di Adair Turner
In December, as the Bitcoin price neared $20,000, a friend asked me whether she should invest. I said that I hadn’t the faintest idea. Today, with the price below half that, my reply remains the same.
Over the next year, the Bitcoin price could double, soar tenfold, or collapse by 95% or more, and no economic analysis can help predict where in that range it will lie. Its value is arbitrarily determined by the collective psychology of the mass of investors; it goes where, on average, they think it will. Like other cryptocurrencies, Bitcoin serves no useful economic purpose, though in macroeconomic terms, such currencies probably also do little harm.
In a modern economy, money has a well-defined real value because governments accept it as payment of taxes and issue debts in defined monetary amounts, and because central banks ensure that total monetary creation, by either the state or the private banking system, grows at a pace compatible with relatively low and stable inflation. In some sense, money is an arbitrary social construct; but its value and ability to serve crucial economic functions are rooted in the authority and institutions of the currency-issuing state.
At any time, however, groups of individuals can choose to believe that some commodity – a specific type of seashell, or gold, or tulips – will be a far better store of value than money, and that its value in money terms is bound to rise. What matters is simply that the supply of the chosen commodity cannot be rapidly and limitlessly increased. Provided that is the case, the price can be whatever speculators believe. In early 1636, a pound of “switsers” (a particular category of tulip bulb) traded in Dutch markets for 60 guilders; by mid-February 1637, the price was 1,500 guilders. In the subsequent crash, some bulb prices fell 99%.
Unlike gold or tulips, whose supply is fixed in the short term and constrained by nature in the medium term, immaterial Bitcoin could in principle be created in infinite quantities. In fact, the currency’s supply is limited by clever software algorithms, supported by huge quantities of computing power, which have enabled Bitcoin’s creators to achieve a previously impossible trinity: decentralized “mining,” collectively limited aggregate supply, and anonymity.
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