With the release of Trichet’s August 2011 letter to Spain, worth noting that his November 2010 letter to Brian Lenihan remains a secret.
The various statements from Michael Noonan and ECB board member Jörg Asmussen raise some very serious questions for Mario Draghi about the OMT programme. Post here.
I received a number of thoughtful comments on yesterday’s article on Bitcoin and wanted to follow up on a couple of important points that they raised and provide some new information.
Some of the pro-Bitcoin enthusiasts were keen to emphasize the difference between Bitcoin and previous potential sources of private money. It’s digital, so doesn’t have physical production or storage issues and it’s hard to melt down a Bitcoin and pass it off as two Bitcoins, thus perhaps ruling out the role governments played in verifying and securing money in the past.
However, commenters were also keen to emphasize that Bitcoin is special because it can only be created according to a special algorithm that ultimately limits the total number of Bitcoins to 21 million and guarantees that payments are anonymous and irreversible.
The fact that Bitcoin advocates rely so heavily on the niftiness of its underlying algorithms and protocol is one of the best reasons to predict its demise. If all you have going for you is a cool algorithm, then at some point there will be someone else out there with an even cooler algorithm. And then someone else.
Indeed, there is evidence that this process is already underway. If you don’t want to use Bitcoin, you can always try Litecoin. It promises to be
a peer-to-peer Internet currency that enables instant payments to anyone in the world. It is based on the Bitcoin protocol but differs from Bitcoin in that it can be efficiently mined with consumer-grade hardware. Litecoin provides faster transaction confirmations (2.5 minutes on average) and uses a memory-hard, scrypt-based mining proof-of-work algorithm to target the regular computers and GPUs most people already have. The Litecoin network is scheduled to produce 84 million currency units.
And if you’re in it for the speculation, Litecoin is showing some nice bubbly movements as well.
Or maybe you could go with Primecoin, an
experimental cryptocurrency that introduces the first scientific computing proof-of-work to cryptocurrency technology. Primecoin’s proof-of-work is an innovative design based on searching for prime number chains, providing potential scientific value in addition to minting and security for the network.
Supporting private money and adding scientific value, what’s not to like?
Peercoin’s major difference from Bitcoin is that it uses a proof-of-stake/proof-of-work hybrid system for coin generation. With this system, coins are generated based on proof-of-stake blocks in addition to proof-of-work blocks. In other words, someone holding 1% of the currency will generate 1% of all proof-of-stake coin blocks.
Proof-of-stake block generation could reduce the risk of 51% attacks ….
This little tour of crypto-currencies (and there’s plenty more) should be enough to convince you that one of these outfits will probably produce a currency that is widely seen as superior to Bitcoin along most dimensions, perhaps attracting lots of supporters on websites and Russian-government-sponsored TV shows.
What happens then to your Bitcoins then? Even Bitcoin’s own FAQ is clear about the uncertainties surrounding its future. A brief excerpt:
Can bitcoins become worthless?
Yes. History is littered with currencies that failed and are no longer used, such as the German Mark during the Weimar Republic and, more recently, the Zimbabwean dollar. Although previous currency failures were typically due to hyperinflation of a kind that Bitcoin makes impossible, there is always potential for technical failures, competing currencies, political issues and so on.
So even if private crypto-currencies are the future, that doesn’t mean that Bitcoins will feature in that future. It’s a bit like investing all your money in IBM in the 1970s because you’re sure computers are the next big thing even though you haven’t yet heard of Microsoft or Apple. Or taking a punt on Pets.com in 1999 because the Internet is the future and sure people will still have pets in the future.
The difference in this case is that private currencies are probably not the future. The very fact that no single private currency can be relied on to have the necessary unique features to become a useful source of value is likely to undermine the whole idea. Like it or not, the US federal government is going to be with us for the foreseeable future, printing dollars, requiring tax payments in those same dollars and enforcing the requirement that creditors must accept dollars as legal tender. Dollars are not going to be dislodged by Bitcoin, Primecoin, Karlcoin or whatever.
Of course, commenters did note another advantage of Bitcoins. They may possibly help to facilitate illegal activities and tax evasion. If that’s why you’re buying Bitcoins, all I can say is good luck with that. Uncle Sam is watching you.
As Bitcoin goes through another day of crazy price fluctuations and huge publicity, this time courtesy of the U.S. Senate, I recommend two readings for those interested in putting the Bitcoin phenomenon in historical context.
The first is this article by my colleague Stephen Kinsella. Stephen’s key point:
Bitcoin has no use value, only exchange value, and because it is has no worth in use other than what others are willing to pay for it, it is always in a bubble: these happen when prices of assets get dislodged from their fundamental value. So Bitcoin is the perfect bubble.
Now the obvious question that this raises is the following: Is Bitcoin so different from the dollar? A dollar bill also has no use other than what people are willing to pay for it. And if people decide they wish to trust the people who create Bitcoins more than their own government, then perhaps it could be an alternative medium of exchange.
Stephen partially gets at the answer as to why Bitcoin differs from the dollar. It is “a currency not backed by any state – meaning nobody has to take it as payment.” The fact that the U.S. government requires payment in dollars in itself creates a direct demand for dollars that cannot be replicated by Bitcoin.
History shows, however, that the state’s involvement in money goes deeper than merely requiring tax payments in its chosen currency and this history is useful for understanding the likely limits to “private monies” like Bitcoin.
My favorite article on this topic is Two Concepts of Money written in 1998 by legendary British economist Charles Goodhart. I strongly recommend that people interested in Bitcoin read it.
Goodhart argues that states have essentially always been in control of monetary systems. He emphasizes that governments have always viewed seigniorage as a useful form of revenue and are unlikely to allow this source of revenue to be replaced by a private source of money.
Right now, Bitcoins are effectively irrelevant when compared with the larger payments system, but those who anticipate it expanding to be widely used might ask how sure they are that private monies of this type would actually remain private. Once big enough to be termed a success, any such currency would attract more attention from governments than a cursory Senate hearing.
Goodhart also shows the theory that private money can emerge as a solution to the inefficiencies of barter has little historical backing. For example, while people often believe that precious metals were adopted over time by the private sector as a useful medium of exchange, in practice people could not be sure whether the metallic content of coins were equal to stated amounts.
Only when governments standardized and verified such coins – and provided security for mints – were coins widely used as a medium of exchange. Goodhart notes that much of the Roman empire went from a monetary economy back to barter after the empire’s decline. Bitcoin enthusiasts may believe that problems with security and verification are less likely to affect a digital currency. Time will tell us the extent to which that is true.
Advocates of Bitcoin enthuse about its commitment to limiting its supply of virtual coins. Goodhart’s paper discusses whether such commitments from private providers of money can actually be credible. He concludes such commitments probably run against the interest of those who control these currencies and so they should not be trusted. Blind trust in the people behind Bitcoin may turn out to be no more sensible than blind trust in the U.S. government, and quite possibly less so.
There’s no doubt that Bitcoin is an interesting invention, useful at a minimum for provoking good classroom discussions in Money and Banking courses about what exactly is the meaning of money. But people should be wary of investing large amounts of their savings in Bitcoins. History provides plenty of reasons to suspect that private money is unlikely to work. Maybe this time is different. Usually it’s not.
After years of turmoil, Europe seems to finally have a good news story. Ireland will be the first of country to exit a “troika” program and yesterday its government announced that it would not even be seeking a “precautionary” credit line from Europe’s bailout fund, the ESM. But is this quite the good news story that most people think it is? I’m not so sure. Indeed, I suspect yesterday’s announcement illustrates how political problems may undermine Mario Draghi’s plans to save the euro.
There is certainly some good economic news coming from Ireland. Targets laid down in the program for the budget deficit were met and while economic growth has been minimal and unemployment is high, employment is now growing again and a large stock of over €20 billion of cash has been built up via borrowings from financial markets and the troika. By the very low bar set by the recent economic performance of the euro area, Ireland is something of a success.
For these reasons, yesterday’s announcement that Ireland would not need a new bailout was not news. This has been known for some time. The news element here was the announcement that there would be no precautionary credit line. But is that actually good news?
Irish government politicians have been keen to claim that there is some good economic news in this announcement, that it “provides clarity” and “reduces uncertainty”. In fact, the opposite is the case.
A precautionary credit line is something that doesn’t have to be used. Anything that can be done without a precautionary credit line can also be done with one. However, without such a credit line, the Irish government run the risk of running out of funds and having to negotiate a new bailout or credit line under far less positive circumstances than currently prevail. This adds to the uncertainties facing Ireland in the coming year, particularly given the possibility that Irish banks may need further recapitalisation next year.
Ireland’s finance minister, Michael Noonan, acknowledged yesterday that economic conditions may not be so benign next year. This should be seen as an argument for negotiating a credit line now but, strangely, Noonan used this observation as an argument for not seeking a credit line. He seemed to be struggling to find anything better than weak talking points to explain the benefits of not having a credit line.
There is, of course, a narrow political benefit to the Irish government from this “clean” exit, because it allows them to triumph about the full restoration of “sovereignty.” However, I don’t think they are so cynical as to have made this decision purely for that populist reason. Instead, my assessment is that the precautionary credit line could not be arranged now because it was politically impossible and that the Irish government are merely putting a brave face on what is a bad outcome.
The political problem is that credit lines from ESM require the approval of all euro area member states and this was not going to be possible now. Germany still does not have a government as Angela Merkel’s CDU continue negotiations with the SPD to form a coalition. During these negotiations, the SPD has regularly insisted that they would not support an ESM credit line for Ireland unless the country followed a series of highly specific policy recommendations.
SPD requirements for approval of a credit line included raising the corporate tax rate and introducing a financial transaction tax. The SPD also ruled out any deal that involved used funds from the credit line to recapitalize banks.
This kind of micro-managing of other people’s economies was not what most people had expected ESM conditionality to look like. Given the existing raft of EU monitoring programs that exist (the six pack, the two pack, the macroeconomic imbalances) a sensible approach would be to require that a country seeking a credit line from ESM commit itself to meeting the recommendations on macroeconomic policy of the European Commission.
When Germany finally has a government and SPD politicians are firmly ensconced in ministerial Mercs, I suspect the desire to micro-manage Ireland’s affairs will recede. However, the damage may well be done. Having sold the Irish public on the idea that the credit line was something to be avoided, it seems unlikely that the government can change its mind next Spring.
This is the odd aspect of yesterday’s decision. Why not announce that Ireland was exiting the program without a precautionary credit line but that discussions about this issue were ongoing? One unattractive possibility is that Ireland’s leaders were asked by their German colleagues to make this announcement to remove it as an issue in the government formation negotiations.
Missed in yesterday’s discussion is that these developments have implications for the ECB’s Outright Monetary Transactions (OMT) program. This is the program announced by Mario Draghi after his “whatever it takes” speech last year. Under this program, the ECB can purchase unlimited quantities of a country’s government bonds. However, the ECB decided that countries could only avail of OMT if they had an agreement with ESM for a bailout program or precautionary credit line.
Ask yourself this: If star pupil Ireland couldn’t negotiate a precautionary credit line based on reasonable conditionality, what chance is there that a credit line of this sort for Italy will be approved by all countries in the euro area? OMT may have been cast as the plan to save the euro but getting it up and running may not be so easy.