What The Pundits Are Still Missing About Bitcoin

Pundit Joe has changed his mind from thinking Bitcoin is completely useless to admitting that it’s at least very useful for buying drugs. Pundit Matt still thinks that’s not really very useful at all.

I don’t blame their narrow impressions; until recently I didn’t grok much more than that (besides the currency’s limited supply, which has no appeal to non-libertarian/Austrian types). But now that I understand Bitcoin a little better, I think pundits like Joe and Matt are still completely missing some of the more revolutionary and universally appealing aspects of the elegant but complex protocol behind the surging cryptocurrency. Bitcoin potentially solves several key weaknesses of the modern financial system that are more easily understood at the extreme ends of the scales.

Bitcoin is a quick, safe, and cheap way to transport very large sums of money. I’m not personally familiar with how hard it is to, say, instantly transfer thousands of dollars to a relative on another continent, although trying to do it with cash is clearly difficult. I don’t how long it takes for wired funds to settle, or how much it costs, or what banks you have to go through, or what information you have to provide. But I’m highly confident that it’s much easier with Bitcoin (especially on a Sunday) – essentially, you just enter the address and wait a few minutes for the next mine block to verify it. It’s difficult to overstate the possible value of lowing these barriers.

Bitcoin is a quick, safe, and cheap way to transport very small sums of money. This end of the spectrum I understand better. The light bulb went on for me when I saw redditors randomly tipping each other in cents and realizing there was basically nothing else like it. Credit cards have enabled the e-commerce explosion, but the overhead of transaction costs rules out tiny purchases. Even with miner fees for quicker verification, Bitcoin obliterates the current system’s minimum viable transaction level, which I think is bound to unlock a whole platform of previously infeasible business models.

Of course, the nearly feeless nature of Bitcoin transactions could appeal to retailers doing business of all sizes; it’s just easiest at the very large and very small levels to see the strengths of cryptocurrency’s cheap, instant, and secure transfers over the weaknesses of the existing system’s expensive, slow and insecure transfers.

Naturally, these advantages attract illicit activities among its early adopters, but as far as I’m concerned that’s beside the point. And cryptocurrencies like Bitcoin, or whatever later supplants it, still face downside risks like scalability, the opportunity cost of relying on electricity, or the third-party add-ons necessary to encourage common adoption (Bitcoin transactions themselves are inherently secure, but storing the result is definitely not.)

But there are enough fundamental advantages that I don’t think optimism is only for the cranks and crackheads. The utopian dreams about ceding power from governments and bankers to the common man may be a little, well, utopian, but to dismiss the whole thing entirely risks sounding like the old doubters of the newfangled Internet who said “no online database will replace your daily newspaper.” Sometimes you just have to wait for the pundits to figure it out.

(Full disclosure: I currently possess 0.00001726 BTC as well as an undisclosed amount of USD.)

Bitcoins and The Spectre of Deflation

I haven’t really blogged about Bitcoin before, but it’s been impossible to ignore this week as the decentralized, anonymous crypto-currency soared to record values and every pundit piped up to predict its fate. If you’ve never heard of Bitcoin, or want to fill in the gaps, check out these explanations and analyses by Felix Salmon (generally pessimistic) and Priceonomics (guardedly optimistic).

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Too Big To Regulate

Normally, when businesses make bad decisions and run out of money, they disappear and better businesses take their place. When the financial crisis hit a few years ago, we were told we couldn’t let this happen to big banks because they would bring down the economy with them, so we had to bail them out. This became known as “too big to fail.”

Now it seems we also can’t get these same banks in too much trouble when they do illegal things like laundering drug money, because punishing them too much would also hurt the economy too much. This is becoming known as “too big to jail.”

Too Big To F(J)ail

Naturally, a lot of people think there’s something wrong about all this, including progressive champion Senator Elizabeth Warren, who recently grilled the Department of Treasury about why they haven’t done much about it, and they almost admitted that they didn’t tell the Department of Justice that doing something about it wouldn’t hurt the financial system:

WARREN: Now in December, HSBC admitted to money laundering. To laundering $881 million that we know of for Mexican and Colombian drug cartels. And also admitted to violating our sanctions for Iran, Libya, Cuba, Burma, the Sudan. And they didn’t do it just one time. It wasn’t like a mistake. They did it over and over and over again across a period of years. And they were caught doing it. Warned not to do it. And kept right on doing it. And evidently making profits doing it.

Now HSBC paid a fine, but no one individual went to trial. No individual was banned from banking. And there was no hearing to consider shutting down HSBC’s activities here in the United States….

WARREN: The Justice Department, in making its decision whether or not to pursue a criminal prosecution, checked with the Department of Treasury to determine your views on whether or not there would be a significant economic impact if a large bank were prosecuted. Is that what you just said?

COHEN: What I said was the Justice Department contacted us, asked whether we could provide guidance on what the impact to the financial system may be of a criminal disposition in the HSBC case….

We informed the Justice Department that given the complexity of the potential dispositions… we were not in a position to offer any meaningful guidance to the Justice Department in that matter.

Warren seems to believe the government refuses to punish people involved in banks that are Too Big To F(j)ail who would otherwise be prosecuted. She may be correct, but she seems to think this injustice can be fixed with more regulation and consolidation of power:

WARREN: Why are their four departments trying to figure out money-laundering? I read through your reports. They seem to overlap significantly… Why is this not consolidated into a single function?

It sounds like a Warren solution would be to add regulation on top of the existing structure with the purpose of simplifying things but would actually probably make them even more complicated and ineffective. It reminds me of the Department of Homeland Security’s attempt to consolidate intelligence gathering by creating more bureaucracies to be involved in it all.

Why Regulation Is Impossible

To understand the futility of regulatory solutions to TBTF(j), one only needs to look at the unfolding implementation, or non-implentation, as it were, of Dodd-Frank, the great financial regulation of our time, created in response to the financial crisis. Washington Monthly has a really long but really interesting piece about the stunning lack of progress, and the lobbyists that are apparently responsible:

Since the law passed, the financial industry has been spending billions of dollars on lawyers and lobbyists, all of whom have been charged with one task: weaken the thing. One strategy has been to carve loopholes into the language of the law, Naylor said. A verb. An imprecise noun…

“You guys have got to be kidding about this ‘as appropriate’ stuff, right?” he said.

“I know,” the muckety-muck replied, admitting it was a stretch. He let out a little chuckle—“but that’s what we’re going with.”

As of now, roughly two-thirds of the 400-odd rules expected to come from Dodd-Frank have yet to be finalized… In the next year or so, the vast majority of these rules will be launched down the rule-making gauntlet…

Since the passage of Dodd-Frank, financial industry groups have also sabotaged parts of the APA’s carefully plodding process, overwhelming rule makers with biased information and fear tactics and threatening to sue the agencies over every perceived infraction.

The takeaway for the author seems to be something like, “Those evil greedy bankers are so evil and greedy and powerful that we need to try even harder to make these regulations work.” But my takeaway is something like, “Those bankers are greedy and powerful and that makes it fundamentally impossible to make these regulations work.”

The modern financial system is extremely complicated. I have a hard enough time remembering how stocks and bonds work, nevermind things like options, swaps, futures, mortgage-backed securities, and credit default swaps (though I plan to watch all of the Khan Academy videos about them once I convince myself it’s worth my time).

Because of this complexity, you can’t really regulate it without the expertise of the people involved. This explains the general industry/lobbyist/regulator revolving doors, but also why the regulators take input from people who are still in the industry.

They have to make sure regulations won’t take down the economy because it’s entirely possible that a misguided regulation will. But to make sure that doesn’t happen, you have to empower the very same people who can also make sure that profit-restricting regulations – and thus regulations that could actually prevent the next crisis – don’t happen, either.

Or, in other words, the only people who could make effective regulation happen are the very same people who can keep effective regulation from happening.

But What About Old Regulation?

Let me pause here to say there is a narrative among the left that financial regulation works, that we had it for decades (Glass-Steagall), but then we repealed it and almost immediately had a crisis, and all we need to do is put that old regulation back in place.

I confess it’s a compelling narrative. I am not ideologically opposed to all regulation, especially financial regulation. Last decade’s crisis played a big part in pulling me in a more pragmatic, postlibertarian direction as I saw market forces failing in the complexities of the system and real greed causing real negative externalities. I see this as a theoretical justification for regulation.

The trick, of course, is to find regulation that is legal, non-harmful, and effective. Some think reinstating Glass-Steagall would do that. The debate on the matter is beyond me, but from the little I do know I’m doubtful that the financial world is that simple. It may be true that the law is better than nothing at limiting negative externalities, and I could probably be convinced to support it, or at least not oppose it, but it’s not going to completely solve our modern, complex, financial woes.

Dodd-Frank is trying and failing to solve that, and as I said above I think there are fundamental reasons it can’t.

What We Should Actually Do

At first glance, it may seem like a depressing worldview to believe that it’s impossible for the government to keep banks away from TBTF(j) with regulation. All the government can really do, as Sonic Charmer keeps saying, is try to arbitrarily keep banks from doing “things that lose money later,” which really just means limiting risk, which limits both profits and losses by arbitrarily making banks less banky.

(Edit: Actually, it’s even worse than that, because regulators aren’t smart enough to accurately limit risk anyway:

All a regulator can do, and does in practice, is try to limit their a priori estimation of the ‘risk’ banks take, but that just means they will accidentally (a) artificially suppress their ability to direct capital to things the a priori model decided was ‘risky’ but really aren’t (or rather, are, but that risk would already be properly priced in), and meanwhile (b) incentivize banks to lever-up on whatever you, the all-knowing regulator, not only didn’t realize was risky but blessed as safe. And there will always be something you didn’t realize was risky and blessed as safe.

So limiting risk is more or less impossible.)

But step back a minute. The only reason we’re so concerned with trying to limit bank losses in the first place is because the government will bail out any losses that get too big. Apparently most of the big banks wouldn’t even be profitable without the corporate-welfare taxpayer subsidies these days.

Maybe if we stopped artificially propping up the big banks, they would shrink. Maybe if we stopped artificially reducing their risk by covering it, they would actually act like they had higher risks and limit their potential losses; the ones that didn’t would get taken care of by the market eventually, anyway.

But what if that caused more financial crises along the way? Well, that seems to be somewhat baked into reality no matter what. If we don’t regulate or bailout, sure, some banks may get too cocky and cause a crisis with their losses. But apparently our flailing attempts at regulation aren’t going to stop another crisis anyways. In the bigger picture it might be better to accept a short-term crisis if it doesn’t lay the foundation for future crises.

Or Is That Impossible Too?

But maybe that kind of libertarian world is just as much a fantasy as the liberal world where Smart regulations keep all the crises at bay. Arnold Kling argues that “promises to end bailouts… simply are not credible,” because politicians will always “compare the immediate consequences of allowing major financial institutions to fail with the costs of a bailout, and they will choose a bailout. Bank executives know this.”

Kling is probably right. He argues for at least trying to do things that would limit the credit guarantees that government could be forced to provide. This may be the “least bad” approach, although I’m not sure if it’s very different from what the Dodd-Frank’s of the world are trying to do already.

And, well, that’s about as far as I’ve gotten. I don’t have many answers yet. If you do, be sure to let me know.

Is The Economy Headed For Good Times or Bad Times?

In one corner, we have the Bulls. “Stocks near record highs.” “Investor risk aversion is disappearing quickly” as “Junk bond yields hit another all-time low.” The housing market is recovering! US unemployment claims are at a 5-year low! Even the deficit is looking optimistic! Etc. Etc. We’ve finally made up for the last few years and are ready to push on towards a bigger and better future!

In the other corner, we have the Bears. “The market has become dangerously euphoric” even as global growth is declining. EU unemployment is still rising. Cyprus is defaulting. Obamacare is not slowing down health insurance costs. US deficits are still over one trillion dollars per year and interest rates are still at zero, and that’s before the next recession hits. Etc. Etc. We’re sitting on top of another artificially inflated bubble that’s about to come crashing down harder than the last one!

Continue reading Is The Economy Headed For Good Times or Bad Times?

BREAKING: The Federal Reserve Does Not Know Everything

Transcripts have been released from some Federal Reserve meetings in 2007. I haven’t read through any of the hundreds of pages, but the word on the pundit street is that, despite having a lot of information at their fingertips, the Fed kinda didn’t really at all anticipate the big crisis that was about to unfold. Apparently this revelation surprised some of the pundits, but it did not surprise me in the least.

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Curious Trends in the National Debt

As another year comes to an end, it’s time for the annual treasure troves of annual statistics. Here’s one: “Treasury 10-year note yields were poised for the lowest annual average since at least World War II.” The interest rates on treasury bonds have continued falling despite the enormous rise in the national debt.

us-national-debt-2012The national debt has tripled since 2000, but the amount of interest paid per year has definitely not. These things are hard to measure, depending on how you count that Social Security IOU thing and “net interest” and other factors that make my head hurt, but by pretty much any metric, the amount of interest paid per year has barely budged. Here’s some data straight from the Treasury website:

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Income Taxes Are Probably Becoming More Progressive

We still don’t know what kind of “fiscal cliff deal” we’re going to get, or when we’ll get it, but I agree with those who think it will probably include an extension of the Bush tax cuts for incomes under some level. Much of the current haggling has to do with whether or not that level is $250,000 or $1 million or somewhere in between.

If this happens, it means the income tax rate will become more progressive than it already is, as higher-income folks see higher tax rates and everyone else’s stay the same. This will be difficult to reverse; can you imagine later trying to sell either a tax hike for everyone except the rich or a tax cut only for the rich?

Such an increase in progressivity would be slightly good for the deficit, and good for my current personal finances, but I’m not sure it’s sustainable policy.

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Correlations In Job Creation and Political Parties

Last night at the Democratic National Convention, Bill Clinton said, “Since 1961, the Republicans have held the White House 28 years, the Democrats 24. In those 52 years, our economy produced 66 million private sector jobs. What’s the jobs score? Republicans 24 million, Democrats 42 million.”

The fact-checkers have said it’s a fact, end of story. But I’m feeling especially wonky tonight, so I dug a little deeper. First, I pulled up the BLS data to see if I could duplicate the stats. I couldn’t figure out how to separate private jobs from government jobs, but I analyzed the full data and found 32 million jobs during Republican years and 48 million during Democratic years. If you add the private and public numbers from the Bloomberg article, that gets you there, and when you calculate the average per month, it looks pretty good for Democratic presidents. (The number in parentheses after the party initial indicates how many years of data are in that sample size)

jobs-added-president-party-1961-2012But I wondered if 1961 was a cherry-picked starting point, so I went all the way back to the beginning of the BLS data in 1939:

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