Austrian economists have long been interested in the study of money and monetization. The last global monetary standard developed largely through market forces, gold, occurred long before the Austrians did their work on the subject. The emergence of the digital cash network known as Bitcoin gives the Austrian a very rare opportunity to observe the rearrangement of global economic life as emerging money aims to kill existing monetary structures.
Like analyzing any other topic, it is important to understand and apply the basic principles of the Austrian economy to correctly draw conclusions about bitcoin monetization. The study of the effects of minimum wage laws cannot be trusted without a rigorous understanding of the law of demand; Likewise, studying the recent law in El Salvador that makes bitcoin legal requires proper application of Gresham’s Law.
at recent days miss wireChristopher Musten Hansen applies Gresham’s Law to the case of Bitcoin legal tender in El Salvador to predict that the scheme will backfire on Bitcoin and the country’s citizens. While it remains to be seen how all this happens, we can largely dismiss Hansen’s conclusions because he uses a faulty understanding of Gresham’s Law. His analysis has two fatal flaws, the first is explicit and the second is implied:
- Gresham’s Law can be applied to any law with dual legal tenders regardless of the structure of the scheme.
- Economic interactions between Bitcoin and the US dollar will occur in a vacuum in El Salvador without interaction with global markets.
Hansen does a good job of defining and explaining Gresham’s Law, which actually concludes that “bad money pays good money”. It is important to briefly examine why this happens.
With a fixed exchange rate between the two legal tenders, people will be incentivized to hold on to better money and sell their worse money. However, those who are beholden to these legal tender laws will have the incentive to move the better money out of their jurisdiction to those without a fixed exchange rate where they enjoy a better exchange rate because the arbitrage opportunity will almost undoubtedly exist. As a result, the better money will be exported abroad so that no one will have it in the place where the law of legal tenders applies.
There is something wrong here: El Salvador explicitly does not specify the exchange rate between the dollar and bitcoin, a point that Hansen actually acknowledges. How does this affect our analysis? Jörg Guido Hollsmann writes in his book The Ethics of Money Production:
“Legal tender laws would merely complicate exchanges were it not for the additional requirement that they are almost always incorporated. In fact, legal tender laws typically create a legal or “statutory” equivalency between privileged funds (premium funds certificate) and other funds and certificates of funds.”
How can we apply Gresham’s law to a situation where there is no fixed exchange rate? Hansen tries to do so by saying, “However, even though there is no fixed exchange rate, you still have two currencies that can be equally served in abrogation. This obligatory parity means that their legal power, if only because of state intervention, is the same.” ”
If we follow the link to the article provided by Hansen, we will find another work by Hulsman, who explains the concept of “legal equivalence” as follows:
It belongs to the nature of legal tender laws that they establish a imposed equivalence (legal equivalence) between the privileged medium of exchange – the legal tender – and the other means of exchange.14 The legislator would like to force the use of his preferred exchange medium, but this presupposes that he sets the prices at which market participants have to accept them. For example, if most contracts hitherto have been denominated in silver and copper, while our legislator wishes to impose his own paper coupons, he must establish the parity rates between these coupons and the specific weights of silver and copper.”
Hulsman further clarifies the concept in footnote 14:
The expression “monetary parity” may seem a little awkward, but it is more accurate than the more common term “price control,” because it allows us to cover cases where prices do not exist in the first place. For example, the introduction of US dollar coins in 1862 was not based on price setting, because the dollar had not yet been circulated, so there was no price that could be controlled. Instead, the US government ordered creditors to accept paper coupons called “dollars” on par with coins and banknotes of the same name. Thus, there was a monetary equivalent of dollars and coins, but no price control. ”
To put it more simply, compulsory parity is the act of the government to select the monetary value of some medium of exchange which is different from the monetary value that the market will allocate to it. Hansen combines the legal requirements for accepting both bitcoin and the dollar as payment with Hulsmann’s definition of exchange rate reform (providing Hulsmann’s definition as evidence contrary to Hansen’s view).
Given this understanding of both Gresham’s law and El Salvador’s legal tender laws, what can we expect to happen? In “What has the government done for our money?” , Murray Rothbard states that it is interference in government decrees by setting prices that prevents bad money from leaving the market. If price controls were not in place, the owners of better money, in this case bitcoin, would have no incentive to trade their bitcoins for dollars outside of El Salvador. Instead, they will do their best to store their bitcoins while choosing to use the dollars when they need to spend the money, if they have any.
Their preference for holding bitcoin will result in a premium on accepting dollars as payment. This increases the price of bitcoin in dollar terms to the local exchange rate in El Salvador, creating an incentive for people outside of El Salvador looking to exchange dollars for bitcoin at a better rate. A pipeline from Bitcoin to El Salvador and the dollar is the expected outcome – the opposite of Gresham’s Law. This is generally known as Thiers’ Law, which states that good money pays out bad money when there is no application of a fixed exchange rate. Their law is to some extent the explanation for why emerging money will replace relatively worse existing money.
It will be interesting to watch the law in El Salvador offering legal tender for bitcoin. Legal tender laws often come with a fixed exchange rate and force bad money into circulation. this is different. It goes without saying that legal tender laws are unethical and even unnecessary in a healthy society and economy, but after a period of potential boarding, will this law be moot as Bitcoin is the money that the people of El Salvador will ultimately choose in an unfettered market? Is this a case of pure government intervention in the market or are we seeing a government mishandling the realities of really healthy money? Austrians should be watching El Salvador and bitcoin with curiosity in general because we are finally looking forward to testing our theories on how money works, and how new money appears.
This is a guest post by Rollo McFloogle. The opinions expressed are their own and do not necessarily reflect the opinions of BTC Inc or Bitcoin Magazine.