The Bitcoin Standard: The Decentralized Alternative to Central Banking

by Saifedean Ammous

As an economy advances and becomes increasingly sophisticated, the connection between physical capital and the loanable funds market does not change in reality, but it does get obfuscated in the minds of people. A modern economy with a central bank is built on ignoring this fundamental trade‐off and assuming that banks can finance investment with new money without consumers having to forgo consumption.

In other words, the value of consumption deferred is less than the value of the capital borrowed.

The excess money, backed by no actual deferred consumption, initially makes more producers borrow, operating under the delusion that the money will allow them to buy all the capital goods necessary for their production process. As more and more producers are bidding for fewer capital goods and resources than they expect there to be, the natural outcome is a rise in the price of the capital goods during the production process. This is the point at which the manipulation is exposed, leading to the simultaneous collapse of several capital investments which suddenly become unprofitable at the new capital good prices; these projects are what Mises termed malinvestments—investments that would not have been undertaken without the distortions in the capital market and whose completion is not possible once the misallocations are exposed.

The central bank's intervention in the capital market allows for more projects to be undertaken because of the distortion of prices that causes investors to miscalculate, but the central bank's intervention cannot increase the amount of actual capital available. So these extra projects are not completed and become an unnecessary waste of capital. The suspension of these projects at the same time causes a rise in unemployment across the economy. This economy‐wide simultaneous failure of overextended businesses is what is referred to as a recession.

The business cycle is the natural result of the manipulation of the interest rate distorting the market for capital by making investors imagine they can attain more capital than is available with the unsound money they have been given by the banks.

Economic logic clearly shows how recessions are the inevitable outcome of interest rate manipulation in the same way shortages are the inevitable outcome of price ceilings.

The central bank's meddling in the capital market is the root of all recessions and all the crises which most politicians, journalists, academics, and leftist activists like to blame on capitalism. Only through the central planning of the money supply can the price mechanism of the capital markets be corrupted to cause wide disruptions in the economy.

Imagining that central banks can “prevent,” “combat,” or “manage” recessions is as fanciful and misguided as placing pyromaniacs and arsonists in charge of the fire brigade.

The form of failure that capital market central planning takes is the boom‐and‐bust cycle, as explained in Austrian business cycle theory. It is thus no wonder that this dysfunction is treated as a normal part of market economies, because, after all, in the minds of modern economists a central bank controlling interest rates is a normal part of a modern market economy. The track record of central banks in this area has been quite abject, especially when compared to periods with no central planning and directing of the money supply. Established in 1914, the U.S. Federal Reserve was in charge of a sharp contraction in reserves in 1920–21, and then the sharp bust of 1929, whose fallout lasted until the end of 1945. From then on, economic depressions became a regular and painful part of the economy, recurring every few years and providing justification for growing government intervention to handle their fallout.

With this background in mind, we can get a far clearer idea of modern monetary history than what is commonly taught in academic textbooks since the Keynesian deluge. The founding text of Monetarist thought is what is considered the definitive work of U.S. monetary history: The Monetary History of the United States by Milton Friedman and Anna Schwartz. A giant tome of 888 pages, the book is astounding in its ability to marshal endless facts, details, statistics, and analytical tools without once providing the unfortunate reader with an understanding of one key issue: the causes of financial crises and recessions. The fundamental flaw of Friedman and Schwartz's book is typical of modern academic scholarship: it is an elaborate exercise in substituting rigor for logic. The book systematically and methodically avoids ever questioning the causes of the financial crises that have affected the U.S. economy over a century, and instead inundates the reader with impressively researched data, facts, trivia, and minutiae.

The money supply expanded by 68.1% over the period of 1921–29 while the gold stock only expanded by 15%.16 It is this increase of the dollar stock, beyond the stock of gold, which is the root cause of the Great Depression. An honorable

It is no wonder, then, that Milton Friedman would later proclaim Irving Fisher as the greatest economist America had produced.

Policymakers, instead of taking this as a sign to stop tinkering with the value of money and allow people the freedom to use the least volatile commodity as money, took it as an invitation to micromanage the smallest details of global trade.

The value of money, supposed to be the unit of account with which all economic activity is measured and planned, went from being the value of the least volatile good on the market to being determined through the sum of three policy tools of the government—monetary, fiscal, and trade policy—and most unpredictably, through the reactions of individuals to these policy tools.

Governments deciding to dictate the measure of value makes as much sense as governments attempting to dictate the measure of length based on the heights of individuals and buildings in their territories. One can only imagine the sort of confusion that would happen to all engineering projects were the length of the...

Only the vanity of the insane can be affected by changing the unit with which they're measured. Making the meter shorter might make someone whose house's area is 200 square meters believe it is actually 4...

Modern economics has formulated “The Impossible Trinity” to express the plight of modern central bankers, which states: No government can successfully achieve all three goals of having a fixed foreign exchange rate, free capital flows, and an independent monetary policy.

It is also a huge boon for large financial institutions which have generated a foreign exchange market worth trillions of dollars a day, where currencies and their futures are trading. But this arrangement is likely not to the benefit of almost everyone else, particularly for people who actually have productive enterprises that offer valuable goods to society.

Firms that have spent decades working on a competitive advantage could see it wiped out in 15 minutes of unpredictable foreign exchange volatility.

With free capital flows and free trade built on a shaky foundation of floating exchange rate quicksand, a much higher percentage of the country's businesses and professionals need to concern themselves with the movements of the currency. Every business needs to dedicate resources and manpower toward studying an issue of extreme importance over which they have no control.

Perhaps one of the most astonishing facts about the modern world economy is the size of the foreign exchange market compared to productive economic activity. The Bank of International Settlements20 estimates the size of the foreign exchange market to be $5.1 trillion per day for April 2016, which would come out to around $1,860 trillion per year. The World Bank estimates the GDP of all the world's countries combined at around $75 trillion for the year 2016.

This means that the foreign exchange market is around 25 times as large as all the economic production that takes place in the entire planet.21 It's important to remember here that foreign exchange is not a productive process, which is why its volume isn't counted in GDP statistics; there is no economic value being created in transferring one currency to another; it is but a cost paid to overcome the large inconvenience of having different national currencies for different nations.

In a free market for money, individuals would choose the currencies they want to use, and the result would be that they would choose the currency with the reliably lowest stock‐to‐flow ratio.

It is an astonishing fact of modern life that an entrepreneur in the year 1900 could make global economic plans and calculations all denominated in any international currency, with no thought whatsoever given to exchange rate fluctuations. A century later, the equivalent entrepreneur trying to make an economic plan across borders faces an array of highly volatile exchange rates that might make him think he has walked into a Salvador Dali painting.

The combination of floating exchange rates and Keynesian ideology has given our world the entirely modern phenomenon of currency wars: because Keynesian analysis says that increasing exports leads to an increase in GDP, and GDP is the holy grail of economic well‐being, it thus follows, in the mind of Keynesians, that anything that boosts exports is good. Because a devalued currency makes exports cheaper, any country facing an economic slowdown can boost its GDP and employment by devaluing its currency and increasing its exports. There are many things wrong with this worldview.

But even if all of these problems with devaluation as the route to prosperity were inaccurate, there is one simple reason why it cannot work, and that is: if it worked, and all countries tried it, all currencies would devalue and no single country would have an advantage over the others.

A highly recommended historical account of the disastrous and yet grimly hilarious consequences of price controls across history is Forty Centuries of Price and Wage Controls: How Not to Fight Inflation, by Robert Schuettinger and Eamonn Butler.

Under a sound monetary system, government had to function in a way that is unimaginable to generations reared on the twentieth‐century news cycle: they had to be fiscally responsible.

Money supply management is the problem masquerading as its solution; the triumph of emotional hope over hard‐headed reason; the root of all political free lunches sold to gullible voters. It functions like a highly addictive and destructive drug, such as crystal meth or sugar: it causes a beautiful high at the beginning, fooling its victims into feeling invincible, but as soon as the effect subsides, the come‐down is devastating and has the victim begging for more. This is when the hard choice needs to be made: either suffer the withdrawal effects of ceasing the addiction, or take another hit, delay the reckoning by a day, and sustain severe long‐term damage.

Recessions, for Keynes, are caused by abrupt reductions in the aggregate level of spending. Keynes was not very good with grasping the concept of causality and logical explanations, so he never quite bothered to explain why it is that spending levels might suddenly drop, instead just coining another of his famous clumsy and utterly meaningless figures of speech to save him the hassle of an explanation.

He blamed it on the flagging of “animal spirits.” To this day, nobody knows exactly what these animal spirits are or why they might suddenly flag, but that of course has only meant that an entire cottage industry of state‐funded economists have made a career out of attempting to explain them or finding real‐world data that can correlate to them. This research has been very good for academic careers, but is of no value to anyone actually trying to understand business cycles. Put bluntly, pop psychology is no substitute for capital theory.3

Freed from the restraint of having to find a cause of the recession, Keynes can then happily recommend the solution he is selling. Whenever there is a recession, or a rise in the unemployment level, the cause is a drop in the aggregate level of spending and the solution is for the government to stim...

There are three ways of stimulating aggregate spending: increasing the money supply, increasing government spending, or reducing taxes. Reducing taxes is generally frowned upon by Keynesians. It is viewed as the least effective method, because people will not spend all the taxes they don't have t...

In any sane society, Keynes's ideas should have been removed from the economics textbooks and confined to the realm of academic comedy, but in a society where government controls academia to a very large degree, the textbooks continued to preach the Keynesian mantra that justified ever more money printing.

The other main school of government‐approved economic thought in our day and age is the Monetarist school, whose intellectual father is Milton Friedman. Monetarists are best understood as the battered wives of the Keynesians: they are there to provide a weak, watered‐down strawman version of a free market argument to create the illusion of a climate of intellectual debate, and to be constantly and comprehensively rebutted to safely prevent the intellectually curious from thinking of free markets seriously.

While this debate over tax cuts versus spending increases rages on, the reality is that both policies result in increased government deficits which can only be financed with monetized debt, effectively an increase in the money supply.

A decline in the price level, or deflation as the Monetarists and Keynesians like to call it, would result in people hoarding their money, reducing their spending, causing increases in unemployment, causing a recession.

wants. By constantly expanding the money supply, central banks' monetary policy makes saving and investment less attractive and thus it encourages people to save and invest less while consuming more. The real impact of this is the widespread culture of conspicuous consumption, where people live their lives to buy ever‐larger quantities of crap they do not need.

When the alternative to spending money is witnessing your savings lose value over time, you might as well enjoy spending it before it loses its value.

By placing a hard cap on the total supply of bitcoins, as discussed in Chapter 8, Nakamoto was clearly unpersuaded by the arguments of the standard macroeconomics textbook and more influenced by the Austrian school, which argues that the quantity of money itself is irrelevant, that any supply of money is sufficient to run an economy of any size, because the currency units are infinitely divisible, and because it is only the purchasing power of money in terms of real goods and services that matters, and not its numerical quantity. As Ludwig von Mises put it:8

The services money renders are conditioned by the height of its purchasing power. Nobody wants to have in his cash holding a definite number of pieces of money or a definite weight of money; he wants to keep a cash holding of a definite amount of purchasing power.

For a school of thought steeped in high time preference, it is understandable that Keynes could not understand that increased savings' impact on consumption in any present moment is more than outweighed by the increases in spending caused by the increased savings of the past.

For Keynesians, the fact that the whole world's central banks run on fiat currencies is testament to the superiority of their ideas. For Austrians, on the other hand, the fact that governments have to resort to coercive measures of banning gold as money and enforcing payment in fiat currencies is at once testament to the inferiority of fiat money and its inability to succeed in a free market.

Money is the medium through which trade takes place, and the only tool through which trade can expand beyond the scope of small communities with close personal relationships. For the price mechanism to work, prices need to be denominated in a sound form of money across the community that trades with it.

Trade between peoples creates peaceful coexistence by giving them a vested interest in each other's prosperity. When communities use different kinds of unsound money, trade becomes more complicated, as prices vary along with the variation in the value of the currencies, making the terms of trade unpredictable, and making it often counterproductive to plan economic activity across borders.

The 2005 United Nations Human Development Report12 analyzed death from conflicts over the past five centuries, and found the twentieth century to be the deadliest.

Liberalism triumphed on the principle that the best government is that which governs least; now for all the western nations political wisdom has recast this ideal of liberty into liberality. The shift has thrown the vocabulary into disorder.

Sound money, then, enforced a measure of honesty and transparency on governments, restricting their rule to within what was desirable and tolerable to the population. It allowed for society‐wide honest accounting of costs and benefits of actions, as well as the economic responsibility necessary for any organization, individual, or living being to succeed in life: consumption must come after production.

Unsound money, on the other hand, allows governments to buy allegiance and popularity by spending on achieving popular objectives without having to present the bill to their people. Government simply increases the money supply to finance any harebrained scheme it concocts, and the true cost of such schemes is only felt by the population in years to come when the inflation of the money supply causes prices to rise, at which point the destruction of the value of the currency can be easily blamed on myriad factors, usually involving some nefarious plots by foreigners, bankers, local ethnic minorities, or previous or future governments.

Unsound money has eradicated the notion of trade‐offs and opportunity costs from the mind of individuals thinking of public affairs.