Monday, December 4, 2017

Is cryptocurrency the mechanism of Friedrich Hayek's denationalisation of money?

In 1976, Nobel laureate Friedrich Hayek proposed that money should be denationalized, such that privately issued moneys would compete over their relative ability to retain stable value. In 1978 he revisited this concept, adjusted a few of his predictions about the ensuing dynamic (placing more emphasis on the role of network effects), and published his findings in "Denationalisation of Money: The Argument Refined". I will not recount the argument here, since the book does so well enough.

Perhaps history will one day find irreparable fault in Hayek's thesis, who knows. But even if so, the idea was no more foolish than would intrigue an economist celebrated for his insight into money.

If Hayek erred, I have yet to read an analysis which shows me how. Cryptocurrency skeptics could improve their credibility if they first acknowledge the plausibility of the thesis, and then proceed to counter rather than duck the logic behind it.

51 comments:

  1. I've yet to read a good counter argument against cryptocurrencies. Most critics default to the it can't happen so it won't, but they don't typically even discuss whether it would be a good thing for humanity if it did happen. Is there ever a situation where public good would demand the state to be able to devalue or limit the circulation of a certain currency?

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    1. The economy is the most important and yet also the most complex and least understood machine ever built by humans, so it is difficult to answer your question with too much confidence. But I guess we can look at popular answers, and some recent precedent.

      Conventional modern monetary policy theory would say yes, such cases exist. It is widely believed for example (e.g. by Ben Bernanke) that the 1930s great depression was caused by the Fed's decision to raise rates too aggressively, which caused a rapid contraction of the money supply, which in turn caused liquidity shortages and a rapidly growing value of the dollar. Thus, people suddenly had less means and also less incentive to invest and purchase, so investment and purchasing nearly stopped, and thus the depression. The solution in such scenarios is often said to be to inflate the money supply so as to restore liquidity, and to cause a weakening of the dollar, thus increasing both means and incentive to invest and purchase. But how can you do that when you are on a gold standard, and the public is free to demand gold for their dollars but you don't have enough gold in Fort Knox? Well, the US made it illegal to own gold during the 1930s, and it would remain illegal to own significant gold, or to write contracts in terms of gold (which had previously been standard), until I think the late 1970s - well after Richard Nixon officially suspended convertibility of the dollar to gold in 1971 (the final death of the gold standard, so now USD is pure fiat.) The argument was largely that the central bank needed to get people to spend their money rather than to just sit on it.

      So there are both arguments and precedent for governments interfering in competing currencies so as to exercise monetary policy, taking the US as a 'recent' example. (Recent, in terms of the history of money.)

      On the other hand, unlike bitcoin, USD operates on fractional reserve - and this results in a money supply subject to large and often unintentional expansions and contractions. Central bankers walk on egg shells whenever they speak because the amplifying effect of the hierarchy of fractional reserve banks beneath them can exaggerate any signal into unintentional or excessive changes. Bitcoin does not have this characteristic, its money supply is stable.

      I do worry that the rapid strengthening of bitcoin could sap incentive to spend and invest, and thereby cause a large and widespread depression. On the other hand, those who hold their own private keys need not worry about bank runs - which I'd expect should avoid destabilizing panics. Owing to the stable preprogrammed money supply I also don't see why liquidity would be an issue. (I do hope the lightening network and related developments mature quickly!) I would have to expect the real value of bitcoin (not necessary value in terms of USD) would eventually stabilize, and thus so would economic incentives. Although it is common today to say that moderate inflation is good for the economy, I'm not sure I agree with that - I might instead agree with Hayek that inflation is detrimental and destablizing in the long run. I think our economy today is addicted to excessive and unsustainable growth, which is bad for the environment and bad for making the most of our limited time on this planet, and so I do hope that cryptocurrency will eventually prove to have been a very positive development. Regardless, it seems safe to say it will be both the best and worst thing to have happened in some time, not unlike the invention of the printing press.

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