Paul Krugman | A Virtual Currency Raises Real-World Questions

It’s always important, and always hard, to distinguish positive economics (how things work) from normative economics (how things should be). Indeed, with many of the macroeconomics issues I’ve written about, it has been obvious that large numbers of economists can’t bring themselves to make that distinction; they dislike an activist government on political grounds, and this leads them to make really bad arguments about why fiscal stimulus can’t work and how monetary stimulus will be disastrous.

But I’d like to talk not about macroeconomics but about money – specifically, about Bitcoin, the virtual currency. So far, almost all of the Bitcoin discussion has centered on positive economics – can this actually work? And I have to say that I’m still deeply unconvinced.

To be successful, money must be both a medium of exchange and a reasonably stable store of value. And it remains completely unclear why Bitcoin should be a stable store of value. The economist Brad DeLong explained it earlier this month in an online article for the Washington Center for Equitable Growth:

“Underpinning the value of gold is that if all else fails you can use it to make pretty things,” he wrote. “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 percent/year.”

He continued:

“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.

But as I said, this is a positive discussion. What about the normative economics? Well, you should read Charlie Stross: “Bitcoin looks like it was designed as a weapon,” the science-fiction writer wrote in an online post last month, “intended to damage central banking and money-issuing banks, with a libertarian political agenda in mind – to damage states’ ability to collect tax and monitor their citizens’ financial transactions.”

Go read the whole thing. Mr. Stross doesn’t like that agenda, and neither do I, but I am trying not to let that tilt my positive analysis of Bitcoin one way or the other. One suspects, however, that many Bitcoin enthusiasts are, in fact, enthusiastic because, as Mr. Stross wrote, “it pushes the same buttons as their gold fetish.”

So let’s talk both about whether Bitcoin is a bubble and whether it’s a good thing – in part to make sure that we don’t confuse these questions with each other.