Austrian Economics and Bitcoin: A Virtuous Cycle
by Dominik Stroukal — Economic Expert at SatoshiLabs and External contributor to Trezor Blog
I first met Slush, CEO of SatoshiLabs, at the University of Economics in Prague in 2013. We lectured — surprise! — about Bitcoin. His job was to explain it more technically, I did it more economically. It was clear why they had invited Slush. But me, a nobody in the Bitcoin world? I received the invitation because I loudly defended the ideas of the so-called Austrian School of Economics.
I was attracted to Bitcoin by another “Austrian”, Jeffrey Tucker. He used to be “biased against it,” as he later admitted, but once he tried a few transactions, he changed his mind, and a lot. Even another of the Austrians, Peter Schiff, who had been predicting the fall of Bitcoin to zero since 2013, eventually bought some satoshis.
The Austrians were initially skeptical that Bitcoin would work, let alone become money. But once they tried it, they were very quickly convinced, or at least recognized that there was something interesting to study. Or to invest in. Or simply to know more about in order to be able to criticize it.
“Money is not the root of all evil. Bad money is.”
Bitcoin and the Austrian economy are the ultimate power couple. The more people know about Bitcoin, the more they find out about the Austrians. The more people understand their arguments, the more they like Bitcoin. It is already a successful pairing and thanks to it we can be optimistic about the future, as well.
But what is the Austrian School of Economics about, and why did Bitcoin begin to attract (and repel) its supporters so early on?
Can we print money from thin air?
Money is not the root of all evil. Bad money is. This is just one of the many conclusions of the Austrian School of Economics and it is already clear why it is so aligned with Bitcoin. But where does one find good money? The two greatest proponents of this branch of economic thought — Ludwig von Mises and F. A. Hayek — explained in the first half of the 20th century that good money could not come from the thin air. Money is a good like any other, not too different from apples or pins, except that it is the most marketable good. In order for a good to become money, it must stem from something that is marketable. Something that people value in ways other than monetary value. In the words of another great Austrian economist, Murray Rothbard: “Even coercion could not force people and institutions to accept meaningless tickets that they had not heard of or that bore no relation to any other pre-existing money. Money arises on the free market, as individuals on the market try to facilitate the vital process of exchange.”
Even the dollar used to be gold. The word “dollar” has interesting origins in the Czech Republic. In the 16th century, silver coins known as Joachimsthaler, abbreviated to thalers, were minted here in a town called (in German) Joachimsthal. This term travelled around the world until it became twisted into dollars (as well as tolar, taler, tallero, talar, dare, dalur…). The “dol” in “dollar” is from “thal” in German which means “a mine”. How far have we come since? Shall we go back to the “mines”? To “thal”? Isn’t it wonderful that Bitcoin is “mined”?
It is no surprise that Austrians are usually fans of the gold or other commodity standards. They see the abandonment of the role of gold in the financial world as a fundamental problem. Today’s money, without intrinsic value — fiat money, tends to be inflated. People would not voluntarily use fiat money. After all, history shows that they preferred commodities or at least a commodity standard.
Value is subjective
So, it makes sense that a lot of Austrians (including myself) were skeptical of Bitcoin until about 2013. Bitcoin is fiat. It does not contain gold or any other precious metal. It is not redeemable for anything. After all, it should not be possible to create good money from thin air. If anyone could do that, what would it look like? Who would want to use something like that as money?
But our thoughts were locked in the old world. In the physical world, Bitcoin is really difficult to imagine. Money must be controlled by some central authority, which we must trust not to cause inflation. Bitcoin was from a completely different world. It elegantly solved both problems that bother us with fiat money — it has no central authority and its supply is clearly limited and known in advance.
It suddenly became clear that what bothered us about fiat money was not its origin. After all, if Pablo Picasso’s original paintings were used as money, they would probably be awkward to spend, but would they be fiat? Probably not, as they would have “intrinsic value” — they’re beautiful. Plus, they’re scarce.
Is Bitcoin beautiful? The entire Austrian School of Economics is based on the method of its founder, Carl Menger, who developed a subjective theory of value in the second half of the 19th century. We have no idea why someone exchanges $5 for bread, but we know that bread is, for them, subjectively worth more than five dollars (and vice versa for the baker). Both sides are better off. Bread has no objective value, the value is subjective. Why does anyone like Pablo Picasso’s paintings? Why did someone like Bitcoin enough to be willing to pay for two pizzas to play with them? Nobody knows and it doesn’t matter. Bitcoin can easily be money, and “intrinsic value” is nonsense. Scarcity is important, and it’s very difficult to find anything scarcer than Bitcoin.
It all fits together!
Austrian economists, especially Mises and Hayek, linked bad money to other great findings in their field. Just consider these contributions:
The economy needs to be planned, but not centrally. Resources must move in the economy, and it can be done from top-down or bottom-up. A century ago, in 1920, Mises convincingly showed that socialism and a centrally-planned economy could not rationally allocate resources, because without private ownership there is no market for the means of production, i.e. the market for capital goods, without which prices to indicate what to make and how to produce it are unknown. Thus, central planners must guess, copy from the capitalist past or from neighboring states. Hayek went one step further and showed that the price mechanism is an infinitely complicated network of local knowledge of each of us that central planners are never able to gather, understand and embrace. Each of us is planning our little bit and we coordinate our activities through prices without usually even knowing about it.
Inflation (whether visible or hidden) has a problem (in addition to a lot of other costs), in that it obscures these price signals. It is practically impossible for entrepreneurs to find out whether the demand for his product is growing naturally or because of additional money supply. Should I just increase the price? Or should I produce more?
Trying to plan money centrally leads to problems. One of them is the disruption of the natural value of money in time. People have different time preferences. If you dance the night away, max out your credit cards, heavily eat and drink, and you don’t care what happens to you in a month’s time, then you have very high time preferences. But if you save a lot, do sports, do everything with the vision of leaving as much as possible for your grandchildren, then you have low time preferences. In society, people with low time preferences naturally save, while those with high time preferences borrow from them (usually through banks).
Boom!
The biggest conclusion of the Austrian School of Economics is that all this leads to the business cycle. F. A. Hayek received the 1974 Nobel Prize in Economics for this. Naturally, an interest rate would form in the economy, which would equilibrate low and high time preferences — the natural rate of interest. But today, if you want to borrow money, they don’t come from someone else’s savings, they come from nothing: the bank creates them from thin air.
If you wanted mortgages and business loans and had to find someone who saved money and is willing to lend it to you for 20 years, the interest would certainly be much higher than what the bank will give you now. How much would you want in return to lend money to someone like you? 10%? 15%? The bank can afford to do it for 2% because it “prints” money.
Naturally low interest rates motivate entrepreneurs to pursue long-term projects (at high interest rates, you will not want to borrow for something on which you expect to break even in 20 years), but having lower interest rates means that we need to have lower time preferences. When more people save, it pushes interest rates down. Entrepreneurs then, for example, build new housing projects, for which we have saved. It’s a miracle. They build what we want, or will want. On the contrary, if we do not save anything, interest rates will be high and there will be no long-term projects. At most, someone will borrow to build a fast food stall in front of a club. So the question is — do we want to live for today or for the future? Either way, time preferences through interest will take care of that.
Today, interest rates are artificially lower due to the creation of money from thin air. They are lower without lower time preferences. The result of this disequilibrium is a disaster. On the one hand, artificially low interest rates motivate us all to save less and spend more money now (who would save for 0% return?) but, on the other hand, they send a signal to entrepreneurs that they should build long-term projects. Sooner or later, new money will start to push up prices and central banks will have a choice — to either let the market be damaged by inflation or to raise interest rates, which will stop growth and cause the economy to collapse. Doesn’t this feel familiar? How close is it to the story of the 2008 financial crisis? For the Austrians, the crisis was not random noise, but the bursting of a long-inflated artificial bubble. It is the bubble we should study!
Bitcoin is Austrian
According to many Austrians, good money, such as Bitcoin, solves a lot of the above problems. Good money makes it possible to reveal real prices, prevent inflation and the costs associated with it, reconcile time preferences and smooth the business cycle. Isn’t that great?
To make it even better, Austrians have long talked about how perverse the political market and the public sector are. At the end of the war, Hayek explained why the worst kinds of people rose to the (political) top, and a year before him Mises had perfectly analyzed Bureaucracy in a book of the same name. Bitcoin takes power from politicians and bureaucrats. The worst can still easily reach the top, but they have nothing to destroy there. Bureaucrats may continue to be ineffective figures maximizing their own well-being, but the monetary policy of Bitcoin is not affected.
In short, Bitcoin and the Austrian school of economics understand each other. Bitcoin is Austrian. Thanks to Bitcoin, more people than at any point in the history of the world have thought about what money is. Young people went online, older people went to libraries and looked for information on how central banks work, how money is created. And they often came across an Austrian school that does not see the existence of fiat money and central banks as unchangeable, but as an experiment that still needs to be approached critically. Bitcoin was able to educate more people on economics than any book.
But the relationship is mutual. Thanks to the Austrian school and the conclusions of its analysis, many people who understand their teachings are naturally looking for an alternative to current forms of money. Some go back to gold, others see a better alternative in cryptocurrencies. It is a virtuous cycle that hopefully leads us to a better future.
