Written on September 15, 2021
The aim of this article is to create a coherent argument around the basic microeconomic idea of price equals marginal cost (P = MC), fiat money as a product, and the relationship between Bitcoin and these two. I have to warn all readers that this is just a mindset, or as Steve Jobs put it, “connecting the dots”. It is by no means a finished concept, and the community will have to help develop and refine this idea, just as I took this idea from others and hopefully improved it.
Before we get started, a little reassurance to all readers: don’t worry, high-level math is not required to understand the concepts described here. I will also do my best to keep things short and simple. Hope you enjoy my little exploration of microeconomics, the Federal Reserve, and Bbitcoin.
First things first, let’s start with microeconomics. And I can already hear you ask:
“What is this basic microeconomic concept that you talk about so much, General Kenobi?”
I am glad you asked. The concept that I keep referring to is a basic microeconomic idea within general equilibrium theory (GE). The GE theory is one of the first things any business student learns, and with it the idea of perfect competition. Within the perfect competitive model lies a simple equation with potentially large implications: P = MC. The gist of this is that, in a perfectly competitive market, the price of the product approaches and eventually becomes equal to the marginal cost of the given product.
“But what are marginal costs?” I hear you say
In economics, every time you see “marginal” it helps to think of “next unit.” Hence, MC is the additional cost of creating / manufacturing an additional unit. With perfect competition, companies optimize their profits by minimizing the MC, and the market equilibrium is therefore found at the lowest MC, which tends to be a non-zero number for normal companies.
Therefore, the basic idea is that companies optimize for their MC in a competitive market and that the price of the respective product approaches the MC. Thus, P = MC under a competitive market. And if you’re wondering why, that’s because companies have an incentive to produce an additional unit when the MC is lower than that of the previous unit as it means “increasing economies of scale”. Bigger is better. However, if the MC grows for the production of an additional unit, it means that you have entered the area of ”diminishing returns to scale” and are starting to lose profits. Bigger is worse. It does this on the assumption that companies are looking for profit maximization.
But enough of that; I said I would try to keep it short and simple. Let’s move on to the fiat currency and why the US dollar is a product.
First, a fun fact about our favorite fiat currency: the US dollar’s issuer, the Federal Reserve, is a privately held company and has shareholders. Yes, the Fed is a private body with shareholders. Can you guess who these shareholders are? Right, the banks. Only banks can be shareholders in the various private companies that represent the Fed, and only banks can receive the dividends generated by the Fed. So if the Fed is a company and has shareholders, they get dividends. What do you sell? What is your product
Well they are selling money. This is the product. Everyone wants it, and despite popular belief, there are plenty of them. But even though it’s so ubiquitous, most people barely stop and think about it.
If you stop for a minute and think about money, you will find that money is just one asset – certainly the most liquid – but just another asset. And because this asset is offered by a private company, it is also a product. It’s the Fed’s AirPods. The money is cheap for the Fed, has very good margins and is a super seller.
Stay with me a second because now we see that fiat money is a product, but in order for us to merge P = MC and fiat as products, we need to find out if the US dollar works in a competitive market. The thing is, the forex market is not a standard market at all. It is not a normal market, such as that for potatoes or corn, because of the inherent monopoly 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. It is therefore a binary monopoly market. You either have the best money or you don’t, and if you don’t, drop other money to switch to the best type of money available. Thus, the fiat currency market goes from one monopoly to the next.
But when people hear “monopoly” they either think of fun tabletop games or anti-competitive markets. From my point of view, the foreign exchange market is not only a monopoly market, but also a competitive market. It’s the most competitive market. Because if your country’s currency wins this binary currency battle, the price is endless. They become the world reserve currency and the world bows to you. In fact, this is such a competitive market that the US dollar is also known as the “petrodollar” and is protected by the most powerful (and most polluting) entity in the world, the US military.
Breathe, the hard part is over. We saw that P = MC and we established money as a product, and that product is in the most competitive market in the world. Now is the time to roll! Let’s look at the MC of money. During the gold standard (the epoch of history when world trade mainly used gold-based currencies), the MC of money was the cost of acquiring gold. All right, that means money had a verifiable MC under these monetary systems – the cost of mining an extra unit of gold. And the MC of the fiat money? Well, the cost of creating an extra amount of this asset, which we call a fiat, is next to zero. The MC of fiat money, especially US dollars, is zero. The cost is NADA. It’s almost nothing, nothing at all. A person pushes a button, a few electrons move, and new money is created.
This effectively means that the US dollar is approaching zero. And that for decades. It could also be argued that as time went on, the more and more fiat money in a gold-based system became, the closer it got to its demise. Historically, when empires crumbled, the first thing they would do was devalue and inflate their currency and slowly turn it into fiat money when the MC of the currency / product hit zero. If the previous money market winner was weak enough, there would be a global rotation to stronger money.
I could go on and on about fiat incentives, inflation, devaluation and whatever. But I’m not the expert you’re looking for, nor have we talked about Bitcoin, so let’s see how Bitcoin interacts with these ideas. Well, Bitcoin is expensive to produce, and each additional BTC produced costs more than the previous one. This basically means that while Fiat’s MC is always at zero and the market is only slowly approaching it, Bitcoin’s MC keeps going up to infinity and the market knows it.
Bitcoin has a verifiable cost, is not a product of any company and is therefore a finite and immutable asset, and the incentives set out in its protocol ensure that MC is never zero. Satoshi gave us a gift. We are all only now discovering it!
We have the height!
PS: I know this topic is much more complex and deeper than this. I may have got some things wrong, I may even have oversimplified some concepts, but I believe the mental framework it creates is really powerful. Not one to live on, but one that could be interesting to see how it behaves. I’ve left some of the discarded paragraphs below in case anyone finds them interesting or takes inspiration from them. Enjoy 🙂
This framework shows that BTC is approaching a US dollar denominated value of infinity while the US dollar is approaching a final abstract price of zero. This is almost like physical models showing negative energy. Just as negative energy is impossible in physics models and makes us think outside the box, this mental model showing a BTC price of infinity in US dollars is the same kind of impossible that should make us Think outside the box. 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 money worked for it or just created it out of nothing, but the same reality has an alternative. You decide what money to use, and so do the rest of humanity.
So far, the asset that brokered all transactions was a centrally controlled corrupt currency that we usually didn’t think about much. In the near future, this asset will be studded with the best money that we have all discovered little by little. An asset that no economic operator can create without incurring significant and verifiable costs.
This is a guest post by General Kenobi Nakamoto. The opinions expressed are solely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.