Financial History Issue 125 (Spring 2018) | Page 17
relatively few hands (some 95% of out-
standing coins are said to be held in just
4% of accounts) is the most perfect specu-
lative asset ever devised. Throw in some
leverage, open a futures market and there’s
no limit to bitcoin’s potential upside.
The Visionary Speculator
The word speculator derives from the
Latin word for a “look out.” The financial
variety looks out into the future and backs
this vision with money. Great bubbles are
often uncannily accurate premonitions
of the future. The 17th century mania
for tulips anticipated the development of
the country’s flower industry, now one
of Holland’s largest exports. Britain’s
railway mania of the 1840s reflected an
enthusiasm for the commercial and cul-
tural potential of this new transportation
technology. Likewise, speculators in the
dotcom bubble foresaw how the Internet
would profoundly change our lives.
John Law’s Mississippi Bubble appears
most relevant to what is going on today
in the cryptocurrency world. Law believed
that money needn’t be backed by any com-
modity. The Scottish-born projector estab-
lished a bank, the Banque Générale, which
issued a paper currency and demonetized
gold. Law used the newly-issued bank notes
to support the share price of his Mississippi
Company and reduce the rate of interest. In
other words, he provided the world’s first
quantitative easing experiment.
Law’s vision was prescient. We now live
in his world of paper credit and central
bank money. However, it was also deeply
flawed. Law tried to achieve, in the space of
a few years, what would eventually take two
and a half centuries to accomplish. Only in
1971 was the link between currencies and
gold finally severed with the collapse of the
Bretton Woods currency accord. When
confidence in what Law called his “system”
collapsed, the Mississippi Company’s share
price fell by 90%. Law, who in his heyday
boasted of being the world’s richest man,
died in penury in Venice. Speculators from
the tulip mania to the dotcom frenzy have
learned the hard way that in investment to
be early is to be wrong.
Bitcoin and the Nature of Money
Exponents of cryptocurrencies are the
heirs to John Law. They aim to cure
today’s monetary problems — a lack of
confidence in paper credit and central
bank money — with a new technology, the
“distributed ledger” or blockchain. Bitcoin
possesses many of the characteristics of a
proper currency: it can be divided, stored
(provided it’s not with a dodgy broker
where it’s liable to disappear) and trans-
ferred. And its supply is limited.
Money is just a social technology which
has been through many previous incarna-
tions — among the exotic varieties of cash
listed by Paul Einzig in his book Primi-
tive Money (1948) are gin, jam, mulberry
cakes, rat traps (in the Congo) and wood-
pecker scalps. Most of our current money
is already held in digital form as electronic
book entries at the bank. So at first glance,
bitcoin with its distributed ledger appears
to be a straightforward advance on current
financial technology.
Its fervid believers have even more gran-
diose ambitions, however. They claim that
cryptocurrencies will bring about the end
of stat e-controlled money. Their vision is
borrowed from the Austrian economist
Friedrich Hayek, who envisaged a dena-
tionalization of money that would bring
about an end to both inflation and defla-
tion, cure unemployment and, by render-
ing redundant the easy-money-peddling
central banks, would limit the reach of the
state. What’s not to like?
The trouble is that bitcoin enthusiasts
confuse the typical features of money with
its true character. Admittedly, this is a dif-
ficult subject. People have argued about
the nature of money since the dawn of
civilization. Mainstream economic theory
has little to say on what money is, assum-
ing it a mere contrivance to do away with
the bother of barter. In the era when
bank notes were redeemable in gold, most
people believed that money contained the
intrinsic value of the precious metal. But
as Law pointed out, “Money is not the
value by which goods are exchanged, but
the value for which they are exchanged.”
Simply put, gold derived much of its value
from its use as money rather than the
other way around.
Where, then, does money derive its
value? From the earliest times, going back
at least to Mesopotamia in the third mil-
lennium BC, money has been defined as
a unit of account authorized by govern-
ment for the payment of debts. The state
theory of money holds that money is a
credit issued by a sovereign, whose value
comes from the fact that it can be used
to pay taxes. Governments have tena-
ciously maintained control over the unit
of account, a key aspect of sovereignty.
The law prescribes this official money as
legal tender for the repayment of debt.
Law and his contemporaries had
another insight, namely that circulating
IOUs are in fact a form of money. For
instance, in early 18th century England,
much of what constituted money com-
prised bills of exchange issued by mer-
chants against future receipts. At the same
time, early English bankers were creating
money through the act of lending out their
deposits. This bank money was backed by
claims of real economic value. The credit
theory of money maintains that money
is just circulating credit. “Currency is
ephemeral and cosmetic: it is the under-
lying mechanism of credit accounts and
clearing that is the essence of money,”
writes Felix Martin in his 2013 book
Money: The Unauthorized Biography.
The economic system commonly
referred to as capitalism consists of a vast
network of credit relations. Credit money
is its key feature. Hayek, of course, realized
this. His proposals to strip the government
of its money monopoly envisaged the
replacement of a dominant central bank
with competing private money-issuing
banks. Competition between the currency
banks would thus produce a sounder cur-
rency. But Hayek’s money would still be of
the credit variety.
Bitcoin and other cryptocurrencies are
a different kettle of fish. They purport to
be non-credit currencies — that is, mon-
etary assets without corresponding lia-
bilities. Yet all money is by its nature a
claim upon society; otherwise, it cannot be
spent. Why should society wish to confer
vast monetary claims on the enterprising
nerds and opportunistic speculators cur-
rently in possession of crypto-fortunes?
More importantly, because cryptocur-
rencies lack a mechanism for creating
credit, they are not well suited to the capi-
talist economy. Imagine what would hap-
pen if bitcoin were accepted as the mon-
etary unit of account. The result would be
a scarcity of the digital currency, whose
maximum issuance is supposedly limited
by design to a total of 21 million units, fol-
lowed by a severe economic contraction
and stagnation without end.
This is not going to happen. Not just
because it makes no economic sense but
because governments are not going to
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