Monetary Systems like Bitcoin Inherently Increase Interest Rates & Reduce Investment & Innovation

Bitcoin was invented to allow the wealthy to avoid taxes and isolate monetary systems from gov’t control

Image by 3D Animation Production Company from Pixabay

By David Grace (Amazon PageDavid Grace Website)

What Is The Money Supply?

The total amount of money in an economy is called the Money Supply. It’s made up of physical money — coins and paper bills — and electronic money — records in financial institutions’ computers of how much each person has on deposit.

About 7% of the U.S. money supply is in bills and coins and about 93% of the U.S. money supply is composed of numbers in files on the hard disks of various financial institutions.

Competing Systems Of Money

There are two fundamentally different systems of money:

  • Restricted-quantity money (originally gold coins & now Bitcoin & Ethereum), and
  • Unrestricted-quantity money (paper money and electronic money)

Restricted-quantity money is money whose number of units is strongly limited and cannot easily be increased. There are a fixed or strongly limited number of monetary units (bitcoins or gold coins) in circulation at any one time.

Unrestricted-quantity money is money whose number of units is not strongly limited and can easily be increased. The number of monetary units (dollars, euros, etc.) in circulation can be substantially increased by the government or by private lending at any time.

Determining Which Is Better

We can’t figure out which monetary systems are good, bad, or ugly until we first determine the purpose of money and money’s function in an economy.

What Does Money Do?

Money does three things. It functions as

  • A tool to facilitate the purchase and sale of goods and services
  • A mechanism to hold wealth and,
  • A tool to create wealth.

Most of us understand money’s role in the purchase and sale of goods and services and how money works as storehouse for wealth.

But how is money a tool that creates wealth?

Borrowed Money Creates Wealth

Every time invested money or borrowed money is used to build a factory, design a useful product, or fund new technology, that borrowed money acts as a tool to create new wealth in the same way that a lathe operates as a tool to transform low-value pieces of raw metal into high value industrial parts.

Both money and a lathe are tools that transform things with a lower value into things with a higher value. They are both tools that create real wealth.

An Example Of How Borrowed, Unrestricted-Quantity Money Creates Wealth

Suppose you buy 100 acres of almost worthless desert land. You want to borrow $1M from the bank in order to develop this land.

By law, a bank can make loans equal to 90% of its deposits. John Smith has a savings account with $1,112,000 in it at your bank. Your bank writes you a check for a $1 million loan which is equal to 90% of Mr. Smith’s savings account.

At the end of the day Mr. Smith still has his $1.112 million savings account and you also have the $1M in loan proceeds, a total of $2.1 million. Your bank’s $1 million dollar loan has expanded the money supply by one-million dollars.

You use this newly created million dollars to pay contractors to drill into an underground aquifer and install pumps and irrigation pipes on your formerly worthless land. When you’re done your worthless 100 acres have become 100 acres of prime farm land worth $3 million.

Your $1 million dollar loan proceeds have functioned as a tool that created three million dollars in real value.

  • $1.1 million is still in Mr. Smith’s bank account
  • $3 million in farm land is owned by you
  • – $1 million debt you owe to the bank

If you sold your land for $3 million and then paid off the $1 million loan, you would have $2 million in the bank and Smith would have $1.1 million in the bank and the money supply would have increased by $2 million dollars.

The Treasury didn’t print this $2 million. Because the U.S. operates under an unrestricted-money-supply system this $2 million increase to the money supply was created by a private bank in the form of a loan which money you, a private citizen, used as a tool to create new wealth.

An Examination Of A Restricted-Quantity Money System

Originally, money was only a physical thing, a coin, whose quantity was limited by its scarcity. Governments acquired precious metals like gold and silver and turned them into coins whose quantity was limited by their scarcity and their acquisition cost.

When the King wanted to build a castle or fight a war he had to acquire gold or silver either by taking it from his subjects in the form of taxes or by acquiring more precious metal that he could then turn into coins.

Banks couldn’t just create more gold coins out of thin air the way your bank created your $1 million dollars by just handing you a check (unrestricted-quantity money).

Gold was hard to come by and that meant that, unlike today’s unrestricted-quantity money, there was a limit on the amount of money that could be in circulation at any one time, a limit on the money supply.

A money system that uses gold coins (or bitcoins) is a restricted-quantity money system because there is a practical limit on the number of coins that exist at any one time.

With Restricted-Quantity Money, Wealth Is A Zero-Sum Game

A limited-quantity money supply in the form of coins is almost entirely a zero-sum game. Short of the King drastically increasing the money supply by minting many more gold coins, the more coins one person has, the fewer gold coins that are available for others to have — a zero-sum game.

Deflation Occurs When The Supply Of Restricted-Quantity Money Fails To Keep Pace With Population Growth

If the population increases faster than the King mints more gold coins, the average number of gold coins per citizen decreases so that many if not most people became increasingly poorer as the population grows larger as the same number of coins are spread over a larger number of people.

As the average quantity of gold coins per person declines, as most people have fewer coins to spend, sellers are forced to reduce their prices because there were fewer buyers who have the money to buy their products at the old higher prices.

When prices go down, each coin buys more goods and services, that is, there is deflation.

Deflation is a general lowering of the prices for goods and services in contrast to inflation which is a general increase in the prices for goods and services.

An Increase In The Country’s Wealth Without An Increase In The Supply Of Restricted-Quantity Money Causes More Deflation

If you have a restricted-quantity form of money and the population increases and/or new land, new factories, or new technology increase the country’s physical wealth, the same number of coins has to cover the purchase of a larger quantity of valuable things which means that the value of each unit of money, each gold coin, gets ever higher and we see more and more deflation.

If you created $2 million in new value with new farmland in this restricted-quantity-money economy and the king did not mint $2 million in additional gold coins to match that new value, there would be deflation because there would be the same amount of gold coins in the money supply which would have to cover the purchase a bigger quantity of valuable stuff.

When There Is Deflation, Interest Rates Go Up

Because tomorrow each gold coin will be worth more than it is today, it will buy more stuff, people will want to hold onto gold coins rather than spending or lending them.

Why lend money to earn a low interest rate when just holding onto your gold coins will give you an equal or higher return, will let you buy more stuff tomorrow, with no risk?

If each gold coin will buy more stuff tomorrow than it will today, it makes more sense to keep it rather than lend it at a low interest rate. No, it will take a high interest rate to get you to make a loan.

When there is deflation it becomes more expensive for people to borrow money, fewer people will be able to borrow money, and those loans will be at higher interest rates.

Fewer loans and higher interest rates mean that less new wealth will be created.

When There Is Deflation, The Level Of Risk Investors Will Accept Goes Down

When there is deflation and less money is available to lend, not only do interest rates go up but the level of risk that lenders and investors are willing to accept goes down. In order to get a loan or investment approval a project must be more and more of a sure thing.

When There Is Deflation, Sales Of Luxury Goods Flourish

Those with lots of gold coins will be willing to spend some of them on luxury items and those with few gold coins will hold on to them more tightly.

Because the wealthy have lots of gold coins, the sales and manufacture of luxury goods will flourish.

When There Is Deflation, Consumer Spending Decreases

If over several years population growth and new wealth outpace the supply of gold coins, people will know that a gold coin will have more buying power tomorrow than it has today. That means that gold coins will become an investment vehicle that will appreciate in value each year whereas whatever you buy now with a gold coin will be worth less next year.

No middle or working class person will want to spend any more coins than they must because next year each gold coin will purchase more stuff than it can purchase this year.

When Consumer Spending Is Low, Investment In New Factories & Products Declines

Manufacturers need strong consumer demand to justify building a new factory. Deflation in a limited-quantity money system lowers consumer demand which, in turn, deters the creation of new production facilities because the makers of goods and services know that there are fewer people willing and able to spend money to buy their products.

In A Deflationary Economy The Rich Stay Rich & The Poor Stay Poor

Because each gold coin will be worth more and more, as time goes by each hour of labor will be worth less and less, and wages, like the prices of other goods and services, will continuously decline.

Because borrowing, investment, and economic growth are all mechanisms that move money to new recipients and fund the middle class, the reduction of borrowing, investment and economic growth in a restricted-quantity-money economy means that the poor will tend to stay poor and the rich will tend to stay rich.

In a restricted-quantity money economy, wealth will tend to stay where it is.

Summary Of The Effects Of A Restricted-Quantity-Money System

A deflationary economy with a restricted-quantity form of money will have

  • Declining wages
  • Low investment
  • Low innovation
  • Low lending
  • High interest
  • Low consumption
  • Low economic growth
  • Low economic mobility
  • Systemic deflation

Effects Of An Unrestricted-Quantity Money Supply

By contrast, an economy based on an unrestricted-quantity form of money will have the opposite characteristics:

  • Increasing wages
  • High investment
  • High level of innovation
  • High levels of lending
  • Low interest
  • High consumption
  • High economic growth
  • High economic mobility
  • Systemic inflation

Why Was Bitcoin Created?

Bitcoin is a HIGHLY restricted-quantity-money system.

My understanding of the claimed reasons for the creation of bitcoin are:

  • To take monetary policy out of the hands of governments which have a history of over-increasing the money supply thus resulting in inflation;
  • To promote anarchist principles by creating a form of money that can store wealth without being subject to taxation
  • To promote anarchist principles by creating a form of money that can facilitate the purchase and sale of goods and services both free of government prohibitions and without the knowledge of the government

Do Bitcoin’s Benefits Outweigh Its Detriments?

Do the benefits of

  • (1) Allowing wealthy people to avoid paying taxes,
  • (2) Allowing criminals’ services and illegal goods to be anonymously purchased and sold, and
  • (3) Having a monetary system immune to inflation & central bank manipulation

outweigh the detriments of

  • (1) High interest rates;
  • (2) Low economic growth;
  • (3) Low innovation;
  • (4) Low economic mobility;
  • (5) Constant downward pressure on wages;
  • (6) Systemic deflation
  • (7) Concentration of wealth;
  • (8) Avoidance of taxes by the wealthy
  • (9) Re-direction of a majority of tax collections from wealthy individuals onto the shoulders of wage earners;
  • (10) Facilitation of blackmail, kidnapping, sales of stolen property, extortion & ransom
  • (11) Facilitation of the sale of firearms, drugs, biological weapons, and child pornography
  • (12) A massive increase in electricity consumption and pollution

If you are an anarchist or a libertarian your answer is “Yes.”

If you are not, then your answer is “No.”

— David Grace (Amazon PageDavid Grace Website)

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David Grace

David Grace

3.3K Followers

Graduate of Stanford University & U.C. Berkeley Law School. Author of 16 novels and over 400 Medium columns on Economics, Politics, Law, Humor & Satire.