William J. Luther and Lawrence JH. White write,
An inelastic supply in the face of volatile demand makes the value of bitcoin unstable relative to established currencies. While a drawback, this need not preclude bitcoin from spreading as a medium of exchange. Entrepreneurial innovations—market exchange pricing and instantaneous exchange facilities—enable bitcoin to function as a medium of exchange while allocating the speculative risk of holding it to those who are most willing to bear it (for a small price). Although it is still too early to know how greatly these innovations will widen bitcoin use, they give it a better chance of becoming a commonly accepted medium of exchange. If nothing else, the evolution of bitcoin and rival crypto-currencies will continue to provide us with the opportunity to ponder alternative payment systems and the possibilities for non-state money.
One way to think of money is to use William Gibson’s famous description of cyberspace: a consensual hallucination. We accept it as payment because other people accept it as payment. We think that prices will be pretty stable because other people think that prices will be pretty stable.
This takes us away from the mechanical quantity theory of money. Instead it suggests that there are multiple equilibria, one of which we happen to be experiencing. The behavior of prices is part of our consensual hallucination.
If the consensual hallucination concerning the dollar should break down, my guess is that another state currency will serve as the anchor. Swiss Franc? Canadian dollar? Singapore dollar?
How likely is it that an “anchor” or “world reserve” currency would NOT be based in some great power? That is, in the current world, it would be the US or the EU.
In a world where those entities no longer hold the hilltop (military, market size, economic capacity) wouldn’t the anchor currency tend to move some entry in the next circle of great powers?
China? India? Brazil?
I agree with the idea of currency value as consensual hallucination. Likewise for many asset values. Volatile assets have a shakier foothold on the psychic landscape!
The expectation that the grocer will always give me food in exchange for dollars may be part of a weirdly recursive local equilibrium, but the fact that the IRS will let me stay out of jail in exchange for dollars seems to be a bit more anchored, and that anchor extended to everyone who pays US taxes. If we ever lose reserve currency status, that should be a bit of an upper limit on the resulting inflation. Even if we ever get a Mugabe in charge of the printing presses, I expect the grocer will start accepting Bitcoin, but they’ll still have to convert some of those Bitcoins to dollars (or megadollars, whatever) to pay taxes on the transaction.
Professor:
I’ve long thought that, if someone wanted to pop our consensual hallucination about the value of the dollar, the Chinese government could do it very quickly by tying their currency to gold or silver and actually issuing a lot of gold or silver currency. It might not last, of course, but it might do a lot of damage to the dollar’s standing as a reserve currency.
Max
Arnold, Not Lawrence J. White. Lawrence H. White. Lawrence J. White is at NYU.