Economics 2.0

THE MEANING OF SOCIAL ORDER

IF there is dumb, there’s dumber; smart, smarter; thievery, plunder; good, saint; plain Jane, invisible; pretty, beauty; etc.

The point is that we can use these gradations to better understand economics.

When you do things for status, that’s social order driving the economy.

But what kind of good is status? It’s not rival, because you can’t eat it; but it’s exclusive. A club good?

Citizenship is a club good. So is formal education. So is the opinion of your peers. We strive for and shed these things, depending.

And that makes the economy, micro or macro, somewhat unpredictable. Yet, understandable.

Perhaps status is an informal club good, akin to Groucho’s inexistent club. And as an informal club good, status is like fiat money, valuable only on the prevailing whim of a society that confers that value.

But unlike fiat money, status can’t just be printed. There is no central bank that can create status.

This kind of thinking leads us nowhere, doesn’t it? Still, better to know that we’re not anywhere, than to pretend we’ve arrived.

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Economics in disarray

Economics has problems. Because of Samuelson, it got a half-century case of physics envy. Then people read Schumpeter and McCloskey, and realized economics can’t predict a whit. Economics became useful (ex post) stories, a bit like archaeology or geology.

Then came The End of History (1989) and The Great Recession (2008), and weirdos still talk of evolving economics, but into what they can’t explain. Like Marx redux, they blame ‘capitalism’ or neoliberals, though they can’t go whole hog back to old-style apparatchik economics. Some think that the missing link is a co-equal infant science called psychology.

What to do? At one point, one way out was to study ‘institutions.’ But this seemed like hard work — too much scholarly pain for little gain. But gains there were if you read Coase or Ostrom, or (if you want Keynes to shudder) Hayek.

Perhaps that’s just the way it is. Economists are more like chickens with no heads but imaginarily pecking away at crumbs of intellectual progress. Some toil away at saving the world from falling over a cliff, much like Salinger’s Catcher in the Rye. That’s at least humanitarian if mostly unheralded.

Keynes did say that economists should be more like dentists. Dentists are good guys who help people prevent cavities and enable them to smile. The economist can then go home after a day’s work knowing the economy will still do its wayward thing but not die.

Virtual currencies and their institutions

Or why Bitcoin and its variants are risky assets.

It’s fair to say that virtual currencies need block chain. Block chain is an essential or necessary innovation behind such currencies. That block chain is not sufficient becomes obvious when we consider the question of how many virtual currencies can exist.

This is pretty much a question in institutional economics. It would be like asking which fiat currency would dominate global transactions.

Ronald Coase’s transaction-cost theory of the firm probably has the answer.

The dominant virtual currency is the one with the least transactions cost. While trust is an unmeasurable element that reduces transactions cost, transaction cost can itself be measured.

There are other factors along with trust that augur well for the dominant virtual currency. Among these factors are:

It should have ‘standing’ with central banks if only because they issue legal tender, whereas virtual currencies are not.

Its value in terms of the dominant fiat currencies must be reasonably stable. For now, the leading virtual currency, Bitcoin, fails.

Also equally important is transparency in its creation and modification. It seems that users of a virtual currency will need at least an unwritten constitution that lays out the fundamental laws of the community of users, even if they wish to be as ‘decentralized’ as possible. Again, here, Bitcoin fails, as can be seen with the ongoing ‘fork’ controversy over Segwit2.

CONCLUSION. It’s too soon right now to say that Bitcoin is here to stay.

SATOSHI 2.0, or how to create a better Bitcoin

Will Bitcoin survive? In what form? These are the two most pressing questions on the most popular ‘virtual’ currency, or crypto currency, today.

Bitcoin emerged along with a computing technology called block chain. Once understood, block chain promises to permit security arrangements for payment and even barter systems that are vastly superior to existing ‘centralized’ systems.

For the use of a virtual currency, the block chain has already proved itself as a solution to the counterfeiting problem while also giving transactors a relative degree of privacy. With the internet, the portability of a cryptocurrency clearly surpasses that of gold. Because of advances in computing technology, the transaction costs of a virtual currency are likely to be smaller than for existing payment systems, including the use of cash. Economists and thoughtful policy makers, including some heads of central banks, consider that virtual currencies have a useful role to play.

But the existing Bitcoin has a fundamental flaw. Its market price is too volatile for anything that aims to be a substitute for fiat money.

The problem can be traced to Bitcoin’s fixed supply (21 million coins) coupled with its lack of a ‘commodity anchor.’ The first means that the market price will be volatile, subject to shifts in demand. The latter – the lack of an anchor – underlies and exacerbates the price volatility problem.

The extreme upside is supposedly when bitcoin could supplant gold, and one calculation suggests that it would do so at $500,000 per coin. This scenario has driven wide-eyed fanaticism and speculators into the Bitcoin ecosystem.

The extreme downside, on the other hand, is that bitcoin holders could for some reason ditch the cryptocurrency and make it worthless.

In between, there could be ‘pump and dump’ scenarios, characteristic of a legal-but-Ponzi-like speculative asset that would occasionally have its Minsky Moments.

A better approach may be to think of a cryptocurrency as a ‘digital’ banknote that at least maintains its real purchasing power. To some extent, the banknotes of central banks with low inflation targets already provide the best protection there is to those who hold their monies. Can there be a better, kinder, saner version of Bitcoin?

Perhaps, if the pricing problem could be solved.

The way out seems to be as follows.

A new virtual currency, to be called, say, the bitdollar, is initially priced at par with the existing dollar. Its initial supply is then set as elastic as can be — the first ‘investors’ in the bitdollar will decide, through the amounts they commit to buy, the initial stock of bitdollars.

From there, bitdollars would go on ‘secondary’ trading just like the current Bitcoin.

If the price of a bitdollar falls below par, the initial investors would realize that they were too optimistic. Nothing else happens, and the crypto currency may fall into disuse.

But the initial stock of bitdollars is fixed, and sooner or later its price would recover if it attains usefulness as an alternative to currencies. It may then be seen as an alternative to banknotes but with a supply that an issuing central bank cannot control or alter.

When the price gets to exceed, say, 20% of the fiat dollar, by prior agreement among bitdollar holders, they would expand the supply by 10%. This should be enough to keep the price from shooting up, and also enough to keep it above ‘par.’ If the price continues to remain above 20% over parity, a sliding scale of new ‘issuance,’ say, 5% of the initial stock is calendared.

If the initial issuance is judged too small relative to (growing) demand, new secondary offerings would be issued at prices close to then market prices.

Over time, the price is likely to fluctuate in a range above par, but perhaps close to 10-15% over par. The stock of bitdollars would naturally rise to meet demand but at a price that is essentially anchored to that of the fiat dollar.

This scheme depends on the soundness of the anchor currency. If the central bank prints too much money, the bitdollar holders can or would decide to slow down issuance with a view to stabilizing the purchasing power of bitdollars. In effect, the fiat and virtual currencies will compete as different but similar moneys.

An important question: What happens to the money paid in by initial investors? I suggest that this be sequestered into essentially risk-free long-term government securities held by an agreed custodian bank. It will be set up as a trust fund to cover the possibility that the bitdollar would be unwound. The same rule can be applied to any new secondary public offerings of the cryptocurrency. This approach sets up the crypto currency as akin to commodity money, with the anchor currency as the underlying ‘commodity.’ (It is also akin to a share of stock in the trust fund holding the backing for the virtual currency.)

How would the block chain system be maintained if there is no ‘mining’ as in the current Bitcoin scheme? The obvious answer is that the computing services needed for validating the block chain will be bidded or contracted out in such a way that their cost can be recovered through fees paid by cryptocurrency holders.

Who will profit from the new scheme? As with the current Bitcoin, competing platforms for validating transactions (‘mining’), trading, and transferring of bitdollars will emerge, and would earn fees for transaction processing. Merchants who accept bitdollars would profit from paying a lower transaction fee than that paid to credit card companies. The trustee holding the backing for the bitdollar earns seigniorage in the same way that issuers of travelers checks do, and some of that seigniorage could be distributed to bitdollar holders.

Although in theory the block chain and efficiencies in computing would minimize the cost of operating the system, any crypto currency remains vulnerable to untoward events that generate mistrust in its operation. Trust in the cryptocurrency will have to be earned, requiring the participants to abide by legislation and guidance from monetary authorities. This is particularly important in combatting money laundering and use of virtual currencies by organized crime or terrorists. New platform providers who might try to cartelize transaction fees could also undermine the demand for virtual currencies.

CONCLUSION. Like Humpty Dumpty, Bitcoin is good but with its fixed supply, it is likely to take holders and speculators on a frenzied ride headed for a great fall. Caveat emptor.

EC42 basics – how to

develop a thesis topic.

The goal is to convince your stakeholders (parent, teachers, future employers) that you have learned a substantial amount of economics, although the gain is more yours than theirs.

The University of Michigan gives some pointers, the most important is that you have to do some hard reading.  Long, wide, and even deep.  See also the format of a student essay contest.

So, there, for the Christmas break, take some time to smell the academic coffee. Read.  Do it at Starbucks.  At Jollibee.  On the web.  But don’t strain your eyes.

 

Student Essay Competition

For EC42 students:

Just a link for now.

In this site, you can read prize-winning student essays. I’m guessing that the winners are essay-form versions of student dissertations.

You may get an idea on how to structure a topic and proposal for your own thesis from reading and learning from the student essays.