Written September 15, 2021
The goal of this article is to unite and create a coherent argument around the basic microeconomic idea of price equals marginal cost (P=MC), of fiat money as a product, and how bitcoin relates to these two. I must warn all readers that this is just a frame of thought, or, as Steve Jobs would have put it “connecting the dots.” It is by no means a finished concept, and the community will have to help evolve and polish this idea, the same way I have taken this idea from others and, hopefully, improved upon it.
Before we get going, a little reassurance to all readers: don’t worry, high-level math is not necessary to understand the concepts described herein. I will also try my best in keeping things short and simple. Without further ado, I hope you enjoy my little exploration of microeconomics, the Federal Reserve, and Bitcoin.
First things first, let’s start with microeconomics. And I can already hear you ask:
“What is this basic microeconomic concept you talk so much about, General Kenobi?”
I’m glad you asked. The concept I keep referring to is a fundamental microeconomic idea inside the general equilibrium (GE) theory. GE theory tends to be among the first things that any economics student learns about, and with it, the idea of perfect competition. Inside of the perfect competition model lies a simple equation with potentially great implications: P=MC. The gist of it is that in a perfectly competitive market, the price of the product will approach and eventually equal the marginal cost of the given product.
“But what is marginal cost?” I hear you say.
In economics, every time you see “marginal,” it is helpful to think “next unit”. Therefore, MC is the extra cost of generating/producing an extra unit. Under perfect competition, companies optimize profits by minimizing MC, and the market equilibrium is therefore found at the lowest MC, which for normal companies tends to be a number not equal to zero.
Therefore, the basic idea is that under a competitive market, companies will optimize for their MC, and the price of the given product will approach the MC. Thus, P=MC under a competitive market. And if you are wondering why, that is because companies will have an incentive to produce an extra unit if the MC is lower than that of the previous unit, because that represents “increasing returns to scale.” Bigger is better. But if the MC of producing an extra unit grows, it means you have entered the realm of “decreasing returns to scale,” and are starting to lose profit. Bigger is worse. This is under the assumption that companies are looking to maximize profits.
But enough of that; I said I would try and keep it short and simple. Let’s continue with fiat currency and why the U.S. dollar is a product.
First, a fun fact about our favorite fiat currency: the issuer of the U.S. dollar, the Federal Reserve is a private company, and it has shareholders. Yes, the Fed is a private entity, complete with shareholders. Can you guess who these shareholders are? Correct, the banks. Only banks can be shareholders of the various private companies that represent the Fed, and only banks can get the dividends generated by the Fed. So, if the Fed is a company, and it has shareholders, they get dividends. What do they sell? What is their product?
Well, they sell money. That is the product. Everyone wants it, and despite popular belief, there are copious amounts of it. But, despite being so ubiquitous, most people barely ever stop and think about it.
If you stop and think about money for just a minute, you will find that money is but a mere asset — the most liquid one for sure — but just another asset. And because this asset is offered by a private company, it is also a product. It’s the AirPods of the Fed. Money is cheap for the Fed to make, maintains very good margins, and is a super-seller.
Stick with me for another second, because now we see that fiat money is a product, but for us to merge P=MC and fiat as products, we must find out if the U.S. dollar operates in a competitive market. The thing is that the currency market isn’t a standard market whatsoever. It is not a normal market, like the one for potatoes or corn for instance, because of the inherent monopolistic properties of money. What I mean by that, is that consumers tend to choose the best form of money for themselves and drop any other form of money that isn’t the best money. Thus, it is a binary monopolistic market. You either have the best money or you don’t, and if you don’t, you drop other money to move to the best form of money available. Thus, the fiat currency market goes from one monopoly to the next one.
But when people hear “monopoly” they either think of fun tabletop games or of anticompetitive markets. The way I see it, the currency market is not only a monopolistic market, but also a competitive market. It is the most competitive market. Because if your country’s currency wins this binary currency battle, the prize is unending. You become the world reserve currency, and the world bows to you. In fact, this is such a competitive market that the U.S. dollar also goes by the term “petrodollar” and is protected by the mightiest (and most polluting) entity on the planet, the U.S. military.
Breathe, the hard part is over. We have seen that P=MC, and we have established money as a product, and this product as residing in the most competitive market in the world. Now, it’s time to roll! Let’s look at the MC of money. During the gold standard (the period of history when the world’s commerce used mostly gold-based currencies), the MC of money was the cost of acquiring gold. Alright, this means that under those monetary systems, money had a verifiable MC — the cost of mining one extra unit of gold. And the MC of fiat money? Well, the cost of creating any extra amount of this asset we call fiat is as good as zero. The MC of fiat money, especially that of U.S. dollars, is zero. The cost is NADA. It is nearly nothing at all, nothing whatsoever. A person presses a button, a few electrons move around, and new money is created.
This effectively means that the U.S. dollar approaches a price of zero. And it has been doing so for decades. One could also argue that under a gold-based system, the more the money resembled fiat across time, the closer it was getting to its demise. Historically, as empires were crumbling, the first thing they would do is to debase and inflate their currency, slowly turning it into fiat money as the MC of the currency/product reached zero. When the previous winner of the money market was weak enough, a rotation to stronger money would happen worldwide.
I could go on talking about incentives of the fiat system, inflation, debasement and what have you. But neither am I the expert you seek, nor have we spoken about bitcoin yet, so let’s see how bitcoin interacts with these ideas. Well, bitcoin is expensive to make, and every subsequent BTC made will cost more than the previous one. This basically means that while the MC of fiat is always at zero and the market just slowly approaches it, bitcoin’s MC keeps increasing to infinity, and the market knows it.
Bitcoin has a verifiable cost, is not a product of any company and is thus a finite and unalterable asset, and the incentives laid out in its protocol ensure that MC will never equal zero. Satoshi gave us a gift. We are all just discovering it now!
We have the high ground!
P.S.: I know that this topic is much more complex and profound than this. I may have gotten some things wrong, I may even have oversimplified some concepts, but I believe that the mental framework it generates is truly powerful. Not one to live by, but one that may be interesting to keep around, to see how it does. I have left some of the discarded paragraphs down below in case anyone finds them interesting or gets any inspiration from them. Enjoy :)
This framework shows BTC approaching a U.S. dollar-denominated value of infinity, while the U.S. dollar approaches an abstract final price of zero. This is almost like physics models showing negative energy. The same way that negative energy in physics models is impossible and makes us think outside our box, this mental model showing a BTC price of infinity in U.S. dollar terms is the same type of impossible that should make us think outside the box. We’re all thinking of the same thing, of a world where only BTC exists. Because we now live in a world in which you don’t know if the person giving you cash worked for it, or just created it out of thin air, but this same reality has an alternative. You decide which money you use, and so does the rest of humanity.
Till now, the asset intermediating all transactions was a centrally-controlled corrupt currency of which we usually didn’t think much about. In a near future, that asset will be occupied by the best money, which we have all gradually discovered. An asset that no economic agent can create without incurring significant and verifiable costs.
This is a guest post by General Kenobi Nakamoto. Opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.