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Digital Tulips: The Bitcoin Mania

Gary North - December 03, 2013
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In 1637, the tulip bulb investment mania peaked in Holland. It had made some people rich. Now it was about to make others poor.

Bulb prices rose steadily throughout the 1630s, as ever more speculators wedged into the market. Weavers and farmers mortgaged whatever they could to raise cash to begin trading. In 1633, a farmhouse in Hoorn changed hands for three rare bulbs. By 1636 any tulip--even bulbs recently considered garbage--could be sold off, often for hundreds of guilders. A futures market for bulbs existed, and tulip traders could be found conducting their business in hundreds of Dutch taverns. Tulip mania reached its peak during the winter of 1636-37, when some bulbs were changing hands ten times in a day. The zenith came early that winter, at an auction to benefit seven orphans whose only asset was 70 fine tulips left by their father. One, a rare Violetten Admirael van Enkhuizen bulb that was about to split in two, sold for 5,200 guilders, the all-time record. All told, the flowers brought in nearly 53,000 guilders.

Soon after, the tulip market crashed utterly, spectacularly. It began in Haarlem, at a routine bulb auction when, for the first time, the greater fool refused to show up and pay. Within days, the panic had spread across the country. Despite the efforts of traders to prop up demand, the market for tulips evaporated. Flowers that had commanded 5,000 guilders a few weeks before now fetched one-hundredth that amount.

The story is here.

What goes up comes down. Whatever offers fabulous riches for no good reason then offers fabulous losses for a very good reason: no new buyers at higher prices, and then a wave of selling.

Bitcoins that sold for $2 two years ago were selling for $1,242 on Thursday, November 29. Then they fell by a third in three days. Then there was a rally.

Volatility? Like nothing ever seen before.

Would you bet your future on Bitcoins? Would you hold 90% of your wealth in Bitcoins instead of dollars? No? Neither will anyone else. That is why Bitcoins will not replace the dollar or any other currency. An asset that traded for $50 for 10,000 units in 2009 is just too volatile. Multiply $1,242 by 10,000; that is $12,420,000. If you asked the buyer, he would say this: "Bitcoins have been very, very good to me."

Eat your heart out, Warren Buffett! It was all so easy. Just buy and hold.

That strategy is why Bitcoins will never become a replacement currency for the masses. Felix Salmon explains why.

This is something which should worry the bitcoin faithful, if they really want to see bitcoin become a broadly-used global currency. After all, press coverage of bitcoins runs in lockstep with the bitcoin price: it's times like this, when the price is at its fluffiest, that bitcoin gets written about the most. (If it's not physical bitcoins, it's hard drives in landfills.) The largely unspoken assumption behind all such stories: bitcoin is an asset class, and people should get excited about it when (and, implicitly, only when) the price is going up. This is what I think of as the CNBC Premise: when an asset rises in price, that is necessarily a Good Thing, and when it falls in price, that is always a Bad Thing.

The CNBC Premise has never made much sense with respect to currencies, however. And with respect to bitcoin in particular, its most exciting aspect is not its value, but rather its status as an all-but-frictionless international payments mechanism. If you want bitcoin to really take off with respect to payments, you actually don't want to see crazy price spikes -- such things are the best possible way of stopping people from using bitcoins for payments. After all, if your bitcoins are doubling in value every few days, why on earth would you want to spend them?


I am writing this response to a critic of my criticism of Bitcoins.

He dismisses me as if I am an economic ignoramus. He is not the first. I always have fun responding. He says of me that "his arguments diverge from Austrian economics." This, I must admit, is a new twist. I have not faced this accusation in the past.

I must respond. If an author does not respond, some of his followers may think he cannot respond. Trust me. I can respond.

Let me say from the beginning that I have never heard of the author, John Mather. His article was introduced by Jeffrey Tucker. Mr. Tucker was wise enough to get a stand-in for this hatchet job. "Let's you and him fight."

North purports to base his critique of Bitcoin on Austrian economic theory. However, his arguments are so weak that he makes Austrian economics look bad, to the point that someone unfamiliar with Austrian theory could finish his article doubting the validity of Austrian theory. One reader who linked North's article on a message board even commented that the article made him want to stop referring to himself as Austrian.

Rule: When debating seriously, save your rhetoric of condemnation for your conclusions. You may overplay your hand when you start this up front.


He begins with this.

Is Bitcoin a Ponzi Scheme?

In my article, I carefully defined how I was using the term. Here is what I wrote.

The individual who sells the Ponzi scheme makes money by siphoning off a large share of the money coming in. In other words, he does not make the investment. But Bitcoins are unique. The money was siphoned off from the beginning. Somebody owned a good percentage of the original digits. Then, by telling his story, this individual created demand for all of the digits. The dollar-value of his share of the Bitcoins appreciates with the other digits.

This strategy was described a generation ago by George Goodman, who wrote under the pseudonym of Adam Smith. You can find it in his book, Supermoney. This is done with financial corporations when individuals create a new business, retain a large share of the shares, and then sell the stock to the public. In this sense, Bitcoins is not a Ponzi scheme. It is simply a supermoney scheme.

The Ponzi aspect of it comes when we look at the justification for Bitcoins. They were sold on the basis that Bitcoins will be an alternative currency. In other words, this will be the money of the future.

The coins will never be the money of the future. This is my main argument.

Mr. Mather then goes on to develop at length his argument by applying Wikipedia's definition of a Ponzi scheme to my article. The Wikipedia article does not address my definition. Neither does Mr. Mather.

When arguing against a person's statements, it is best to quote his statements, not quote a Wikipedia article as a substitute.

I am willing to substitute tulip mania for Ponzi scheme, in order to keep Mr. Mather happy. As I said, the heart of my criticism is this: "The coins will never be the money of the future. This is my main argument."


Here is the heart of my article: fiat money is money "spoken" into existence. It is not money developed over centuries of market transactions.

Bitcoins are wanna-be fiat money digits. They were spoken into existence. This is the characteristic feature of fiat money. Bitcoins are not yet money.

Because of the mania, they will not become money. They lack money's characteristic feature: predictable value.

1) North says Bitcoin is made "out of nothing." This is a specious argument.

On the contrary, this is a specie argument. I reject fiat currencies that are not the product of long years of use in the free market.

The fact is that the Bitcoin currency and payment network is comprised of computer code. Is the web browser you're using to read this article made out of nothing? That Bitcoin is not a physical good doesn't mean it is made out of nothing. Billions of people, including North, assign economic value to all sorts of things which have no physical form. The most obvious example aside from the computer code of companies like Google or Apple is the vast supply of US dollars, the majority of which exist only in digital form.

My reference is to the fact that Bitcoins were created out of nothing to perform a service. This service is to replace fiat currencies with a new currency, which will replace fiat currencies in trade.

Unlike gold and silver, which became monetary units out of millennia of human action, Bitcoins were launched as a fiat currency that would become a new currency unit. My point is this: the volatility of Bitcoins' price is an indication of why they will not replace central bank fiat currencies, which are easily used in trade, and which are -- so far -- stable in purchasing power. This can change, but this is sure: dollars are used in trade by millions of people in billions of transactions.

The market has determined that the dollar is money. It has not determined that Bitcoins are money. The crucial factor in money is predictability of purchasing power. Bitcoins lack this.

2) North writes, "Something that was valuable for its own sake, most likely gold or silver…." Nothing is valuable for its own sake. All value is assigned. This is Subjective Theory of Value 101. North doubtless knows this, but it appears he's attempting to imply gold and silver possess some sort of intrinsic value.

Rule: when you are an unknown author, and you attack a well-known author who, ever since 1969, has been publicly defending the idea that gold does not have intrinsic value, you really do look silly if you use rhetorical arguments like this.

The man who wrote this is not a skilled debater. That is why I am cutting him some slack. My guess is that the author was not born when my first article on this was published in The Freeman. The article was titled, "The Fallacy of Intrinsic Value."

He then adds:

It may feel good to believe (especially if you own gold and silver), but it's just not true.

This young man thinks he is making a damaging attack on me by arguing that I in some way was arguing for the doctrine of intrinsic value, despite the fact that he writes, "North doubtless knows" that value is subjective. Yes, I do. So, why go into a discussion of what I "doubtless" know? The answer: rhetoric.

Rule: when rhetoric has no supporting logic, avoid it.


The author then launches into a discussion of something he calls a "network effect." He uses the language of programmer instead of the economist. But he makes the same point I made in 1969: gold is marketable.

Gold and silver have many uses, for example in electronics or silver in water filtration. But most of the value of gold in particular is due to its marketability, meaning, the acceptability of gold by other market participants.

Yes, yes, yes. It's time to stop beating a dead horse. But he doesn't.

This acceptability is a mutually reinforcing process by which people are more willing to accept gold because others are more willing to accept it. The existence of a mutually reinforcing cycle of demand is known as a network effect. Some examples of other network effect markets are cell phones, fax machines, web browsers and web servers, cars/roads/gas stations, and fiat money.

The difference between network effect goods and direct use goods is that, for example, the enjoyment of a steak dinner does not depend on its acceptability or adoption by others. A direct use good directly meets an individual's needs, while a network effect good derives a significant part of its value from the network. Most goods we use today have some combination of both.

And on, and on, and on.

As the Austrian economist Karl Menger argued, money itself replaced non-money as a market network effect good.

Karl Menger was Carl Menger's son. Mr. Mather is confused here. I can assure you that Carl Menger, the founder of Austrian school economics, did not use language like this: "money itself replaced non-money as a market network effect good." No Austrian school economist ever has. Austrian school economists do their best to communicate in something other than programmers' professional jargon.

Network effects can come and go. An example is the adoption of fashion. A particular look can go in and out of style either very quickly or over a much longer time frame.

Now he's getting close. The "network effects" of gold and silver go back thousands of years. The network effects of Bitcoins as an alternative currency have yet to come.


I argued that the extreme volatility of Bitcoins has killed the possibility that Bitcoins will become a currency.

Any time a once-popular good falls out of favor, does that mean it was a fraud?

No, nor did I say it was a fraud. I said it was not a fraud.

This author has a habit of putting words in my mouth, and then refuting these words.

3) North writes, "But Bitcoins are unique. The money was siphoned off from the beginning." By calling it money, North is contradicting himself. And unique? With every fiat currency, the state siphons off a portion of the money it prints. It's standard operating procedure.

I see. We should buy Bitcoins as money because Bitcoins' creators imitated the State.

Rule: when you're in a hole, stop digging.

With market money, early adopters have always profited from their foresight.

My point is that Bitcoins are not market money. I have not heard of market money profiting early users. There are no records of this. That is my main point in my article on "The Regression Theorem As Conjectural History," which I cited in my original article.

It is not a matter of being early adopters of a new fiat money. They are not adopting Bitcoins as users of money. They are in a tulip mania scheme. This scheme will keep Bitcoins from ever functioning as money. Bitcoins lack what money must have: predictable purchasing power over an entire economy's goods and services. Their value is wildly unpredictable.

Bitcoins went into mania mode so early that they will be tarred and feathered as a tulip mania launched by programmers who got rich with their invention, but whose invention will lead to huge loses by a lot of people. These two words will kill Bitcoins as future money: "Never again." Also these: "Once bitten, twice shy." "Fool me once, shame on you. Fool me twice, shame on me."

The creator(s) of Bitcoin may be sitting on lots of them; I don't know. But there's nothing unique about that. Early adopters also take on a lot of risk. The founder of every multi-billion dollar company had mountains of stock at the company's inception. That doesn't mean money was siphoned off. What is unique about Bitcoin compared to all fiat currencies is that there is a hard limit on how many currency units can be created/mined. Fiat money can be replicated instantly without limit on central bank computers.

Notice what he is doing. He is using my argument against me, yet he presents it as if it were his own original argument. I wrote this:

This strategy was described a generation ago by George Goodman, who wrote under the pseudonym of Adam Smith. You can find it in his book, Supermoney. This is done with financial corporations when individuals create a new business, retain a large share of the shares, and then sell the stock to the public. In this sense, Bitcoins is not a Ponzi scheme. It is simply a supermoney scheme

Rule: when you try to score a debating point by quoting your opponent's exact argument, skip this point.

4) North observes, "Money develops out of market exchanges." Yes, and that's what is happening with Bitcoin. People began using it from the beginning knowing it was not money by the Austrian definition as the most widely demanded commodity. Yet they kept using it for market exchanges. They could do so because Bitcoin is also a payment system which allows secure peer-to-peer transactions with no third party fees. That feature in and of itself has great utility. If Bitcoin becomes money by the Austrian definition, it will be because it developed out of countless market exchanges.

Here is my point: Bitcoins are not being used in market exchanges. They are merely a tulip mania craze in which people are buying them with dollars in order to sell later for dollars. That is why they are not money.

5) When North proclaims, "Bitcoins cannot serve the consumer. There is nothing to consume," he makes an absurd statement. As if a customer cannot be served without consumption! When was the last time North consumed a gold coin? Never, because gold is not consumed. Even if it's made into jewelry, it can be refashioned into coins or any other form.

I really do know the difference between consumption as "using up something" vs. gold as a consumer good that is "used by not using it up." For decades, anti-gold standard pundits have said: "You can't eat gold!" I responded to this in 2004 in my article, "You Can't Eat Gold!" I had written similar pieces for over 30 years by 2004.

Rule: When you're in a hole, stop digging.

6) North continues with more nonsensical statements: "But the fundamental characteristic of money is its relatively stable purchasing power." Stable purchasing power is desirable in a money, but it is most certainly not the fundamental characteristic of money. Rather, the fundamental characteristic of money is that it is the most widely demanded commodity in a given economy.

And why is it the most marketable commodity? (Hint: it has something to do with predictable purchasing power.)

Rule: When you're in a hole, stop digging.

North keeps pointing to the US dollar as money, yet even the US government's inflation calculator (which statistically "adjusts" the real figures lower) shows that since 1988, the US dollar has lost half its purchasing power. In my grandmother's lifetime, the US dollar has lost over 96% of its purchasing power. Several goods over those periods have had more stability in their exchange power for other goods than the US dollar. If stable purchasing power were the fundamental characteristic of money, then the US dollar would no longer be money.

Year to year, the dollar is relatively stable. That is why it is money.

North frequently in his writings points to gold and silver as the most desirable money commodities. Yet the price of gold went from $35 to $1,910/oz. Perhaps upside volatility is acceptable to North, with the exception of Bitcoin of course.

I have argued that gold is not money. I presented my case in 2003: "The Re-Monetization of Gold." I wrote: "That's why I do not expect to see gold as money in my lifetime. But I still recommend gold as an investment."

He thinks I am using a straw-man argument.

7) North goes on to set up a straw man argument, framing Bitcoin not as an open source international currency and payment system, but rather as a mania-driven, against-and-dump investment.

Mania-driven? Yes. Pump? By definition: the ultimate private fiat money pump. Dump? No. Strategic sales to each new wave of investors? Yes. They created millions of digits for some programming costs. They are worth billions on paper . . . in dollars.

He writes, "Whenever somebody tries to sell you an investment that is based on the economic analysis of a market -- an analysis that cannot possibly be true -- do not buy the investment."

Then he again affirms what I explicitly denied:

Now that his monetary theory arguments regarding Bitcoin have failed, he points to the rapid price increase in Bitcoin as evidence that Bitcoin itself must therefore be fraudulent.

I said that it is not fraudulent.

He goes on.

Perhaps Bitcoin is in a bubble and the price will crash.

There is no "perhaps" about it. This is a digital tulip mania.

Maybe it will be overtaken by another crypto-currency some day. Perhaps the rapid price increase is pointing at an acute worldwide demand for a secure, borderless, person-to-person, expense-free form of payment. The fact is nobody knows why the price of Bitcoin is what it is right now, or what it will be in the future. For North to claim he does, and importantly, for him to use Austrian economics as the basis for his claim, is unfounded and misleading.

It is neither unfounded nor misleading.

When a good is adopted as money, its value goes up because it is adopted as money. And unlike yielding assets, there is no way to say that it is over-valued because you can't calculate a yield.

True. But if you see a non-money asset marketed on the basis that it will become money someday, and it rises from $2 to $1,250 in two years, you can draw conclusions. Here is mine: this is a tulip mania.

8) A final piece of Northian Ponzi logic masquerading as sound argument: "The mania has destroyed Bitcoins' use as money. Bitcoins are too volatile in price ever to serve as a currency. Which is money: dollars or Bitcoins? The answer is obvious: dollars." So to follow his line of thinking, US dollars are money. Agreed. Yet every single fiat currency throughout history that has hyperinflated into oblivion was money by North's standard before its hyperinflation. Going from money-status to worthlessness is the most extreme case of volatility -- terminal volatility so to speak. Bitcoin has not done that -- quite the opposite -- making North's argument contradictory. Once the US dollar has lost 99% of its purchasing power (rather than the 96+% my grandmother has suffered), will it still be money? Further, if one defines a currency as a medium of exchange, we see that Bitcoin is used many thousands of times per day in exchange for thousands of different products and services. So in that regard it already has been and continues to "serve as a currency."

I see. Thousands of transactions per day. He offers no proof, but I will accept this estimate. Maybe 5,000. Maybe 10,000. He does not know. He cites no source.

How many transactions per day are there in dollars? No one knows. But the flow of funds is around $14 trillion. That is because the dollar is money. Bitcoins are not.

Now he invokes "I don't know."

It is true that if the exchange rate of Bitcoin continues to be highly volatile indefinitely, bitcoins will be ill-suited as a currency over the long term. But Bitcoin is still in its infancy.

It has become a tulip mania in its infancy. It's doomed. It will not escape this digital mark of Cain. "So, you got sucked in. What were you thinking of?" Volatility is the kiss of death for currency. When a currency isn't a currency, a mania will kill its reputation.

During the adoption phase of any good as money, the purchasing power rapidly increases from its initial value as a non-monetary good as more and more people adopt it.

He is making this up. There are no records of any such private fiat money in history. All fiat monies have been extensions of previous government money systems or a previous commodity standard.

Only time will tell if Bitcoin is currently in a bubble or undergoing adoption as money. If it were to, say, triple from here and then stabilize, clearly this period would not be viewed in retrospect as a bubble.

"Only time will tell." That's it? This is Ben Bernanke on housing prices in 2005. But housing prices had not gone up by 600 to one in two years.

He says that if it triples and then stabilizes, this will convert the biggest bubble in American monetary history into a non-bubble. Then Bitcoins will become currency.

My point is this: it cannot stabilize. The mania will reverse. The price will collapse. Its wild swings will continue.

In short, this time it's not different.


Then he goes on to say that Bitcoins -- five years old -- already stack up well against gold and silver.

Here he goes into the outer regions of space cadet analysis. He simply ignores the entire history of monetary economies.

It is inherently scarce by virtue of the underlying cryptographic math which sets a hard limit of 21 million bitcoins. As the total already-mined supply increases toward the limit, additional bitcoins can only be mined with ever-increasing difficulty. In this respect, Bitcoin is different than gold and silver which, while difficult to produce, do not have a known cap on their production. There is no guarantee, for example, that large undiscovered deposits of the metals could not exist. . . .

Uniformity: Bitcoin is superior to gold and silver because both metals are easily adulterated. One of the ways gold and silver coins were inflated in the past is by debasing them with more common metals. The Roman denarius initially was almost pure silver, but subsequent regimes continually debased the denarius until it only contained 2% silver. A metallurgist can for a fee tell you with a high degree of confidence if a coin or bar contains the purported concentration of gold or silver. A layperson cannot. In comparison bitcoins are completely uniform, and there is no mechanism by which they can be adulterated in the way precious metals can.

Conclusion: Durability: It would seem at first glance that gold and silver would win hands down, but I submit that Bitcoin actually wins. It's easy to dent and scratch gold, yet to its credit gold is practically indestructable. But if a gold coin gets badly banged up or bent, a vendor would likely hesitate to accept it. Sure an expert can assay the metal content of the damaged coin for a fee, so it is durable in that sense. But Bitcoin has a different, and arguably more practical, sort of durability. Namely, you can make any number of perfect backups of your bitcoins. While a USB thumb drive containing one's Bitcoin wallet is susceptible to breakage, that wallet can be stored on any number of other digital storage devices. This provides for a kind of durability that gold and silver cannot offer. You can have your bitcoins with you on a mobile device, on a thumb drive in a secure spot at home, even perhaps stored in another state or country in case of local disaster.

This is a computer programmer's answer to monetary history.

How strong is his summation? You judge.

I have focused on gold and silver because of their historical importance as money, because North focuses on them in his writings, and because the Austrian school has a lot to say about them. If I had to choose a commodity money, it certainly would be gold and silver for the reasons outlined above. My purpose was not to suggest that they are unsuitable as money, but rather to show that Bitcoin shares, and in some cases exceeds, the traits which make gold and silver good forms of money.

Yes, the Austrian school has had a lot to say about gold and silver.


He takes a new tack.

If Bitcoin can never be money for the reasons North argues, how is it that the US dollar has been money for so long while violating North's own self-imposed standards? Legal tender laws aren't a valid answer because legal tender laws have not stopped other fiat currencies from becoming worthless.

What has legal tender got to do with anything? Legal tender laws apply only to Federal Reserve Notes and coins. Most of these notes are outside the United States. Furthermore, no one has to accept them. The U. S. Treasury says this.

The pertinent portion of law that applies to your question is the Coinage Act of 1965, specifically Section 31 U.S.C. 5103, entitled "Legal tender," which states: "United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues."

1. This statute means that all United States money as identified above are a valid and legal offer of payment for debts when tendered to a creditor. There is, however, no Federal statute mandating that a private business, a person or an organization must accept currency or coins as for payment for goods and/or services. Private businesses are free to develop their own policies on whether or not to accept cash unless there is a State law which says otherwise.


He is unaware of all this.

He is unaware of a lot of things, as I have shown.

Most of all, he is unaware of the basics of debate, especially this: When you are in a hole, stop digging.

Mr. Mather and the other Bitcoins defenders are kids. Worse -- a lot of them are programmers. Old timers can see what's coming. This is the biggest tulip mania in history.

You can read his article here.

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