Private currencies have always played an important role in the history of money. In the United States, for example, it was estimated that 8,000 different types of money were printed by private banks, railroad and construction companies, stores, restaurants, churches and individuals during the so called ‘Free Banking Era’ from 1837 to 1866, when almost anyone could issue paper money.
Only with the National Bank Act of 1863 the U.S. government decided to end the “wildcat bank” period and fiat money, the currency with an assigned value only because the public authority uses its power to enforce the value of a fiat currency, remained as the only allowed money. We may find other notable examples of competitive and crisis-prone systems in many other states: Scotland, Canada, Sweden, Switzerland, Chile, Australia, Colombia, China, France and Ireland. And yet, today, the money market is dominated exclusively by fiat currencies issued by central banks.
Why did this happen? According to Lawrence H. White “free banking often ended because the imposition of heavy legal restrictions or creation of a privileged central bank offered revenue advantages to politically influential interests. The legislature or the Treasury can tap a central bank for cheap credit, or (under a fiat standard) simply have the central bank pay the government’s bills by issuing new money.”
This is the reason why today we take for granted that the best monetary system is the one regulated by the public sector, with money issued by central banks.
In his highly regarded 1976 book “The Denationalization of Money,” Nobel Laureate Friedrich August von Hayek shared his thoughts about the role of money and challenged this belief. His main proposal was the establishment of competitively issued private moneys as a replacement for the central banks’ decisional monopoly power on money that existed then – and still exists today.
Two years later, the great philosopher and economist published a revised and enlarged version of the book entitled “Denationalization of Money: The Argument Refined,” where he proposed a monetary system where, rather than entertaining an unmanageable number of currencies, markets and citizens would converge on one or a limited number of monetary standards.
Hayek’s idea was, needless to say, a revolutionary one, as he maintained that private business should be given the opportunity to issue their own private currencies, which, thanks to competitive market forces, would compete for acceptance. In his view, free competition presumably would favor currencies with the greatest stability, since currency devaluation hurts creditors, while a revaluation hurts debtors. In the current fiat monetary system, people are not free to choose among different currencies but they are obliged to accept the money imposed by governments.
According to Hayek, stability emerges as a “spontaneous order” of the market, rather than through a political decision made by central bankers. According to Hayek’s view, since inflation is a bad, rather than a good – as many Keynesian economists maintain – the first goal a market-based monetary system has to achieve is stability of prices. Hayek believed that central bankers were not able to achieve this goal, as they are prone to artificially change interest rates, lowering them to such a low value that the private sector is incentivized to overinvest (or “malinvest,” according to how it defined it in his business cycle theory). This behavior is at the base of economic cycles and leads to the creation of financial bubbles.
In the monetary system advocated by Hayek, customer-citizens would choose the monies which they expected to offer a mutually acceptable intersection between depreciation and appreciation or to achieve price stability. Hayek maintained also that institutions may find through experimentation that a basket of commodities forms the ideal monetary base. Institutions would issue and regulate their currencies primarily through loan-making, and secondarily through currency buying and selling activities. It was assumed that the financial press would report daily information on whether institutions are managing their currencies within a previously-defined tolerance.
For many years, libertarians have proposed the use of gold as the way to achieve a stable monetary system (Gold Standard). And, of course, this is still one of the most supported ideas.
Nowadays, another revolution could make Hayek’s denationalization of money dream come true: digital currencies. While it is too early to predict the future of the blockchain technology, which represents the architecture of digital moneys such as bitcoin or litecoin and its effect on everyday life, one may reasonably believe that, all the speculation-related issues left aside – that certainly surround the current digital currencies market – these currencies may represent the future of a private, Hayek-style monetary system, where a basket of cryptocurrencies could be the new world monetary basis.
In fact, if we analyze the market of cryptocurrencies, we can easily observe the presence of many elements characterizing the Hayek monetary world. First, private issuing. Digital currencies are issued through a private, decentralized mechanism, based on the blockchain technology and computerized mining process, which is somehow comparable with the more famous and old-fashioned gold mining. The decentralized nature of bitcoin has been recognized by many prominent experts, such as the academic Mercatus Center, the U.S. Treasury and the IEEE Communications. Not surprisingly, digital currencies have often been assimilated to gold, and the monetary system they form as the “Digital Gold Standard.”
Of course, there is a huge difference between the most famous precious metal and a digital currency, as the first is a metal with specific features such as brilliance, durability, beauty and preservability over time, which of course a digital currency does not possess. Nevertheless, digital currencies have a common feature with gold, which makes them candidates for being the base of a monetary system: scarceness. In brief, bitcoin’s “monetary policy” is based on artificial scarcity due to the inception that there is a finite number of bitcoins in total.
According to the bitcoin’s mining process, numbers are being released roughly every ten minutes and the rate at which they are generated would drop by half every four years until all the coins are in circulation. According to the bitcoin creators, the most famous digital currency of the world will be issued in the limited quantity of 21 million. Not a single coin more.
Once this number is achieved, the current skyrocketing price should stabilize or change only according to the demand/supply law. Gold, as well, is limited in quantity, although nobody can quantify its precise amount. We only know that this quantity is finite. The bitcoin network is where peer-to-peer and transactions take place among users directly through the use of cryptography, without any intermediation. Transactions are then verified by the so-called “network nodes” and recorded in a public distributed ledger called blockchain. This of course is something that a gold standard system does not envisage, but the adoption of a public ledger makes transactions transparent and storable in the long run.
The ability of digital currencies to be used as a medium of exchange or payment, issued in finite quantities and in a decentralized way, could make them suitable for being the base of a modern market-based monetary system. Of course, they are not perfect monies, as one may always argue that they can be stolen by hackers from savers’ digital wallets, their limit may be raised by miners’ decisions and so on.
We are just at the very beginning of what could be not only a technological but also a monetary revolution. Only time will demonstrate if these new currencies will be adopted as the new world monetary standard or they will simply disappear as fast as they has been introduced. But the question is if the current monetary system, left in the hands of a very small group of bankers, does work. After having observed the disasters provoked by central bankers with their “ultra-expansionary” monetary policies (read, by printing fiat money as much as they could) we can be brave and answer that it does not and give these new instruments a chance.
Digital currencies could really pave the way to a non-inflationary economy. Unlike the traditional fiat money, digital currencies do not bear interest rates, so that the cost of money is simply zero in a digital monetary system, although paying a transaction fee could be an option, even though not a good one. The absence of interest rates means the absence of inflation, and vice-versa, as it has been empirically demonstrated that the correlation between the two dimensions is very strong and reducing to zero the former means reducing to zero the latter.
Notwithstanding its increasing reputation, there is still a great debate on the nature of digital currencies, and the question whether they are a real currency or a commodity or any other financial asset is still disputed. Nevertheless, according to the simple theory of money, these currencies possess three typical qualities a currency must have: ability of being a store of value, being a medium of exchange and being a unit of account. After all, according to the first lesson of a typical course in monetary theory “money is anything accepted as a medium of exchange.” And digital currencies are, as the increasing number of shops who accept them clearly demonstrates.
There is something more than currencies related to the blockchain revolution. A decentralized system of transactions, which bypasses the banking system and the intermediation process of money lending is arising. The blockchain technology is, in fact, able to make peer-to-peer transactions possible, without storing fiat money savings in commercial bank and without any need for expert bankers to decide to whom stored money will be lent. To be sure, saying that banks will no longer have any value with the advent of the digital currencies revolution is an exaggeration. Nevertheless, these institutions will be obliged to profoundly rethink their business model towards more decentralized goals. The most recent news report how many investment giants are already thinking of jumping into the digital currency business and some of them have already made it. It is not this evidence the clearest sign that the bitcoin revolution has already changed many historical paradigms in the financial world?