Growing pains
In 1906 President Theodore Roosevelt signed the Pure Food and Drug Act into law. It had been a long time coming and corporate interests had done their best to derail and delay reformers who advocated the contents of the act. The meatpacking industry had been a major focus of reform as was the over the counter drug industry, each for different reasons.
Meat was unwholesome especially in the warm weather. Cattle were driven by cowboys to railheads in Kansas City Missouri and then transported live by rail to Chicago which became a major distribution point after the American Civil War. Meat packers slaughtered cattle in Chicago and shipped to markets in the east. This prompted the need for refrigerated railroad cars or reefers. At first, reefers were cooled by ice and not necessarily very well. People in the east got sick from tainted meat and Upton Sinclair’s novel, The Jungle was a story about abuses in the industry that led to unsafe products.
Over the counter drugs contained high quantities of alcohol and opioids and their makers over promised what they could do for patients. Newspapers, which relied on advertising revenues from the drug companies, were enjoined from expressing support for legislation regulating the drug industry on pain of losing their ad revenue.
Muckraking which we might call investigative journalism today, came into its own and crusading journalists like Sinclair and many others published exposés of abuses that led to the Pure Food and Drug Act as well as the Federal Meat Inspection Act which Roosevelt signed into law together.
A century later, the meat supply still has occasional problems, but no one tries to hide the truth and both producers and regulators work to correct issues when they arise. Also, producers rigorously test over the counter drugs both for safety and efficacy before going to market. Libertarians and conservatives might want to complain about the added costs involved or the rights of participants in free markets in other situations, but they are largely silent here.
Today
The social networking industry today is in a similar position to meat packing and pharmaceuticals more than a century ago. Our news is full of stories such as Cambridge Analytica stealing 50 million Facebook profiles while that company did little to protect its users. The US intelligence services all point to Russian active measures in interfering with the 2016 presidential elections by using the tools available with social networks as they were designed.
All of this is awakening many people to the understanding that social networks are not free because they collect a fee in kind; namely consumer data which they use to model profiles and sell to advertisers. Some have suggested that in the face of these revelations that Facebook might be doomed or that social networking in general may be. But nothing could be further from the truth.
Social networks are at the same place that meatpackers and drug companies were in 1906. Regulation was and is a way to enable the people to influence markets in such ways as to not interfere with any single company. Regulations apply equally to all those regulated and businesses should, after a period of adjustment continue as they were in the newly regulated markets.
My two bits
Regulation can take many forms. I’ve previously advocated for treating the social networks as utilities and that’s certainly one approach. Another is simply to put forward legislation like the Pure Food and Drug and the Federal Meat Inspection Acts of 1906. The Pure Food and Drug Act ultimately spawned the Food and Drug Administration which regulates industries without treating them as utilities.
The history of regulation in the US and much of the west has involved setting standards and fines for violation. Government agencies randomly sample many aspects under their direction and in some cases government meat inspectors work at slaughterhouses. But the regulation and enforcement is largely something that individuals take on because they are good for business.
The point is that regulation can work well with business and it doesn’t necessarily mean the end of an industry or crippling rules. A level playing field is good for all and often increased the size of markets.
Social networks, and the Internet more generally, need some regulation right now for the good of the society they serve. There are approaches and models that we can adopt. The current issues we face are not unique in history and we should heed its lessons.
Further reading
Time to call it—the social utility has arrived. That has important consequences
Document management revisited
The IT industry has been playing whack-a-mole since its inception. We’ve been applying sophisticated technology to our biggest business problems not once but repeatedly as each new generation of technology offers and delivers order of magnitude improvements to our business processes. In some cases we’re on our fourth or fifth iteration of solutions.
For instance, about 25 years ago most business processes were manual. People did things for customers and often this involved paper documents. Document management systems came along at the end of the last century to modernize documents by storing them in digital format for quick retrieval. The improvements saved businesses millions of dollars in overhead and the problem was deemed solved.
However, digitizing a document (a very good idea) is not the same as automating the process that the document participates in. For many businesses modern document storage and retrieval supports manual business processes. These businesses still spend a lot on printing documents and manually or semi-manually routing them around the building or throughout the customer base. Today businesses looking to tackle business process automation are rightly investigating ways to keep documents from being printed even as they circulate.
That’s a different problem from the earlier one defined by storage. It wasn’t even visible when document digitization was thought to be the key need. If you manage business processes that still use lots of paper and printing, welcome to your personal edition of whack-a-mole.
Today’s edition of the problem comes with an especially menacing complication. Many CIO’s would love the chance to streamline their document dependent processes and the ROI for most of them is readily apparent in avoiding the costs of paper, printing, and better customer engagement. But with upwards of 80 percent of their budgets on average dedicated to keeping the lights on, it’s hard to grab even the low hanging fruit if it means a purchase.
You can find the lowest of the low hanging fruit not in some exotic business processes but in the every day customer administration that organizations spend so much time in. From professional services to healthcare to finance, opportunity is easy to spot in any business that produces a custom or semi-custom product or service directly to customers. Advancing regulation also plays a role increasing the amount of paper documents involved even in routine processes. So the problem is not getting better and whack-a-mole is really just a feeble attempt to keep it from getting worse.
The solution to this dilemma may be as simple as changing software vendors. The original digital document vendors may not have an incentive to change their business models or their products to address the new reality. They’ve defined solutions to “document management problems” but in an era that needs business process solutions, their models and technologies may be a bad fit.
If any of this feels familiar there’s a lot you can do. First look for new solutions that avoid putting documents back on paper, for example, to capture a signature. Signature capture is one of the easiest processes to digitize with modern software. Also, consider what’s in your documents. Are people still reading them on multiple occasions to understand what promises and commitments your company made that need to be implemented? Or are there customer commitments buried in physical documents that indicate future purchases? Paying people to read documents is expensive and unnecessary.
Digital documents, unlike those on paper, can feed the data they contain to analytics engines. The resulting insights might drive an ROI many times greater than the cost savings from simply automating the storage and retrieval of documents.
My two cents
As good as document digitization solutions were twenty years ago, the business need has changed and many vintage systems show their age today. Modernizing document based business processes can, in many cases, offer attractive ROIs that even budget-constrained organizations will benefit from. The key to all of this might be in how we frame the business problem. Is it the same document problem your business fixed decades ago or did time and circumstance change the need to something greater? A new generation of solutions based on more modern demands can provide order of magnitude improvements. The first step may be to evaluate the problem with fresh eyes.
4IR (wonkish)
I’ve taken the lead from Paul Krugman who labels some of his blog posts wonkish if the subject gets into the weeds to make a point that might not be appreciated by the average reader. In addition, this piece reflects some of the arguments in my new book, “The Age of Sustainability,” which I think you should purchase.
It has become fashionable to talk about the times we live in as another Industrial Revolution and for some reason popular culture suggests we live in the Fourth IR or 4IR. The meme seems to be floating around Davos and it’s only a matter of time before we’re all uttering 4IR in our sleep. Not for nothing but I am certain we live in the 5IR and it’s ending. The 6IR is on the tee and people are taking practice swings. Why does it matter and can I prove any of this?
Well, it matters and here goes.
Scholars differ on exact beginning and ending points but most agree that the original IR began in the middle to end of the 18th century about the same time that people like Adam Smith were writing about the invisible hand of the market, supply and demand, and what would be called capitalism. Smith’s enduring classic, “The Wealth of Nations” was published in 1776.
Just prior to that others like Rousseau, Locke, Burke, Hume, and Hobbes, to name some of the more famous ones, were writing about the natural rights of man and things that were eventually subsumed into democracy. The age is generally referred to as the Enlightenment. So the philosophers came first, then by 1760 practical men (yes, they were all men) began putting Enlightenment ideas into practice. The result was capitalism and in Jefferson’s America, democracy. Capitalism spread everywhere especially in the UK.
Many scholars use 1760 as the kickoff for the first IR and the date is important because later researchers discovered that any IR has a lifecycle of 50 to 60 years. The cycles are based on disruptive technological innovations that ripple through the economy creating wealth and jobs and in some ways improve life.
From 1760 to 2018 is a span of 258 years, which gives us a bit over 5.16 lifecycles using the 50-year interval or 4.3 lifecycles using 60-years. For completeness, here’s a table from, “The Age of Sustainability” with IR’s or ages stipulated at 50 years.
| Technological age | Beginning | End |
| The Industrial Revolution | 1760 | 1820 |
| The Age of Steam and Railroads | 1820 | 1870 |
| The Age of Steel and Heavy Engineering, Mass Production | 1870 | 1929 |
| The Age of Oil, Electricity, the first electronics, and the Automobile | 1929 | 1971 |
| The Age of Information and Telecommunications | 1971 | 2020 (est.) |
| The Age of Sustainability and Ecosystem Services | 2020 (est.) | 2080 (est.) |
The difference 5 or 6 ages isn’t very great if you simply adjust the time frames for each age but what to leave out? 1820 and 1929 seems opportune. Steam, railroads, steel and heavy engineering seem like they could go together. But steam and railroads had a long life when iron was the structural material. Steel was a known quantity but hard to make until Henry Bessemer invented his steel-making process in the 1850s. Steel enabled railroads to develop into the continent-spanning network they became thus fulfilling the promise of early rail.
Also steam power goes back to the early 1700’s well before the official start of the IR. But early steam engines were impractical, took up a whole building and burned and wasted coal at a prodigious rate.
Similar stories can be told about the age we live in, The Age of Information and Telecommunications (IT age). But now the lifecycles become important because we need to understand if we’re at the beginning or end of the age. If you think the IT age began in about 1971 suggested in the table, it would coincide with the introduction of the mini-computer about 5 years earlier by Digital Equipment Corporation.
As with steam engines, iron, and steel, mainframes were introduced in the early 1950s but they were big, consumed resources prodigiously, and were generally too hard to use and expensive to make significant inroads. If you accept this reasoning then the 5IR is getting long in the tooth and a new disruption is likely. If you take the longer 60-year view of the lifecycle then we’re right in the heart of 4IR and the new meme makes all the sense in the world. This is where it gets interesting.
The lifecycle
Regardless of your position on the 50 or 60 year split, the lifecycle, like all cycles, has an upside and a down side. The upside produces a booming economy (yes there is some lag time) because the disruptive innovation driving things needs new infrastructure, which investors gladly pay for. That spending permeates all parts of the economy. But when the infrastructure is fully built out the down side of the cycle emerges caused by two things.
Early on customers pay high prices for the innovation causing an opening for anyone with an improvement on the basic design. High prices are used to build out the delivery infrastructure. When the infrastructure is finally built and paid for a wave of automation takes hold and the cost of products and services dives. Consumers make out with scads of low priced goods and services but too soon they discover that high prices paid the salaries of suddenly unemployed workers themselves included.
So where are we? Are we closer to the middle of 4IR, suggesting a 60-year average? Or are we at the end of 5IR and a 50 year cycle? Logic tells me that we’re at the end of the Age of Information and Telecommunications. The IT market has already expanded to global proportions, it is increasingly automated by way of AI, ML, IoT, and other advances. Their products and services are now dirt-cheap—think handheld devices and 99-cent apps—so it’s hard to make money in IT these days.
My take
It’s much more likely that we’re at the end of the IT era than in the middle of it. This is important because the frame of reference determines what’s most important to invest in. Further investments in technology such as the IoT and machine intelligence will continue regardless of this discussion. They will be easy investments with opportunities in big markets but the possibility of failure is high because a small number of large vendors, an oligopoly, already control these markets.
When cloud computing was new you couldn’t count the number of vendors in the space. They sold infrastructure, software, and platforms. Most were acquired or went bust. Today Oracle, IBM, Google, Amazon, Facebook and other social media, Microsoft, and Salesforce are the dominant players and invading that space with a new offering is problematic at best. That’s not a new IR it’s a continuation of an older one.
At the same time there is a boatload of renewable energy companies and more electric car companies than you can put arms around. That’s the new IR. Next year most carmakers will begin deploying fleets of electric vehicles causing a further ripple effect in demand for a new electric infrastructure and all that entails.
So how you think about it, 4 IR or 6IR, is important. The free market will determine who is right, as it should be.
Cryptocurrency’s duality
Disruptive innovations all have at least one characteristic in common. They percolate through an economy seeking a best use scenario because it’s the market, and not the inventor, that makes a determination of utility. Cryptocurrency is undergoing such a moment and it may be hampered by use of “currency.” Is it a currency or a security?
Cryptocurrencies have proliferated like rabbits. One study concludes there are 1,448 of them and the number is growing. https://coinmarketcap.com/all/views/all/ In a world of central banking, reserve currencies and sophisticated trading markets, is there a place for this asset category? There is little doubt that cryptocurrency is a disruptive innovation but its existence begs the question of what’s being disrupted.
Some advocates say that cryptocurrencies are a new form of currency that skirts the limitations of government-controlled currencies by avoiding regulations. But those principles also represent hard-won knowledge about how markets work and how best to control inflation and ward off the worst effects of recession. Also, there is little of value backing up cryptocurrencies which makes them pawns in a confidence game at worse or just another fiat currency at best. But other fiat currencies, like the dollar, are backed by “the full faith and credit” of the nation state and its ability to tax or otherwise use the assets under its control to support the value of currency.
Others look at this asset class more as investments akin to securities that can fluctuate on open markets. It’s possible cryptocurrencies are both or neither but the current rollercoaster ride seems tailor-made for figuring it out.
It’s possible we may have to get used to a duality of uses for this asset class. Sometimes cryptocurrencies act like currencies while other times they act like securities. As a metaphor, this is reminiscent of the quantum duality of light—it can be described as an energy wave (electro-magnetic radiation) as well as a particle of zero mass (the photon). We routinely use the best definition for a circumstance. Or consider silicon, a “semi-conductor” a material that can act as either a conductor or a resistor depending on the electric current flowing through it.
Currency and banking
As it stands cryptocurrencies are not very good currencies. Their value changes depending on the whims of the market and there is no central banking facility to maintain liquidity in times of financial stress or to manage inflation and the money supply. Cryptocurrency can be used in transactions the same way that Monopoly money can be—under very specific circumstances and so long as both parties agree.
As we’ve recently seen, cryptocurrencies are not great stores of value either, because their value can fluctuate significantly within a day or a week. Stability in a currency is vital for without it, people would be resistant to spending it if they felt that the price was likely to rise or they would be resistant to own it if they expected it to inflate and become valueless in the near term.
Securities and finance
Markets for cryptocurrencies act more like stock exchanges and we’ve seen wild swings in recent trading of Bitcoin, the grand daddy of the group. So cryptocurrency seems to be a better fit as a security whose value is expected to fluctuate.
Fluctuation can be a good thing. I was a guest on the streaming show, “The Gillmor Gang” last week when the discussion turned to cryptocurrency. Another guest, Keith Teare, a venture capitalist involved with cryptocurrencies, described his use of crypto to raise capital for his venture funds. His method avoids the typical funding process of raising big contributions from a small number of investors. Instead it can raise any amount from average investors by selling cryptocurrency. Tears’ description and explanation begins at the 46-minute mark and it’s well worth the time.
Unlike a crowdsourcing model in which people invest money at face value, say $100, Teare’s model generates heavily discounted cryptocurrency and sells it to investors while giving the hard currency raised to startups. For example, he might issue a crypto dollar with a value of one cent based on the value of the startups in the portfolio. As the startups progress through time the value of the currency increases (or not). At some point your investment is either worthless in which case you’ve lost one cent on the dollar or it’s worth potentially more than the face value of the cryptocurrency.
Generally, if you invest this way in a portfolio and not an individual company the chances of all portfolio companies going south is small and the odds of your investment becoming worth more than one cent on the dollar in the future is reasonable. But wary investors will note that this scheme operates outside of the rules of the Securities and Exchange Commission (SEC) in the US and similar bodies elsewhere. So, sadly, there’s room for the unscrupulous to game the system.
Nevertheless, in this process the cryptocurrency acts more like a stock or a bond or possibly some as yet unnamed derivative that combines aspects of each. The cryptocurrency is far from being a legal tender for all debts but in the right situation it’s a good fit. In this model it’s easy to see how cryptocurrencies could proliferate, each securing part of a transaction such as a venture fund, in the same way that bonds are issued for a particular debt offering. So at the end of the day, the cryptocurrency acts both as a security and as a currency, that’s the duality.
When crypto currency is used for discrete commerce or as an investment it works reasonably well. Teare’s use of crypto is a good example of using it as a form of a bond. Like a bond, it is heavily discounted initially and its value fluctuates but it still generates value in a kind of interest payment.
Analysis
Cryptocurrency is more likely to be a disruptive innovation in finance but not one in banking and currency. It’s too volatile to act as store of value but might well have a place as a token of debt or more broadly as a security such as a bond with some stock attributes.
As a currency cryptocurrencies lack the necessary central banking infrastructure so it will be hard gaining traction there. The exception is that convertibility to dollars, Euros, or another established currency enables a cryptocurrency to access part of the beneficial aspects of conventional currencies such as the liquidity provided by central banks.
So as long as there are real currencies and the central banks needed to keep them functioning, it’s difficult to see how they replace conventional currencies. But it’s also hard to see how they harm functioning economies unless they all evaporate. This is an area of concern for anyone who appreciates how involved Russia and China are in cryptocurrencies. A hostile power intent on doing harm to the global economy could, in theory, flood the market is bogus cryptocurrency inflating them and rendering them useless and valueless.
Proponents of cryptocurrencies point to blockchain technology, a distributed ledger system designed to make it virtually impossible to carry off such a scheme. Two years ago one might have said the same about social media and democratic systems.
A recent article in the New York Times Magazine, “Beyond the Bitcoin Bubble,” by Steven Johnson observes,
“The Bitcoin bubble may ultimately turn out to be a distraction from the true significance of the blockchain.”
and blockchain could ultimately be the tail wagging the dog in all this.
My two cents worth
It is entirely possible that the disruptive innovation of cryptocurrency has not found its niche yet. If the market for cryptocurrency tanks, its use as a neo-currency will be over. As a way to raise money and reward investors crypto might face better odds especially if it can find its niche.
Here’s an idea.
The conventional economy seems reluctant to embrace the infrastructure needs of a world in crisis over climate change. Cryptocurrency could turn out to be the financing arm of a movement that builds more renewable power generation and distribution or that finances new ecosystem service provisioning. For example, increasing the amount of fresh water available to support populations in arid regions is such an ecosystem service. So is supporting a Green Race that promotes more photosynthesis planet-wide in an effort to reabsorb atmospheric carbon.
As we said at the start, inventors create products but the marketplace is responsible for defining best uses. In this, the experiment in cryptocurrency is not over by a long shot.
Cryptocurrency and central banking
Gold stored at the Federal Reserve Bank of New York.
Several people have questioned my criticism of cryptocurrency especially in the face of the Bitcoin’s recent run up and pull back. I am not ordained, consecrated, or even dedicated to money matters and my opinions are just that—opinions. So don’t take any of what follows as investment advice.
Cryptocurrencies lack two things that enable them to provide the vital services to modern economies—something of value backing them up and central banking to regulate them. We can debate the first point though recent wild valuation swings substantiate the value question.
Central banking is shrouded in mystery largely because most people can lead their lives oblivious to what central banks do to safeguard the4 global economy. Ironically, it seems that the rules and regulations put in place by central banks to provide stability are the ones disputed by advocates of cryptocurrency who see them as needless impediments to commerce rather than the defenses they are.
So the central question about cryptocurrencies revolves around central banking and an important additional question follows: Why do we need to reinvent the currency-central banking wheel? A question for later, and for a broader audience, is how can we further evolve the current central banking paradigm to address the needs that cryptocurrencies seem to expose? Central banking has evolved over hundreds of years and it can still evolve more given logical needs.
Central bank functions
First, let’s get some terms right. Cryptocurrencies such as Bitcoin have been described as a value store as well as a currency. Many people describe it as a better alternative than conventional currencies sponsored by governments because BTC has no regulations to clog up commerce and it therefore reduces economic friction and makes for more efficient business. That efficiency often comes from not having structures that manage the money supply, functions that evolved from hard experience in economic crashes over centuries.
So for any cryptocurrency to succeed their advocates must be engaged—consciously or not—in developing a central bank that will compete with other central banks such as the US Federal Reserve, the Bank of England, or the European Central Bank.
A central bank issues banknotes and controls interest and exchange rates thereby managing the money supply and maintaining the value of money in circulation. If a central bank issues too many notes thereby creating money, the result can be inflation because the value of each note represents a smaller amount of value. For example, paper money backed by gold or some other precious metal represents a call on a specific amount of metal. Increasing the amount of paper money in circulation without increasing the amount of precious metal means each note represents a smaller amount of value. The problem is the same for currencies not backed by metals as we’ll see.
A central bank also manages interest rates and has a monopoly on increasing the monetary base. Without such a monopoly anyone could flood the market with bank notes whose value would be close to nothing. Central banks are also the lenders of last resort able to maintain liquidity during a financial crisis when other lenders stop lending or raise interest rates to prohibitive levels or when buyers stop making purchases. In both cases, economic activity slows and a recession ensues.
Bitcoin and its miners, dealers, and brokers are not a central bank and lack many of the attributes of a central bank on which modern finance is based. Lacking a central bank function, cryptocurrencies act more like stocks. In an ICO (initial coin offering) cryptocurrencies’ promoters are attempting to have the advantages of a currency without providing a central bank’s key functions. So the markets treat cryptocurrencies as securities whose value is extrinsic and subject to the whims of the marketplace.
Value store
Money is generally considered a store of value. They are fungible, able to be easily converted from one thing of value to another. They enable people to take the fruits of their labor to the marketplace where they can acquire goods and services without the hassle of bartering a dozen eggs for a quart of milk, for instance. Exchange media can vary according to the tastes of the users. For example, in New France, in the 17th century, now part of Canada, a beaver pelt was an accepted medium of exchange. Money can also be saved for future use, something that eggs or milk or pelts are not good for. Milk and eggs can spoil and money can still lose value due to inflation.
Money is able to supply this service because there is something “behind it” some form of tangible or intrinsic value. Critics will note that the money circulated by central banks today is fiat money meaning it has no value other than what is assigned to it. But while it is true that value is assigned, the assignment is not arbitrary.
Money was initially made out of a valuable thing, a commodity such as gold or silver. This is also called commodity money because the money is made of a valuable commodity. It evolved into a system with artificial placeholders, such as paper money, to represent the precious commodity and early on, you could exchange your paper money for the commodity, hence it was also called representative money.
In 1971, Richard Nixon decoupled the US Dollar from the gold standard—the ability to get real gold for your paper money—and thereafter the value of the dollar has floated on the markets as a fiat currency having a value assigned to it by a government. Other nations followed suit so that today the paper money in circulation is largely not backed by precious metal.
But that’s not to say that all of our money is without value. The US dollar is backed by “the full faith and credit” of the United States. This means, among other things, the ability to tax the citizenry to collect value with which to pay government debts. We should pause here to understand that money is a government creation used to pay government debts. We use money in the same way but as an after thought.
This government use of money necessarily puts a limit on the amount of money that any government can simply print, which brings us back to the importance of managing the money supply. The assurance of value management is enough to convince most people that a US dollar has intrinsic value and is a suitable means of value exchange.
In contrast, Monopoly money from the popular board game is a pure fiat money, its value is set by whatever the game players believe it to be though you can’t buy a cup of coffee in the real world with it.
So the question about cryptocurrency is what value does a currency represent? There are two answers. First, cryptocurrency represents the cost and effort that goes into mining it—intrinsic value. Second, cryptocurrency represents the value that traders are willing to assign to it when they buy and sell it—extrinsic value.
Mining value
There are costs associated with making a cryptocurrency but mining begs the question of why one would mine it at all instead of simply working with existing currencies? In the real world of tangible assets like buildings, (and this is not to slight cryptocurrency mining) constructing a building involves real costs that include land, materials, labor, design and a lot more. When the building is complete its value often exceeds the construction costs because tenants or buyers see intrinsic value in having the asset in the precise location and being able to use it for commerce or living.
The building has intrinsic value principally because other people see ways to profit from owning it or renting space there and they bid for access. A cryptocurrency has a small amount of intrinsic value as well but a lot of extrinsic value assigned by the marketplace by people who believe they can sell it for more than they paid for it.
Neither cryptocurrency nor a building are perfect stores of value. A building is only as valuable as what a buyer is willing to spend to acquire all or part of it. The same is true of cryptocurrency. Neither is terribly liquid or able to be exchanged for other value quickly though cryptocurrency exchanges are coming on stream.
A prospective buyer can purchase a building, but usually only after a good deal of diligence to determine its value. Value can be manipulated. It is therefore in the interest of the seller to control the flow of information to the buyer highlighting the building’s assets and downplaying its liabilities. For example the location may be an asset while the heating system might be getting old and in need of replacement.
When one party to an exchange can withhold or obfuscate information, the market is said to be inefficient. The opposite of an inefficient market is one with a high degree of transparency. So for instance, a regulation that requires a building owner to disclose the condition of its heating system would be said to promote transparency. Such a regulation would help to reduce transactional friction and aid in setting a fair price for the building.
Building owners might chafe at such “regulations” as interference with the free market but what they essentially oppose is the loss of ability to manipulate information for their own good. The Romans understood this and “Caveat Emptor” or “Let the buyer beware” stems from all of this.
Cryptocurrencies use blockchain or distributed ledger technology to assist in providing transparency for trading. Blockchain is highly useful in this regard but proponents of blockchain often forget that the ledger system does not add any value to the underlying currency whose value is specious. Worse, there are documented instances of hacking cryptocurrencies resulting in the loss, for the owner, of all value. An important function of central banks is to safeguard the integrity of a currency and to secure deposits. Without those safeguards markets could not operate and economic activity would slow considerably. When activity slows an economy goes into recession; how severe the recession is determined by how deftly central banks do their jobs. Without a central bank in the middle, all bets are off.
Macro stuff
Currency is used to operate an economy and there are conditions that cause an economy to operate more or less well. When economic efficiency is threatened, it’s the job of central banks to make things work again.
As we’ve seen, inflation occurs when there is an imbalance in the supply of circulating currency and the amount of goods available. Too many dollars in the hands of the public chasing too few goods and services results in bidding up the price of those goods and that’s inflation. A certain amount of inflation is good. Most of the world operates on the expectation of 2 percent inflation, which is mildly stimulative.
Recession happens when there are too many goods available and insufficient demand represented by owners of currency deciding not to use it in transactions. This is a form of hoarding different from savings. When an individual saves money in a bank for instance, the bank lends the money at interest to others who wish to buy or build and therefore spend it and stimulate the economy. In a recession, lenders raise interest rates making it harder for borrowers because repayment terms are higher, so economic activity slows.
So far, cryptocurrencies lack any macroeconomic structures for managing things like inflation and recession and on exchanges they behave much like stocks. As we’ve seen in many mergers and acquisitions company stock can be used in part or in lieu of cash to enable the transaction provided both sides agree on the value represented by the stocks. But as an everyday currency that one might use to purchase groceries or pay a utility bill, cryptocurrencies are still way behind the curve.
What happens in a recession when interest rates are cut to near zero as was the case over the last ten years post recession, could happen in cryptocurrency. With interest rates at or near zero if consumers refused to spend their money or use it to pay down debt rather than make new purchases, a recession would persist. That’s called a liquidity trap. When a liquidity trap threatened the US economy, in the last recession, the Federal Reserve stepped in with quantitative easing to purchase assets, which effectively increase the money supply when consumers and corporations can’t or won’t use the money in their hands. Cryptocurrencies have no such mechanism or central bank to operate it.
Why cryptocurrency?
So we come back to the core question, why would anyone decide to use a cryptocurrency instead of a conventional currency? Certainly there is the allure of significant and rapid price increases but that’s an attribute of a security not a currency. Sudden and rapid declines are also part of securities as well as cryptocurrency as we have seen. But high volatility is not desirable in a currency which is supposed to be a store of value.
What’s missing from the cryptocurrency boom is any form of a central banking function. Some people have estimated there are more than one thousand cryptocurrencies and most of them are convertible into US dollars or other established currencies. But this only begs the question of why have cryptocurrencies at all? Convertibility into standard currencies does not convey any protection against inflation in the currency, for example, or recession in the broader economy dependent on the currency. On the other hand, credit cards represent the purchasing power of conventional currency and offer benefits like increased fluidity suggested as an asset of cryptocurrencies and interoperability in regions denominated by other currencies. It would seem that “plastic” already supplies the benefits sought by cryptocurrencies while enabling use of central banking’s real advantages.
My 2 bits: Disintegration of the nation-state?
There are several attributes or functions that a nation-state provides its citizens and in so doing define a state. Nation-states provide security to citizens by preventing as much as possible random violence against them and providing a judicial system capable of administering justice evenly and fairly. This enables private property to exist, which, according to the late economist Angus Maddison, is a prerequisite for modern democracy. Maddison’s other requisites include transparent markets, acceptance of scientific rationalism, and good communications in both information transmission and transportation infrastructures.
Promoting a currency that is safe, liquid, and not given to huge swings in value is also essential to most of Maddison’s four pillars. A nation-state that can’t help its citizens preserve their wealth and provide for other security needs offers little to the individual. Rich individuals and corporations can circumvent some of the problems of security by arming themselves including hiring small armies to secure their persons. But the natural outcome of this self-arming is chaos because private armies look out only for what their employer wants. The result can easily become tribal warfare. We tried this once and the result was the Middle Ages.
The rise of cryptocurrencies parallels the rise of multi-national corporations, stateless warriors sowing chaos and terrorism, and its backlash is nationalism and tribalism. We are not yet at a doomsday point where civilization is collapsing, but there are many worrying signs that the norms and standards that shaped our international systems are beginning to wobble. Those systems were instituted as needed in simpler times and our international order grew up around them. That’s why destabilizing them is a concern. The international order can’t simply or easily revert to earlier times when kings and the rich could issue currencies any more than we can postulate the city-state or benevolent despotism as ideal forms of government.
Cryptocurrencies are a big deal because they upend the existing economic and financial order without necessarily replacing it with anything that improves on that order. In fact, absent a central banking system to help economies ride out inevitable rough spots and upheavals, cryptocurrencies pose a significant danger to the world economic system and ought to be avoided.
