Written on September 15, 2021
The goal of this article is to consolidate and create a coherent argument about the basic microeconomic idea of price equals marginal cost (P = MC), fiat money as a product, and how Bitcoin relates to these two. I must warn all readers that this is just an intellectual framework, or as Steve Jobs put it “connecting the dots”. It’s by no means a final concept, and the community will have to help develop and refine this idea, the same way I’ve taken this idea from others, and I hope to develop it.
Before we begin, some reassurance to all readers: Don’t worry, high-level mathematics is not necessary to understand the concepts described here. I will do my best to keep things short and simple. Without further ado, I hope you enjoy my little explorations of microeconomics, the Federal Reserve, and Bbitcoin.
First things first, let’s start with microeconomics. And I can already hear you ask:
“What basic microeconomics concept do you talk about so often, General Kenobi?”
I’m glad you asked. The concept I am still referring to is a basic idea of microeconomics within general equilibrium (GE) theory. GE theory tends to be among the first things any economics student learns, and with it, the idea of perfect competition. Within the perfect competition model there is a simple equation with potentially large effects: P = MC. The essence of it is that in a perfectly competitive market, the price of a product will approach the marginal cost of the given product and will eventually equal it.
“But what is marginal cost?” I hear you say.
In economics, every time you see a ‘marginal’, it’s helpful to think of the ‘next unit’. Therefore, MC is the incremental cost of generating/producing an additional unit. Under perfect competition, firms improve profits by reducing MC, thus market equilibrium exists at the lowest MC, which for normal firms tends to be a non-zero number.
Therefore, the basic idea is that in a competitive market, firms will improve their MC, and the price of the given product will approach MC. Thus, P = MC under a competitive market. And if you are wondering why, it is because firms would have an incentive to produce an additional unit if the MC was less than the previous unit, as this represents an “increase in returns to scale”. Bigger is better. But if the MC grows to produce an additional unit, then it means that you have entered the realm of “reducing returns to scale”, and you are starting to lose profits. The biggest is the worst. This is based on the assumption that companies are looking to maximize profits.
But that is enough; I said I would try to keep it short and simple. Let’s get on with fiat currency and why the US dollar is a product.
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 Federal Reserve is a complete private entity with shareholders. Can you guess who these contributors are? That’s right, banks. Only banks can be shareholders in the various private companies that represent the Federal Reserve, and banks can only receive dividends generated by the Federal Reserve. So, if the Federal Reserve is a corporation, and it has shareholders, they get dividends. What do they sell? What is their product?
Well, they sell money. This is the product. Everyone wants it, and despite popular belief, there are copious amounts of it. But, even though they are ubiquitous, most people hardly stop and think about it.
If you stop and think about money for just a minute, you will find that money is only an asset – certainly the most liquid – but just another asset. And because this asset is offered by a private company, it is also a product. They are AirPods from the Federal Reserve. The money is cheap for the Fed, keeps very good profit margins, and is an excellent seller.
Stay with me for another second, because now we see that fiat money is a product, but for us to combine P = MC and fiat as products, we have to see if the US dollar works in a competitive market. The thing is that the currency market is not a standard market at all. It is not an ordinary market, like that of potatoes or corn for example, 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 is not the best money. Thus, it is a binary monopoly market. You either have the best money or you don’t, and if you don’t, you drop other money to move on 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 board games or anti-competitive markets. In my view, 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 global reserve currency, and the world bows to you. In fact, this is a competitive market where the US dollar also uses the term “petrodollar” and is protected by the most powerful (and most polluting) entity on the planet, the US military.
Breathe, the hard part is over. We have seen that P = MC, and we have created money as a product, and that product is in the most competitive market in the world. Now, it’s time to get started! Let’s look at MC for money. During the gold standard (the period of history when world trade used mostly gold-based currencies), the MC of money was the cost of acquiring gold. Well, that means that under those monetary systems, money had a verifiable MC – the cost of mining one additional unit of gold. The mc paper money? Well, the cost of creating any additional amount of this asset that we call an order is zero. The MC of paper money, especially in US dollars, is zero. Nada cost. Almost nothing at all, nothing at all. A person presses a button, some electrons move, and new money is generated.
This effectively means that the US dollar is close to zero. It has been doing so for decades. One could also argue that under the gold-based system, the more money resembles money through time, the closer it is to its demise. Historically, while empires were collapsing, the first thing they would do was devalue and inflate their currency, slowly converting it into fiat money with the currency/product’s MC reaching zero. When the previous money market winner was weak enough, the rotation of the stronger money will occur around the world.
I could go on and on about the Fiat incentives, inflation, decadence and what you have. But I’m not the expert you’re looking for, and we haven’t talked about bitcoin yet, so let’s see how bitcoin reacts to these ideas. Well, Bitcoin is very expensive, and each subsequent BTC will cost more than the previous one. This basically means that while fiat’s MC is always at zero and the market is slowly approaching it, Bitcoin’s MC keeps increasing to infinity, and the market knows it.
Bitcoin has a verifiable cost, it is not a product of any company, and therefore it is a finite and immutable asset, and the incentives stipulated in its protocol ensure that MC will never equal zero. Satoshi gave us a gift. We are all discovering it now!
We have a raised floor!
General Kenobi
Note: I know this topic is more complex and in depth than this. I may have gotten some things wrong, and maybe oversimplified some concepts, but I think the mental framework it generates is really powerful. Not someone you live with, but it might be interesting to keep it, to see how it works. I’ve left some neglected paragraphs below in case anyone finds it interesting or gets any inspiration from it. 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. This is similar to physical models that show negative energy. In the same way that negative energy in physics models is impossible and makes us think outside the box, this mental model that shows the infinite price of BTC in US dollars is the same kind of impossible that should make us think outside the box. We are all thinking the same thing, in a world where only BTC exists. Because we now live in a world where you don’t know if the person giving you money is working for him, or he just made it out of thin air, but that same reality has an alternative. You decide what money you use, and so do the rest of us.
Until now, the asset that mediates all transactions has been a corrupt, centrally controlled currency that we usually don’t think much of. In the near future, this asset will occupy the best funds, which we 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. The opinions expressed are their own and do not necessarily reflect the opinions of BTC, Inc. or Bitcoin Magazine.