Paul Krugman, Adam Smith & Bitcoin Mining

Paul Krugman, Adam Smith & Bitcoin Mining

The understood return potential for Bitcoin is well-known, as at year’s onset a Bitcoin was worth $13.51. On April 10, it traded as high as $266. And on Thursday, it fell to less than $100 mostly due to issues at Mt. Gox. For good measure, that is similar to if the exchange rate for the British pound soared from $1.62 (where it was on Jan 1.) to $31.90 and the falling back to $12.

Paul Krugman took his swing at Bitcoin on Friday.  He cites an article, first of all, in which the author states two reasons Bitcoin cannot be money:

First, because it has the endorsement of no government, it will never be usable for official transactions. If you are an American, you will eventually have to pay your taxes, which means getting hold of some dollars, and as long as everyone needs to use dollars, that will be the way the currency in which an overwhelming majority of U.S. transactions occur.

A central premise for this statement is the eternal and ubiquitous nature of government. In fact, there is no law of social relationships or economics wherein it is stated that a government must exist. And also,

Second, the cap on the supply of bitcoins may reassure people that there will be no inflation, but in fact it ensures that it can never go into widespread use. A currency needs to be elastic — that is, its supply has to rise and fall in order to keep prices stable even as people’s demand for money varies. Part of the reason the Federal Reserve was created a century ago is that the dollar was at that time an inelastic currency, its supply was basically fixed based on how much gold banks had in their vaults. That meant that when harvest season came around in what was then a heavily agricultural nation, there was always a shortage of cash and a spike in interest rates, and in some years a banking panic.

Due diligence can be a pain, but often spares the outspoken of mis-stepping in their reasoning. In this one by Neil Irwin, he clearly understands that only a certain amount of Bitcoin will ever exist. But, what this individual does not get, is that Bitcoin can be divided to the eighth decimal place, creating so much elasticity that, in today’s dollar terms, the market could grow to theoretically 21 quadrillion.

Krugman fails to use his imagination, and thus viewing Bitcoin as literally being gold. He cannot make the extrapolation that there is a theory on which Bitcoin is based to which the gold mining process can lend insight. But the insight must go much deeper than merely Internet workers digging holes into the dirt of the web to pull out certain specs from the digital abyss, with the same variables input as with real-world mining. Krugman writes:

One thing I haven’t seen emphasized, however, is the extent to which the whole concept of having to “mine” Bitcoins by expending real resources amounts to a drastic retrogression — a retrogression that Adam Smith would have scorned.

But, the real resources expended in mining Bitcoin do not equal the real resources expended in mining gold. Plus, the vector of real resources eventually expended to create money based on fiat ends up draining the economy much more. Krugman:

Smith actually wrote eloquently about the fundamental foolishness of relying on gold and silver currency, which — as he pointed out — serve only a symbolic function, yet absorbed real resources in their production, and why it would be smart to replace them with paper currency:

The gold and silver money which circulates in any country, and by means of which, the produce of its land and labour is annually circulated and distributed to the proper consumers, is, in the same manner as the ready money of the dealer, all dead stock. It is a very valuable part of the capital of the country, which produces nothing to the country. The judicious operations of banking, by substituting paper in the room of a great part of this gold and silver, enable the country to convert a great part of this dead stock into active and productive stock; into stock which produces something to the country. The gold and silver money which circulates in any country may very properly be compared to a highway, which, while it circulates and carries to market all the grass and corn of the country, produces itself not a single pile of either. The judicious operations of banking, by providing, if I may be allowed so violent a metaphor, a sort of waggon-way through the air, enable the country to convert, as it were, a great part of its highways into good pastures, and corn fields, and thereby to increase, very considerably, the annual produce of its land and labour.

And now here we are in a world of high information technology — and people think it’s smart, nay cutting-edge, to create a sort of virtual currency whose creation requires wasting real resources in a way Adam Smith considered foolish and outmoded in 1776.

Resources expended mining Bitcoin are nowhere near the amount of real resources expended in eighteenth century gold and silver mining technology

Krugman lacks an understanding about the nature of the Internet. He fails to note that never before has information technology and its infrastructure been used for such purposes, and it is by far an exact mathematical equivalent to the mining process. It is not the gold mining industry. This is as clear as day. He takes the simile too far.