The Meaning of Money By: Gabriel PotterMBA, AIFA® 2014.03.12

“Since we decided a few weeks ago to adopt the leaf as legal tender, we have, of course, all become immensely rich. But we have also run into a small inflation problem on account of the high level of leaf availability, which means that, I gather, the current going rate has something like three deciduous forests buying one peanut.  So in order to obviate this problem, and effectively revalue the leaf, we are about to embark on a massive defoliation campaign,, burn down all the forests. I think you’ll all agree that’s a sensible move under the circumstances.”

        - Douglas Adams, The Hitchhiker’s Guide to the Galaxy

Most of our clients have, by now, heard our advisors’ market commentary where we point out the reasons for the strengthening US dollar, such as the Federal Reserve tapering of Quantitative Easing programs. By boosting the value of the US dollar, this can have a diminishing effect on other assets, like export-driven businesses, real assets (like commodities) or international positions in general.  In other words, the monetary policies of central banks all over the world can have a significant impact on your net worth.  It is little wonder that investors might look for an alternative money, not subject to the political whims of the Fed, the European Central Bank, and so on.

Have you been paying attention to digital crypto-currencies, like Bitcoin and Litecoin?  They are fascinating examples of what happens when people try to create an alternative medium of exchange, without a central government manipulating the relative value of this type of money.  I understand the primary reasons for these new programs, but clearly these programs aren’t yet as sophisticated as worldwide currencies with decades of experience and maturity. 

The systems are suffering through some growing pains as supply and security are not yet under control.  The supply for Bitcoins, Dogecoins and others determined by the calculation of particularly complex algorithms.  Instead of crushing rocks and mining for physical gold, high-powered graphics processing video cards are used to crunch numbers and go cyber-mining for Bitcoins, literally creating money out of nothing.  However, as computer technology gets cheaper, and electricity costs more variable, the supply is harder to manage.  Counterfeiting is a problem for every currency, but digital currencies are going to attract considerably more attention since they have key advantages for illicit activities.  For example, crypto-currencies are easier to keep anonymous and less exposed to government intervention and seizure.  Several large scale “hacks” of digital currency repositories have made it onto the news lately.  Also, there’s no way to know if today’s medium of exchange will became dated as new standards arise.  With no barriers to entry – anyone can create a medium of exchange – there are a lot of reasons to wonder which currency could become an accepted standard.  For those with an economics background, this is a curious application of Metcalfe’s law which states that a value of a network increases exponentially as people enter the network.   

While digital currencies continue to fight for acceptance, the US dollar has enjoyed remarkable price stability, with low inflation despite a recession and the direct government interventions of the past 6 years 

Out of curiosity, I asked people – inside and outside of the office – if they owned any Bitcoins and why.  I learned one person buying $10 of Bitcoins on a whim, hoping it would appreciate.  Again, this is purely anecdotal evidence, but this action suggests Bitcoins exist for most people as a speculative investment, not as a medium of exchange.

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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