How Harmful Is Bitcoin To The Health Of The Economy?

Guardian Economics correspondent asks: is the currency safe or even necessary?

Powered by Guardian.co.ukThis article titled “Is Bitcoin a potential weapon of mass economic destruction?” was written by Phillip Inman, economics correspondent, for theguardian.com on Thursday 28th November 2013 16.02 UTC

Why are we giving Bitcoin house room? Surely it is akin to a counterfeiting scam promoted by people who like the idea of their computer making them rich without lifting much more than a finger?

The story on Wednesday of the Newport IT worker James Howells who threw away a hard drive with £4m worth of Bitcoins stored on its memory is a case in point. If Howells had set up a printing press in his bedroom and run off a whole bundle of banknotes, only to throw away the suitcase he stored them in, sympathy would evaporate and the police would pay a call.

Of course, Howells is no fraudster, yet somehow, because he generated the money based on computer programs designed in the hallowed confines of Silicon Valley tech offices, the process is deemed, at least by some people, as a legitimate way of generating funds.

As an article by my colleague Alex Hern described earlier this week, Bitcoin is being taken seriously in the US Congress, by US central bank boss Ben Bernanke and by some larger commercial businesses, notably Virgin.

So why do we need Bitcoin? Is there something about existing currencies, or even the lack of a global currency, that makes Bitcoin attractive? Likewise, is there something about the way we buy and sell electronically at the moment – the speed and the cost – that can be made faster and cheaper by a new electronic currency?

As an aside, these questions reinforce my general view that graduates of Stanford, MIT and Cambridge – to name just three science-oriented universities – are potential weapons of mass financial destruction, adopting the term used by Warren Buffett when asked to describe the mortgage derivatives behind the Lehman Brothers crash (he said they were WMFDs). Where once these graduates were small in number and locked in a room with the letters NASA on the door, these excessively clever people (I didn’t say worldly or wise) are now appearing in their millions, bored and restless and in search of a quick way to grab the kind of fortune that buys a mansion and a big car.

More central to the argument, the drive to create a peer-to-peer currency that operates outside the existing authorities and exchanges is the same one that encouraged investment banks to devise peer-to-peer trading platforms away from the central exchanges in London, New York and Tokyo. These exchanges were deemed to be slow and subject to excessive charges. They were regulated by government or quasi-government agencies and sometimes subject to taxes.

When governments refused to back radical reform, the JP Morgans and Citibanks took their trading to these so-called dark pools where no regulator could see what was going on.

Five years after the financial crisis there is still a debate about size, scope and legitimacy of a global trade that the Bank of England’s deputy governor Charlie Bean has said could create “a serious problem”.

Regulators say they are worried about the growth of shadow banking as much in China as in the US and Europe (China has its fair share of restless, clever graduates). They should be equally worried about Bitcoin.

Regulation is annoying and banks can charge too much for processing transactions, but that is not a justification for a shadow currency with the potential, should it be allowed to proliferate, to wobble and crash.

The Bitcoin early adopters and the people who are currently using computer programs to “mine” Bitcoins want a new currency so they can make trading profits from doing nothing other than trading. There is no higher motive. In the early days of its operation individuals can go bust – so who cares? They took the risk of a collapse in the currency’s value (so far it has only gone from $1 to $1,000 in its five-year life). But once institutions are trading with other people’s money – pension money – then it becomes serious when losses occur. Before you know it there will be a clamour for regulation and the regulators will impose charges to cover their costs, place restrictions on trading and possible apply a tax. And the reaction from the Bitcoiners? Start another currency.

We often talk about the brightest graduates turning their backs on manufacturing and engineering in favour of banking. They still do but there is not enough banking to go round for the star-studded students of today and tomorrow. Left to their own devices, and without being channelled into more productive activities, of course they will print new money if, in our ignorance, we all say it is OK.

In the meantime, businesses should shun the currency. It is no surprise that Virgin boss Richard Branson, who loves to pose in anti-establishment garb, has embraced Bitcoin. That does not mean anyone else should. Shareholders should demand real money in exchange for goods and services, for the good of society at large.

As Paul Krugman, the Nobel prize-winning economist, wrote more than two years ago: “What we want from a monetary system isn’t to make people holding money rich; we want it to facilitate transactions and make the economy as a whole rich. And that’s not at all what is happening in Bitcoin.”

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