Saturday, August 18, 2018

A healthy economy can't guarantee a fixed share of wealth

In December 2017, on the day when the Bitcoin price reached the all time high (ATH) near $20,000, we had a party organized by the Václav Klaus Institute. The hype was at the top on that day as well (the searches for the Bitcoin dropped by 90% since that month) and most "investors" bought their Bitcoins in that month – and have lost 2/3 of it so far. The cryptocurrencies were one of the topics at the party, some economists agreed with my skeptical attitude. But one "classical liberal" guy who didn't was Marek L. He disputed my assertion that the Bitcoin movement is a left-wing one, a form of collectivist communism.

He said: The wealth isn't owned by everybody, is it? Someone has the Bitcoin, someone doesn't.

So far so good. But the Bitcoin movement isn't about owning something – or owning anything. It's a movement that considers the fiat money – and other usual forms of wealth including the stocks – to be their big enemy. The whole point of the Bitcoin cult is about the alleged advantages of the Bitcoin relatively to the fiat money, about the differences between the two. I say that the movement is a left-wing one mainly because the intrinsic value of the Bitcoin is by definition zero and for the whole carnival to exist, the users need a collectivist brainwashing designed to persuade every participant that the Bitcoin price should be over $6,000 (or a similar huge number) instead. The Bitcoin comes with no assets or guarantees that would back it up but for some miraculous reasons, people are supposed to believe and repeat that the price will always be highly separated from $0. It's just like the de facto mandatory praising of the worthless comrades in communism. Everyone has to say that the emperor has nice new clothes.

Now, Vitalik Buterik is the creator of the Ethereum, the 2nd largest cryptocurrency after the Bitcoin by capitalization, and almost certainly the greatest known contributor to the cryptocurrency ideas. The Ethereum is really smarter than the Bitcoin in some nontrivial ways. And no one knows for sure who was (or were) Satoši Nakamoto or Luboshi Nakamotl or what was the name of the creator of the Bitcoin.

I have previously noticed that Buterin is very far from the typical Bitcoin cultist. He is actually smart. He understands – and was able to make great inventions – about the cryptocurrency technology. But he also understands some (not only basic) points about politics and economics.

In particular, I appreciated that in February 2018, Buterin warned that the cryptocurrencies were highly risky as investments. They could drop to near-zero levels almost immediately, he warned. Since the ATH of the cryptocurrency capitalization above $800 billion in January 2018, the value of the cryptocurrencies dropped by 80% or so.

In a useful sense, the initial investment already dropped to near-zero levels. But the prices may drop further, of course. And the drops may be much faster than the slow decline we have seen in recent 7 (altcoins) or 8 (Bitcoin) months. Buterin's warning was refreshingly different from the typical deceitful rubbish about the "safest investment" that the Bitcoin snake oil salesmen routinely pump into the mainstream media. Of course the cryptocurrency "investments" (it's really gambling) are much riskier than any conventional ones, including the investments into the stocks of any emerging markets.

Now, Buterin has produced a wonderfully complete and obvious proof that the Bitcoin cultists are basically a bunch of totalitarian Bolsheviks and whining leftists. It started with his innocent tweet comparing the "Bitcoin is the largest and should be the only currency" ideology with the well-known totalitarian ideologies:

Right, exactly. The idea that the Bitcoin should regain the near-100% "dominance" (percentage of the cryptocurrencies' capitalization) – it has recovered from a 35% low to 50% or so – and then beat the real fiat currencies (which are "larger" by some 3-4 orders of magnitude now) is a wishful thinking but if it could be realized in some way, it would be a form of totalitarianism. Like similar totalitarian dogmas, this guaranteed dominance of the Bitcoin among the "forms of money" would prevent any innovation or opposition.

Indeed, the Bitcoin cultists were already annoyed by this tweet, e.g.:

What Buterin wrote is a heresy. If someone else may surpass the Bitcoin, we are all doomed and the Galaxy will explode! It's almost like global warming.

Now, Buterin disagreed and posted the most important tweet I want to discuss in this blog post:

At the top, he linked to a nontrivial February 2018 economics essay on his website, A signaling theory model of cryptocurrency issuance and value where he discussed a few scenarios how the capitalization of the Bitcoin, existing altcoins, and hypothetical newly emerging major cryptocurrencies (especially expressed in the units of the world's GDP) may evolve in time. It is very clear that this guy has a natural, instinctive, quantitative understanding of economics. He greatly differs from the Bitcoin cultists whose reactions look like the monkeys' gymnastics in comparison. I don't believe that someone who has completed the elementary school may fail to see the obvious fact that Buterin is vastly smaller than the brainwashed Bitcoin cultists who rarely go beyond 3-word insults and 2-word or 4-word slogans of the type "Bitcoinu Akbar".

Let's repeat what Buterin wrote:
The idea that an individual can have the immutable right to own a fixed percentage of all the world's money indefinitely, on the other hand, feels very oligarchic.
Now, this is quite a localization of the fundamental problem underlying the Bitcoin religion! The proposition is so amazing because it summarizes the main idiotic belief underlying the Bitcoin cult perfectly – more clearly than any Bitcoin cultist has ever phrased it. And it also adds that everyone who has at least some instinct for economics must know what's wrong about that belief.

If we simplify a bit, this Bitcoin cult's dogma, as summarized by Buterin, is a variation of the left-wing delusions of the form
People have the human right (or are entitled) to be wealthy, or as wealthy as others, or as wealthy as they were before, or some variation of these conditions.
Well, as I will discuss, people just can't have any "human right" to be wealthy and every society that would try to introduce such "human rights" would be doomed. But first, you could protest. The Bitcoin cultists are surely not dumb enough to believe such a staggering idiocy, are they? Buterin must be just mocking them. He must only be caricaturing their opinion.

Not at all. They are exactly as staggeringly stupid as Buterin presented it. To show it, let us repost the first reaction by a Bitcoin jihadist that has (shockingly enough) received a greater number of "likes" than Buterin's original tweet:

Exactly, Bitcoin Gent! The idea that people should be guaranteed to have a non-decreasing percentage of the mankind's wealth is pretty much the most fundamental dogma that attracts the people into the Bitcoin cult.

It wasn't just Bitcoin Gent. The whole Bitcoin cult was clearly driven up the wall when Buterin, a famous cryptocurrency guy, contradicted this main dogma of that cult. For another example:

In an ideal Bitcoin world, Buterin would already be burned at stake! ;-)

At this point, I believe that you believe that this idea is indeed a defining idea of the Bitcoin cult. Let us discuss the question whether (A) it's sane or whether (B) the people believing this picture of economics are financially illiterate lunatics. Be sure that (B) is correct. Why?

Consider the Western world. It uses various currencies – the U.S. dollar and the Euro are the two most important ones. The central banks governing these two currencies – and many other currencies – are more or less targeting the 2% inflation rate. It means that the numerical value of the price of a fixed (well, sometimes updated) basket of products gets multiplied by 1.02 every year in average – there are oscillations around this number.

If you have savings, what do you do not to get poorer? If you have a savings account or some CDs, you may expect to get something like a 2% interest. Sometimes the interest rates are a bit higher than the inflation rate, sometimes the interest rates are a bit lower (that's surely the case now in Czechia, especially if you talk about the interest rates that savers get in the banks). In recent decades, the average interest rates were really close to the average inflation rate. The savers barely covered the inflation! It means that after X years, their money on the savings accounts could buy the same number of "baskets of products" (used to define the inflation rate) as they did at the beginning.

Meanwhile, the real economy is expanding, by some 3% a year in average. Let's use this most standard figure for the real average economic growth. The word "real" means that the inflation rate has been subtracted. If you don't subtract it, you deal with the nominal (numerical) GDP growth that may be some 5% in average (3% of the increase from the real growth plus 2% of the increase of the numbers due to inflation). Out of this growth rate, 1% is the growth that may be attributed to the average annual growth rate of the population of the nations. So without this 1% for population growth, you get the growth of the GDP per capita which may be some 2% in real terms or 4% nominally.

Your numbers could be a bit different but I think that at least among integer-valued assignments of the rates, my numbers are the most widespread ones among similar essays that top economists would write. Just to be sure, these estimates for the rates aren't any universal physical constants. Some of them may be changed as innocent conventions, others may change profoundly when some more far-reaching laws are changed, others depend on the individual and collective psychology. When the numbers change in 100 years, you need to redo the analysis.

Now, the total wealth of the mankind is close to a fixed multiple of the annual GDP. This point is far from obvious and it might be wrong – in may deviate in both directions (the ratio may go up or down). If the ratio changes with time, a part of similar analyses must be revised, of course.

But let's assume that the "accumulated wealth or savings" divided by "the GDP" is basically constant in time for a given nation or the Western civilization or the mankind. Because the nominal GDP (and the mankind's accumulated wealth) increases by 5% a year, if you save your money on a savings account where you get 2% in average, your percentage of the mankind's wealth decreases by 3% a year. Out of these 3%, 1% may be attributed to the "redistribution of wealth" among a population that grows by 1% a year. But most of it, 2%, is an authentic "per capita" decrease.

If you have money on your savings account, the interest rates roughly cover the inflation so you're not getting less capable of buying food plus similar things. But your percentage of the mankind's wealth is decreasing because the mankind is getting richer. The number of humans increases by 1% a year. On top of that, the real-term purchase power of each human increases by 2% a year. Every human may buy 1.02 times more food than a year ago. This is a substantial change over a lifetime, of course – in 50 years, you should be able to buy about \(e\approx 2.718\) times more than you could at the beginning.

Clearly, the savings accounts are not very good in preserving the long-term value.

Stocks can do better. The average Dow Jones nominal yields are some 5% in the recent century. On top of that, you earn 5% in dividends in average. If you reinvest the dividends, your nominal wealth expands by some 10% a year (now, the second-order effects – interests from interests or composite interests – start to matter for the 1% precision). If you subtract the 2% inflation rate, you still get a 8% increase of your wealth in the real terms.

This result may be too optimistic. You may get less than 8% yields in the real terms, and the real wages or wealth of the regular people may be growing by more than the 3% that I have used. However, let's believe this number. If the numbers are right, then an investor who invests into stocks such as the Dow Jones index and who reinvests the dividends may outpace not only the inflation but even the real economic growth by the additional 5%.

You may divide the 10% by saying that the increasing stock prices (by 5% a year nominally) guarantee that you have a stable percentage of the mankind's wealth; and you may spend the 5% from the dividends because at the end, the money is useless if you never spend it (and if no one else ever spends it). Just to be sure, if you only have a part of your savings in stocks, you must expect "something in between" the optimistic stock-based growth and the lousy growth of the savers.

Great. The savers get lower returns in the long run than the stockholders. This is one reason why we say that the richer people are getting richer. Richer people invest into stocks (and perhaps real estate and other things but let me not expand this essay in this – for my purposes irrelevant – direction) which have a better return on investment than the savings account.

The Bitcoin fans are stupid when it comes to economics but many levels of this stupidity may be distinguished. Some people are so obsessed with the "evil of inflation" that they haven't been able to understand that the interest rates are basically such that they beat the inflation so the level of inflation doesn't matter (countries with the 10% inflation generically also have the 10% interest rates so the savers don't lose anything close to 10% of their money in the real terms – these 10% inflating countries work pretty much equally as countries with very low inflation rates).

I don't want to discuss this level of stupidity – although it actually exists outside the Bitcoin movement and some gold fans and people of the Ron Paul style are actually confused about this totally elementary point (which Juan Maldacena described as the \(\RR^+\) gauge invariance of the monetary systems, see especially pages 5-8 here), too.

But let's talk about somewhat smarter Bitcoin cultists who understand that the inflation isn't the end of the world because what really matters for the fate of people's wealth are the rates expressed in the real terms – the inflation rate may simply be subtracted from all the nominal ones and it's a largely irrelevant time-dependent change of units. These somewhat smarter people may still be bothered that the percentage of the mankind's wealth that a saver possesses is going down – by 3% in real terms, according to my numbers – because there is the 3% real GDP growth. (Again, let me remind you that this 3% is composed of the 1% of population growth which redistributes the money over a larger mankind and 2% is the real growth of the GDP per capita.)

The savers are still being ripped off! So that's why the wonderful members of the Bitcoin want the Bitcoin with certain desired properties to exist. The Bitcoin gives everyone the entitlement – or the human right – to have savings such that they don't decrease if expressed as the percentage of the mankind's GDP. You don't have to do anything, you don't face any risks and any volatility, and you're guaranteed not to lose in the "percentage of the mankind's wealth" game. Isn't it wonderful?

Yes, it is. It is wonderful. In fact, it is too good to be true.

If such an offer existed, almost every rational person – and especially every person at the high risk of experiencing a decreasing fraction of the wealth – would accept this offer. It's easier to do nothing, and it's more convenient to avoid the risks and volatility. If you didn't gain anything in average by taking risks or by doing experiments (or by doing anything), it would be a great idea not to take risks, not to make any experiments, not to invent any new things, or not to do anything.

It would mean that progress, optimization, inventions, and innovation would stop in such a society. No one would be motivated to do any such things. Why would you do any of these things if you can do equally well just by doing nothing – like the Bitcoin HODLers? By sitting on your aß, doing nothing, and praising your and your fellow Bitcoin sheep's ingenious and groundbreaking ideas?

Now, you would really need to introduce quite some harsh enforcement if you wanted this setup to be a reality – if you wanted the citizens not to lose their percentage of the mankind's wealth. The enforcement would include a huge amount of redistribution because without the redistribution, the fractions simply aren't stable. But if a society introduced these enforcing mechanisms, it would turn into a stagnant communist nation. It would produce lots of unhappy people, it would lose a Cold War, it would be fudged up in many fronts.

A healthy society simply cannot guarantee everybody to be "average" in some respect – e.g. in the evolution of the personal wealth as a fraction of the mankind's wealth. If a society guarantees everyone to be the average (or at least the average), everyone who is likely to be below the average and some other people would instantly accept the offer.

But if no one were below the average – in any quantity like the "rate of the change of wealth as a percentage of the mankind's wealth" – then no one could be above the average, either! It's a simple rule of mathematics.

In other words, there always have to exist many people who are below the average. In most quantities related to wealth, a majority is actually below the average most of the time (because the average is usually higher than the median – the average is highly increased by the rare high earners or rich people). This is a totally universal law that applies to all kinds of quantities related to wealth and comfort. And it's also a law that the leftists generally want to deny. Every kind of a leftist ideology is basically a variation of the theme "no people should be below the average".

But if no one could be above the average, no one would be motivated to do anything that requires work or taking the risks. The whole society would be screwed. The higher return of entrepreneurs or stockholders is basically a reward for their extra risks, extra volatility, extra work (with the adjustments of the portfolio etc.), extra responsibility, and extra creativity. The free market distributes these rewards "automatically" – no bureaucrat needs to adjust the return on the investment into companies to exceed the interest rates on the savings accounts. A society where no one is below the average is a society where no one is above the average and no one is therefore motivated to take risks, do work, be responsible, and be creative. Such a society doesn't have a rosy future. Such a society shouldn't be considered a utopia, it is clearly a dystopia. This terrible fate is an inevitable consequence of the assumptions. It's an inevitable consequence of an idea that is really a defining idea of the Bitcoin cult. That's why I consider the Bitcoin cultists to be a dangerous, quasi-Marxist, far left, financially illiterate movement that is threatening all the progress on Planet Earth.

Thank God that at least some people related to the cryptocurrencies – such as Vitalik Buterin – don't belong into this stupid cult. I guess his family's experience with communism is an important reason that gives him much of this wisdom that is so often completely absent among the young people in what we used to call the "West".

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