The Market Beats Monopoly Money

Why Austrian economists favour the privatisation of the monetary system to a government monopoly on money. By Thorsten Polleit

The Austrian School of Economics advocates for a re-organisation of the monetary system according to market principles. Austrian economists conclude from their ethical and scientific insights that a state-run monetary system should be replaced by free market money. What are the reasons for this conclusion, that completely contradicts mainstream economics?

From the point of view of Austrian Economics, there is no economical, legal and moral legitimation for a state authority over money production. They also show that such an arrangement disrupts the system of free markets. A state money monopoly not only contradicts the productive competition of currencies, but it allows the creation of money by banks out of thin air, each time they grant a loan.

Knut Wicksell

The money supply increases as a result of political decisions without real savings being available for additional investments. Money production by credit lowers the interest rate beneath what Knut Wicksell (1851 – 1926) called the “natural interest rate”. This rate would prevail if the money supply was not artificially expanded through lending. The artificially low interest rate creates a fake boom. Monetary expansion out of thin air leads to a national economy living beyond its limits: consumption rises at the expense of saving, while investments increase.

Furthermore, the interest rate reduction distorts the economical production structure. “Detour production”, as Eugen von Böhm-Bawerk (1851 – 1914) called it, increases and production routes become longer timewise. The economic success of such a system is fully dependent on low interest rates, and that requires a further expansion of the credit- and money supply. If this does not happen and the interest rate rises to its natural level, investments and jobs created by the low interest rate become unsustainable.

Eugen Böhm von Bawerk on the Austrian 100 Schilling banknote

A bust is imminent. Facing this, politicians offer “measures to fight” the crisis. The central bank lowers interest rates even more to avert a production decline and creates more credit and money. The fresh injection of money can temporarily convert the downturn into another fake boom. However, this boom will collapse sooner or later for the same reasons as its predecessor.

The resulting Boom and Bust Cycles, as Ludwig von Mises (1881 – 1974) called them, allow debtors to pay their creditors at low interest rates for loans that financed unsustainable investments; additionally the cycles encourage more credit-backed spending. Therefore, malinvestments are not liquidated. Debt keeps growing through these cycles faster than real incomes, so that a policy of fighting Boom and Bust Cycles by ever more credit leads to ever lower interest rates and the national economy descends into excessive debt.

The state-run money system – also known as the fiat money system (from Latin “Let it be done”) – expands government activities at the expense of private businesses. Politicians blame the crisis they caused themselves on the free market and carry on with their interventionist policies of regulations, price controls etc. Politically induced money expansion allows the state to grow its spending activities far beyond its regular tax revenue.

From an Austrian point of view, both aspects undermine the foundations of a free market. But most importantly, ever-growing debt exceeding the income creates a burden which societies try to shed through costly hyperinflation, as in such a dire situation inflation arises as the “lesser evil”.

Ludwig v. Mises

Austrian economists have developed solutions to avoid such a development and to bring the money system back to a sound economical foundation. Ludwig von Mises suggested to stop the expansion of the US dollar money supply, relieve the gold market from any government intervention, and make the US dollar exchangeable based on the gold market price.

Mises’ student Murray N. Rothbard (1926 – 1995) argued similarly. He suggested pegging the US-Dollar to the US central bank’s gold reserves with a 100% gold exchange standard. This was meant to lay the foundation for a privatisation of money production, as suggested by Friedrich August von Hayek (1899 – 1992).

Murray Rothbard

Compared to the spread and influence of mainstream economics, such as Neoclassics, Keynesianism and Monetarism in academics and politics, the Austrian school remains marginalised. The state funded economic science institutes are a hostile climate for Austrian Economics with its appeal for free markets and its warning against the ever increasing state activity. This means: “Austrians” have limited career opportunities.

However, this does not invalidate in any way the Austrian scientific program, its prognostic quality or its substantial consistency. On the contrary: Many Austrians warned early on against the economic crises of both 1929 and 2008 because their theory – unlike mainstream economics – provides a coherent explanation for the roots of a crisis.

Friedrich August v. Hayek

Friedrich August von Hayek knew nothing of the Internet, cryptography or open source software when he demanded a privatisation of money in his 1976 book The De-Nationalisation of Money. Bitcoin seems to meet most requirements set by Austrians regarding good money. While many open source fans discover the teachings of the Austrian School of Economics, Austrian economists watch this new digital market money with critical interest and goodwill.

Thorsten Polleit is an economist at the gold trading company Degussa and the author of many articles and books on Austrian Economics.