Cryptocurrency speculators claim that bitcoin and its peers will mean the end of state-controlled money. That’s economically and politically impossible, says Edward Chancellor.
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Cryptocurrency speculators claim that bitcoin and its peers will mean the end of state-controlled money. That's economically and politically impossible, says Edward Chancellor.
It's easy enough to identify bitcoin and the other cryptocurrencies as being caught up in a speculative mania. A more difficult question is whether "cryptos" have any future as money. In a world where the stability of conventional monies is threatened by the vast expansion of central-bank balance sheets, high government indebtedness and ultra-low interest rates, it would be nice to think this was the case. Yet bitcoin and its peers aren't money.
It's true that bitcoin possesses many of the characteristics of money: it can be divided, stored and transferred, and its supply is limited. Money is just a "social technology", which has been through many previous incarnations among the exotic varieties of cash listed in Paul Einzig's Primitive Money are gin, jam, mulberry cakes, rat traps (in the Congo), and woodpecker scalps. Most of our current money is already held in digital form as electronic book entries at the bank. At first glance, bitcoin and its distributed ledger appears to be simply an advance on our current money technology.
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But bitcoin's fervid exponents have greater hopes. They claim that cryptocurrencies hail the end of state-controlled money. Their vision is borrowed from the Austrian economist Friedrich Hayek who envisaged the denationalisation of money bringing about an end to both inflation and deflation, curing unemployment, and resulting in the abolition of easy-money-peddling central banks, thereby limiting the reach of governments. What's not to like?
The trouble is that bitcoin enthusiasts confuse the characteristics of money with its nature. This is a thorny subject. Mainstream economics has little to say on what money is, assuming it is a contrivance to do away with the bother of barter. In the era when bank notes were redeemable in gold, most people believed that money had the intrinsic value of the precious metal. But as John Law (pictured)pointed out in the 18th century, "money is not the value for which goods are exchanged but the value by which they are exchanged". Gold derived much of its value from its use as money rather than the other way around.
Where then does money get its value? Money has long been defined as a unit of account authorised by the government for payments. Governments have maintained control over the unit of account as a key aspect of sovereignty. The law prescribes this official money as legal tender for the repayment of debt.
Law had another insight: credit when it circulates acts as money. In the 18th century, much of the money in England comprised bills of exchange issued by merchants against future receipts. At the same time, English bankers were learning to create money through the act of making loans. This bank money was backed by claims of real economic value. As Felix Martin writes in Money: The Unauthorised Biography, "currency is ephemeral and cosmetic: it is the underlying mechanism of credit accounts and clearing that is the essence of money".
The economic system we call capitalism consists of a vast network of credit relations. Credit money is its key feature. Hayek, of course, realised this. His proposals to strip the government of its money monopoly envisaged the replacement of a dominant central bank with competing private money-issuing banks. Competition between the currency banks would thus produce a sounder currency, but Hayek's money would still be of the credit variety.
Underestimating governments' iron grip
Bitcoin and other cryptocurrencies purport to be non-credit currencies that is, monetary "assets" without corresponding liabilities. Yet because cryptocurrencies lack a mechanism for creating credit, they are not well suited to the capitalist economy. Imagine what would happen if bitcoin were accepted as the monetary unit of account. The result would be a scarcity of the digital currency followed by a severe economic contraction and stagnation without end.
This is not going to happen not just because it makes no sense, but also because governments are never going to relinquish their monopoly over money. However desirable in theory it might be, Hayek's proposal to denationalise money was a pipe-dream. As he himself wrote, "everybody knows that if such a private experiment promised to succeed, governments would at once step in to prevent it". Everybody, it seems, but the crypto speculators.
A version of this article was first published on Breakingviews. Edward Chancellor is a financial historian, journalist and investment strategist.
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Edward specialises in business and finance and he regularly contributes to the MoneyWeek regarding the global economy during the pre, during and post-pandemic, plus he reports on the global stock market on occasion.
Edward has written for many reputable publications such as The New York Times, Financial Times, The Wall Street Journal, Yahoo, The Spectator and he is currently a columnist for Reuters Breakingviews. He is also a financial historian and investment strategist with a first-class honours degree from Trinity College, Cambridge.
Edward received a George Polk Award in 2008 for financial reporting for his article “Ponzi Nation” in Institutional Investor magazine. He is also a book writer, his latest book being The Price of Time, which was longlisted for the FT 2022 Business Book of the Year.
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