Why Bitcoin is Not a Threat to the U.S. Dollar

December 3rd, 2013
in Op Ed

by Chris Mayer, Daily Reckoning

The best place to park some cash in the last five years was in Bitcoin, the digital currency.

Bill Bonner wrote recently in a note to members of his family office (of which I am one):

"The value of [Bitcoin], per unit, has gone from under 10 cents when it emerged, in 2008, to $754 at this writing. If you'd put in $10,000 a few years ago, your stake would be worth over $75 million today."

There's nothing that has come close to that.

Follow up:

Which inspires the thoughts that follow. Below are some speculations about the nature of money, Bitcoin, the U.S. dollar and the wealth-generating power of a simple coffee can.

I don't know that anyone turned 10 cents into $75 million, but there are a lot of great stories out there about people reaping big gains with Bitcoin. I like the one about the guy from Oslo who bought $27 worth of Bitcoin - and then forgot about it. Four years later, he remembered, and found out his account was worth $1 million.

This story illustrates the power of what I call the coffee can idea.

The premise of the coffee can portfolio, you may remember, is to take a select group of stocks and forget about them. Figuratively speaking, you put them in your coffee can. Open 10 years later and see what you have.

Coffee Can

What's in your coffee can?

The theory is you'll be richer for your negligence, which protects you against your impatient and impulsive self. There is no way our man holds onto his Bitcoin if he's paying attention. He talks himself out of his gains long before they hit $1 million. But he coffee-canned it, and made a handsome pile.

That's the power of the coffee can concept.

Anyway, the guy wound up cashing in his Bitcoin once he found out his stash was worth a million bucks. He used one-fifth of that stash to buy an apartment in an expensive part of Oslo. Nicely turned.

Predictably, mind-boggling returns in Bitcoin have led to the creation of lots of new digital currencies: Peercoin, Namecoin, WorldCoin, Gridcoin, FireFlyCoin, Zeuscoin, HoboNickels and more. According to The Wall Street Journal, there are more than 80 such variants.

And why not? It's of a piece with speculative mood of the times. Frankly, I don't know what to make of it all.

I know a lot of people frame Bitcoin as some sort of free-market competitor to the U.S. dollar - or to any state-backed currency. On one level, this is obviously true. Bitcoin is an option of something you can hold instead of dollars, at least for a time. It's a competitor to the dollar in the same sense as an ounce of a gold, a share of stock, a barrel of oil or a piece of real estate.

But Bitcoin isn't a threat to the U.S. dollar as a currency - at least for the American taxpaying population - unless one thing happens: The government accepts it for the payment of taxes.

I know that's about as likely as snow in Miami.

But it's useful to think about because it gets to a question of why we accept paper dollars at all. Why does the U.S. dollar have any value at all?

What is the Income Play Rich Investors Love? (Hint: It's Tax-Free)

Why does this have any value at all?

There are many theories on the nature of money. I have become enamored lately with the ideas of a little-known writer named Alfred Mitchell-Innes. He wrote a pair of essays in 1913 and 1914 that explored the history and nature of money.

The essays got quite a bit of attention in their day, even drawing the review of John Maynard Keynes. But economics went in another direction, and Mitchell-Innes got lost in the mists until a recent revival by a fringy group of economists and anthropologists.

The full story, as interesting as it is, would take us too far afield. Mitchell-Innes, though, made one point in these essays that is a timeless observation relevant here. He wrote, "Government money is required everywhere for the discharge of taxes or other obligations to the government."

It's pretty simple. If he's right, then acceptance of the dollar depends on the ability of the U.S. government to collect taxes. And the U.S. is very good at collecting taxes, which any number of otherwise hard-to-bring-down criminals have found out. (They got Al Capone on tax evasion, don't forget.)

Al Capone

Al Capone found out why everyone accepts U.S. dollars

So the U.S. levies taxes on the U.S. population, and when combined with its fearsome tax-gathering goons and prisons, it instantly turns everyone in dollar-seekers to settle those obligations. I think people tend to forget this elemental truth, especially when they start talking about Bitcoin.

It's been true since the time of kings and explains why all kinds of odd things have been money at some point. Randall Wray, who seems like a bit of a nut, sums it up nicely in a book about the work of Mitchell-Innes (Credit and State Theories of Money):

"Why would the population accept otherwise 'worthless' sticks, clay, base metal, leather or paper? Because the state agreed to accept the same 'worthless' items in payment of obligations to the state."

This doesn't mean Bitcoin can't grow in value or settle transactions among individuals. Of course it can. And it doesn't mean the dollar can't lose value over time. Of course it does.

The dollar, despite its ability to settle up with Uncle Sam, isn't an investment. It's really a token, a way of keeping score. It's something to tally up credits and debits. This is an idea Mitchell-Innes understood.

And Bill Bonner, to bring the thing 'round to where I began, also knows this: "Money is just a placeholder," he wrote. "It has no value in itself. It just signals your position relative to everyone else... It doesn't really matter what you use as money. But some things work better than others."

As for Bitcoin, your guess is as good as mine what happens. (I don't own any.) As for the U.S. dollar, until the facts discussed above change, we're stuck with the U.S. dollar. But I wouldn't put it in your coffee can.

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