Monetary policy and the danger of revolution

The Thinker by Rodin

My recent post on quantum computing and its impact on cyber currencies like BitCoin have taken me exploring the world of money some more. This exploration took me to this video, which discusses who controls money and how it is created.

I think this video is meant to be shocking. Most of us are painfully aware of how important money is, because we cannot survive without it. While vital, money is also completely abstract. We like to think money is a form of permanent liquid value. This video points out the “shocking” fact that money is not this and that it is created almost universally by central banks, the Federal Reserve in the case of the United States.

As you get on in the video, you also learn that banks create money when they issue loans. If you were hoping to trade in your dollars for gold bullion, those days are gone. President Nixon turned the U.S. dollar into a fiat currency. This essentially means that the dollar has value because the government says it does. If it’s backed up by anything, it’s backed up by your faith that our government can manage money intelligently.

But really, the only ones managing money is the Federal Reserve, since they are the sole suppliers of money. The degree to which the Fed controls the spigot of money generally determines the health of the economy. Quantitative easing, which the Fed (and other central banks) have been doing since the Great Recession is basically the creation of lots of money which are then used to buy assets. Doing this helped pick up the economy and over many years took us out of recession.

So one might extrapolate that it’s not how much money that gets printed that is important, but how frequently it gets circulated. If circulated a lot, the production of goods and services continues apace. If it gets circulated too much, you end up with inflation, which means the same money buys fewer goods and services. If it’s not circulated enough, you may end up with deflation, which seems worse than inflation, in that the same money tomorrow buys more than it will today. In a deflationary environment, you would rather hold onto money than spend it, and that tends to stifle economic activity.

Lots of people like Ron Paul don’t like the way money actually works, which is why they would prefer the dollar be based on a gold standard, or some standard which equates a dollar to some amount of something precious. These people are probably economic Don Quixotes chasing electronic money windmills that may have existed at one time but which are probably gone for good. They look for impartial standards of value instead, which is why they turn dollars into BitCoin and similar electronic currencies.

The video says that central banks, being run by bankers, are a system that essentially pumps money from the lower classes to the upper classes. There’s a lot of recent evidence that they are right, as our middle class seems to be disappearing. Americans owe a lot more than they used to and in general earn a lot less in real wages than they used to. It used to be that wage increases followed productivity increases, but for decades that has not been the case. Today, the level of personal debt is staggering. Without meaningful raises, it gets harder and harder to pay off debt or do things we used to take for granted, like buy cars and homes. The Uber/Lyft phenomenon may be in part a reaction to these new facts of life.

Something ought to be done. In part, Donald Trump’s election was due to these economic anxieties. Trump was going to be our fixer to these various problems by bulldozing his way through all obstacles. Of course, he has done just the opposite. There is more than $1 trillion in outstanding student loan debt, but Trump’s education secretary Betsy DuBois is actually making it harder for people to pay off their student debts, and is promoting pricey private education at the expense of relatively affordable public education. So Trump is turning the screws even tighter on the working class.

Democratic presidential candidates have all sorts of ideas for addressing these problems. My senator, Elizabeth Warren, is distinguishing herself by having the most comprehensive set of policies for addressing these issues, including a lot of student loan debt forgiveness. All these policies though are basically ways of trying to solve the fundamental problem of more of our wealth going to the wealthiest and to put more money into those who need it the most. They all depend on redistribution of income from the wealthy toward the poor.

This “socialism” of course has the wealthy up in arms, since maintaining and increasing their wealth is all they seem to care about. So they are dead set against any of these ideas. Based on how our money supply works though, all this will do is keep pushing more of the wealth toward the wealthy.

It makes me wonder how all of this economic anxiety ends. And that gets me to figuring out what money really means. Money is essentially a social compact for the exchange of wealth, and whoever sets the rules controls the flow of wealth. The Fed is essentially accountable to no one. At best, all you can do is wait for someone’s term to expire. Trump’s inability to get people like Herman Cain on the Fed speaks to Republicans true values: they want the Fed to be populated with people that think like them, and that’s not Herman Cain. He’s too out of the mainstream.

To cut to the chase, the real threat to the wealthy is revolution. That’s exactly what happens if you screw the working class for too long. Revolution is upsetting the whole apple cart and starting over because the system is fundamentally broken and cannot be fixed. I believe this is the root of the partisan tensions we see these days. It’s not about value, or whether you are white or not; it’s about money and who gets to control it and how it should be distributed and used. Revolution though is very dangerous. It brings severe economic disruption, likely civil war, complete upheaval and a fundamental reordering of society. Hopefully when it is over the new system is more fare, but as we watch these things play out in places like Brazil it doesn’t look like that’s likely.

Ideally, rich Americans would understand that giving more back to society is in their interest. Sucking ever more wealth from the lower classes exacerbates tensions and increases the likelihood of revolution. They don’t seem to believe it though, and want to maintain control of the levers of power. If they succeed they will likely bring about the real revolution that will destroy their wealth, because wealth is predicated on connected economic systems that work. Unfortunately, the rich seem to be deliberately tone deaf, increasing the likelihood of the exact outcome they fear the most. Should it occur, BitCoin is not going to save them.

As billionaire Nick Hanauer puts it, the pitchforks are coming.

Quantum computers will kill cryptocurrencies, but that’s just the start of it

The Thinker by Rodin

About five years ago I took my first gander at the BitCoin phenomenon. In that post I wrote:

In short, to trust a Bitcoin you must buy into its assumption that it can’t be hacked. Since the dawn of the computer age, hackers have demonstrated their ability to hack anything. They love the challenge. It’s reasonable to believe that Bitcoin is going to be hacked one of these days.

Five years later, BitCoin and similar cryptocurrencies are still safe, but they may not be much longer. This is because quantum computers, which are still-in-the-laboratory are going to fundamentally reinvent computing.

When I wrote this post on BitCoin, I was thinking some hacker would just figure out a very clever way to hack these coins that wasn’t so computationally prohibitive. Right now you can throw supercomputers for years at the problem and they won’t succeed.

Quantum computers though are leveraging actual quantum physics, and that looks like a game changer. If you follow my blog, you’ll realize I’ve been fascinated by quantum physics and its implications, most recently this post. Quantum physics is the study of the ultra tiny; it’s a realm so tiny it cannot be seen at all, but only inferred. The foundation of quantum physics seems ridiculous: it postulates that two things can be in two different states at the same time.

Quantum computers take advantage of this seemingly impossible fact of nature. By allowing a bit of storage in a quantum computer (an atom) to take on not just two values (0 or 1) but an extra value (both 0 and 1 at the same time), putting a quantum computer to a task that would challenge even a supercomputer becomes doable. As a practical matter, this puts the security of the Internet and most of our electronic trust-based systems in jeopardy. It looks like someone with the right quantum computer will be able to decode anything electronically encrypted without breaking much of a sweat!

One thing this will impact is digital currencies like BitCoin. Right now to “mine” a new BitCoin requires rooms full of servers. As most BitCoins have already been “mined”, creating new BitCoins gets prohibitively more expensive. With the right quantum computer though, creating new BitCoins won’t be a problem, even if there aren’t that many more that can be created.

But any digital currency that depends on this blockchain technology could be minted quite easily on a quantum computer. Effectively this means that the “preciousness” of digital currencies is going to go away. Quantum computers will be able to “mine” new digital currencies in whatever quantities will be desired. These currencies then move from being on something similar to a gold standard (a finite number of Bitcoins, for example) to a fiat currency.

But with fiat currencies like the U.S. dollar, some entity controls the creation of dollars (the Federal Reserve). With digital currencies, anyone with a correctly programmed quantum computer can create as many units as desired and the currency permits. In short, digital currencies will reach a point where they cannot be trusted and quantum computers should kill them.

Much scarier though is how easily these computers will crack passwords and encryption keys. Consider that electronic commerce is carried out over the Internet using pairs of public and private keys. The private key is retained by vendors like Amazon, and the public key is handed out, but you need both to make the transaction secure. If you can figure out the private key though you can certainly purport to be some entity that you are not, and once you have someone’s credit card or bank account number grabbing their money won’t take much effort. Of course, if you can easily figure out someone’s password with a quantum computer, not much remains private anymore, at least not in electronic form.

As bad as this is, it has much worse implications. Suppose North Korea or China get a leg up on us on quantum computers. Imagine the havoc they could create. Right now, China is leading on quantum computing. It’s not clear if the United States even has a strategy in this area. We have to hope the NSA is studying the problem and perhaps surreptitiously developing quantum computers too. Quantum computers will break the model of electronic trust that we take for granted. We will need something else that can’t be broken with quantum computers but which can still be done electronically. I can’t think of what can viably replace it. But moving whatever solution we come up with, we have to retrofit every system to use it instead.

The United States would be well advised to become the leaders in quantum computing, and quickly. Unfortunately, our tone-deaf Trump Administration is much more concerned about people seeking asylum on our border or getting rid of Obamacare than tackling a super-huge national security threat like quantum computing. Let’s hope that when the grownups are back in charge again, there is still time to gain the upper hand.

To get your head around this, watch this 3:44 video:

Bitcoin reevaluated

The Thinker by Rodin

In December 2013 I looked at Bitcoin and called it libertarian bit nonsense. Like most pundits, I’m not good at admitting I was wrong. But I was wrong about Bitcoin. In December 2013 a Bitcoin was worth about $716. As of today one Bitcoin is worth about $3250. (See this index chart.) So if bought a Bitcoin in December 2013 and traded it today for U.S. dollars, your return on investment would be 354%. That’s an annual return of 96%. You are not going to get that sort of return from an S&P 500 index fund.

The dates I picked were random so coins bought at other times might have lost money. In truth if you had bought a Bitcoin in December 2013 you would have to have waited until November 2016 to see a positive return on your investment. For the last year or so though Bitcoin appears to be picking up real traction, taking the new currency to surreal highs.

One reason I was wrong in 2013 is that back then I did not anticipate its major use. Back then it was used for shady transactions but existed on the fringes of this world. Bitcoin seems to have found its niche as a method for facilitating ransomware. Illicit hackers are using it to get money from you when they do things like hijack your computer and won’t let you access key parts of it until you pay them sufficient Bitcoins. (Even then it works only about half the time.) If they asked for dollars or yen then hiding their tracks would be much harder. Making you go out and buy Bitcoins and then sending it to them though makes anonymous electronic thievery much more possible and practical. While each transaction is recorded in the Bitcoin itself, there is no mechanism in the transaction to positively identify the buyer and seller. Thus it’s much harder to catch electronic thieves at work.

I doubt these thieves hang onto their Bitcoins. Bitcoins are still a hassle to trade. Bitcoin exchanges are few and their trustworthiness not to mention solvency are problematic. Thieves probably don’t see the Bitcoins they collect as investment since they are hard to spend on real world goods and services. Most likely they are quickly converted into a local currency where they are then used to buy goods and services.

As a libertarian currency, Bitcoin is having some success. It is theoretically money that can be stored and used independent of taxation, although legitimate sellers that accept Bitcoins probably have to charge taxes on Bitcoin transactions. The percent of sellers that accept Bitcoins though is still tiny, which provides evidence that their value comes from being able to transmit value relatively free from prying eyes. This is one aspect of cash that allows it to endure into the 21st century.

So while Bitcoins may appeal to the libertarians among us, its primary usage is probably to facilitate crime, thus its value and surging price. The harder it becomes to trade illicit money with conventional currencies, the more valuable Bitcoins become, since there are a finite number of Bitcoins out there. Most governments are getting quite good at monitoring transactions of conventional currency. Transactions that are too large result in inquiries that may slow down or stop the transfer of money. With Bitcoins this is currently not much of an issue. Governments are getting better at regulating these transactions. At one time China blocked Bitcoin transactions altogether. They are accepted on certain Chinese exchanges now, but China is proposing to make Bitcoin exchanges subject to money laundering laws and to collect information verifying the identity of buyers and sellers exchanging Bitcoins.

As I noted in 2013, the more a Bitcoin is traded, the larger its digital fingerprint becomes. Some of these coins are becoming so digitally huge that they are inefficient to verify it is a legitimate coin. This is frustrating to many in this community, which is causing other more practical digital currencies to emerge like Ethereum. Currencies like Ethereum try to address issues like the huge blockchains in many Bitcoins and to build in features like identifying buyers and sellers and a limited blockchain ledger. If they gain traction then this undercuts Bitcoin’s ability to keep these transactions confidential.

Whether Bitcoin or some other form of digital currency, all such currencies that rely on blockchain technology are inherently risky, for the same reason that I noted in 2013: they are potentially hackable because they are encrypted. So far to our knowledge no one has successfully hacked into a Bitcoin. If it happens though that a hacking algorithm or a quantum leap in computing power reveals an easy way to mine new Bitcoins then the coin should drop in value precipitously and become essentially worthless. However, if a coin can be “minted” by a provable and legitimate source, say a country’s equivalent of a Federal Reserve, then such digital currency should hold value. This could be done by such organizations holding a registrar of coins it has “minted” that are publicly electronically available.

If that happens though then the onus for having a Bitcoin also goes away, as its value is in its surreptitiousness. Electronic coins that only go through legitimate exchanges and follow policies for tracking and handling illicit uses become essentially legitimate currencies because they are issued and accepted by trusted institutions.

So there are likely to be many more digital coins in our future. Bitcoin’s future as an electronic currency though is likely coming to an end as it becomes computationally inefficient to record transactions with Bitcoins and as advancements in computers, like potential quantum computing potentially render obsolete our current methods of encrypting data, making the encryption keys faster to crack.

Bitcoin’s time has arrived but with its success it is also likely quickly passing into obsolescence. What comes next is unknown but any permanent way of electronically storing untraceable electronic value was probably always myth.