Written on September 15, 2021
The aim of this article is to unite and create a coherent argument around the basic microeconomic idea of price equal to marginal cost (P = MC), fiat money as a product, and the relationship between bitcoin and those two. I must caution all readers that this is just a framework of thought, or, as Steve Jobs would have said, “connect the dots”. This is by no means a finished concept, and the community will need to help evolve and refine this idea, in the same way that I took this idea from others and hopefully improved it.
Before you begin, reassure all readers a little: don’t worry, high-level math is not required to understand the concepts described here. I will also do my best to keep it short and simple. Without further ado, I hope you enjoy my little exploration of Microeconomics, the Federal Reserve, and Bbitcoin.
First, let’s start with microeconomics. And I can already hear you asking:
“What is this basic microeconomic concept that you talk about so much, General Kenobi?” “
I’m glad you asked. The concept I constantly refer to is a fundamental microeconomic idea within general equilibrium (EG) theory. GE theory tends to be one of the first things any economics student learns, and with it, the idea of perfect competition. Inside the perfect competition model is a simple equation with potentially important implications: P = MC. The bottom line is that in a perfectly competitive market, the price of the product will come close and eventually equal the marginal cost of the given product.
“But what is marginal cost? I hear you say.
In economics, whenever you see “marginal” it helps to think of “next unit”. Therefore, MC is the additional cost of generating / producing an additional unit. In perfect competition, firms optimize their profits by minimizing the MC, and the market equilibrium is therefore at the lowest MC, which for normal firms tends to be a number other than zero.
Therefore, the basic idea is that in a competitive market, companies will optimize for their MC, and the price of the given product will approach the MC. Thus, P = MC in a competitive market. And if you are wondering why, it is because companies will be incentivized to produce an additional unit if the MA is lower than that of the previous unit, as this represents “increasing returns to scale”. Bigger is better. But if the MC of production of an additional unit increases, it means that you have entered the realm of “diminishing returns to scale” and start to lose profit. Bigger is worse. It is under the assumption that companies seek to maximize their profits.
But enough of that; I said I would try to keep it short and simple. Let’s continue with fiat money and why the US dollar is a commodity.
First, a fun fact about our favorite fiat currency: The issuer of the US dollar, the Federal Reserve is a private company, and it has shareholders. Yes, the Fed is a private entity, with shareholders. Can you guess who these shareholders are? Right, the banks. Only banks can be shareholders of the various private companies that represent the Fed, and only banks can receive dividends generated by the Fed. So if the Fed is a business and it has shareholders, it receives dividends. What are they selling? What is their product?
Well, they are selling money. This is the product. Everyone wants it, and despite popular belief, there is plenty of it. But, despite their ubiquity, most people hardly ever stop to think about it.
If you stop and think about money for a minute, you will find that money is just a simple asset – the most liquid for sure – but just another asset. And because this asset is offered by a private company, it is also a product. These are the Fed’s AirPods. Money is cheap for the Fed, maintains very good margins, and is a great seller.
Stick with me just a second, because now we see that fiat money is a commodity, but to merge P = MC and fiat as commodities, we need to find out if the US dollar is operating in a competitive market. The point is, the currency market is not a standard market at all. It is not a normal market, like that of potatoes or corn for example, because of the monopoly properties inherent in money. What I mean by this is that consumers tend to choose the best form of money for themselves and ditch any other form of money that is not the best. It is therefore a binary monopoly market. Either you have the best money or you don’t, and if you don’t, you give up other funds to switch to the best form of money available. Thus, the fiat currency market moves from one monopoly to another.
But when people hear “monopoly” they either think of fun table games or anti-competitive markets. In my opinion, the currency market is not only a monopoly 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 endless. You become the world’s reserve currency and the world bow to you. In fact, it is such a competitive market that the US dollar is also called a “petrodollar” and is protected by the most powerful (and polluting) entity on the planet, the US military.
Breathe, the hard part is over. We saw that P = MC, and we established the 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 for money. During the gold standard (the period in history when world trade primarily used gold-based currencies), the MC of silver was the cost of acquiring gold. Okay, that means that in those monetary systems, silver had a verifiable MC – the cost of mining an additional unit of gold. And the MC for fiat money? Well, the cost of creating an additional amount of this asset which we call fiat is almost zero. The MC of fiat currency, especially that of the US dollar, is zero. The cost is NADA. It’s almost nothing at all, nothing at all. A person presses a button, a few electrons move, and money is created.
This effectively means that the US dollar is approaching a price of zero. And this for decades. It could also be argued that in a gold-based system, the more silver looked like fiat over time, the closer it got to its demise. Historically, as empires crumbled, the first thing they would do was depreciate and inflate their currency, slowly turning it into fiat currency as the MC of the currency / product reached zero. When the previous money market winner was weak enough, a rotation to a stronger currency would occur around the world.
I could go on talking about the incentives of the fiduciary system, inflation, debasement and so on. But I’m also not the expert you’re looking for, and we haven’t talked about bitcoin yet, so let’s see how bitcoin interacts with these ideas. Well, bitcoin is expensive to make and each subsequent BTC will cost more than the previous one. This essentially means that while the MC of fiat is still at zero and the market is slowly approaching it, the MC of bitcoin continues to rise ad infinitum, and the market knows it.
Bitcoin has a verifiable cost, is not the product of any company and is therefore a finite, unalterable asset, and the incentives set out in its protocol ensure that MC will never be zero. Satoshi gave us a gift. We’re all finding out now!
We have the heights!
PS: I know that this subject is much more complex and deep than that. Maybe I misunderstood some things, I maybe even oversimplified some concepts, but I believe that the mental framework that it generates is really powerful. Not one to live with, but one that can be interesting to keep, to see how it goes. I’ve left some of the paragraphs deleted below in case someone finds them interesting or inspired by them. Enjoy 🙂
This framework shows that BTC is approaching an infinite value denominated in US dollars, while the US dollar is approaching an abstract final price of zero. It’s almost like physical models showing negative energy. In the same way that negative energy in physical models is impossible and takes us outside our box, this mental model showing infinity BTC price in US dollars is the same type of impossible that should take us out. off the beaten track. We all think of the same thing, of a world where only BTC exists. Because we now live in a world where you don’t know if the person giving you the money worked for it, or just created it out of thin air, but that same reality has an alternative. You decide what money you use, just like the rest of humanity.
Until now, the asset that went into all transactions was a centrally controlled corrupt currency that we usually didn’t think about much. In the near future, this 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 article by General Kenobi Nakamoto. The opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.