Many things have been used as money in the past; ranging from metals – both precious and base – to tally sticks and printed paper. In primitive societies cowrie shells and giant stone wheels have been used as money. Whatever thing was used as money, it was only valuable because people agreed it was. In other words, money is in its essence an abstraction.
Whatever form it takes, money serves these three basic functions in an economy:
To store and preserve wealth.
To serve as a means of exchanging value.
To index the relative value of things.
Much has been said, and the debate rages yet, as to whether or not it is essential for money to have “intrinsic value.” In other words to BE wealth rather than to simply represent wealth. Most people would say that money is wealth, but it isn’t actually. It can only be traded for wealth.
The philosopher John Locke said that wealth is the result of labor applied to resources. Wealth is tangible, and it has utility. Economists would count money as wealth, and insomuch as it can be traded for things with real value, they are right. But, like folks say, “you can’t eat money.”
Without getting into the definitive nuances of wealth, let’s suffice it to say that wealth is that which benefits us humans by feeding, clothing, housing, transporting, or simply entertaining us. Money is what we use to trade for these things.
Very few of the aforementioned tangible forms of money have any intrinsic value. An example is the “tally stick.” a form of money used in Europe for nearly 700 years, without the carved notches it was just a stick. With them it represented wealth.
The form of money most often presented as having intrinsic value is gold. And yet gold’s primary usage other than as money is not to feed, house, or clothe, but to adorn. Your grandmother’s wedding ring won’t bring as much because of its intrinsic value as jewelry as it does for its abstract value as money.
Most other forms have not a shred of intrinsic value. I dare say EVERY other form; sticks, shells, paper and giant stone wheels, were “place holders.” They were physical representations of abstractions; ideas that exist in the minds of human beings. Money’s value is established by mutual agreement, and subject to the same laws of supply and demand that determine the value of anything we trade.
That does not mean place holders are not important, but what it does mean is that the intrinsic value of the place holder is irrelevant. It obviously does not matter that the only intrinsic use value of paper money is ruined because it’s already covered in ink. Its value is derived from the ink. Is it One Dollar or a C-note? The difference is not the inherent value derived from utility. It is an abstraction.
The irrelevance of the intrinsic value of the thing money is made from is obfuscated in the minds of “gold bugs” – people who insist that the only form of true money is gold. (A group to which I once belonged) While they are correct in believing that gold as money reduces or eliminates its debasement through inflation, they wrongly attribute that quality to its intrinsic value.
Its ability to prevent inflation is not because of its usefulness in making jewelry, or electronic connections, but because there is a finite amount in existence, and increasing the available supply requires labor.
Wealth requires labor, and therefore so should its place holder. That which the market considers wealth’s equivalent in value should not be increased without work. In the modern world human labor has been supplanted by technological advancements which have redefined the term work to include computer processing. (The point of which I will get to.)
Gold bugs point to the historical record to support their case for gold as money; and rightly so. Gold’s value has endured through the millennia, and if one were take a trip in a time machine gold would be the thing to carry along for spending money. Regardless of whether one goes backward or forward in time gold would be precious and exchangeable for goods and services.
Advocates of gold backed currency will argue that the money doesn’t have to be made from gold, it just needs to be “backed” by gold. But this is the arrangement that led to fractional reserve banking – permitting banks to loan money into existence; creating it from thin air. And that led to the inflationary creation of money from nothing.
There is no way to avoid the fact that money, no matter who or what guarantees its value, is only worth what the community agrees it’s worth – in the goods and services they are willing to give in exchange for it. And that is an abstraction that has nothing to do with intrinsic value.
The difficulty of transmitting gold from one place to another is what led to the invention of paper money in the first place. It served as a secure “place holder” that performed one of the three functions of money – as a means of exchange.
While the system of paper backed by gold functioned well as a means of preserving purchasing power because it placed a some restriction on the creation of currency, that day has passed. And thank goodness it has because that monetary system has required the services of a third party.
We call them bankers. In time they achieved a monopoly on the creation of money. They became the central banks and through political clout disconnected the paper from it gold backing. They were then free to further inflate the money supply to their heart’s content. And they have.
Until now these third parties have been indispensable to the financial system. I say until now because for the first time in human history modern computer technology, combining secure cryptography with digital processing, has created what may prove to be perfect money. Perfect because it performs the three functions of money without the inherent pitfalls that have led to one system after another throughout the history of money. This new money is called Bitcoin and it is:
Instantly transferable, with minimal or no fees.
Finite in quantity. (there will only ever be 21 million of them)
Yet infinitely divisible. (100,000th of a bitcoin is called a Satoshi, in honor of the inventor)
Anonymously owned. (Accounts on the shared public ledger are known only by cryptographic pseudonyms) Governments hate this.
Impossible to spend twice.
And even though it is considered a negative fact by critics bitcoin is not created or controlled by a central authority.
History is replete with failed fiat currencies, and the reason for their failures was that they were inflated into worthlessness by the central authorities which controlled them. It is easy to see why people would abandon a currency in which the hard earned labor invested in it was disappearing like piss on a hot sidewalk.
It is difficult to imagine why anyone would abandon a currency which was increasing in value. So, to those who predict that the “bubble will burst,” leaving late investors holding the bag. Why? The Tulip mania bubble burst because the day came when there were no more buyers for tulips. When will there be no more users of money? Why would anyone convert their Bitcoin to dollars, or yen, or pesos, or any other fiat currency which steadily loses its purchasing power.
Note: At just 2% inflation per year, which is the Federal Reserve’s target rate, Dollars lose half of their purchasing power every 35 years.
My conclusion is that if all Bitcoin ever does is serve two functions directly – secure value from the ravages of inflation and provide frictionless transmittal, its future is secure.
The third function of exchange for goods and services can continue to be, as it is mostly now, via exchanges with other forms of money, whether fiat or digital. It won’t matter.
Bitcoin performs the three functions of money, and it serves them without the cost of a third party, securely and anonymously. Its critics say it’s a fad that won’t last because it has no intrinsic value.
I say it has the value of utility, and that is the only value money of any kind has ever had.