Gilder Says Bitcoin Is Not Gold, And Maybe Not Even Money

Posted: Aug 09, 2018 8:09 AM
Gilder Says Bitcoin Is Not Gold, And Maybe Not Even Money

George Gilder has changed his mind about Bitcoin. Maybe. He has argued in the past that Bitcoin would, over time, converge with gold in price dynamics and become more and more correlated with gold. That's understandable; bitcoin is designed to be a digital version of gold. It is even mined.

The problem is that sometime late last year it stopped acting like gold. Here's research showing that as of six months ago.

Since the time of that data, the gold/bitcoin lock has for the most part remained broken. If Bitcoin doesn't act like gold, then it isn't digital gold. Gilder's new book Life After Google explains his reasons for rejecting the Bitcoin=gold thesis on the way to explaining monetary dynamics in general. After all, we can't understand whether Bitcoin is money if we don't know what money is. Gold is money because it is limited in supply, and in supply growth, and also because it is in high demand. But why is it in high demand? One reason is that it has been used as money for several thousand years. It was legally money. Bitcoin is not legally money. It might become legal currency, but so far it has not. Interestingly, our analysis at Bowyer Research is that the price movements of Bitcoin are not related to shifts in supply. Supply increases do not correlate with price increases.

It mainly responds to government signals of shifts in policy…raids on exchanges, statements by regulators, etc. The legality (or lack thereof) of Bitcoin is relevant to demand, not supply. Supply occurs in the bowels of the network as math puzzles get solved. Demand is about being able to use it in transactions.

Then there's the long-term problem: Bitcoin does not have the same supply dynamics as gold. When gold prices go up rapidly, gold mining operations can respond accordingly, whereas Bitcoin has de facto (and eventually de jure) ceilings on supply increases. This makes Bitcoin deflationary relative to gold. This is a problem because it is a form of volatility, which you don't want in your money. The deflationary tendencies of Bitcoin bring a second problem: if Bitcoin is not legal currency, then price increases are taxable. A bitcoin the supply of which does not increase as quickly as gold is a Bitcoin the prices of which rise faster than gold. Rises in nominal prices are taxed as capital gains.

Of course, criminal transactions are generally not reported to the Tax Man, which means that Bitcoin might have disproportionate utility when it comes to illegal activities. But I'm not just talking about the bad guys: sometimes illegal activity is persecuted refugees fleeing across the border with gold sewn into their threadbare jackets. As Gilder pointed out in a recent interview with me, Bitcoin has tended to spike in response to government collapse or overreach. It's an effective way to keep assets out of the view of governments. Crooks want to do that, but so do victims of oppression.

The problems with Bitcoin as money are that it is inherently deflationary. Gold supplies are highly adaptive in response to changes in demand. When demand for gold-backed money goes up, the price rises and gold starts flowing out of the ground as miners ramp up production. If gold prices go up a lot, then gold mining can go up proportionately.  But Bitcoin algorithms put various caps on growth, which will eventually end with a hard cap at 21 million units. At that point it will be more like Picassos or acres of land than like gold - they ain't making anymore. 

The other problem is that Bitcoin confuses the unit of value (like gold) with the medium of payment (like bank accounts).   Gold is a unit of value, a gold-backed dollar is a claim on gold. Bank balances are claims on dollars. You can have more dollars than you have gold, in fact even under gold standard regimes, there are almost always more units of the currency than there are equivalent units of gold. And in a system which allows fractional reserve banking, meaning banks are not required to keep all the money in the vaults which are deposited in their accounts, the deposits are larger than the money supply. Bitcoin tries to be both the gold and the bank deposit at the same time. This also makes it more deflationary. As demand for Bitcoin rises, the price rises and supply from mining can’t rise fast enough to bring it back down. And as Bitcoin is used more, that means demand is higher, but the supply can't rise  by use of fractional reserve banking, which is probably an even greater long-term deflationary force. And finally, as I pointed out before, eventually it becomes a fixed-forever quantity good - think Monet instead of Money - soaring in value. Bitcoin is strong on security, but weak on currency characteristics, which means that at best it's going to tend to be money only in situations which are big on cash-only, high security and anonymity, and which aren't too picky about paying taxes.