The Gift of Bitcoin: Chapter 2 – The Problems with Money

This is the second chapter of “The Gift of Bitcoin” – a world class bitcoin education sent to recipients of bitcoin gifts sent with GiveBitcoin.

Congratulations on receiving your GiveBitcoin gift! Someone who cares about you gifted you some Bitcoin (BTC) and it’s our job to help you learn about it. Reminder to read through Chapter 1: Introduction to Bitcoin if you haven’t already already.

Quick summary:

  • We’ve got a money problem: Governments control our money and they inevitably abuse that power.
  • The purpose of money is to provide a way to:
    • 1- Exchange goods and services
    • 2- Save/store value for the future.
  • Money has taken many forms throughout history (ie: shells, beads, gold coins, etc.) but there are always new entrants in the evolutionary money competition.
  • The gold standard kickstarted an era of unprecedented economic progress, including the industrial revolution and many of the major inventions that fuel our society today.
  • Governments have abandoned gold-backed currencies when they want to increase spending, like when fighting wars. 
  • Hard money produces better outcomes than soft money.

In this lesson, you’ll learn all about the origins of money and the problems with our current monetary system. It helps to understand Bitcoin in the context of other forms of money. Most people are surprised to realize how little we were taught about money in school. We’ll also recommend some additional resources if you’re hungry to continue learning 🙂

The lesson only takes ~15 minutes to read. You can also listen to the lesson if you prefer audio content.

 

Chapter 2: The Problems with Money

Let’s begin…

So there’s a problem with money? The only money problem I deal with is not having enough of it!

You might not see it in your everyday transactions, but there are massive problems with the way our money works today. Top of the list: the production and transaction of money is controlled by governments and that creates all kinds of issues.

Like what?

Governments shut down access to money when they feel threatened. We’ve seen it happen over and over again around the world, often leading to humanitarian disasters. And even if you live somewhere where you think that will never happen, money is increasingly going digital which means third parties, like banks and payment processors, can arbitrarily freeze your account or deny access to goods they don’t like (plus, they must follow government orders if they’re told to freeze your funds). In short, you don’t really have control of your money. And that has all kinds of psychological impacts on society.

Sounds like a real nightmare. But I feel like those sorts of things are unlikely in my world.

Governments that can print their own money eventually wind up abusing that power. History teaches us that. They’ll say they’re “managing the economy” and that it’s for your benefit, but it inevitably goes sideways. 

How so? 

Governments invariably print money to finance a never-ending expansion of government and/or wars that drag on forever. They can do this, in part, because there is no ceiling on the amount governments can spend to fund these wars.

There are also government abuses of money (via central banks, etc.). And the massive artificial availability of credit enables governments to spend money freely while pushing the costs onto future generations. 

Taxing the future

“Rather than explicitly taxing us now, the government can force future generations to pay for things. It’s a monetary system where the government is basically taking your wealth without you really being able to do much about it.”

Stephan Livera, Bitcoin podcast host and GiveBitcoin Advisor 

And then you have all the privacy issues that arise now that governments can trace all of our digital transactions.

What kind of issues?

Digital payments mean governments can watch and control everybody. In fact, in some countries, you can only use small denominations for cash transactions. That means an authoritarian government can track all large transactions. Think of the implications of that; the state can see everything you do and even shut you out of the financial system. With almost half of the world’s population living under authoritarian control, these citizens are essentially trapped in a matrix where governments control their financial future.

This government ability to trace transactions can even be dangerous. For example, China could see that a bunch of people are buying train tickets to go to Hong Kong to protest and decide to crack down on them. This could lead to a very Orwellian future where the government monitors transactions to make sure they’re “appropriate.”

The Trust Problem

“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.”

-Satoshi Nakamoto, creator of Bitcoin

Money Around The World

Aren’t there laws to prevent government overreach? 

Laws change and what was once totally normal and legal can quickly become illegal (or wind up under government control). If we allow payment systems to be completely centralized, we create a system where the government controls what people can do and when they can do it. 

In fact, there are already examples of this in America. You can go and buy marijuana in a state where it’s perfectly legal, yet the marijuana shop can’t actually process credit cards since federal law prohibits it. This may seem like a minor flaw, but it’s a microcosm of how the government can control populations.

Is it the same situation all over the world?

In America, you can seek legal relief if a bank misuses your funds and there’s generally trust that the government and your bank won’t steal your money. In other countries, it’s different. We’ve seen government action lead to currency collapse in Greece. And in India, the government declared certain bank notes to be worthless. You can see similar stories in the Soviet Union, Venezuela, and China. 

Around the globe, we’ve witnessed the negative effects that occur in countries that exert extremely tight central control over their currency and payment systems. The result is often massive shortages of goods, governments that keep an iron grip on the economy, or people who are forbidden to move capital. 

“I came from the former Soviet Union. There, we had a tightly controlled central economy where the government was setting the prices of everything and printing money. The ruble was devalued by factors of a thousand many times over. And when we left the Soviet Union, we were not able to keep our money since it was illegal to own foreign currency. So we were forced into using this government currency which was constantly devalued and couldn’t buy anything. As a result, we left the country with only $400 in our pockets. So I was very familiar with the idea of the government controlling money. But I didn’t think about it until much later when I got into Bitcoin. Once you start looking at Bitcoin, you think, ‘Hey, this is a thing that if we had it in the former Soviet Union, we would have had this stash of wealth that we could have taken with us.’ That’s where it kind of clicked for me.”

Yan Pritzker, author of Inventing Bitcoin and GiveBitcoin advisor

To understand all of this, it’s important to understand the history of money too…

The Evolution of Money

(source)

What actually makes something money?

Money can come from the ground up. It’s something Carl Menger discussed in his seminal 1892 book On the Origins of Money. He explained that the marketplace, not government edicts, is what creates money. Individuals decide which good is best as a medium of exchange. “Man himself is the beginning and the end of every economy,” Menger wrote. It’s important to remember the purpose of money which is to provide a way to 1) exchange goods and services and 2) save/store value for the future.

So how do we decide what works best as money? Basically, it’s a competition where people choose the most salable and liquid asset to use as their store of value. It’s an evolutionary process. For a long time, gold rose to the top of the heap. But there are always new entrants in the evolutionary competition for the best money in the world.

The Origins of Money

“In the earliest human societies, trade between groups of people occurred through barter. The incredible inefficiencies inherent to barter trade drastically limited the scale and geographical scope at which trade could occur. A major disadvantage with barter based trade is the double coincidence of wants problem. An apple grower may desire trade with a fisherman, for example, but if the fisherman does not desire apples at the same moment, the trade will not take place. Over time humans evolved a desire to hold certain collectible items for their rarity and symbolic value (examples include shells, animal teeth and flint).”

-Vijay Boyapati, The Bullish Case for Bitcoin

So we can just make money out of nowhere?

Value is subjective; things are valuable once humans place value on them. Think of it like the old phrase “beauty is in the eye of the beholder.” Money’s value is a result of the market’s demand for it.

But hasn’t money been around forever?

Money predates written text, so we can’t know exactly how it came to be. The first metal coins entered circulation around 600 BC. However, they didn’t catch on everywhere. Beads were used by Native Americans as currency for a long time. Certain areas of Europe didn’t use coins or paper money until the mid-18th century. And shells were still being used by Africans as currency within just the past century.

Why don’t we still use things like shells or glass beads for money?

The problem with using things like shells or glass beads as money is that people eventually recognize it’s easy to discover and/or produce more of them. Eventually the market is flooded and that devalues the object as currency. A better solution is required.

The Gold Standard

When did we start using metals like gold and silver as currency? 

Precious metals, including gold and silver, were the best forms of money for a long time since they are hard to obtain. While seashells are easy to find and thus easy to inflate, metals aren’t. Gold is rare and virtually indestructible; that means it’s accumulated slowly and has a very high stock-to-flow ratio. 

Define: Stock-to-flow ratio

Stock to Flow Ratio is the amount of a commodity held in inventories divided by the amount produced annually. It is a measure of abundance. (source)

People quickly realized why gold was superior to other currencies and started putting it into vaults and issuing pieces of paper that represented a claim on that gold. And that’s how we got our earliest paper currency. Eventually, that led to the gold standard.

What’s the gold standard and why does it matter?

In a gold standard system, gold is a “standard of value.” The gold standard was widely used in the 19th and early part of the 20th century.

Define: The gold standard

The gold standard is a monetary system that directly links a currency’s value to that of gold. A country on the gold standard cannot increase the amount of money in circulation without also increasing its gold reserves. Because the global gold supply grows so slowly, being on the gold standard theoretically holds government overspending and inflation in check. No country currently backs its currency with gold, but many have in the past, including the US. The country effectively abandoned the gold standard in 1933, and completely severed the link between the dollar and gold in 1971. The U.S. now has a fiat money system, meaning the dollar’s value is not redeemable for any specific asset. (source)

Under the gold standard, a government (or central bank) has to maintain enough gold reserves to match the money supply and be able to convert the currency into gold at all times. In times of war or crisis, it’s hard to maintain sufficient gold reserve levels. That makes it hard for nations to engage in long-running disputes or wars.

What happened after the gold standard was implemented? 

In the 19th century, the international gold standard emerged and it kickstarted an era of unprecedented economic progress. It was the era of the industrial revolution and many of the major inventions that fuel society today.

Flourishing

“A case can be made for the nineteenth century being the greatest period for human flourishing, innovation, and achievement that the world had ever witnessed, and the monetary role of gold was pivotal to it.”

Saifedean Ammous, author of The Bitcoin Standard and GiveBitcoin Advisor 

The gold standard ended during World War I and most governments eventually replaced gold with fiat money. According to many economists, the results have been disastrous; fiat money resulted in economies that were centrally planned and government-directed failures.

Define: Fiat money 

Fiat money is a currency without intrinsic value that has been established as money, often by government regulation. Fiat money does not have use value, and has value only because a government maintains its value, or because parties engaging in exchange agree on its value. (source)

Although gold may not be a perfect standard of value, we have centuries of experience of countries using gold standard systems with terrific results. And up until the invention of Bitcoin, no one had come up with a better standard of value.

(source)

Is there any downside to the gold standard?

The gold standard limits the flexibility of a government’s central bank to influence monetary policy; there’s no easy way to expand the money supply under the gold standard. In the US, for example, a return to the gold standard would make the Fed powerless to fight recessions or slow down an overheating economy. Also, gold supplies are inherently unreliable. Nonetheless, many economists believe money that is unchanging, stable in value, and free of human meddling is the best option and see the gold standard as an excellent way to achieve it.

If it’s so great, why did we abandon the gold standard?

The US abandoned the gold standard to help combat the Great Depression. In 1933, President Franklin D. Roosevelt cut the dollar’s ties with gold, allowing the government to pump money into the economy and encourage banks to lend to businesses for expansion.

However, America continued to allow foreign governments to exchange dollars for gold until 1971. Then, President Richard Nixon ended the practice after realizing that foreign nations had way more dollars in their hands than the US had gold in its vaults; he was afraid of what would happen if they all wanted their gold at the same time.

Abandoning the gold standard came with a lot of alluring short-term promises, but ignored the long-term problems that would arise.

What happened after the gold standard ended?

The end of the gold standard allowed governments and central banks to increase the money supply at will, diluting the value of each note in circulation. This process is known as debasement

Define: Debasement

Debasement refers to lowering the value of a currency, particularly one based on a precious metal, by adding metal of inferior value. Today, most currencies are fiat currencies and are not based on a precious metal. So, debasement only requires that the government print more money, or since much of the money exists only in digital accounts, create more electronically. (source)

Abandoning the gold standard means citizens have to trust governments not to abuse their monetary printing press, an urge that is both tough to resist and inevitably leads to economic woes. 

In centrally planned regimes where the government controls the money, such as Venezuela, the currency has become nearly worthless and the country is on the verge of collapse. This is a common scenario when authoritarian governments control the economy. 

The ability of governments to print money also extends wars and disputes since regimes no longer have to worry about running out of funds. Running out of cash is a great motivator to settle disputes. When governments can constantly print more money, they can fight endless wars.

(source)

So should we go back to the gold standard?

Physical gold has problems as a currency too; it’s cumbersome, expensive, and insecure. Centralized physical gold reserves kept in a few locations—banks and central banks—wind up vulnerable to government takeover. The reality is what we really want isn’t gold necessarily; we want hard money as opposed to easy money.

Hard vs. Easy Money

What is hard money as opposed to easy money?

Money must be durable and hard to produce. Money that fits that description is called “hard money.” If money is easy to produce (aka “easy money”), there’s likely to be a rapid increase in its supply and a decrease in its value.

What are some examples of easy and hard money? 

Things like beads and shells are examples of easy money. Even within metals, there are significant variations. For example, copper is easy while gold is hard. Copper is bad as a store of value since it’s easy to produce in response to increased demand. Gold, on the other hand, is hard money because even if the price increases, it’s quite hard for gold miners to increase the supply of it.

The hard money paradigm

“The ‘hard money paradigm’ argues that an economy is best served by a currency that is stable, reliable, unchanging and free of human influence, a universal constant of commerce somewhat like the meter or kilogram. The ‘soft money’ paradigm argues that the economy is best served by economic bureaucrats who constantly manipulate the currency (in the process changing its value; a floating currency), along with interest rates and other related factors, to attempt to achieve a variety of favorable outcomes including managed interest rates; credit expansion or restraint; lower unemployment or avoidance of recession; trade relationships; and many other such things. I would say that history has shown that the ‘hard money paradigm’ is the winner — that it consistently produces better outcomes. The ‘soft money paradigm,’ despite all its alluring promises, tends to cause a lot of problems.”

Nathan Lewis, author of Gold: The Final Standard

What’s the impact of using hard money?

When we’ve been on a hard money standard, things have gone well. For one thing, it encourages risk taking; it lays the groundwork for explosions in entrepreneurship since people know their money is not going to be deflated. That stability means people can save and invest freely. In the past, that scenario has created an environment of progress, resulting in major inventions like the airplane, the computer, and more. The ideal combination would be this type of hard money standard without the pitfalls of physical gold. Enter Bitcoin.

Additional Resources

Books

Essays

Videos

Podcasts

Infographics

 

Let’s wrap up

That concludes Chapter 2: The Problems with Money

In Chapter 3 we’ll discuss why Bitcoin is the perfect solution to our current system.

Comment below with ONE thing you learned from today’s lesson, or one question you’d like answered. We’d love to hear from you!

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