"I, Broken Pencil": An Economic Analysis of Bitcoins

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Reality Check

In 1958, Leonard E Read wrote an essay, “I, Pencil.” He did not know it at the time, but this article soon became the most important description of the division of labor that has ever been written. It is not as famous as Adam Smith’s description of the pin makers, but analytically, it is far superior. It is also a lot more fun to read.

The article begins with the narrative of a pencil. The pencil tells of his origin. He makes the crucial point thatnobody knows how to make a pencil. This seems fantastic. Yet, as the narrative continues, it becomes obvious that the statement is true. There is so much that goes into a pencil. There is wood, carbon, rubber, metal, and paint. There is also all of the equipment to make these items into a single pencil.

But this just is the beginning. How is the metal made? How is the tree harvested? What about the chainsaws that cut down the tree? This goes on, and on, and on. That is the whole point of the article.

Read makes this point: all this is done without central planning. All of this is done by means of the division of labor.

But what Read doesn’t mention, which is the heart of the matter, is the monetary system. It is only through a system of prices, meaning monetary prices, that all of this can be coordinated by the market process. It is the miracle of the market, as Read called it, but this miracle depends completely on one thing: a monetary system. Without a monetary system, the division of labor simply collapses.

VIRTUAL MONEY IN A REAL WORLD

Now let’s talk about Bitcoins. Bitcoins exist as a means of payment only because there is yet money in the general economy. Bitcoins is a spinoff of the fiat money systems of the world. Bitcoins could not exist if there were not an integrated system of digital currency.

You have to have digital currency in order to buy bitcoins. This digital currency leaves a record. Every purchase you make with the digital currency leaves a record. You are then told that you can make purchases with Bitcoins. These will not leave a record. As long as you never have to reenter the monetary economy of the government’s fiat money systems, there is no further trace of your purchases with respect to digital entries.

But this creates a problem for the person selling you something. If the item that he sells you is manufactured, then he has to rely on the division of labor. He has to reenter the world of fiat money currencies, meaning government run and central bank run fiat money currencies. He must convert his Bitcoins to real money. That is because he must by real goods.

Bitcoins are virtual money. Problem: virtual money buys very few real goods. For virtual money to buy anything, the virtual money must be converted back into real money, which is digital money, which is money that is an entry in a bank account. At this point, all of the supposed privacy of Bitcoins disappears. Now the government can trace whatever happens.

In order for Bitcoins’ promise of privacy to work, the division of labor must be exclusively governed by Bitcoins. There must be no re-entry into the world of government fiat money. The moment there is a re-entry into the world of government fiat money, privacy disappears. Whatever the economy has adopted as its pricing system, this is what every market participant, meaning the seller of a particular good, must deal with. He deals with the real world of real prices in real time.

This creates the philosophical problem for Bitcoins. That problem is known as the regression theorem. This was coined initially by Carl Mennger, but it was developed by Ludwig von Mises. There has to be an extension from an existing price system to a new price system in order for a new currency to replace the old.

The problem for the defender Bitcoins is this: we need a comprehensive system of prices. For Bitcoins to work, they must be autonomous from the fiat money pricing system of the various government currencies. In order to make a pencil, there has to be a comprehensive, universal, widely recognized Bitcoins network. It is not possible to run Bitcoins as a separate currency system unless it applies to every product, every transaction, every service that is presently priced in terms of government monetary systems. Why is this? Because the division of labor must be integrated by a single currency system.

In order to make the pencil, everything must be priced in terms of Bitcoins: paint, wood, carbon, rubber, metal, and every raw material and every piece of capital equipment that was used to make the pencil.

UNIVERSAL PRICING

This is the whole point of Read’s thesis. There has to be universal pricing. There has to be a profit-and-loss system governed by the universal pricing system in an integrated currency system. The only way for cross-currency transactions to take place is on the market. The most sophisticated futures market in the world is the market for currency futures. Every single transaction is recorded. Every single transaction is governed by written rules of the exchanges, as well as customary rules of exchange. The private property system and the entire legal system that undergirds the private property system come into play in order for the currency markets to operate.

Bitcoins’ defenders do not openly say that there is no need for a private property system, no need for legal appeals, no need for any kind of arbitration system no need for contracts, no need for anything except algorithms. Yet they must assume this if they are to piggyback on the central banks’ monetary system. Ours is not a world governed mainly by bits and bytes and algorithms. Bitcoin’s is — officially. In fact, the whole system is a piggyback system. Theoretically, there is no personality in it. There’s no person in it. There are no property rights in it.

Bitcoins rests on a religious confession of faith. “The system will, without law or custom, and without enforceable property rights, autonomously evolve into a system with the same features and benefits as the present property rights order enjoys. It will do this without any intervention by the courts.” This is faith in a unique god: the god known as algorithm. This god is known by his promise: “seamless transition.”

Fact: there is no way to get the extraordinary division of labor that is necessary to make a pencil, unless the social and institutional framework, which is the foundation of all systems of real-world money, exists comprehensively.

A social framework that is necessary — a moral, intellectual, and legal framework — to make possible the monetary systems of the world, which in turn make possible the modern division of labor. The advocates of Bitcoins do not discuss any of this. All they talk about is the vaunted privacy aspect of the system — its independence from central banking.

There is more to free market exchanges than privacy. In fact, very few free market exchanges are private. Exchanges are based on contract and custom. There are court systems that enforce the contracts. There are methods of social pressure that enforce the customs. There are jury systems. All of this is foundational to the existence of the monetary unit, and the monetary unit is foundational for the entire division of labor economy.

Never in the history of libertarianism has there been any more utopian proposal that Bitcoins. They rest on an implicit denial of the private property system. They rest on an implicit denial of contracts and a denial of courts. They rest on an implicit denial of face-to-face resolution of disputes. They rest on an implicit denial of bargaining on a face-to-face basis. This is an implicit denial of virtually everything that exists in the free market society. The whole idea is delusional beyond anything I have ever seen.

Am I exaggerating? No. The Bitcoins system has no customs, courts, legally enfirceable contracts, no resolution of disputes. All it has is algorithms. Yet its defenders say that the system is an extension of the free market’s social order. It is in fact a denial of such an order. Its defenders think the Bitcoins markets can do without the social order that brought capitalism into existence a millennium ago. It is a classic free rider. Yet they insist that their system can replace the present capitalist order.

This is a programmers’ fantasy.

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