Krugman Bitcoin Dilemma Pt. 2: How to Discuss Economics

So, the plan laid out in Part 1 of this series was, and still is, to discuss the idea of an inflationary vs deflationary currency, especially as it pertains to Bitcoin, and the larger Keynesian/Austrian debate.  However, as this touches on one of the most controversial and fundamental arguments between traditional economists as well as Bitcoin enthusiasts, I need to touch on one point first, one that applies to most economic conversations.  

(The ferocity in what should be a philosophical/intellectual argument is stunning)

Spend a few minutes on Reddit, and you will see that the emotional and rhetorical levels seen in this debate are off the charts, to the detriment of all involved.  Outside of religious fundamentalism (and possibly not even there), the dogmatic approaches to economic issues are unrivaled in their violence and fervor.  You are more likely to see the pope accept Buddah as his savior than you are to see a Keynesian embrace methodological individualism, or an Austrian to accept that macroeconomic forces can be modeled based on observable statistical data.  This is not an argument that is going to be settled, ever, but that does not mandate or excuse the level of venom from both sides that is injected into the conversation.

So here is the biggest point to take away from everything that follows here, and anywhere else you choose to read about economics:

We are all wrong.  And we are all right, insofar as none of us are provably wrong.

The real problem is that economics (the field, and those who study it) still suffers from the delusion that this is not the case.  While it can be approached “scientifically,” it is not a science in the way that physics is (and for the record, that field still has huge fundamental differences in interpretation as well).  Economics, despite the use of so many numbers in the mainstream practice now, is not math, but a combination of political theory, social psychology, game theory, and philosophy.  Every school, every law, and every theory in the field of economics, is basically just a really fancy opinion.  Now, they can be really well thought out, and based on a plethora of examples and solid theoretical underpinnings, but that doesn’t make any of them predictive, and that’s the problem.

Think of an economist the way you do a meteorologist.  They have a lot of data about what has happened in the past, and a lot of theories about why they happened, and yet the prediction of the weather, even over as short a time period as a few days, remains almost impossible.  There are just too many variables that can’t be measured and accounted for, and too much complexity in the system even if we could have values for all of them.  So what they can do is one of two things:

1.) They can look at how weather patterns work and the forces that they know are involved, from convection to gulf streams to the condensation points at various altitudes, and try to synthesize certain principles that make logical sense based on this information (Austrian approach).

or

2.) They can collate as much of the data as possible into a huge database, and create a “dumb” model that says, “in the 100 observable situations we have measured in which case variables X, Y, and Z were found at the same time, there resulted n instances of O1 outcome, n instances of O2, outcome, and n instances of O3 outcome” (Keynesian approach).

Both of these are very reasonable ways to go about this process, and yet both contain extremely troubling methodological problems from a predictive standpoint.  Each attempts to deal with the “known unknowns” by either reasoning them away (Austrian), or modeling/regressing them away (Keynesian), but neither is capable of addressing the “unknown unknowns” despite seeing their effects everywhere (In physics, this is basically where the dark matter theory came from, but the lack of absolute laws in economics prevent you from working backwards to missing data in equations).

Again, think of this in terms of weather prediction.  I used to live in the midwest, and often times in the summer, we would have hot muggy air coming up from the south and cooler, drier air coming from the northwest.  Every so often they would come together just right, and we would be warned that circumstances were ripe for a tornado.  Weather people who favored one approach would look at what they know of how tornadoes form, then work back from there to figure out why the weather patterns that were converging on us would interact in such a way that logically we should get a tornado.  Other weather people would look back at their data and say, “over the past 70 years that we have been collecting data, the combination of conditions today were present most frequently on days when tornadoes were observed, so we are most likely to get a tornado.  Both are sound approaches, that arrive at the same conclusion, that there was a good chance a tornado was going to form.

Then we would usually not have a tornado.  

There is a similar situation where I live now, in Oregon.  Being in a valley in the Pacific Northwest, with some mountains to the east and a big warm ocean to the west, conditions are pretty perfect for rain a lot of the time.  Both logically based on what we know of meteorology, and observationally based on what has happened in the past, you can often count on seeing Weather.com show you a 30-60% chance of rain at any given time here.  But like all of the cliches about predicting the weather, and if you don’t like it just wait an hour, etc., etc., it’s pretty much a coin-flip whether or not they are correct in their assessment just days or hours ahead of time.

And yet, I never see people fighting so viciously over weather prediction as I do economics.

The primary reason for that is that we can’t entirely separate our own political and moral beliefs from economics.  We just can’t.  Due to the fact that an economic argument is tied to a policy argument (i.e. I believe in X theory/school, so I want the government to do Y), we all have an agenda, from the ivory tower economics to the professional bloggers to the people fighting on Reddit, including me.  By suggesting that our opponents, whoever they might be, have some bias that underlies their analysis, the implication is that we ourselves are free from such a problem, and therefore our analysis is superior, but that’s simply not the case.  Everyone has an agenda when it comes to economics, without exception.  It doesn’t necessarily invalidate anyone’s opinions, but it can’t be ignored either, simply because this is not a context-neutral environment.

Another big impediment to having a reasonable discussion between followers of different schools of economic thought is that very rarely are people even talking about the same thing, and if they are it is probably by chance.  Let’s take the relevant concern here, in this case ‘Is it better for the economy to have an inflationary or deflationary currency?’  This is usually how the debate is phrased, or something similar to this.  

What does “better” mean?  How are we defining success or failure?  Per capita GDP?  Real wages

Further more, what is “the economy,” exactly?  Is it some autonomous, ethereal collection of statistics?  Is it made up of actual people who participate in commerce?  Is it the entire population of a place that uses one currency?  In this era of globalization, can one country really even have an economy that is separate from the global economy?

Without even defining the parameters of the debate, how can we hope to answer the central question?  And yet, it’s not easy to do.

So, what’s the solution?  

This is discourse, and that means that words matter.  There are no absolute truths in economics, which means that we can’t speak in absolutes.  We also too often use words with a moral or religious overtones, such as “good” or “bad” that have no real-world meaning in this context, as economies are non-sentient and have no agency, so they cannot recognize or ‘behave’ in a manner that is positive or negative morally.  Above all, we need to explain our thought process to reveal our preconceptions and acknowledge that we are expressing opinions, rather than just shouting at eachother.

So, here is an example of a terrible way of saying something that might have value:

“Federal deficits are bad and so is anyone who disagrees!”  (Absolutism, moralistic, no context)

Here is a way to say the same thing that has a great deal of value in a conversation:

“I believe that growing government deficit spending can potentially have a negative impact on future economic growth and social prosperity because increasing debt liability, combined with expansion of the monetary supply in order to cover servicing the interest payments thereof, can force governments to allocate resources in a sub-optimal manner in the long run and prevent capital from being put to its most efficient and logical use.”

See what happens there?  I said everything that was in the first example, but fleshed it out and worded it in a way that is productive rather than combative.

Normal Krugman/mainstream economist response:

“You’re dumb and don’t understand modern macroeconomics.” (Absolutism, moralistic, no context)

Better response:

“I see what you are saying, and I understand the need to be cautious with deficits to prevent the cost of servicing that debt to become unmanageable (acknowledging historical examples like Weimar republic), however, in looking at the past 130 years worth of data from the 20 most developed economies in the world, sovereign debt/GDP ratios have been more than one standard deviation above where the current US ratio X times without a corresponding drastic rise in inflation or correlation to negative adjusted GDP growth.” (numbers are made up, it’s just an example argument)

Now, I realize that I am asking a lot here, especially for the internet.  My point though, is that while we may disagree on an issue, if one person (Krugman, in this case) takes the time to think about a position and write several hundred words on the issue, while we (Bitcoin supporters) simply respond with a variant of “you’re wrong and I hate you,” he essentially wins by default.

You have to play to win, and most people will (correctly) assume that if you can’t articulate your position, then you don’t really have one.

Ok, NOW the next post is on to the potential effects of a deflationary vs. inflationary currency!

The Krugman Bitcoin Dilemma, Pt. 1: Is it Good Money?

Happy New Year, Everyone.

It’s hard to believe that I went all of 2012 and 2013 without writing a post about Bitcoin, considering how much I was talking about it in the analog world.  As the calendar turns over though, I think I’m finally ready to put some thoughts on paper, in part to address some of the more persistent misconceptions and logical fallacies that still seem to infect the discourse, from both supporters and detractors.  This will probably have to be a series, so I will try not to disappear for weeks between posts, as I often have in the past.

Since I haven’t written about the subject in this forum yet (given the very slim connection to marketing), I think that a little context on my own backgrounds and biases is certainly in order, in the interest of full disclosure.  So a few stipulations:

1.) I am a Bitcoin supporter, an enthusiast, even.  I own some, so that bias exists.

2.) Unlike many of the most vocal Bitcoin enthusiasts however, I have some reservations, and my skepticism will not allow me to overlook either current or potential flaws.

3.) I am not a programmer.  I can read/write a very little JS and HTML and have some fundamental understanding of programming, but that’s it, so I can’t look at the code itself and get anything from it, despite it being open source.  I trust the community for my information there.

4.) I am not a cryptographer, and while I have a pretty good grasp of the fundamentals of how Bitcoin and the SHA-256 implementation work together, and how the hashing function works, etc., it is an imperfect understanding even after a year or two of study by a novice.  I like to think that I am a pretty smart guy, but this stuff is complicated, so once again, I tend to trust smarter people than myself on the details here.

5.) I am not an economist by training or trade officially, but I am on more solid ground here than programming or cryptography.  I have made a long-time hobby of the subject, have read a fair bit of the major primary and secondary sources, and keep up with the various schools of thought.  

6.) I like liberty, but I am not a libertarian.  This also sets me apart from a lot of Bitcoiners.

That should do it, but if I think of anything else as I write this I will make sure to include it.  I just want everyone to go into this knowing approximately how large a grain of salt they will need at various times.  

One of the issues that has been at the forefront of the public discussion lately has been the opinion of the popular economist Paul Krugman, who writes for the New York Times, which is generally negative towards Bitcoin.  While we mainly focus on him, and his back and forth with the Bitcoin community, he serves as the face of what is a broader group of traditional public economists, which tends to share a number of his views on the matter.  Now for a bit more disclosure, I will say that unlike the vast majority of Bitcoiners, I often like Krugman’s work and columns, and respect his intellect and the body of both scholarly and popular writing on recessionary/depressionary monetary policy that he has produced in particular.  I don’t hate quantitative easing, I don’t fear the imminent collapse of the US fiscal system due to rampant inflation, and I generally subscribe to what are considered “liberal” economic theories, so we have all of that in common.  That said, I respectfully disagree with him on the subject of Bitcoin, for a number of reasons.

I think that he is in part unable to separate, despite his claims to the contrary, his own political and moral beliefs from the debate, which has often lacked in civility from both sides.  In discussing the “normative economics” of Bitcoin here, he allows a logical leap to be made from the features of an inherently apolitical computing process to the aims of its users relying on no more than assumption.  He sees the Bitcoin community at large as a single mindset dominated by libertarian motives and thought process.  While that is undoubtedly describes a large number of Bitcoin enthusiasts (spend any time in the forums and you will see it), I am living proof that there is a more diverse ecosystem below the surface, and that it is possible to believe in the protocol without espousing a particular set of political beliefs.  To paint with such a broad brush is damaging, and seems to cloud his judgement a bit at times.  To be fair, the abuse heaped upon him would ruffle almost anyone’s feathers, but that’s the unfortunate reality of a debate played out entirely over the internet between one public individual and a legion of anonymous opponents.  The price you pay for the vast reach of the digital realm is the lack of a filter, so you have to take the polite, well-reasoned argument with the… less so.

There does seem to be a disconnect with traditional economists and the source of Bitcoin’s “intrinsic” value, which ignores the fact that this is largely an irrelevant argument.  The comparison to gold which is often drawn, while overly simplistic and imperfect, is apt enough to be commonly used in this debate, so for now I will gloss over those imperfections and keep to the analogue that everyone is comfortable with.  For those who aren’t familiar with the article that I linked above, I’m going to quote a relevant section:

Underpinning the value of gold is that if all else fails you can use it to make pretty things. Underpinning the value of the dollar is a combination of (a) the fact that you can use them to pay your taxes to the U.S. government, and (b) that the Federal Reserve is a potential dollar sink and has promised to buy them back and extinguish them if their real value starts to sink at (much) more than 2%/year (yes, I know).

Placing a ceiling on the value of gold is mining technology, and the prospect that if its price gets out of whack for long on the upside a great deal more of it will be created. Placing a ceiling on the value of the dollar is the Federal Reserve’s role as actual dollar source, and its commitment not to allow deflation to happen.

Placing a ceiling on the value of bitcoins is computer technology and the form of the hash function… until the limit of 21 million bitcoins is reached. Placing a floor on the value of bitcoins is… what, exactly?

I have had and am continuing to have a dialogue with smart technologists who are very high on BitCoin — but when I try to get them to explain to me why BitCoin is a reliable store of value, they always seem to come back with explanations about how it’s a terrific medium of exchange. Even if I buy this (which I don’t, entirely), it doesn’t solve my problem. And I haven’t been able to get my correspondents to recognize that these are different questions.

So the argument being made by Krugman here is about Bitcoin’s usefulness as a store of value (or lack thereof), and comparing it to gold as a counter-example.  However, citing the ceiling value of gold says nothing about the floor value of Bitcoins.  Additionally, there seems to be some conflation here with ceiling on supply and ceiling on value, and they are not the same thing, which begs the question of whether he really doesn’t see the distinction, or whether he is just being sloppy.

Regardless, the factors that affect the upside price opportunity (and make no mistake, the factors that he cites are simply several of many that determine price, not actual fixed limits), are not the same as qualities that make a good store of value, nor do they confer a special “intrinsic” value upon the medium.  What he is getting at with that mining business is scarcity, which IS one of the qualities you look for in a store of value, along with fungibility, divisibility, etc., all things that bitcoins have in common with gold.  However, when push comes to shove critics of BTC always come back to a.) gold has value because people have long agreed that it does, so basically credibility, b.) gold has some industrial applications that make it useful and will provide a minimum of demand (it is a good semi-conductor), and c.) that gold is pretty and jewelry/aesthetics will also provide a minimum level of demand.

Here is where the argument that Krugman is making falls apart.  He specifically complains that supporters of BTC use its utility as a medium of exchange to explain why it is a good store of value, and he is saying that they are different questions.  But in fact, when trying to explain something like “intrinsic value” (which we shouldn’t bother with, but the critics insist), that utility is exactly the same as citing gold’s utility as a semi-conductor or jewelry material as reasons that it is a good store of value.  You can’t have it both ways.

As to the credibility argument, this in part gets back to why any discussion of “intrinsic” value is a waste of time.  Quite frankly, Bitcoin is a good store of value because right now tens of thousands of people in the world are willing to pay upwards of $700 for a bitcoin.  As long as some people think that they are worth more than nothing, they can store value.  Not to mention the fact that price stability isn’t a valid argument in a year that has seen gold price fall so substantially.  You can say that this means that gold is also not a good store of value, but it’s both or nothing.  Now the argument of gold/bitcoins vs the dollar is one worth having, because there you are basically trading stability with slow depreciation vs volatility with a chance of appreciation.  Like bonds vs equities, it is simply a matter of personal risk tolerance, but that’s finance, not economics.

Another part of the issue here, is that Krugman keeps thinking about what makes Bitcoin viable/valuable as “money,” which is near-sighted when looking at Bitcoin as a whole.  It can function as money, certainly, but in viewing it as an equity or a commodity, you have to look at the whole, rather than specific parts.  When someone talks about, or invests in, Google, they aren’t simply referring to the search engine.  There is an entire suite of products and services that make up Google, from the ubiquitous e-mail service to analytics, social media to hardware like Google Glass, and a million other things.  Sure, the search engine was the foundation for their empire, but it is not the only facet that a valuation is based upon, and the same is true of Bitcoin and it’s function as money.  The features that make it a great payment protocol are part of what make it a good medium of exchange, and that utility in turn provides some basis for its “floor” as a store of value.

Up Next, BTC Deflation & the Economic Schools at Play: Keynes vs. Hayek!