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  |  Spring 2018  |  FINANCIAL HISTORY  15