Render unto the Von Mises what is Von Mises’… the balance goes to Caesar.
Gary North recently wrote an in-depth article on Bitcoin. For those who may be interested, I have deconstructed the article below.
Bitcoins: The Second Biggest Ponzi Scheme in History
Gary North – November 29, 2013
I hereby make a prediction: Bitcoins will go down in history as the most spectacular private Ponzi scheme in history. It will dwarf anything dreamed of by Bernard Madoff. (It will never rival Social Security, however.)
Right off the bat, if Bitcoin is “the most spectacular” “in history” then the implication is that it has a long way to go to the upside. This would be a very bullish statement in the sense of “Rome as a spectacular Ponzi… until it wasn’t…”
To explain my position, I must do two things. First, I will describe the economics of every Ponzi scheme. Second, I will explain the Austrian school of economics’ theory of the origin of money. My analysis is strictly economic. As far as I know, it is a legal scheme — and should be.
First, someone who no one has ever heard of before announces that he has discovered a way to make money. In the case of Bitcoins, the claim claim is literal. The creator literally made what he says is money, or will be money. He made this money out of digits. He made it out of nothing. Think “Federal Reserve wanna-be.”
It’s true that math is an abstract concept, but to say math is “nothing” is a pretty strong statement. Rather than correlate it to the Fed, it may be a more accurate metaphor to correlate it to resolving Poincare’s conjecture, then being awarded the $1 million Fields Medal and then never showing up to pick up the cash. In that instance, math is nothing… however in the case of Bitcoin resolving the double spend is something… that is assuming people will continue to spend. (Dave on economic abstractions such as truth “approximated” http://tradewithdave.com/?p=18383)
Second, the individual claims that a particular market provides unexploited arbitrage opportunities. Something is selling too low. If you buy into the program now, the person running the scheme will be able to sell it high on your behalf. So, you will take advantage of the arbitrage opportunity.
First of all, that’s why it’s referred to as “price discovery.” The idea is to “discover” how valid the market “claim” being made by “the individual” is aka caveat emptor. The word “scheme” is defined as follows: a large-scale systematic plan or arrangement for attaining some particular object or putting a particular idea into effect. Buying low and selling high is a universal way to profit from assuming risk, so I don’t see exactly how your “Second” paragraph defines a Ponzi.
Today, with high-speed trading, arbitrage opportunities last only for a few milliseconds seconds in widely traded markets. Arbitrage opportunities in the commodity futures market last for very short periods. But in the most leveraged and sophisticated of all the futures markets, namely, the currency futures markets, arbitrage opportunities last for so brief a period of time that only high-speed computer programs can take advantage of them.
Uhhhh… ummmm. If that’s the case, then something like the White House HAMP home “affordability” program lasts a few milliseconds. Jamming up the market clearing mechanism with some Marxist “scheme” creates just as much of an arbitrage opportunity as allowing the mechanism to function in a capitalist genuine price discovery mode. It’s true that in the Marxist model, only select beltway insiders can access the arbitrage, but HFT algos are by no means the only arbitrage opportunity and if anything the economy is more of a slow motion train wreck than a Nascar pile up. By the way, are you excluding Bitcoin from your definition of “currency futures markets”? We need some clarification there.
The individual who sells the Ponzi scheme makes money by siphoning off a large share of the money coming in. In other words, he does not make the investment. But Bitcoins are unique. The money was siphoned off from the beginning. Somebody owned a good percentage of the original digits. Then, by telling his story, this individual created demand for all of the digits. The dollar-value of his share of the Bitcoins appreciates with the other digits.
True, but only partially true. If the means of production weren’t constricted and if capital flows weren’t subject to capital controls, then something like Bitcoin would have likely gone entirely unnoticed. It’s an extreme form of economic self-expression that is a result of market suppression. Think of it as Occupy Wall Street gone bad… for Wall Street. It’s the classic Pilgrim’s Progress attempt to escape from the burden 0f Zuccotti Park.
This strategy was described a generation ago by George Goodman, who wrote under the pseudonym of Adam Smith. You can find it in his book, Supermoney. This is done with financial corporations when individuals create a new business, retain a large share of the shares, and then sell the stock to the public. In this sense, Bitcoins is not a Ponzi scheme. It is simply a supermoney scheme.
Right on brother… right on. What’s super about it. It resolves the double spend. What’s not so super? It’s not fast enough for prime time in the absence of an escrow mechanism… but that’s on the way.
The Ponzi aspect of it comes when we look at the justification for Bitcoins. They were sold on the basis that Bitcoins will be an alternative currency. In other words, this will be the money of the future.
The coins will never be the money of the future. This is my main argument.
How do you define the future? How do you respond to the Rothschild’s Economist Magazine meme of “money as a technology”?
THE AUSTRIAN SCHOOL’S THEORY OF MONEY’S ORIGINS
The best definition of money was first offered by Austrian economist Carl Menger in 1892. He said that money is the most marketable commodity. This definition was picked up by his disciple, Ludwig von Mises, who presented it in his book, The Theory of Money and Credit, published in 1912.
In that book, Mises argued, as Menger had before him, that money arises out of market transactions. That which did not function as money before, now functions as money. Something that was valuable for its own sake, most likely gold or silver, becomes valuable for another purpose, namely, the facilitation of exchange. People move from barter to a monetary economy. This increases the division of labor. As more and more people use the money commodity in order to facilitate exchanges, the division of labor extends, and as a result, people’s productivity increases. They can specialize. This specialization produces increased output per person, and therefore increased income per person.
In this scenario, something that had independent value becomes the focus of traders, who find that their ability to buy and sell increases as a result of the use of this commodity. Money develops out of market exchanges. Money was not used for its own sake initially, but it becomes widely used as money as a result of innumerable transactions within the economy. (I discuss this in my chapter in Theory of Money and Fiduciary Media, published by the Mises Institute in 2012.)
Here is the central fact of money. Money is the product of the market process. It arises out of an unplanned, decentralized process. This takes time. It takes a lot of time. It spreads slowly, as new people discover it as a tool of production, because it increases the size of the market for all goods and services. No one says, “I think I’ll invent a new form of money.”
Note: any time you see a proposal of a new form of money, hold on to your old form of money.
Excuse me… did you just say that?
A one million mark Weimarian bank note used as notepaper, October 1923
The central benefit of money is its predictable purchasing power. A monetary commodity is not easy to produce. The cost of mining is high. Money is slowly adopted by a large number of participants. These participants use money as a means of exchange. Why? Because it was valuable the day before. They therefore expect it to be valuable the next day. Money has continuity of value. This is not intrinsic value. It is historic value. So, a person can buy money by the sale of goods or services, set this money aside, and re-enter the markets in a different location or in a different time, in the confidence that he will probably be able to buy a similar quantity of goods and services.
Okay… now we’re getting somewhere. “Predictable purchasing power”… I can buy that. Will Bitcoin become a victim of it’s own success? I can buy that too. Will the single most important aspect of Bitcoin (pre-engineered scarcity) make it so inelastic that it breaks? Ummm. Well, probably not break entirely, just be a really, really rough ride and when the blockchain goes all Robert Frost on us and forks it could get even rougher (http://tradewithdave.com/?p=19249)
Money is not accumulated for its own sake. It is accumulated to buy future goods and services. It is useful in the facilitation of exchange precisely because its market value varies little over time. It is the predictability of money’s market exchange rate that makes it money.
There you go again… generalizing time value… tisk tisk. You can’t do that. You’re essentially offering up the same proposition of “buying time and selling distance” that Michael Woodford offered up as the packaging for the zero lower bound. You’re doing the other side of that coin. That’s a no no. Yes, stability is key. No, you’re not allowed to define time simply as “varies little over time.” Sure the Fed’s dividend is 6% annually and yes it does appear that they are planning a metaphorical Tower 7 “pull it” demolition from within, but even as they continue “the halving of the halving” (as Fekete described it) you can’t use the word “time” without defining the word “future.” It’s disingenuous to use the microseconds of HFT algos as a benchmark for arbitrage and then to turnaround and not to provide some “theory of forms’ relative to your time frame for defining what makes money… money. Woodford is claiming “the map is the territory” and you’re claiming “the territory is the map”… same difference. (http://tradewithdave.com/?p=19232 and http://tradewithdave.com/?p=19009 and http://tradewithdave.com/?p=19036)
BITCOINS ARE NOT MONEY
Now let us look at bitcoins. The market value of one bitcoin has gone from about $2 to $1,000 in a year. This is not money. This commodity is not being bought for its services as money. It is unpredictable to a fault.
Wrong again. It may just be very short-lived Woody Allen money that is a victim of it’s own fifteen minutes of fame and I’m in full agreement with you on the significance of a predictable value (which you address) defined over a reasonable time frame (which you ignore), but that doesn’t mean it wasn’t/isn’t money any more than math doesn’t have any value… intrinsic or otherwise. The intrinsic value of math is more worthy debate than how to define Charles Ponzi if you ask Dave… but you didn’t. You also didn’t ask Dave about Mises Regression and how technology reduces friction to the point where it appears to reverse Gresham’s law (http://tradewithdave.com/?s=mises+regression+)
Admittedly, those who got in early on this Ponzi scheme are doing very well. They will probably continue to do well for a time. As more people hear about this investment, which is justified in terms of its future potential as money, more people will buy it. Late-comers are not buying it because they understand its potential as future money, any more than the late investors in Charles Ponzi’s scheme thought they were buying into the arbitrage potential of foreign postage stamps. They are buying Bitcoins because we are in the midst of a Ponzi scheme mania. They will continue to buy because they think this time it’s different.
What does it mean to do well? Takes us back to that time value question again. See Matthew 6:19-21 for a definition of “doing well.”
This digital so-called money will not be used to facilitate exchange. Nobody is going to be getting rid of an asset that has moved from $2 to $1,000 in one year in order to buy pizzas. People want to hang onto it, refusing to sell, in the hopes that it will go to $2,000. This is the classic mark of Ponzi scheme psychology. People do not buy the investment for the benefits that the investment provides as an investment, in other words, because it is a capital asset. They buy it only because it has gone up in price. They expect this to continue.
Really. Did Mises say that or was it Menger… or was it neither?
Here is the Austrian school’s theory of money. People buy money because it has not fallen in price. But it has also not gone up in price much, either. It is predictable. Why? Because it is held in reserve by a large number of people over a large geographical area. It has become money through tradition, through experience, and through endless numbers of exchanges on a voluntary basis. It has proven itself in the marketplace as a means of facilitating exchange, and thereby as a means of preserving value over time. This is not the characteristic feature of a Bitcoin. People are not buying it to serve as money; they are buying it because they are in the midst of a mania, and they are gambling that the number of buyers will continue upward forever.
You said it yourself. Arbitrage has accelerated. The world is clearly more connected. So how long exactly does it take to travel over “large geographical areas” and how long does a Woody Allen “tradition of fame” take these days and how many exchanges of Bitcoin are taking place every day… Marco Polo? Are you saying that the blockchain isn’t proven and the Comex is? We’ll see whose plumbing fails first. How do you know why people are buying bitcoin? Maybe a Mexican housekeeper in Greenwich is using it to send bail money to Mexico City… did you ever think of that? Maybe the Winkelvii are getting ready to lose big again… you did build that.
Here is an economic fact: the number of fools is limited. They are a scarce economic resource. As the price of bitcoins rises, more fools will be lured into the market. But this is a finite market.
Hat tip P. T. Barnum.
In other words, bitcoins cannot possibly fulfill their supposed purpose: to serve as an unregulated currency unit. Bitcoins are not an alternative currency. They are something you buy in the midst of a mania, and you will sell at some point in order to get back your money. You are thinking of buying Bitcoins, not because Bitcoins will serve as a means of exchange, as originally argued, but because you want to get back lots more money than you paid for them. In other words, Bitcoins are not money; dollars are money. There has been no challenge from Bitcoins to the reign of the dollar.
A rapid rise in the price of Bitcoin and/or a rapid decline in the price of Bitcoin has little or nothing to do with the value of resolving the double-spend, the triple entry accounting power of a public record of all transactions not to mention the brand equity and first mover advantage of being the best known of the crypto-currencies. Just because somebody is a one hit wonder like The Knack’s My Sharona (voted #6 all time best one hit wonders by Rolling Stone readers) or if the hits keep coming like those from the gellin’ felons at the Fed’s POMO desk we all must render unto Caesar what is Caesar’s and render unto God what is God’s.
If you ask Dave a more interesting question than is Bitcoin money would be when you divide the world into the Occidental and the Oriental and view it from within a Mervyn King divorced currency framework (separation of the double coincidence of wants from the store of wealth – hundreds of articles on the subject here on the blog) what is the chance that the tax and regulatory policy for Bitcoin will be different in the Eastern Hemisphere than in the West.
JUST SAY NO
When you see an offer of an investment which inherently cannot possibly exist on its own merit, and yet lots of people are coming into the market to buy the item, you know, without any question, that this is a Ponzi scheme. In other words, people are buying into the program, not because of an arbitrage opportunity, and not because of a capital breakthrough in terms of technology, but because somebody else bought it cheaper yesterday. You buy it today, not because you think it is going to offer a stable value, but because you think you’re going to make a bundle of money when more people come into the market. Again, this is the classic mark of a Ponzi scheme.
In order for Bitcoins to become an alternative currency, there will have to be millions of users of the currency. There will have to be tens of millions of users of the currency. They will have to develop in a market on their merit as money, not as an investment of dollars in order to get more dollars back. It would have to develop through exchange, not bought as an investment. In other words, the free market will have to adopt Bitcoins as a means of increasing the division of labor.
Bitcoins are not increasing the division of labor. They are bought on the basis that somebody can get into a game of musical chairs. Instead of running out of chairs, leaving one person the great winter, the promoters started with a given number of chairs, and then they hoped that lots would come and bid on the chairs. “If we issue it, they will come.” This took place. The promoters creators are now very rich, as measured in dollars.
The fact of the matter is this: Bitcoins will not increase the division of labor by serving as an alternative currency. Inherently, Bitcoins have made their mark, not on the basis of their stable value in exchange, that is, their value in increasing the division of labor in alternative markets that do not use the dollar. On the contrary, Bitcoins are being purchased for one reason only: to get in on the deal. Buy low; sell high. Buy with what? Dollars. Sell for what? Dollars.
The mania has destroyed Bitcoins’ use as money. Bitcoins are too volatile in price ever to serve as a currency.
You’re making a huge assumption that Bitcoin won’t stabilize.
Which is money: dollars or Bitcoins? The answer is obvious: dollars.
This is a Ponzi scheme.
And the petro dollar isn’t?
WHAT GOES UP COMES DOWN
Tell that to Richard Branson.
This will lead to the ruination of more people than any private Ponzi scheme in history. There will be the poor schnooks to get in at the end, paying perhaps thousands of dollars per Bitcoin. Then the market will unravel. It will unravel for the same reason that all Ponzi schemes have unraveled: not enough new buyers. When the new buyers do not show up in great numbers, the holders will start to dump them. What went up in price, as measured in dollars, the real money, will come down in price.
And I guess government pensions are safe and school teachers and firemen have nothing to fear.
This mania is going to be the stuff of best-selling books. This is going to be this stuff of Ph.D. dissertations in economics and psychology. This is going to be the equivalent of Mackay’s book, Extraordinary Popular Delusions and the Madness of Crowds.
The interesting thing is the mania started among the most technologically sophisticated people on earth: computer techies. The techies who got in early are going to be fabulously wealthy . . . if they sell. But the poor schnooks who come in at the and are going to lose money. Collectively, this will be the greatest single scheme for lots of people losing money that we have ever seen. This Ponzi scheme is not illegal . . . yet. It will spread. It has gone viral.
The price will soon be too high for most people to buy one Bitcoin. What I think is going to happen next is that somebody is going to start a Bitcoin mutual fund. You will be able to buy fractional shares of a Bitcoins. Maybe you can get in for $250.
Anytime you buy an investment, you had better have an exit strategy. There is no exit strategy for Bitcoins.
You must get out at the top, or you lose your shirt.
Anytime that anybody tries to sell you an investment, you have to look at it on this basis: “What are the future benefits that this investment will give final consumers?” In other words, how does it serve the final consumer? If it does not serve the final consumer, then it is a Ponzi scheme.
Do you believe that it is a benefit to have a general increase in the consciousness of where money comes from and just how much of a Ponzi the Fed really is?
Bitcoins cannot serve the consumer. There is nothing to consume. The only way that Bitcoins can work to the advantage of the consumer is that they provides the consumer with increased opportunities, based on Bitcoins’ function as money. But the fundamental characteristic of money is its relatively stable purchasing power.
And Amazon dollars, Facebook credits have been a big hit… not.
Bitcoins will never achieve this. It is a mania going up. It will be a mania coming down. It will not increase the division of labor, because people will recognize it as having been a Ponzi scheme, and they will not again buy it. They will not use it in exchange. Companies will not sell goods and services based on Bitcoins. Bitcoins have to have stable purchasing power if they are to serve as money, and they will never, ever achieve stable purchasing power.
Whenever somebody tries to sell you an investment that is based on the economic analysis of a market — an analysis that cannot possibly be true — do not buy the investment. This is a simple rule. I adhere to this rule.
Uhh… who are you trying to convince… your reader or yourself? Enough already.
There has to be an economic justification for a capital investment, and there is no economic justification of buying Bitcoins as an alternative currency. That was how Bitcoins were initially sold, and it was impossible as an economic concept from the beginning. The Austrian theory of money shows why.
And the world’s largest distributed computer network is worthless and cracking PGP would be a non-event.
I do not invest in capital that has no economic justification other than the greater fool theory. There are too few fools to keep the scheme going.
Cue Alec Baldwin’s Capital One “transaction eraser” commercial. Erasing a transaction is the one thing you will never be able to do with Bitcoin. http://www.youtube.com/watch?v=5E5r88XedRY
Bitcoins are not illegal. They should not be made illegal. They should merely be avoided.
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