NEW YORK (InsideBitcoins) — Previously, we covered the first nine points made by former Federal Reserve Bank Examiner Mark T. Williams in his recent presentation at the World Bank Conference, Virtual Currencies – Bitcoin Risk. Point ten was much longer and discussed the idea of bitcoin removing power from central banks, so it rightly deserved its own full article.
The final point made by Williams in his presentation discussed bitcoin’s sovereign attack risk. In his first bullet point, Williams noted:
“If adopted in its current raw form, bitcoin has the potential to undermine the longstanding bond between sovereign and its currency.”
This could be the most ironic statement found in the entire presentation because the other points were all used to explain why the risks involved with bitcoin will eventually lead to its downfall. In this final point, it seems that Williams is open to the idea of bitcoin becoming so prevalent throughout society that central banks will lose the power to control monetary policy.
Central banks and economic stability
The second bullet point in this section talks about how governments and central banks are needed to provide economic stability for their citizens. Venezuelans and Argentines will have to hold back a mixture of laughter and anger as they read the following statement from Williams:
“Governments exercise a monopoly power on currency creation with the understanding that doing so will provide its citizens with a greater level of economic stability.”
Williams seems to be ignoring the fact that a government’s ability to stabilize the economy depends on a level of perfect execution from the central bank that is simply unattainable. Whether you’re talking about the United States or Zimbabwe, the idea that central bank regulators are economic monks that are immune from corruption and error is laughable. We’re only five years into the bitcoin experiment, and this new digital currency paradigm is already competing favorably with certain central banks around the world.
Who controls the bitcoin monetary base?
Williams also seems to be concerned with how bitcoin manages its own monetary base in a decentralized manner. He notes that controlling the monetary base is “an immense power and responsibility” that is put into the hands of “those who create the algorithm, protocol, manage the transactional ledger and mine virtual currencies.”
First off, it should be noted that the above system may be preferred over what’s currently going on in places like Argentina and Venezuela. Secondly, Williams is correct in stating that the miners have a large amount of authority when it comes to whether or not bitcoin’s monetary policy could be changed in the future. One could even imagine a scenario where the mining community agrees to create more bitcoins due to the fact that transaction fees have not risen to compensate for the drop in block rewards; however, the miners also need to keep the economic majority in mind.
It’s important to remember that, in a world of competing cryptocurrencies, the controllers of a currency’s monetary policy are competing with other currencies available on the market. A country experiencing hyperinflation may turn to bitcoin, gold, or US dollars, and a cryptocurrency that makes a highly-inflationary change to its monetary policy may find itself losing out to other cryptocurrencies with monetary policies that are more advantageous for its users.
Deflation is scary
In another bullet point, Williams points out that bitcoin’s current monetary policy is inherently deflationary over the long term. This is a common point made by bitcoin critics, although they never seem to get into the details of why deflation is bad. There are many arguments to the contrary, including the deflationary period in the late 19th century. This was one of the largest periods of real growth in human history that also happened to coincide with a mostly deflationary monetary policy. As A.E. Musson noted in his “The Great Depression in Britain, 1873-1896: a Reappraisal”:
“Prices certainly fell, but almost every other index of economic activity – output of coal and pig iron, tonnage of ships built, consumption of raw wool and cotton, import and export figures, shipping entries and clearances, railway freight clearances, joint-stock company formations, trading profits, consumption per head of wheat, meat, tea, beer, and tobacco – all of these showed an upward trend.”
Although the conventional wisdom is that deflation is bad, it makes sense to also take a look at the counter arguments coming from alternative points of view. After all, there seems to be a general correlation between people who believe deflation is bad and people who were oblivious to the impending economic collapse in late 2008.
That’s not how Gresham’s law works.The last point made by Williams in this particular section is a complete misunderstanding of Gresham’s Law. He argues:
“If bitcoin were allowed to co-exist as ‘legal tender’ it could also create a situation where under Gresham’s Law ‘Bad money drives out good.’ In such a scenario, bad currency (bitcoin) would be used and good currency (US dollar) would be hoarded, creating greater economic instability.”
Anyone who is involved in the bitcoin community understands that this is the exact opposite of how things work right now. If you’re someone who has adopted bitcoin, you’re mostly using it as a store of value (part of your savings). Remarkably, Williams seems to be aware of this fact, as he states, “Over 90 percent of bitcoin are also hoarded setting a temporary price floor.”
This point is actually also at odds with the previous argument made by Williams in regards to deflation. He seems to be claiming that bitcoin will be “dangerously deflationary” (increase in value over time), while at the same time claiming that people will choose to store the inflationary US dollar for long term savings.
This kind of logical inconsistency is a perfect example of why Williams should not be taken seriously as a bitcoin critic.