What Frederick Hayek would have said about Cryptocurrencies

Many politicians pay lip service to Frederick Hayek's ideas about the free market, but in practice they are loathe to give up central control. Their version of a free market is one that is free only up to a point – they can't resist managing it, often for the benefit of the oligarchs who finance their political campaigns. This article explores what Frederick Hayek would have thought about the financial crash of 2008 and about the new cryptocurrency movement that started in 2009.

Some background on Hayek

Hayek was born in Vienna in 1899. After the first world war, Hayek saw Austria and it's nearest neighbour experiencing hyperinflation, crippling debt and soaring unemployment. It was all caused, he believed, by the government abusing the supply of money.

The first world war had left what remained of the Austro-Hungarian empire in huge debt. But because they'd lost most of their empire, they had low tax revenues. So the government simply printed the money they needed, which was used to purchase bonds, which financed the government. They printed so much that inflation hit 10,000%.

Hayek wasn't just interested in what was happening in Austria. He'd become employed by the Institute of Business Cycle Research in Vienna, and was engaged in trying to examine all of the world's economies for lessons. And in early 1929, he issued a prediction – he felt that the stock boom in the United States was unsustainable and that there would be a crash.

This was the culmination of a new thesis he was developing – that the seeds of an economic bust were sown in the boom. Then in October 1929, Wall Street crashed, validating Hayek's new theory of the economy.

But what were these seeds that Hayek thought had been sown? In 1913 the United States had set up the Federal Reserve Bank to regulate and manage the supply of money. Hayek believed that the Fed had set the interest rate too low, and if the Fed hadn't existed and the market was setting rates, the boom wouldn't have happened, and therefore neither would the bust. Worse, the Fed had increased the supply of money by actively buying up government bonds.

In 1931 the London School of Economics invited Hayek to give a series of lectures in London. Hayek was thrilled, he had deep admiration for the LSE. The LSE had an agenda in inviting Hayek – they wanted to oppose the ideas coming out of Cambridge University from John Maynard Keynes.

Hayek and Keynes didn't really disagree about the cause of the crash – they both believed that it was down to low interest rates (Keynes thought it was down to loose fiscal policy as well – economic speak for governments spending too much in the boom). The issue was how to deal with the bust now that it had happened.

Keynes thought that the government should intervene to restore the “animal spirits” needed for an economy to function. He believed that people's psychology affected the economy as much as interest rates. In his view, “confidence” was everything – when people were fearful they made bad economic decisions that prolonged the bust and it was up to the government to restore hope so they could function without fear again. Hayek thought the government should step aside and let the markets correct the mess. For him price was everything and if the market was left to set it's own prices (which entailed weak businesses going to the wall), normality would be restored.

Hayek was in Britain on another lecture tour when the Germans invaded Austria. The Nazis represented everything this fastidious Austrian of aristocratic origins loathed, so he stayed on, becoming a British citizen in 1938.

The 2008 Financial Crash

The 2008 financial crash vindicated yet again Hayek's theory about what causes crashes in the first place. Interest rates were held too low by the Greenspan Fed and an unsustainable asset boom took place, which inevitably imploded.

Initially it looked like the Bush administration would follow Hayek's remedies – they declined to bail out Lehman Brothers, and allowed it to go bust. But this caused a meltdown in the rest of the banking system. The question is why. If Hayek's theories were correct, the elimination of Lehmans should have created space for the other financial businesses to function better. But it didn't – perhaps because the players manipulated the system to ensure that a doomsday scenario emerged, so that governments had to stuff their mouths with gold to stop it. So billions and billions were poured into the banking system and some called it Keynesianism.

The irony is that Keynes would have not bailed out the banks either – he had no time for cartels. His idea of stimulus would have been to bail out the citizen instead – to send them the bailout billions in small amounts so they could spend it on real businesses in the real economy, which would generate growth and tax revenue, which in turn would reduce the debt. But instead the burden on the citizen was increased with extra taxes levied on them to pay for the bank bailouts – something which both Keynes and Hayek would have opposed.

So what we have in the aftermath of the 2008 crash is not the triumph of Keynes over Hayek, but the triumph of the oligarchs of the banking industry over both Keynes and Hayek. Neither economist had anything to say about how to deal with cartels and oligarchs because they thought that good government would have prevented them forming in the first place.

The Cryptocurrency Revolution

Hayek's most revolutionary idea was that there should be no central currency in a nation. Rather that individuals and companies should all issue their own and they should be allowed to compete so the market decided which was best.

Cryptocurrencies go one further – there is not only more than one type of cryptocurrency, but the cornerstone of Cryptocurrencies is their decentralised nature. This means that no individual or company controls them. Even Hayek never imagined that!

There is no central ledger, it's dispersed. A mature cryptocurrency is held so widely that no-one controls it. Therefore no cartels or oligarchs can manipulate it to force governments to bail them out in the event of a crash (they way they would if one oligarch-issued currency gained market dominance in a Hayekian world). And because of it's decentralised nature, no government agency like the Fed can manipulate it in normal economic times to stimulate a boom.

And because the supply of Cryptocurrencies is controlled (for example only 21 million Bitcoins will ever get mined), they solve the problem that Hayek had identified – of the seeds of the bust being laid in boom time by loose monetary policy. They also solve the oligarch problem that emerged after the 2008 crash – because it's impossible for oligarchs to gain control of mature cryptocurrencies, they have no leverage to persuade governments to throw money at them.

The question remaining is whether cryptocurrencies solve the problem that Keynes had identified – that of “animal spirits”. His insight is true – humans are more emotional than rational, they make mistakes because their emotions overwhelm their rational side, and sometimes because they are not all of equal intelligence nor possesed with equal quality of information on which to base their decisions. As a result mass psychology does have an impact on economies.

I would argue that yes it does. By so clearly making it impossible for oligarchs to gain control over them, and by holding their value, cryptocurrencies give “confidence” and even “animal spirits” to those who hold them.

As a result cryptocurrencies may yet be the resolution to the old arguments about how to have sound money, how to prevent busts and how to deal with negative impact of mass psychology on economies. Unfortunately only a small part of the population holds cryptocurrencies. The rest are living in fiat world, and as the Fed pumps money into the system and the oligarchs funnel it into assets, the seeds of another crash are being laid. It's come to the point where the Dow Jones drops when good information is released about the economy - because if ordinary people are finding jobs and small businesses are growing, the Fed may not need to print money any more, and the party is over for the speculators. Will the oligarchs in the financial markets engineer another crisis that requires their mouths to be stuffed with gold again, at the expense of the real economy? And will the switch to cryptocurrencies defeat them?

Related articles: Bitcoin and the BigMac Index Differences between different types of Cryptocurrencies


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