The Bear’s Lair: Dogecoin beats the digital dollar

The Fed, the People’s Bank of China and the Bank of England are planning digital currencies linked to their currencies. Their real objective is to stop people using cash so they can create even more distorted interest rate structures. Their new constructions will thus combine the insecurities of digital currencies with the Gosplan approach to monetary management that is now so popular. Dogecoin, started as a joke and with money creation controlled by an algorithm, will be a much better store of value than these central bank constructs and will protect the public against the tyranny of bureaucrats.

Fiat currencies are always something of a confidence trick. The early attempts at them, the Song dynasty paper money, the American continentals and the French assignats, all collapsed into hyperinflation (the Song money only did so after a Mongol invasion, to be fair). So also, gradually, did the Austrian Gulden paper money issued by the Stadt Banco from 1759, which depreciated in value as inflation increased (fluctuating between 16% and 31% a year between 1770 and 1816) until Austria declared bankruptcy on February 20, 1811. The Stadt Banco’s notes, amounting to 1.06 billion gulden (nominally over $30 billion at today’s values) were converted to new notes, the Wiener Wahrung at one fifth of their value. Further war expenditures then caused the Wiener Wahrung to trade at one fifth of their silver value by 1816, although two years later, by establishing yet another new bank, Austria was able to redeem at least some of the Wiener Wahrung and undertake to issue no further paper money.

The Austrian saga, so damaging to the country’s savers, made Austria and those parts of the Holy Roman Empire that used its currency impoverished economic backwaters, with real Vienna wage levels one eighth of those in London, by the early 19th Century. Austrian policy was criticized heavily by Karl Marx, who grew up under the aftereffects of those policies in what had been the Electoral Bishopric of Trier. As a result of his childhood experiences, Marx was unquestionably a sound money man, but alas lacking a belief in capitalism, since the Trier of his childhood never really experienced it.

As experience since the 1930s has shown, fiat currencies work adequately provided their issuers do not go overboard with the printing press and the population that uses them has adequate confidence in the issuing government. Both conditions are now coming under question. Governments for decades have forced interest rates far below their natural levels, killing productivity growth and making savers speculate ever more unsoundly in tech stocks, SPACs and crypto-currencies in order to receive a return on their money.

Should the burst of inflation that seems inevitable be met with a return to soundness by the world’s monetary authorities and fiscal policymakers, all will be well, and after a severe period of pain the fiat currency confidence game can continue. That seems increasingly unlikely, and the move by central banks to create digital currencies suggests they will take extreme steps to avoid any such economic rigor.

With physical paper money, we always have the possibility of storing our wealth in actual banknotes, complete with elegantly drawn pictures of George Washington, Ben Franklin, Jane Austen and the like. These draw no interest, but they provide the incomparable benefit that, if the issuer of our currency decides to impose negative interest rates, we can always hold physical cash and incur only storage and insurance costs.

However, should the world’s central banks go digital, that protection will no longer be available. Currency that is stored only on our cell-phones can have arbitrary amounts wiped off it as negative interest rates, “storage costs,” central bank fees, “slavery reparations” and the like, and we ordinary savers will have no recourse. We will be in the position of the inhabitants of the Electoral Bishopric of Trier trying to use the Stadt Banco’s dodgy gulden as a store of value.

At that point, with the world’s central banks issuing digital currencies, crypto-currencies become an interesting alternative. First, they are not issued by national central banks or by any central authority beyond the algorithm controlling their issuance, so cannot be subjected by outsiders to negative interest rates and arbitrary fees, provided their management is not under central control. Second, like physical cash they provide considerable anonymity to their holders – complete anonymity in the case of Monero. A crypto-currency with a sound algorithm is thus as good a means of exchange and a better store of value than the state-controlled fiat currency of a state that has outlawed cash.

There are a number of criteria that a crypto-currency must fulfil to be a sound store of value. The algorithm under which it is created must not be excessively inflationary and must not be subornable by currency holders or anybody else – it must be fully outside the control of national authorities, in particular. The currency must be secure from central control; if as in Bitcoin it is possible for 51% of the miners to suborn it, there must be sufficient incentive for miners to avoid such a scenario. The currency should avoid having large hidden holding or unclaimed troves that could be used to manipulate it. The currency must be readily transferable, with modest transaction costs. Finally, the currency must be secure from fraud; if you hold a quantity of the currency, you must be sure that nobody else can steal your holdings, and that no exchange bankruptcy can render them worthless.

Bitcoin fails on a number of these criteria. Because it was the first crypto-currency to be created, there are large “lost” holdings of people who created Bitcoins many years ago, when they were worth little, and lost the hardware on which they were stored. Also, the creator of Bitcoin kept a huge store for himself, and that store, now worth over $100 billion, is itself apparently “lost” and therefore subornable. Bitcoin is the principal coin traded on Coinbase, now a U.S. public company; it is therefore increasingly controlled by the U.S. authorities, and its value and tradability are endangered thereby. Furthermore, Chinese “mining” companies were able to create large quantities of equipment specifically for manufacturing Bitcoin, which combined with state energy subsidies gives them a competitive edge. This equipment, now presumably controlled by the Chinese government, would threaten the currency if the incentive to mine was ever considerably reduced. The transaction cost for Bitcoin as of April 18 was over $50 per transaction, (it varies by Bitcoin value and transaction volume) far above a reasonable level.

Finally, the cost of creating new Bitcoin is already very high and will only get higher as the maximum possible number of coins is approached, so mining it may become unprofitable as the coin’s value fails to keep up with its escalating scarcity. Should that occur, Bitcoin will become vulnerable to mining attacks, and its value may drop catastrophically.

The “joke” crypto-currency Dogecoin passes the tests that Bitcoin fails. It was created in 2013 as a joke –its symbol is a large Shiba Inu dog, better looking than George Washington! Its creators never kept vast quantities of it – the currency was intended to reach a broader demographic than Bitcoin, so its initial creation was very widespread, without high-value holdings or “premining”. Its algorithm was close to that of Bitcoin (it was a derivative of Litecoin, itself derived from Bitcoin) but it was sufficiently different that Chinese mining equipment could not manufacture it for the first year or so, preventing large quantities from falling into the Chinese maw.

Dogecoin’s algorithm allows for the creation of 5 billion DOGE of new coins annually, so it is far less vulnerable to a “51% control” attack or domination by China. With the guaranteed additional supply, it is more like a conventional fiat currency in money supply creation – at the present maximum DOGE volume of 129 billion, next year’s increase in potential DOGE supply will be 3.88% of the outstanding amount. That compares with a 6% annual increase in U.S. M2 in the years 2010-19, and a 28.2% increase since February 2020.

Dogecoin’s transaction costs are reasonable – about $1.35 at the high point of April 18. It is also not tradeable on Coinbase, so not subject to control by the meddling Biden administration. It is a little difficult for Americans to buy – you may have to go through a foreign exchange — but British and European investors can buy it quite freely, through an exchange in EU member Malta, for example. With the minimum possible danger of control by the U.S. government, the Chinese government and the Mexican drug cartels, Dogecoin is about as secure a store of value as you can get. Needless to say, DOGE assets, once they are created, cannot be arbitrarily subjected to negative interest rates.

Dogecoin started as a joke. The Fed, the Bank of England and other central banks were started perfectly seriously but have become a joke through their appalling monetary policies. As a store of value, I prefer the joke that knows it’s funny.

Disclosure: Neither Martin Hutchinson nor his immediate family own any Dogecoin.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)