By: Tim Hayes Financial Advisor - posted in: Investment Advisor - Last updated Nov 18, 2018

Bitcoin the Future of Money or a Novelty?

by | Investment Advisor

One bitcoin today is worth roughly $2,500—which goes to show how out-of-whack this cycle’s pet rock, tulip craze or dot-com stock (pick your financial bubble) has gotten. Proponents hail the bitcoin as the world’s first virtual currency, forgetting or unaware that 97% of today’s money is virtual.[1] Transacted without the use of physical cash, it is instead processed with bank money consisting of computer digits.

Adam Smith’s Big Mistake

One of capitalism’s founders, Scottish economist and philosopher Adam Smith, got much right. However, one of his great errors, still made today, was the theory that money replaced barter: “The greater part of his occasional wants are supplied in the same manner as those of other people, by treaty, by barter, and by purchase. With the money which one man gives him he purchases food. The old clothes which another bestows upon him he exchanges for other old clothes which suit him better, or for lodging, or for food, or for money, with which he can buy either food, clothes, or lodging, as he has occasion.”[2]

However, Dame Caroline Humphrey, Sigrid Rausing Professor of Collaborative Anthropology at Cambridge University, rebutted Smith in a 1985 paper: “No example of a barter economy, pure and simple, has ever been described, let alone the emergence from it of money. All available ethnography suggests that there has never been such a thing.”[3]

David Graber, in his landmark book Debt: The First 5000 Years, makes a similar argument of the lack of anthropological evidence of money replacing barter: “The problem is that history shows that without money, such vast barter systems do not occur. Even when economies ‘revert to barter,’ as Europe was said to do in the Middle Ages, they don’t actually abandon the use of money. They just abandon the use of cash. In the Middle Ages, for instance, everyone continued to assess the value of tools and livestock in the old Roman currency, even if the coins themselves had ceased to circulate.”[4]

Mitchell Innes, in The Banking Law Journal of May 1913, pointed out the complete lack of proof of money replacing barter: “A moment’s reflection shows that a staple commodity could not be used as money, because, ex hypothesi, the medium of exchange is equally receivable by all members of the community. Thus if the fishers paid for their supplies in cod, the traders would equally have to pay for their cod in cod, an obvious absurdity. In both these instances in which Adam Smith believes that he has discovered a tangible currency, he has, in fact, merely found—credit.”[5]

Q/A Financial Advisor Tim Hayes

Yet the myth of barter remains central to capitalism.

WhereThenDid Money Come From?

Money evolved from debt, not barter. In fact, money is transferable debt. Moreover, it is capitalism’s ability to transfer debt, together with the capacity of private banks to create almost unlimited amounts of money that helped give rise to money’s enormous power.

Not all debt is money, though—only those debts that can be used to pay your tax bill. For example, if you borrow money from a friend and give that friend with a written IOU, that document is not money. If, however, you take out a home equity loan for $25,000, you can pay your taxes with that debt.

The Free Market Myth

Economists cling to the myth of barter in part because, if money did not evolve from it, their other big theory that markets do best with little involvement from government becomes suspect. Furthermore, without the myth of barter a powerful state is required to fuel the growth in capitalistic economies, as a strong state is needed to guarantee the bank-produced money and enforce the debt contracts.

Problems Today from Those Myths

The euro comes to mind. If money simply replaced barter and made transactions that would have happened through barter happen faster, thus creating a currency, the euro not backed by a country might make sense. If, however, money evolved from debt, and if it needed the support of a sovereign state to function, then what country would do that for the euro? And which state would back another country’s bank-created money?

Deregulation of Lending

Because they believe it just replaced barter, most economists think money is not that important. Thus, regulating its production makes little sense to them. Over the past thirty years, this theory gave the banks the space they needed to go on a massive money-producing binge through their loan-making processes. All that debt, though, now weighs on the world’s economies, leading to the low-interest rates and low-growth rates.

If Bitcoin Is Not CurrencyThen What Is It?

Bitcoin is novelty. Its value comes from a misplaced view of where money comes from, together with its scarcity. (Bitcoin’s founder, Satoshi Nakamoto, limited the number of bitcoins to be mined.)

If demand for bitcoins remains high, and with a fixed supply, the bitcoin’s price could stay high. But if demand shrinks as investors move on to the next novelty, the bitcoin’s value could suffer a fate similar to that of many Internet stocks after the dot-com bubble.

Notes

[1]   McLeay, Michael, Amar Radia, and Ryland Thomas of the Bank’s Monetary Analysis Directorate. “Money Creation in the Modern Economy.” Bank of England Quarterly Bulletin, 2014, Q1. http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q101.pdf

[2]   Smith, Adam. “Of the Principle which Gives Occasion to the Division of Labour,” in An Inquiry into the Nature and Causes of the Wealth of Nations. London: W. Strahan and T. Cadell, 1776. http://geolib.com/smith.adam/won1-02.html

[3]   Humphrey, Caroline. “Barter and Economic Disintegration.” Man, New Series, Vol. 20, No. 1 (March 1985), pp. 48-72. http://www.jstor.org/stable/2802221?seq=1#page_scan_tab_contents

[4]   Graeber, David. “Primordial Debts,” in Debt: The First 5000 Years. Brooklyn and London: Melville House Publishing, 2014.

[5]   Innes, A. Mitchell. “What is Money?” The Banking Law Journal, May 1913. https://www.community-exchange.org/docs/what%20is%20money.htm

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