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Why Bitcoins Will Go To Zero, But Gold Will Not

If you lived in a simple civil society, how would you survive?  First, you’d have to do something –  like make a tool, cut some wood, harvest some food, catch some fish, etc.  Otherwise, you would just lay there and die.

If you wanted something from someone else, you would not go up to them and say “give me your stuff!” without starting a fight – remember, this is civil society.  You would offer them something in exchange. From time to time, if you wanted to give something away or someone gave you something for nothing, fine, but that would be the exception, not the rule.  If you keep asking for free stuff, that usually doesn’t go over very well.  If you demand free stuff, it leads to fights and wars.

This brings us to a cardinal rule of economics, and life: there is no such thing as a free lunch.  Someone has to do something in order to survive.

To go beyond mere survival, to flourish, people have to do even more work and succeed at living to such an extent that they can survive while spending time thinking, inventing, and producing.  For example, if one guy figures out how to produce the same amount of food that used to take 10 guys, then the other 9 guys can work on other things besides food like inventing engines, spaceships, medicine, or computers to name a few. This is how human beings actually advance – how they live longer, healthier, and happier.

If you thoroughly understand and integrate this principle into your thinking, you will be able to detect about 90%-100% of the BS that flows from the modern economics profession.  When a PhD or Federal Reserve official tells you that there is a magic way to create economic growth and prosperity without work or production, you will know something is wrong, even if he has a lot of formulas and pie charts.

When people begin advancing, it becomes a hassle to offer a random chicken or piece of wood in exchange for a carrot or some tobacco or whatever.  What if you don’t have exactly what the other guy wants just then?  What if you don’t want to carry a chicken around with you?  It is much easier to offer a standard asset that is valuable to everyone all the time.  If an asset has certain properties, it can serve as this asset.  What are these properties?

First, the asset would have to be universally recognized as a value, i.e., just about everyone could find a use for it.  It would be nice if it was found to be so valuable that a small amount would generally be accepted for just about anything.  This way, you could carry it in your pocket instead of in a wagon.  It would have to be something that could last a long time so you don’t have to worry about it vanishing.  It would have to be divisible so you could cut it up into different sizes to correspond to other goods that have differing values.  It would have to be something that does not change in value constantly due to dramatic changes in its supply.  It would be best if the material was homogeneous, or the same throughout, so that people could agree easily on its value without having to evaluate it every time you want to trade.

For thousands of years, humans have chosen precious metals like gold and silver since they meet all of these criteria (see this for examples of gold’s practical uses).  Again, these are not arbitrary criteria set by me or some government agency.  They are criteria that follow from the nature of reality, i.e., the marketplace.  This does not mean people shouldn’t barter good for good.  It just means that using a standard asset is much easier most of the time, and people freely choose to use them since it makes trade and life easier and more productive.  Quoting George Reisman (Capitalism, p. 142):

Thus, an economic system operating under the constraints of barter exchange would obviously offer only very limited opportunities, for division of labor and would thus be extremely primitive.  In essence, to live in such an economic system, one would either have to be a farmer or produce the kinds of things that could be readily exchanged with farmers, such as blacksmithing services.

What is required for the existence of a division-of-labor society is the existence of money and monetary exchange.  Money is a good readily acceptable in exchange by everyone in a given geographical area, and is sought for the purpose of being reexchanged.

So, the need for production and trade follows from man’s basic nature and the nature of the world in which we live.  The exchange of value for value is a requirement of human life.  The usage of barter or a standard asset such as precious metals in these exchanges is not arbitrary, it is an objective necessity of human survival.  Money, such as gold and silver, is preferable to barter if you want to live a more productive, happier life. Due to their unique properties, precious metals have been the objective money choice of the market for thousands of years.  Contrary to the claims of modern economists, gold and silver are not “barbarous relics” from a bygone age, but vital and necessary tools of exchange, which allow for an advanced division of labor economy and an increasing quality of life.

From the above, it can be seen that Bitcoin, a so-called digital currency, does not have these properties.  A Bitcoin is not itself valuable as you can not make a wire or a bowl or bullets or a house out of Bitcoins like you could with metals. The only thing that makes Bitcoins temporarily valuable is the belief that someone else will accept them in exchange.  In essence, Bitcoin is a like an even crappier fiat currency.  It’s crappier, because at least fiat currency is legal tender, i.e., transactions are legally settled upon payment, and one must pay taxes in fiat currency.  Bitcoin does not even have this property!

At some point, Bitcoin’s dollar value will go to zero as everyone who holds them tries to sell them to the next person and no one chooses to accept them.  In fact, since dollars are fiat currency, their value will one day go to zero in terms of actually valuable goods for the same reason.  Gold will never go to zero in terms of other commodities because of its special properties, like the fact that you can use it to do work and survive.

While many people express gold as a price in dollars, conceptually, it should be thought of in the reverse way.  An ounce of gold is an ounce of gold and can always be exchanged into other commodities. Gold is the money. Any commodity price can be expressed in terms of a price in ounces of gold. Even the value of dollars or other fiat currencies and Bitcoins can be expressed in terms of gold. For now, at least, those prices are not yet zero.

  • Chris Sutton

    This post is leaves out lots of critical detail to support the claims laid out.

    First, the statement “Contrary to the claims of modern economists, gold and silver are not “barbarous relics” from a bygone age, but vital and necessary tools of exchange, which allow for an advanced division of labor economy and an increasing quality of life.”

    Ok…why? You alluded to the fact that gold can be made into useful things, but this doesn’t explain its use as money. A gold ring has about zero objective value, since it’s a luxury item. It’ll be one of the first items to be devalued in a crisis situation. (when the “value” of the gold is the differentiating factor. A stable society can have anything as a medium of exchange.) Other, more immediate items, like non-perishable food should therefore be used as money, but they’re not.

    Money is in a class of its own. The only reason we’ve begun to use gold and silver as money, to my knowledge, is because they’re universally novel (everyone says “ooohh, shiny yellow!”) and because they’re sufficiently scarce to where this novelty drives up the price rather quickly.

    Second, your statement of “From the above, it can be seen that Bitcoin, a so-called digital currency, does not have these properties” is not very well explained.

    What properties? The fact you can’t “make” things out of Bitcoin? Does that not make _all_ intangibles not useful as a medium of exchange or store of value? Why would that be so? The value of metals are partially derived from their use as raw materials, but they have use as mediums of exchange because they are divisible and non-perishable…as is Bitcoin. Also, the four points laid out above that statement apply equally to Bitcoin as they do to any other form of currency. Even more so, because Bitcoin has a fixed supply and son’t be subject to price inflation like national paper currencies.

    I thought this was particularly funny, and isn’t specific enough to be an actual prediction: “At some point, Bitcoin’s dollar value will go to zero.”

    Well, yes, but are we talking in the next 1 year? 10? 100? 10,000? At some point, the US will cease to exist. At some point, the Earth will be swallowed by the Sun. Yes, I suppose at that point Bitcoin would be worthless.

    Can you please elaborate on these points? I’m not seeing how these statements are accurate.

    BTW, it’s worth mentioning I believe Bitcoin to be electronic gold, except better. I predict it to take over the world economy as the standard against which everything else is measured. I can explain why if you like. I haven’t seen an intelligent criticism of Bitcoin yet. (i.e. a criticism coming from someone who both A. knew what they were talking about, and B. spent the time and effort to accurately and concisely discredit Bitcoin.)

  • writeby

    Given recent developments & reports, I wonder.

    Bitcoin crashes again: http://finance.yahoo.com/blogs/the-exchange/third-bitcoin-crash-in-three-months-reveals-cryptocurrency-flaws-161929360.html

    The Exact Date for Bitcoin’s Final Crash to $0.00: http://www.wallstreetdaily.com/2014/02/27/bitcoin-2/

    Gold is universally accepted as valuable. It’s not that it’s shiny, it’s that a) it’s rare; therefore it cannot be debased, that is, one cannot “print” it off or increase its amount arbitrarily; b) the mining of gold has, historically, kept pace with economic growth; c) gold (& silver) can be wrought into a variety of sizes representing differing values _by weight_, rather than by what’s printed on paper.

    Finally, gold has stood the test of eons, maintaining its value.

    In short, gold possesses objective value.

  • Chris Sutton

    Bitcoin is also rare. The growth in gold supply is somewhat irrelevant, because any unit that isn’t manipulated artificially will be priced appropriately. We just don’t experience that today, because, well, all our currencies are manipulated by central planners. (central “bankers” as they like to be called. ;-) )

    The fact that gold is _divisible_ as well as being highly valuable in small amounts, are significant advantages over most materials, but also disadvantages over a digital financial instrument. Digital numbers can be divided to infinite decimals, and therefore are _more_ divisible than Gold. Also, digital numbers have no weight other than the minuscule amount of storage they take to record. Further if a variable’s number is capped, it has the same effect as a scarce physical resource.

    Also, it’s worth noting that Bitcoin is “version 1.0″ of the protocol in a lot of respects. It may or may not be strong and versatile enough to survive, but it’s fairly easy to create another altcoin with the same small inflation you would see when using gold.

    And it’s critical to define the word “value.” Value, is something that someone determines has some sort of use. The use may be status, increasing productivity, exchange, etc. The use can be anything, but the critical point is that value is the _subjective_ assessment of the one assigning the value. All value is relative. Gold has quite a few different ways to be valued by a human, so it’s _more_ valuable than, say, rocks. The value (demand) pulls against the scarcity (supply) and creates the price.

    Ultimately, all prices are moving targets, but to cope we’ve created one measuring stick that we call money and measure all other goods and services against. This “money” can be literally anything.

    The advantage of a commodity-backed money was the fact that it couldn’t be printed on-demand. The disadvantage was that it artificially drove up the price of the underlying commodity. Gold, therefore was artificially scarce in addition to already being scarce, just because we all agreed to use it for our money.

    Bitcoin solves this scarcity problem within the algorithm, and also frees up ALL other commodities to be used strictly for their physical usefulness.

    In short, it’s a more efficient system.

  • Chris Sutton

    One more thing to ponder: In the beginning of the Internet, there were very few, if any, firewalls. I remember about 15 years ago being able to browse the files on my neighbors’ computers that had cable Internet connections. It was just open, so if files were “shared” they were shared with the entire neighborhood. (quite literally “Network Neighborhood.” ;-) ) Now every PC from Windows XP onward have firewalls, and in addition, everyone has one at the border of their home network. (Built into their router)

    Did the Internet die because of this one critical flaw, or was the idea, the concept, strong and flexible enough to survive despite these weaknesses?

    The same can be said of Bitcoin. If you’re open, you would probably find Andreas Antonopolous’s Youtube videos quite enlightening.

  • writeby

    “The use can be anything, but the critical point is that value is the _subjective_ assessment of the one assigning the value.”

    And herein lies your error, a la Hume. Gold has objective value. Numbers–no matter who makes the assessment (actually, the assertion)– whether counted in digital code or counted on a printing press, do not.

    See: Is-Ought (Fact-Value) Dichotomy

    http://plato.stanford.edu/entries/hume-moral/

    http://aynrandlexicon.com/lexicon/is-ought_dichotomy.html

    And an excerpt from my own essay on this:

    “David Hume destroyed much during his lifetime assault on the Age of Reason. But his most infamous exploit was to divorce fact from value in his sceptic philosophy—to claim that facts were objective and were approached by rational methods but that values were approached subjectively, the result of men’s biases and prejudices, i.e., the result of men’s feelings, which Hume claimed were intrinsically a-rational. He identified these two approaches as, respectively, Intellectualism and Sentimentalism. This (false) opposition of Hume’s is known in philosophy as the is-ought dichotomy (which, in justice to Hume, is a derivative of Descartes’ (and, before him, Plato’s) mind-body dichotomy).

    “What Hume did, in essence, was to render unto reason the world of science but unto emotion (a-rationality), the world of ethics and morality. Thus, one could prove—using Hume’s argument—that increasing the yield of crops on a given acre of land was in fact possible. But not that it was moral. One could prove that freedom increased men’s prosperity but not that this was necessarily good. One could prove that anesthetics relieved men’s pain, but not that this was right.

    “Hume had, in essence, placed morality outside the realm of reason. No one, after Hume, could state with any certainty—unless they refuted his argument at its base—that famine was objectively bad; that progress was objectively good; that increasing men’s life expectancy was objectively right.

    [...]

    “Hume’s (Jupiter sized) mistake lay in the morality that he himself implicitly accepted with certainty, never placing his ethics within the sphere of his sceptic philosopher’s eye. Hume never questioned whether Man’s life qua rational being ought to be the moral standard; never doubted the moral standard that he had accepted by default—that of placing the welfare of others above one’s own life; above one’s own values; above one’s own reason, honesty and integrity.

    “Hume therefore never saw, having not identified Man’s life as the moral standard, the fact that fact determines value:

    · The fact that men can be cured by antibiotics makes their discovery a value because antibiotics save men’s lives
    · The fact that interchangeable parts lead to mass production makes their invention a value because mass production saves men time, allowing them to be more productive with their time and, thus, to have more time to enjoy their lives.
    · The fact that the political recognition of rights leads to freedom makes their formulation a value because individual rights protect the fruits of men’s labors, preserving men’s lives

    “Hume never discovered any of this and more because Hume never made philosophical inquiry into the nature of facts and their relationship to men’s lives. Because he never viewed Man’s life as a value–and, therefore, never discovered human life as the moral standard. Fortunately for mankind, a modern philosopher did (“It is only the concept of life that makes the concept of value possible.”); and in so doing (finally) rebutted Hume’s philosophy of scepticism (and the mind destroying philosophy of Kant, whom he made possible) with a philosophy of Objectivism…”

    BTW, inflation is the effect of currency manipulation–the reduction in value of fiat; gold, of course, can suffer no such manipulation.

    See:

    http://aynrandlexicon.com/lexicon/values.html

    http://aynrandlexicon.com/lexicon/gold_standard.html

    http://mises.org/etexts/menger/eight.asp

  • writeby

    Chris,

    PS. Here’s the way to save BC & precisely where BC ought to head:

    “Could Bitcoin, or an equivalent digital currency, be put on the gold standard?”

    http://media.blubrry.com/peikoff/13be01ddf3b1d677ded1-f884a1b570187d379829b71385ab845d.r57.cf2.rackcdn.com/wp-content/uploads/2014/04/2014-14-4.317_D.mp3

    A particular bank or other financial institution could encrypt their own brand of BC, thereby safeguarding it against manipulation (by putting it out of reach of the government, which cannot be done with normal “non-virtual” currency), back it by gold and issue it. Here’s a way to avoid the devaluation of the Dollar & the ensuing inflation.

    And some smart, young capitalist entrepreneur will run with this.

    Soon, I think (& hope).

  • Chris Sutton

    Not going to happen in my estimation. Bitcoin will be THE standard, by its widespread use and ensuing network effect, within the next 3-5 years. After that, all fiat currencies will begin their decline, (I’m not sure if it’ll happen quickly or slowly, but it’ll happen) and all other virtual currencies will be priced against the “standard” of Bitcoin.

    After a while, IF Bitcoin maintains its usefulness, (i.e. there are no exploits of the underlying protocol or encryption) “precious” metals will become less precious, and lose most or all of their usefulness as a long-term store of value, simply because Bitcoin, at that point, can be adequately trusted to maintain its value over time. This trust, (or rather. the lack thereof) is the reason gold has been used as a “hedge” against the inflation of fiat currencies.

    Since gold can’t be easily spent, its value as a “money”, (using the term loosely) rests solely in the assumption that it’ll be as valuable in the the future as it is today – an assumption that’s been accurate to date.

    With the introduction of a frictionless medium of exchange that ALSO meets this criterion, the usefulness of gold as a store of value will decline over time.

  • Cameron Martin

    The growth rate for the amount of bitcoins in circulation has logarithmic growth, which closely matches the growth rate of the amount of gold. This behaviour was chosen for this reason. In general, bitcoin has very similar properties to gold. This article is a load of crap.