Chapter 2 - Bitcoin Standard

Purpose of the lecture

Having established in Lecture 2 what money is and what function it serves, the lecturer begins a historical survey of the development of money by examining the earliest and most primitive forms of money known to us.

Two lessons are drawn from each example:

1. How these monies operated helps us understand Bitcoin.
2. How these monies died helps us understand fiat money and why it fails.

1. The rai stones of Yap

What they were

• Large (and some small) stones made of limestone, used as money on Yap, an island in the Pacific, today part of Micronesia.
• Yap had no limestone of its own. The stones had to be quarried and brought from Guam or Palau, carried on boats over hundreds of miles.
• Yap had no metals and little trade with the outside world, so the stones were, in the lecturer's words, "the best money that they could get."

Why inconvenience was the point

• Using something difficult to produce as money seems perverse, but that is precisely why it worked: if the stones had been easy to produce, their supply would have grown constantly and they would have lost value.

Ownership by oral tradition, not by location

• The stones were too heavy to move, so ownership was recorded and transferred orally. The community would gather around the stone; the owner would announce the transfer to another person, and everyone would agree that the new person was now the owner. The stone itself never moved.
• The Bitcoin parallel: Bitcoin nodes agree that coins belong to an address; when the coins "move", they belong to another address. Nothing physical moves — it is all entries on a ledger, and ownership is a matter of collective agreement.

Salability assessment (using the three-part framework from the earlier lecture: across space, across scales, across time)

• Across space: surprisingly good within the island — payment could be made anywhere on Yap without the stone moving. But the stones were useless outside the island, a massive disadvantage and a key reason they eventually ceased to be money.
• Across scales: partial. Stones came in various sizes, so small stones served small payments and large stones large payments. But a large stone could not be combined from smaller ones, and breaking a large stone up would likely destroy value. A 100 kg stone was not equivalent to 100 one-kilogram stones — they were not fungible.
• Across time: strong. Limestone is extremely durable (many stones survive today, some in museums), and — crucially — the stones were very hard to produce on Yap, giving them a high stock-to-flow ratio on that island only.
  • In Guam and Palau they were abundant and easy to quarry, so they were not money there. Same object, different hardness, different monetary role.

Speculation not included in the book

• The stones most likely began as small pieces of rare rock used as money; over decades, centuries or millennia, islanders travelled to fetch more, so supply grew — but slowly enough that the stones kept their monetary role. There appears to have been no sudden or accelerating increase in supply growth that would have collapsed their value — at least until industrialisation in the late 19th century.

2. Milton Friedman's misreading

The lecturer cites Friedman's writing on the Yap stones and argues he drew "the completely wrong lesson."

"The Yap islanders regarded stones quarried and shaped on a distant island and brought to their own as the concrete manifestations of wealth. For a century and more, the civilized world regarded as a concrete manifestation of its wealth. Metal dug from deep in the ground, refined at great labor, and transported great distances to be buried again in elaborate vaults deep in the ground."

"Both examples demonstrate how important myth — unquestioned belief — is in monetary matters. Our own money, the money we have grown up with, the system under which it is controlled, these appear real and rational to us. The money of other countries often seems to us like paper or worthless metal, even when the purchasing power of individual units is high."

The rebuttal

• Friedman treats both rai stones and gold as irrational, myth-driven conventions.
• Ammous's counter-argument: both are extremely rational precisely because they are expensive to produce. Cost of production is "a feature, not a bug" — not a myth, not a collective hallucination.
• Evidence: limestone never became money in Guam, Palau or anywhere limestone is common, because the easy money trap applies there — rising value invites more production, which crashes the price and ruins the holders.
• Friedman never adequately explained why gold was money, and his broader programme of activist monetary policy (rules for increasing the money supply, e.g. by 2% a year, or targeting 2% price inflation, or productivity rules) shows no recognition of why one might not want the money supply to grow at all. Hence he would probably have judged Bitcoin's fixed supply "suboptimal."
• Had Friedman appreciated the hardness of rai stones and of gold, he would have been far more likely to appreciate Bitcoin.

3. How the rai stones lost their monetary role — His Majesty O'Keefe (1954)

The lecturer turns to Hollywood rather than economics for the clearest account, citing the 1954 film His Majesty O'Keefe, starring Burt Lancaster.

The story

• An American sailor, David O'Keefe, is shipwrecked on Yap and sees the island's wealth — above all its coconuts, which would fetch a fortune abroad.
• He cannot persuade the islanders to work: they live in a tropical paradise and have no interest in cigars, a cuckoo clock or other products of colder, more tedious civilisations.
• The one thing they value is the rai stone. O'Keefe realises he can obtain stones far more cheaply than they can: he charters a large modern vessel in Hong Kong, takes modern equipment to Palau, and returns with a boatload of rai stones.
• Chief Buluru objects, insisting that only stones acquired through the hard work of the Yapese should have value — not those acquired easily by O'Keefe. The lecturer notes that the chief thus emerges as "more of an economist than most economists today."
• O'Keefe ultimately gets his labour, ships out the coconuts and leaves the islanders with vast numbers of stones.

The economic lesson

• The flood of stones destroyed their monetary role: people ended up with more money and less wealth. The stones could not be eaten, spent or used — they simply sat there. The islanders had traded away coconut that could have bought modern technology, cars and homes.
• O'Keefe functioned like a modern central bank: he created a great deal of money; the population ended up holding far more money but was poorer, while he walked away with the real resources.
• Whether or not O'Keefe personally caused it, demonetisation was inevitable: modern technology would always have made the stones cheaper and cheaper to obtain, and the monetary role would pass to whatever is harder to produce on Yap.
• Rai stones are no longer money; Yap, as part of Micronesia, uses the US dollar.
• The general rule: once the stock-to-flow ratio of a money declines — once its supply starts growing rapidly — it loses monetary status.

Extension to fiat money

• Money supply in every country today is many multiples of what it was 20, 40, 50 or 100 years ago, yet the extra dollars do not correspond to extra wealth. The increase devalues existing savings and relocates wealth from holders to money-creators.
• Hence the concentration of wealth towards those able to generate money — large corporations buying up ever more houses and assets. Yap is "a microcosm of what's happening in the world economy today thanks to fiat money."

4. Aggry beads of West Africa

Origins (uncertain)

• Glass beads used as money in West Africa. Proposed origins: meteorites; trade with Phoenician or Egyptian traders in antiquity; or an ancient West African glass-making method that was later lost, making existing beads scarce and precious.

The arbitrage

• By the 16th century, Europeans arriving on the West African coast found the beads expensive there but cheap in Europe — where they were not money.
• Europeans therefore bought beads cheaply in Europe and used them to pay for West African resources: gold, ivory and spices.

Salability assessment

• Across space: good — small, high value, easy to move and to transfer large amounts of value.
• Across scales: decent — beads could be strung into necklaces or bracelets and split back into individual beads. But not fungible: some beads were more valuable (e.g. attractive colours), creating multiple exchange rates and "a partial barter problem."
• Across time: decent — glass is durable, does not rot or disintegrate, and the beads were hard to produce in West Africa at the time, giving them a reasonable stock-to-flow ratio.

The collapse

• Because the beads were not hard to produce in Europe, Europeans shipped them in enormous quantities — literally filling ships' hulls with them as ballast, to be traded for valuable goods on the return voyage.
• Bead prices in West Africa fell and their market value collapsed; anyone storing wealth in beads became steadily poorer through high inflation.
• They eventually became known as "slave beads", because they were used to purchase slaves. As West Africans' savings collapsed, Europeans could buy not only resources but people themselves — "losing the ability to save can be the difference between freedom and literal slavery."

Sudden collapse versus slow drain

• A one-off collapse or hyperinflation is a disaster, but people can move to another money and begin accumulating again.
• A slow drain over years and decades can be worse: savers keep pouring new savings into a medium of exchange that keeps losing value, so wealth is drained continuously and they are left powerless. This, the lecturer argues, is what happened with aggry beads over hundreds of years.

Further reading cited

• Toby Green, A Fistful of Shells — a book the lecturer encountered after writing The Bitcoin Standard. It describes similar processes involving shells and other monies, and argues that African societies that used gold as money were protected from this effect.

5. Seashells and wampum in North America

• Seashells were used as money in North America; wampum — the hardest sea shell to find, and possibly the highest stock-to-flow money of its time — was legal tender in the European colonies from 1636.
• Over time, more silver and gold arrived from Europe and displaced shells. Industrialisation also made it possible to harvest shells in far greater quantities with large boats.
• Shell supply rose, shell value fell, and people moved to harder money — silver and gold — i.e. a money with a higher stock-to-flow ratio and lower supply growth rate.

6. Comparison of the three monies

7. Conclusion

• Modern industrialisation made artefact monies easy to manufacture: more seashells, more rai stones, more of every primitive money.
• At the same time, modern machinery, industry and metallurgy made it far more feasible to produce metals and turn them into money — and metals are a superior money, for reasons to be discussed in the next lecture.
• "Money that is easy to produce is no money at all." Easy money does not make a society richer; it makes it poorer, by putting all of a society's hard-earned wealth up for sale in exchange for something that is easy to produce.