By Asker Voldsgaard
This article is a version of a talk given at Rethinking Finance in Oslo April 2018
In response to the dramatically escalating valuation of Bitcoin and other cryptocurrencies in late 2017, many wondered if the craze for crypto was a sign of popular distrust of the governmental fiat currency. Cryptocurrencies are electronical tokens recorded as a chain of transactions among the users – the so-called blockchain. The record is decentralized as it is distributed among the users, so everyone can see where the tokens are distributed and how they change hands in each block of transactions. It is ensured that users cannot use the same token twice by a system of decentral recordkeeping, where certain users (the miners) are rewarded for spending computer power solving cryptographic puzzles to verify the transactions. Thus, the users can have faith in the validity of the payments even without a central authority to trust. In a world of increasing political fragility and polarization, could the decentralized, trust-free cryptocurrency be a suitable replacement for money? And if so, could it happen naturally through individual decision-making?
The phenomenon of money is one of the most difficult topics to engage. However, to answer whether a cryptocurrency could replace current money, we must first have a shared understanding of what money is. If you study mainstream economics, you will be comforted by the imposed belief that money is neutral to real economic activity. You will be told that short-term variations in the quantity of money may affect economic activity, but that prices will eventually adjust to restore the equilibrium of the economy, which is determined by the supply of productive capacity available. Since money is taken as merely a neutral veil over the real economy, it seems pointless to spend too much time dwelling on what money is.
On the contrary, people who pay too much attention to money and its effects are often labelled as suffering from money illusion – a forceful social control mechanism. Therefore, in mainstream macroeconomics, one is usually taught a functionalistic definition of money: money is what money does – and that is serving as medium of exchange. In this view, anything can in principle be money if people choose to use it as medium of exchange. This is known as the metallist view of money. In the metallist belief, money originated in a money-less barter economy, where people swapped their products at the market. As this was very cumbersome, the market participants eventually decided to use a popular commodity as medium of exchange to reduce the transaction costs in the economy. This commodity would be used as measure of value to express the price of other commodities, e.g. 1 cow is worth 10 apples. Sooner or later, precious metals would tend to be the preferred medium of exchange due to its useful properties, such as its ability to maintain value over time and portability.
Until this point, money is strictly a market phenomenon, but at this stage central authorities can assist the market by first coining and later also storing the precious metals against debt certificates (IOUs) against the metal reserves. This would be done to further reduce transactions cost but it also introduced political risk, which is still feared by certain economic schools of thought. When gold convertibility was abandoned in wartime and permanently in 1971 with the Nixon-shock, and inconvertible fiat currency prevailed and functioned well, metallists had to change emphasis from the commodity-oriented theory of money to a more open, though circular reasoning; whatever serves as money is money. Persons are presumed to accept the central bank’s IOUs (such as a 100 dollar bill) because they expect others to do the same. Obviously a very fragile, mutual trust-reliant system. With this view of money, it is very possible that something else could be utilized as money if the trust in fiat currency was to evaporate. And why not cryptocurrency – a decentralized, cryptographic technology where trust is not required?
However, economics students are not told that they are learning the metallist theory of money, nor that there is a mutually exclusive alternative: chartalism.
The chartalist theory of money has a different starting point: money is primarily a unit of account. This is a socially determined measure of value, which primary purpose is to measure the value of debts. It requires a central authority to determine this standard of value in a given territorial area. The IOUs which are denominated in the determined money of account can potentially circulate between citizens as a means of payment, although this is not the initial role of money.
This interpretation finds support in historical, archeological and anthropological research, like Michael Hudson’s research of ancient Mesopotamia 2500 years BC where palace authorities imposed a unit of account and collected fees and rent measured in this unit. This is approx. 2000 years before the first coins were struck in Lydia, contemporary western Turkey. Furthermore, anthropologists have never encountered an actual barter economy. Thus, debts and the unit of account function seem to predate the medium of exchange-money.
This alternative view forces one to think radically differently about the dynamics of our current capitalist economies. As G.F. Knapp pointed out in 1905 in his book The State Theory of Money (only in German until 1924), it is absurd to think of money without the state at the center of attention. The state is the source of money, as it determines the money of account and creates the most sought-after IOU every time it spends. All non-state money-things used to settle payments, such as bank deposits, are debt certificates of somebody. These money-things are ultimately promises of payment in the IOUs of the state.
But why would anybody demand the IOUs of the state? Surely, a declaration of the IOUs being legal tender to settle debts will go some of the distance of ensuring demand, but this cannot guarantee that the citizens won’t switch to another country’s currency – or cryptocurrency for that matter. This is ensured by the imposition of taxes, fines and tariffs. When some (or all) citizens regularly have to pay the IOU of the state back to the state, there will be continual demand. This is why chartalists say taxes drive money.
The economic school of thought called Modern Money Theory, led by Randall Wray, Stephanie Kelton and Bill Mitchell, are currently championing this view and recommending less worry about public deficits in monetarily sovereign states. As the creator of the currency, the state can never run out it. The US central bank division in St. Louis put it this way in 2014: “As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent, i.e., unable to pay its bills. In this sense, the government is not dependent on credit markets to remain operational. Moreover, there will always be a market for U.S. government debt at home because the U.S. government has the only means of creating risk-free dollar-denominated assets”. Naturally, a government can run out of foreign currency and accordingly should avoid public debt in foreign currency. With debt only in its own currency, the consequence of too much public spending is inflation, not lack of ‘confidence’ by creditors.
So what are the prospects for cryptocurrencies to replace our current monetary systems? First, as cryptocurrencies are recorded tokens, released to the miners according to the properties of the underlying algorithm, they are not IOUs of anybody. It follows, that they are not financial assets, as nobody are liable to pay the holder anything nor to give debt relief according to the nominal value. Cryptocurrencies should therefore be regarded as real assets, like gold and tulips, rather than financial assets, like bonds and money. This means that the value ultimately depends on its (lacking) use-value and could realistically drop to zero if speculative activities turns sour. This potential price volatility is not a sound basis for a monetary system.
Secondly, fiat currencies (or promises thereof) will continue to be the primary kind of money demanded in economies as long as governments continue to impose and collect taxes in its own IOUs. As the monopolist of the means to settle tax liabilities, the government is in a unique position to influence economic activity within its borders. This is a crucial aspect of sovereignty, as the southern Europeans experienced in 2012 when doubts rose about the creditworthiness of their public bonds. Euro-governments are effectively indebted in a foreign currency. By imposing taxes in a cryptocurrency, governments would lose their economic sovereignty by no longer issuing the means of payment within the national borders. This has natural appeal to libertarians, who have supplied the technological enthusiasts of cryptocurrency with a suitable political ideology. However, if others prefer to have a government with the ability to stabilize employment and economic activity whenever the private sector loses faith in the economic prospects, this is not a policy to pursue. Instead, one should appreciate that governments use taxes to drive its own currency and use this sovereign power to pursue social and political goals.