The Gold (and Bitcoin) Fallacy

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In theory, it is possible to manage the entire world’s economy with a single brick of gold, probably far less. A brick of gold can theoretically be divided down to the atom and, if money is merely a token representing value, then there are more than enough atoms in it to easily cover the value of everything on Earth.

So why isn’t that the case?

Why do governments collect tons of gold? Why do “gold bugs” buy many coins rather than just a single one?

Guys like Nick Szabo tout the infinite divisibility of Bitcoin to address its fixed limit token issue, which has been my main criticism regarding it. However, I decided to use gold as my primary example for this post in the hopes that those who believe in the infallibility of math will begin to understand the real world challenges of dividing a fixed limit currency versus simply expanding a non-fixed limit one.

There’s a reason why the world doesn’t use a single gold brick as its currency, even though it is theoretically possible to do so. What I don’t think guys like Szabo, Vinny Lingham, Balaji Srinivasan and the like truly understand is that, in order for infinite divisibility to be feasible when managing a fixed limit currency, the proportion that every holder has must shrink in order to meet demand. For example:

Let’s say four people hold equal portions of an entire fixed limit currency. Then each would hold 25% of it. If an additional person above the four was granted an equal share of the currency, then the five holders would own 20% each. If five more people were given an equal share, then the ten holders would each own 10% of the currency.

Now let’s look at the original four holders. By increasing demand for the currency, they went from owning 100% of the currency collectively to owning 40%. Their individual and collective proportions of the currency shrank.

In my previous example, each current holder had to surrender an equal portion of his share to meet the increased demand. Assuming there isn’t a physical limit for how far the currency can be divided, it is theoretically possible that a currency can be divided indefinitely under those circumstances.

However, is that possible in the real world?

Let’s say you have a brick of gold and someone purchases 25% of the brick. Now let’s say that nine others later want to purchase equal shares of the brick. What happens?

What will likely happen is that the nine will get equal shares of what remains of the brick. The proportions would then be as follows: one holder would own 25% of the currency while the other nine hold slightly more than 8% apiece.

The nature of a fixed limit currency is that it is inherently zero sum. In both of my examples, ten people were distributed 100% of a fixed limit currency. However, in my second example, the amount that could be split between nine subsequent demanders of the currency was distorted by the initial large purchase of the first. For a fixed limit currency, accumulation of it that exceeds the mathematical equilibrium of proportion of its supply relative to its demand at the individual level negatively impacts one or more holders of that currency. In other words, for a fixed limit currency, someone’s surplus of currency is someone else’s deficit. If ten people hold 100% of a fixed limit currency, the only way one of the holders could acquire more of the currency would be directly at the expense of one or more of the other holders.

Though I’m not completely certain, I suspect this was ultimately why the gold standard failed. Granted, there is no fixed limit for the supply of gold but its accumulation is slow and generally capital intensive. Its accumulation by governments and the wealthy would not have been an issue in a slow growth world, particularly as long as the pace of gold production kept up with demand. However, as economist Robert Gordon has shown, 1870 was the year the world started to profoundly change. The pace of technological progress began to rapidly accelerate along with population growth. My guess is that, in a world of the gold standard, rapidly increasing demand severely outpaced gold production and was exacerbated by governments and individuals who accumulated large quantities. In the end, my speculation is that the world simply outgrew gold. It was too scarce with which to serve an increasingly global economy.

If I’m correct and the world simply outgrew gold, then what are the prospects of an absolutely fixed limit (wannabe) currency like Bitcoin succeeding where gold failed? The same economic distortions relative to gold would be far worse with Bitcoin. Early adopters have already hopelessly distorted its ability to be used as a mass currency and, unlike gold, it is absolutely zero sum. Accumulation of bitcoin absolutely negatively impacts subsequent holders, particularly in the face of high demand. Bitcoin works until excessive demand smacks face first into the “hodlers,” particularly large accumulators. High demand will cause Bitcoin’s price relative to fiat currency to skyrocket which will slow its velocity to a trickle. Bitcoin is barely used as a currency now and its fixed limit practically guarantees that it likely will never be mainstream.

Bitcoin only works if, when divided down to the next fraction, everyone’s holdings are also automatically divided down to the next fraction. In my articles, The Post Where I Fix Bitcoin and Fixing Bitcoin Part II: Pricing with Bitcoin Units, I introduce the concept of the “bitcoin unit” to simplify the mathematics of Bitcoin and also allow it to be “expanded” and “contracted” usefully for mainstream economic purposes. Using my methods, Bitcoin’s divisibility could indeed be leveraged to make it a viable currency. However, the exercise also revealed that Bitcoin divisibility is indeed inflationary by nature and that high demand is naturally price inflationary.

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