The Daily Item, Sunbury, PA


April 14, 2013

Bitcoin and the grand illusion of money



The common thread here is that money has almost nothing to do with physical form. It also doesn't have much to do with who creates it: The dollar bills were issued by the Federal Reserve, the checking account created by my neighborhood bank, the money market fund was created by a mutual fund manager, the gold was mined out of the ground, and the refrigerator was made by General Electric.

Rather, what makes it money is what you can do with it. If you can buy goods and services with it, it is money; if you can't, it isn't. Money is memory, said Narayana Kocherlakota in an important 1996 paper (he is now president of the Minneapolis Fed). It is the way we as a society record how much capacity to buy stuff each of us possesses. In other words, the Onion was right. Money really is just a symbolic, mutually shared illusion.

That reality has important implications for all the monetary debates that captivate people today, from David Stockman's assailing 80 years of economic policy to fretting over whether the Bank of Japan will unleash some dangerous inflation genie with its new bout of activism to the question of whether the euro zone can hold together.

Once you accept that money truly is an idea rather than a thing, it becomes clearer that there is no single "right" way to run a monetary system. It is merely trying to figure out, through trial and error (and mankind has had plenty of error over history), what system works best.

Some societies, including this one until 1933, have strictly tied the value of their money to gold or other precious metals. That has some advantages, most notably that a government can't create more of it from thin air and thus allow inflation to take hold. But it has some significant downsides as well. For one, the government may not be able to create new gold from thin air, but miners can definitely get it out of the ground. And it is a strange state of affairs when the price level of an entire society is allowed to fluctuate based on advances in mining technology or the discovery or non-discovery of new reserves.

Text Only