Former Fed Chairman Alan Greenspan, most notable for inflating not one but two bubbles of his own, is sounding the alarm over Bitcoin – the virtual electronic currency now rapidly gaining traction among international investors, the unbanked, and, increasingly, speculators.
“It’s a bubble,” he told viewers in an appearance on Bloomberg Television. “It has to have intrinsic value. You have to really stretch your imagination to infer what the intrinsic value of Bitcoin is. I haven’t been able to do it. Maybe someone else can.”
Greenspan’s comments, however, aren’t just limited to Bitcoin: They go to the very heart of what a currency is, and the function the currency serves. Currency – any currency – functions for one reason and one reason only: Faith. Anyone taking currency in lieu of barter for goods and services does so only because he is confident that he himself will be able to exchange that currency for goods and services for himself at some later time. That’s it.
Intrinsic value provides a handy floor for the value of a currency, regardless of what happens to its scarcity – but it is not, strictly speaking, necessary for a currency to function.
Now, let’s step back for a moment, and consider Greenspan’s intellectual history: In the 1950s and 60s, Greenspan himself was a public admirer of Ayn Rand, author of Atlas Shrugged and the Fountainhead, and the founder of the Objectivist school of thought.
In 1966, Greenspan published an essay in Rand’s The Objectivist newsletter called “Gold and Economic Freedom,” in which Greenspan embarked on a detailed defense of the gold standard, then under withering attack from progressive circles – Greenspan called them “welfare state advocates” — who had been aiming to repeal it since William Jennings Bryan gave his famous “Cross of Gold” speech at the Democratic National Convention in 1896.
But let’s take a close look at Greenspan’s conclusion in his essay, the last two paragraphs I’m reproducing, verbatim:
In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.
That was in 1966. But President Nixon finally took the U.S. dollar off the gold standard in 1972. (He had little choice – he was hemmed in between the simultaneous Cold War, a hot war in Viet Nam, and the continuing War on Poverty spending imposed upon him from the Johnson Administration and the Democratic Congress, fresh from the Medicare Act. The result was an immediate and substantial inflation spike that eroded the value of the dollar for the next decade like cancer eats bone.
But what is the intrinsic value of gold? It has beauty and it has scarcity. It is regarded widely as a luxury good, because it can be refined into beautiful jewelry. It is durable, and as such it meets the test of good currencies that Greenspan lays out in his essay. But does it have intrinsic value in any useful sense from an investment point of view? It generates no cash flow. It generates no dividend. It represents a claim on nothing except itself, except insofar as other people are willing to play along and accept it as a currency. But there are no expected future cash flows to discount to the present day using a reasonable interest rate to arrive at a net present value.
Gold’s value is defined simply by whatever other people are willing to pay for it in the here and now, and that’s the long and short of it. Warren Buffett pointed out the absurdity of gold investing in 1998:
“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility,” he is widely attributed to have said. “Anyone watching from Mars would be scratching their head.”
Now, it’s very nice for currency traders that the dollar and other currencies tend to float against each other. If they were all married to a fixed exchange value with gold, or any other commodity, then they’d all move together and it would take all the fun and profit potential out of Forex. We’d all have to be commodity traders, and play the great game of Hot Potato where every commodity trader in the world attempts to buy and sell the contract before the semi truck full of eggs pulls up to the dock and the driver starts looking at you for the payment you’re now legally obligated to make.
But Greenspan would do well to remember that Bitcoin, in many ways, is a reaction against the general withdrawal of national currencies from the Gold Standard – or any other standard, for that matter, over the last century. In international circles, people with any money at all are terrified of their own governments. Unlike the U.S. Federal Reserve, which has embarked on a massive quantitative easing campaign in which they are now purchasing some $84 billion in securities every month with Monopoly money, the Bitcoin programmers committed the currency to a scarcity of supply: The system is limited to 21 billion units. No single central bank or politician can undercut that limit in order to buy themselves votes or pay off a national debt with devalued currency – an act that has become almost commonplace in recent decades.
I write this not as an opponent of the Federal Reserve or quantitative easing – (I do not believe that Bernanke had much choice, given the hand he was dealt when he inherited the Chairmanship of the Federal Reserve).
And since it’s a virtual peer-to-peer currency, with a tracking system distributed across thousands of servers worldwide, it’s resistant to the kind of outright wealth confiscation we saw in Cypress last year.
The demand among wealthy and even middle-class people around the world who are distrustful of their own governments’ commitment to a sound currency make for a pretty solid demand floor – and we may well be near the very beginning of developing this base – the online merchant space for Bitcoin transactions is nowhere near saturated for instance.
Meanwhile, there may well be another layer of demand as vast economy of people in first-world nations becomes aware of the absence of bank fees involved in transmitting and receiving Bitcoin – making it the most cost-efficient way to transfer wealth internationally, by far.
This doesn’t mean that Greenspan is wrong, mind you: One look at a Bitcoin price graph indicates that there is room for a dizzying decline.
The public is also beginning to become aware of Bitcoin’s many downsides, too: The risk of losing a hard drive with millions of dollars of Bitcoin irretrievably stored on it, for example. (I doubt a homeowner’s insurance policy will cover Bitcoin stored on a stolen computer!). We saw a sharp decline in Bitcoin pricing just today after China told its financial institutions not to accept Bitcoin. (I don’t expect communist tyrants to be too friendly to the concept). Additionally, following the Silk Road murder-for-hire scandal, the Federal Bureau of Investigation did manage to seize $28 million in Bitcoin belonging to underworld figure and alleged conspirator Ross Ulbricht.
By all accounts, Ulbricht had it coming – but the event shot a hole in the most heady promises that Bitcoin would be immune from government seizures.
Is Greenspan right? Nobody knows. Nobody can know, at this point. We are in absolutely uncharted waters here. Demand is still in the ramp-up phase and we don’t know where demand will cap out. This isn’t like the Internet craze, where you had 20 different competitors all priced as if they would each have fifty percent market share of the same market in five years.
On the other hand, Bitcoin can be a great idea, and underpriced currently, relative to eventual demand… and still wind up getting supplanted by another online currency some time from now, the way VHS ate Betamax.
The bottom line, though, is this: If Bitcoin is in a bubble, then the same can be said of any currency that relies primarily on continued faith on the part of counterparties.
Which is to say, all of them.
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