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Is the Bank of England right about the dangers of Bitcoin and digital currencies?

Is the Bank of England right about the dangers of Bitcoin and digital currencies? Mindful Money

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It was only yesterday that I was reviewing the march of the central banks as they gather more powers and intervene in more areas. This was added to later by the Sydney Morning Herald reporting that the Bank of Japan was getting near to being the biggest investor in the Japanese stock market. From time to time, economists appear and suggest that central banks should spend the profits or seigniorage from issuing currency. If you think about it, there is quite a profit margin in turning some ink and paper into something of high value, and electronic money creation which is the modern form has even lower costs.

Added to this have been events in Cyprus and Bulgaria. In Cyprus, non-insured bank deposits saw a haircut applied to them, which of course posed the question: could this happen elsewhere? Such fears would be particularly prevalent in the euro area as it has crossed the Rubicon already. The issue in Bulgaria is the one which I have covered before concerning the collapse of Corpbank. But for today’s purpose, the main issue is the failure of the national deposit insurance system to pay out. Yesterday, the European Commission took action on this front.

"Bulgaria must allow bank customers to access their money.

"The Bulgarian deposit guarantee scheme is currently not paying out on claims by depositors of Corporate Commercial Bank AD and Commercial Bank Victoria EAD within the timeline foreseen in the DGS Directive.

"Both banks have been closed since the second half of June. Depositors have not had access to their funds for three months. According to a decision by the Bulgarian National Bank (BNB) on 16 September 2014, no decision will be taken before end-November [...] The current situation may undermine public trust in the deposit guarantee scheme in Bulgaria."

I do like the “may undermine” as it plainly already has! The European Union is tiptoeing around this a little because such deposit insurance is supposed to be harmonized these days.

The digital currency and Bitcoin

The paragraphs above explain why interest has developed in currencies which do not require a clearing or central bank. In essence, as central banks have expanded, their operations trust in them has headed in the opposite direction. It is, in my opinion, no coincidence that Bitcoin began in 2009 as the era of extraordinary monetary policies were underway in many major central banks. Of course, the gains in computer and internet technology made it possible, but they did not provide the motivation. The Bank of England puts it thus.

"The foundational motivations for Bitcoin appear to have been largely ideological. The digital currency was expressly designed to avoid any centralized control (of either the money supply or the payment system) and to minimize the degree of trust that participants need to place in any third party."

Indeed at a time of increasing surveillance, Bitcoin also offers what for many will be a refreshing anonymity.

"Bitcoin users do not have to disclose who they are. They maintain a digital ‘wallet’ on their computers and, by use of special software, trade the currency among each other in exchange for traditional currency or goods and services."

Of course, this travels in the opposite direction from the official line which is that there is nothing to fear from officialdom knowing an increasing amount about you. We are also told that the data collected by officials is safe, which in the UK at least is usually followed by some piece of news about a laptop containing such data being mislaid on a train or bus. Actually, secrecy is a double-edged sword as it allows personal privacy, but of course does provide a potential hideaway for illegal activities. After all if illegal activities are hidden away, how can the authorities count them in the new improved gross domestic product statistics?

Next we have a feature which really sends a chill up the spine of the economists and officials at the Bank of England.

"Most digital currencies incorporate a pre-determined path towards a fixed eventual supply."

Such a concept must seem incredibly alien to central bankers wedded to “pumping it up” and “more, more, more”. You can almost taste their scorn in the quotation below.

"In addition to making it extremely unlikely that a digital currency, as currently designed, will achieve widespread usage in the long run, a fixed money supply may also harm the macroeconomy: it could contribute to deflation in the prices of goods and services, and in wages. And importantly, the inability of the money supply to vary in response to demand would likely cause greater volatility in prices and real activity."

It is rather a cheek to talk about deflation of wages don’t you think? Perhaps they have not looked out of their ivory tower for a while! After all, it was the Bank of England which helped drive down real wages in the UK as it accommodated above-target inflation whilst it expanded monetary policy.

Indeed, those who think like me that the expansionary monetary policy of the credit crunch era has plenty of hazards will have a wry smile at least at the cheek of this bit.

"Digital currencies do not currently pose a material risk to monetary or financial stability in the United Kingdom, given the small size of such schemes. This could conceivably change, but only if they were to grow significantly. The Bank continues to monitor digital currencies and the risks they pose to its mission."

You did not know that the Bank of England had a mission? Well if every coffee shop chain has one, then surely a central bank must have one too? If we are being kind, we could infer that Mark Carney is a fan of the Mission Impossible series.

"Your mission, Jim, should you decide to accept it..."

Sadly for him, the records of the first effort at Forward Guidance did not self-destruct in five seconds, although the policy nearly did. Oh, and what about the policies of the Bank of England being a threat to the monetary or financial stability of the UK?

Actually Bitcoin does still have room for expansion in its money supply.

"There are currently a little over 13 million bitcoins in circulation and that system’s protocol dictates that there will be an eventual total of 21 million, which should be largely reached by around 2040."

Is it money?

The Bank of England spends quite some time analyzing the features of money (store of value, medium of exchange and unit of account) so it can point out the weaknesses of Bitcoin as it perceives them.

"In theory, digital currencies could serve as money for anybody with an internet-enabled computer or device. At present, however, digital currencies fulfill the roles of money only to some extent and only for a small number of people."

As you can see in essence it is money and should it expand will become ever more like it.

Comment

I have analyzed Bitcoin today and looked at the driving forces behind it. Most of the analysis is general to the issue of digital currencies as my view remains the same as it was on November 19th last year.

"For that reason I welcome the digital currency era although it comes with a litany of warnings as if we recall the railways of the nineteenth century there was a boom/bust cycle with maybe more collapses than successes. On its side is that a problem then (cost of entry) is much lower now but as I have discussed earlier that may yet create its own problems."

Back then, it cost some US $900 to buy a Bitcoin as it boomed. Since then there has been more of a bust, as the price is hovering above US $400 as I type this. However, some care is needed as that is still a lot higher than this time last year.

As ever there is a yin and yang on these matters. Last November, comments to my post pointed out that there was an issue around exactly who would police any Bitcoin counterfeiting? However today, we have news about more corruption in the world financial system as UK banks are told to prepare for around £2 billion of fines as a punishment for foreign exchange market rigging. At least that is one area of revenue which is booming and reducing our fiscal deficit. We have replaced taxing banks with fining them. Of course, the threat that the Bank of England is probably most worried about is that digital currencies may one day supersede much of what is currently done by banks and indeed it

If you are a golf fan, then enjoy the Ryder Cup; if you are not then I guess the book A good walk spoiled gives a hint at an alternative.

This article was written by Shaun Richards and originally published on September 26, 2014, in Mindful Money under the title: Is the Bank of England right about the dangers of Bitcoin and digital currencies?


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