Is Digital Currency Viable?
Distinguishing innovation from chicanery is not always easy, particularly when a market is developing much faster than the average consumer will gather information about it. The market for digital currencies is one of those markets. Publicized failures of new gold-based currencies make it more difficult for others who have viable plans for new systems of exchange. It is appropriate, therefore, to first examine the rationale behind money before we invest heavily in plans to create new currencies.
Money is made valuable not so much because of its substance as because of its acceptability. If I accept a dollar in exchange for my goods or services, it is because I believe I can turn around and give that dollar to any merchant for other goods and services. We all recognize this, implicitly. But the acceptability of dollars did not appear overnight. And no one wants to be the fool who takes a dollar in a society where dollars are not yet used as money. So if no one would accept a dollar without the knowledge that there are already many merchants who want dollars, why would the first dollar be accepted by anyone?
One of the twentieth century’s greatest economists, Ludwig von Mises, developed the theory of money regression to explain this conundrum. A person accepts dollars today, Mises explained, because they were accepted by other people yesterday. Those people accepted dollars yesterday because they were accepted the day before. But the regression is not pushed back infinitely. There is an ultimate explanation for the value of dollars.
The explanation rests in the original nonmonetary use of the good that has become our money. Gold, for example, was used for ornamentation or utensils before it became widely used as a medium of exchange. Its wide use meant that people could be reasonably assured that they could easily find a buyer, and the buyer could easily discern the quality of the goods. As barter transactions involving gold became more common, a separate but important value became attached to gold as a medium of exchange. Even if those who had no desire for the ornamentation or industrial properties of gold would accept it in exchange because it could easily be stored and used later to buy something they wanted. As Mises wrote,
If we trace the purchasing power of money back step by step, we finally arrive at the point at which the service of the good concerned as a medium of exchange begins. At this point yesterday’s exchange value is exclusively determined by the nonmonetary—industrial—demand which is displayed only by those who want to use this good for other employments than that of a medium of exchange.1
One of the consequences of the regression theorem is that money must arise from a commodity already in general use. If there is no nonmonetary use for the good, it will not develop the widespread demand that must precede its use as a medium of exchange. As Mises’s student Murray Rothbard wrote, money "cannot be created out of thin air by any sudden ‘social compact’ or edict of government.2 But once a good develops a monetary nature, it is there to stay. The nonmonetary uses are no longer necessary to maintain the good’s monetary value, because there is already a set of prices based on that good.
Advocates of a return to gold-based money would probably agree with much of what Mises, Rothbard, and others in the Austrian School of economics have to say. Yet the regression theorem’s significance is often forgotten in the rush to go out and start new currencies that eschew the government’s inflation-prone dollars. F.A. Hayek, a Nobel Prize-winning economist who would have agreed with Mises on many points, nevertheless failed to grasp the importance of the historical origin of money. Hayek’s "denationalization of money" scheme would dismantle legal tender laws and allow anyone who wished to issue his own currency, backed by anything (or nothing). Competition in money, Hayek believed, would result in the market’s choice of sound (perhaps gold-backed) currencies. Dollars and other fiat money would fall by the wayside.
The problem with this plan is not that it allows competition with government-provided money. Hayek and others should certainly have the freedom to issue currency of any kind. The problem is, as Rothbard pointed out, that Hayek’s new currency tickets are divorced from the necessary history of nonmonetary uses and will therefore not be accepted. "New names on tickets," Rothbard wrote, "cannot hope to compete with dollars or pounds which originated as units of weight of gold or silver and have now been used for centuries on the market as the currency unit, the medium of exchange, and the instrument of monetary calculation and reckoning."3 Even a bad government currency will have an advantage against an unfamiliar 100 percent-reserve ticket. Why else would German citizens continue using the mark in 1923 during rampant hyperinflation instead of developing alternative currencies?
Some digital currency proponents are advocating variations on Hayek’s plan. If the digital currency plan requires people to trade and quote prices in terms of something other than the widely used dollar, yen, mark, euro, or other established currency, Mises’s regression theorem would imply that the plan is doomed. Well before e-money became possible, Rothbard addressed this problem:
Even the variant on Hayek whereby private citizens or firms issue gold coins denominated in grams or ounces would not work, and this is true even though the dollar and other fiat currencies originated centuries ago as names of units of weight of gold or silver. Americans have been used to using and reckoning in "dollars" for two centuries, and they will cling to the dollar for the foreseeable future. They will simply not shift away from the dollar to the gold ounce or gram as a currency unit.4
What will work is a plan that simply facilitates the exchange of already-recognized currencies. This would include, for example, an Internet bank that provides customers an option of denominating their accounts in a variety of currencies or assets and then guarantees an instantaneous exchange into one of these currencies at any time when an Internet (or non-Internet, for that matter) transaction is desired. Debit- and credit-card based systems have provided international travelers with worldwide purchasing power for decades. Now Web-based firms are poised to provide that service, with increased security, for the ballooning world of Internet commerce. Mises’s regression theorem sets a critical limit on how that service can be provided.
Ultimately, a workable denationalization of money would link the dollar to some market commodity. The supply of dollars need not be controlled by the government or printed by the U.S. Mint. It would be enough to define the dollar at, say, 1/20 an ounce of gold, and let the market handle the printing and issuance of dollars. As was once the case in the United States, banks could print bank notes denominated in dollars and backed by the requisite amount of gold. Until that day, Mises, Rothbard, and others would suggest that nationally controlled currencies are our only viable option.