Posted by: Dr Churchill | December 23, 2013

Monetary Policy – Value Perception – Risk and a New Coin

Milton Friedman was an interesting fellow.

I believe that you’d be hard-pressed to find someone more influential on modern economic theories and policies and especially on monetary policy of the FED than him.

Now if he were alive to see one of the most exciting and disruptive developments of the modern era – he might have been feeling vindicated on one of his most extreme predictions.

Like many gifted men, he was often forced to make decisions that saw necessity trump his convictions.

As a Treasury spokesman during the height of World War II, Friedman advocated Keynesian-style taxes because the wartime government was struggling to fund massive wartime spending. This resulted in his helping invent the payroll withholding tax system.

When asked about it later in life, Friedman said: “I have no apologies for it, but I really wish we hadn’t found it necessary, and I wish there were some way of abolishing withholding now.”

A similar compromise born of necessity for Friedman came with the Federal Reserve. He opposed its very existence, but eventually had to accept that it wasn’t going to be shutdown. Ultimately, he had to advocate using the Fed to create a steady, small expansion of the money supply.

Instead of invasive government involvement, Friedman wanted a real, non-government gold standard where money is produced by the private market.

This proved to be out of reach.

As Friedman noted in 1961: ”If you could re-establish a world in which government’s budget accounted for 10% of the national income, in which laissez-faire reigned, in which governments did not interfere with economic activities and in which full employment policies had been relegated to the dustbin, in such a world you might be able to restore a real gold standard.”

A real honest-to-God gold standard is not feasible because there is essentially no government in the world that is willing to surrender control over its domestic monetary policy.

As we know today, the US government and the rest of the world strayed far from the Nobel prize winner’s ideals.

Yet in the twilight of his life, decades after he retired, he started to see signs of change…

In 1999, seven years before his death, he saw real promise in the disruptive forces of the digital age, stating: “I think the Internet is going to be one of the major forces for reducing the role of government. The one thing that’s missing, but that will soon be developed, is a reliable e-cash.”

If only Friedman held on for several more years, he would’ve seen the rise of currencies that could fulfill so many of his ideals.

Over the last four years, and in 2013 in particular, a non-governmental, free market currency has taken root. And it isn’t just appealing to a conservative banker/economist, and a financier, with a libertarian streak – like me…

On the contrary, this new currency is bridging otherwise impossible divisions between drastically different people, economic ideologies, and political spectrum denizens.

The Fed cannot manipulate it to suit domestic policies, and its monetary base is being slowly expanded at a set rate.

Fed chairman Ben Bernanke openly acknowledges this in a letter to Congress, in which he states that the Fed “does not necessarily have authority to directly supervise or regulate these innovations or the entities that provide them to the market.”

Yet the architect of some of the most profoundly radical monetary policies in history believes that it “may hold long-term promise, particularly if the innovations promote a faster, more secure and more efficient payment system.”

As for politicians on opposite sides of the spectrum, libertarian Ron Paul said, “There will be alternatives to the dollar, and this might be one of them.” If enough people start using it more, “it’ll go down in history as the destroyer of the dollar.” And to not be outdone, Al Gore stated: “I’m a big fan… Regulation of money supply needs to be depoliticized.”

Good luck finding something else these polar opposites would agree on.

If you haven’t figured out what I’m referring to yet, you’re in the majority. What Friedman referred to as e-cash has taken root in the form of “cryptocurrencies.” And am talking about Bitcoin in particular…

We’ve been living in a digital age for years, and digital money has been foreseen by science fiction writers for many decades, even though it hasn’t taken hold. Largely because it is so damn hard to unseat the ease of habit. This the reason it has taken so long for cryptocurrencies to catch on, lagging far behind Internet-based commerce, And even though Pay-pal and all other money systems on the net and mobile phones, are agile and adaptable — they aren’t money.

Yet Bitcoin is and here are the Five Pillars of the New Currency:

1) Security: First, the system has to be secure. This problem has been solved by using extremely complex algorithms to guarantee that all new money created is legitimate. Counterfeiting is impossible, along with spending the same money multiple times. Part of the reason this is possible is thanks to a unique approach to recording transactions that eluded developers as they tried to address the second problem… Instead of using a single ledger that is prone to being hacked and falsified, a digital currency can use many independent people to automatically maintain ledgers. By comparing many of these ledgers against one another, erroneous or fraudulent entries cannot exist.

2) Strong Encryption preventing counterfeiting: The encryption for private account information needed for withdrawals and deposits is ironclad as well. Finally, the transactions had to come from personal and private accounts that would still appear on the ledger. This was handled by using a public digital key and a private one. The public one will appear in the ledger; the private one is always encrypted and hidden. Only the account holder can initiate payments. With the security virtually guaranteed, digital cryptocurrencies are rapidly and radically creating an alternative to fatally flawed, government-issued and manipulated currencies.  The computers that create bitcoins are compensated same as are the laborers of the virtual mines where Bitcoins are unearthed. Instead of swinging pickaxes, these custom-built machines, which are running an open-source Bitcoin program, perform complex algorithms 24 hours a day. If they come up with the right answers before competitors around the world do, they win a block of 25 new Bitcoins from the virtual currency’s decentralized network. The network is programmed to release 21 million coins eventually. A little more than half are already out in the world, but because the system will release Bitcoins at a progressively slower rate, the work of mining could take more than 100 years – until the ”Bitcoin Gold” is exhausted and the mine runs dry.

3) Investor Interest: It is also rapidly gaining the attention of investors, consumers, and merchants alike, mainly because of the scarcity — along with the speculative mania that has grown up around digital money which has made each new Bitcoin worth as much as $1,100 in recent weeks, before dropping down to $500 after the Chinese government clamped down. Yet because Bitcoins are invisible money, backed by no government, useful only as a speculative investment or online currency, but creating them commands a surprisingly hefty real-world infrastructure — the investors are thrilled.

4) Speedy & Clean Transacting: It provides a far faster and cheaper system than traditional payment methods through credit and debit card companies and banks.

 5) Automation & Accelerated Growth: An automated payment processing system for digital currencies that was started a little over two years ago has already logged over $100 million in transactions. Over 15,500 merchants use it in over 200 countries. The number of new merchants listed through it has increased over 50%, and its transaction volume has tripled in November alone. A website that tracks user-submitted reports of physical stores that accept digital currencies saw an 81% surge in listings just in November. And ATMs that will exchange digital currencies for your cash on the spot are popping up across the globe. On October 30, 2013, the first machine went live. By its 29th day, it had already logged over $1 million (Canadian) worth of transactions.

The only remaining problem with digital currencies has nothing to do with the new currencies themselves. It’s our perception and our comfort with the existing system…

We’ve been living in a world where each nation has a stranglehold on currencies. Only the ”fiat currency” paper notes they issue have been acceptable until now.

People are accustomed to the use of the national government IOUs and the banking systems that serve such promissory notes, and of all the rules and regulations of credit and debit cards, and all the inconveniences, because there have been no other reasonable options so far.

Truly — the only other option would be exotic instruments, or precious metal transactions, and the expensive check-cashing services, thus severely limiting access to the commerce of goods and services.

It is hard for any of us to start to break ingrained habits and the culture of greenback money that we’ve built over an entire lifetime.




 I was profoundly skeptical of all digital currencies up until recently, because they were and still are severely flawed…

Yet once these new independent digital currencies began gaining a foothold, they started drawing my attention and still they were all gravely faulty except perhaps the units of the Mpesa system.

 So it wasn’t until I took a detailed look at how elegantly simple, secure, and independent the cryptocurrency of Bitcoin is, that I realized how biased I was after decades of working with Finance and FX in the overly expensive, slow, complex, and taxing system designed by the Fed, the national governments, and the central banks.

It was a new dawn for me and after trashing the Bitcoin recently in one of my posts — some good folks helped me see the merits of the new currency…

Am not entirely convinced but I prefer the new explanation a bit more than anything I thought of before.

Yet again, it all might be a big hole readied for all of us to jump inside…

It’s a big ocean out there and we’ll be well advised to blow bubbles like little fish gasping for breath — before we all take to the water of the cryptocoins….

Much like the Gold rush — speculative fever is contagious for the miners and investors alike. Miners, though, are among the virtual-currency faithful, believing that Bitcoin will turn into a new, cheaper way of spending cash, transacting on the fly, on the net and on the web of mobile communications, and of sending money around the world, leaving behind its current status as a largely speculative commodity.

Yet it’s good to remember that if the system did crash, the Bitcoins themselves would be essentially useless because they are custom-built for Tulip bulb scarcity believers and digital flower mining enthusiasts and you can’t eat digital cash anymore than you can eat greenbacks either.

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