The Digital Denationalisation of Money

In 1976, F.A. Hayek made a splash with his book The Denationalisation of Money (DNM). Prior to this work, even some of the most prominent free market thinkers — such as Milton Friedman — believed that the supply of money should be left to the government. But it was this book that really opened the door to the idea of private, competing currencies. As Hayek put it:

As soon as one succeeds in freeing oneself of the universally but tacitly accepted creed that a country must be supplied by its government with its own distinctive and exclusive currency, all sorts of interesting questions arise which have never been examined.

Trying to answer some of these questions, Hayek imagined that firms would, if legally allowed, issue currencies that had freely floating exchange rates with other such private monies. And this competitive process would incentivize these firms, by their own self-interest, to control their supply in such a manner as to make it “most acceptable to their users.” He further conjectured that governments would at first continue to issue their own money, but wasn’t optimistic about government’s long-term ability to stay competitive with private firms, and figured, in the long run, government currencies would fall from circulation entirely.

Enter Free Banking

Admittedly, DNM was not an instant success at altering academic opinion of how money should be supplied. However, as the 1980s began, Hayek’s work started to influence a new generation of economists such as Lawrence White (now at George Mason University) and George Selgin (now at the Cato Institute). Starting with White’s Free Banking in Britain and followed by Selgin’s The Theory of Free Banking, the concepts of privately issued money and free banking were more fully developed.

However, this theory of free banking looked quite different than the picture painted by Hayek in DNM. While Hayek envisioned freely floating fiat currencies, White and Selgin theorized about private notes of issue, backed by a single base money (likely a commodity such as gold), that would trade on par with one another. Selgin (1994) lays out briefly how competitive banking could look:

Notes issued by different banks are distinct but redeemable at equivalent par values in … base money. Consumers favour particular brands of notes, not by accepting them at favourable exchange rates, but by retaining them as part of their asset portfolios, spending or depositing unwanted notes.

Using historical examples of relatively free-market banking (such as in periods in Scotland and Canada) along with rigorous theory, the free bankers showed not only that money could be provided on the free market (in a different manner than Hayek proposed) but that this would have many beneficial macro-level outcomes that governments could only hope to achieve.

While Hayek was undoubtedly a looming intellectual inspiration in the field, the free-banking model seemed to have won out over Hayek’s DNM model as the most likely system of private competitive money supply — that is, until the arrival of cryptocurrencies.

Enter Bitcoin

Looking at the rapidly growing cryptocurrency market, it’s hard to miss the striking parallels between it and Hayek’s 1976 vision.

Instead of issuing money built on fractional reserves of a universal base money (perhaps the latter would now be Bitcoin), each supplier of money issues a distinct currency. And if one looks at any of the crypo-exchanges, it’s very clear their values are not pegged to one another but are freely floating, just as Hayek predicted.

Curb Your Crypto-Enthusiasm

The world of cryptocurrencies seems to be much more Hayekian than akin to the canonical free-banking models, but does this mean Hayek himself would see this market as the way forward in money supply? I would say no — at least for the moment. Crypto right now is far too volatile. This could just be due to its being a young market, but Hayek’s insights would suggest the volatility is baked into the coins themselves.

Most cryptocurrencies, including Bitcoin, have a predetermined money supply growth built into their programming. This is what gives them a credible commitment against any unpredicted (and nefarious) inflation of supply. While ensuring supply against inflation is certainly a desirable feature of a medium of exchange, Hayek did not see it as sufficient. This is because what people primarily value in a medium of exchange is the ability to “minimise the effects of the unavoidable uncertainty about price movements.” Therefore, it is price stability that makes a money attractive. Far from implying a stable money supply, this would require a supply responsive to market forces: “the amount [of money] would have to be promptly adapted to any change of demand, whether increase or decrease.” In other words, the supply of money must show “considerable elasticity.” A currency is unlikely to see mass adoption with a predetermined rate of growth, but is more likely to gain acceptance by figuring out what quantity of money will keep the prices of goods and services as predictable as possible. Simply put, people want to hold money when they have an idea of what it will buy them at the store in a week, a month, or even years in the future, and this kind of certainty won’t likely come with a predetermined supply.

A Hayek Coin?

Cryptocurrencies are still quite new and seem to just be scratching the surface of their potential. If they are to succeed — not only as a fringe medium of exchange or speculative investment, but as real competitors with government currencies — some new programmers are going to have to come along and make currencies whose digital coins are created in a much different manner than the current ones. Perhaps digital coins whose supply is determined by demand will lower volatility enough to cut the future uncertainty of prices. Those may be adopted as true media of exchange. Until that time, Hayek’s vision of private currencies will not be quite realized.

This article was originally published on the blog of the American Institute For Economic Research.

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