A lot has been written about Bitcoin and the regression theorem, but I haven't seen much written about Bitcoin and Gresham's Law.
The thought occurs that if a person is faced with the choice of paying with a depreciating currency or an appreciating currency, he/she would likely pay with the depreciating currency and choose to keep the appreciating currency in his/her cash holdings.
If this were to happen, it would/could suppress or inhibit the widespread use of the appreciating currency in commerce. People would hold the appreciating currency as part of their cash holdings and trade with their stock of depreciating currency. Obviously, if given a choice, people would prefer to give away that which is declining in value and hold on to that which is increasing in value.
"It would be preposterous to assert apodictically that science will never succeed in developing a praxeological aprioristic doctrine of political organization..." (Mises, UF, p.98)
No, not at all. The merchant (person A)need not be an idiot.
I just find it hard to fathom that people A (merchants) will be, as a whole, more ignorant on monetary matters than people B (consumers). Your scenario only applies if buyers are more informed than sellers. It is possible to have a thought experiment like this but I don't see how it could apply to the real world
"Edit: Bitcoin supporters always say that bitcoins lower transaction costs. This is an obvious reason why merchants will prefer bitcoins."
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There are at least two distinct entities:
1. The Bitcoin payment system as that was designed by Satoshi Nakamoto:
http://bitcoin.org/bitcoin.pdf
I will refer to this by writing "Bitcoin" with a capital B.
2. The individual bitcoins that are a part or a component of the Bitcoin payment system.
I will refer to those as "bitcoins" with a small b.
The Bitcoin payment system eliminates, or potentially eliminates, the need for a third-party payment processor in Internet commerce (Visa, Mastercard, Amex. PayPal). Currently, for small merchants (excluding large merchants like Wal Mart or Amazon) third-party payment processing fees are 2.5% to 3.5% of revenue. If there are $10,000 in revenue processed in one month, then the processing fee the merchant must pay is around $250 to $350 per month or $3000 to $4200 per year. Obviously, many "small" merchants have much larger monthly revenues and their payment processing fees are much higher. Bitcoin has the potential to lower merchant payment processing fees from around 3% of revenue to close to zero.
This is one reason that a person engaged in Internet commerce may see value in Bitcoin. There are also other possible reasons besides this.
This factual situation is independent of the situation in which a merchant may obtain bitcoins (through his business or through other channels) and then face the choice whether to use them to purchase goods and services. In this case, the merchant becomes a "buyer." And if this buyer is able to purchase what he wants with either dollars or bitcoins (at the current exchange rate), and if he believes the future value of dollars will be much lower while the future value of bitcoins will be much higher, the suggestion is that something analogous to Gresham's Law may take place. The buyer may pay with dollars and withhold his bitcoins from circulation. If many buyers act similarly, this may constitute a general phenomenon which theory is called upon to explain.
"I just find it hard to fathom that people A (merchants) will be, as a whole, more ignorant on monetary matters than people B (consumers). Your scenario only applies if buyers are more informed than sellers. It is possible to have a thought experiment like this but I don't see how it could apply to the real world."
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I'm not referring to an objective merchant or consumer. I'm referring to the actor in his role as either a merchant or consumer.
When the actor holds bitcoins and dollars and must decide whether to either relinquish bitcoins or relinquish dollars in making his purchase, I am referring to this actor as a "buyer" regardless whether this same person also owns a store and in this regard is a "merchant."
When he buys something he is a buyer, when he sells something he is a seller or merchant.
I'm assuming the case where the merchant will accept bitcoins or dollars at their current exchange value, and where the buyer believes that the future exchange value of dollars will be much lower while the exchange value of bitcoins will be much higher.
When these assumed conditions are met, I'm suggesting that something like Gresham's Law may apply. Individual bitcoins (the "good" money) may be withheld from circulation while dollars (the "bad" money) may continue in circulation.
That's the difference between the real Gresham's Law and this pretender law. The real one needs no assumptions, merely analyzing a situation that has existed many times, legal tender laws overvaluing one of two currencies. The law has apodictic certainty [to use a buzz word], and follows logically from first principles.
Contrast this with thie pretend law, where an arbitrary, unrealitic assumption is made, as Adam made clear. Granted the conclusion follows from the assumption, but no Nobel Prize for that lame thing, sorry.
As for Robert Mundell, he missed the boat, too. What he should have said is that bad money drives out good money, unless the bad money is fiat and rapidly losing all value. In that case, it's not a question of the good money driving out the bad money. It's the bad money being abandoned and left for dead. Even if there was no alternate money, the bad money would be abandoned. [I've already started a campaign to have William Vickrey's Nobel Prize transferred to me. Robert Mundell. you're next].
Nothing to see here for bitcoin. Don't expect it to drive out the dollar anytime soon, or ever. It's not money at all, Malachi's esteemed opinion notwithstanding, and the regression theorem proves it never will be. A car with four flat tires will not drive anything.
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"Granted the conclusion follows from the assumption...."
Assumptions:
1. Merchant will accept either bitcoins or dollars at their current exchange value.
2. Buyer believes the future exchange value of dollars will be lower and the future exchange value of bitcoins will be higher.
Then in trade, the buyer will tend to relinquish (pay with) dollars and keep his bitcoins.
Even if the buyer believes Bitcoin is superior to and more desirable than fiat currency in terms of economics and political philosophy, he may wish to use fiat currency for purchases in cases when the merchant will accept both. In making a purchase, the buyer gives to the seller the objects he believes are decreasing in exchange value and keeps for himself the objects he believes are increasing in exchange value. If this thought process were widespread, then while these conditions remain (merchants willing to accept both currencies at current exchange rates: buyers believe that the future exchange rate between the two currencies will be markedly different) the "bad" money would be driving out the "good" money in the sense that dollars would remain in circulation as the general medium of exchange while bitcoins would remain in the cash holdings of market participants.
Adam Knott: "Granted the conclusion follows from the assumption...." Assumptions: 1. Merchant will accept either bitcoins or dollars at their current exchange value. 2. Buyer believes the future exchange value of dollars will be lower and the future exchange value of bitcoins will be higher. Then in trade, the buyer will tend to relinquish (pay with) dollars and keep his bitcoins.
Potentially missing step 1.5: Buyer, knowing bitcoins appreciate, will seek to trade all his dollars for bitcoin before conducting any purchase at all and thus has no fiat left to buy with. When confronted with the need to buy something, reasoning he would've spent fiat for it anyway, he spends the bitcoin he'd been saving, knowing that it's deflated partially since he got it, so the bought item is already 'cheaper' and the business-owner is also offering better price/terms if paid in bitcoin due to lower transaction costs, so it's a double-win.
Adam Knott:Even if the buyer believes Bitcoin is superior to and more desirable than fiat currency in terms of economics and political philosophy, he may wish to use fiat currency for purchases in cases when the merchant will accept both.
If the buyer believed that, chances are he would've already traded all his fiat for bitcoin up-front. In fact that's the only way we can be certain the buyer does believe that. An iffy bitcoin user is the one that hedges by keeping some fiat on hand, just in case.
Adam Knott: In making a purchase, the buyer gives to the seller the objects he believes are decreasing in exchange value and keeps for himself the objects he believes are increasing in exchange value.
Agreed, but he does this at the point of exchanging dollars for bitcoin, not at some later purchase.
Adam Knott:If this thought process were widespread, then while these conditions remain (merchants willing to accept both currencies at current exchange rates: buyers believe that the future exchange rate between the two currencies will be markedly different) the "bad" money would be driving out the "good" money in the sense that dollars would remain in circulation as the general medium of exchange while bitcoins would remain in the cash holdings of market participants.
Eh, if everyone tries to exchange fiat for bitcoin, the value of fiat plummets, bitcoin increases dramatically, and suddenly everyone both wants bitcoin and deprecates dollars. At that point, dollars are essentially delegitimated and people make a rapid switch to bitcoin as the unit of account.
Thier's law holds: "good money drives out bad money whenever the bad money becomes nearly worthless."
Gresham's Law is valid only when currencies are legally pegged, which is not the case for bitcoin.
Like worn and tear gold coins being legally equal to their original weight, or banana republic dollars that trade at fixed exchange rates against US dollars.
A. "Potentially missing step 1.5: Buyer, knowing bitcoins appreciate, will seek to trade MOST OF his dollars for bitcoin..."
B. "If the buyer believed that, chances are he would've already traded MOST OF his fiat for bitcoin up-front. In fact that's the only way we can be certain the buyer does believe that."
C. In making a purchase, the buyer gives to the seller the objects he believes are decreasing in exchange value and keeps for himself the objects he believes are increasing in exchange value.
"Agreed, but he does this at the point of exchanging dollars for bitcoin, not at some later purchase."
And he does that when deciding whether to give up bitcoins or dollars in exchange for product or service X.
D. "Eh, if everyone tries to exchange fiat for bitcoin, the value of fiat plummets, bitcoin increases dramatically, and suddenly everyone both wants bitcoin and deprecates dollars."
Eh. This was part of the original assumption of what the buyer believes: that the value of fiat will go lower and the value of bitcoins will go higher.
Two comments:
1. Today most people receive their income in fiat currency. The buyer who hoards bitcoins still receives increments of fiat currency as his customary stream of income.
2. The Gresham's Law effect suggested is a tendency and not intended as a statement about what every actor must necessarily do in every concrete instance. In a given individual case, an individual may spend a bitcoin instead of a dollar even if he believes dollars are depreciating and bitcoins appreciating.
"The narrow interpretation of Gresham's Law is valid only when currencies are legally pegged, which is not the case for bitcoin."
However:
The principles of Gresham's law can sometimes be applied to different fields of study. Gresham's law may be generally applied to any circumstance in which the "true" value of something is markedly different from the value people are required to accept, due to factors such as lack of information or governmental decree.
http://en.wikipedia.org/wiki/Gresham%27s_law
Thus, Gresham's law can be understood as a more general phenomenon. Due to "lack of information" (about the future exchange value of bitcoins and dollars) another person may decide to sell me bitcoins for $20. In turn, if I believe the future exchange value of bitcoins and dollars is "markedly different" than their present exchange value (bitcoins will be worth much more; dollars will be worth much less), I may decide to keep bitcoins in my cash holdings and use dollars as a medium of exchange.
What you described is not Gresham's law, it's just a difference in expectations.
It's what motivate somebody buy some FX futures for example.
Gresham Law applies only when you have fixed prices and two different moneys.
If one of these is being debased or somehow becomes less valuable than the other, it will be generally used in transactions (given away), as long as the counter parts are forced to accept it as a means of payment.
That's not the case with bitcoin, which has a perfectly floating exchange rate.
"What you described is not Gresham's law, it's just a difference in expectations."
It is a theory about why market participants who may believe Bitcoin is superior to and more desirable than fiat currency may nevertheless choose to use fiat currency for purchases instead of bitcoins, and in doing so, effecting a tendency for the "good" money to be withdrawn from circulation leaving the "bad" money in circulation. The difference in expectations is part of the theory.
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"If one of these is being debased or somehow becomes less valuable than the other, it will be generally used in transactions (given away), as long as the counter parts are forced to accept it as a means of payment."
I'm not referring to Gresham's Law narrowly interpreted, but rather the general principle or general phenomenon of Gresham's Law: A person is able to pay with a "good" object or a "bad" object, and chooses to pay with the "bad" object. If many market participants act similarly, then the "bad" objects (tend to) flow into circulation while the "good objects" are withheld from circulation.
The Nobel prize-winner Robert Mundell believes that Gresham's Law could be more accurately rendered, taking care of the reverse, if it were expressed as, "Bad money drives out good if they exchange for the same price."
Clarification / Correction:
My intended focus is on an actor who possesses both bitcoins and dollars and who is able to pay for good or service X with either dollars or bitcoins.
(not on an actor who is assumed to relinquish bitcoins in an exchange)
Adam Knot:It is a theory about why market participants who may believe Bitcoin is superior to and more desirable than fiat currency may nevertheless choose to use fiat currency for purchases instead of bitcoins, and in doing so, effecting a tendency for the "good" money to be withdrawn from circulation leaving the "bad" money in circulation. The difference in expectations is part of the theory. […] I'm not referring to Gresham's Law narrowly interpreted, but rather the general principle or general phenomenon of Gresham's Law: A person is able to pay with a "good" object or a "bad" object, and chooses to pay with the "bad" object. If many market participants act similarly, then the "bad" objects (tend to) flow into circulation while the "good objects" are withheld from circulation.
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If exchange rates are free to adjust to offer and demand for a given currency, it reaches an indifference level where market participants are willing to trade in both units of money.
Gresham's law, and the notion of "good" and "bad" money applies only when you have multiple currencies and a fixed exchange rate between them.
The scarcer currencies will have more demand than offer, and that's why people will hoard them, because they cannot be legally exchanged at the market price where people are indifferent.
And generally the "good money" becomes scarcer because the "bad money" is being debased, either deliberately through inflationary methods or due to wear and tear of old metal coins.
Gresham's law can apply to bitcoin only to the extent that bitcoin operators are not able to unpeg bitcoin prices to other prices.
Gresham's law is something that happens when prices are constrained. In a way, it's similar to shortages, waiting lines and surplus production that cannot be transported.
But even in a market free of official regulations pegging currencies, there's some level of "gresham effects", because of the general transaction costs involved in currency conversion and price monitoring. It could locally and momentarilly better to withold transactions in a given currency due to these expected costs, but these market inefficiencies would soon be corrected by the action of currency arbitrageurs.
But even in a market free of official regulations pegging currencies, there's some level of "gresham effects"....
Again, I'm not talking about Gresham's Law narrowly interpreted, but what you refer to as "Gresham Effects." The exchange rate is "fixed" not permanently by government, but temporarily by the exchanges such as Mt. Gox. Meanwhile, the buyer who holds both bitcoins and dollars believes that the value of bitcoins will appreciate significantly relative to the dollar.
Example: Let's say I have an art gallery and I sell paintings online. On my website I announce that I accept payment in bitcoins as well as dollars. My customer possesses both bitcoins and dollars and is deciding which to use for payment. He sees that bitcoins have appreciated in exchange value from around $20 in early February, to around $160 presently. Individual bitcoins have appreciated significantly in terms of dollars in a short amount of time, and this could possibly continue in the near future with no end in sight. His bitcoins might be worth $400 each by September he believes. In this case, it is likely that he will decide to pay with dollars and keep the bitcoins for himself. If many market participants act similarly, I'm arguing this would constitute the Gresham Effects you refer to. The exchange rate between bitcoins and dollars is "fixed" temporarily by the exchange. The buyer prefers to pay with the "bad" money rather than the "good" money which would effect a tendency for the bad money to remain in circulation while the good money remained in the cash holding of market participants.
This could be why Mundell proposed a more general and less narrow formulation of Gresham's Law: