Last Chance to Save Your Savings

Plastic stored-value BitBill cards; the money of the future?

Well, this is it, folks... It's down to the wire... There is only less than a week left for the Democrats and Republicans to hash out an agreement that will allow the U.S. to avoid going into default on at least some of its various financial obligations... And, disturbingly, we do not seem any closer to an agreement than we were several weeks ago... The Republicans seemed determined to refuse anything that the Democrats offer them (they "won't take yes for an answer")... The Tea-Party Caucus, in particular, seems determined to actually drive us into default... Some of them actually campaigned on the promise that they would never raise the debt ceiling under any circumstances!  I believe that a number of Republicans actually want to cause another major financial crisis, because more than anything else, they want the Obama administration to fail.  They would drive this country into a ditch just for the sake of seeing that uppity "boy" driven out of office...

Anyway, whatever the underlying motivations here, I have a bad feeling that there is indeed going to be a default, of one form or another.  If the debt ceiling is not raised, various people have proposed that the Treasury might just print money, either by issuing gold certificates backed by the gold in Fort Knox (assuming it's really still there), or mint just a few platinum coins stamped "ONE TRILLION DOLLARS" each (an extreme version of an ancient practice known as "coin seigniorage"), and in either case deposit the newly-created money into its account at the Federal Reserve, and use it to pay off outstanding Treasury bills as they mature, thereby directly reducing the debt. This is 100% legal!  By this means, Obama could circumvent both Congress and the Fed.  However, the financial markets would likely still consider this to be just another form of default, as it would increase the supply of, dilute, and thus debase the value of all dollar-denominated assets.

In other words, if the insane Tea Party Republicans stick to their guns, and do not raise the debt ceiling no matter what, then, come Aug. 3rd or so, there is going to be a fiscal/monetary crisis like the world has never seen.  Credit rating agencies have already said that they will lower the U.S.'s credit rating if the debt ceiling isn't raised; some have even threatened to lower it all the way to "D", the lowest "junk bond" status.  Investors will dump Treasuries like crazy, and the value of the dollar will plummet.  Of course, the US dollar is the world's reserve currency, so if the dollar falls, it will take all manner of global institutions with it - from international companies to governments, all manner of major players will find themselves increasingly insolvent as they find themselves increasingly unable to find buyers for their fast-falling dollars.  Meanwhile, as the interest rates on dollar bills skyrocket, the U.S. will have to give up all hope of lowering the deficit, except by printing more and more money, further debasing its currency.  (And this debasement will not even help with the U.S.'s long-term debt problem, since Social Security benefits are adjusted for inflation, and Medicare payouts necessarily relate to real-world health care costs.)  The end result is that hyperinflation of the U.S. dollar will occur, and all dollar-denominated assets will become virtually worthless, almost overnight.  So, too, will the stocks of companies that end up stuck holding a lot of worthless cash, and so will the bonds of all manner of domestic & foreign entities (companies, governments, trust funds) that are heavily invested in US dollar-based assets, and so forth.  It will be nothing short of global fiscal armageddon.

One wonders, facing such a massive risk, what classes of investments would still be safe.  First off, no form of paper wealth is safe, since in such a chaotic environment, how does one know that the counterparties will even be able to hold up their end of the bargain?

Consider, then, real estate.  But, this is safe only so long as there exists a stable government, law-enforcement system, and court system, with jurisdiction over said property, that can protect the owner's property rights.  In a major economic collapse scenario, any government may at any time be at risk of being overthrown, and so enforcement structures may be in flux; the rule of law may be absent for extended periods.  So one cannot count on the government to protect one's property.  You can try to protect your own real estate using your own physical defense systems, but if your government becomes desperate, or is taken over by hostile entities, than it may seize your property, and you are unlikely to be able to fight off an army of law-enforcement officers if it is determined to occupy your land.

What about physical commodities other than land?  Those tend to be heavy and difficult to transport (which could be important if you need to flee the country due to war or revolution), and they suffer from the same risks of theft and seizure that real estate does.  You can try to hide your portable items (burying gold bars under a tree in the woods, say), but someone could always surreptitiously follow you to your hiding place and still steal them.

No, as far as I can see, the only truly safe place to save one's wealth, in case of a total global economic breakdown, is in the form of Bitcoins, locked safely in secure digital wallet hidden in an encrypted shadow volume, with multiple redundant backups at numerous physical locations, and where only you (and your immediate heirs, say) know the password to reveal and unlock the hidden file.

The supply of Bitcoins can never become hyperinflated (this is guaranteed by the way they work), and if you take the above precautions, no one but you can never access your coins, so they can never be stolen from you nor seized by any government.. To prevent you from spending your backed-up, encrypted Bitcoins, a hostile party would have to lock up you and all of your associates with no communication to the outside world (no means to send a message out).

Therefore, I strongly advise that everyone in the world who cares about protecting their assets ought to take all of their paper wealth and convert it to the form of Bitcoins, as soon as possible.  The sooner you do this, the better off you'll be, since you'll get a better exchange rate if you beat the rush.

Here Come the Bitcoin Banks

In the past few weeks, I have noticed at least two emerging organizations that claim to be "Bitcoin Banks."

• Global Standard Bank (Montreal)
• Flexcoin

I applaud this development.  Let's keep an eye on them, and see what happens.  So far, Global Standard Bank appears to be farther along in its development.

Cryptocurrency and Sustainable Taxation

Much has been made about how Bitcoin is a supposedly untraceable, anonymous form of electronic money. Actually, this is not quite true: How untraceable Bitcoin is depends greatly on the measures individual users take to make their transactions untraceable, or not. Let me briefly explain.

All transfers of base Bitcoins (with the sender's and receiver's digital addresses) are published in the public record - specifically in Bitcoin's distributed database. So in that sense, the flow of money between Bitcoin accounts is not untraceable at all. However, users of Bitcoin can, if they wish, take measures to make it more difficult to trace their flow of transactions.

First, at the most basic level, a user can create a new receiving address for each payment they receive, which makes it more difficult to identify the recipient. Still, if the coins received are later spent together with other coins in the same wallet, this ties them together and makes it easier to identify a pattern of payments going to a single recipient. The real-world identity of that recipient might then potentially be traced by using conventional investigation methods (through contacts or computers used to distribute addresses, etc.).

Another layer of difficulty can be added by using a third-party service such as a Bitcoin "laundromat" which accepts Bitcoins from many sources, mixes them together in a single wallet and then redistributes them from random addresses to intended recipients. Such a service can make it very difficult if not impossible to show that a transaction took place between a given buyer and a given seller.

On the flip side, if a Bitcoin user wishes to prove that he/she ordered a given transfer, that can be easily accomplished by digitally signing a statement of one's identity using the private key associated with the sender's address.

Most casual users of Bitcoin will probably not resort to taking extra measures to either hide or reveal their identities, at least not until tools exist that make it easy and convenient for them to do so.

Still, in time, such tools should become more readily available as the Bitcoin economy continues to develop, and a sufficiently motivated user can find or develop such tools even now, so this raises the question: How are governments going to enforce income taxes on income that is in the form of Bitcoins?

Some crypto-anarchists might say, "They can't; that's the whole point, let the governments fall!"

But I, for one, am in favor of (sufficiently good) government, and I don't expect governments would fall anyway (since they can always just tax in other ways), so I would like to propose a different, and (IMHO) much saner answer, something that I think we need to do anyway, namely:

We should abandon the income tax, and replace it with an excise tax on the development (extraction or first processing) of raw natrual resources: fossil fuels, minerals, arable land, forests, fisheries. Such a tax is enforceable because the government can go after and inspect the (generally large-scale) physical facilities where such processing is done: oil fields, refineries, mines, new farms, newly cleared forest, large fishing vessels. Cryptocurrency can't hide such activities.

Such a tax would naturally be passed down along supply chains, and so would impact end users (consumers or companies) in proportion to the extent to which they cause consumption of raw resources, whether directly or indirectly, through the products and services that they buy.

As a result, this form of taxation would provide a very strong incentive for companies and individuals to minimize their personal level of consumption, and give them an easy price signal to help them do so, since in this system the cheapest products would be those that are produced most efficiently in terms of raw resources consumed. So by simply being a frugal shopper, one would automatically also be helping conservation efforts.

Furthermore, by tuning the tax rates on individual types of resources to match their projected ecological impact on long-term public health and safety, this new tax regime would foster the public interest, and would do wonders to make our civilization more sustainable, and help to ensure a much longer and more glorious future for humanity on this planet.

One final note: This consumption tax would not imply a tax increase, just a shift in the tax burden from less-wasteful to more-wasteful activities. An individual would not necessarily be paying any more in taxes than before - probably less, to the extent that he is able to adapt to a low-environmental-impact lifestyle. To make the transition easier, the consumption tax could be phased in (and the income tax phased out) over a number of years.

This is something we need to do anyway, to save the Earth from excessive development and spare ourselves from a severe resource crisis and ecological reckoning down the road. The difficulty of taxing Bitcoin income just makes the case for getting rid of the income tax even better. So this is yet another reason why everyone should adopt Bitcoin - to give governments an additional impetus to restructure their tax base in this way that will best serve the public interest.

Shorting the Dollar

The situation in Washington continues to fascinate one with its utter insanity.  Republicans walked out on talks to raise the debt ceiling after refusing the Democrats' generous deal to end the deficit which only closed 20% of the budget gap through increased revenue (ending tax loopholes) and accepted 80% in spending cuts.  And the Senate has refused to even debate the debt ceiling openly on the floor.

Both sides are stalling and stonewalling, and it is looking more and more like the August 2nd deadline may arrive with no deal being reached, and so the U.S. may go into at least a technical default, failing to meet some financial obligations, or (I half expect) paying some bills by just printing new currency (resurrecting the old United States Notes, for example - which are still legal tender, but are no longer backed by gold).  Of course, international investors would react to any kind of default with complete horror and shock.  Standard & Poors has said that if this happened, they would immediately lower the U.S. credit rating to "D" - their lowest score.  And certainly, investors would shed U.S. Treasuries like the plague, knowing that they were no longer a safe investment.  Yields on T-bills would skyrocket so high that we would be forced to keep printing more and more money just to keep the interest payments manageable.  The value of the dollar would plunge on the Forex, and in general across world markets.  And back in the U.S., price inflation would skyrocket, as critical imported commodities - most notably oil - suddenly became much more expensive.

One wonders, in the current environment, whether it might not be prudent to hedge against the possible loss in value of one's dollar-denominated investments (including stocks in companies that hold a lot of cash) by short-selling the dollar - which just means, taking a short (leveraged) position in dollars against some other, more inelastic commodity.  Many suggest gold, but the gold supply could always increase unexpectedly - for example, a lost cache of gold and other treasures valued at $22 billion was just discovered in India.  Further, if global investors collectively lose faith in the dollar as a reserve currency, large institutional holders of gold may be forced to open their long-sealed vaults, as they start using bullion again as their preferred medium for conducting regular international settlements.  As the "velocity" of exchange of non-dollar-denominated transactions increases, the effective supply of gold that is actively in circulation may actually increase (rather than decrease), so the price of gold may not fare as well in that environment as one might otherwise expect.

As a result, my best suggestion for hedging against a fall in the U.S. dollar is to short-sell the dollar against not gold, but the Bitcoin.  The base supply of Bitcoins is guaranteed, by the nature of its peer-to-peer protocol, to increase only at a slow and decelerating rate, until the limiting supply of 21 million is reached asymptotically over coming decades.  Bitcoins are mathematically impossible to counterfeit, and they can only be obtained by exchange or by "mining" them - which is the slang term for helping to secure the authenticity of transactions within Bitcoin's peer-to-peer network.  The important point is that the supply of Bitcoins cannot be hyperinflated by any government, or other central authority.  And unlike gold, they can be transmitted between parties very easily and at negligible cost directly over the Internet.

How does short-selling work?  It is actually very simple.  All you need is a way to borrow a substantial amount of the asset you are shorting.  For U.S. dollars, a simple cash loan (from any source) would suffice.  Depending on how confident you are that the dollar will fall, you might even be willing to take a cash advance on your credit card.  (Personally, I would, if I still had any credit cards.)  Then, you exchange the asset you're shorting for something else whose (medium- to long-term) stability you are more confident in - which (in my case) is Bitcoins.  (Why not Euros?  In part because the Euro, too, is in danger, because of the Greek debt crisis, which is not over yet, not by a long shot.)

U.S. dollars can be traded for Bitcoins on any of several exchanges, the most popular of which is Mt. Gox, which recently suffered a setback (it was taken down by hackers for a week), but no permanent harm was done in the attack, and it has come back more secure than ever.  It is still by far the most popular exchange.  The price of Bitcoins in U.S. dollars is fairly cheap right now (down about 55% from its high in early June), but it can be expected to rebound significantly if the U.S. goes into default.  Anyway, its longer-term trend has been an increase in price by more than 100x over the last 9 months.  (See logarithmic chart below - the price increased from below US$0.10/BTC to more than $10.00/BTC from Oct. 2010 to July 2011.)

Bitcoin price in US dollars over the past 10 months. (Click to enlarge.)

Let us now examine a hypothetical scenario for a short-sell play.  Suppose one borrows US$10,000 for a 1-year period at 10% interest, and immediately exchanges it for Bitcoins (BTC) - at the current price of about US$13.50/BTC, this would buy the short-seller about 741 BTC.  Now, suppose that the U.S. goes into at least a technical default, and international investors start dumping the dollar, and its value (measured in terms of a basket of currencies and/or international commodities) goes down 50% over the next year.  Then, even if the overall popularity of Bitcoins did not grow at all over that period, their value in US dollars would go up by a factor of 2x (+100%) because of the fall of the dollar.  So the 741 BTC would become worth $20,000, and you could pay off the original loan ($10K) plus the interest ($1K) and have $9K to spare.  This, then, effectively hedges the short-seller against the possibility that $9K worth of his personal savings might decline in real value by 50% over this period.

Alternatively, if the U.S. doesn't default, and the value of the dollar stays about the same, and Bitcoins retain the same popularity that they have currently, then their price in dollars stays about the same, and so at worst you can just sell the Bitcoins at the end of the year and pay off the debt, and you are just out the $1,000 in interest - which is worth it, perhaps, for the added peace of mind that you gained with the hedge.

Of course, the picture looks far better if we build into the model that the Bitcoin may continue to gain in popularity as more people learn about its benefits, as it has done in the past.  Suppose conservatively that the popularity of the Bitcoin increases just 10x over the next year (compared to its 100x increase over the past year) - this could happen either because of the widespread debt crisis in the world's leading sovereign currencies, or just because of increasing public knowledge and education about Bitcoin's security advantages.  If this happened, then the initial $10,000 investment in Bitcoins would turn into as much as $200,000 (if the value of the dollar falls by half), or at least $100,000 (if the value of the dollar stays the same).  In either case, the $1,000 interest payment on the loan becomes completely negligible, and the short-seller has gained enormously (since effectively, the value of the dollar in Bitcoins has indeed fallen greatly, by a factor of 10-20x).

As a result of the above considerations, and because of my own uncertainty about the near-term prospects for the U.S. dollar, I am hereby publicly announcing that I am willing to take a personal loan from anyone, at 10% interest (or less of course), and of any size from $1,000 up to at least $10,000, which I will personally use to short the dollar against the Bitcoin in coming months.  (I would offer to take even more, but I want to be responsible, and make sure that the loan is for an amount that I could surely afford to cover the interest payments on even in the worst case.)  

So, dear readers, put your money where your mouth is.  If you, unlike me, believe that the value of the dollar will almost certainly remain fairly steady over the next year, then you should view 10% as a pretty decent return on investment, and offer me a loan contract.  

But if, like me, you have some serious doubts about the prospects for the U.S. dollar (along with other national currencies) looking forward, then, like me, you should similarly be willing to borrow as many of those dollars as you can responsibly afford to pay back, and then use that leverage to buy up all the Bitcoins that you can.  Or, you could reasonably stock up on petroleum ETFs or something like that instead, although if the global economy tanks, demand for oil might not do so well either.  And, unless you're already a sophisticated investor, buying Bitcoins is a heck of a lot easier.

In other words, bottom line is, if you want to protect your personal savings right now, you should short-sell the dollar, one way or another.  I know that I am.  If you disagree, then please send me your loan offer at michael.patrick.frank@gmail.com. :)

Why Bitcoin Will Be the Last Refuge of the Wealthy

Things are looking grim.  It seems as if these days, practically the whole world is drowning in a deluge of debt, brought on in large part by the excessively loose monetary policy of the United States' Federal Reserve System, the manager of the world's primary reserve currency, the US dollar.

The Euro is in trouble as well.  Bond market bookmakers are giving Greece about an 80% chance of default, with the solvency of other several other nations in Europe standing all lined up and ready to topple like dominoes if Greece's debt goes bad.  Even if these countries don't default right away, the problem will just recur in another year or two.

And what is especially frightening is that the United States itself, whose sovereign currency is supposedly the last bastion of safety, seems politically paralyzed and unable to resolve differences between raising revenue vs. decreasing spending.  Congress seems determined to play chicken with the debt ceiling until the last possible moment, and perhaps longer.  As a result, there seems to be a not-insignificant possibility the United States may actually default on its debt, in some sense, when the current round of 3-month Treasury bills matures in August - either by delaying interest payments, or perhaps (I wonder?) by firing up the presses for old-fashioned greenbacks (United States Notes, still legal tender!) to retire some of this debt at the cost of directly inflating the base money supply, thus debasing the currency.  Either one of these actions would probably be considered a technical default by international investors, and so the value of the dollar will collapse as a result, as they start fleeing from Treasuries in search of safer investments.  (Standard & Poors has threatened to cut the US credit rating to "D" if Congress doesn't raise the debt ceiling.)

The underlying cause of the problem can perhaps be traced back to an excessive power held by the Fed to inflate the money supply through fractional-reserve lending practices, which are no longer (since 1971) tied down to the gold standard.  As a result, in recent decades, vast amounts of liquidity were created willy-nilly and tossed around foolishly to make all kinds of sub-prime consumer loans (and other bad investments) that greatly enriched the financial industry with fees and bonuses.  By 2008, enough of the Fed's loans into the US financial system had gone bad that it was, itself, essentially bankrupt, which is why it then had to come running to Congress for a bailout.  Of course, through the magic of fractional-reserve lending, that little $700 billion loan from the taxpayers morphed, in the Fed's hands, into 10x as much ($7 trillion worth) of ability to spin new liquidity out of thin air.  This money promptly went out, hundreds of billions of dollars of it at a time, to the Fed's best buddies, the major US banks, to enable them to soak up Treasuries and sit on them, earning interest from the US taxpayers to help the banks lick their self-inflicted wounds.  This went beautifully as far as rescuing the banks was concerned, but it arguably did dick-all to jump-start the US's real economy.

Furthermore, the real economy itself (both US and global) is arguably nearing the end of a major long-term bubble caused by the excessively rapid industrial expansion of the last 50 or 60 years (fueled, again, by loose money from the Fed).  Global rates of "production" (i.e., development and harnessing) of many basic natural resources (oil, fresh water, arable land) is leveling off and is becoming unable to meet projected demand growth.  Meanwhile, the effects of pollution are beginning to destabilize the natural order of the oceans and atmosphere, with runoff from agricultural fertilizer creating offshore dead zones, CO2-acidified surface waters bleaching corals and interfering with the marine food chain, and, of course, the climate is increasingly becoming destabilized by an excess of greenhouse gases which, by basic physics, upset the radiation balance between the Sun and Earth's surface.

Due to the combination of all these effects and more, ecologists have estimated that in terms of global rates of consumption, we are already at least 50% above Earth's sustainable carrying capacity over the medium to long term (50-100+ years).  A major correction to the size of the global economy (and possibly also population) is therefore inevitable sooner or later, and probably sooner (possibly starting in as little as the next 5-10 years, or I'd guess at most 20-30) if the recent rate of acceleration of the severity of these various problems is any indication.  When the resource crisis hits in earnest, and people start to become truly desperate, the streets will fill with angry crowds, and governments all over the world will start dropping like flies, or else will take extreme measures to hold onto power.  The so-called "Arab spring" in the Mideast and Northern Africa is a sneak preview, due in part to the fact that these countries have been affected more than most by the inflation of food prices on the world market.

What happens when a major revolution and/or government crackdown begins in the US?  Even if we will have managed to avoid default and continue propping up our currency until then, the government eventually can be expected to start taking extreme measures to redirect resource allocation in a way that will help it stay in power (i.e. towards food assistance to starving people, and/or to crowd control by force).  High taxes and/or high inflation will siphon vast amounts of money away from the nation's wealthy to pay for such programs.  As the value of the dollar falls, or as assets are seized, most individuals' personal life savings (those who have managed to avoid bankruptcy) will get largely wiped out.

Many people will naturally try to protect their assets by converting their wealth to portable forms of "hard currency," such as gold.  But this is doomed to backfire.  During the last major economic crisis, the Great Depression, the US government (in 1933) simply seized all the gold being held by private individuals, and used it to replenish the government's reserves, which were (at that time) backing the dollar on international markets.  It remained illegal for individual Americans to own any gold (apart from a few exceptions such as jewelry or dental fillings) until 1974.  You might have a plan to flee the US if it looked like this was going to happen again, but the same thing could in principle occur in any country - or your gold could just be seized at the border.

As a result of these troubling risks, one of the reasons that many people find Bitcoin to be particularly attractive is that it provides a way that personal wealth can theoretically be totally protected from hyperinflation or seizure by any central authority.  Let's discuss how this works.

First, protection from hyperinflation:  Unlike existing fiat currencies, the base supply of Bitcoins (by the very nature of its peer-to-peer protocol) can never be inflated beyond a predetermined slow and decelerating rate of growth, which approaches a limit of 21 million BTC gradually over the coming decades.  New Bitcoins in excess of this predetermined growth schedule simply cannot be created.  Therefore, Bitcoin could serve as the most stable, reliable base currency for a global monetary reserve system that the world has ever seen - better than gold even, since the gold supply could increase unpredictably if large new deposits were discovered, and plus, gold is heavy and is difficult to transport and to appraise (especially from a distance).  In contrast, Bitcoins can be instantly transmitted over the Internet, and can be easily verified by anyone, anywhere.

Second, protection from seizure:  Perhaps the most secure way to protect one's Bitcoins is to stash your digital "wallet" (which contains your Bitcoin ownership credentials) into a file that is hidden undetectably within an encrypted volume, a file that only you know the passphrase to unlock.  This can be done using any of a variety of free open-source encryption tools, such as TrueCrypt.  (Even if you were tortured for your password, you could plausibly deny that the hidden file that contains the majority of your coins even exists.)

After creating this encrypted digital "safe" to hold your wallet, you can then, to prevent your Bitcoins from being lost or kept away from you, upload numerous backup copies of your safe into the "cloud," i.e., into various online backup services and/or anonymous file-sharing networks.  You can even put a few copies of your safe onto USB thumb drives that you bury in locations in the woods that only you know about.  No matter how chaotic things may get in the world, as long as you can find your way to some copy of your digital safe, and you still remember your passphrase, and the Bitcoin network itself is still operating, then you can access and spend your coins.

Even if the Internet itself is someday shut off by a government "kill switch" or a power outage, you could have a grassroots person-to-person network of Bitcoin users who personally meet face-to-face and exchange thumb drives containing transaction data, and in this way, the free flow of information that powers the Bitcoin peer-to-peer network could continue to take place - even in the total absence of the Internet!

In contrast, no other investment is as safe.  Land can be seized by governments.  Even if you stock up on weapons and ammo to protect your property, those too can be defeated and taken away by a superior force.  But, no amount of force can make you reveal the passphrase to your largest secret personal stash of Bitcoins, tucked away in a hidden, encrypted, backed-up wallet that only you are aware that you even own.

Therefore, as a result of the above points, I think there is a very compelling argument to be made that Bitcoin is in fact the safest place to store wealth long-term, and it holds the additional promise that as more and more people come to understand and appreciate this fact, and the popularity of Bitcoin grows, Bitcoins purchased today will continue to appreciate in value.  This is why I would advise everyone (especially those who have a lot to lose) to invest a significant fraction of their total liquid wealth in the form of raw Bitcoins, or at least in Bitcoin-denominated instruments.