Bitcoin madness: I wrote to the FED and the ECB and they are playing ostrich

Judging from the current media frenzy surrounding Bitcoins, one wonders if almost four hundred years after the tulip mania in the Netherlands humanity is as gullible as ever when it comes to get-rich-quickly speculation.

What is remarkable this time is that the speculation is global and the object of speculation is not a venture or a commodity but a virtual form of private fiat money, notwithstanding the fact that the debate on the free issue of money was closed almost a century ago when central banks were given the monopoly of issuing fiat money.

Indeed, contrary to what some economists and central banks say, Bitcoins are not a form of virtual of real money and the scheme has the hallmarks of a gigantic Ponzi scheme – anonymous/dubious issuers promising returns that are too good to be true to be achieved through undisclosed (but implicitly illegal) sources.

If nothing is done to stop this scheme, the madness of crowds may reach proportions similar to the infamous Mississippi and South Sea bubbles and we might see again a situation where “puritan ladies” begin selling their jewels and virtue to buy Bitcoins.

This should not be happening now, since we are supposed to be protected by a plethora of financial regulators paid by taxpayers. So, I decided to search the site of some of them to check what advice they had for us. I limited my visits to the sites of the FED and ECB because they have the monopoly of issuing the two major currencies – the Dollar and the Euro, respectively – and play a key role in their corresponding payment systems.

In the FED’s site I could not find a single reference to Bitcoins while the ECB site had a single link to a policy paper with an academic tone and a badly disguised sympathy for private “virtual” moneys like the Bitcoins. So, I decided to email them to question the legality of private virtual moneys in the following terms:

Dear Sir/Madam,
Would you please confirm if the following operations are legal?
1) To pay and accept payment in Bitcoins
2) To trade Bitcoins against the USD/Euro
3) To issue Webcoins, a money similar to Bitcoins, except that it will be issued by mining real goods
4) To establish an electronic brokerage or exchange to trade Bitcoins and Webcoins against the Euro and other currencies.
I would appreciate an answer ASAP.
With kind regards
Marques Mendes

So far the FED has not answered (see note at the end of this post) my email of the 27th November, but the ECB replied promptly by directing me to the paper mentioned above as follows:

Dear Mr Mendes,

Thank you for your interest in the European Central Bank.

The ECB's position on virtual currencies such as Bitcoins is outlined in this report:
http://www.ecb.int/pub/pdf/other/virtualcurrencyschemes201210en.pdf.

With kind regards,
EUROPEAN CENTRAL BANK
DG Communications and Language Services
Press and Information Division

Both played ostrich by not replying directly to my specific questions on the legality of such currencies. Yet the answer should be easy.

Indeed, Bitcoins cannot even be categorized as a temporary currency substitute like the chips used by casinos, the token notes used by monopoly game players or the pieces of metal used by some farms to pay harvesters. The reason being that at the end of the day there is no issuer obliged to convert the Bitcoins into legal money like there is for chips, tokens or pieces of metal.

The sponsors of Bitcoins claim that it is not a Ponzi scheme, because like the growing of tulips in the Netherlands, there is no central organization and anyone can create Bitcoins by “virtual mining” a mathematical algorithm that generates the encrypted codes used for transfers among peer-to-peer electronic networks. This, is obviously a fallacy because someone has to hide the codes. The process of mining Bitcoins is just like the popular garden game of hide-and-seek messages in Easter eggs played by children. In fact, it is less competitive and worthy because in the end players do not even get something with value like the eggs.

Bitcoin promoters are equally fraudulent when they claim that Bitcoins can be exchanged through peer-to-peer networks anonymously like the legal notes and coins. In fact, a central organization (bitcoin.org) is needed to support the network software and the peer-to-peer participants have to date stamp them so that a trail is inevitable.

Moreover, peer-to-peer networks do not provide any type of anti-fraud guarantee to their users. As a payment system, its security is even less than that of informal payment networks like the Hawala system used in Asia and India. Hawala is based on the performance and honour of known money brokers whose honesty users can check, not on some anonymous internet counterparty.

Any fiat money must be issued by known issuers on whose reputation rests its value. Of course its issuers may be central banks or private entities and these may be more or less creditworthy. Indeed, we can even foresee the existence of competing issuers. However, using as a medium of exchange fiat money issued by anonymous entities it is a complete stupidity that any half-witted regulator should be able to understand.

In conclusion, Bitcoins or any similar faceless Webcoins (the Web here stands for Worthless Economic Bullshit) must be considered as a fraud.

P.S. If I were in any doubt about the fraudulent nature of Bitcoins, that doubt would be over on the 6th of January 2014 when someone went through the trouble of writing an email to me pretending to reply from the FED and directing me to a bogus organization (Coindesk) based in the UK which claims that Bitcoins are legal "depending on what you’re doing with it".

Is the ECB Intent on Replacing Euro Hara-Kiri by Euthanasia?

Another useless EU Summit - thank you Mr. Cameron for killing the new “Merkozy” version of an absurd fiscal union for the entire EU. This time, the absurdity of setting a budget limit of 0.5% of GDP (when it has been unable to comply with the existing limit of 3%), was compounded by requiring its inscription as a rule in national legal systems at constitutional or equivalent level (see here why this is a mistake).

Let us now hope that a referendum in Ireland or any other country will kill the alternative proposal for a fiscal union among Euro Zone members through a new "fiscal compact". As we said here, a fiscal union between Germany and France may make sense but it would be a disaster for the entire Euro Zone.

The potential collapse of the Euro Zone will not be due to a fiscal problem in the Euro Area; which does not exist, despite the fact that three smaller members have excessive debt and Germany has an excessive current account surplus. The problem resides in the ECB’s refusal to act to stop the speculation against the Euro by invoking that its charter does not allow for the monetization of fiscal deficits.

Mr. Draghi is either naïve or wants us to believe in fairy tales. During his last press conference, he said that funding the IMF to finance exclusively the Euro Zone governments would be against the ECB charter. However, the ECB practice of accepting modern day versions of accommodation bills, in the form of bank drafts and bonds issued and subscribed by the same bank with a government guarantee and used to purchase the debt of the said government, is a more dangerous form of debt monetization since it lacks any kind of conditionality. Moreover, it puts those governments in the position of sitting ducks for speculative attacks.

As we said before bank-to-bank loans with strong conditionality are preferable. Obviously, we do not advocate that the ECB should negotiate or monitor such conditionality. Specialized institutions such as the IMF or the EFSF/ESM should do that.

Unfortunately, as we said repeatedly and the experience of Greece, Ireland and Portugal shows the IMF adjustment policies for monetary unions are seriously flawed.

Yet the ECB did not demand from the European Council that the ESM should take its place. Instead, the Council decided that all EU member states would lend to the IMF an extra 200 million Euros in the hope that non-EU countries might do the same.

In summary, by accepting the self-inflicted fiscal Darwinism of Germany that will lead to expelling peripheral countries from the Euro Zone, despite a half-baked mix of ECB and IMF support, will not restore confidence in the Euro. All it does is to replace the previous ECB hara-kiri intent with a slow euthanasia carried out by an IMF firing squad.

Is the ECB-IMF Proposed Back-to-Back Loan Enough to Stop the Euro Suicide?

It seems that the ECB is considering moving towards the type of back-to-back loan solution that we advocated in a previous post to stop the speculative bet on the collapse of the Euro. Bloomberg has just announced that the ECB is in talks with the IMF to set up a special $270 billion lending facility that would bypass the legal constraint of acting as lender of last resort to Euro Zone governments.

Although the details are not yet known, this is a positive development. Its main advantage is that it leaves the onus of imposing the necessary conditionality terms to the IMF, a task outside the remit of the ECB. However, the IMF failure in the Greek adjustment program raises serious doubts on its ability to deal with the Euro zone crisis.

We would prefer a European solution, intermediated and co-financed by private banks backed by the reformed European Financial Stability Facility, once it gets competence in adjustment lending.

Still, to be credible the ECB needs to go further. First, it needs to make sure that the size of the facility is big enough to leave no doubt about its power (the $270 billion reported are a fraction of what is needed). Second, it needs to ensure that the IMF can speed up its decision-making process. Finally, and most importantly, needs to stop its programs of bond buying in the secondary market that are feeding the speculation. A substantial reduction in the bond supply issued by some sovereigns is indispensable to squeeze those shorting the Euro.

In conclusion, the ECB has finally taken the first step in the right direction. Let us hope that it is followed by additional measures and is not offset by the fiscal fundamentalism that the surplus countries are trying to impose in whole Euro zone.

How the ECB Can Prevent the Suicide of the Euro Zone

First, three facts:
1) For a currency that is in risk of imploding, the Euro has done better than the Dollar:

2) At the end of 2010 the total foreign net debt (private and public) of Italy was $0.5 trillion (26% of GDP) while that of the US was $2.47 trillion (17% of GDP); the current account deficit of the two countries was identical (3.24% of GDP); and the total central government debt was 109% of GDP in Italy and 61.3% in the US.
3) Yet the markets are pricing their sovereign debt in a way quite unrelated to these fundamentals (yesterday the 10-year Yield for Italy reached 7.48% while in the US it was at 2.01%):

This is clearly a speculative attack against the Euro itself.

Yet, the ECB seems hand-tied to do anything to repel such attack. By hiding behind its statutory limitations in lending to sovereigns; waiting for successive failed schemes of Merkel-Sarkozy to deal with the sovereign debt problems of Greece, Ireland and Portugal; and sticking to self-defeating half-hearted bond buying in the market, the ECB risks letting the downfall of the Euro occur before its own eyes.

This does not need to be so. By itself, the ECB can kill this speculative attack. First, it needs to point out to the European Union governments that if they persist in a simultaneous suicidal pursuit of restrictive budgetary policies it will need to offset them by pursuing an aggressive expansionary monetary policy. Second, it needs to send a strong message to the markets that, if necessary, it is ready to act as lender of last resort for the Governments under attack.

Here is a suggestion of how it can be done. The ECB should replace its bond-buying in the secondary market (which is fueling the speculation) by a new bank lending facility that in practice would work as back to back loan to the governments. There are various ways to structure such facility within the current lending practices of the ECB; and, as long as the loans would not feed back into the market, they would work.

A new job for Mr. Trichet

Recently the media has been concentrating on the race to replace Mr. Jean Claude Trichet at the helm of the European Central Bank, when his mandate terminates in October. However, what he will do next may be equally important.

Mr. Trichet had a distinguished career in banking before taking over at the ECB, and that contributed to the success of his tenure at the helm of the ECB. He is certainly looking forward to a well deserved retirement.

Yet, given his unique statesmanship, Europe would be well advised to ask him for a last service to Europe – to restructure the sovereign debt in the periphery countries. He was a driving force in the ECB policy of rescuing the banks in the periphery of the Euro Zone and his past position at the helm of the Paris Club makes him specially qualified to lead the process of debt restructuring in the periphery countries of the Euro Area.

Yes I know, one must deny the need for foreign debt restructuring until the last minute. However, with 2-year rates in Greece at 23%, one can hardly pretend that things can go on for long. Moreover, the recent experience of dealing with bailouts on a case by case basis was not exactly a success.

So the appointment of a restructuring czar within the European Financial Stability Facility must be considered now. This is preferable to letting things deteriorate until they have to recur to the traditional Paris Club mechanisms.

Such czar needs a credibility that only a few like Mr. Trichet have.