Towards a more honest monetary system

Nasir Iqbal
Jul 10, 2017 · 8 min read

Monetary system is important as it forms the basis of how we exchange and save. The fiat nature of the current system has enabled parasitic rent-seeking by financial services industry, out right theft by central bank through so-called quantitative easing, and facilitates imposition of information flow, trade, and exchange barriers by governments which also frequently indulge in robbery through taxation of citizen-hostages and demonetisation.

While cryptocurrencies are seen as a solution, block-chain’s decentralized public ledger is indeed a revolutionary technology, it is not (a) as anonymous as we think it is, and (b) it does not fulfil the ‘store of value’ function of money either.

Background

Wealth, Money and Currency: Wealth is a valuable asset which either holds value in itself or generates an income; Money is a transportable form of wealth –it has value in itself and does not need a counterparty; and, Currency is a transferable transaction medium which serves as a unit of transaction and frequently poses a counterparty risk.

The features of money are:

a) Store of value

Money can be seen as ‘frozen labour’ or ‘collective memory of a society’ and consists of both ‘commodity money’ and ‘debt money’ allowing someone to either store their labour in a commodity having inherent value or receive similar goods or services.

b) Unit of account

In order to measure anything the unit of measure must itself be unchanging and unvarying. This is the reason International System of Units measures time, length and mass to such exacting standards. Imagine the confusion that would arise if weight of a kilogram depended on the harvest for the year, yet exactly this is happening in the realm of money. Also we experience no shortage of ‘kilograms’ preventing us from weighing a commodity while there are constant complaints about there being ‘not enough gold’.

c) Medium of exchange

A currency must be convenient, compact, consistent and an easily verifiable standard to prevent ‘double spend’ or similar frauds.

Commodity money and debt money are amongst many concepts discussed at length by David Graeber in his excellent book Debt: The First 5,000 Years

Information Theory of Money

George Gilder, in his fabulous book Knowledge and Power, describes Claude Shannon’s insight being the distinction between order and information. Information and order are not the same, in fact they are opposites. Information is the ‘unexpected’ or unknown and new element in a message. Information is thus best equated with dis-equilibrium and disorder, not regularity and order. An orderly and predictable mechanism embodies no new information. It is the out-of-ordinary or out-of-pattern transmission that is regarded as carrying information. The information density or ‘information carrying capacity’ of a medium is determined by the uniformity of the carrier or background which then enables information carried on it and then retrieved with a low loss. For example, a blank white paper can carry a lot of easily readable writing whereas trying to scribble a message on a newspaper makes it difficult to separate the background from the message. Similarly in radio transmissions a ‘carrier’ wave with a known modulation pattern is used to embed voice transmission which a radio receiver is then able to separate from the signal at the other end.

Economy is a knowledge system which would be surprising to most economists and central bankers who still like to regard it as a mechanistic ordered system which reverts to equilibrium. No wonder they always get it wrong. We have a complex, interconnected economy almost along Darwinian lines where millions of entrepreneurs ‘tinker’ and experiment but its being run as a large, inflexible centralised system by folks with nothing personal at stake or as Nassim Nicholas Taleb beautifully puts it ‘Intellectual Yet Idiot’ with no ‘skin in the game’.

An information-rich signal requires a stable and predictable carrier, or a highly entrepreneurial, high growth, high value economic needs minimal but stable governmental policies as required by the information theory of economy.

Points to ponder

Bitcoin is based on a system of global public ledgers confirming the transactions by embedding them in block-chain. Computing resources to confirm the block-chain and thereby confirm and embed transactions are provided by ‘miners’ which are rewarded new coins for doing so. Both Gold and Bitcoin require a steadily increasing amount of effort to “mine” them which, in the case of bitcoin, has been designed to off-set the increased computational power due to Moore’s law.

Paper currency (cryptocurrencies such as Bitcoin included) and other fiat forms of money are units of exchange but are not necessarily a store of value. Cryptocurrencies such as Bitcoin bootstrap a pretence of ‘value’ by expending significant resources (computing cycles and electricity) on self-created algorithmic hurdles mimicking work.

Store of value can only be embedded in the reality you live in. Cryptocurrencies are indeed the gold-equivalent of the virtual world and they will become more and more relevant and their ‘value’ harden when we increase our virtual foot print and digital assets form an increasing proportion of our lives.

The problem is not that cryptocurrencies can be hacked or more coins created but that a parallel cryptocurrency can be created.

Governments have always sought to give the prevailing fiat currency a semblance of value through legal tender laws and a minimal value through requiring taxes to be paid in them. Can ‘ransomware’ or being given legal tender status provide such a value base for a cryptocurrency?

Purpose of block-chain is to track every single cryptocurrency transaction and ownership to prevent double spend. To do so entire transaction history of a cryptocurrency over its lifetime is embedded in block-chain. Such embedded information could provide opportunity to ambitious government agencies and courts to call legality of a past transaction into question and forfeit money. Cryptocurrencies remains anonymous only as long as they do not touch the non-virtual economy, buying or selling cryptocurrencies (at least in cooperating jurisdictions) or having goods or services delivered or linked to a real-world address or person creates the weakness where information can be collated and this led to the downfall of Silk Road.

The store of value function is intrinsic to commodity money although factors such as susceptibility to loss (decay, death, disease, and rust for, grains, cattle or ferrous metals) and sudden changes in stocks available (bumper harvest, discovery of a new mine etc., or robbing Inca of their gold) have to be considered.

Currency provides single information variable -Value, to be efficiently employed, disregarding legality of actions of past holders of the currency as to whether it was legitimately earned, were taxes and tithes paid etc. Such questions of morality (social or legal) add friction, for transaction purposes currency has to have only one variable.

Money supply multiplied by velocity assumes that this number has to be equal to value of all goods and services in the economy over a period of time (GDP). This optimal number is targeted by central bankers when they suggest lower velocity as the reason for increasing supply of money to be keep the economy ‘sufficiently funded’ for flow or GDP purposes. Any changes in money supply mean the value of stock is also impacted. The point that velocity is not a pure monetary metric, it is also dependent on government regulations which only seem to ratchet up, seems to be lost on them. Central banker have a monetary hammer and all problems are nails.

With commodity money backed cryptocurrency, gold in this example, thus becomes equivalent of M0 money but with a vastly greater level of honesty compared to fiat currencies. It is expected that multiple competing exchanges will exist and market will weed out any bad actors and jurisdictions. This will provide a bedrock of liquid fully-backed cryptocurrency acting as M0 money for the financial system to anchor itself.

United States has $3.7 trillion in M0 money and gold reserves of 8,133 tons (237 million troy ounces) which translates into nearly $300 billion at $1250 per ounce, and can replace 8% of M0 at this gold price level and without taking into account privately held gold which is expected to form almost all of the gold contributed into GWH. Globally over 170,000 tons (5 billion troy ounces) of gold exists over-ground valued at current prices at $6.2 trillion at 1250/ounce, if global M0 is assumed at the same proportion of economy as it is in United States then over-ground gold reserves can replace over 40% of global M0 money at current prices.

Enabling cryptocurrencies based contracts which derive their value entirely from the underlying asset means existing exchanges and registries could be by-passed for the $350 trillion global equity, bond and real estate markets.

Central banks, such as Bank of England for example theorize creation of money away from the traditional ‘money multiplier model’ (Money creation in the modern economy, Bank of England Quarterly Bulletin Q1, 2014 ) which imply causality to be:

a) The central bank sets the reserve ratio, creates base money and injects it into the economy.

b) Banks lend out most of the money deposited with them and keep a fraction ‘in reserve’.

c) The loans are spent and the money circulates, before it is re-deposited into another bank. The bank uses this new (smaller) deposit to make a further (smaller) loan, again keeping a fraction of the deposit ‘in reserve’.

d) The process continues until the amounts being re-lent are miniscule. The money supply is now a multiple of the base money (with the multiple being determined by the reserve ratio).

Towards a bank-centric model of causality where a commercial bank creates a new bank deposit when it advances a loan, i.e. when the loan amount is used to make a payment it goes to another bank and sits there as a deposit.

This is explained away as banks increasing both sides of the balance sheet and thus not actually needing money to make a loan. Except for that it does, loans resulting in deposits is correct except that the deposit may be in a different bank and thus its true only for the banking sector in aggregate and there too, the central bank reserve requirement which puts a limit to this multiplier.

The difference between Money Multiplier effect and the modern explanation is that of looking at a repeating pattern such as ABCABCABCABCABCABC and reading it as BCABCABCABCABCABCA, its almost the same, in fact exactly the same if you start somewhere in the middle and thus its not a full and complete explanation.

This flawed premise leads to the entire monetary system measurement and control mechanisms to be misunderstood resulting in structural rifts being experienced by the economy.

Implementation

I hope some of these thoughts contribute towards folks working to further develop solutions to our monetary mess whereby a system consisting of a commodity-money such as gold can be the ‘store of value’ anchor and provide a ‘unit of measure and account’ while cryptocurrencies linked to commodity-money can provide a fast and efficient ‘unit of exchange’.

Such a system can be extended out to anchor any asset class into a cryptocurrency using standard embedded contracts forming a global exchanges which are deep and liquid.

Such cryptocurrencies would not be bootstapping their value by burning electricity for computing cycles to solve a self-created algorithmic scarcity.

It would instead establish a unit of measure and store of value in an easy to exchange cryptocurrency held in a wallet.

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