Are Bitcoins money?

 

 

 

 

There has been a lot of discussion in the news lately around Bitcoins (see for instance this article in The New York Times and this on in the Sydney Morning Herald).

Can we classify Bitcoins as money? We defined “money” in class as having 3 functions: as a medium of exchange, as a unit of account, and as a store of value. Bitcoins satisfy the medium of exchange function, which is to say people will accept Bitcoins as payment, in a very limited number of markets. Bitcoins might help if you want to buy something on Silk Road. But try buying your groceries at Woolworths with a Bitcoin. Bitcoins are really not that good as a medium of exchange, at least at the moment, because they are accepted by only a tiny fraction of people and businesses in the economy.

In terms of serving the unit of account function, Bitcoins could in principle serve this function quite well, as indeed can any numeraire (i.e., a standard by which values are measured). In the past, societies have used shells and cows as money, so Bitcoins can fulfill this function as well as any other.

The main problem with Bitcoins, as I see it, is that it doesn’t perform the last function of money very well – it is not a very good store of value. The fact that Bitcoins have fluctuated widely in value over the last few weeks (from $27 to $230, according to bitcoincharts.com) gives you an idea of the problem. (In fact just today, April 16, 2013, the value of Bitcoins has fallen from $80 to $60.) Would you hold your wealth in an asset that fluctuates that widely in value? It would be very risky. Of course Bitcoins can increase in value as well (and make you a tidy profit if you time the market right). But the point is, people hold money because they know the amount of goods and services it will buy from one day to the next. Something that fluctuates widely in value does not serve this function very well – one day a Bitcoin might buy you a mean at a fancy restaurant (assuming you could find one that would accept it for payment), another day you might be lucky to buy a loaf of bread with it. I suspect most people would prefer to store their wealth in Australian dollars (or other major currency) because they know what the currency will buy them from one month to the next. In all, Bitcoins don’t serve the store of value finction very well.

But Bitcoins are also fundamentally flawed in a macroeconomic sense – Bitcoins have programmed in deflation. The reason is simple: the supply of Bitcoins is set to decrease over time. This means they will become more expensive (due to market forces) over time, which is another way of saying that the goods and services a Bitcoin can buy will become cheaper over time. As we discussed in class, an economy in which prices are continually falling is one in which everybody puts off buying until tomorrow when the prices are lower. This means that an economy with Bitcoins operating as the money supply will suffer from continual deflation and as a result suffer from recessions, falling incomes and rising unemployment.

A related issue is who (or what?) is the central bank for Bitcoins? The current design of the Bitcoin currency hardly has the same level of credibility or transparency that, for example, the Reserve Bank of Australia has built up over many, many years. How do we know that the Bitcoin system won’t suddenly increase the supply of the currency (perhaps to ward off the deflation mentioned above)? If that happened, the Bitcoin would instantly become worthless and Bitcoin-denominated wealth would be destroyed. History tells us we can trust that the RBA won’t suddenly inflate. Do we have that level of trust in the Bitcoin system? Not at the moment and I suspect it will take a long time to establish.

Week 6: Week 6 Market dynamics

This week we turn to microeconomics and focus on the economic theory of the firm. This means we have to go through some foundational material linking the concept of a demand curve to a firm’s revenue as well as covering the difference between accounting costs and economic costs. The main purpose is to illustrate the firm’s profit maximizing decision about how much to produce and sell to its customers. We will then use the model of the firm to start talking about how market structure affects the firms’ behaviour. The series of slides with commentary below show how price and profit dynamics play out in a typical market in the economy.

What does a falling Yen mean to businesses?

The following 2 minute video from Reuters discusses how the falling Japanese yen could impact businesses. Watch the video and consider the impact of Japan’s on-purpose devaluation of its currency. Could we start to see “currency wars” with countries like South Korea? What export related policies could you expect to see? What abut Australia? Which industries do you think would be affected by Japanese products becoming less expensive?

Week 5: The banking system and the money supply

Like most countries, the Australian banking system comprises a central bank, the Reserve Bank of Australia (RBA), and several large private banks (Westpac, ANZ, etc.). In essence, private Banks take deposits and use the deposits to make loans. The main source of their profit is the interest rate differential between the interest rate they pay to the depositors and the higher interest rate they charge on loans. This means that to maximize profit, the private banks will lend out as much of their deposits as they can, subject to having enough on reserve to serve the needs of their account-holders. The RBA manipulates the amount of deposits in private banks by buying or selling government bonds in a process referred to as open market operations. The following short video explains how open market operations are used by the RBA to manipulate deposits in private banks and ultimately to control the level of interest rates in the economy.

Future crisis in China?

We finished this week’s lecture talking about the implications of exchange rates. An ABC news report yesterday discussed the implications of China’s  monetary policy, used to foster economic growth, but putting China at risk of a financial crisis due to unsustainable debt levels.

What would this mean for Australia? The article discusses how ‘Australia could be hit with the double whammy of falling commodity prices and a rising currency if the looming financial crisis in China materialises’ (Morgan 2013).

What do you think would happen if the Australian dollar continues to rise while commodity prices continue to fall?

Week 4: The foreign exchange market and the money market

International trade of goods and services has grown exponentially as the world economy has become more integrated. Like many countries, Australian GDP is partially dependent on its level of net exports (i.e., the value of exports minus the value of imports). One of the main determinants of net exports is the exchange rate. The following set of slides describe the economic model of how exchange rates are determined.

Investment, which is an important and highly volatile component of GDP, is partially dependent on the interest rate at which firm borrow. The interest rate also influences consumer spending and, in a small country like Australia, is linked to the exchange rate. The interest rate is determined by a complex interaction between private banks (e.g., Westpac, ANZ, etc.) and the central bank (i.e., the Reserve Bank of Australia) in the money market. The following videos describe the economic model of the money market. The first video deals with money demand.

In the second video we discuss the interaction of money demand and money supply and the determination of the interest rate.

To review your understanding of this week’s key concepts, please log into blackboard, go to BUSS5001 Learning resources and complete the quizzes that accompany this video.

Week 3: The labour market and the AD-AS model (part 2)

We think of employment (and unemployment) as being determined in an economy-wide labour market where all the buyers of labour (i.e., firms and businesses) and all the sellers of labour (i.e., individuals who want a job) come together. On the buyer side of the labour market (the demand side), firms are willing to hire more workers as the real wage falls, because that makes workers relatively cheaper. On the seller side of the labout market (the supply side), more people are willing to work as the real wage rises, because that makes working a more attractive option. The interaction of buyer and seller activity causes the real wage to adjust over time to clear the market, determining the market equilibrium.

GDP, the CPI, and total employment are closely related. For example, total employment will depend on the amount of total production; total production may depend on the average level of prices, and; employment may depend on the. Moreover the relationships can move in both directions. For example, production might be rising because prices are going up as firms seek to take advantage of higher prices, or prices might be rising because production is not rising fast enough to keep up with demand in the economy. In other words, the relationships between GDP, inflation, and employment are complicated and so an economic model is used to help understand what’s going on. The model, which we develop in class, is called the aggregate demand/aggregate supply model or the AD-AS model for short. The model is an abstract representation of the main forces and influences that determine the main important macroeconomic variables: GDP and inflation. Part of the AD-AS model looks at activity in the labour market and so the model also explains the level of employment and unemployment in the economy.

To review your understanding of this week’s key concepts, please log into blackboard, go to BUSS5001 Learning resources and complete the quizzes that accompany this video.

The Cyprus bail-out

I news item that has come up consistently in the tutorials this week has been the euro zone’s bail-out of Cyprus. A good article by Schumpeter in the Economist discusses the ramifications of the 10% levy to be  imposed on depositors in Cyprus’s banks.

With popular anger growing the Cypriot parliament will be voting again today on a new plan that would nationalize state pension funds and carry out a bond sale.

What do you think about this new solution?

Week 3: Measuring economic activity (part 1)

This week’s class has three main objectives – an overview of the main subject areas in economics, to begin our study of macroeconomics, and to introduce some key definitions and concepts that we will use in the weeks ahead.

Economics is broken down into two main sub-areas. Macroeconomics deals with the overall working of the economy and the role that policy can take in its management. We talk about concepts you may have heard before like GDP, inflation, unemployment, and so on. Macroeconomics is important because it helps us to understand the environment in which businesses operate – from whether their customers will have enough spending power to the interest rates at which they borrow money to the wages they pay and the taxes they pay on profits. Microeconomics deals with the behavior of the individual markets, firms, and consumers that make up the economy. It focuses on things like what causes prices to rise or fall in a market, how companies set their prices and how they interact with their competitors. One of the main tools in microeconomics is game theory – the mathematical science of conflict and cooperation – used to examine strategic interaction between firms.

When economists look at an economy they focus on three key aspects: the total amount of goods and services the economy is producing, the average level of prices at which the goods and services are being sold, and the total level of employment. So the first thing we need to understand is how each of these things is measured and what they tell us about the economy:

To review your understanding of this week’s key concepts, please log into blackboard, go to BUSS5001 Learning resources and complete the quizzes that accompany this video.

GDP and accounting

Gittins 2013 in the Sydney Morning Herald March 16 Edition

An interesting article in the Sydney Morning Herald on Saturday asked whether it was “the growth in ‘nominal’ gross domestic product or the growth in ‘real’ GDP” that mattered (Gittins 2013).

Of course the answer was ‘it depends’:

“If your interest is in how fast the economy’s growing (or not growing), the answer is real GDP – GDP after allowing for the effect of inflation. But if your interest is in how fast the federal government’s tax receipts are growing the answer is nominal GDP – GDP before allowing for inflation.” (Gittens 2013)

Gittens provides his reasoning for this here. What do you think? Do you agree? Disagree?