The cryptocurrency craze is fascinating to an economist, or at least a student of catallactics, because it is a test of the theory of exchange ratios and prices, which is what catallactics is about.
For this reason, the outcome of the cryptocurrency craze is of great theoretical interest. It is also of interest to students of the psychology of speculation.
Supporters of cryptocurrencies claim they are money. If they are unable to substantiate this claim, then we must conclude that cryptocurrencies are only a medium for speculation, drawing on increasing numbers of the public to maintain their value. For this reason, their validity as money is fundamental to their future. Supporters of cryptocurrencies are certainly very sensitive to accusations that they are not money, presumably for this reason.
Mere opinions do not matter. A critical, detached analysis is needed. The purpose of this article is to test the proposition, that cryptocurrencies are money, from a sound theoretical perspective.
The basis of money
Before cryptocurrencies, there was government money, and before that metallic money, which was gold and silver. Government money evolved out of metallic money, drawing upon it for its credibility, before abandoning all pretence at convertibility when the US Treasury finally abandoned the dollar peg in 1971. The difference between the two is gold and silver are chosen by people exchanging goods in free markets, while government money is imposed on people by their governments.
Catallactics, as a theoretical discipline, investigates the exchange of goods in a free society, and is the basis of classical economics from Cantillon, Hume, Ricardo, Jevons/Menger through to the Austrian school. Government money does not stand up to catallactic examination, because its issuance always subverts free markets by interposing influence from the state into transactions between ordinary people.
The modern justification for government money has its origins in the German historical school of economists, when Georg Knapp declared, on what appeared to be little more than a point of principal derived from the supremacy of the not-long formed federal German state, that the state has the sole right to issue its citizen’s currency.
Knapp’s one book was titled The State Theory of Money, published in 1905. In it, he argued that state money may be recognised by the fact that it is accepted in payment by the state. Money exists according to state regulation and creditors must accept it without being legally entitled to other forms of money in exchange for it.
In his preface to the first edition, Knapp made it clear that he regarded money as a matter for political science. In other words, its existence, in accordance with the tenets of the German historical school, was a matter for the executive setting the law instead of free markets. The first sentence of Chapter One leaves us in no doubt on this matter: “Money is a creature of lawâ€.
The law is horribly deficient. It does not even recognise that the purchasing power of money can change. The law does not compensate those robbed by currency debasement. The law makes no distinction between fiat money and credit money. The law will tax you if you benefit from the wisdom of holding catallactic money instead of state money. The law denies the logic of catallactics entirely, and rules only on state money, irrespective of whether it is backed or convertible into gold. It does not recognise the money chosen by free markets. The law is not equipped to decide on monetary matters.
Therefore, by no stretch of the imagination was Knapp’s treatment of money catallactic. Money issued by the state cannot last beyond the ability of a government to impose it on its people. Knapp died in 1926, three years after his own government’s money had collapsed both predictably and dramatically, disproving his state theory of money.
Today’s state-issued currencies are no different in concept from the currencies that collapsed in the wake of the First World War. With no convertibility into gold or silver, they depend for their purchasing power and validity as money on no more than the rule of law and public faith in the state. Since the Bretton Woods Agreement began to collapse, the dollar lost over 97% of its value measured in gold. These are relative purchasing powers set in the markets between sound money, still accepted as such by most of the world’s population (even though it is not usually used for day to day purchases), and the reserve state-issued currency.
Supporters of cryptocurrencies appear to be more aware than most of the weaknesses of state currencies, particularly when the issuing central banks have stated that their objective is to continually reduce their purchasing power every year as a matter of policy. The collapse in purchasing power seen so far has destroyed nearly all the value of money-based savings such as bank deposits and bonds, a government policy set to continue. Furthermore, there may be an understanding among some cryptocurrency enthusiasts that credit money, issued by the commercial banks, undermines the purchasing power of state money as much, if not more, than the issue of money by central banks.
