If bitcoin is to be considered money it believe it must seek to be neither inflationary nor deflationary. Ideally money itself is not an investment but rather the machinery of commerce with its role as a medium of transfer of work done in an economic system. What I propose is an algorithm which attempts a partial implementation of the 1913 Federal Reserve act, focusing on it's key element and eliminating its other two flawed objectives.
"The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. "
http://www.law.cornell.edu/uscode/text/12/225aThis charter contains one meaningful statement:
STABLE PRICES, the rest are crap.
Employment is, of course driven by highly complex socioeconomic factors other than monetary policy, this is at best a delusional objective for monetary policy. Likewise, moderate long-term interest rates are set by the markets who's purpose overall is to price risk into debt by using a yield as a measurement of risk. The key is the
STABLE PRICES component of the Federal mandate that enables a sane business and social environment that will aid in employment, and as a by product, moderates long-term interest rates.
To achieve a stable commodity prices the value of money should strengthen with rising commodity inflation and weaken as inflation falls. During rising inflation a rising currency value will encourage savings and investment since it has a multiplier effect of dividends plus rising exchange rate. This would drain money from present economy reducing demand and invest it for the future. As commodities fall the exchange rate reverses and encourages spending over saving so if the economy fails and demands is reduced money is pulled from future growth to the present be decreased savings, this increases demand. The result is a system that seeks to keep prices as stable as monetary policy alone can do ... no guarantees because obviously its driven by other factors but it would be a force for stability.
Since all economic activity and services require energy the system should track energy usage in BTU's as a basis for the exchange rate. Energy costs are the key driver of inflation and are the usually the first place where central banker side affects show up: you can print all the money you want but you can't print oil. For starters a simple, perhaps overly simple, algorithm to determine the exchange rate could look like this:
Suppose you had an accurate real time measurement of worldwide energy demand. It would probably look like this:
http://en.wikipedia.org/wiki/Energy_in_the_United_States#mediaviewer/File:US_historical_energy_consumption.pngTake two moving 200 day averages separated by one year and take the difference to create a seasonly adjusted energy usage number. The percentage change between today's number and yesterday's number is the percent of change in the value of the currency.
The devil of course is in the details: What to use for real time measurement energy consumption? There are real time ETNs/ETFs that track the price of sources of energy such as natural gas, coal and oil, but these are expressed in US dollars that are subject to the toxic fallout of Central Bank policy. Usage in BTUs is a purer measurement in my opinion because it reflects demand offset by energy cost. Sadly I don't know what that input would be.
Assuming an accurate real time measurement is found you would have a currency exchange rate that seeks to stabilize prices in the economy. It would be predictable since its based on long term moving averages both the trend should be clear and day to day price fluctuations small.
Bitcoin now is being used in part as an investment vehicle, but it produces no actual work in the economy other than draining energy resources for computation. To me this is flawed and the bitcoin exchange should be automated based on the principles above so that it can be used as sound money.
