One of the buzzwords of assorted right-wing libertarians and conservatives is sound money. What’s interesting about their advocacy of “sound money” is that they typically identify “sound money” with restoring gold standard, or, more edgily, adoption of some new privately created currency like the bitcoin.
The past couple of months have seen a rapid run-up in the value of bitcoins which, after shooting up to over $1000 in 2014, had fallen back to the $200-300 range where it had been wallowing until for some reason it recently started a steady rise until shooting up to over $400 last week.
So I was interested in reading Dan McCrum’s piece in the Financial Times the other day in which he compared bitcoins to a pyramid scheme, providing a lot of historical background on similar schemes going back to General Gregor MacGregor in 1821. McCrum also points out an inherent flaw in the bitcoin which is that the very feature that is supposed to ensure its stability — the absolute limit on the total number of bitcoins — will ultimately cause its failure.
The inherent flaw of pyramid schemes is that they must always suck in new converts to avoid collapse, and the exponential growth in users is impossible to sustain. Bitcoin shares some of these features. It requires constant evangelism because its value derives from its use.
The limited supply of bitcoins then becomes a fatal constraint. The more people use it, the greater the price must rise, dissuading its use as a currency.
Of course, after each run-up in the value of the bitcoin, a reaction sets in, people then shifting away from bitcoins as a medium of exchange, causing its value to drop, so the bitcoin is naturally beset by sharp swings in its value – just what you want from sound money. Yeah, right. So, after a price increase of over 60% in less than a month, bitcoins have lost 20% of their value in a week. Have a look:
Doesn’t get much sounder than that.
I especially liked this quotation from Walter Bagehot provided by McCrum:
One thing is certain, that at a particular time a great deal of stupid people have a great deal of stupid money.
Uneasy Money 