I wanted to write down the most common errors I observe when I hear economists discussing money.

What is money?

Money is a financial technology that allows users to price goods and services in order to exchange value. Money is what settles credit/debt.

Misconeptions:

  1. Money and credit are the same thing. There is this theory in modern banking that banks create money through lending. The idea here is that when banks create a new loan asset, they also create an equal and opposite liability, in the form of a demand deposit. This demand deposit, like all other customer deposits, is included in central banks’ measures of broad money. In this sense is is assumed that when banks lend they create money. The missing piece here is settlement. Banks issue credit, and if the market accepts that credit at par with the money (in the US that means federal reserve notes) because they assume the credit risk of the lending institution is negligible, then they believe they can redeem bank credit for actual $$. Because of the insurance the government has claimed they’re able to provide (even though the FDIC insures $13 trillion in deposits with <$10 billion in assets) the market feels protected and so bank credit generally trades at par with dollars. This will not always be the case, and isn’t in the crypto stablecoin market. When the market perceived the risks that the Tether USD token would not be redeemable 1:1 for USD, the peg dropped to 60 cents. This is what would happen without fake government insurance.
  2. Money must be backed by something. No money is actually backed by anything other than the market’s demand for the money. Generally a money’s demand were relative to how it ranked on characteristics of divisibility, fungibility, unforgeable costliness to counterfeit, portability, etc. In the past people used gold and silver as money because they scored well on all of these metrics so that they could function as both a store of value and medium of exchange over a long time period. The introduction of state monopoly money (meaning counterfeit laws protected the state’s sole right over production) led to the demonetization of metals because it was easy for the government to regulate large financial institutions that held everyones’ gold and silver. The rise of cryptocurrency changes the dynamics of the money market as it lowers the cost for individuals to hold, transport, store, and maintain privacy despite the monopoly control over money. Really, it disrupts the state monopoly because it makes it easier for individuals to ignore laws.
  3. Comparing base money of today’s financial system to bitcoin’s potential future valuation. There is the idea that bitcoin can only be as valuable as base money today. This assumes that the relationship between credit and money will stay the same forever. The nature of money and credit will likely invert for a couple of reasons. Credit today is artificially manipulated by the federal reserve in order to prop up markets. The US10Y treasure trades at about 1% even though inflation is at 12% and rising on a year-over-year basis. The only people buying these bonds are speculators believing the fed can bring rates negative, and so they attempt to front-run the fed. Historical interest rates have been around 10%, so when we see reversion to the mean as central banks lose control over money, the ratio of money to credit will drastically change, sending prices lower in terms of the new money. This ultimately means that the value of money is going to increase relative to other assets because credit will contract as it will once again come from savings, and not the printer.
  4. Money isn’t valuable. There is the idea that because money has little use value, meaning physical notes can’t really be used for anything other than to burn for heat, that it’s worthless. I see many Keynsian economists conflate consumable use value of the money with peoples’ willingness to accept it. The money has value proportional to the number of people willing to trade it for their goods/services.
  5. Natively digital Money is more scalable because it can be divided nearly infinitely. Digital money is a new invention. Because many have the idea that the realm of the internet is infinite, they extrapolate that the whole world can be priced in one money. Bitcoin is unique in that supply is fixed, but equally unique in that transaction rate is fixed. When demand increases, so does the cost, which raises the minimum transfer value that can possibly occur on-chain.
  6. The introduction of new monetary competition is inflationary. Demand for any money is relative to the quanitity and quality of goods that can be purchased with the money. When money is open to free market production, like there is with gold, the market produces more gold when the market price of gold (demand)rises. When gold is produced, it consumes resources that were once demanded in the money in exchange for new supply such that there is no inflation. New gold produced consumes an equivelant amount of gold in the production process as is produced in new gold. In the case of bitcoin, the price rises as quantity of goods demanded in other monies leave their former monetary networks and join the bitcoin network. As bitcoin becomes monetized, it shifts demand from other monetary networks; a wealth transfer. Once bitcoin becomes fully monetized, meaning it reaches the point where higher value transactions added only add equal value relative to the number of goods priced out due to rising fee levels, a new bitcoin will emerge. Since bitcoin can be implemented multiple times, when demand for lower value transfers cannot be rationally performed on the BTC chain, the market will create another implementation of a new chain. Many believe this affects bitcoin’s scarcity, but it has no effect because bitcoin has become fully monetized and cannot accept more goods in the money.