Monthly Archives: September 2011

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.