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CHAPTER ONE: Listening to the Past
“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.” — Satoshi Nakamoto
The trusted third party problem has haunted modern financial systems and centralized exchanges because people require an intermediary to make them work. The third party’s good or bad motives become a defining aspect of the transaction, and the those who use the institutions are at the mercy of those intentions. This is especially true of the current system of state-issued money and central banking.
A trustless system avoids intermediaries and does not depend upon the intentions of participants; that is, the system functions in the same manner regardless of anyone’s intentions. The blockchain, with a transparent and immutable peer-to peer protocol, is called trustless because there is no corruptible intermediary upon whom exchanges must depend.
On a small scale, the trusted third party problem may always exist because a middleman is useful or necessary in some situations. If third parties offer competitive services on a free market, however, the damage of dishonesty or incompetence is limited. People can take their business elsewhere, report a swindler to watchdogs, warn others, and file a lawsuit.
An occasionally dishonest third party is not the problem Satoshi addresses. He speaks to the institutionalized corruption of government and central banks from which the average person could not escape by using a competitor or by suing. Almost everyone who works over the table, runs a business, buys or sells goods, accepts government benefits or pays taxes has had to accept a fiat that constantly plunges in value due to inflation. Almost everyone who uses credit, accepts checks, takes out loans, conducts commerce or does business abroad has needed to go through banks that steal like drunken muggers.
For average people, the situation used to seem hopeless because no legal, practical, and private alternative existed for transferring funds across considerable distance, including borders. Attempts to reform or remove the system also seemed doomed because it was inherently corrupt and self-serving. In fact, fiat and central banking were serving the purpose for which they had been established: financial control by elites. People’s need for money and exchange became their straitjackets.
Then Satoshi. Then the blockchain and crypto. A new concept of money was created in a form that cannot not be inflated; the number of bitcoins is fixed at 21 million divisible units. The supply can only decrease when coins are lost, as inevitably happens. Satoshi notes, “Lost coins only make everyone else’s coins worth slightly more. Think of it as a donation to everyone.” Bitcoin solved the fiat problem.
A new concept of financial transfer solved the third party problem, especially with regard to banks. Although peer-to-peer transactions involve a middleman or miner, no trust is required since the transaction is released only when “proof of work” is rendered, which consists of solving a complicated math problem. Arriving at a solution may be costly in computer power and time, but the solutions themselves are easy to verify. Satoshi comments, “With e-currency based on cryptographic proof, without the need to trust a third party middleman, money can be secure and transactions effortless.” The soundness and propriety of the blockchain’s protocol itself is assured by the use of open source that is visible to all and verifiable. The political outcome: A private currency and method of exchange freed people from financial oppression.
The idea of private currency itself is hardly new, however.
Precedent in Radical Individualist Theory
The late Friedrich Hayek is the most respected Austrian economist of the 20th century. His book The Denationalisation of Money: An Analysis of the Theory and Practice of Concurrent Currencies argues vigorously for private and competitive currencies to displace government-issued ones. Hayek ponders a key question. “When one studies the history of money one cannot help wondering why people should have put up for so long with governments exercising an exclusive power over two thousand years that was regularly used to exploit and defraud them. This can be explained only by the myth” that government money was necessary “becoming so firmly established that it did not occur even to the professional students of these matters…ever to question it. But once the validity of the established doctrine is doubted its foundation is rapidly seen to be fragile.”
Governments reap incredible profits from debasing the currency, but the rigged game works only if people have no alternative but to play it. The political purpose of legal tender and banking laws is to grant a monopoly to the state, which permits the redistribution of wealth and power from average people upward to the elite of society. Fiat money and banking remains fragile, however, because the system relies on people either not understanding the dynamics or not having a choice. Hayek wonders why public understanding is so elusive. Why was “a government monopoly of the provision of money…universally regarded as indispensable” and what would happen “if the provision of money were thrown open to the competition of private concerns supplying different currencies?”
With eerie prescience, Hayek argues for currencies developed by entrepreneurs who innovate new forms of money just as they innovate in other areas. One of the drawbacks of government’s monopoly is that it imposes a freeze on the sort of invention that now runs free in crypto. The voluntaryist historian Carl Watner observes, “No one can tell in advance what form these monies might take because no one can know for sure what choices individuals would make or what new technologies might be discovered. Laws forcing people to use the Federal Reserve System money have frozen monetary developments at a certain stage…Just imagine if Congress had protected the Post Office by passing laws that would have prevented people from communicating via the internet. We would never have experienced the marvels of e-mail.”
The late Austrian economist Murray Rothbard also wrestles with the question of “why do people so vigorously resist private currencies?” His book For a New Liberty: The Libertarian Manifesto advances an explanation. “If the government and only the government had had a monopoly of the shoe manufacturing and retailing business, how would most of the public treat the libertarian who now came along to advocate that the government get out of the shoe business and throw it open to private enterprise?” Rothbard predicts that the skeptics would attack the libertarian for depriving them of the only possible source of shoes—the government. People are thoroughly indoctrinated to believe that daily life cannot function without the state and fiat.
Hayek and Rothbard are unusual among free-market economists in their embrace of private money and monetary systems. Even laissez-faire zealots rarely champion free-market currencies or private banking. Instead, they debate marginal issues such as fractional reserve and other reforms they think will improve the existing system. Or they argue for the restoration of a gold standard as though it were a panacea. But if a gold standard were applied to fiat, the system would still require people to trust the government and banks. This means trusting both institutions to act against their own interests, which they have historically neglected to do.
The modern neglect of free-market money and banking is odd because 19th century radical individualists focused intensely on the importance of private money and private banking to personal freedom. They placed a primal emphasis on the right of every individual to create his own currency and to function as his own bank. It was a natural right as important as freedom of speech or of religion. The pivotal individualist Benjamin Tucker believed that the right to issue private currency was so important that it could destroy the State all by itself. Hisreasoning: The money monopoly, including control of credit, was how the State sustained itself and robbed average people not merely of wealth but also of economic opportunity.
Two specific events sculpted the approach that the early individualist-anarchists adopted toward the monetary monopoly. One was the Panic of 1837 that tipped the United States into recession until the mid-1840s. Commonly cited causes of the Panic include a collapsing land bubble and a sharp fall in cotton prices. Blame is also placed at the feet of President Andrew Jackson for vetoing the recharter of the Second Bank of the United States and precipitating an unfortunate chain of economic events. Drawing on the work of Professor of Economics Peter Temin, Rothbard disputes this interpretation.
First, he [Temin] points out that the price inflation really began earlier, when wholesale prices reached a trough of 82 in July 1830 and then rose by 20.7 percent in three years to reach 99 in the fall of 1833. The reason for the price rise is simple: The total money supply had risen from $109 million in 1830 to $159 million in 1833, an increase of 45.9 percent, or an annual rise of 15.3 percent. Breaking the figures down further, the total money supply had risen from $109 million in 1830 to $155 million a year and a half later, a spectacular expansion of 35 percent. Unquestionably, this monetary expansion was spurred by the still-flourishing Bank of the United States, which increased its notes and deposits from January 1830 to January 1832 from a total of $29 million to $42.1 million, a rise of 45.2 percent. Thus, the price and money inflation in the first few years of the 1830s were again sparked by the expansion of the still-dominant central bank.
Arguably, the Panic began in May 1837 when banks in New York City announced they would not redeem commercial paper for specie at full face value. Of the approximately 800 banks in America, all but six ceased at one point or another to redeem banknotes and deposits for gold or silver coins. Suspicion and hatred of traditional banks and government-issued money soared, with radicals scrutinizing alternate systems.
The other event dramatically to impact the radical fever from monetary reform was the Civil War for which the North financed its fighting through Legal Tender Acts and the National Banking Act of 1863.
The radicals did not merely theorize; they experimented with private currencies and new economic models. Their efforts are fascinating, but they are also cautionary tales. A major problem for 19th-century individualist-anarchism was the movement’s general acceptance of a link between sound money and the labor theory of value. This theory states that the true value of a good or service is based on the labor required to produce it rather than the price at which a seller and buyer are willing to exchange. In short, a good has intrinsic and not subjective value. (More on this in the section on the Regression Theorem.) Happily, their main economic goal was the abolition of the “money monopoly.” The term referred to three different but interacting forms of monopoly: banking, the charging of interest, and the privileged issuance of currency. The abolition of state power over currency was the focus, and they eschewed the use of force to implement their own schemes.
Josiah Warren provided a real-world example of what was meant by a currency that rested on the labor theory of value. Credited with being the first American anarchist, Warren tested his specific solution to the money monopoly through a Time Store from which he issued “Labor Notes.” In 1827, the business opened with $300 worth of groceries and dry goods that were offered at a 7 percent markup from Warren’s own costs in order to cover expenses such as overhead. This was before groceries were prepackaged or preweighed, and it was usual for buyers to bargain with the shopkeeper rather than pay a posted price. One of
Warren’s innovations was to post prices, which drove costs lower because transactions consumed less time. The customer paid in traditional money for the goods and paid with a Labor Note to compensate Warren for his time. The Labor Note obliged the customer to provide Warren with an equivalent amount of his time. If the buyer was a seamstress, for example, the Labor Note committed her to render to Warren X units of time to produce clothing. Warren’s goal was to establish an economy—or to establish a proof of principle, at least—in which profit was based on the exchange of time and labor. The Labor Notes were circulated and traded widely with in the community.
To some degree, Warren succeeded. People traveled from a hundred miles away to avail themselves of the Time Store’s low prices. After a few years, he declared the experiment to be a success and closed the store. Whether the Labor Notes were a success is questionable, however. The store itself may well have succeeded due to its low prices, not to the Notes. Whichever explanation is true, it is difficult to see how this novel currency could function in dense populations or on a grander scale of commerce. Few people today would be convinced of the viability of private money based on the Time Store experiment.
What could convince the public and economists that private currencies work as well or better than government-issued ones? Going back a bit further in American history is a good place to start because the future is always based on the past.
– by Wendy McElroy.
The above chapter is an excerpt from the 2020 e-book ‘The Satoshi Revolution’.