Perhaps private-money options need not be the stuff of fantasy.
Perhaps private-money options need not be the stuff of fantasy.
I nflationary breakouts have a way of concentrating people’s minds about anything related to money. People start looking to invest in assets that, they hope, will maintain or increase value as their money’s purchasing power declines. Property, stocks and shares, inflation-indexed bonds, and even works of art get snapped up as large swaths of the public seek to reduce their cash holdings.
One effect of the current inflationary spike is that it has sparked considerable interest in cryptocurrencies such as Bitcoin. While many smart people are baffled by how cryptocurrencies work, their unfamiliarity does not stop them from asking whether they might turn out to be an inflationary hedge. Boosters of Bitcoin claim that it offers better protection than gold, partly because Bitcoin has a finite supply of 21 million units. Skeptics, however, argue that the often drastic fluctuations in Bitcoin’s value indicate that it is at best an unreliable safeguard against the depreciating value of national currencies.
We’ll likely need to endure an extended period of inflation to discover who is ultimately right. But in many ways, the more important discussion concerns how crypto fits into long-standing critiques of our present monetary system of central banking.
Cryptocurrencies are not, after all, issued as legal tender by a state monetary authority. Grounded on dispersed private networks that utilize blockchain technology, they also deploy state-of-the-art cryptography to ensure privacy. That is how cryptocurrencies are inoculated — or, so the theory goes — from government efforts to play inflationary games with the economy.
This in turn points to some of the deeper reasons underlying crypto’s emergence. Put simply, there is an ongoing tension between money’s use by private actors in the marketplace and the way in which state monetary authorities use their money-supply monopoly to stimulate economic growth or, if deemed necessary, deflate irrationally exuberant booms so that they don’t end in the tears of a severe bust.
As anyone who studies high-school economics learns, money’s most basic role is to be a medium of exchange. It functions as a proxy for the value of the goods and services that are objects of individual economic exchange. Money also serves as a store of value, a unit of account, and a standard of deferred payment. These are not only crucial for the workings of the price system that bring order to market exchanges; they also permit us to accumulate capital and then invest it in different enterprises across an economy.
If these are accepted as money’s essential functions, there are strong reasons to try to ensure that, as far as possible, the supply of and the demand for money doesn’t become detached from the actual supply of and demand for goods and services (what economists call the “true” price relativities). But when central banks choose to prioritize the stimulation of sluggish economies through low — or even, as we have seen, negative — interest rates, it doesn’t take much for this equilibrium to be undermined and, at some point, for inflation to take off.
Fixing this situation and restoring stability to money’s value can be costly. America discovered just how difficult this could be in the early 1980s when Paul Volcker’s Fed used high interest rates to reduce inflation from a high of 14.8 percent in March 1980 to 3 percent in 1983. The approach worked and was an act of courage on Volcker’s part, for which he is rightly applauded today. But smashing inflation also contributed to high unemployment and businesses’ being crushed by a federal-funds interest rate that reached 20 percent in June 1981 and a prime rate of 21.5 percent that same year.
Such problems have led many to argue for alternatives to our present monetary order. Discussion of the gold standard’s merits, for example, always reemerges whenever it appears that inflation is getting out of control. Others have argued for strict rules to bind tightly the hands of central bankers.
Perhaps the most radical remedy was proposed by the Nobel economist F. A. Hayek. In 1976, he famously argued in his Denationalization of Money for ending the state’s monopoly of the money supply by allowing banks to issue private currencies that would compete with one another. Hayek wasn’t advocating eliminating the state’s ability to issue currency. Nor did he say that his market for private currencies would be without any regulation whatsoever. Hayek was, however, confident that market competition would supply better-quality money — what he called “good money” — than the state.
Over time, Hayek argued, the growth of private currencies would diminish the place of government-issued currencies in the economy. One effect would be to limit the state’s ability to manipulate the money supply as part of its quest to try to manage economies from the top down. This mattered because Hayek considered the efforts of central banks to guess the optimal-interest rate for multitrillion-dollar economies in two, twelve, or 18 months’ time to be a quixotic, even hubristic, exercise. Such guesses, Hayek believed, couldn’t help but disrupt the economy’s natural corrections to its cyclical ups and downs.
Hayek was somewhat pessimistic about governments’ actually allowing private money to largely replace state-issued currencies. Yet more than one person has seen Hayek’s proposal as foreshadowing the advent of cryptocurrencies. Moreover, for all the technological differences between the 1970s and now, Hayek’s envisaged competitive market for private currencies and the actual growth of cryptocurrencies today both have the potential to disrupt the state’s control of the money supply. It’s no surprise, then, that governments and central banks have expressed reservations about cryptocurrencies. While some state institutions have opted to try to regulate the crypto-world, others may end up following the People’s Bank of China’s lead and declare cryptocurrency transactions illegal.
Whatever governments do, however, cryptocurrencies seem here to stay. There is significant market demand for it, with even some major institutional investors building crypto-holdings into their portfolios. Certainly, governments will go a long way to try to neutralize any development that they fear might undermine their ability to engage in demand-side management of the economy. But cryptocurrencies’ very existence reminds us that we shouldn’t assume that state monopolies of the money supply are inevitable — let alone forever. And during an inflationary period that many believe has been induced by central banks’ ineffectually using their money-supply monopoly as a means for perpetual crisis management, it’s good to know that private-money options need not be the stuff of fantasy.