Innovation and Cryptoventures. Why Money? Campbell R. Harvey. Duke University, NBER and Investment Strategy Advisor, Man Group, plc

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1 Innovation and Cryptoventures Why Money? Campbell R. Harvey Duke University, NBER and Investment Strategy Advisor, Man Group, plc Revised February 20, 2017

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3 Purposes Purposes: Primary Unit of Account: A way to compare the value of various goods and services Medium of Exchange: Allows for non barter transactions. Secondary Store of Value: Allows value to be retained even if partially rather than complete decay (e.g. storing food). Transfer of Value: Ease of transfer of value and to defer value. 3

4 Characteristics Traditional characteristics: Durability: Withstand repeated use (coins, paper, gold) Portability: You can carry around Divisibility: Fractional units Uniformity: Versions of the same currency have identical value Limited Supply: Unlimited supply would mean zero value Acceptability: This is legal tender for all debts, public and private Stability: If unstable, people will look for alternatives 4

5 The Communist Dream The Principles of Communism, 1847 Finally, when all capital, all production, all exchange have been brought together in the hands of the nation, private property will disappear of its own accord, money will become superfluous, and production will so expand and man so change that society will be able to slough off whatever of its old economic habits may remain. 5

6 The Communist Dream A World without Money, The new people will resemble their hunting and gathering ancestors who trusted in a nature which supplied them freely and often abundantly with what they needed to live, and who had no worry for the morrow, over which in any case they had no control. L'homme nouveau se rapprochera de son ancêtre chasseur collecteur qui faisait confiance à une nature fournissant gratuitement et souvent abondamment de quoi vivre, qui ne se souciait pas d'un lendemain sur lequel de toute façon il n'avait pas prise. L'homme de demain aura pour nature le monde qu'il aura façonné, l'abondance naîtra de ses propres mains. Il sera sûr de lui car il aura confiance en sa force et connaîtra ses limites. Il sera insouciant parce qu'il saura que demain lui appartient. 6

7 The Communist Dream But Even North Korea uses money! 7

The Communist Dream Further Hunter gather life style is no easy life style Five years ago, members of the Nukak Maku unexpectedly wandered out of the Amazonian rainforest at San José del Guaviare in

8 The Communist Dream Further Hunter gather life style is no easy life style Five years ago, members of the Nukak Maku unexpectedly wandered out of the Amazonian rainforest at San José del Guaviare in Colombia. The Nukak were a tribe that time forgot, cut off from the rest of humanity until this sudden emergence. Subsisting solely on the monkeys they could hunt and the fruit they could gather, they had no concept of money. Revealingly, they had no concept of the future either. These days they live in a clearing near the city. Asked if they miss the jungle, they laugh. Niall Ferguson, The Ascent of Money 8

The History of Money Not just coins 3300 BC Clay tokens in Mesopotamia In the Mesopotamian cities, there were 16 main types of tokens and dozens of sub categories for things

9 The History of Money Not just coins 3300 BC Clay tokens in Mesopotamia In the Mesopotamian cities, there were 16 main types of tokens and dozens of sub categories for things like honey, trussed duck, sheep's milk, rope, garments, bread, textiles, furniture, mats, beds, perfume and metals. 9

10 The History of Money Not just coins 2800 BC Silver ring money in Mesopotamia Others used tin, copper or bronze Allowed for trade within a city and between cities 10

11 The History of Money Not just coins 1650 BC Clay tablets in Mesopotamia Babylonian town of Sippar. A clay tablet found there was inscribed with this promise: At harvest time, someone named Amil mirra would pay 330 measures of barley to whomever held that tablet. First promise to pay Bitcoin: And the Future of Money, Jose Pagliery 11

12 The History of Money Paper money Fiat money invented in China ~600 AD China T ang Dynasty promises to pay (hence the term promissory notes) First record of metallic reserves around 1000 AD, where reserves were 3/7ths of the face value. John F. Chown, A History of Money: from AD

13 The History of Money Europe Roman coinage, the silver denarii, was used well after the fall of the Roman Empire. However, there was a shortage of silver in Europe. Why? because of deficits with southern Mediterranean and Near East. Alternatives to coins arose for small amounts (like squirrel skins and peppers) 13

14 The History of Money Europe Discovery of silver in New World solved the shortage problem 170 tons of silver heading to Castilian monarchy per year Spanish pieces of eight used outside of Spain so a global currency Inflation resulted. In 100 years, the price of food increased 7X 14

15 The History of Money USA Federal Reserve Bank relatively new set up in 1913 Until that period, essentially free banking Over 30,000 banks in 1922 many undercapitalized 1933 deposit insurance introduced during Great Depression Highly fragmented system; the first state to allow interstate banking

16 The History of Money Rise of Banking Late 1300s the Medici established modern banking Banking spread to northern Europe, Amsterdam Exchange Bank set up in 1609, resolved problems that merchants faced with multiple currencies. 100% reserve ratio. 100% commercial transactions. Swedish Riksbank 1656 did deposits as well as lending. Fractional reserves Bank of England Granted monopoly power was able to issue promissory notes that did not bear interest. Designed to help government with financing. 16

17 The History of Money Fractional reserves increase money Money multiplier results because a deposit is not 100% held at a bank, some is lent out and the person that borrows, deposits at another institution,. M0 (monetary base or high power money) = total liabilities of central bank (cash plus reserves of private sector banks at the central bank) M1 (narrow money) = cash in circulation + demand deposits 17

18 The History of Money Gold or commodity based currency not necessarily a solution Countries choose when to be on gold standard and when to abandon it US is a good example Illegal to hold gold from 1933 to

19 The History of Money 1,000 US in and out of gold standard 100 Fiat Money Average inflation rate: 3.7%/year U.S. GDP Deflator 10 Basically Silver Average inflation rate: 0.1%/year Fiat Paper Money Average inflation rate: 0.1%/year Basically Gold Average inflation rate: 1.1%/year True Gold Standard Average inflation rate: 0.7%/year Quasi Gold Standard Average inflation rate: 3.2%/year 1 Data source: U.S. GDP deflator from Johnson and Williamson (2011). Currency regime labels from Elwell (2011). See Erb and Harvey (2013). 19

20 The History of Money Gold also subject to inflation Just as discovery of new world gold led to high inflation, technological change will dramatically increase the supply of gold 20

21 The History of Money Gold also subject to inflation Just as discovery of new world gold led to high inflation, technological change will dramatically increase the supply of gold Near earth asteroid Eros might have 125,000 mts (Science, 2009). That equals all gold ever mined on Earth. 21

22 The History of Money Pure fiat currency is a bubble US dollar, for example, has three features: Legal tender Government can tax Government can incarcerate you if you do not pay tax 22

23 The History of Money Pure fiat currency is a bubble Nevertheless, any fiat currency is a bubble the currency only has value because people believe it is valuable There are plenty of historical examples of when faith was lost in a currency 23

24 The History of Money Hyperinflations November 2016, Venezuela becomes 57 th entry Highest Highest Highest Start End Daily Start End Daily Start End Daily Country Year Year Inflation Country Year Year Inflation Country Year Year Inflation Angola % Danzig % Philippines % Argentina % Estonia % Poland % Armenia % France % Poland % Armenia % Georgia % Russia % Austria % Georgia % Soviet Union % Azerbaijan % Germany % Srpska % Belarus % Germany % Taiwan % Belarus % Greece % Taiwan % Bolivia % Hungary % Taiwan % Bosnia % Hungary % Tajikistan % Brazil % Kazakhstan % Tajikistan % Bulgaria % Kazakhstan % Turkmenistan % Bulgaria % Kyrgyzstan % Turkmenistan % Chile % Latvia % Ukraine % China % Lithuania % Uzbekistan % China % Moldova % Yugoslavia % Congo (Zaire) % Nicaragua % Yugoslavia % Congo (Zaire) % Peru % Zimbabwe % Congo (Zaire) % Peru % Note: Data from Hanke and Krus (2012), Bernholz (2006) and McGuire (2010). These sources use a definition from Cagan (1956) that says hyperinflation exists when a country's monthly inflation rate exceeds 50%. 24

25 The History of Money Currency does can exist without government Gold is the traditional example but gold has uses Cigarettes used in POW camps as medium of exchange Other examples include cowrie shells and peacock feathers Papua New Guinea China 25

26 The History of Money Iraqi Swiss dinar Iraqi Swiss dinar was the currency of Iraq until the first Gulf War in 1990 (plates made in Switzerland, printed in the UK) In 1991, Iraq was split in two with Saddam Hussein in the south the Kurds in the north Because of sanctions, could not import dinars so Saddam ordered the printing of a new currency html 26

27 The History of Money Iraqi Swiss dinar In May 1993, the Central Bank of Iraq announced that citizens had three weeks to exchange old 25 dinar notes for new ones 27

28 The History of Money Iraqi Swiss dinar However, old Swiss Dinar continued to be used in the north. Saddam cranked the printing press to finance regime and soon the exchange rate was 300 Saddam dinars=1 Swiss dinar See Mervyn King, 28

29 The History of Money Iraqi Swiss dinar However, old Swiss Dinar continued to be used in the north. Saddam cranked the printing press to finance regime and soon the exchange rate was 300 Saddam dinars=1 Swiss dinar 29

30 The History of Money Iraqi Swiss dinar Key insight is that Iraqi Swiss dinar had no official backing yet it was accepted as money because people were willing to accept it as money. Interesting related story with the introduction of the Brazilian unit of real value in 1992 when inflation was running at 80% per month. fake money saved brazil 30

31 Recap: History 9000 BCE Barter Market in Egypt exchanging goods, i.e. cows for sheep to bitcoin a story of money and blockchain/#.yf9zg3w:id5p 31

32 Recap: History 600 BCE Coins In Lydia 32

33 Recap: History 1290 Banknotes Marco Polo introduces the idea to Europe (originates in China) 33

34 Recap: History 1871 e Money First Western Union money transfer 34

35 Recap: History 1950 Credit Cards First credit card is Diners Club 35

36 Recap: History 1967 ATM First ATM introduced in north London by Barclays Bank 36

37 Recap: History 1983 Telephone Banking Bank of Scotland introduced Homelink which is the first application of Internet banking 37

38 Recap: History 1990 Internet Banking Began to become widespread in the US 38

39 Recap: History 1997 Contactless Payment Mobil introduces Speedpass at gasoline stations 39

40 Recap: History 2005 Chip and Pin Introduced with credit cards 40

41 Recap: History 2009 Bitcoin Programmable money introduced 41

42 Recap: History 2014 Apple Pay 40% of US retailers have capability for contactless pay 42

43 Recap: History 2017 Blockchain All leading banks have blockchain initiatives 43

44 Future 201? Back to Barter Cross blockchain trading of objects Billions of bilateral exchange rates Still need some way to store your wealth Open question of whether currency as we know it, either in fiat or crypto, is necessary 44

45 Summary 45

46 The History of Money Conclusion All fiat currency is a bubble. Bubbles need not burst they can be rational and long living All cryptocurrencies are bubbles. If someone dismisses a cryptocurrency saying it is a bubble, it is likely they do not understand basic monetary economics. 46

47 The History of Money Highly recommended 47

48 Supplement: The History of Money 48

49 Supplement: The History of Money 49

50 Supplement: The History of Money 50

On Measuring Hyperinflation

On Measuring Hyperinflation Steve H. Hanke and Charles Bushnell Key Points Introduction 1 On Error and Deception Figure 1: The fall in the value of the Venezuelan Bolívar: the black market USD/ VEF exchange