On Price and Output Volatility: How Bad is Bitcoin’s Flaw?
In the olden days from which our modern economic world sprung, prices were usually long-term stable but short-term unpredictable. While the value of the currency unit – the amount of goods and services you could get for a given amount of funds, income, or wealth – held fairly stable over cycles and over decades, it could shift by 10% or more from one quarter to another. Harvests mattered; economic crises mattered; gold extraction and money demand mattered. The structure of labor and employment was also very different, as everyone from farmers and miners to pre-industrial weavers faced volatile prices for their outputs.
Importantly, they also faced uncertain output quantities. Piecework for a 19th-century weaver, inside or outside Britain’s emerging “manufactories,” was subject to fluctuations on both sides of the economic equation: price and quantity. Workers, too, faced uncertain labor opportunities and volatile working days, hours, and thus take-home earnings.
The 20th century is the odd-one-out in that labor arrangements overwhelmingly were standardized, pay adjusted to working hours rather than (or as a proxy for) output, and a macroeconomic environment focused on keeping even short-term prices stable and predictable (excepting the World Wars, various hyperinflations, and the Great Inflation of the 1970s).
With the gig economy, the pandemic’s huge boost to remote working, and the sizable return to independent piecework for sole traders and contractors, one question is more pertinent than ever: Do you want to be paid for your time or for your product?
In Will Luther’s September 10 extract from his and Pete Earle’s edited collection of essays The Gold Standard: Retrospect and Prospect, he investigates some problems with bitcoin as money – precisely for reasons that have to do with price volatility and macroeconomic stability. He correctly identifies that bitcoin’s fixed supply (its inelastic supply schedule) is a weakness, making long-run price expectations unanchored and short-term fluctuations unresponsive to money demand. I have argued the same point before – though, I confess, less eloquently than Prof. Luther.
His argument is that when the underlying monetary unit is price volatile, long-term contracting is costly and imposes new and additional risks on people. Insofar as we don’t want to ride the volatility of pricing in everyday items we are worse off in a bitcoinizing world as the prices we face will be less stable, the values of incomes (and wealth we already possess) having less long-term predictability. He admits that bitcoin’s structure is an improvement on many others, but still
a far cry from ideal. It provides remarkable predictability of the supply of bitcoin. It provides little predictability of the value of bitcoin and makes no effort to promote monetary stability.
These arguments come from a time where adjusting the price for long-term contracts was a hassle and we were unaccustomed or ill-prepared to stomach even minor volatility in our effective purchasing power. Increasingly, the modern world is different on both accounts – and more alike the uncertain one from which we came.
With the gigantic boost to remote working that the pandemic seems to have permanently caused, millions of workers find themselves in situations of much higher price and income volatility than which characterized the stable employment relationships of a few decades ago. For those who choose this life, the norm is no longer a set, contracted salary from a single employer in exchange for a set number of hours worked, but piecework – and from several different clients, likely at different rates and uncertain quantities. Freelancers, side-hustlers, and nomads routinely have incomes in two or three different currencies, pay taxes in a fourth, and expenses in a fifth or sixth. For them, juggling highly volatile currency exposures quickly becomes second nature. Even in foreign exchange markets that by bitcoin’s standards have pretty low volatility, those can combine to produce monthly swings in real incomes of 10% or more.
Work security and income security are far from assured, and varying prices, rates, and hours worked effectively bring us back to how many of our great-great-grandparents worked.
Another feature of this is how little those who opt into a nomading or bitcoinized world seem to mind. They are self-selected for people more able to stomach volatility in their personal finances, and more technically and financially equipped to protect against it. They know, frankly, what they’re getting into, and it doesn’t seem to upset them.
Technology, the factor that more than anything else allowed us into this world in the first place, is also handing us the tools to adjust for the volatility. All you need is a provider indexing their invoices to a mutually-agreed-upon, third-party standard. In principle, it wouldn’t be too hard to currency-match expenditures to incomes, or to hedge price changes between the time you earn income and the time you spend it. This is what futures markets do, after all, and it is firmly established and developed, for bitcoin as well as for other financial assets.
To use a personal example: my rent is already tied to the official inflation rate of my country, adjusted monthly. The calculation is done by a real-world third party (a bit like betting markets), and the inclusion into my monthly rate happens automatically, with few of the long-term contracting issues raised by Luther. This happens to be a fiat currency, but could equally well be a bitcoin adjustment. If it were to suffer from bitcoin-sized volatility, we could split the unexpected change – or contract with another target in mind, say some price that we are both exposed to (electricity, construction material, etc.). In a world where some of my income is earned in BTC and some of my regular expenses are in USD, there’s a niche for products that effectively hedge my currency risk should I not want to carry it. That could happen through a fintech – of which most nomads are already prolific users – or through mutual agreements. If my landlord or mortgage provider face similar currency risks, our contracts can split the difference, say a rental payment (partly) indexed to the month-closing BTCUSD price at CoinDesk. Does that amount to an extra contracting cost and burden along Luther’s argument? Perhaps, but if so it’s rather unimposing.
The practice of indexing costs to some observed value, though initially odd, makes a lot of sense and is often standard practice in countries that have experienced currency collapses or massive foreign exchange volatility in the recent past (Chile’s UF or Brazil’s URV come to mind). We have financial techniques for adjusting and contracting away the annoying effects of high volatility – it would be great if the price volatility could disappear, but maybe it’s not feasible and maybe the trade-offs required for that to occur are too great.”
Even more intriguing is that a dollar-indexed bitcoin economy (or a bitcoin-indexed dollar economy) might be the best we can practically get. There are academic arguments where an Ivory-tower scholar can show, blackboard-style, that a more ideal outcome is feasible. Regarding bitcoin’s supply mechanism, again I don’t disagree, but I ask: Is that really feasible? It doesn’t take much skepticism about the role of central banks in the modern world to accept that it might not be. Though central bank policies targeting NGDP (level or futures) can theoretically improve upon the discretionary inflation target of today, it is by no means obvious how central bankers steeped in the latter credibly commit to the former. Or that they revert when their political overseers come knocking.
The bitcoin revolution doesn’t take an Act of Parliament, or convincing those least likely to appreciate the harm of current monetary policy; it merely takes individuals to opt out, to vote with their feet.
Bitcoin doesn’t present an ideal form of money issuance. On this Luther is correct. But it has the power to overcome the obstacles placed before other more theoretically sound such proposals, and to actually work.
More persuasively, the working arrangements of a new generation of freelancing nomads are keen on and capable of handling the discrepancies between many currencies’ relative purchasing power, crypto or old-school. That makes the volatility argument against bitcoin’s money supply so much less powerful.
Interestingly enough, the future of work could thus become a lot more like the past.