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Saturday, Aug 18, 2018 - 20:17 SGT
Posted By: Gilbert

Some Things Never Change

Dear Sirs:

Today's rebuttal is on another Krugman op-ed in that doyen of the mainstream media, the New York Times, on "Transaction Costs and Tethers: Why I'm a Crypto Skeptic". One would scarcely have time to devote to other, mostly more pleasant, matters, if the aim is to address all of his claptrap. However, this particular piece was so egregiously misinformed, that one could not help but try to level the scales a little.

Although the reader may wish to read the original article in the interest of fairness, I believe the following summary captures Krugman's intent faithfully: he is a cryptocurrency skeptic mainly because cryptos have high transaction costs, and because cryptos lack a tethering of value.

On that first point, Krugman claims a clear direction of progress "in the broad sweep of monetary history": first, the use of precious metal coinage - inconvenient and labour-intensive to mine. Next, banknotes backed by said precious metals, and further operating on fractional reserves. And then, a trend towards greater and greater convenience: paper cheques, credit cards, and finally today's mobile e-payments.

Therefore, Krugman explains, cryptocurrencies are strange in that they buck this trend - Bitcoin, which has returned to dominating the crypto landscape, has relatively high transaction costs, as well as a wasteful production process. Indeed, it is probably not a coincidence that this process is termed "mining", as that for gold and silver was. To this, Krugman wonders: "...in other words, cryptocurrency enthusiasts are effectively celebrating the use of cutting-edge technology to set the monetary system back 300 years. Why would you want to do that? What problem does it solve? I have yet to see a clear answer to that question."

To this query, we might delve somewhat further back into the past, which might cast some doubt on Krugman's simplified unidirectional precious metal → representative money banknote → fiat banknote → fiat electronic money narrative. Cribbing liberally from Weatherford's The History of Money, Ferguson's The Ascent of Money and Martin's Money: The Unauthorized Biography, one might recognize a certain pattern going on. To begin with, consider this description of the Roman economy, almost two thousand years ago, from Weatherford:

"Faced with climbing government expenses, emperors searched for new revenue and new ways to make existing revenue stretch further. Nero began to tamper with the coinage itself. In A.D. 64, in a naive attempt to deceive the populace, Nero decreased the silver content in the coins and made both the silver and gold coins slightly smaller. By collecting the existing coins and remining them with his portrait bust but using less silver, Nero produced a momentary surplus of silver and gold. The same pound of silver that had formerly produced 84 denarii now produced 96, giving Nero almost a 15 percent 'profit'..."

Decline and fall of the Roman coinage
(Source: wikipedia.org)

One good turn deserved another, and by the reign of Gallienus some two hundred years later, the denarius - once almost pure silver in Nero's time - had degraded into the antoninianus, which contained less than 5% silver... but was supposed to represent twice the nominal fiat face value. Of course, that didn't work out, as price inflation in coin terms simply took place.

Skipping from some 1800 years ago to about 800 years ago, Marco Polo observed that Kublai Khan had set up a system whereby all private gold and silver had been confiscated, and paper money issued in its place. Foreign merchants like himself too had to convert their precious metals at specified exchange rates, to paper notes for internal use. Arabic traders of the same period also noted the extensive security measures, which included having their portraits sketched for easy distribution, in case they fell foul of the law (which is being echoed by modern China's surveillance state); this Mongol paper money also repeatedly fell to rapid inflation from their introduction about 1300, and the following Ming Dynasty would suspend printing by 1450, to return to silver.

Even restricting ourselves to Krugman's chosen time period of the last three hundred years, it can firstly be noted that fiat currencies have tended to continue failing at worst, and relentlessly devaluing at best. And, it has to be emphasized that the latest iteration of unbacked fiat currency - not backed by precious metal, i.e. representative - is very, very new, dating from Nixon's 1971 taking of the U.S. dollar off the gold standard. But wait, isn't this - and Roosevelt's 1933 confiscation of private gold - simply more or less Kublai Khan's policy of the 13th century? As Marco Polo sagely noted then, "this system of paper money could work only where a strong central government could enforce its will on everyone within its territory", which Krugman at least recognizes in admitting that, "...if you like, fiat currencies have underlying value because men with guns [i.e. Big Uncle Sam] say they do."

Rewinding to the next previous example, the depreciation of even the U.S. dollar - surely the dominant fiat currency of our age - uncannily mirrors that of Roman coinage. In the two hundred years from Nero to Gallienus, the same quantity of silver that had minted a single denarius, would later mint some twenty antoniniani with a face value of two denarii, a roughly 97% depreciation. Well, the Fed Dollar has depreciated about 95% in purchasing power terms in a century, and over 60% (if well over 90% at certain times) against gold, despite all the fixing taking place to sever that connection. Unlike the Romans, however, contemporary governments do have the option of printing prettier banknotes, rather than having their sins reflected by debased coins. This of course doesn't change the reality.

And part of why TRUMP's bid to correct the trade deficit is so timely
(Source: azizonomics.com)

If we may go yet further back, we might realize that near-frictionless transactions - the Holy Grail that Krugman's monetary narrative has us headed towards - was actually where humans started from! Per Graeber's Debt - The First 5000 Years, our ancestors began with informal credit: Ugg gave Thar a rabbit, Thar would fix Ugg's stone axe in return, and if there was anything left over or uncovered, it simply went on the tab. Sure, this may have worked only in small social groups, but the general point is that Krugman's presentation of monetary development as linear is fundamentally incorrect. Money is more properly described as developing cyclically: some ruler "cleverly" realises that he can leverage political power and monopoly over violence into profits, and abstracts the nature of currency away from commodity to fiat; then, when his empire weakens, the currency reverts. Thus was it with Nero and Gallienus, thus was it with Kublai Khan, and thus it will be with our latest tokens.

Definitely, this is far from an original observation. As David Ricardo wrote about 1817, "...experience, however, shews, that neither a State nor a Bank ever have had the unrestricted power of issuing paper money, without abusing that power". The thing, then, is whether economics is at its base a humanistic or a scientific affair. I submit that it is far more the former, since the temptations of today's governors towards over-issuance of money are basically little changed from those of the Romans, from two thousand years ago and beyond - riches and popularity for me today, who cares about tomorrow?

More specifically towards Krugman's transaction costs argument, there are two main avenues by which it can be answered. The first is that Bitcoin at least is more a commodity than a currency by nature, as analyzed back in 2014, and this should be factored into arguments against it not being a good currency (a misunderstanding that Buffett also appears to exhibit). The problem it solves, then, is that of unilateral confiscation of value through intentional devaluation, or loss via depreciation, with this value stored in a decentralized and largely-trustless manner throughout the globe, without permission needed from a third party, without physical encumbrance, and with a completely transparent and public supply schedule. There might be some demand for this.

The second is that, for all of Krugman's enthusiasm towards technological progress in money (i.e. digital methods), he seems to entirely discount the possibility that cryptos - most of which are barely five years old - might have much room for improvement in transaction speed and cost. The existing Bitcoin network is best understood as a settlement layer, or a backed monetary base; further layers can then be built upon the settlement layer, e.g. with Lightning Network being a TCP/IP stack that trades off certain reserve requirements for speed.

The Lightning Network has been silently and steadily growing since February, but what's fundamentals against 1 million TPS ICOs?
(Source: bitcoinvisuals.com)

Once more with reference to monetary history, the cost of Bitcoin mining can then be seen as the price of "honesty". Consider why relatively-primitive peoples bothered to collect shells, or carve huge stone wheels - even at some risk to their own lives in the procurement of the stone - which also answers in part Krugman's critique on value tether.

Within a society, there is a demand for two broad categories of things: actual goods and services, and monetary tokens. Absent a strong central authority, the value of the tokens has to be commensurate to the goods and services. If the society accepted, say, fallen leaves instead of huge stone wheels as money, then their economy might not make sense simply because leaves are too abundant and easy to acquire.

Or, from an individual viewpoint, consider a group of ten men who hunt and farm, and another group of ten men who band up to collect and carve the stone. If the first group acknowledged the produced stone wheel at only a tenth of their food output, then the men of the second group should logically conclude that they are better off hunting and farming instead of creating tokens. The commodity token is itself a good in the society's wider free marketplace! This should go some way towards explaining the necessity of crypto proof-of-work thus far. Of course, having a central authority issue the monetary token has to be cheaper... but how long will that state of affairs last, before self-interest and corruption sets in? As seen time and again from past experience - not very. Proof-of-work, whether with gold or crypto, may be an inefficient equilibrium, but autocracy tends to descend into anarchy.

Gentlemen, we stand by all our past analyses - crypto is here to stay, and Krugman is wrong... but that's not saying very much.

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