According to recent reports, the Federal Reserve is slowly turning its attention to the Bit Coin phenomenon. Bit Coins were developed by Satoshi Nakamoto as an alternative currency to the paper fiat monies issued by central banks. Using encrypted software, transactions take place online using the virtual currency; physical bit coins have been produced to provide a substitute for online transactions.
Value is something that the market provides services. Since there is no such thing as intrinsic value in economic goods and services (contra Marxists and classical economists who thought mixing labour somehow created value); accordingly, the value of a monetary commodity comes from the demand and supply for the money itself and the demand and supply for the goods and services that it can buy.
Whether something is accepted as money in the marketplace depends on the willingness of traders to use it in exchange. That's it. It has nothing to do with intrinsic notions that the money is somehow valuable in itself or that its value is somehow decreed by an authority - the king or a central bank.
The value of money is dependent on these two markets (demand and supply for money and the demand and supply for goods and services - of which, of course, there are millions of markets transacting each day): the value of money typically becomes disturbed when its supply to the market becomes volatile - notably on the inflationist side of the equation.
Inflationism is the policy of systematically undermining the value of a currency by increasing its supply. When money was gold (and in many respects, despite political exhortation, it still is) the only way its supply could increase was through mining, melting down of jewellery and ornaments, or seizing enemies' treasure. The amount of extra gold entering the economy was thus limited to physical discoveries or alteration of use.
When governments discovered the fraudulent scam of fractional reserve banking and the commercial use of money substitutes such as cheques and paper, they had a field day: now inflationists could expand the money supply at will. And that is what governments have generally done.
When they have not been actively printing paper money, they have borrowed 'cheap' funds from the banking system that they permit to lend out more than the reserves held on account (fractional reserve banking).
The temptation for both practices is incredibly high and it takes an iron-clad constitutional prohibition to stop such scams.
Traders, properly speaking, are not really bothered what money they use. As long as its value is not volitive over time, they will converge on those monetary media that enable them to reduce transaction costs.
This principle is profound and highly useful for us to help us understand why Bit Coins emerged and why the Fed and other Central Banks are keen to regulate them. (Monitor = regulate).
It also helps us understand why throughout history traders have converged onto either gold or silver as universal media for exchange.
In the last decade, we have seen monetary wobbles around the world - as economists, we often look back to the hyperinflation of Weimer Germany and other nations as textbook cases of what not to do with a currency. We've had Zimbabwe's trillion dollar notes, but more importantly, the world's reserve currency's monetary base has, under Obama, expanded more than four fold. It has risen from around 800 billion $ to over $36 billion.
That money has to go somewhere and we know it will have deleterious effects.
Much of it has gone into the bond and stock markets (the Fed has been voraciously 'buying up' US government debt in exchange for paper - paper for paper...not economically healthy and it's the kind of accounting fraud that companies go down for); that is why we have had obvious bubbles growing in these paper markets. A proportion will have gone abroad as most commodities (e.g., oil) are still priced in US $.
But traders are not fooled by the growing quantities of $ and other currencies around the world.
Basically, if the Fed prints more money, or uses QE - same thing, other central banks generally follow suit so that the US$ is not seen to plummet in value against these other currencies: but we can assuredly see the effect on the price of gold that has risen from just over $200 dollars in 2001 to a high of $1900 in 2011; it has dropped to around $1200 over the past 12 months as investors' money has expected more gains from the paper markets, but it is slowly creeping up again and the savvier newsletters remain 'bullish' on gold.
When traders fear that the currency will fall in value or become unacceptably volatile, they seek alternatives. The ultimate alternative will always be something difficult to replicate, i.e., gold and silver. Entrepreneurs though are attempting to replace or avoid using paper currencies with Bit Coin.
Bit Coin is a symptom of the general implicit malaise in the paper currency world - a world that permits the creation of an extra $70-$80 billion per month without a moment's hesitation - and hence the attempt of traders to avoid the paper notes issued by and for governments (central banks are effectively government agencies regardless of their 'private status').
Although transactions are currently small, the Fed has expressed its 'interest'. Other US organs of violence have attacked illicit Bit Coin users - traders who are active in illicit markets who would be targeted by governments anyway - but now they are raising the attention level. Why? Because they cannot control Bit Coins so long as they are produced by entrepreneurs for entrepreneurs.
Bit Coin or any such alternative forms and alternative money supply and hence an alternative monetary value to the use of paper currencies. If the latter are printed in greater quantities than the former, the value of the paper currencies will be seen to deteriorate with respect to the Bit Coin alternatives (just as the $ has fallen with respect to gold).
And being seen to deteriorate is not what the Central Banks want. They want the superficiality of all is normal and stable with their flimsy currencies; they do not want traders rushing en masse away from paper and back into gold or alternatives, because then the governments they work with would not be able to raise the monies required to pay their huge debts (currently, the US government debt is over $17 trillion and counting).
The entire monetary policy of the western governments would quickly be seen to be thoroughly hollow.
And so such entrepreneurial tactics to avoid using toilet paper money must be 'investigated' - i.e., controlled, regulated, brought to heel.
If Bit Coin use (or the use of gold coins in transactions) increases, the demand for paper currency will fall given a supply. This means that the market value of national currencies will fall - and that means inflation. (Of course the supply keeps on increasing, which will heighten the inflationary effects).
As inflation becomes more apparent, commercial transactions will seek more stable monetary environments whether from Bit Coins or gold and silver exchanges. That is inevitable, regardless of politicians' desires. Traders will always seek the best form of monetary exchange, and governments have been woeful at supplying a stable and strong currency over time.
In many respects, I wish the Bit Coin entrepreneurs all the best in circumnavigating the Central Banks. However, an electronically based currency is not and cannot be as stable as a physical hard monetary medium such as gold or silver. It offers too much of a tempting target for governments and banks to either take over or prohibit. And while governments have prohibited the private ownership of gold in the past - notably and most embarrassingly the United States of America, the land of liberty - in 1933, gold can always be hidden, dug into the ground, melted into jewellery, etc.
A day after writing this: US Feds are keen to accept bit coins ... why not? There's so many transactions out there they can't tax! Also, two arrests of bit coin dealers acting in illegal markets (i.e. markets the authorities can't tax...) NEWS ABOUT BITCOINS ON THIS SITE