monopoly. As I’ve explained before:

Fiat currency is demanded by individuals in exchange transactions because its acceptance in payments of debts is enforced by the state, because it is required in tax payments, and because reproducing the same currency without state approval is prevented via the threat or use of aggression. This ensures that there will always be some kind of demand for it.

The internet, arguably the freest economy in the world today ( ironically originally created by government bureaucrats :) ) has changed and is changing the world in ways that many still cannot fathom and are slow to catch up with.

While free competition on the internet has already decentralized the market for media and communication, and has allowed to bring to bear the benefits of the free market upon an enormously large segment of today’s population, in particular the younger generation, bitcoin appears to be the internet’s first serious attempt to challenge the government’s currently global oligopoly on the production of money, and so far it seems to be a medium that is gaining in popularity. Who knows where exactly it will go?

The other day I read a criticism from a guy as to why bitcoin won’t work and why its decentralized mechanism of producing currency is flawed etc. etc. But all those who criticize the concept of a decentralized, non government controlled, currency are either paid off or missing the point:

Us libertarians do not proclaim to know which single commodity out there in the world will be the best medium to facilitate exchange for all time to come! We are not in love with gold, silver, or bytes streaming through cyberspace. All we say is this: “The initiation of the use of force is immoral.” And as I explained above, unfortunately every single pillar that fiat currency rests upon is rooted in just that. We say: Let free and peaceful people decide for themselves what they prefer as currencies, and let them produce currencies where they think they can fill the need for a stable medium of exchange better than others.

(It is precisely this that the governments of the world fear: to have to actually be subject to the mundane and annoying checks and balances called consumer demands, complaints, and competition from superior service providers. Thus, just as in the case of Net Neutrality and the FCC, you can be sure that they will use every trick in the book to curb bitcoin’s emergence as much as possible. They will say that it’s used by crazy people who sell drugs and prostitution and who eat puppies and babies etc. etc., just to get moral sanction from the public to crack down. Of course they will have to pass in silence the fact that cash fiat money, purely and 100% created by the state, is still organized crime’s prime medium of exchange.

But in the case of bitcoin a crackdown will have to be well planned and orchestrated because if its decentralized nature does indeed prove to be safe from government meddling, then its popularity will only rise exponentially!)

So, to go back to my prior point, even if bitcoin turned out to be a gigantic failure, it absolutely doesn’t matter! This is precisely the point of having free competition in the realm of money: To allow the better producers to stay in business and let the irresponsible ones fail. So long as irregularities and problems are addressed on a smaller level, the repercussions for the affected customers are far less of a drain upon society than continuous and ongoing nationwide or even global boom and bust cycles, financial crises, and fiat money and credit financed wars.

We are not wed to conclusions. We do not say that gold or platinum or bits are the one best currency forever and ever. We are only wed to a process: that of logic and evidence. Market competition and the respect for individual’s body and property leaves little room for arbitrariness and whim and forces suppliers to test their hypotheses about what is and what is not demanded by the majority. Where their decisions were wrong they will be negatively affected and try and improve, where they were right, they will be rewarded.

So to the critics of bitcoin who intend use it as an example of how decentralized currencies won’t work, impatiently awaiting its apparently oh so predictable collapse, I would say this: Why don’t you calm down and let the chips (or coins) fall where they may? :)

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China Pegging Yuan to Dollar Again?

From June 1995 through the beginning of 2005, the Chinese government was pegging its Currency to the US Dollar. It was producing money (Yuans) to purchase Dollars, fostering a US current account deficit.

In 2005 the Chinese government ended the peg against the US dollar and switched over to a currency basket. From 2005 though June 2008, the value of one Dollar dropped from RMB 8.28 in 2005 to about RMB 6.83 by June 2008.

Since then, it seems, the fall of the dollar has stopped and the Yuan/Dollar exchange rate remained suspiciously stable. This has gone on through right now. The chart below illustrates this:

The stabilization of the Dollar against the Yuan has almost coincided the reversal of the Dollar’s fall against other major currencies. It thus appears as if, since mid 2008, the Yuan/Dollar peg has been reinstated and continues to be in place as these lines are written. What is also noteworthy is that the US current account deficit has been declining sharply since then.

A first look at the above chart leads one to believe that Chinese and US authorities aimed at putting an end to the fall of the Dollar, and thus intervened accordingly. However, another possibility which I would like to propose is that the Dollar had fundamentally and truly begun to stabilize at the level of RMB 6.83 at that point and was actually in for a major revaluation upwards. Thus the current intervention by Chinese authorities could actually be aiming at a stabilization of its own currency at a higher level than the market would mandate.

Some points fundamentally support the thesis that the dollar should gain in value against the major currencies:

– Global deleveraging is driving investors from other currencies back to the Dollar
Deflation hitting the US first, and other countries only later
– Imports into the US are falling rapidly
– Significant domestic spending sprees by the Chinese government

All this may indicate that if the Chinese government were to let the Yuan float freely at some point, it may actually drop significantly against the US Dollar. Such an event could possibly be the ignition for a significant Dollar rally in the years to come.

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True Money Supply

The money supply inside a country is the total nominal value of money units ready to be spent in its respective territory. Money is a medium of exchange. This is its ultimate purpose. All other so called money functions, like value storage medium, measure of utility, etc. are nothing but derivatives of this function. More precisely, money is that medium which is accepted by virtually everyone inside a certain territory as a medium of exchange for products and/or services rendered.

As explained in Credit Expansion Policy, the major business cycles, booms and recessions are caused by an increase and subsequent drop of the money supply, respectively.

If one carefully tracks the true stock of money and its growth or contraction over time, one can make fundamental assessments and predictions about the state of the economy and the outlook for asset and consumer prices in general.

The Federal Reserve Bank employs two measures for the money supply: M1 and M2. It also supplies other data, called ‘Other Memorandum Items’ which in its opinion is not part of the money supply.

We shall analyze each component of the data provided, and figure out whether or not it should be included in the money supply.

A lot has been written about the true money supply. There are completely different views on this matter. However, the solution to the question is pretty simple so long as one agrees that the definition of money is that it is the medium of exchange accepted by everyone within a certain territory.

Each component simply has to pass the following test: Is this item accepted by virtually everyone as a medium of exchange inside the USA?


M1: Currency + Traveler’s Checks + Demand Deposits + Other Checkable Deposits

Currency: This is cash money in the pockets, lockers, mattresses, or hands of individuals. Cash, when printed and used by the federal reserve to purchase assets and thus channeled into circulation increases the nominal amount of media of exchange available in society. Virtually everybody accepts cash as payment. It is without a doubt a component of the money supply.

Traveler’s Checks: Traveler’s checks are issued by American Express and other credit institutions. A traveler’s check has to be purchased in exchange for currency or checking deposits. Money is transferred from the purchaser’s account to the company issuing the traveler’s check. When used, money is transferred from the issuing company’s deposits to the person redeeming the check. Hence, traveler’s checks do not add to the overall availability of media of exchange, they are merely a means to facilitate the transfer of actualy money. Traveller’s checks are not commonly accepted as a means of payment inside the US. They are not to be included in the money supply.

Demand Deposits: Demand deposits are checking accounts. Additional checking account money can be created in different ways: When people deposit cash money in exchange for demand deposits, the overall money supply does not change. However, if we observe both figures, then all cash deposits will reduce the ‘Currency’ account, and increase the ‘Demand Deposit’ account. Another way of creating demand deposits is when the central bank issues new demand deposit money instead of printing new money, and purchases bank assets with it. In addition to that, banks may issue credit themselves by making out loans that are not fully backed by deposits. This money will appear on the loan recipient’s checking account. Checks can be written against them. Virtually everyone accepts payment in demand deposit money. Demand deposits are thus to be included in the money supply.

Other Checkable Deposits:These are savings deposits that can be drawn upon when demand deposits are overdrawn. But a savings deposit is not part of the money supply. A savings deposit does not function as a medium of exchange. When someone deposits money in a savings account the bank turns around and invests the money in credit instruments. It will then appear on the checking account of the seller of the credit instrument. This does not change when the savings deposit can be partially drawn upon. A buyer of a good cannot write a check against his savings deposits. At the best he writes a check against demand deposits that he is going to obtain after liquidating a fraction of his savings deposits. It would be rather impossible to try and use one’s savings deposits as a means of payment. No one would accept a payment ‘in savings deposits’. This even applies to that portion of it which can immediately be turned into checking account money. The recipient of a check written against the checkable portion of a savings deposit still demands checking account money as final means of payment. Thus the payer’s savings deposit dollars need to be converted into checking deposit dollars settling the transaction. (If this was NOT the case, savings deposits and other checkable deposits would indeed be a part of the money supply.) Other checkable deposits are hence not part of the money supply.


M2: M1 + Savings Deposits + Small-Denomination Time Deposits + Retail Money Funds

Savings Deposits: As explained above under ‘Other Checkable Deposits’, savings deposits don’t function as media of exchange. Nobody would accept a payment from someones savings deposit straight to his savings account. But our definition of money is that is is precisely that medium which is broadly accepted as payment. Savings deposits are hence not part of the true money supply.

Small-Denomination Time Deposits: These are deposits where the depositor contractually commits to not withdrawing the money for a fixed time frame. Time deposits cannot be used as media of exchange and are hence not part of the true money supply, even less so than savings deposits.

Retail money funds invest in short-term debt, such as US Treasury bill and commercial paper. They are not used or accepted as media of exchange, and are hence not part of the true money supply.


Other Memorandum Items: Demand Deposits at Banks Due To Foreign Commercial Banks and Foreign Official Institutions + Time and Savings Deposits Due To Foreign Commercial Banks and Foreign Official Institutions + U.S. Government Deposits + IRA and KEOGH Accounts

Demand Deposits at Banks Due To Foreign Commercial Banks and Foreign Official Institutions: These are checking account deposits held by foreign banks and institutions at American banks. Foreigners hold funds in checking accounts of other countries in order to cover expenditures in those same countries. These expenditures are covered using that country’s medium of exchange, money. They clearly are to be added to the true money supply.

Time and Savings Deposits Due To Foreign Commercial Banks and Foreign Official Institutions: As already explained above, time and savings deposits are not to be included in the true money supply.

U.S. Government Deposits: These are demand deposits held by institutions of the the U.S. Government at commercial and the Federal Reserve Bank. It is a curious fact that they have been excluded from the official money supply data. The money does not disappear from circulation. If A pays taxes to government entity B the funds are merely transferred from one account to another. The funds are used to cover expenses during day to day operations, pay employees, etc. and are hence a part of the true money supply.

IRA and KEOGH Accounts: These are, like savings and time deposits, merely investments in credit instruments and other investment vehicles and are not part of the true money supply.


Retail Sweeps

One more important item to be mentioned are so called bank ‘retail sweeps’. Retail sweeps were introduced in January of 1994 when the Federal Reserve Board allowed commercial banks to use a software that classifies certain portions of customers’ checking account deposits as money market deposits accounts (MMDAs). Researchers at the regional Federal Reserve Bank of St. Louis have summarized it as follows:

“At its start, deposit-sweeping software creates a “shadow” MMDA deposit for each customer account. These MMDAs are not visible to the customer, that is, the customer can make neither deposits to nor withdrawals from the MMDA. To depositors, it appears as if their transactionaccount deposits are unaltered; to the Federal Reserve, it appears as if the bank’s level of reservable transaction deposits has decreased sharply. Although computer software varies, the objective is the same: to minimize a bank’s level of reservable transaction deposits, subject to several constraints.”

This means that customers don’t notice the slightest change to their demand deposit account. In effect, their behavior doesn’t change at all, no matter whether or not their checking deposit has been reclassified. Retail sweeps are nothing but an accounting fiction that enable banks to lower their minimum reserves and lend out more money.

But this means that the statistics on demand deposit accounts have been inaccurate since 1994. That portion which has been reported as MMDA when it was actually demand deposit money to customers needs to be included in the money supply. The Federal Reserve Bank of St. Louis provides a monthly estimate on this number. Retail Sweeps are part of the true money supply.

Conclusion: Thus the true money supply ( we shall call it M(t) ) is defined as follows:

M(t) = Currency + Private Demand Deposits + Demand Deposits Due to Foreign Banks and Institutions + Government Demand Deposits + Government Federal Reserve Deposits + Retail Sweeps

Below is the development of the true money supply from 1959 through 2008:


Click image to enlarge.

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