Wednesday, 10 April 2013

The economic fundamental of money substitutes

Since Patrik Korda still criticises my approach to money substitutes, I thought I'd summarise here their fundamentals. This is not a definition of a money substitute, nor an exhaustive listing of all possible types of substitutes. Rather, it is to explain their essence in a way that is easily understandable and clarify why Bitcoin has nothing to do with them.

The fundamental of a money substitute is a causal link between money in the narrower sense and the substitute. This causal link is the main, necessary, factor explaining the price of the substitute. For argument's sake, I'll leave it open whether other, optional, factors exist. This is the essence of the point Mises was making, he was trying to explain the price of money substitutes. And he found the explanation in the causal link to the money in the narrower sense.

For Bitcoin, there is no such underlying causal link to a money in the narrower sense that explains the price of Bitcoin. The price of Bitcoin is determined by other factors.

Therefore Bitcoin is not a money substitute (or it wouldn't be if Bitcoin was money).

8 comments:

  1. Something is a money substitute if it can be redeemed at par on command for the money proper, and it is thus treated as if it were money proper.

    I know there are some physical bitcoins that are made and printed with information on them. I wonder if those might count as money substitutes (where Bitcoin would simply be money proper)?

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    1. The definition you provide is more narrower than mine, and while it's closer to that of Mises, I don't think it's accurate. I intentionally used as broad an explanation as possible, to explain the essence and avoid getting trapped in the unuances.

      The casascius coins are not substitutes because they are not redeemed. They are the real Bitcoins, just in a form of a plastic hologram rather than files on a disk. Of course, redeemable coins are also possible to make, and those would be Bitcoin-substitutes. Check out my thesis, Chapter 2.

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  2. I personally think the soundness of cover is only of subordinate importance as far as fiduciary media are concerned. It may disappear entirely, at least in a certain sense, without prejudicing their capacity for circulation.

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    1. Patrik,

      you're again diverting the attention to "soundness" and neglect the actual argument. Complementary currencies, for example, are not claims at all, i.e. there are no reserves. It is impossible to redeem them, and typically they do not trade against the underlying money in the narrower sense on the exchanges. For example WIR Bank. But they are derived from the underlying money in the narrower sense, and that is the main determinant of their price.

      If the price decouples, i.e. if the causal link weakens to the extent that other factors influencing the price become dominant, then the medium of exchange in question ceases to be a money substitute. For example, instead of being a fiduciary medium, it can become credit money (i.e. a new monetary base). Whether that's due to soundness or any other reason is not the point, that's just one possibility. The point is that none of these mechanisms have anything to do with Bitcoin.

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  3. Peter, First let me thank you for the insightful and thought-provoking comment you left on my site. I am a bit relieved because the barriers to entry into the Digital currency space are not as low as I originally thought. They are high enough to satisfy me.

    But there is another question I believe you have not addressed. That of state interference. Should BitCoin start gaining any sort of Widespread acceptance, I believe the state(s) will step in to try to stop that. To what extent would the state(s) be successful is the next question we must answer.

    Finally, you need to make it easier for people to follow your blog. I would like to follow the comment section of certain posts in your blog via email notifications. But at the moment I cannot do that. If you could look in to that, it would be great. Thanks

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    1. I added a "follow by email" option, you should be able to subscribe, just scroll to the bottom of the page (RSS feed already were available before). I'll read your posts and reply later.

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  4. As I mentioned before, I have a post regarding my concerns about State opposition to BitCoin. My post is at

    http://masculineffort.wordpress.com/2013/04/13/bitcoin-state-interference/

    Would love your comments on the same

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