Showdown: Bitcoins vs. Greenbacks and/or Precious Metals

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Reality Check

There are conflicting stories among Bitcoins’ supporters about why a Japanese programmer or team of Japanese programmers, who are known by a pseudonym Satoshi Nakamoto, developed the original idea for the Bitcoins software.

The primary justification for Bitcoins among libertarians is the prediction that Bitcoins will become an alternative currency to all existing central bank currencies. Bitcoins are seen as a first-stage revolt against central bank money.

In this essay, I’m going to make a series of arguments. I’m going to tell you in advance what my arguments are. You can then judge whether or not I have been successful in presenting my case. Here are my arguments.

First, the primary benefit that libertarian promoters of Bitcoins offer in justification of their theory that Bitcoins will become an alternative currency is this one: Bitcoins offer privacy. Paper money today offers a much greater degree of privacy that Bitcoins do, plus a whole series of other major advantages that Bitcoins do not offer.

Second, money is the most marketable asset. Paper money is vastly more marketable than Bitcoins.

Third, gold-based and silver-based digital currencies are more likely to become future world digital currency than Bitcoins.

Fourth, most Americans do not want privacy in their exchanges. This is manifested by the fact that they do not use the form of currency in which privacy is easily available and totally legal: greenbacks.

I will compare the advantages of Bitcoins with the advantages of greenbacks. I will then compare the disadvantages of Bitcoins with the disadvantages of greenbacks. Then I will compare Bitcoins to digital currencies that are backed by either gold or silver.

1. PRIVACY

Here, I discuss the price of buying privacy.

Greenbacks. There are three ways that anyone with a bank account in the United States can obtain greenbacks. First, he can walk into his bank, fill out a request for greenbacks, hand it to the teller, and the teller will hand over a specific quantity of paper money. Second, he can drive up to a booth in the bank’s parking lot, put a check into a tube, put the tube back into a reception box, and within a couple of minutes, the tube will come back with a specified amount of paper money in it. Third, an individual can walk over to an ATM machine, specify how many dollars he wants, run his bankcard through the machine, and will immediately receive his paper money.

All three approaches raise no eyebrows. All three approaches are quite conventional. The banks promote the use of ATMs, because they eliminate tellers’ labor time. ATMs are available in many locations. There is nothing controversial about them. They are easy to use, and most people who have a bank account know exactly how to use them. There is almost no learning curve involved.

As soon as an individual has paper money, he has total privacy. He also has total control over his money. He knows where the money is. He decides where the money will go. He decides how long he will keep the money. He can of course be robbed, but this is relatively rare.

He now has perfect “privacy money.” He can go into any retail establishment in the United States and buy whatever he wants if he has enough money. In all likelihood, these purchases will be limited to no more than a few thousand dollars. Purchases of anything that costs more than $10,000 will probably be avoided, because there are reporting requirements for these purchases. But very few people ever make a purchaseof more than a few thousand dollars.

For any legal purchase, he can receive a receipt from the seller. This establishes the base price of whatever it is that he purchased. There’s nothing controversial about asking somebody for a receipt. He does not have to ask for receipt, but he can. He also knows where the seller’s place of business is located if it is a retail business.

He has a virtually unlimited number of establishments from whom he can make the purchases. That is to say, he enjoys all of the advantages of the digital money system with respect to the division of labor. He knows what anything will cost, because the price is denominated in digital money, and the purchasing power of paper money is as high as the purchasing power of digital money. In fact, in some cases, the purchasing power is higher. People will sometimes negotiate for payment in currency, because they do not intend to report the income to the Internal Revenue Service. They will therefore offer discounts for anyone who is willing to pay cash. When you have paper money, you can often negotiate for a better price, although of course not it in a store that uses electronic cash registers.

Once the money leaves the bank, no government agency knows what an individual does with his money. He has total privacy. His expenditures will leave no paper trail, unless he wants to create it by asking for a receipt.

There is nothing controversial about taking out currency. It draws no attention to itself. The government has no idea or interest in what the person who withdraws the money does with this money. It is just a routine transaction — lost in the noise. It is the kind of transaction that has gone on in banking circles from the beginning of banking. It is basic to all banks that some people make withdrawals of currency.

So, with respect to privacy, currency is true privacy money. It is close to invisible to the government at the point of initiation: an ATM. It can be spent anywhere. It leaves no traces. It draws no attention to itself.

Bitcoins. Almost nobody knows how to buy Bitcoins. The person must buy them through a Bitcoins currency exchange company. He has no idea which ones are reliable. He risks getting into an exchange like the Silk Road, which the government shut down. He risks getting into an exchange like the one that replaced it, Sheep Marketplace, which was hit by a $100 million heist, and which shut down, leaving its users with a 100% loss. There is no way to prosecute. There is no way for a depositor to get his digital money back. He bought secrecy with respect to any police agency, so nobody can find out where his money went, and he has no legal claim against anybody.

He has to know how to use computers to get access to this kind of money. Not many people know how to do this online. In other words, there is a huge learning curve involved in gaining access to this privacy money.

Conclusion. Here is a fundamental economic rule: as the price of anything increases, less is demanded. The information cost of discovering how to gain access to Bitcoins is high. The information cost of discovering how to use an ATM machine, or a drive-through bank teller system, or walking into a bank and withdrawing currency is about as close to zero as imaginable.

Therefore, anyone who promotes Bitcoins is a viable alternative to greenbacks is ignoring the following: (1) the low information costs of gaining access to greenbacks; (2) the complete lack of interest on the part of the government or the bank in withdrawals of a few hundred dollars at the time; (3) a market for this currency that is essentially the same as the market for digital currency; and (4) the possibility of negotiating discounts for purchases with this currency.

2. MARKETABILITY

Here, I discuss the Austrian school’s definition of money: the most marketable commodity.

Greenbacks. If you own dollars in the form of paper currency, these dollars are available for use in any retail establishment. You can go into Walmart, Target, or any other retail establishment, and you can buy anything in that store for paper money. You will not be asked to show an identification card when you leave. No one will pay any attention to the fact that you are buying this with paper money. The person at the checkout counter will simply take your money, and issue you a receipt. You will walk out of the store with your receipt and whatever it is that you bought.

You can repeat this with any public utility. Paper money is familiar to everyone at a checkout counter. The employee will probably not examine the currency to find out if it is counterfeit. In other words, there are no transaction costs in using currency, other than driving to the retail establishment and driving home. But, with respect to buying with this currency, there are no transaction costs. There are no search costs. You do not have to search for which companies are willing to sell you something for your paper money. They all are.

The market for paper money is essentially the same as the market for digital money. There is no restriction on the use of paper money. The Federal Reserve System is behind its paper money. The Federal Reserve System is not going to limit the use of paper money. Its name is on the paper money. There is no hostility between the Federal Reserve System and paper money issued by the Federal Reserve System. There is no hostility by government agencies to the use of currency, as long as the currency is being used in statistically normal patterns, with respect to withdrawals. Because there are no restrictions on the use of paper money, no question is asked at a retail establishment regarding the use of paper money to make a purchase. Therefore, retail establishments constantly allow people to buy anything they want in the store with paper money. The market for paper money is coterminous with digital money within the geographical area under the jurisdiction of the United States government and the Federal Reserve System.

Bitcoins. You cannot use Bitcoins to buy anything in approximately 99.9% of American retail establishments. This is probably too low an estimate. You cannot buy what you want, when you want, where you want with Bitcoins. There are search costs involved in locating anybody who will sell you anything with Bitcoins.

When you walk into a retail store and ask if you can buy anything in the store for Bitcoins, the employee will not know what you are talking about. Almost nobody in the store will know what you are talking about. There is no checkout counter that converts Bitcoins into digital dollars, and then issues you a receipt for whatever it is you just purchased Therefore, Bitcoins have close to zero marketability.

The only way you can buy anything with Bitcoins is because the seller is going to convert the Bitcoins immediately into dollars. Bitcoins do not have a separate market that is not tied to the banking system. In China, on December 5, the People’s bank of China issued new regulations on Bitcoins.

“Internet websites that provide bitcoin registration or transaction services should be sure to fulfill anti-money laundering obligations, identify user identities, request users to register with real names and provide information of names, identity card numbers, etc…. any clues related to using bitcoin for fraud, gambling, money laundering and other criminal activities should also be promptly reported to the police.”

Bitcoins all over the world fell by one-third within a day. The peak had been a few days earlier: $1,242. They are in the low-$700s today. The volatility is gut-wrenching.

Therefore, hardly anyone is going to sell you anything for Bitcoins who does not have the ability to convert instantly those Bitcoins back into dollars or his own domestic currency. The risk of holding Bitcoins more than a few seconds is way too high for any retail establishment. So, for a retail establishment to be willing to sell you anything for Bitcoins, it must have a computer program tied to its bank in order to convert Bitcoins into dollars instantaneously. This means that the retail seller has to let his bank know that he is using Bitcoins. This means that, at any time, the Federal Reserve System can collapse the price of Bitcoins.

A joint announcement of the Federal Reserve, the European Central Bank, the Bank of England, and the Bank of Japan would complete the destruction. They could simply threaten expulsion from their respective banking systems for member banks that offered Bitcoins services. “Bitcoins, R.I.P.”

Therefore, with respect to marketability, Bitcoins are an extension of the central banking system. They are in no way independent of the central banks. The Bitcoins market operates only at the discretion of the central banks. The central banks allow Bitcoins for the moment, and only because of this toleration by the central banks does any market for Bitcoins exist.

Conclusion. There is virtually no possibility that the Federal Reserve System is going to outlaw the use of Federal Reserve notes. There is always a possibility of the Federal Reserve System will prohibit banks from dealing with any retail company that uses Bitcoins in its transactions. The likelihood that a central bank will prohibit the use of Bitcoins is vastly higher than the possibility that the central bank will prohibit the use of the paper money issued by the central bank.

Therefore, the argument that Bitcoins can become a rival currency to paper money must rest on this hypothesis: the value of Bitcoins will be based at some point in time on a system of exchange that is 100% independent of commercial banks, and second, that the value of Bitcoins will be rising in terms of the national currency system, which is mostly a digital currency system. In other words, people will use Bitcoins as a means of exchange instead of using gold coins, silver coins, or digital money that is backed by either gold or silver.

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