Krugman’s Bitcoin Error

Paul Krugman, the Nobel Prize winning economist, is not really interested in Bitcoin. The only reason he recently wrote about the new cryptocurrency in his New York Times blog is because some people have urged him to. What he really wants to do is make a point about monetary systems, deride anything functioning “like a new gold standard.” His argument goes as follows: 1) Bitcoin is like gold; 2) currencies should be used for transactions; 3) people are hoarding Bitcoin; therefore, 4) Bitcoin once again demonstrates that anything functioning like gold is a bad idea.

To his credit, Krugman tells us where he read up on Bitcoin. He gets his arguments from an excellent post by James Surowiecki on the MIT Technology Review blog. Surowiecki’s point is that many people are using Bitcoin as an investment (asset) and not as a currency. If Bitcoin users ever want the system to function as a currency then they will need to use it more than they are to buy products and services. Krugman should have read the Surowiecki post closer. As it is, he is so in a hurry to make his the-gold-standard-is-a-bad-idea argument that he doesn’t realize that the very evidence he musters could prove to be Bitcoin’s salvation.

Krugman believes that the drop in value of transactions since June means that people are hoarding Bitcoin. Since he doesn’t take the time to understand the Bitcoin economy, he makes an error by extrapolating from more fully developed currencies. What he doesn’t consider is that the value of transactions follow quite closely what is occurring on the exchanges. This indicates that most of the value of transactions are speculative (or investment) transactions. The drop in value of transactions, as Surowiecki points out, could actually represent an emerging healthier distribution between speculative and non-speculative portions of the economy.

Hoarding is holding onto a currency or a commodity that you could otherwise spend or sell. For the most part people are not hoarding Bitcoins because there are as of yet not very many things or places where you can spend them except on the currency exchanges and a few dozen other places. Krugman completely neglects the fact that non-speculative markets for Bitcoin are still poorly developed. In his argument he does not distinguish between speculation and other types of transactions. As Surowiecki writes, this distinction is fundamental. As speculators abandon Bitcoin, the value of transactions may continue to fall. This could prove to be a good thing for Bitcoin. What has yet to be seen, however, is if people and businesses will continue to adopt and use Bitcoin even without all the speculative excitement around the currency.

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12 responses to “Krugman’s Bitcoin Error

  1. Anony Mouse September 11, 2011 at 9:14 PM

    spelling nazi says “hoard”, “hoarding”

  2. presentcynosure September 11, 2011 at 9:26 PM

    I really was too quick on this one. Now looking it over, I found two other spelling errors. Thank you.

  3. Pingback: Present Cynosure: Krugman’s Bitcoin Error | Bitcoin News

  4. beeemtee September 12, 2011 at 4:02 AM

    While the intonation of Krugman’s writing is superficial, and it’s also clear that he did not put too many efforts into the analysis of the bitcoin economy, his concerns are deeper and his argument is stronger than what the bitcoin community currently perceives.

    What Krugman says – as I understand it – is that the deflation inherently present in bitcoin’s nature makes the work out of a healthier balance between the speculative and non-speculative parts impossible.

    1. Why would anybody spend a coin that’s destined to increase in value until his/her regular income comes in bitcoin form?
    2. Why would anybody want to make his/her life or business depend on a currency whose price is highly unpredictable?

    I think these are the questions that hold the bitcoin economy in its highly speculative form.

  5. Jean-Pierre Rupp September 12, 2011 at 9:28 AM

    I for one converted all my money to bitcoins. It’s not under the control of a central bank, and not subject to random swings in its money supply. It’s not debt, so while I keep them I know I actually have them. If I want to pay for something, I prefer to pay with bitcoins since I almost exclusively have bitcoins.

  6. Daryl the Data Plumber September 12, 2011 at 10:08 AM

    @beeemtee

    I have a response to your questions, but I got very long-winded and posted them here instead: http://dataplumber.blogspot.com/2011/09/bitcoin-fud.html

  7. Pingback: Bitcoin FUD « beeemtee

  8. presentcynosure September 12, 2011 at 9:40 PM

    @beeemtee, I find your exchange with Daryl the Data Plumber very interesting. You are both bringing up many important points. I would like to weigh in on just one. In both of your comments so far you use the word “inherently”. In the first one you write, “the deflation inherently present in bitcoin’s nature.” And in the second you write about “the inherent deflation of the currency.” Correct me if I am wrong, but I can’t help thinking that at least in the second case you are referring to the fact that ultimately the total number of Bitcoins mined will not exceed 21 million. In practice, however, Bitcoin is at the present moment an inflationary currency like any national fiat currency. The only difference is that we know in advance the rate of growth of the money supply. An argument could be made that it is the inflationary “nature” of Bitcoin that is contributing to its current slide in value. Bitcoin will be an inflationary currency for all intents and purposes for at least another 20 years.

    Krugman’s point, was a little different. He claimed that Bitcoin was effectively (not inherently) deflationary because people were hoarding it. As I point out in my post, this is not at all evident. It may very well be that the decline in value of transactions is reflecting a decreasing quantity of trade, and that non-speculative transactions have actually been on the rise over the same period. It would be impossible to tell what is actually the situation from the data he cites, or any data that I have seen up until now.

  9. Pingback: Present Cynosure: Krugman’s Bitcoin Error | Coin Collecting Etc.

  10. example September 13, 2011 at 10:14 AM

    “I for one converted all my money to bitcoins. It’s not under the control of a central bank, and not subject to random swings in its money supply. It’s not debt, so while I keep them I know I actually have them. If I want to pay for something, I prefer to pay with bitcoins since I almost exclusively have bitcoins.”

    But, if people convert all their savings to bitcoin, and they’re still making an income some government currency, it’s likely they’ll spend their government currency rather then their bitcoin.

    The thing is, though, there is a self balancing aspect that Krugman isn’t thinking about. Bitcoins only have value because of their utility. If no one spends them, then their utility goes down and thus the value goes down. And if the value goes down then the tendency of people to hoard them also goes down, and turn this makes people spend them, which pushes the value back up.

    The problem, though, is that you can have wild swings, which also hurt the value, but aren’t balanced out

  11. Jean-Pierre Rupp September 13, 2011 at 12:37 PM

    Keynesian economic theory premises do not make much sense to me. And logic states that if we start with the wrong premises, we can only achieve bad conclusions. Garbage in, garbage out.

  12. Dino September 14, 2011 at 7:51 PM

    I can’t believe people write articles analyzing Paul Krugman’s thoughts on Bitcoin. Paul Krugman loves anything big government and despises anything that interferes his saviors ability to print/spend relentlessly. Could you imagine if we paid taxes in Bitcoin and the Feds had to use it

    So…… of course he hates Bitcoin. What silly ass reasons/excuses/explanations he comes up with are irrelevant and most assuredly devoid of logic.

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