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rhollerith_dot_com comments on General Bitcoin discussion thread (May 2011) - Less Wrong
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Has anybody seen any reply to Tyler Cowen's argument that Bitcoin's monetary velocity is unstable?
The arguments I have encountered focus on Bitcoins' strengths as a medium of exchange, but not (as Cowen points out) as a store of value, as one currency among a monetary universe composed of many money-like substitutes. Why hold non-negligible amounts of Bitcoin (as opposed to cash for its state-enforced liquidity, or any less-liquid but higher-return financial instrument of choice - recall Fisher's equation here)?
The mainstream Keynesians like to talk up liquidity preference. The post-Keynesians and modern monetary theory types talk about fiat money demand as driven by the state (to pay taxes, etc.). Well, Bitcoin cannot do that, either - it is fiat money without a fiat. We know all about Bitcoin's stable money supply. What determines its money demand? Demand for anonymous money? But the supply of anonymous-money-substitutes is not limited to Bitcoin.
(An alternative way to phrase the problem, via a standard result from international macro - flexible exchange rates and high rates of currency substitution imply unstable exchange rates; the more perfect and costless the substitution, the more unstable the exchange rate, with the rate becoming indeterminate as cost goes to zero. This is the point made by the paper Cowen mentions. Currencies in use in the world tend to correlate remarkably well with geopolitical boundaries, regardless of whatever optimal currency areas that may exist, for reasons that have less to do with their intrinsic economic properties than with state measures; states have central banks and central banks can defend currencies, so the problem presented by rampant currency substitution is really only limited to weak states in military turmoil. Bitcoin is another matter, though - it doesn't suffer any of the vagaries of bad central banking, but it can't claim any of the strengths either.)
edit: "unstable exchange rates" is not quite clear. "Exchange rates highly elastic to changes in money demand and supply" might be better.
I haven't seen Cowan's argument, but wouldn't the argument apply just as well to gold and silver, which were used for thousands of years as currencies?
Well, no. Concisely put, the problem is under-determined money demand because of readily available money or money-like substitutes (in the theoretical framework of money demand/money supply). This is an issue limited to the period of readily available new money, of which Bitcoin itself is one, really. For those thousands of years there were few such substitutes, and substitution would have been costly anyway, so the problem does not apply there.
Thanks.
(The problem does apply to gold speculation in this day and age, though, right? I will BTW readily concede that gold speculation in this day and age is high risk.)
It would apply if gold were legally enforced and usable as a currency, but I don't think it is.
It does apply to forex speculation, though.
OK, so investors buying and holding gold do not cause the problem.