Bitcoin Standard Ch. 4

 Oh, boy, do I have a lot to learn. I've always fancied myself rather good with money, not that my circumstances have ever required me to be exceptionally so, but I feel I've always been good about balancing my spending, etc. But I had no idea how little I really understood money. 

WWI marked the beginning of fiat currency, which was originally backed by (or redeemable into standardized amounts of) gold (or no one would want it). Since it is centrally controlled it is prone to having it's supply increased quickly compared to its stock (too easy and tempting to print more money without increasing gold supply to back it), impoverishing holders. This chapter gives examples of fiat currencies doing just that, collapsing, and ruining lives.

Within only a few weeks of WWI, governments began printing money, above and beyond what their gold stores allowed. This was an incognito way (as opposed to taxation) of funding the war, which devalued people's stored wealth. If a government tried to raise taxes to fund a war, it wouldn't be a very popular move. But if they just print more money, no one needs to know--at least right away. Increasing the supply lessens the value of each dollar, including the ones people had saved away for their nest egg. In this way, inflation is theft. Eventually, the losers of the war saw their currency devalued to the point that the war effort could not continue. And poor Germany, forced to pay reparations, had nothing left with which to pay them, paid via further inflation. 

To get back on the gold standard would require admitting the harm the government had done (stealing citizen's wealth via inflation) and cause people to hoard gold, no longer trusting banks to do it. Fearing this lack of faith in centralized banks (which is the only thing that makes fiat currency work) and a run on gold reserves (of which they had insufficient to cover all the money they had printed), the government placed  restrictions on gold ownership. Instead of admitting mistakes and getting back on the gold standard, world powers formed Treaty of Genoa, an agreement to go along with inflationary policies, which leads to the great depression. "Safety was sought in numbers: if everyone devalued their currencies, there would be nowhere for capital to hide." I think the common understanding of economic policy of this time paints FDR and his interventionist ways as a hero for getting our country back on track through the Great Depression. Let's just say, the Austrian (the school of thought in economics, not necessarily nationality) economists that I have read disagree.

 "It's important to realize there was nothing unique or new about the New Deal. It was a magnification of the heavily interventionist policies which Hoover had instituted. A precursory understanding of economics will make it clear that price controls are always counterproductive, resulting in surpluses and shortages. The problems faced by the America economy in the 1930s were inextricably linked to the fixing of wages and prices. Wages were set too high, resulting in a very high unemployment rate, reaching 25% at certain points, while price controls had created shortages and surpluses of various goods. Some agricultural products were even burned in order to maintain their high prices, leading to the insane situation where people were going hungry, desperate for work, while producers couldn't hire them as they couldn't afford their wages, and the producers who could produce some crops had to burn some of them to keep the price high. All of this was done to maintain the prices at the pre-1929 boom levels while holding onto the delusion that the dollar had still maintained its value compared to gold." 

It isn't much of a stretch to see how this could serve as a warning for the current economic climate.  Hoover and FDR were both interventionist, FDR campaigned on being less interventionist and they changed courses. FDR banned gold ownership, bought gold back around 20 dollars and then reevaluated the dollar to $35 per ounce, a 41% devaluation of the dollar in real terms. Can you even imagine having your life savings instantly worth 41% less? 

As major countries went off of the gold standard, fluctuating currency exchange rates hampered international trade. It also allowed countries opportunities to manipulated exchange rates in their favor. Some began devaluing currency to give exporters an advantage, instituting tariffs and trade barriers. This made countries relative wealth not a product alone of their productivity, the value they were able to add to peoples lives, but of their manipulative monetary policy. People blamed their failures on other nations, leading to a rise of hateful nationalism that Otto Mallery warned about thus: "If soldiers are not to cross international boundries, goods must do so. Unless the Shackles can be dropped from trade, bombs will be dropped from the sky." He was right, of course, and WWII soon began. 

The end of WWII lead to some doom and gloom prognostications from the Keynesian economists. (I haven't read anything from this school. Perhaps I should, for balance, but all that I've read from the Austrian economists treats all things Keynesian with thinly veiled contempt and ridicule.) Basically, the idea was that war is good for economies; all spending is good spending and when the government stops spending so much money on war, that decrease in the flow of money will negatively impact everyone. It is difficult to argue that all spending is good and benefits everyone. How is the soldier better off at war with the government paying exorbitant amounts for his weapons and health care than at home, working a minimum wage job? How can you say war is good for the economy (and therefore everyone) when rationing and scarcity were very real during the war? So, without hearing the Keynesian counterargument, I'm inclined to side with the Austrians. Come to think of it, that section of the book could probably have been left out--but how then would they dunk on Keynes? 

Governments were again faced with the problem of having paid for war with inflation beyond what they could otherwise have afforded. At the Bretton Woods conference, a solution, if you can call it that, was agreed upon. The plan (which the author thinks is even stupider than Keynes) was that teh US would concentrated the world's gold supply in its possession. Other countries would then hold the US dollar, rather than gold, in their reserves. 

"In essence, Bretton Woods attempted to achieve through central planning what the international gold standard of the nineteenth century had achieved spontaneously. Under the classical gold standard the monetary unit was gold while capital and goods flowed freely between countries, spontaneously adjusting flows without any need for central control or direction, and never resulting in balance of payment crises: whatever amount of money or goods moved across borders did so at the discretion of its owners and no macroeconomic problems could emerge. In the Bretton Woods system, however, governments were dominated by Keynesian economists who viewed activist fiscal and monetary policy as a natural and important part of government policy. The constant monetary and fiscal management would naturally lead to the fluctuation of the value of national currencies, resulting in imbalances in trade and capital flows."

With the US holding the gold, and other countries holding the dollar, the US could now steal from not only its citizens with its money printing and inflation, it could steal from the world. and so, "the only winning political formula consisted of increasing government spending financed by inflation, and every single presidential term in the postwar era witnessed a growth in government expenditure and the national debt and a loss of the purchasing power of the dollar. In the presence of fiat money to finance government, political differences between parties disappear as politics no longer contains trade-offs and every candidate can champion every cause." The tenuous link to gold also lead to higher gold price. Countries wanted their gold back. Nixon ended dollar convertibility to gold in 1971.

We return now to the topic of the fluctuating values of foreign currencies in the absence of gold to gold convertibility. Currencies with a smaller yearly increase in supply have the highest salability globally and are most accepted worldwide--they are "harder" or more stable. More money printing leads to lack of faith in that country's central bank, and faith is what makes fiat money worth anything. An interesting thing happened to the Iraqi dinar in 2003. The central bank was destroyed, and overnight the value of the dinar went way up. Since the bank could not print more money, the supply to flow ration was extremely low and people's faith or confidence in the hardness (lasting value) of the dinar went up. Something similar happened to the Somali shilling when its bank was destroyed. On the other hand, governments that print (and spend) money too quickly experience hyperinflation. 

"Hyperinflation is a far more pernicious phenomenon than just the loss of a lot of economic value by a lot of people; it constitutes a complete breakdown of the structure of economic production of a society built up over centuries and millennia. With the collapse of money, it becomes impossible to trade, produce or engage in anything other than scraping for the bare essentials of life. As the structures of production and trade that societies have developed over centuries break down due tot the inability of consumers, producers, and workers to pay one another, the goods which humans take for granted begin to disappear. Capital is destroyed and sold off to finance consumption. First go the luxury goods, but soon follow the basic essentials of survival, until humans are brought back to a barbaric state wherein they need to fend for themselves and struggle to secure the most basic needs of survival. As the individual's quality of life degenerates markedly, despair begins to turn to anger, scapegoats, are sought, and the most demagogic and opportunistic politicians take advantage of this situation, stoking people's anger to gain power. The most vivid example of this is the inflation of the Weimar Republic in the 1920s, which not only led to the destruction and breakdown of one of the world's most advanced and prosperous economies, but also fueled the rise of Adolf Hitler to power." 

  Hyperinflation has happened 56 times since WWI (when fiat currency first began exceeding the gold reserves which backed it), plus Venezuela "now" (now being 2018 when the book was written. I confess I don't know exactly where Venezuela is now-inflation still going, or on the road to recovery? I just know it's not great.) Hyperinflation only happened once before, in 1795 France, and then it was also produced through government money. Remember when we talked about investment bubbles, and how they only work if you time it perfectly, and know when to sell before the price begins to drop? In the inflation game, the government and those paid by the government (read: Military-Industrial Complex) are the ones who get the timing right. Everyone else loses value.

This new age of government money without a gold standard introduces a new aspect of salability when considering what makes good money. "The market for foreign exchange, at $5 trillion of daily volume, exists purely as a result of this inefficiency of the absence of a single global homogeneous international currency." With money being centralized, we deal with third party fees and unreliability. More and more, banks handle our money for us, and we pay them to do so in one way or another, and governments control what our money is worth. Hayek said in 1984, "I don't believe we shall ever have a good money again before we take the thing out of the hands of government, that is, we can't take it violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can't stop." The author comments, "In its infancy, Bitcoin already appears to satisfy al the requirements of Menger, Mises, and Hayek: it is a highly salable free-market option that is resistant to government meddling."

So here we are, about 30% of the way through the book, and we might just start talking about actual Bitcoin. I already have a sort of basic understanding of Bitcoin, and I have invested in it, but these background chapters have helped me understand money a lot better, and have given me a greater appreciation of what Bitcoin is trying to accomplish, why it might be necessary. I look forward to learning more.