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Dec 292013

Paul Krugman, who won the 2008 Nobel Memorial Prize in Economic Sciences for his work in Economic Geography, was at it again in December 2013, in yet another of his anti-Bitcoin rants in the Opinion pages of the New York Times: “Bits and Barbarism” (22 December 2013).  It is unclear why something with a total value of about 5% of Carlos Slim’s personal portfolio so upsets him, but Bitcoin has a hold on his imagination that borders on obsessive.

Normally, I prefer not to create any incentive to drive traffic to the trolling of attention-princesses, but this one is so rich with absurdity that it calls for point-by-point rebuttal.

Krugman begins by conflating goldbugs with bitcoiners, and then mocking them, as a neoprog welfare statist might conflate collectivist neocons with individualist libertarians as ‘right-wingers’.  Specifically, he sees anyone who is concerned with the prospect of inflation in the foreseeable future as an environment-destroying throwback to the days of swashbucklers and buccaneers.

“But gold prices, while down from their recent peak, are still three times what they were a decade ago…” in very large measure due to the inflationary policies that Krugman has cheered on.  On the one hand, he ridicules the notion that inflation is a problem, and on the other he provides evidence of 11.6% annual inflation, using the USD price of gold as a proxy.  For both to be true, he must believe that 10-15% inflation is nothing to worry about; pity the pensioner on a fixed income.

“Bitcoin is a digital currency that has value because… well, it’s hard [for me] to say exactly why [without directly addressing what it is that gives it value]…”

Like government fiat and gold, bitcoins are fungible, durable, portable, and divisible.  Like gold and unlike government fiat, bitcoins are scarce.  Unlike both government fiat and gold, bitcoins are transmittable from any computer or smartphone with Internet access, and one can digitally sign documents with a bitcoin wallet and embed a hash of the signed document into the bitcoin blockchain.

Unlike gold, which has very little intrinsic value beyond jewelry—The Bling Theory of Value—Bitcoin provides a decentralized financial infrastructure that is immune from the kinds of political manipulation that have led to housing bubbles, hyperinflations, and other asset bubbles since government fiat replaced gold-backed national currencies in the early 1970s.

“…but for the time being at least people are willing to buy it because they believe other people will be willing to buy it.” This, of course, being the defining characteristic of an asset, as opposed to a consumption good.  With this statement, Krugman tacitly dismisses all financial markets along with global wholesale trade and distribution.  After all, my local grocers are willing to stock their bins with fruits and vegetables because they believe other people will be willing to buy them.

“It is, by design, a kind of virtual gold.”

The passage in Satoshi’s paper to which this assertion refers reads:

The steady addition of a constant of amount of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, it is CPU time and electricity that is expended.” (p.4 §6)

The operative phrase here is “is analogous to“.  It is a metaphor; a model, as it were.  As an economist, Krugman should understand that models are simplified extractions of reality used to render the salient points of a complex concept rhetorically more palatable.  One might as well dismiss the entire body of Krugman’s work on economic geography because he did not possess the huge tracts of land that so occupied his imagination, but only brooded over from afar.

“And like gold, it can be mined: you can create new bitcoins, but only by solving very complex mathematical problems that require both a lot of computing power and a lot of electricity to run the computers.”

That is not how gold is mined.  One mines gold with shovels, pickaxes, and other sundry bits of base metal.  As for Bitcoin ‘mining’, the new bitcoins are rewards for being the first to solve a fiendishly difficult mathematical puzzle after confirming a batch of recent transactions. It is a game of skill, and not a scavenger hunt.

As for his mental excursion to Iceland, it is very difficult for the Icelanders to export the abundant hydrothermal energy with which that land has been blessed and cursed.  Unlike oil, it is not easy to transport steam by supertanker.  Better to convert it to electricity in place and use it to produce aluminum and bitcoins for export.  Far from being a waste of energy, it is an ideal use of a resource that otherwise might lie fallow.  Krugman’s argument screams in favor of concentrating bitcoin transaction confirmation—aka, ‘mining’—in Iceland!

“The third money pit is hypothetical.”  Here, ‘hypothetical’ is a polysyllabic term that means something akin to ‘cherry-picked’.

“[Keynes] went on to point out that the real-life activity of gold mining was a lot like his thought experiment. Gold miners were, after all, going to great lengths to dig cash out of the ground, even though unlimited amounts of cash could be created at essentially no cost with the printing press.”

By this logic, why bother with the printing press?  Why not simply adopt sand or seawater as money, both of which can be had in the seemingly limitless quantities of government fiat?  If Krugman truly does not see the difference between a good that is durable, portable, divisible, fungible, and scarce from one that can be produced in seemingly unlimited supply, then it is very difficult to see how he managed to pass undergraduate Economics 101.

“Keynes would, I think, have been sardonically amused to learn how little has changed in the past three generations.”

Keynesianism prevails predominantly in the USA and the UK, and it is not very influential elsewhere in the world.  Krugman’s lament is provincial and suggests that he believes that the USA’s 4% of the world’s population is representative of the great mass of humanity.

With regard to his swipes at gold, he seems to operate under the misconception that national currencies are still backed by gold.  Otherwise, why obsess about it so, in a discussion of money in general and bitcoins in particular?  (Never mind that bitcoins have no connection, other than occasionally metaphorical, with gold.)

Whether Keynes would be amused to learn how little has changed since the severing of national currencies’ ties to gold in the early 1970s is a matter of speculation.  However, Krugman is right that modern inflation rates would have been unthinkable a half-century ago.

In 1971, Pres. Nixon initiated a 90-day price freeze in the USA, in response to inflation rates that had risen to a high of 6% per year, and seemed to be stuck at a devastatingly high rate of 4% per year!

“So why are we tearing up the highlands of Papua New Guinea to add to our dead stock of gold…”

If Krugman disapproves of gold mining, then he should not join with others to tear up the highlands of Papua New Guinea to add to his and their dead stock of gold.  As to why, the answer is so simple that even an economist should understand it: expected benefits exceed expected costs.

“…even more bizarrely, running powerful computers 24/7 to add to a dead stock of digits?”

The answer is so simple that even an economist should understand it: expected benefits exceed expected costs.  More to the point, though, why does this bother him so?  One similarly could argue against collecting comic books, listening to what passes for popular music these days, or spending one’s days writing attacks on Bitcoin. Aside from traffic to his New York Times Opinions, what does Krugman gain from misrepresentations? Alternatively, what does Bitcoin threaten that is precious to him?

“[I]nflation in advanced countries is clearly too low, not too high.”

Apparently, Krugman does not live on a fixed income, and he does not have to deal with the erosion of the currency’s value.  Four decades ago, an inflation rate of 4% per year was justification for a price freeze in the world’s presumptive bastion of capitalism.  Today, Krugman brushes off 10-15% per year as clearly too low.

If Bitcoin succeeds as the foundation of a global financial system that is accessible to anyone in the world with a smartphone, even with its tendency to increase in value over the long run, it will repudiate the foundation of Krugman’s Keynesian faith, and that is what all his trolling and ranting seems to be about. Otherwise, just let us run our little experiment in peace.

Invest accordingly.

Prof. Evans

Dec 112013

In response to my earlier “The Miami Century,” a reader asks:

I would appreciate your view on Bitcoin / cryptocurrencies and the US regulatory framework and law makers. Most innovation in finance during this decade most likely takes place in virtual currencies and related areas. Do you see any major hurdles for Miami coming from the regulators and law makers?”

The short answer is that the future is unknowable, but it is not unimaginable. No one knows what the future holds, but it would be odd for US regulators to let Bitcoin develop further, if their plan were to shut it down.

If Bitcoin really is the Next Big Thing, as I called publicly 19 March 2013, American regulators and legislators are going to be loath to see this market migrate to Panama, Singapore, and—Heaven help us all!—China.

The USA is home to the New York Stock Exchange, Space X and Virgin Galactic, Microsoft and Apple, Facebook, Google, Amazon, Linus Torvalds, and Silicon Valley; and the Americans like it that way.

They’ll want Bitcoin and crowdfunding to be centered here, as well.

US officials’ three main concerns in this context are tax evasion, money laundering, and terrorism financing.

  • Tax evasion could be put to rest by changing the focus of taxation from things that are easy to hide—e.g., income, virtual assets, offshore trusts, etc.—to things that are hard to hide, like cars, gasoline stations, ports, wholesale consumer goods, buildings, and land.
  • Money laundering similarly could be put to rest by ending the War on Drugs, and the pendulum seems to be swinging in this direction.
  • If one believes the actual statistics on this, terrorism is less of a real-world concern than lightning strike, slipping while bathing, or texting while driving. Considering that the vast majority of successful home-grown terrorists in the USA have been white guys, people in the USA are growing weary of jumping at every brown shadow.

For this reason, I am watching the 2014 Congressional elections and the 2016 general election in the USA very closely. I expect that the news will be either very, very good or very, very bad for Bitcoin. That I remain in my native South Florida after having lived all over the USA, in Western Europe, and in the Caribbean over the past embarrassingly many decades, is evidence of my cautious optimism.

With regard to Miami specifically, for good or ill, we South Floridians have a well deserved reputation for having a healthy disdain for Anglo-Saxon formalisms. If Bitcoin is going to flourish anywhere, this is one of the most likely regions in the world. We are not great engineers, but you should see us move people, cargo, and money around!

We already have a strong and growing Bitcoin market between here and Argentina, Brazil, and Venezuela, which have currency controls. It is increasingly common for Latin American programmers, graphic designers, and website developers to ask foreign clients to pay them in Bitcoin, so that they can carry their savings with them, when they come up here to visit friends and family and to go shopping.

TL;DR: Invest in South Florida Bitcoin startups that focus on international trade, and make sure that the principals speak Spanish, update their passports, and have filled their vaccination cards, in case you want to relocate them in a hurry.

Invest accordingly.

Prof. Evans

Nov 152012

3 November 2012, Clayton Christensen, whose earlier works I have found inspirational and illuminating, published an article in the New York Times—”A Capitalist’s Dilemma, Whoever Wins on Tuesday“—that starts with a reasonable premise, and veers hopelessly off course.

To Wit: “Whatever happens on Election Day, Americans will keep asking the same question: When will this economy get better?”

Fair enough. That is a very reasonable question, and it is a very reasonable expectation that Americans will keep asking it.

So far, so good.

Then, we get this:

“The Fed has been injecting more and more capital into the economy…”


The Fed has been pumping more and more money into the economy. The value of money is measured by the ratio of units in circulation to the value of stuff. If the number of units in circulation increases faster than the quantity, value, or both of stuff, then prices rise.

Capital is the long-term means of production: drill presses, trucks, robots, etc.. The Fed doesn’t have any of that, and Fed governors are not in a position to command others to make such things available.

The Fed lends money to the US Treasury, buys toxic assets from commercial banks, and regulates banks. It isn’t a hardware store.

Now, if one is sitting on a lot of money that one can convert into capital assets, then one might adopt the financier’s habit of referring to that money as capital, but one should avoid conflating fiat inflation with the means of production.

“And yet cash hoards in the billions are sitting unused on the pristine balance sheets of Fortune 500 corporations.”

Firms are supposed to keep pools of cash as a kind of self-insurance policy against slow economic times. We call this ‘working capital’. When the future is even scarier than normal, the prudent thing to do is to hold more cash. The ‘Fiscal Cliff’, Pres. Obama’s political rhetoric expressing open disdain for those who are wealthier than he, the unknowable effects of Obamacare, the ongoing transition away from a capital/labor economy toward a service/knowledge economy, and the specter of another decade of ‘Bush’s war’ are enough to render all expectations of the future little more than random bets and wild guesses.

And, no one gets fired for playing it safe. So, until things settle down, executives play it safe.

“Billions in capital is also sitting inert and uninvested at private equity funds.”

Does Prof. Christensen believe that fund managers have piles of big, canvas sacks with dollar signs on them, filled with cash… like Scrooge McDuck or the dapper little fellow from the Monopoly™ game?!?

The money is invested somewhere, most likely US Treasury debt, because the US Treasury has a reputation of always paying its debts… even if it has to print more money to do so. In these highly uncertain times, the safest bet is the safest bet.

“Empowering innovations create jobs, because they require more and more people who can build, distribute, sell[,] and service these products.”

Sadly… no, no, no, and no.

Build: Factories are increasingly automated, and when meat-that-talks is needed, one hires labor where it is cheap; i.e. Latin America, Southeast Asia, and increasingly Sub-Saharan Africa.

Distribute: DHL, FedEx, UPS, already have that pretty well covered.

Sell: Amazon.com.

Service: What is that? Throw it away and buy a new one.

“[T]he Toyota Prius hybrid is a marvelous product.”

Except that [o]nly 35 percent of hybrid car owners bought a hybrid again when they purchased a new vehicle in 2011.

“‘[E]fficiency’ innovations… almost always reduce the net number of jobs…”

This one is spot-on. It is unfortunate that Christensen did not make it the centerpiece of his analysis.

“The economic machine is out of balance and losing its horsepower. But why?”

Peter Drucker answered this question in Post-Capitalist Society, which was written nearly twenty years ago, and reads today like a play-by-play account of what happened in the 1990s and 2000s.

[Reread the sentence above, click on the link, and buy the book. You can thank me later.]

Also, the total value of goods manufactured in the USA continues to exceed the value of goods manufactured in China.

The scorpion’s sting is in the tail. Toward the end of the article, Christensen states, “We can use capital with abandon now, because it’s abundant and cheap. But we can no longer waste education, subsidizing it in fields that offer few jobs.”

No one knows where the ‘jobs’ of the future will be. Social engineering always fails. In the 1960s, it was plastics; in the 1980s, software development; in the 1990s, Dot.Com… No one knows what it will be next decade.

“[T]he [capital gains tax] rate should be reduced the longer the investment is held — so that, for example, tax rates on investments held for five years might be zero — and rates on investments held for eight years might be negative.”

It might have made sense a century ago, when technology changed slowly, to make it costly to change plans quickly in response to new information, but Christensen’s advice in a highly dynamic—even chaotic—integrated global economy would create an incentive to keep sub-optimal plans running beyond their use-by dates.

“Federal tax receipts from capital gains comprise only a tiny percentage of all United States tax revenue.”

This suffers from two fatal flaws. 1) The universe does not end at the US border. 2) If capital gains represent a trivial portion of the federal budget, then eliminate the cost of collecting and enforcing them and call for their repeal. Leave the money in the owners’ hands, rather than seize it at gunpoint, if it is hardly worth collecting.

“It’s true that some of the richest Americans have been making money with money — investing in efficiency innovations rather than investing to create jobs. They are doing what their professors taught them to do, but times have changed.”

Indeed, times have changed, but that does not mean that this time is different, as Christensen seems to assume. We are in the latter stages of a transition as profound as the 18th Century Industrial Revolution, from a capital/labor division—in which semi-literate proletarians drive industrial machines—to a knowledge/service division, in which skilled workers are the ‘capital’ and are not interchangeable.

However, the wealthy will invest where they expect the greatest opportunities are, as has been the case since the Renaissance a half millennium ago. When princes, presidents, and parliamentarians create uncertainty, the wealthy will hunker down and wait until circumstances stabilize.

Christensen started with the premise that the president and the Fed do not have the power to fix things, and then concluded that the IRS does have such power.

This conclusion is counterintuitive. An alternative would be for presidents, princes, and parliamentarians to enforce transparency, and otherwise to mind their knitting, rather than concern themselves with affairs that are beyond their abilities.

Invest accordingly.

Prof. Evans

Oct 072011

The graph above depicts the supply of US dollars from January 1975 through September 2011. The gray bars represent periods recognized by US government statisticians as recessions. Note the swell in the 1990s, during the Clinton Administration, when the supply of US dollars fell. Ah… the good ol’ days!

Now, come over to 2008 or so, and hold onto your hat!

In general, and all other things held constant (or, as we say in the business, ceteris paribus), prices can rise for three reasons: demand increases (e.g., an auction or a popular restaurant), supply decreases (e.g., lower efficiency, war, or natural disaster), or the number of units of currency increases faster than the rate of increase of goods and services (inflation).

Today, we are witnessing a lack of consumer confidence bordering on panic (demand down; prices down), increasing efficiency (supply up; prices down), and a massive increase of the currency base (inflation; prices up). In other words, sagging consumer confidence and increasing productive efficiency are putting a lid on inflationary price increases.

However, efficiency can increase at a high rate for only so long before leveling off (supply stops increasing), and eventually people will go shopping again (demand stops decreasing). When that happens, the downward pressure on prices will weaken. Use your favorite analogy here: a pressure cooker, a plunger, a spring, whatever.

It is reasonable to expect that the downward pressure eventually will be released. Coupled with the inflation depicted in the graph above, this could lead to a period of large and swift price increases.

Invest accordingly.

Prof. Evans