Why Nobel Prize Winning Economist Paul Krugman is wrong about Cryptocurrencies
Nobel Prize winning economist Paul Krugman has once again used his New York Times column to berate the world of cryptocurrency, and at the same time set a little challenge at the end of his article titled “Transaction Costs and Tethers: Why I’m a Crypto Skeptic” for those wanting to argue that his “crypto skeptic” standpoint is wrong he suggests “if you want to argue that I’m wrong, please answer the question, what problem does cryptocurrency solve? Don’t just try to shout down the skeptics with a mixture of technobabble and libertarian derp.” Well Mr. Krugman – Challenge accepted!
According to Krugman, his beef with the world of crypto “comes down to two things: transaction costs and the absence of tethering.” To answer Krugman’s question we need to take a look at the article which starts off with a little history of how money came to be, developing from chunks of precious metals into the FIAT system we know today of banknotes, credit cards and cheques etc. Krugman argues “Banknotes worked because people knew something about the banks that issued them, and these banks had an incentive to preserve their reputation. Governments have occasionally abused the privilege of creating fiat money, but for the most part governments and central banks exercise restraint, again because they care about their reputations.” Whilst this is true to an extent, I would seriously question the “occasional” abuse of creating FIAT money, and central banks caring about their reputations.
Krugman continues his rant by suggesting that there is no faith in Bitcoin stating “you’re supposed to be sure that a Bitcoin is real without knowing who issued it, so you need the digital equivalent of biting a gold coin to be sure it’s the real deal, and the costs of producing something that satisfies that test have to be high enough to discourage fraud.” Obviously Krugman has failed to learn anything about what a decentralized ledger is or does, and alludes to there being a large number of staff in central banks around the world whose job is nothing more than biting gold coins all day to check the validity of them. To this end – cryptocurrency itself is capable of solving the problem of irresponsible banks and governments printing money willy-nilly to cover debt by the simple fact that (in the case of Bitcoin) there is an irrefutable amount of currency in existence that cannot be changed.
He then argues that 8 years after the creation of Bitcoin, cryptocurrencies have made “very few inroads into actual commerce” – very odd when you consider the number of blockchain patents acquired by Mastercard alone – including one that sets the premise for Mastercard to be able to process crypto transactions alongside traditional FIAT. Granted Mastercard are not fans of Bitcoin as a currency, but this is largely where Krugman’s rant falls apart – he really doesn’t appear to understand the difference between cryptocurrency and blockchain, nor as we illustrated earlier, what a decentralized ledger is. If cryptocurrencies were not attractive to everyday commerce, why are major financial institutions (including those Krugman has no doubt advised or consulted for over the years in some form or another) spending billions on staff, research, development and hardware? I hardly think they are doing it for a laugh.
Krugman then digs into the physical cash side of things – cash transactions for purchases are falling whilst at the same time, dollar cash holdings have risen as a share of GDP since the 1980’s, this growth in cash holdings is allegedly in the form of only $50 and $100 bills. Krugman claims many large denomination notes (assuming $50 & $100 bills) aren’t regularly used for payments and many stores won’t accept them, citing high value bills are being hoarded for illegal activity – to which end he claims cryptocurrencies are competing for the same business. For me, this sounds an awful lot like the FIAT world has a problem it needs to solve first – all that cash (more than half of which is in foreign hands)is doing a dandy job of fueling the drug trade, election bribes and so on. For the record, it would be worth noting the primary reason any store in any country refuses to accept the highest denomination bills of any currency is very simple – if you get caught with a counterfeit you have absolutely no recourse because you cannot claim someone gave it to you as change for a transaction. Oddly, Krugman fails to provide an example of a counterfeit Bitcoin.
The Kool-Aid really appears to kick in once Krugman attempts to address the subject of tethering, or in his words, “its absence for cryptocurrencies”. His argument supporting dollar notes is immediately flawed: “we accept dollar notes because other people will accept dollar notes. Yet the value of a dollar doesn’t come entirely from self-fulfilling expectations: ultimately, it’s backstopped by the fact that the U.S. government will accept dollars as payment of tax liabilities — liabilities it’s able to enforce because it’s a government. If you like, fiat currencies have underlying value because men with guns say they do. And this means that their value isn’t a bubble that can collapse if people lose faith.” By stating the only real factor propping up FIAT currency is that the government says so is poor at best – governments around the world have had to revalue their currencies over the years (Venezuela, Turkey, several African Nations) and it could be argued the that first world economies (such as the USA) are in fact constantly manipulating the dollar via the oil industry and the price of crude.
The dollar is not tethered to anything other than the government (who you will of course obey ‘cos they have guns) – once upon a time there was the gold standard, but the moment things got tough in the depression and governments abandoned it because it meant they were unable to “create money” to stimulate the economy. Worth noting perhaps if the governments at the time were as clever as they believed they were, they would have been able to devise a method with which to stimulate the economy without resorting to printing cash.
Is the abandonment of the gold standard the fault of cryptocurrencies? Of course not, however, what is evident is the inability of governments to stimulate their economies effectively without resorting to the printing press. I suspect Krugman’s skepticism actually stems from the fact that as an economist, he knows full well that a defined and finite medium of currency is exactly the right tool for the job to build a solid economy upon, he just lacks sufficient understanding of the underlying technologies that make such a medium possible.
So, in response to your question Mr. Krugman - Just imagine for a moment if all the dollars in circulation right now were magically written to the blockchain, enabling the government to account for every single dollar? Would it mean you could then account for all that cash and perhaps governments could spend it more wisely? We all know it would, and so do you. The only reasons you have to continue to berate and deride cryptocurrencies are simple:
You don’t appear to understand the basics behind cryptocurrencies
You don’t appear to have any knowledge of decentralized ledger technology
Your underlying arguments suggest people trust paper money because of their “faith” in the governments that print them – with printing presses they can fire up any time they like. Cryptocurrencies can be defined at creation and impossible to alter after the fact – “fact” being the key word here rather than “faith”
As an economist, (which I am not) surely “facts” outweigh “faith” when it comes to managing economies in general? Or is it a case of there is just too much "technobabble and libertarian derp" for you to learn, making faith based monetary systems easier to continue to push toward government decision makers?
Like Mr. Krugman, I too am happy to be wrong of course – and feel free to support any arguments with the “faith” angle – I enjoy a good laugh. Oh, and one last thing for Mr. Krugman – remember the time you commented on technology, specifically the adoption and usage of the internet? I’ll just leave this here as a reminder…
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