The fiat experiment: Stopping time

[aminorex]

blockchain is increasing exponentially in size.... I've yet to see a response that makes sense.  

It has been suggested that bitcoin is useful for large transfers and reserve use, while alts and layered apps fulfill petty transactional use.  This would be analogous to the historical use of bimetal exchange.  I personally don't like that outcome.  It leads to political abuse and gaming, and is inefficient in many ways.  Certainly alts and layered apps will exist, but a great deal of the appeal of BTC is as a universal exchange vehicle.  Unless it adapts to fulfull those requirements, it will either be obsoleted by an alt or layered protocol which does, or we will fail to have a universal exchange medium.  I prefer a world in which bitcoin is dominant, in part because of personal stake, but also because I want my life simplified, not complicated, by crypto.

I would hope that the core devs would be motivated by stake alone to make BTC dominant.  That would strictly require either a fundamental change in the implementation or a fundamental innovation in layered protocols.  A centralized app is worse than nothing.  Of course the layered apps may not come from the core devs, but fundamental changes in the implementation would have to go that route.

Is anyone aware of an initiative to produce a layered protocol to deal with scalability problems?

[HairyMaclairy]

There is no reason why Bitcoin QT (or it's replacement) has to download anything more than say the past 100,000 blocks. Prior blocks could be stores on supernodes which still do not have to be centralised.

Problem solved.

[aminorex]

There is no reason why Bitcoin QT (or it's replacement) has to download anything more than say the past 100,000 blocks. Prior blocks could be stores on supernodes which still do not have to be centralised.

Problem solved.

unfortunately not quite.  implementation remains, and the transactions per block issue is fundamental, protocol forking.

[DieJohnny]

fiat failures are not necessarily a good thing if they result in wars and acquisitions, see my thread on what i think would be an end-of-bitcoin historical event

https://bitcointalk.org/index.php?topic=413236.0;topicseen

[2017orso]

doesn't the political pathway fork at "fiat failure" and "world war"?

do you think the U.S. thus far is at least neutral if not slightly positive to Bitcoin because of the potential for fiat failure protection without war?  do you think this may have been one of the goals of bitcoin in the first place?

do you also think China is slightly below neutral because the pieces were aligning for reserve currency status transition to the yuen with military collaboration underway if/when the hard political fork draws closer?

serious questions.

[aminorex]

I think China turned negative because they don't want a bunch of millionaires who are not beholden to the princelings.

I think the Senate hearings were favorable because the foundation did a great PR offensive, and because no one wants to be the guy who killed the Internet (electric light, wheel, fire, polio vaccine, whatever) in commitee.

In the long-run neither will matter.

[BTCtrader71]

I solicit discussion of the estimated time for a forthcoming sovereign crisis, and its relation to that window of opportunity.

There is an interesting podcast of Econtalk that is focused on hyperinflation.

http://www.econtalk.org/archives/2012/10/hanke_on_hyperi.html

Summary of podcast:
"Steve Hanke of Johns Hopkins and the Cato Institute talks with EconTalk host Russ Roberts about hyperinflation and the U.S. fiscal situation. Hanke argues that despite the seemingly aggressive policies of the Federal Reserve over the last four years, there is currently little or no risk of serious inflation in the United States. His argument is that broad measures of the money supply lag well below their trend level. While high-powered reserves have indeed expanded dramatically, they have not increased sufficiently to offset reductions in bank money, in part because of requirements imposed by Basel III. So, the overall money supply, broadly defined, has fallen. Hanke does argue that the current fiscal path of the United States poses a serious threat to economic stability. The conversation closes with a discussion of hyperinflation in Iran--its causes and what might eventually happen as a result."

One of the interesting tidbits I picked up from this podcast is that there are, by his count, 57 examples of hyperinflation throughout history, defined as a rate of price increase that exceeds 50% in one month. (I'm not sure how long it has to stay above that threshhold to count.)

[Chalkbot]

No sign of hyperinflation in any advanced economy today.  Maybe come back in 10 years and check again.  

Where will we look to determine the rate of inflation or hyper-inflation? What are the signs? The first sign is deflation. The economy slows and money must be injected to maintain momentum. The graph above is a pretty good indicator that we're doing that, and like aminorex said before, it's pretty impressive that it's been done in such a way as to maintain a relatively stable rate of inflation, from the consumer point of view.

The price of gold and other commodities. Going down? Surely we can't be in a period of inflation. This could either be a reflection of the deflation we're in (per above chart) or manipulation, depending on which theory you subscribe to. Either one has the same conclusion, I think.

Hyperinflation will kick in when the economy recovers it's momentum, i.e., if QE actually starts "working" and this glut of wealth "trickles down" to consumers. You can see how this would happen quickly, and uncontrollably, as the money has already been in the system for some time, therefore there won't be any "warning signs" for the average Joe to begin hedging.

[BTCtrader71]

I have been struggling to understand how and why the broader measures of the money supply have been more or less constant despite the dramatic increase in monetary base shown in the figure. According to the econtalk podcast with Steve Hanks, it has something to do with Basel III which (by my cursory knowledge of the subject) increased capital reserve requirements on banks. So, if I understand correctly, and I'm not sure I do, it means that the 2 Trillion USD printed (metaphorically speaking, since most of it is held electronically) since 2007 just sits there and does nothing other than satisfy Basel III requirements.

What I don't understand is why the powers-that-be would implement the above strategy. From their perspective, what's the point of printing money and then requiring it to sit there doing nothing in bank vaults? I think I'm missing something key. But I am thinking that if inflation got started, then banks would want to convert all those excess USD into some other asset, which would stimulate inflation, which would make them want to dump their USD even faster, and suddenly you have massive inflation coming out of nowhere and catching everybody (except the architects of the system) by surprise. It creates in my mind the image of a slingshot that is getting poised to go off.

But like I said, I think I am missing something. Why would the powers that be set this system up? The first reason that comes to my mind is that it's a big payoff to the banks, who surely spread the money around to their friends. But if this is the story, then my question becomes: why now?

[Chalkbot]

I have been struggling to understand how and why the broader measures of the money supply have been more or less constant despite the dramatic increase in monetary base shown in the figure. According to the econtalk podcast with Steve Hanks, it has something to do with Basel III which (by my cursory knowledge of the subject) increased capital reserve requirements on banks. So, if I understand correctly, and I'm not sure I do, it means that the 2 Trillion USD printed (metaphorically speaking, since most of it is held electronically) since 2007 just sits there and does nothing other than satisfy Basel III requirements.

What I don't understand is why the powers-that-be would implement the above strategy. From their perspective, what's the point of printing money and then requiring it to sit there doing nothing in bank vaults? I think I'm missing something key. But I am thinking that if inflation got started, then banks would want to convert all those excess USD into some other asset, which would stimulate inflation, which would make them want to dump their USD even faster, and suddenly you have massive inflation coming out of nowhere and catching everybody (except the architects of the system) by surprise. It creates in my mind the image of a slingshot that is getting poised to go off.

But like I said, I think I am missing something. Why would the powers that be set this system up? The first reason that comes to my mind is that it's a big payoff to the banks, who surely spread the money around to their friends. But if this is the story, then my question becomes: why now?

I'm with you on not fully understanding the goals or methods being implemented. My guess is that we were treating a symptom of a problem instead of the problem. We reached a point where banks were going to be insolvent, leading to financial collapse. What's the solution to this? Get more money in those banks! I don't think this addresses the real problem at all, and actually creates a bigger monster.

[johnyj]

There is no significant inflation because the money distribution is extremely unbalanced: FED printed 4x more money but did not cause 4x rise in everything's price, simply because banks hold majority of those money and save them back at FED as reserve

Banks get themselves 100 dollars and spend only 1 dollar to make sure there is no inflation. Their first priority is to keep the inflation in check, not helping the economy. The amount of money in circulation purely depends on a few people's action, they become extremely rich after financial crisis, but a few of them spending a couple of million dollars buying luxury things won't help the economy at all

Same thing could happen in bitcoin, if majority of miners hold their coin, they will create heavy deflation and raise the exchange rate of bitcoin, if they start to spend, they will increase the money in circulation. Although there are lots of miners decide the money in circulation, their action can be highly identical in a crisis

[BTCtrader71]

There is no significant inflation because the money distribution is extremely unbalanced: FED printed 4x more money but did not cause 4x rise in everything's price, simply because banks hold majority of those money and save them back at FED as reserve

Banks get themselves 100 dollars and spend only 1 dollar to make sure there is no inflation. Their first priority is to keep the inflation in check, not helping the economy. The amount of money in circulation purely depends on a few people's action

I found this blogpost that more or less agrees with what you said. Also more or less agrees with my post (#30).
http://theecoptimist.wordpress.com/2012/05/08/money-multipliers-and-basel-iii-liquidity-rules/

Same thing could happen in bitcoin, if majority of miners hold their coin, they will create heavy deflation and raise the exchange rate of bitcoin, if they start to spend, they will increase the money in circulation. But at least lots of miners decide the money supply, not a few

One of my main concerns about bitcoin in the long term is volatility; as a bitcoin bull, the short term volatility does not concern me, because I see it as just a necessary growing pain; but what about the long term? What will cause the purchasing power of one bitcoin to stabilize eventually? IMHO colored coins (or some variant, like mastercoin perhaps?) may be the answer to this problem. If the global banking system were to suffer a meltdown like hyperinflation of the USD or something along those lines, I sure as hell hope that a colored coin infrastructure is solidly in place before that happens.

[aminorex]

When it approaches its long-term fundamental value it will stabilize.  For now, the price is orders of magnitude too low, and the risk factors dominate discounting.  When waves of fear or greed hit the user base, price fluctuates dramatically because the discounting factors are moving so much.  As these factors converge and stabilize the price will rapidly stabilize.  I think what I am saying is trivial, in that it is essentially tautological, given classical no-arb assumptions, but it is simulatenously very hopeful, i.e. it indicates a very favorable future outcome.  When you invest on the side of tautologies, you usually do well.  I'm also implying that the risk factors of public imagination are not very realistic.  Why would this be?   I suspect it is because P2P and ECDSA, open-source and mining incentives, all are not well-understood by the public.  The safety factors which design introduces are lost on them.

[BTCtrader71]

When you invest on the side of tautologies, you usually do well.

How is that?
One of my college courses exposed me to the philosophy of Alfred Jules Ayer. One of the take-home messages was that a tautology is true or false based on how we define the words we are using, eg "a unicorn has a horn" is tautologically true because that's how we define the word unicorn. Unfortunately, a tautology tells us nothing about the real world, like whether unicorns do or do not exist outside our imaginations. The danger is that we sometimes allow ourselves to forget this fact, and we end up using a tautology to let us see what we want to see, even when it is an illusion.

When you say this:

When it approaches its long-term fundamental value it will stabilize.

I think: that is a tautology because by definition, the "long term fundamental value" is the value where it stabilizes. But how do we know whether the bitcoin "long-term fundamental value" will be observed in reality -- or will remain as elusive as a unicorn?

[aminorex]

When you invest on the side of tautologies, you usually do well.

How is that?

If I were to wager on Tail in the next toss, it would be an indifferent investment at 1:1 odds.
If I were to wager on whether (P->Q) -> (~Q->~P), at any odds, it would be a good investment.

When it approaches its long-term fundamental value it will stabilize.

I think: that is a tautology because by definition, the "long term fundamental value" is the value where it stabilizes. But how do we know whether the bitcoin "long-term fundamental value" will be observed in reality -- or will remain as elusive as a unicorn?

The long-term fundamental value is determined by PQ=MV, Fisher's quantity theory of money.  A minimum feasible long-term value of PQ > 500bn USD2014.  There may be elusive unicorns out there somewhere, but they are well north of 5000.  Probably north of 50,000.  Possibly north of 500,000.

[Cryddit]

The issue with Basel III is actually very simple.

The Fed issued a godawful amount of $USD which now has to sit in banks, not to trigger inflation or deflation, but in order to stabilize the banks.

The increased reserve requirement is effective in propping up banks, even if the money backing it up is just an illusion.  

I'm going to just use hypothetical numbers here instead of the ones that the Fed actually used, but this is how it works.  

Let's say banks are doddling along with a 20% reserve requirement, cheerfully lending out five times as much money as they actually hold.  And the doctrine is, "you can't suddenly inflate the money supply.  That would lead to hyperinflation.  Imagine every atom of your body, radiating outward at the speed of light!  That would be BAD!

Then something happens (like the financial industry crashing) that makes it utterly clear that 20% is not enough of a reserve requirement.  Banks that actually did hold 20% reserves are struggling to keep from going under as 17%, 18%, and 19% of their loans suddenly go into default.  It's a crisis of Biblical proportions!  And what about this guy over here who caused the crisis?  It's true sir, this man has no dick.

Guys at the Fed decide that it's really only safe for bankers to loan out 3 times as much money as they hold, so the reserve requirement ought to be raised from 20% to 33%.  But if the banks suddenly have to make it up on their current reserves, then we are all DEAD, because they are struggling to survive by spending down a 20% reserve to meet their obligations.  To deal with that you'd have to suddenly and dramatically raise the money supply!  And that would be BAD!  In order to even get back to 20% within some reasonable time, the bankers are having to raise interest rates on mortgage holders by some obscene amount like going from 8% to 23% on long-term mortgages.  If they were trying to get to a 33% target, they'd have to raise their interest rates on mortgage holders to something even more obscene like 50% or 60%, and then we would all be dead.  Panic in the streets, rains of blood, dogs and cats living together,  -- it's the end times!!  

Then someone comes up with a ray of hope in the darkest hour, and says ....  hey, Quantitative Easing!  The new reserve requirement will turn the financial sector of our economy into a "giant sucking noise" that takes a hell of  a lot of money out of the economy, but what if we just give out about that same amount of money?  People will spend it once or twice, then it'll wind up getting sucked into the giant black hole we've just created in our banking sector, and if we add the money to the economy at about the same rate that it gets sucked up by the giant black hole, then we can do it without creating (too much of) a liquidity crisis!  Why, we might not even have a revolution!  But hey, wouldn't that be .... you know, BAD? Well, There's a chance -- a very small chance -- we might survive.  Oh, I love this plan! This is a great idea!!

And so the Fed set out to do this thing.  They've been adding money to the economy at about the same rate that the banks have been required to suck it out of the economy.  Now it's a couple years later, the reserve requirements have been raised and, mostly, met, and the amount of money actually in circulation has stayed roughly the same.  The banks are now holding 33% instead of 20%, they've even managed to recover the reserves that they had to spend down in the crisis, if another 20%-threatening crisis occurs they'll be able to withstand it, and the public has been largely unaffected because money has entered the economy through QE just about as fast as it has gotten sucked out of the economy by banks that would otherwise collapse.

It's -- actually not that bad a plan.  What it comes down to is that in order to raise the amount held in bank reserves from 20% to 33%, the 'actual'  money supply had to increase from 1/5 to 1/3 of the 'circulating' money supply - meaning, from $3 on every circulating $15 to $5 on every circulating $15, so 40% of the 'actual' money supply at the end is 'new' money that didn't exist before.  Throw in another 15% or so to allow the banks to recover from the hole they were in with respect to their 20% margin obligations at the start of the crisis, and you have a picture that looks pretty much like the picture today.

Now comes the next and possibly even more difficult trick.  Now that the goal of stabilizing banks and raising the reserve requirements so they stay a bit more stable is more or less met?  Now they have to ... stop.  If they can manage this one last trick, then hats off to them because, well, frankly there's no other way we could have come through that mess starting from where, through ignorance and incompetence, they started.  If the new reserve requirement is met, then maintained, and they can judge exactly the right moment to stop printing so goddamn much new money, then we won't have hyperinflation because all that new money will stay in the banks and won't enter circulation.

[aminorex]

Excess reserves are reserves in excess of requirements.  The fed pays interest on these reserves, to favored money-center banks.  Some of these are primary dealers, which bid on treasuries at auction.  The fed also purchases treasuries from primary dealers.  In this way, the primary dealers get a spread on treasuries which end up owned by the fed.  The interest and the spread are subsidies in effect paid by diluted currency holders to the money-center banks and primary dealers.  The excess reserves being literally in excess of requirements, the banks can stop holding them on deposit, and lend them into the economy, with a fractional multiplier.  If they don't, it's because they don't see a risk-adjusted benefit in doing so.

The stated policy mechanism for withdrawing excess liquidity, should it arise, is reverse repo.   They ran some reverse repos a few months back to test the mechanism.  No one has ever attempted to remove trillions of USD in liquidity via reverse repo, and it is rational to consider the risks involved in such an untested enterprise at such vast financial scale to be very large.

Swap lines with European banks are used to shore up those banks as well.

Public knowledge of the monetary operations of the fed outside of the open market programs is very poor.  Hence the Congressional campaign to "audit the Fed".
They keep lots of secrets.  Some of these are probably hiding malfeasance, given the history of government secrecy and human nature.  That malfeasance is probably quite grand in scale, given the patterns seen elsewhere (such as the plane loads full of pallets of $100 bills that went missing in Iraq) and the scale at which the Fed operates.

The Fed suffers from enormous political risk.

[BTCtrader71]

When you invest on the side of tautologies, you usually do well.

How is that?

If I were to wager on whether (P->Q) -> (~Q->~P), at any odds, it would be a good investment.

I too would wager that A = A. But who's wagerin' against it?

[Chalkbot]

The issue with Basel III is actually very simple.

The Fed issued a godawful amount of $USD which now has to sit in banks, not to trigger inflation or deflation, but in order to stabilize the banks.

The increased reserve requirement is effective in propping up banks, even if the money backing it up is just an illusion.  

I'm going to just use hypothetical numbers here instead of the ones that the Fed actually used, but this is how it works.  

Let's say banks are doddling along with a 20% reserve requirement, cheerfully lending out five times as much money as they actually hold.  And the doctrine is, "you can't suddenly inflate the money supply.  That would lead to hyperinflation.  Imagine every atom of your body, radiating outward at the speed of light!  That would be BAD!

Then something happens (like the financial industry crashing) that makes it utterly clear that 20% is not enough of a reserve requirement.  Banks that actually did hold 20% reserves are struggling to keep from going under as 17%, 18%, and 19% of their loans suddenly go into default.  It's a crisis of Biblical proportions!  And what about this guy over here who caused the crisis?  It's true sir, this man has no dick.

Guys at the Fed decide that it's really only safe for bankers to loan out 3 times as much money as they hold, so the reserve requirement ought to be raised from 20% to 33%.  But if the banks suddenly have to make it up on their current reserves, then we are all DEAD, because they are struggling to survive by spending down a 20% reserve to meet their obligations.  To deal with that you'd have to suddenly and dramatically raise the money supply!  And that would be BAD!  In order to even get back to 20% within some reasonable time, the bankers are having to raise interest rates on mortgage holders by some obscene amount like going from 8% to 23% on long-term mortgages.  If they were trying to get to a 33% target, they'd have to raise their interest rates on mortgage holders to something even more obscene like 50% or 60%, and then we would all be dead.  Panic in the streets, rains of blood, dogs and cats living together,  -- it's the end times!!  

Then someone comes up with a ray of hope in the darkest hour, and says ....  hey, Quantitative Easing!  The new reserve requirement will turn the financial sector of our economy into a "giant sucking noise" that takes a hell of  a lot of money out of the economy, but what if we just give out about that same amount of money?  People will spend it once or twice, then it'll wind up getting sucked into the giant black hole we've just created in our banking sector, and if we add the money to the economy at about the same rate that it gets sucked up by the giant black hole, then we can do it without creating (too much of) a liquidity crisis!  Why, we might not even have a revolution!  But hey, wouldn't that be .... you know, BAD? Well, There's a chance -- a very small chance -- we might survive.  Oh, I love this plan! This is a great idea!!

And so the Fed set out to do this thing.  They've been adding money to the economy at about the same rate that the banks have been required to suck it out of the economy.  Now it's a couple years later, the reserve requirements have been raised and, mostly, met, and the amount of money actually in circulation has stayed roughly the same.  The banks are now holding 33% instead of 20%, they've even managed to recover the reserves that they had to spend down in the crisis, if another 20%-threatening crisis occurs they'll be able to withstand it, and the public has been largely unaffected because money has entered the economy through QE just about as fast as it has gotten sucked out of the economy by banks that would otherwise collapse.

It's -- actually not that bad a plan.  What it comes down to is that in order to raise the amount held in bank reserves from 20% to 33%, the 'actual'  money supply had to increase from 1/5 to 1/3 of the 'circulating' money supply - meaning, from $3 on every circulating $15 to $5 on every circulating $15, so 40% of the 'actual' money supply at the end is 'new' money that didn't exist before.  Throw in another 15% or so to allow the banks to recover from the hole they were in with respect to their 20% margin obligations at the start of the crisis, and you have a picture that looks pretty much like the picture today.

Now comes the next and possibly even more difficult trick.  Now that the goal of stabilizing banks and raising the reserve requirements so they stay a bit more stable is more or less met?  Now they have to ... stop.  If they can manage this one last trick, then hats off to them because, well, frankly there's no other way we could have come through that mess starting from where, through ignorance and incompetence, they started.  If the new reserve requirement is met, then maintained, and they can judge exactly the right moment to stop printing so goddamn much new money, then we won't have hyperinflation because all that new money will stay in the banks and won't enter circulation.

Thanks for that. Does all of this new money not also come with huge interest obligations? Assuming the "plan" worked flawlessly, how is this new interest to be paid going forward, assuming everything else went back to normal? Wouldn't that require more money, and more debt all on its own? (setting aside the impossible task of tapering).

[BTCtrader71]

The issue with Basel III is actually very simple.

The Fed issued a godawful amount of $USD which now has to sit in banks, not to trigger inflation or deflation, but in order to stabilize the banks.

There must be conditions defined by Basel III under which the banks could actually spend those reserves. After all -- if they were NEVER allowed to spend it, then it wouldn't be a stabilizing force, would it? Imagine if the US government in its war on poverty required everyone to put at least $100,000 into a "rainy day" savings account, even giving it to you if you didn't already have it -- but NEVER EVER allowed anyone's balance to drop below $100,000. If such were the case, those $100,000 may as well not even exist. There would have to be "emergency" conditions under which your balance could drop below $100,000 for it to serve its purpose.

So the question arises: under what circumstances would the banks end up spending some or all (well, a significant amount, not necessarily all) of their reserve USD? and what are the odds of that happening?