Archive for June, 2013

Bitcoins and Monetary Reform in the Digital Age

June 9, 2013

Recently, there has been a rising wave of interest in a new Internet-based currency called bitcoins. In one sense, bitcoins are the latest attempt to improve capitalism through monetary reform. But unlike other monetary reform schemes, bitcoins are very 21st century, based as they are on modern computer technology and the Internet.

According to Wikipedia: “Bitcoin (BTC) is a cryptocurrency first described in a 2008 paper by pseudonymous developer Satoshi Nakamoto, who called it a peer-to-peer, electronic cash system. Bitcoin creation and transfer is based on an open source cryptographic protocol and is not managed by any central authority. Each bitcoin is subdivided down to eight decimal places, forming 100 million smaller units called satoshis. Bitcoins can be transferred through a computer or smartphone without an intermediate financial institution.”

A short history of monetary reform before the Internet

One monetary reform that was popular among small farmers and small businesspeople in the late 19th-century U.S. was bimetallism. The bimetallists proposed that the U.S. dollar be defined in terms not only of gold but also of silver, at a fixed ratio of 16 to 1. Under this proposed reform, the silver dollar coin would weigh 16 times as much as the gold dollar coin.

The supporters of bimetallism argued that this would, by sharply increasing the money supply, increase demand and thereby raise the prices of agricultural commodities. The increased demand would, the supporters of bimetallism argued, put unemployed workers back to work. In this way, the bimetallists hoped to unite the interests of workers, small farmers and small businesspeople against the rising power of the Wall Street banks.

A basic flaw in this proposal was that while at one time the ratio of 16 to 1 more or less reflected the actual relative labor values of gold and silver bullion, by the late 19th century the value of silver was falling sharply relative to the value of gold. Given a choice of using either silver or gold coins at this ratio, people would have chosen to pay off their debts in cheap silver—which is why bimetallism was so popular among highly indebted small farmers and businesspeople—while using the cheap silver dollars to purchase and hoard the more valuable gold dollars. This effect is known as “Gresham’s Law,” named after the early British economist Sir Thomas Gresham (1519-1579).

Under Gresham’s Law, cheap silver dollars would have driven gold dollars out of circulation, leaving the silver dollar as the standard dollar. This would have had the effect of devaluing the U.S. dollar from the value of the gold dollar down to the value of the silver dollar. Fearing that supporters of bimetallism would win the upper hand in the U.S. government during the 1890s, foreign capitalist investors began to cash in their U.S. dollars for gold leading to a series of runs on the U.S. Treasury’s gold reserve as well as the gold reserves of U.S. commercial banks.

A wave of bank runs and an associated stock market crash that occurred in the northern hemisphere spring of 1893 has gone down in history as the “panic of 1893.” This panic was followed by a prolonged period of depression, mass unemployment and plunging commodity prices. This was the exact opposite of what supporters of bimetallism desired.

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