This week’s episode of Econtalk was about BitCoin…

This week’s episode of Econtalk was about BitCoin, the online crypto-currency that Security Now covered a few months ago. It took the form of a rambling interview with the project’s principal Gavin Andresen about the high-level function of the system.

Unfortunately, since it was for general consumption, there was very little technical content. While there was also relatively little in-depth economic analysis of the system, they did hit on a kernel of economic wisdom that also came up during our last dinner: the importance of economic expectations.

Andresen: It’s hard to imagine [BitCoin replacing the dollar]. I could imagine that happening in maybe a smaller country that has decided to peg their currency to the dollar–maybe they decide to peg to the bitcoin or decide to use bitcoins as their national currency. I could see that happening before dollars gets replaced.

Roberts: But the biggest problem in those cases is they don’t keep their promises. So, they promise to peg it to the bitcoin but then they break their promise. The reason the promise has so much appeal–besides that it’s cool–it’s very cool. Wouldn’t it be great if we could just run our lives this way?

If I knew that over the next four years bitcoins were going to be created 50 at a time every ten minutes, and I came to trust that, and then knew down the road it would be 25 and then 12.5 until the stock was basically fixed, I’d rather play in that sand pile rather than the one where I have to trust Ben Bernanke [not to inflate the Dollar]. Ben Bernanke will tell me we can’t have that world because we need monetary policy to do x, y, and z; and I would say, yeah, I’ll take my chances.

In any economic transaction, there are a implicit economic predictions: the price of the good won’t (or will) go up tomorrow. The real (i.e. inflation-adjusted) value of your dollars won’t go up (or down) tomorrow. When unions negotiate contracts, they predict inflation for the term of the contract, and negotiate for wages that will rise accordingly.

In short, efficient markets require accurate economic expectations. This is why economists get so nervous about sudden, shocking infusions of cash in to the market: if people know to expect 10% inflation yearly, they can plan accordingly. If inflation becomes 10% and most people don’t even realize it as it’s happening, bad things follow.