The Federal Government’s Reaction To Bitcoin Is An Acknowledgement Of The Dollar’s Vulnerability

Published August 25, 2013

With an insight that eluded many 20th Century macroeconomists, the cybergeek innovators recognized the natural market connection between the value and the quantity of the currency.  So Bitcoin is organized to inherently limit its quantity.  All transactions in the currency are recorded by servers, designated as Bitcoin miners, on ledgers that are regularly updated and archived.  Under a formula originally specified in the founding documents for Bitcoin, new Bitcoins are created with every ledger update.  But the formula specifies that the number of new Bitcoins created with each such update is cut in half every 4 years, until it reaches zero in 2140, when the total number of Bitcoin units will reach their maximum quantity of 21 million.  Each Bitcoin unit, however, is subdivided down to 8 decimal places, which creates 100 million smaller subunits called satoshis.

The value of each Bitcoin unit and satoshi subunit is established by market demand in daily transactions.  So the specified Bitcoin supply can cover more in market value transactions depending on that market demand.

Bitcoins are bought and sold over the Internet every day.  Those market transactions determine the current value of Bitcoins daily.  Each company or individual in the market is free to determine whether and to what degree they will accept Bitcoins in return for the goods, services, and even property they sell.  Germany formally recognizes Bitcoin as a legal form of private currency.  But what is most significant about the development and rise of such currencies is that no government authorization or recognition is necessary for such currencies to operate in the market through the free exchanges and decisions of buyers and sellers.  The validity and value of Bitcoin is up to each individual in the market.

No doubt Bitcoin aficionados can contest, expand or clarify every statement and judgment uttered about the cybercurrency.  But the bottom line is that it is a private, alternative, competing, and complementary currency on the model espoused by Nobel Laureate Friedrich Hayek, designed basically on the monetarist model espoused by Nobel Laureate Milton Friedman.  That monetarism is reflected in the steady, regular, predictable increase in its supply, and in the daily market revaluation of its value.

Bitcoin is not a fiat currency in that no government declares by fiat that it is legal tender for any particular use.  But it is fiat in the sense that it is created in the cybersphere out of nothing more than imagination, with no inherent value, unlike gold or silver coins, or currencies backed by precious metals.  In the book Rethinking Money, former EU monetary official Bernard Lietaer reports that 6,000 to 7,000 such private, alternative, competing and complementary currencies are currently in use around the world, the great majority not backed by anything of inherent value except the willingness of market participants to trade in them.  The number of such currencies has shot up from an estimated 5,000 in 2005.

The public reason for the attention of government officials and regulators to this development is the potential for malevolent use of Bitcoin, and other such currencies, by criminals and even terrorists, to transfer funds for illegal activities and worse, and for money laundering.  The Senate Homeland Security letter states regarding these currencies, “Their anonymous and decentralized nature has also attracted criminals who value few things more than being allowed to operate in the shadows.”

The Personal Liberty Digest (PLD), a top libertarian website, reported on August 14, “Liberty Reserve, another virtual currency system based in Costa Rica, was shut down in May when the Justice Department charged the company with money laundering and used the Patriot Act to lock it out of the American financial system.”  The government complained that Liberty Reserve allowed customers to convert money into a virtual currency and transfer it from account to account with a 1% transaction fee, the PLD website explained.  That sounds like a good deal to me, but “Justice and Treasury officials said that allowed criminals to hide the sources of their money,” PLD reported.

But criminals are not criminals until they are convicted of something, and hiding the source of your money is not against the law, except for what you are legally required to disclose on your tax return.  The source of your money is not a public matter, but a feature of your personal privacy, absent a specific legal disclosure requirement.  The Justice Department has no business even asking you about the source of your money until it has sufficient probable cause to bring you in for questioning, and/or to file for a warrant for your personal financial records.

Personal Liberty Digest quotes U.S. Attorney Preet Bharara as saying about the Liberty Reserve case, “The global enforcement action we announce today is an important step towards reining in the ‘Wild West’ of illicit Internet banking.  As crime goes increasingly global, the long arm of the law has to get even longer, and in this case, it encircled the earth.”  But there is nothing on the public record I can see showing that there was anything illicit about Liberty Reserve.  It is Bharara’s “global enforcement action” which is the first documented abuse I have seen of the Patriot Act, warranting Congressional investigation and correction.  Without convicting any Liberty Reserve customer of breaking any law by converting money into a virtual currency and transferring it from account to account, Bharara’s “global enforcement action” against Liberty Reserve is an apparent violation of Due Process.  Nor does the jurisdiction of the Patriot Act “encircle the earth,” which is imperialist rhetoric.

In March, the Financial Crimes Enforcement Network (FinCEN) of the U.S. Treasury cleared American users of Bitcoin, and similar currencies, of any legal obligations under U.S. law.  But it held that American entities that sell such currencies to the public were Money Service Businesses (MSBs) subject to mandatory registration and disclosure requirements under U.S. law.  Those duly adopted requirements are legally valid and enforceable.  They apply within the U.S.

Which means that any foreign financial institution that operates wholly outside the U.S. can issue any sort of currency it desires, and its activities are not subject to U.S. regulation or enforcement.  Moreover, it cannot even be punished by exclusion from the U.S. financial or payments system without due process of law.  It must be shown at least to have participated in some activity that violated U.S. law, before it can be punished under U.S. law.

The Coming End of Fiat Currencies

The term “fiat currencies” is strange and mostly not understood in this modern “progressive” era, where everything is transformed by political “Progressives” into fiat rather than natural forms, which continue to exist as long as so-called “Progressives” have the power to impose them.  So instead of Natural Law, we have fiat law, which is whatever those who currently have the political power say it is.  And instead of Natural Rights, the world today mostly recognizes only fiat rights, which are only the rights those in power say we have.  America was rooted in Natural Rights and Natural Law, which so-called Progressives have been rebelling against for more than 100 years, certain they had better ideas more suited to the modern world.

And so today we have fiat money instead of natural money.  Fiat money is money with a government declared value, rather than a natural, inherent value.  That is how the government takes some paper, slaps some ink on it, and supposedly it has the value the government and the ink says it has.

But that fiat money also lasts only as long as the ruling class has the power to impose it on us.  That means the political power and the market power to do that.  At some point, the market power, which is more real and natural, can overcome the political power.  And that is the point we are reaching, when the innovation becomes more real and natural.

It is not Bitcoin, or Liberty Reserve, or any other private organization that is abusing and trashing the dollar.  It is the United States Federal Reserve.  Since the Fed was established in 1913, the dollar has lost 95% of its value.  That is due to the depreciation of the currency resulting from the Fed’s monetary policies.  The Fed has been a true to form “progressive” institution since its founding as one of the first reforms of the “Progressive” Movement.

Jim Cramer was quite wrong, and trite, when he appeared on a CBS TV show to say that Bitcoin is not a true currency, because there is no central bank to regulate it.  Currencies do not need regulation by central banks to function as true currencies.  Central banks need regulation by markets to keep their currencies functional.  And Bloomberg News was equally wrong, and trite, when it so predictably published the dysfunctional progressive party line in a column on April 4 by Mathew Zeitlin, saying that durable currencies can only function as creatures of a state.

The dollar prevails as the world’s reserve currency because it has only been in competition with other fiat currencies that have been equally mismanaged or worse.  The regulatory and prosecutorial hostility of the U.S. government towards private alternative currencies tells us that the U.S. government itself sees a vulnerability of the dollar to these currencies.  The Fed has expanded that vulnerability now to the breaking point with its wild reckless policies of recent years.

When the Fed embarked on its Quantitative Easing policies years ago, Chairman Bernanke was so sure he could reverse them before they caused any real problems.  But the real difficulty he should have foreseen, given past Fed experience, was that it would never seem like a good time to do so before it was too late.  Now, years of near zero real interest rates and QE have not produced any real economic recovery.  But these policies have stuffed the balance sheets of American banks, and the Fed itself, with government and corporate bonds that are going to plummet in value when the Fed slows QE bond buying, letting interest rates return towards normal, market levels, which will signal everyone else in the markets to stop buying too.

And how many other investments throughout the American economy have been based on those same near zero interest rates for continued viability?  So when the Fed backs off QE, and its years long zero rates, that is going to rock the solvency of the entire U.S. banking system, the U.S. economy, and even the Fed itself.  But if that forces the Fed to reverse course, and try to persist with QE and zero rates, that will ultimately cause ruinous inflation that will only worsen, until the Fed goes back to trying to withdraw from QE and zero rates.

The economy is already barely growing, if inflation is currently measured correctly.  If the Fed further destabilizes the economy, the dollar will probably further decline, as who will want to buy dollars to invest in a declining economy only continuously threatened with even higher tax and regulatory burdens?  But if the Fed redoubles on its current policies, the dollar will probably decline further under the threat of eventual inflation.  Who will want to hold dollars under this increasingly narrowing conundrum?  That is when the world may turn to something different.

It is not Bitcoin that will arise as the alternative global reserve currency, because as discussed above, it has no inherent value either, so it is subject to wide swings in market value too.  The real threat to the dollar is a different, private, alternative currency that can arise, that is based in real commodities with inherent value.

Such a currency will not be rooted only in the imagination of cyberspace, but will look more like the currencies of old that gave rise to booming capitalism.  A foreign financial institution free from meddling, destabilizing, self-interested, U.S. policy interference can issue a currency where each unit entitles the bearer to specified quantities of a diversified basket of precious commodities, like gold, silver, copper, oil, diamonds and similar commodities that inherently hold their value over the long run.

The market value of such a currency will inherently be stable, tied to real value in the real world.  When the market value of the underlying commodities declines, the issuer of the currency can buy more, and expand the currency, which will stabilize its value, and accommodate a growing economy.  When the market value of the commodities rises, the issuer can sell some commodities, and retire some currency, which will again stabilize its value.  The rest of the world can and will see the value in such a new reserve currency, which would be designed more on the hard money, supply side model of Nobel Laureate Robert Mundell, and his former student Art Laffer.

Such a private, alternative currency was described and explained in detail in Lietaer’s book.  This is the real threat to the global reign of the dollar.  And the reaction of the U.S. government to Bitcoin shows that the U.S. government itself sees that dollar vulnerability.