I did not have the honour of directly being involved in the G20 proceedings on the weekend, but I did go to an event on Sunday night in Brisbane. It was on the sidelines of the G20, and it was organised on those sidelines. It was a conference put together by the Australian Digital Currency Commerce Association. They put on a conference in Brisbane today with some of the delegates and some countries sticking around for it. I thank them for inviting me to that and asking me to say a few words.
As the Senate would know, the Senate Economics References Committee is currently inquiring into digital currency. For that reason, I do not want to talk about the taxation and regulatory issues associated with digital currencies, but I would like to make a few remarks about the potential of digital currencies to revolutionise our economy. It is clearly apparent that they have that potential; they could significantly change how we store our money, how we pay for goods and services and how we compare the value of different things. But few would go on to consider how digital currencies could actually contribute greatly to economic prosperity and competition in goods and services.
Many years ago, I had to choose a topic for my honours thesis, at the University of Queensland, in economics. I was searching around for a topic desperately early on that year, and I happened to be reading a book by Friedrich Hayek on the denationalisation of money. Senator Brandis might have read this book.
Senator Brandis: “A great philosopher.”
A great philosopher, that is true, Senator Brandis, and a great economist too. This book was consistent with Hayek’s philosophy in terms of promoting competition and the value of competition in delivering high-quality goods and services in abundance. He posed the question: if competition is so good in product markets, why should we not allow competition in currency markets too? I was pretty intrigued by that argument, so I decided to write 25,000 words on it. Ultimately, after those 25,000 words, I concluded that competition in currencies probably would not work, that there would be too much information asymmetry in these markets and we would not get stable equilibrium. My study was pretty narrow, though. It was only an honours thesis. I only looked at fiat based currencies—that is, those not backed by gold and only those issued by private institutions, not by governments.
The principal 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 for anyone issuing currency are time inconsistent. They can make massive profits in the short term by overprinting and issuing lots of money and yes, they will lose reputation in the long term, but that still would not offset those big temporary profits.
In effect, there is no more reason to believe that a bank or a private institution would be any more disciplined than Robert Mugabe. In fairness though, it is not clear why governments are not all more ill-disciplined at times. They all have the same incentives, the same issues of time inconsistency. Those issues with governments issuing currencies are why Friedrich Hayek wrote this book in 1976, in which Hayek bluntly put:
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, though, is that the experience of privately issued currencies is not much better. There is quite a history of privately issued currencies, a history largely forgotten. In America before the Civil War many private institutions issued their own currencies. They bloomed after President Andrew Jackson abolished the Second Bank of the United States in the 1830s, calling that bank a monopoly at the time in the vetoing decision he made. Then a lot of banks popped up before the Civil War in America, but in this ante-bellum period most of those currencies tended towards a wildcat nature. They were fraught with over-issuing and devaluation. They particularly flourished in the south of America and some say that it was the lack of financial stability which contributed to the South’s defeat in the coming war.
There were also privately issued currencies in Scotland before the Bank of England took over currency issuing in that country. Indeed, that concurred with the time of Adam Smith in the late 18th century, but it is notable that even Adam Smith was sceptical of the potential for private currencies to displace public ones. It has always struck me as quite unusual, as quite ironic that libertarian economists who otherwise believe in freedom, liberty and small government in all other spheres usually vehemently defend the right of the state to prevent anyone else to issue currency.
Milton Freidman, perhaps the 20th century’s most famous monetary and libertarian economist, is a great example. He rejected Hayek’s arguments 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, and because the costs of switching from one currency to another are very high, there would not be enough ability for people to signal their preferences and to compete. Markets for bread work because if you do not like the bread you bought today you can wake up tomorrow and go to a different baker. It is not quite so easy with the money in your wallet.
As was the case in my own honours thesis, I have tended to come down on Milton’s side not Friedrich’s side in this debate. There are more recent examples and evidence of this too. In Somalia after 1991, the people were basically left without a government and a central bank. In substitution, a number of local tribesmen issued their own currencies, but instead of issuing their own brands of currencies, they simply forged the hitherto national shilling. That demonstrates how it is difficult to for private brands of currency to emerge, even in unregulated space. But things might be changing because we now have bitcoins, litecoins and other digital currencies, things that were not around when I did my thesis 12 years ago. It would be fascinating to hear what Milton Friedman had to say today about bitcoins because bitcoins have decentralised rules about the currency creation exchange—no-one controls those, no central authority, corporation or government. And with the internet and different forms of accounting, there is great potential for people to switch between different currencies as well. If that is the case, if these currencies become more population, they could make a real different to the world, particularly in parts of the world where governments tend to inflate their currencies religiously.
As I said earlier, the Australian Digital Currency Commerce Association hosted the G20 conference in Brisbane this week. The G20 is a very young international institution which emerged only after the global financial crisis. Of course, there is still debate about what caused the global financial crisis, but many think that the crisis had its origins in the monetary policies of the United States and potentially China as well. There are other economists who think the seeds of the next financial crisis could be emerging from the enormous money printing that is occurring in different countries through quantitative easing policies. Even if we put aside what might happen to inflation in the future, we only need look at the past record of monetary policies to see that something is not quite right.
When Richard Nixon in 1971 finally broke the link between the US dollar and gold and he ended the Bretton Woods arrangements. Back then gold was worth US$35 an ounce. Today it is around US$1,200 an ounce. So the value of the US dollar in terms of gold has fallen by more than 95 per cent in about 40 years. It took the Romans about 200 years to achieve that level of devaluation and it has taken us just 40 years. I suppose that is progress.
In some senses Hayek has been proven right. He proposed choice in currency to try to ward against inflation. He did not get perhaps the choice part right but the inflation part has certainly proven true. If we can foster world competition in money, that has the potential to produce greater stability, greater choice and greater outcomes, just like competition have those effects in other markets. Indeed, I think competition in money markets has the potential to have just as great an impact on world growth and prosperity as competition in product markets has, particularly since GATT and eventually the WTO. Keeping that in mind, perhaps the use and promotion on digital currencies would be a useful topic for the G20 proper to consider next year when they meet in Turkey. It does have the potential to revolutionise our monetary markets. While effective competition in currencies is probably a long way off and it is not even clear yet that it could indeed happen, the potential benefits are so great it certainly deserves serious consideration.
That is why I am excited about our Senate inquiry. I see Senator Ketter over there. I am sure he is very excited as well at what we might be able to do. It is a humble inquiry but, hopefully, it will explore all the issues and continue the great record Australia has with financial innovation.
