Tag Archives: economics

Crypo-Currencies: A Proving Ground for Theories of Optimal Monetary Systems

After having been cued in to Bitcoin a few weeks ago, the crypto-currency’s rise has been quite impressive. Its value has quintupled since I began following it, and the amount of goods and services for which people are willing to accept Bitcoin has been consistently expanding. Barring any unexpected catastrophe, then, I feel like it’s reasonable to expect that crypto-currency will be an important part of the economic landscape in the years to come.

That being the case, I think it is important to engage in a meaningful conversation as to the nature of the optimal monetary model for a crypto-currency. After ingeniously solving the double spending problem, the initiators of Bitcoin chose to implement a system in which, for the first few years, a large amount of money is created but, within a decade, the supply of currency will reach a cap of around ~21 million units. This model of a predictable and stable money supply could very well be the optimal one, but it carries certain risks, the largest of which might be some of the pernicious effects of deflation.

The primary concern is that, in a deflationary environment, people will choose to horde rather than spend their money. For instance, why buy a t-shirt today for six Bitcoins today when you’ll be able to get it next week for five? Such incentives might hobble the growth of the Bitcoin economy, meaning more transactions happen in other units of value while people with Bitcoins hang on to them in order to realize potential capital gains.

Different schools of economics hotly debate the legitimacy of such concerns, but, until now, they’ve never really had a chance to engage in a full blown competitive experiment to test the issue. However, since the Bitcoin source-code is open source, it would not be difficult for someone to create a rival currency that, rather than capping off at ~21,000,000 units, is designed to consistently increase the money supply by 1% per year indefinitely after the initial takeoff period. By doing so, it might be possible to learn an enormous amount about monetary economics by comparing the performance of the two economies. Additionally, an environment might emerge in which currencies with innovative elements are regularly introduced to the mix, allowing for the empirically-based semi-organic evolution of an increasingly optimal monetary system. Truly, this is an exciting time to be an econ nerd!

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Regulation and Structure: Two Paths to Reform

While lazing about the house one Sunday morning while my partner was out to lunch with a friend, I decided to take advantage of her absence to watch a documentary on the Netflix instant play (she’s not a huge fan of political or economics films, so this was a bit of a treat for me). While scrolling through the enormous selection in their database, I happened upon Michael Moore’s Capitalism: A Love Story. Now, given his propensity for ignoring nuance and shamelessly appealing to emotion, I’m generally not a huge fan of his work. However, given his influence among the statist left, I figured it’d be interesting to get a sense of his interpretation and framing of the financial meltdown, so I made a bag of pop-corn and settled in for a viewing.

All in all, I was pleasantly surprised. Sure, there were generous helpings of the shameless heart-string pulling and agenda-driven propaganda that Moore’s films are known for. However, he also does a decent job of laying out a good portion of the facts of what happened during the boom, bust, and bailouts we experienced over the last decade. In that aspect of his film, I felt like it was roughly equivalent in usefulness to Inside Job, the fantastic investigation into the financial crisis that won this year’s Academy Award for Best Documentary. Both films do a fine job of showing how the enormous fraud and subsequent politically corrupt bank bailouts played out historically; however, I also find that they fall flat in their attempts to prescribe a solution to the problems they so skilfully demonstrate.

The fixes that they advocate are representative of the overall left-liberal narrative of the financial crisis. The argument goes that, at the dawn of the millennium, the Glass-Steagall Act was repealed. This Depression-era regulation served to separate the functions of investment and commercial banks, and its repeal caused the banking sector to go on a hog-wild frenzy of complex transactions that served as a cover for an enormous wave of fraud in the mortgage market. This, in turn, resulted in an entire sector of our economy assuming the characteristics of an enormous Ponzi scheme, which came crashing down in 2008. The solution, liberals argue, is for the Federal Government to re-establish tight regulation of financial markets in order to ensure good behavior on Wall Street and prevent further calamities.

As far as it goes, I believe that this narrative has great descriptive value; the repeal of Glass-Steagall was, indeed, one of the major factors that allowed for the financial crisis to get out of control. However, I also think the purveyors of this line of reasoning fail to grasp an important piece of the puzzle. Underlying their model is the assumption that the behavior we observed during the meltdown is rooted in human nature. As a result, they believe that all financial markets will “naturally” behave in the same fraudulent manner if left unsupervised by the state.

The fatal flaw of this perspective lies in the fact that financial markets (and by extension, virtually all markets) are not primarily made up of atomized individuals, but, rather, people whose incentives and opportunities are powerfully determined by the institutions in which they are embedded. Far from being “natural” or fixed, the structures of human-created organizations can be as widely varied as the limits of the human imagination, and, in a totally free market, the ownership and incentive structures of firms would be essential factors in their performance. As a result, competition would pressure firms to organically evolve towards the structures that most appeal to consumers.

If all of that seems a bit abstract, let me provide a brief hypothetical example from the financial crisis. The Federal Government’s bailouts saved an enormous number of banks, many of which likely would have become insolvent and failed. By contrast, during the same period, only a tiny number of credit unions were in serious jeopardy, because the ownership structure of credit unions (the depositors are also the owners) steered the institutions towards more conservative, risk-averse behavior than their joint-stock cousins. Had the Feds not intervened on behalf of the banks with seven hundred billion dollars, many of those banks’ large depositors would have suffered serious losses. Furthermore, they would have noticed that their peers who’d kept their money with credit unions had not taken haircuts, and would thus subsequently view credit unions as safer places to store their deposits than banks. Credit unions would then find it easier to attract deposits, and banks would have to engage in an enormous amount of self-regulation to remain viable institutions.

As such, the effect of government regulation of financial markets (and of the economy in general) is to subsidize sub-optimally structured firms. A co-operatively owned credit union is inherently more trustworthy to a depositor than a for-profit bank, but regulations artificially level the playing field by establishing the State as a guarantor of the good behavior of banks. In good times, the shareholders of these firms reap the benefits of this subsidy; when their companies screw up, however, the whole of society often ends up paying for the inflicted damage. As a result, our economy is chock-full of firms that would succumb to more efficient, just, and trustworthy business models in a truly free market, but persist thanks to the legitimization that the state provides.

Given all of this, the proper response is not, as Moore and other liberals would have it, to create new reams of regulations. While creating temporary stability, such a regime would simply serve as a fig-leaf for the abuses and dishonesty that stems from the very structure of many presently existing businesses. Instead, we should go to the root of the problem and eliminate the entire regulatory regime. By opening up competition between different kinds of firms and forcing them to fully internalize the costs of their behavior, consumers would begin to take into account the structure of a business when deciding where to deposit their money, buy their groceries, etc. The best that regulators can hope to do is curb the worst excesses of fraudulent and exploitative behavior; by contrast, fully freeing our markets will finally provide us with the opportunity to witness the flowering of an economy that truly works for all of us, not just a handful of well-connected plutocrats.

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In which we interview Dr. Roel Boumans

Miles and Matt talk economics, ecology, and epistemology with Dr. Roel Boumans, a former UVM professor and computer modeling expert who’s teaching a homesteading skills class this summer at his homestead (Windy Corners) in Charlotte, VT.

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A little flashback to 2000 to get psyched for this Tuesday!

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It’s the Monday morning after the Bailout…

…and I’m extremely curious to see what the markets will do this week.  An hour and 45 minutes into the trading session, the DOW is already down almost 500 points and gold is up 42 dollars (or 5%).  Is this an oversell that people will profit off of by picking up bargain shares, or is this the beginning of a correction that even Uncle Sam’s pocketbook can’t stave off any longer?  It’ll be interesting to watch.

Also, there are a few good articles on CounterPunch this morning about the Bailout and the credit crisis, and specifically how the bailout will not only fail, but that its failure will further erode confidence in American economic stability, exacerbating the problem.  Good times.

In any case, I’m off to pretend these problems don’t exist for a few hours of good company and heavily accented German social theory (I’m seeing Jurgen Habermas lecture at Yale *sqeeeeal*).  Until then, good luck preserving your capital (what little I have after my student loan payments is sitting in the relative safety of gold mining stocks and foreign government bonds thanks to Prudent Bear ^__^ ), and enjoy the day!

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