"A Synthetic Currency for the World" (Discussion Item 19)

[solutions]

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Subject: A Synthetic Currency for the World (Discussion Item 19)
From: Solutions
Date: Sat, October 5, 2013 11:42 am
To: John Karls
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Dear John,

Your Discussion Outline Item 19 said --

“19. Most news-media “talking heads” blithely opine that the U.S. dollar will never be attacked as the world’s de facto “national currency” (often called the world’s “reserve currency’) because “where would investors go instead” -- as if investors have to hold their wealth in investments denominated in currencies of real countries without bothering to realize that it wouldn’t take much imagination for our young financial whizzes to invent a synthetic currency that is NOT tied to any particular nation’s currency (but floats on its own) and that DOES displace the U.S. dollar as the world’s reserve currency.”

Is this realistic?

Sincerely,

Solutions

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Subject: Re: A Synthetic Currency for the World (Discussion Item 19)
From: John Karls
Date: Sat, October 5, 2013 3:17 pm
To: Solutions
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Dear Solutions,

Yes, it is realistic!!!

And any student of Merih Uctum could easily do it!!!

[The top Google hit for an Advanced Google Search = must include the exact phrase “countries without their own currency” -- is Chapter 17 of Prof. Uctum’s 2006 course outline on Exchange Rate Regimes at City University of New York.]

Indeed, Chapter 17 is a “cook book” for anyone who would like to invent a new synthetic currency to displace the U.S. dollar as the world’s “national currency” (aka, world’s “reserve currency”).

As we discussed at our 12/14/2011 meeting on the subject of “Balanced-Budget Amendments and Redeeming National Debt with ‘Wallpaper’ Both in Europe and the U.S.,” virtually all of the currencies in the world are “fiat currencies.”

To explain what that means, first think of the name of Britain’s currency = “The British Pound Sterling.” Virtually all of us only think in terms of British Pounds and think, whenever we hear anyone say “Sterling,” that they are just being quaint. Without ever stopping to think what “Sterling” means/meant. “Sterling” meant Sterling Silver. And in “ancient” history, the British Pound Sterling was indeed 16 ounces of Sterling-quality Silver.

Until the last century, most of the world’s currencies were not only geared to the value of a precious metal such as gold or silver, but their currency actually comprised the precious metal on which the currency was based.

Indeed, the only reason why coins and currency were minted in those days was to put an official stamp on a quantity of precious metal to certify its authenticity and weight. But, of course, such official stamps could be counterfeited. Which is why you see in Hollywood movies set in olden times someone biting a coin to see whether it was genuine.

Under the Bretton Woods Agreement (circa World War II) which fixed international currency-exchange rates based on gold, some nations would run foreign-trade surpluses and others would run deficits. But rather than letting the exchange rates fluctuate freely, a nation with a surplus which, of course, would be represented by an accumulation of foreign currency, could demand that the foreign nation whose currency it held exchange gold for that currency.

The reason why Nixon, if memory serves, renounced Bretton Woods and took the U.S. off The Gold Standard is that our national gold supply at Fort Knox, WHICH HAD NEVER BEEN MORE THAN A SMALL FRACTION OF THE AMOUNT OF U.S. CURRENCY IN CIRCULATION, had dwindled to such a small amount that the next annual round of foreign countries demanding Fort Knox gold for the U.S. currency that had piled up in their coffers during the previous 12 months, would have more-than-exhausted the remaining supply of gold at Fort Knox.

In other words, Nixon simply announced to the world that the U.S. no longer had a discernible supply of gold to redeem its currency piling up in foreign central banks so (1) the U.S. would no longer redeem currency for gold, over which it had no choice anyway as Nixon was admitting, and (2) the U.S. was renouncing Bretton Woods and would, going forward, let the foreign-exchange rate for dollars float rather than remain fixed at the Bretton Woods exchange rates.

By decree or “fiat” Nixon was saying that the U.S. dollar would still have value even though that value had nothing to do with gold. And despite considerable fear that nobody would believe him, he proved right. Governments, by and large, can get people to believe that the paper they issue has much more value than its intrinsic worth as wall paper!!!

By the end of the century, according to the International Monetary Fund’s survey of the currencies used by the world’s then 186 countries, 39 countries did NOT have their own currency [including the 17 members of the European Union which use the Euro -- the 17 exclude the U.K., Sweden and half-a-dozen Eastern European members of the E.U.], 47 had their own currencies that floated freely, and the remainder had their own currencies that were geared to other currencies or were completely managed artificially.

All, however, were/are “fiat” currencies, meaning that they are NOT geared to the value of anything such as a precious metal and only have value because the currency issuer claims the currency has value (“fiat”).

Much like some celebrities are famous only for being famous!!!

That is why, except for American media “talking heads,” there is an appreciation for the fact that the loss of faith in the claim by a currency issuer such as the U.S. that its currency has value is much like the credibility of a bank, since its loss of credibility creates a “bank run.” And, in the case of a currency, a loss of credibility creates a run on that currency as everyone rushes to salvage as much value as possible while dumping it.

You might be interested to know that following the 2008 Economic Meltdown, there was considerable discussion among the G-20 countries about whether the International Monetary Fund’s “Special Drawing Rights” (“SDR’s”) could compete with the U.S. dollar as the world’s “national currency” (aka, “reserve currency”).

SDR’s were $250 billion of “special drawing rights” that the G-20 nations had authorized the IMF to create and allocate among the IMF member countries to try to alleviate some of the financial aspects of the meltdown.

Although the SDR’s have NOT become a rival for the U.S. dollar as the world’s “reserve currency,” the discussion among the G-20 shows that there is considerable latent demand for such a substitute among the G-20.

Not to mention the amount of latent demand that undoubtedly exists in the non-governmental financial world.

So who/what does have $250 billion of recognized value to begin competing with the U.S. dollar as the world’s “reserve currency”???

At this point, it may be instructive to pause for a moment to consider something that might seem initially to be utterly irrelevant.

Most of us are familiar with mutual funds.

Particularly as a substitute for trying to manage one’s own investments by doing one’s own research or relying on one or more research services.

And because most mutual funds do NOT, on average, out-perform the market despite high fees for the “baked in” research performed by the mutual funds, so-called “market index” funds became popular because the fund’s assets could be invested in the same configuration as a well-known index (e.g., the S&P 500) with minimal fees because there is NO research.

Without checking, I’m sure there are also Index Funds that are based on foreign-stock indexes. And probably even Index Funds that are based on foreign currencies. And perhaps even Index Funds based on the value of commodities such as crude oil or even home heating oil (aka diesel fuel).

So how does this help???

Unfortunately, virtually all human beings now have “baked in” their DNA that governments somehow have a monopoly on decreeing that something that is inherently worthless has value (viz., paper whose design renders it worthless unless one has a peculiar taste in wall paper OR ONE BELIEVES A CLAIM OF VALUE).

What if someone designed a mutual fund whose shares could function as a “reserve currency” for the world???

It would probably have to own something whose value is readily measured in an organized market in order to achieve the credibility that would be lacking if, as a non-governmental entity, it simply decreed by fiat that its shares have value.

But the possibilities are limitless.

For example, the De Beers group of companies that originated in South Africa, was always reputed over the decades to have the world’s diamond market cornered. And that they had to carefully regulate the amount of diamonds they were willing to sell so that the world market price for diamonds would not collapse.

Similarly, the Wildenstein family has always been recognized as having a corner on the world’s market for French Impressionist paintings, with zillions of them stored in their special climate-controlled warehouse in Manhattan. And that the Wildensteins have to carefully regulate the amount of French Impressionist Paintings they are willing to release on the world market so that it does not collapse.

So why did I mention our young financial whizzes???

Because if groups with such incredible wealth as De Beers and the Wildensteins do not step forward to create the world’s next “reserve currency” as a sideline, our young financial whizzes could do so based on something as pedestrian as good old-fashioned gold.

Since gold bars can be purchased from vending machines in many high-toned venues in Middle-East oil-producing countries, why couldn’t a few recently-minted MBA’s organize an index fund based on gold to function as the world’s new “reserve currency”???

Not much imagination needed!!!

Only a small amount of money for set-up costs and good connections to insure success!!!

Just the kind of project a Goldman Sachs could pull off in no time flat!!!

Or some ambitious Goldman Sachs staffers who would like to strike out on their own!!!

Sorry to have run off at the mouth!!! But your question provoked quite a bit more thought!!!

If you have any further questions, please advise.

Your friend,

John K.

[Pat]

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Subject: Re: A Synthetic Currency for the World (Discussion Item 19)
From: John Karls
Date: Tue, October 8, 2013 11:04 am
To: Pat
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Dear Pat,

Thank you for calling my attention to the PBS Newshour report -- I was travelling last week and didn’t see it (and was not previously aware of Bitcoin or its cyber competitors).

The PBS Newshour’s claim that Bitcoin is a currency is fatuous.

As described in my e-mail exchange with Solutions on this subject, currencies historically came into being as an intermediate medium of exchange that displaced direct barter.

And originally, currencies were nothing more than a precious metal such as gold or silver that someone supplying a good or service was willing to accept in exchange because s/he knew (1) that the precious metal had inherent value even though that value was capable of fluctuating, and (2) that the precious metal could be used immediately to purchase a good/service from someone else or that it could be held as a store of value until s/he was ready to purchase a good/service.

Eventually, governments began minting currency which meant, at least at first, simply putting their imprimaturs on various pieces of precious metal as testimony to their composition and weight. Though, of course, the imprimaturs could be counterfeited.

Then President Nixon took the U.S. off the Gold Standard and ushered in the current era in which (1) national currencies became “fiat” currencies meaning they have no value other than the issuer’s claim of value, and (2) all of us have been conditioned to believe that only government’s are capable of issuing currencies.

I was speculating with Solutions that what we have all been conditioned to believe is not true. And that a currency including a new international currency to displace the US dollar as the world’s de facto currency (aka “reserve currency”) could indeed be created by a non-government -- or by a quasi-governmental agency such as the International Monetary Fund whose Special Drawing Rights issued following the 2008 Economic Meltdown were widely discussed by the G-20 governments as being capable of becoming the world’s new “reserve currency.”

The reason why Bitcoin, as presently constituted, will never be more than a cheap substitute for Pay Pal and cannot function as a currency which can perform as a trusted store of value over time is that its value is purely “fiat” and not based on anything real.

Accordingly, for normal business persons to sign contracts specifying future payments in Bitcoins rather than a currently-recognized currency without risking their jobs every time they sign such an agreement, value for the medium of the future payments would have to rest on more than a mere non-governmental “fiat” -- particularly not a “fiat” by some unknown person(s) as reported to be the case with Bitcoin by the PBS Newshour.

And, yes, it is not surprising that drug cartels would attempt to use Bitcoin to launder money as reported by the PBS Newshour. Since money laundering could be accomplished by any Pay Pal substitute.

But the “rubber would have met the road” if the PBS Newshour had bothered to inquire whether there had been any drug cartels that had exchanged “dirty” money for Bitcoins AND THEN HELD THE BITCOINS FOR AN EXTENDED PERIOD OF TIME RATHER THAN IMMEDIATELY EXCHANGING THE BITCOINS FOR “CLEAN” OR LAUNDERED MONEY.

AFTER ALL, WHAT IF ALL BITCOIN HOLDERS AT A SPECIFIC FUTURE INSTANT IN TIME DISCOVER THAT THEIR BITCOINS HAVE BECOME WORTHLESS BECAUSE THE UNKNOWN PERSON(S) WHO CREATED BITCOIN HAVE BUILT INTO THE BITCOIN PROGRAM THAT ALL VALUE AS OF THAT FUTURE INSTANT WILL BE TRANSFERRED INTO THE CAYMEN ISLANDS BANK ACCOUNT OF THE UNKNOWN PERSON(S)???

Two comments come readily to mind.

First =

Pay Pal can be a cheap competitor of credit cards for anyone wanting to purchase goods or services. And Bitcoin might be able to under-price Pay Pal even if it became a serious competitor for Pay Pal, who knows???

But for repeated remittances to a specific person, such as discussed by the PBS Newshour in the case of immigrants, it is easy as pie to open a free bank account and send an extra ATM card to the other person, no matter where s/he is located in the world, so that s/he can withdraw any deposits at no cost from a local ATM. That’s certainly what I did in the 1990’s when my kids attended Milton Academy, and were spending junior years abroad and summers all over the world. [Indeed, a bank's fees for converting US dollars to the foreign currency that came out of the foreign-located ATM were a small fraction of the fees charged for exchanging currency by American Express or the currency-exchange booths at international airports.]

Second =

You can probably appreciate why my exchange of e-mails with Solutions was trying to overcome the conditioning of the general population that only governments can issue currencies by “going back to basics” = basing a new non-governmental currency on something with recognizable value.

And the reason for tossing into the mix of categories of items with recognizable value, something as seemingly esoteric as French Impressionist paintings as well as gold, silver, diamonds and commodities such as crude oil and home-heating oil (aka diesel fuel), is that the super-wealthy people of the world typically invest an incredibly large percentage of their wealth in fine art such a French Impressionist paintings.

If that doesn’t answer your question, I don’t know what else could be said!!!

Your friend,

John K.

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Subject: A Synthetic Currency for the World (Discussion Item 19)
From: Pat
Date: Mon, October 7, 2013 8:31 pm
To: John Karls
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Dear John,

Did you see the piece on the PBS Newshour last Friday about a new computer currency? The transcript follows below but the Newshour’s website also has the following summary:

“Bitcoin, a digital currency, has appealed to high-tech skeptics of government-issued money, as well as global criminals who are eager and able to capitalize on a totally free market. But mainstream investors are taking notice. Paul Solman reports on the potential, advantages and risks of this crypto-currency.”

Pat

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PBS Newshour Transcript 10/4/2013

Bitcoin gains mainstream interest after initial “outlier” appeal

JUDY WOODRUFF: And to two stories from the world of technology, the first focusing on a digital currency that you may not have known about before it made national news this week. Our economics correspondent, Paul Solman, has been tracking its growth and explains. It's part of his ongoing reporting Making Sense of financial news.

MAN: Bitcoins are digital coins you can send through the Internet.

PAUL SOLMAN: The currency known as Bitcoin, which made headlines earlier this week when the FBI seized Silk Road, the popular online black marketplace for drugs and other contraband, payable in Bitcoin, that had done over a billion dollars worth of business in just the last two years. But what makes this strictly computerized currency, created and maintained by a network of computers solving math problems, worth anything at all?

RICHARD SYLLA, economic historian: Money is a convention.

PAUL SOLMAN: Economic historian Richard Sylla:

RICHARD SYLLA: I take paper money -- paper itself isn't worth much -- because I know you will accept it when I want to buy something from you.

PAUL SOLMAN: And that's it?

RICHARD SYLLA: That's right. Money is what money does.

PAUL SOLMAN: And since, these days, in the world of libertarian high-techies, skepticism about government-issued paper money abounds, Bitcoin, a digital currency attached to no country at all, is becoming their alternative of choice.

CHARLES HOSKINSON, Invictus Innovations: I have lost a lot of faith. I mean, a lot of people have. If you look at when we started the Federal Reserve system in 1913 to today, over 90 percent of the value of your dollar has gone down.

PAUL SOLMAN: Charles Hoskinson's lament has been a familiar one among Fed phobes in the past few years.

CHARLES HOSKINSON: I was a campaigner for Ron Paul back in 2008 and also in 2012. I met Ron Paul. He was a great guy, and I really believe firmly in his message.

PAUL SOLMAN: And the key part of his message that pertains here?

CHARLES HOSKINSON: Sound money. Sound money, the idea that your money needs to have rules that can't be manipulated based upon political convenience.

PAUL SOLMAN: By contrast, says Hoskinson, Bitcoin is unmanipulable, apolitical.

MAN: Invented in '09 by a fictitious person named Satoshi Nakamoto.

PAUL SOLMAN: A person or maybe group which has since vanished into cyberspace. Bitcoins were invented so as to have an upper limit -- 21 million Bitcoin can be created, no more.

MAN: Bitcoins are generated all over the Internet by anybody running a free application called a Bitcoin miner.

PAUL SOLMAN: Bitcoins are generated, or mined, by computers, solving math problems that become ever more complex and time-consuming. The coins themselves? Strings of characters like a password or code, hence the name crypto-currency. Easy to break the code? Absolutely not, says mathematician Hoskinson.

CHARLES HOSKINSON: If that was the case, then we'd be in bigger problems, because all of our passwords would be vulnerable. People could break bank encryption. The secret communications the NSA uses and the government uses would all be decryptable.

PAUL SOLMAN: Of course, even seemingly indecipherable codes are sometimes broken, one reason why Bitcoin currency gives economic historian Richard Sylla pause.

RICHARD SYLLA: I'm like Warren Buffett. I don't buy something if I don't understand it. And for all I know, the person who created Bitcoins would be like King Henry VIII in Britain, who decided suddenly to double the amount of British money units around, and there was a big inflation.

PAUL SOLMAN: Well, Bitcoins are supposedly created in a way where that just can't happen.

RICHARD SYLLA: That's the argument they make. And, of course, that's the great argument for gold and silver standards, that the supply is limited. But I think it's much easier to change the algorithms or something like that and double the amount of Bitcoins overnight than it is to actually come up with more gold and silver.

PAUL SOLMAN: No, mathematically impossible, counters the Bitcoin community. And how do Bitcoins actually work?

MAN: Bitcoins are transferred directly from person to person via the net without going through a bank or clearinghouse. This means that the fees are much lower. You can use them in every country. You can purchase video games, gifts, books, and alpaca socks.

PAUL SOLMAN: And, as we saw this week, you can also purchase heroin, high and consistent quality. Buy 10, get two bags free. The FBI has now seized the Silk Road site, calling it the most sophisticated and extensive criminal marketplace on the Internet today. So, first and foremost, does Bitcoin represent an unholy alliance of high-minded, freedom-minded high-techies and global criminals eager and able to capitalize on a totally free market? Look, says mathematician Charles Hoskinson, digital currencies are like any new technology.

CHARLES HOSKINSON: And just like the Internet can be used for bad things, like terrorist activity or child pornography, Bitcoin could be used for bad things, for example, funding rogue states like Iran or North Korea.

PAUL SOLMAN: Or dealing drugs, or laundering money. Yes, Bitcoin as a currency did initially appeal mainly to outliers, admits Kinnard Hockenhull, but it has begun to go mainstream, especially with investors.

KINNARD HOCKENHULL, Bitcoin entrepreneur: They think this is skyrocketing, I better get into it. But you also have people who want to use it to send money instantly over the Internet. And with Bitcoin, you can send money the same way you send an e-mail.

STEPHEN PAIR, BitPay: It's money that's designed for the Internet.

PAUL SOLMAN: Stephen Pair has co-founded BitPay, a Bitcoin payment processor.

STEPHEN PAIR: If you think about credit cards, they were designed in the 1950s, before the Internet existed, right? So this is the first time we have taken everything we know about cryptography and the Internet and security and designed a new payment system from the ground up.

PAUL SOLMAN: A system that bypasses the usual middlemen, making most non-cash transactions way cheaper.

JONATHAN MOHAN, Bitcoin entrepreneur: So, remittances.

PAUL SOLMAN: Like remittances, says Bitcoin promoter Jonathan Mohan, the money sent back home by workers in the developed world, now wired via a third party like Western Union.

JONATHAN MOHAN: If your family at home makes $100 in a year, it costs 40 bucks to send them that $100. And with Bitcoin, it would cost several cents.

PAUL SOLMAN: As illustrated by the small bubbles, some representing tiny transaction fees, on this real-time Bitcoin trade and transaction visualizer.

JONATHAN MOHAN: The vast majority of the planet don't even own a bank account. And it's my contention that -- and a lot of people think this -- that, just as in Africa, they didn't go to phones. They went directly to cell phones, that, in the same sort of adoption curve, in these developing nations, you're not going to see them start getting bank accounts. You're going to see them just going straight to Bitcoins, because if you own a Bitcoin address, you have a bank account on your phone that you can interact on the global stage with.

PAUL SOLMAN: Meanwhile, other so-called crypto-currencies have been started, with different mathematical formulas and rules, trying to compete.

KINNARD HOCKENHULL: There's PPCoin. There's BBQcoin. There's Litecoin. There's Feathercoin. Primecoin is a very interesting one that looks for really large prime numbers.

PAUL SOLMAN: And all because, says historian Richard Sylla, who chairs the board of Wall Street's Museum American of Finance, there's so much skepticism about government and its money in and around the high-tech community these days.

RICHARD SYLLA: Bitcoins are sort of a modern version of gold, computerized, sexier than gold. You know, we think gold is pretty nice. It shines. It looks nice. But Bitcoins are -- appeal to the more technologically savvy of people today.

PAUL SOLMAN: And since many of them have money, and crypto-currencies do have certain advantages, says Sylla, the Bitcoin story may be with us for quite awhile.

JUDY WOODRUFF: And a postscript to Paul's report. The price of Bitcoins did indeed sink shortly after the FBI raid, dropping from $140 to nearly $120. But they have now rebounded back to almost $140, and some observers suggest the bust may have helped boost Bitcoin's legitimacy by ending the Silk Road connection.