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11 Dec

Will Bitcoins Survive?


NEW YORK (TheStreet) by Jason Bond – The critics of Bitcoin say it has no intrinsic value, that it’s a made-up, pretend and worthless currency, a fad like the Dutch Tulip mania of the 1630s was.

It’s a virtual “thing,” made up only of a series of letters and numbers. That’s it. At least tulips can be touched. Right?

But then again, today’s U.S. dollar can be argued as having no intrinsic value. After all, the dollar, like all other sovereign script, isn’t backed by a tangible asset. That’s why today’s monetary system is sometimes characterized as containing only “fiat” currency.

The days of silver certificates and gold standards are long gone. In 1971, the U.S. officially separated the dollar from the remaining precious metal — gold — of the original bi-metallic monetary standard prescribed in the Constitution.

Since then, the dollar bill has had no real intrinsic value tied to it; if the ink were to be wiped off the bill, all that’s left is a 6.14 inch x 2.61 inch piece of special-grade paper.

But what gives the US dollar some value is the implicit promise of the use of physical force, if necessary, to maintain the dollar’s role as a medium of exchange, both domestically and internationally.

The intrinsic value argument has much merit and has been used among precious metals advocates when discussing the dollar’s diminishing role as the world’s premier reserve currency. It’s fair that Bitcoin be discussed in a similar vein.

Intrinsic value is the most contentious issue surrounding the Bitcoin debate and has been used as a club to discredit Bitcoin’s potential as an alternative to the U.S. dollar.

Phil Krugman, a leading advocate of the Keynesian school of economics, said that you can have assets even though there’s nothing to back them. He told Business Insider‘s Joel Weisenthal that Bitcoin’s upward price may reflect the naivete of buyers who might have bought in to Bitcoin’s model because it “sounds impressive” to them.

Bitcoin advocates could rebut Krugman’s comment with, “Bitcoin ‘sounds impressive’ because we believe that it is impressive.”

But “it [Bitcoin] doesn’t pay interest,” Krugman continued.

A reasonable rebuttal could be: “The interest paid on dollar-denominated deposits aren’t nearly adequate to offset the risks of further dollar debasement, confiscation (bail-ins) and/or capital controls.”

According to Dartmouth-trained economist John Williams, the Federal Reserve has understated annualized consumer price inflation by as much as 3.50% to 4% so far during calendar year 2013. Williams believes the demise of the purchasing power of the dollar runs at about 5.50% to 6% per year, compared with the Fed’s 2% reported rate of dollar debasement.

In other words, would a rational depositor accept a fraction of 1% of interest per year in return for CPI that eclipses that rate, as well as take on the risk of a Cyrus-style bail-in solution to a banking system teetering on insolvency as an added risk?

Bitcoin holders are betting that the answer will be “no” for more and more savers as they become aware of the problem and Bitcoin’s proposed solution.

“Fiat currencies are backed by men with guns. Bitcoin is not,” Krugman added to his critique of Bitcoins.

Krugman, however, wasn’t asked at whom would the guns be pointed.

Since there is no centralized issuer of Bitcoins, the threat of violence doesn’t come into play. There is no one body of decision-makers to threaten or coerce. Therefore, the argument that Bitcoin cannot survive because there is no standing army to enforce the currency’s legitimacy could be considered by some as a specious one.

Krugman also didn’t mention during the interview that because Bitcoin is still in its nascent stage (launched in 2009), the currency still lacks the market depth necessary to stabilize its value against other competing currencies that enjoy international sanction and a broad-based population of voters who determine value.

As Bitcoin is adopted by millions, tens of millions and eventually hundreds of millions, the volatility of price will most likely drop significantly. And there’s little doubt that Krugman would agree with that assertion.

Market acceptance begins with the initial segment of risk takers, and then the rest will follow. Bitcoin won’t be an exception to this market truism.

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