Noah Smith on Bitcoins: A Failure with a Golden Future

Noah Smith and I agree that, as I argued in my previous post, Bitcoins have no chance of becoming a successful money, much less replacing or displacing the dollar as the most important and widely used money in the world. In a post on Bloomberg yesterday, Noah explains why Bitcoins are nearly useless as money, reiterating a number of the points I made and adding some others of his own. However, I think that Bitcoins must sooner or later become worthless, while Noah thinks that Bitcoins, like gold, can be a worthwhile investment for those who think that it is fiat money that is going to become worthless. Here’s how Noah puts it.

So cryptocurrencies won’t be actual currencies, except for drug dealers and other people who can’t use normal forms of payment. But will they be good financial investments? Some won’t — some will be scams, and many will simply fall into disuse and be forgotten. But some may remain good investments, and even go up in price over many decades.

A similar phenomenon has already happened: gold. Legendary investor Warren Buffett once ridiculed gold for being an unproductive asset, but the price of the yellow metal has climbed over time:

Why has gold increased in price? One reason is that it’s not quite useless — people use gold for jewelry and some industrial applications, so the metal slowly goes out of circulation, increasing its scarcity.

And another reason is that central banks now own more than 17% of all the gold in the world. In the 1980s and 1990s, when the value of gold was steadily dropping to as little as $250 an ounce, central banks were selling off their unproductive gold stocks, until they realized that, in selling off their gold stocks, they were driving down the value of all the gold sitting in their vaults. Once they figured out what they were doing, they agreed among themselves that they would start buying gold instead of selling it. And in the early years of this century, gold prices started to rebound.

But another reason is that people simply believe in gold. In the end, the price of an asset is what people believe it’s worth.

Yes, but it sure does help when there are large central banks out there buying unwanted gold, and piling it up in vaults where no one else can do anything with it.

Many people believe that fiat currencies will eventually collapse, and that gold will reemerge as the global currency.

And it’s the large central banks that issue the principal fiat currencies whose immense holdings of gold reserves that keep the price of gold from collapsing.

That narrative has survived over many decades, and the rise of Bitcoin as an alternative hasn’t killed it yet. Maybe there’s a deeply embedded collective memory of the Middle Ages, when governments around the world were so unstable that gold and other precious metals were widely used to make payments.

In the Middle Ages, the idea of, and the technology for creating, fiat money had not yet been invented, though coin debasement was widely practiced. It took centuries before a workable system for controlling fiat money was developed.

Gold bugs, as advocates of gold as an investment are commonly known, may simply be hedging against the perceived possibility that the world will enter a new medieval period.

How ill-mannered of them not to thank central banks for preventing the value of gold from collapsing.

Similarly, Bitcoin or other cryptocurrencies may never go to zero, even if no one ends up using them for anything. They represent a belief in the theory that fiat money is doomed, and a hedge against the possibility that fiat-based payments systems will one day collapse. When looking for a cryptocurrency to invest in, it might be useful to think not about which is the best payments system, but which represents the most enduring expression of skepticism about fiat money itself.

The problem with cryptocurrencies is that there is no reason to think that central banks will start amassing huge stockpiles of cryptocurrencies, thereby ensuring that the demand for cryptocurrencies will always be sufficient to keep their value at or above whatever level the central banks are comfortable with.

It just seems odd to me that some people want to invest in Bitcoins, which provide no present or future real services, and almost no present or future monetary services, in the belief that it is fiat money, which clearly does provide present and future monetary services, and provides the non-trivial additional benefit of enabling one to discharge tax liabilities to the government, is going to become worthless sometime in the future.

If your bet that Bitcoins are going to become valuable depends on the forecast that dollars will become worthless, you probably need to rethink your investment strategy.

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19 Responses to “Noah Smith on Bitcoins: A Failure with a Golden Future”


  1. 1 JKH February 2, 2018 at 3:35 am

    Your description makes it seem like the world is still on a kind of strategic gold standard, whereby central bank gold portfolio activity remains a critical factor in determining the value of gold (although obviously not being operationally precise with fixed rates, as in the actual gold standard era).

    In additional to examples of operational fraud or failure, bitcoin is a total scam as a concept. Very few people understand or would care about how governments create demand for a sovereign currency through taxation, or how central banks steer the price level through interest rate control. For many of them, anything contrary to libertarian instinct or fear of hyperinflation falls into the category of fake news.

  2. 2 JP Koning February 2, 2018 at 7:10 am

    “…which clearly does provide present and future monetary services, and provides the non-trivial additional benefit of enabling one to discharge tax liabilities to the government, is going to become worthless sometime in the future.”

    One counterargument that I’ve heard (and I don’t buy) is that worthlessness is staved off by bitcoin’s mandatory use in online drug transactions. If there is only one accepted medium for buying drugs online–bitcoin–and you are an addict who refuses to buy offline, then you need to “discharge your liability” to your online dealer by sending him or her some bitcoins. Wicksteed’s theory that the tax authority drives money becomes the drug kingpin theory for money.

  3. 3 JKH February 2, 2018 at 7:44 am

    Further to my comment above regarding a “strategic gold standard” – I’m not necessarily disputing that. I just think its interesting.

  4. 4 David Glasner February 2, 2018 at 9:10 am

    JKH, The difference between a gold standard and the current role of central banks in propping up the value of gold is that the value of gold is now completely disconnected from the value of a unit of the currency. Under the gold standard, the value of a unit of currency had to be equal to the value of a corresponding weight in gold. Insofar as the monetary authority had sufficient market power in the gold market, the monetary authority was able to control the value of the currency it was issuing, but only subject to the constraint that the value of currency had to equal a corresponding weight in gold.

    JP, The usefulness of bitcoins in illicit transactions only works insofar as people expect it to have a future value, but that still begs the question why they do expect it to have a future value. If you say they expect it have value because you need it to make illicit transactions you are just reasoning in a circle.

  5. 5 JKH February 2, 2018 at 10:34 am

    I’m aware of that David.

    By “strategic”, I’m referring to your description of price influence, as in:

    “until they realized that, in selling off their gold stocks, they were driving down the value of all the gold sitting in their vaults. Once they figured out what they were doing, they agreed among themselves that they would start buying gold instead of selling it. And in the early years of this century, gold prices started to rebound.”

  6. 6 David Glasner February 2, 2018 at 10:42 am

    JKH, OK, but how does this relate to a gold standard? They are just recognizing and acting on their collective interest in propping up the value of an asset in which they all have a substantial financial stake.

  7. 7 Jacques René Giguère February 2, 2018 at 11:02 am

    Many BTC fans are survivalists. Obviously, if civilisation collapse, the safest and most useful assets in the Montana mountains will be a string of digits in a distributed network based on a worlwide electrical and fiber optic networks.

  8. 8 David Glasner February 2, 2018 at 11:41 am

    Jacques Rene, Obviously!

  9. 9 Lord February 2, 2018 at 1:13 pm

    There is another sense in which it will never collapse. The last holders will simply offer it at a price higher than any will buy and it ceases trading until forgotten, so perhaps a zero in trading volume would be more accurate than in value.

    Would central banks buy to keep up the value of their stocks in the future though? Maybe just at financial crises with plunging values for reassurance?

  10. 10 Elwailly February 2, 2018 at 3:30 pm

    I’d like to be a contrarian.

    Bitcoin is a method of storing and transferring wealth with the property that it cannot be confiscated or kept from being transferred (if handled correctly). A search of your person or your home would not reveal ownership (again if handled correctly). It is available to anyone in the world with a smartphone and it can be transferred across the world.

    This has value that is not replicated by fiat; in paper form or in bank accounts. Think Cyprus a few years ago or what happened to those princes in Saudi Arabia recently. I think every billionaire is considering parking a few million dollars in an anonymous Bitcoin key today.

    You can argue how much this value is. You can argue that fools are paying too much today. But you can’t argue that the value will go to zero. There is no basis for that argument. It’s the same as arguing those Rembrandts will go to zero value as soon as everyone realizes they’re ugly.

  11. 11 Henry Rech February 3, 2018 at 10:33 pm

    Elwailly,

    How can it be of any use to anyone, other than speculators, when it is subject to violent alternating bouts of buying and selling?

    Governments may or may not be able to confiscate BTC, but markets are doing a pretty good job of knocking it around.

  12. 12 JKH February 4, 2018 at 12:35 am

    David,

    The gold standard is characterized by central banks that commit to convertibility. They use their balance sheets to intervene in the gold market in order to uphold that commitment (along with interest strategies).

    Your description characterizes a different situation where central banks also use their balance sheets to intervene (ad hoc) in the gold market. And they intervene in order to influence the price of gold.

    That is the connection and that’s the only point I’m making – which others may think is trivial and dismissible. I do understand there is quite a difference between the two situations.

    Setting that aside, I’d be interested in your theory as to why central banks hold gold today.

  13. 13 Henry Rech February 6, 2018 at 3:13 am

    “I’d be interested in your theory as to why central banks hold gold today.”

    The US Fed in particular – have they ever sold an ounce since convertibility was abolished?

  14. 14 spencerengland February 7, 2018 at 10:30 am

    In the 1970s I was a gold analyst and did a study of the long run supply and demand for gold. I concluded that over the long run gold demand would grow with world GDP but the supply would grow less. Consequently, the real price of gold probably would grow at about a 3% real annual rate over the long run. Interestingly, from a 1970 base that is almost exactly where the current gold price is.

    Remember, the era of the gold standard from some 1700 to 1900 was an unusual period. One, there were several new gold discoveries over the period like South Africa, Alaska and California. Second, governments or central banks were paying prices for gold well above the free market price of gold. Otherwise, central banks gold holding would not have increased if they had not been paying above the market clearing price.

    Interestingly, measuring worth has an interesting series of the price of gold since 1257.from 1257 to 1700 Over that period the price the Bank of England paid increased about every 5 to 10 years at a compound annual rate of about 0.5%. Given that the long term real growth of the economy was probably close to 0.5% this rate of growth seems reasonable.

    http://www.measuringworth.org/datasets/gold/result.php

    But this is just another piece of evidence that the 1700 to 1900 period gold buffs cite was a very unusual period and that is unlikely to be repeated.

    For a gold reserve system to work the central bank has to pay well above the private market clearing price to work. If private individuals suspect that the price the central bank pays is too low they will buy gold from he bank and bank reserves will fall. This is what happened in the 1960s and could have been part of the problem in the early 1930s until FDR raised the price of gold to $35..


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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