Remarks to the Australian Digital Currency Commerce Association G20 Event (Brisbane)

It is a great pleasure to have been invited to the Australian Digital Currency Commerce Association G20 event. I want to thank you for inviting me here and also acknowledge Senator Sam Dastyari, the Chair of the Senate References Economics Committee, which I am sure you are all aware is currently conducting an inquiry into digital currency. I am also a member of that committee and will take a keen interest in this inquiry.

The beautiful building we are meeting in tonight is owned by the University of Queensland, and I completed an honours degree in economics at UQ. My honours thesis was about the potential ability of privately issued currencies to reach a stable level.

Without wanting to risk the scorn of the assembled audience here tonight, I concluded that that potential was weak. But my study was narrow. I only looked at fiat based currencies; that is, a currency not backed by any other asset, and it was well before anyone had heard of bitcoins.

The principle reason I was sceptical of fiat based private currencies is that the cost of issuing a bit of paper is essentially zero. The basic incentives then for anyone issuing currency are time inconsistent. I can make massive profits by overprinting today and that will probably compensate me for the loss of reputation tomorrow.

In effect, there is no more reason to believe that a bank would be any more disciplined than Zimbabwean President Robert Mugabe. In fairness though, it is not clear why governments are not all more like Mugabe’s when it comes to money printing — they all have an incentive to over issue to help pay off their debts and to increase their tax base.

That is what caused Fredrich Hayek in the 1970s to propose competition in currency issuance as a solution to inflation. It was reading his work that originally gave me the idea for my thesis. As Hayek bluntly put it:

With the exception only of the 200-year period of the gold standard, practically all governments of history have used their exclusive power to issue money in order to defraud and plunder the people.

The problem for Hayek, however, is that the experience of privately issued currencies, albeit more limited, is not much better.

America before the civil war had many bank-issued currencies in circulation. The issuing of these currencies boomed after the Andrew Jackson government abolished the Second Bank of the United States. In vetoing the re-confirmation of the bank, Jackson labelled the bank a monopoly.

Nonetheless, ante-bellum private currency issuance led to a wildcat industry of money issuers, particularly in the south of America. Indeed, the lack of financial stability in the south may have played some role in their ultimate defeat.

The record in Scotland before the Bank of England paints a rosier picture but pointedly even Adam Smith at the time backed the right of the sovereign to be the sole issuer of currency.

It has always struck me that libertarian economists who believe in freedom and liberty in all spheres usually defend to the death the right of the state to prevent anyone issuing their own currency. Milton Freidman, perhaps the greatest 20th century monetary economist, was a case in point, when he rejected the arguments put by Hayek for currency competition.

Milton Friedman largely believed that competing currencies would not work because the failure of one currency would have large impacts on others because the costs of switching from one currency to another are too high. Markets for bread work because if you don’t like your current baker it costs little to buy your bread elsewhere tomorrow morning. It’s not then the benevolence of the baker that will ensure good quality bread but his selfish interest to keep your custom.

Things are not so easy with money. Once you are paid in certain types of currency, and buy things with certain types of currency, it is hard to change.

As was the case in my honours thesis, I have generally come down on Milton’s side. Some have pointed to the experience of Somalia after it became effectively a nation without a government, and a central bank, after 1991. Local tribesman began issuing their own currencies although most of these were simply forgeries of the hitherto national shilling.

The inability of the locally issued currencies to develop their own brand stopped them having any incentive to be disciplined in the issuing of their currency, and rampant inflation ensued — although not of a Zimbabwean scale.

However, it would be fascinating to hear what Milton Friedman thought of bitcoins today, because digital currencies do change things.  The specific model of bitcoins is attractive, with its disaggregated rules around creation and exchange, no one company is in control, and therefore no one is there to profit from simply letting the virtual printing presses rip.

That to me is not the real potential of digital currencies. Digital currencies provide the potential to get around the problem of switching costs. Milton was a freedom loving guy and he was attracted to Hayek’s proposals to stop making it illegal for people to use different currencies. Milton just didn’t think it could work in practice.

That was before the internet and before most people conducted transactions by numbers not by hard cash. Switching costs simply are not as big an issue. And if they are not as big an issue why can’t we have competition in currency making, just like we have competition in bread making?

I have only been on the sidelines for the G20 this weekend. The G20 is a very young international institution, having its genesis in the wreckage of the Global Financial Crisis.

It’s hard to get economists to agree on the causes of anything. The old joke goes; ask an economist what the economic effects of the French Revolution were, and they will respond: “Too early to tell”!

Yet, some serious economists think that the most recent financial crisis had its origins in the low interest rates that preceded the crisis (often referred to as the "Greenspan Put"), and the aggressive fixed currency policies of the Chinese government.

There are also some serious economists who see the seeds of the next crisis in the enormous money printing that quantitative easing has unleashed.

Yet, even putting aside what might happen to inflation in the future, we only need look at the monetary record of central banks since Bretton Woods to see that something is not quite right.

When Richard Nixon finally broke the link between the US dollar and gold, bullion traded at $35 an ounce. Today it is around $1200 an ounce. In gold terms then, the dollar has lost more than 95 per cent of its value. The Romans took around two centuries to devalue their money to a similar extent. We have done it in 40 years.

So in some senses Hayek has been proven right. He proposed choice in currency in 1976 as a way to stop inflation. While the currency competition part has yet to be proven true, the inflation part certainly has.

If we can foster world trade in money, it has the potential to deliver as much benefit to world progress and stability as did the opening up of world trade in products through GATT and eventually the WTO.

Effective competition in currencies could help promote stability. It is still an open question of course about whether digital currencies can promote such effective competition.

That is why I am excited about our humble Senate inquiry into digital currencies. It won’t change the world on its own but there is a debate to be had here and there are exciting and fresh economic pastures to harvest. 

Australia has always been a pioneer on financial innovation. I hope through this inquiry we can continue that record.

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