German POW Camp Reveals Power of Bitcoin
Ed Note: Today’s piece comes from our UK Daily Reckoning colleague Ben Traynor. He’s helping us out while we put the finishing touches to our latest research. We’ve got a massive week coming up here at Agora Financial Australia. We’re finally launching our business to bring you our best investment ideas. The countdown begins now…
Your questions on precious metals answered
A chin-stroking Daily Reckoning today…
We start with two questions:
Why do some people say gold is money?
Should we believe those who say gold is useless and should therefore be ignored?
To help answer these questions, let’s turn to a tale of cigarettes and German prisoner-of-war camps.
Why cigarettes were used as money
‘The Economic Organization of a POW Camp’ is one of the classic papers of economic literature.
Written in 1945 by one R.A. Radford just three months after his liberation from a German Oflag, it describes how markets for goods and services sprung up within the camps.
Famously, Radford describes how ‘cigarettes rose from the status of a normal commodity to that of currency’.
If you have twenty or so minutes to spare, give it a read. It’s absolutely fascinating.
In the following passage, Radford explains why the POWs ended up using cigarettes as a form of money:
‘Although cigarettes as currency exhibited certain peculiarities, they performed all the functions of a metallic currency as a unit of account, as a measure of value and as a store of value, and shared most of its characteristics.
‘They were homogeneous, reasonably durable, and of convenient size for the smallest or, in packets, for the largest transactions.’
It is for similar reasons that gold has been used as money for most of recorded history. As a chemical element, gold is homogeneous. One ounce of gold is the same as any other.
Gold also possesses an attribute that cigarettes do not. Its supply is tightly controlled by Nature.
Fundamental to the use of cigarettes in POW camps was their scarcity. Outside of such an artificial environment, however, tobacco farmers can increase supply considerably if they have incentive to do so.
Indeed, when tobacco was used as money in Colonial America it created exactly this incentive. The resulting oversupply of the crop wreaked havoc.
How to ‘sweat’ a cigarette
Gold’s naturally tight supply has of course led to many instances in history of coins being debased or clipped (where a small amount of gold is shaved off the edge of a coin).
In the POW camps, something similar happened with cigarettes.
‘They could be clipped or sweated by rolling them between the fingers so that tobacco fell out,’ writes Radford.
Cigarettes in the POW camp exhibited another monetary phenomenon, that of ‘bad’ money driving ‘good’ money out of circulation:
‘Cigarettes were also subject to the working of Gresham’s Law. Certain brands were more popular than others as smokes, but for currency purposes a cigarette was a cigarette.
‘Consequently buyers used the poorer qualities and the Shop rarely saw the more popular brands: cigarettes such as Churchman’s No. I were rarely used for trading. At one time cigarettes hand-rolled from pipe tobacco began to circulate.
‘Pipe tobacco was issued in lieu of cigarettes by the Red Cross at a rate of 25 cigarettes to the ounce and this rate was standard in exchanges, but an ounce would produce 30 home-made cigarettes. Naturally people with machine-made cigarettes broke them down and re-rolled the tobacco, and the real cigarette virtually disappeared from the market.
‘Hand-rolled cigarettes were not homogeneous and prices could no longer be quoted in them with safety: each cigarette was examined before it was accepted and thin ones were rejected, or extra demanded as a make-weight. For a time we suffered all the inconveniences of a debased currency.’
Gresham’s Law, incidentally, is why the idea you sometimes read that different currencies should be allowed to compete side-by-side is probably a non-starter.
Advocates of this idea seem to think this could be a route back to some kind of gold standard, as people naturally gravitate towards harder money.
Gresham’s Law suggests they’re wrong. People would spend the bad and hoard the good. Only when no one accepted the bad money as payment would the good money circulate.
So anyone hoping that some kind of gold standard will replace the current monetary system will probably need to wait until after a collapse.
The ‘gold is useless’ fallacy
Let’s get back to the cigarettes.
One reason cited for their use as currency in POW camps was their relative durability. Gold of course is far more durable, another reason it’s a monetary metal.
Gold is inert, doesn’t rust, and doesn’t do much of anything really. Only a small proportion of global gold demand (less than 10%) is for industrial purposes.
This fact has led some to suggest gold has no intrinsic value. It has value only because it is generally agreed to have value. If the fools who buy it decided to buy something else instead, the argument goes, gold would be worthless.
This is the barbarous relic view of gold, the idea that its value is a quirk of historical custom and nothing more.
As it turns out, however, gold’s relative uselessness is another feather in its cap when it comes to performing the functions of money.
Here’s Radford again:
‘Machine-made cigarettes were always universally acceptable, both for what they would buy and for themselves.
‘It was this intrinsic value which gave rise to their principal disadvantage as currency, a disadvantage which exists, but to a far smaller extent, in the case of metallic currency; that is, a strong demand for non-monetary purposes. Consequently our economy was repeatedly subject to deflation and to periods of monetary stringency.’
If your money is going to work as a store of value, it helps if you can’t smoke it or otherwise destroy it.
So, why does gold have value?
Let’s now answer the questions I posed earlier.
To the first, the reason some people say gold is money is because it has properties that make it uniquely well-suited to that function. It can be used as a unit account and a medium of exchange, but then so can many other things in principle.
Gold has an extra advantage in that it is relatively portable. By that I mean you can store a good deal of value in small units and ship them from place to place.
Being durable helps too, as does being homogenous (diamonds, for instance, would be a poor form of currency as they’re all different).
What sets gold apart is that it combines the above attributes with being tightly controlled by Nature.
To the second question, should we ignore gold because it is useless, the answer is no.
In fact, the dearth of competing uses for gold could be seen as an advantage in the case for its use as money.
In short, gold has value because it is better suited than anything else on earth for performing the functions of money including that of being a store of value.
I’ve talked up the advantages of gold as money. This is not to say there aren’t potential drawbacks. One is the potential for deflation if the supply of good outstrips the supply of money (a phenomenon observed in the POW camp by Radford).
However, I hope I’ve gone some way towards answering the perennial question of why gold, a shiny metal of little obvious utility, has been highly valued throughout recorded history.
OK, so are cryptocurrencies money?
To answer this question, let’s first consider the properties that Radford laid out in his paper.
Cigarettes, he argues, performed the function of money in POW camps because they were ‘homogeneous, reasonably durable, and of convenient size for the smallest or, in packets, for the largest transactions.’
As they’re purely electronic, cryptocurrencies don’t face the same durability challenge that physical money does.
They’re also divisible (you can buy fractions of a bitcoin, for example).
That leaves homogeneity.
Now, there’s the upcoming ‘fork’, which could see bitcoin split into two different currencies come 1 August.
Notwithstanding ‘the fork’, which may or may not turn out to be an issue, a bitcoin is a bitcoin is a bitcoin.
So we can tick the homogeneity box, so long as we’re talking just about one particular cryptocurrency.
Where it gets trickier is when we consider the fact that there are hundreds and hundreds of the damn things.
And that could come to matter.
What if bitcoin is replaced as the pre-eminent crypto by, say, ether, or litecoin, or any of the other hundreds of cryptos?
Each crypto may be homogenous in and of itself, but the crypto universe is extremely heterogeneous.
Let’s now turn to the three classic characteristics of money: a unit of account, a medium of exchange and a store of value.
Cryptos clear the first hurdle pretty easily, in my view.
They clear the second, too. The use of cryptocurrencies to actually buy and sell stuff may be very niche, but it is happening (especially for dodgy stuff on the dark web, or so I’m given to understand).
It’s the store of value one that always stumps me. And it’s a stumper for gold too, by the way.
How can something so volatile (and gold is no slouch, even if crypto does leave it for dust) be labelled with the term ‘store of value’.
What is a store of value anyway?
I guess the ideal store of value is one where you can park $1,000 in it today and know that it’ll have $1,000 of purchasing power at any point in the future.
Quite what that would actually mean in practice is another matter – no amount of purchasing power 40 years ago would have let you benefit from some of today’s technologies.
I guess a pragmatic answer is that a store of value retains some substantial value over the long haul that is not so different from where you started to mean a major change to your standard of living.
Here’s where I reckon. Gold has the edge, based on length of track record.
Gold has had a value (sometimes less, sometimes more) for thousands of years. Cryptocurrencies have been around less than a decade.
True, the more serious cryptos have a built-in limited supply that beats even gold’s claims to scarcity (new deposits can always be found, for example).
What we don’t know – because it hasn’t been tested – is whether demand for cryptos will persist.
Cryptos may yet turn out to be a fad – something that would be hard to level at gold, for all its price volatility.
Perhaps I’m asking the wrong question here. Perhaps we should be thinking not in terms of ‘new currency’ but, as some have argued, ‘new asset class’.
For The Daily Reckoning Australia