JKHC FORUM: Why Economists Are Right to Hate on Bitcoin

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Why Economists Are Right to Hate on Bitcoin - TIME

Why Economists Are Right to Hate on Bitcoin

Read more: Bitcoins -- Why Paul Krugman is Right to Hate Them | TIME.com http://business.time.com/2014/01/03/bitcoin-paul-krugman-is-right-to-hate-them/#ixzz2pZyZ9Yfw

By Christopher Matthews @crobmatthewsJan. 03, 201499 Comments

Nobel Prize winning economist Paul Krugman speaks during the World Business Forum in New York — Nobel Prize winning economist Paul Krugman

Economist Paul Krugman is not one to shy away from a good fight, but he may have vexed his most passionate opponents yet last week with a blog post titled “Bitcoin is Evil.”

Krugman’s title is tounge-in-cheek. He doesn’t actually believe the cryptocurrency, which has captured the imagination of so many, is immoral or depraved. But he doesn’t see it supplanting the dollar anytime soon for the simple reason that it fails the test of what economists call a “store of value.”

According to standard economic theory, a successful currency has to be both a medium of exchange, meaning a something that is easily transferrable, divisible, and universally valued, and a a good which maintains its value reasonably well. And while Bitcoin has proven to be a pretty great medium of exchange, it’s value has swung wildly over the course of its history.

In a recent blog post at The Verge, Adrianne Jefferies questions whether this really is a problem. She writes:

“If Bitcoin is successful, it could prove that money doesn’t need to function as a stable store of value — the price of Bitcoin could jump around constantly, and in the age of the internet it’s trivial to program prices of goods and services to fluctuate with it.”

In other words, since computers programs can easily adjust the price of goods along with the value of bitcoins, the currency doesn’t have to maintain a stable store of value. But this ignores the risk businesses will take by accepting and storing their wealth in bitcoins. Businesses invested in commodities or which deal in international trade know what a pain it is to deal with the risk imposed by the rising and falling values of commodities like oil or wheat, or even small swings in the value of foreign currencies. And the price of oil or the dollar-yen exchange rate have nowhere near the volatility of bitcoins.

On December 6th and 7th of last year, the value of one bitcoin fell from $1200 to $600 in the course of 48 hours. If your business had been storing its revenue in bitcoins at that time, such a decline could have a potentially destabalizing effect on your business. Of course, businesses could decide to accept bitcoins and then quickly change them to dollars to avoid the currency’s volatility. But then this raises the question, why accept bitcoins at all?

Jefferies goes on to posit that bitcoin’s success as a means of exchange could eventually lead to its being a good store of value:

“If people believe that they will be able to buy things with Bitcoin and exchange it for other currencies indefinitely, that could convince them to use it as a store of value. Many early adopters have already put their savings into Bitcoin. And if the technology is sound and the user base is (eventually) global, that doesn’t seem that insane.”

Indeed, some theorist argue that a currency’s stability follows from being a widely used means of exchange. But this gets us back to the question: what will motivate the vast majority of users to abandon dollars and adopt bitcoins? Sure dollars slowly lose value over time through inflation, but this isn’t a problem for most of us, as it happens slowly enough that any wealth we hold on to for very long time horizons can be stored in other investments like real estate or government debt. Secondly–and most important–national governments demand we pay taxes in local currencies and back up those demands with the threat of force. As a decentralized payment system, bitcoin will never hold this same advantage.

Bitcoin is an elegant technological innovation that may find a future in niche applications, like as a means for transferring money cheaply across borders. But economists are right to be skeptical of those who hope it will supplant government-controlled fiat money. Bitcoin enthusiasts simply have not posited a believable scenario where the vast majority of us will abandon fiat money for their virtual coins.

(MORE: How Does Bitcoin Work?)