The Financial Seminary
By Shio Kaze
Early in 1991 the government of Somalia collapsed and totally disappeared. Along with it went the Central Bank and whatever currency reserves it still managed to possess. In the capital, Mogadishu, and elsewhere in the country, merchants continued to accept the Somali shilling as if nothing had happened. Perhaps the attitude was based on the view that "We have always accepted shillings, why should we stop now?" The currency with no government to back it continued to circulate until 2009 when finally a new fledgling Central Bank appeared.
Even more amazing was that easily-identified counterfeit shillings began to circulate side-by-side with those of the now defunct government, and they were almost fully fungible, at most carrying just a very small discount to the real thing. Perhaps there was the vague hope that some warlord would back these various currencies or that someday a new Central Bank would redeem all of them. In any case, use of the Somali shilling was not hindered by the fact that neither government nor any assets supported it. Thus the Somali shilling appears to very closely resemble the bitcoin, although such a comparison is bound to raise the hackles of bitcoin believers.
Bitcoin would undoubtedly be the currency of choice for Ayn Rand if she were alive today. No government created it, and none can directly regulate it. Its creators are anonymous, and for the most part so are its owners. Not surprisingly it is the currency of choice for many engaged in a variety of illegal activities. Libertarians, with their strong hostility toward government, love it, as do the technologically savvy. This is an open source digital currency, accessible by anyone, governed by a computer protocol. It does not exist in conventional forms and is actually created by "miners" who solve increasingly complex algorithms in order to be rewarded with new bitcoins for their success.
These two groups are far more influential in our society than we may realize. Even after the financial collapse of 2008 Rand and her philosophy remained the darlings of Wall Street and many if not most CEOs. Libertarians are powerfully represented in the federal government by such well known persons as Paul Ryan, Rand Paul, and Clarence Thomas. In colleges and universities faculty members are increasingly told to fit as much technology into their courses as possible. The method of instruction has become far more important than the content that is taught. Increasingly the tail now wags the dog.
Bitcoin believers are staunch defenders of their currency. They claim many virtues for it. The acceptance of bitcoins by legitimate business is growing, and the cost of transference from one owner to another is less than with fiat or hard currencies. Proof of this is as of January 2014 the value of all bitcoins in circulation is approximately 10 billion dollars, and protecting their value is the fact there can never be more than 21 million bitcoins, though up to a point these can be fractionally divided. Germany has recognized them as a legitimate currency, and informal opinions expressing the same view have been offered by various American officials.
Ironically Washington saw Bernard von Nothaus's Liberty Dollar, a hard currency based primarily on silver and warehouse receipts for precious metals held in storage, as a form of counterfeit and confiscated his holdings while successfully prosecuting him on felony charges. In his defense, von Nothaus argued he never represented the Liberty Dollar as legal tender. Perhaps the Liberty Dollar was viewed as too great a potential threat to Federal Reserve currency regardless of what it was or was not. Local currencies such as the Western Massachusetts Berkshare and the Ithaca Dollar, which claims to be backed by hours of labor, have circulated freely, as has the Toronto Dollar in Canada.
Another virtue claimed for bitcoins by their advocates is the fact that they cannot be counterfeited. Although technically this is correct, since you cannot counterfeit something that does not exist in physical form, the claim is misleading. Malware has been developed which enables the users to hack into mining computers and effectively steal any bitcoins that are produced.
While bitcoins might serve as an efficient means of monetary transference, it is difficult to see how they can claim a store of value any greater than that of the Somali shilling of the 1990s. Their defenders would claim that can be said of any fiat currency issued by any government. Certainly fiat currencies can be abused and become absolutely worthless. When Mr. Gideon Gono, Governor of the Reserve Bank of Zimbabwe issued 100 trillion dollar banknotes in 2008, he in effect made the Zimbabwe dollar totally useless. Actually that had already occurred, since his 100 billion dollar note issued earlier the same year had the purchasing power of only three eggs for a few days before declining to no monetary value at all. Shortly after the issuance of the 100 trillion note, Mr. Gono threw in the towel, and the country started to use more stable currencies such as the American dollar and the British pound.
Still, if fiat currencies had no intrinsic value, normally one would be about as good as another provided the number of units authorized did not climb to infinity, as was the case of the Zimbabwe dollar and earlier the Yugoslav dinar. Such is not the case, since anyone would prefer to be paid in Swiss francs rather than Laotian kip. Granted what gives any currency value is a rather nebulous thing, subject to some debate, but a few general observations would seem to be valid. First of all, a fiat currency takes on value because it can be used to pay taxes levied by the government that issued it. Secondly, its Central Bank may stand ready to defend it by purchasing it, at least up to a point. Another advantage is that the issuing government can declare them to be legal tender. Bitcoins and their clones do not enjoy such qualities.
While the International Monetary Fund officially does not permit member governments to back their currencies with gold, essentially all of them have gold reserves to some extent, and one must ask if the bullion is not there to help support the currency why is it there? Is the Swiss franc considered among the safest of currencies at least in part because Switzerland has the highest gold reserves per capita of any country in the world? Granted in the event of a global famine of epic proportions a sack of potatoes might be far more useful than a troy ounce of gold, but normally most people see gold as a store of value. If nothing else you can make jewelry out of it. Try that with a bitcoin.
The situation is still more tenuous when we try to take into account the other resources a government might have to support its currency. Certainly any foreign currency reserves would be beneficial. So might a state's natural resources, infrastructure, education system, judicial structure, degree of economic development, and other factors contribute to the willingness of people to accept its currency and assign a value to it. Granted, no one is going to give you a piece of the Interstate Highway System in exchange for Federal Reserve notes, but such attributes do give one the feeling that the country can honor its monetary obligations. While government debt could counteract this to some extent, contrary to popular belief the assets of the United States are still far greater than its debt. Anyone can check the statistics, and despite the conspiracy theorists, the gold reserves still safely rest in Fort Knox. Other than the willingness of others to accept it, what supports bitcoin?
Some critics of bitcoin, while seeing it as a poor substitute for fiat money would claim it can function as a commodity. If this is really the case, then bitcoins are unique among all other commodities. If I were to buy a commodity future for copper or wheat, ultimately the price of the future is even if indirectly connected to the potential price of a pound of copper or a bushel of wheat. This is true though the copper may not yet have been mined or the wheat harvested. Bitcoins have no tangible form. It is difficult to see how they can represent value as a commodity any more than they can as currency.
The nature of bitcoins also creates other problems connected with their production and circulation. Increasingly it takes extremely large quantities of energy to mine bitcoins, so much so that one of the largest producers set up shop in Iceland where energy is about as cheap as it can possibly get. In many cases bitcoin has become the currency of choice for such operations as the Silk Road illicit drug network, child pornographers, and terrorists. Ownership can be close to impossible to trace. Tax evaders also love it, a fact not lost on some Libertarians. While some exchanges, such as Japan's Mt. Gox, that provide "wallets" for storage and buy and sell bitcoin are reasonably reliable, others have been known to disappear without notice or be harassed by hackers. Even Mt. Gox has had its challenges. If you fail to make copies of the codes you need to use your bitcoins, and your computer is lost, stolen, or broken, most likely your bitcoins are gone forever. Governments, such as China, can prohibit the banks they regulate from accepting it.
However, the greatest threat to bitcoins may ironically be their very success. Despite all the negatives one can martial against the currency, including its wide fluctuation in value, its popularity continues to grow with more retailers announcing they will accept them or plan to do so in the future. This could result in numerous bitcoin "clones," other digital currencies similar in nature. Currently there are probably at least fifty that need to be taken at least somewhat seriously, and still more that do not. The most successful is Litecoin, with the equivalent of about 500 million dollars in circulation. Unless the supporters of bitcoin can convince the world that it is superior to its competitors it is difficult to see why the sum total of all digital currencies could not exceed Mr. Gono's supply of Zimbabwe dollars. If such a point is reach a colossal crash seems inevitable.
However. all that has been said here hopefully rests on logic. The world we live in does not always function rationally. Despite their lack of any tangible value bitcoins may continue to survive and circulate indefinitely. It is possible they may even thrive. If people like them, for whatever reason, they will continue to use them. "Convince a man against his will, you have not convinced him still." It does not matter whether the Emperor is wearing clothes or not as long as his subjects believe he is. Bitcoin believers see their Emperor arraigned in the finest of regal garments. Actually today's Somali shilling is better clothed.