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Free Minds & Free Markets

Governments Trash Cash, Making Alternative ‘Money’ More Attractive

Bitcoin, gold, and other unofficial means of exchange get free marketing from idiotic officials.

| December 6, 2016

If governments are trying to jump-start the development of alternatives to their traditional monopoly on money, they're doing a fine job of it. Through methods old and new, political officials seem hell-bent on eroding the shared trust that gives importance to dollars, euros, and all the other currencies we use to facilitate transactions. Recent developments in India and Venezuela reveal jaw-droppingly stupid policies destined to erode the value of the local means of exchange—or else dastardly clever marketing schemes for gold, bitcoin, or anything else that could serve as a store of value.

Despite all of the arguments over the stuff, the basics of modern money are pretty simple. Unconnected to gold, salt, peppercorns, or anything else that's valued in its own right, paper and electronic money keeps the wheels of commerce greased only because people have some faith that's it's a reasonably stable store of value. "In short, money works because people believe that it will," a 2000 article by International Monetary Fund economists Irena Asmundson and Ceyda Oner explains in plain language.

But if shared belief makes money useful, then betraying that trust can make the folding stuff revert to whatever intrinsic value it has in a stack next to the toilet. The IMF piece adds, "Countries that have been down the path of high inflation experienced firsthand how the value of money essentially depends on people believing in it," and notes that when governments play games with their money, "trust in money will be eroded, and it may eventually become worthless."

Inflating the supply of money in circulation is a traditional favorite way for governments to screw with a good thing, because it buys them short-term favor. "[T]he authorities will always be tempted to issue money, because governments can buy more with it, hire more people, pay more wages, and increase their popularity," note Asmundson and Oner.

That's what the socialist government of Venezuela has been up to for years, tanking its currency, the bolivar, in the process. "This is being caused by the authorities ordering those bolivars by the planeload," explained Adam Smith Institute's Tim Worstall last summer as Venezuela increased the money supply by 127 percent in just one year. Officials manufactured money out of thin air so they could spend to win the favor of voters even as their policies destroyed the private businesses that could have generated real wealth.

As inflation nears 2,000 percent, creating a situation under which "a backpack full of cash is often required to pay bills at a restaurant or supermarket," the Venezuelan government has a solution: print new bills with more zeroes on them. The largest of the new bills, the 20,000 bolivar note, will be worth five American dollars. Well, it will initially be worth that—there's no reason to doubt that the country's astonishingly incompetent Maduro regime can drive those new high-denomination notes toward outhouse-only utility very quickly.

India is also on the road to becoming a cashless society, though there it's actually an intended outcome of grasping policy rather than an accidental byproduct of stupidity. It's all part of a plan by Prime Minister Narendra Modi to smoke out the country's vast untaxed wealth – up to 40 percent of India's economy takes place off the books. To that end, India's government announced last month that the country's two highest denomination notes are no longer legal tender. Overnight, 85 percent of the bills in circulation became worthless. People holding them can exchange limited quantities for new notes—but that leaves a lot of people with large holdings of the bills out of luck.

"Anyone trying to swap large sums of cash that they can't legally account for will be subject to investigation and legal action," warns Reason's Shikha Dalmia. "And all the unswapped currency will stay with the government, a massive transfer of wealth from private citizens to the state."

And that's not the end of it.

"We can gradually move from a less-cash society to a cashless society," Prime Minister Modi told his country. That would certainly be a gain for his government, which could more readily monitor and tax credit card payments than cash transactions.

But Indians may not be as cooperative as the government hopes with schemes for reshaping their economic activities. The result of declaring high-denomination rupee notes worthless was "people thronging jewellery outlets seeking to exchange the high value notes for the yellow metal" according to the Times of India. When the government threatened close scrutiny of gold purchases, there was "a surge of prices of gold in the black market."

Gold plays an important role in Indian culture and is valued even more nearly universally than elsewhere, so the stuff was an obvious means of preserving wealth when the government deliberately turned money into wastepaper.

Venezuelans also turned to gold, even taking mining jobs that paid in gold ore rather than bolivars.

Many Venezuelans have also long since turned to barter out of preference for a direct, if inconvenient, exchange of needed goods over money that loses value as you watch.

Some Venezuelans have also turned to digital means of exchange, though not in the easily tracked way that politicians like India's Modi prefer.

"In a country where cash has lost much of its value, and food and other necessities are dangerously scarce, bitcoins are providing many Venezuelans with a lifeline," Reason's Jim Epstein writes. Ironically, one of the ways that Venezuela's government has squandered the country's wealth is on subsidized electricity prices. That has created an opening for cost effective "mining" – electronically producing – of the digital currency. It's a process that requires a lot of computer power, made more attractive by the very policies that destroyed the country's official money.

"Bitcoin," one digital currency miner tells Epstein, "is our only hope nowadays to survive."

A further irony is that one of the traditional objections to bitcoin and other alternative currencies is that they have no institutional backing to firm up the shared belief in their value.

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