[Cryptography] Fun and games with international transaction settlement (was Re: IBM looking at adopting bitcoin technology for major currencies)

[Jerry Leichter]

On Mar 15, 2015, at 1:10 AM, Peter Gutmann <pgut001 at cs.auckland.ac.nz> wrote:
>> 
>> The reason the world treats the dollar as having real value is that the US
>> has an almost-250-year-long history of paying back all its debts
> Looking at the ever-useful http://usdebtclock.org (which currently seems to be
> out of action, you can find older screenshots via Google, e.g.
> http://dailyreckoning.com/dr-content/uploads/2014/08/USDebtClock.png), if I'm
> reading that right then US personal debt is at about the same level as
> sovereign debt, with savings essentially nonexistent.  This means that the
> assets aren't capital but fixed (and some intangible) ones, and what will the
> PRC do with Mt.Rushmore and Golden Gate Bridge?
The US GDP for 2014 was about $17.7 trillion (http://en.wikipedia.org/wiki/Economy_of_the_United_States).  Its public debt was about $18 trillion (same page).  Using your figures, double that to fold in all debts public and private - though that's a gross over-estimate, since the vast majority of private debt is internal and cancels itself out.  (That's true of much of the public debt as well.  Over 28% of the US debt is money one arm of the government owes to another http://www.pewresearch.org/fact-tank/2013/10/09/5-facts-about-the-national-debt-what-you-should-know/)

So by even a very generous calculation, total debt is twice annual income.  What does this mean in practical terms?

Back in the "good old days", before we got wild and crazy with debt here in the US, the rule of thumb for a safe cost for a house was 2.5 times your annual income. (I don't know where to find a reference for this - I recall it from bank ads for mortgages during my childhood.)  Today that would be considered way too conservative - no one but the very wealthy could buy housing in many areas of the country if we stuck to that rule.

During the "2.5 times value" era, US mortgage rates were in the 5-6% range (http://images.dailywealth.com/images/mortgage%20rates.png).  http://www.pewresearch.org/fact-tank/2013/10/09/5-facts-about-the-national-debt-what-you-should-know/ reports that the average interest rate the US government is paying is half that - 2.84%.  (Yes, the comparison isn't an ideal one, as the mortgage rates were almost universally for 30-year fixed rate loans, while much of the US debt is in much shorter-term instruments.)

Mortgage delinquency rates would provide an indicator of how good this rule actually was in determining whether people could pay their mortgages, but I can't find any data sets going back before the early 1990's, when Fannie Mae was created - before that, the market was highly fragmented among a large number of savings and loans.  http://www.crgraphs.com/2011/10/mortgage-delinquency-graphs.html shows that even through 2007 - which includes an era with much higher loan-to-value ratios and much higher rates - delinquency rates were around 0.5%.  Not a bad bet.  (There's always going to be some delinquency - people get sick or injured and can't work, die young, become addicted to alcohol or gambling, or run into any number of other of life's pitfalls.  That's why mortgages are not at the risk-free interest rate.)

So by the old, very conservative standards, the US would be considered extremely likely to be able to pay back its debt based on its income stream.  And, indeed, the US is currently paying close to the estimates for the risk-free rate.

>> It's not clear how Bitcoin would necessarily change any of this.  If Bitcoin
>> somehow becomes completely independent of the existing banking system
> 
> I think it's not so much that it's independent of the banking system, it's
> that there's a perception that it's not tied to the house of cards that is the
> current financial system.
Those who have an actual stake in the system don't act as if they believe it's a house of cards.

What the 2008 crisis - after, again, two generations of boring stability in the financial system - showed us is that if we're stupid enough to let the financial markets go off and set the rules for themselves, they have the capability and the motivation to bring the whole thing down on everyone's head.

The doctrinaire free market types refuse to believe it, but the financial markets are an inherently unstable system.  Just like every high-performance airplane built today.  Both work anyway.

Then again, the reason the Wright brothers succeeded was because they knew bicycles worked even though they are inherently unstable.  What's needed is dynamic stabilization.  The more I hear the big banks complaining that they can't make those huge profits any more because of the drag of their new capital requirements, the better I feel.  Those profits are a sign of the system's ability to take wide swings.  Financial firms profit from those swings.  If the swings are damped, if the system once again becomes boring (it's hard to remember that banking was, not so long ago, the place to work if you didn't want to be challenged and wanted to get home early - "banker's hours"), the rest of us profit as money (and the best minds) move out of financial game-playing and into the real economy.

> Of course BTC is its own house of cards, but as long as there are people around to believe in it...
You need a certain amount of "irrational" belief for people to be willing to take risk - which is how the economy as a whole grows, even if many of those risks don't pan out.  Most startups - most new businesses - fail.  But enough succeed that the optimists will keep trying, and some will succeed and grow the economic pie.

But "beliefs" can turn around very quickly.  Too much reliance on unsupported belief and, indeed, you have a house of cards.

                                                        -- Jerry