Business cycles – where they come from and where they are going

Hayek’s ideas on monetary policy were based on the historical events of 1971: at that time, the Nixon shock shook the global financial system. The U.S. president had suspended the dollar’s convertibility into gold. Too many U.S. dollars had been put into circulation for the country to be able to cover them with its gold reserves. The subsequent system of partially fixed exchange rates, the so-called “Smithsonian Agreement,” also had to be abandoned unsuccessfully in 1973.

For Hayek, money should obviously be used as a means of payment. But he saw no reason why only one legal tender should exist within a country. Even before the introduction of the euro in Germany and Austria, both the Austrian schilling and the Deutsche Mark were widely accepted along the border region between the two countries. The only thing preventing German banks in Salzburg from conducting business in Deutsche Mark in exactly the same way as their counterparts 17 kilometers away in Berchtesgaden was Austrian legislation. Most tourist areas in Austria also accepted the U.S. dollar alongside the Deutsche Mark.

Competition or monopoly in money markets?

Hayek’s ideas are grounded in the concept of currency competition, also known as free banking. In this hypothetical world, there is no central monetary authority like a central bank that attempts to control variables such as the money supply, interest rates, or inflation. Instead, commercial banks simply issue their own currencies. For example, the Swiss UBS could name its currency the “UBS dollar,” the Raiffeisen banks could issue the “R-taler,” and Deutsche Bank could circulate its “DB-gulden.” In such a system, banks effectively act as private central banks. Each bank would be free to pursue whatever monetary policy it deems most advantageous. Banks become similar to companies that treat money as a product, competing with each other to offer their customers the best possible currency.

In the state-run monetary system, a central bank issues money as a monopolist. Each central bank pursues certain goals set by policymakers. The European Central Bank, for example, prioritizes price stability and thus the fight against inflation above all else. In contrast, U.S. policymakers have given the Federal Reserve two equal mandates: maximum employment and stable prices. For some central banks in developing countries that depend heavily on commodity exports, strict value stability may not make sense, as they would need to constantly adjust their money supply in response to swings in global commodity prices. Each central bank has different priorities: price stability, full employment, export promotion, and so on. If a central bank is required to focus only on price stability, it must keep inflation at a certain level, such as the ECB’s target of close to but below two percent. Once policymakers impose additional goals, the central bank must accept some loss of control over inflation. Since central banks always operate to some degree under political influence, the temptation is great to misuse the state money monopoly for private enrichment, financing government spending, or providing liquidity for war. This could be observed in 2022, when the Turkish president Erdoğan, facing inflation rates above 80 percent, pressured the central bank to continue lowering interest rates, believing this would stimulate the construction sector and economic growth. In short, there is a constant incentive for political actors to abuse this power.

Currencies that can go bankrupt

A private issuer can also inflate its currency. The Raiffeisen Bank could print so many R-talers that inflation and a loss of value follow. But consumers in search of a stable currency would flee from the R-taler and switch to a more stable one, such as the UBS dollar. With this in mind, banks would have an interest in maintaining monetary stability to avoid losing customers. Competition ensures that banks keep each other in check on the currency market. Competing currencies could take many forms. One could be backed by gold in the traditional sense, meaning the money supply is tied to the gold reserves the bank holds. If one UBS dollar corresponded to one gram of gold, a bank with 1,000 grams of gold could issue 1,000 UBS dollars.

But it could also be useful for a bank to peg its currency to a basket of goods. Different goods are bundled into such a basket, and the challenge for the bank is to adjust its money supply so that one UBS dollar always buys that basket. Customers could evaluate the stability of a currency using such a benchmark. Besides consumption goods, a basket might include energy prices (electricity, gas, oil) or precious metals. Banks could follow central bank practices and allow their exchange rate to float freely or peg it to another currency. The latter could be an option for currencies aiming to establish a reputation for stability.

Complexity of such a monetary system

All of this sounds very complicated for daily life. Who accepts which currency, and what is it worth at any given moment? Could such a system even function in a globalized world with complex trade flows and global supply chains if each country had multiple different valid currencies? Argentina illustrates these problems very clearly. Since its state bankruptcy and the ensuing runaway inflation far above the Latin American average, the country has had, in addition to an official exchange rate (due to strict capital controls limiting how many pesos Argentinians may legally convert into dollars), a black-market rate that is even officially quoted in newspapers (“dólar blue”). There are numerous additional exchange rates, such as the stock-related “dólar CCL.” The “dólar turista” stands out for its particularly high rate. It imposes an even worse exchange rate on Argentinians when using credit cards abroad, pressuring them to spend their money domestically instead.

New technologies bring cryptocurrencies into play

In 2009, the still anonymous author Satoshi Nakamoto published the whitepaper “Bitcoin: A Peer-to-Peer Electronic Cash System,” describing the technical details of a system in which transactions could be carried out via decentralized networks without a central authority or intermediary—effectively eliminating the need for a bank. Cryptocurrencies define their own money supply by code. In the case of Bitcoin, the supply has been fixed from the beginning. Cryptocurrencies therefore replace not only central banks but also banks as institutions.

They compete with one another through different characteristics. Some serve more as a store of value, others as a medium of exchange. Most share the feature of being easily transported through a digital wallet and globally available through the internet. Thanks to blockchain technology, they are also protected against data loss or technological failure because the data blocks are stored immutably across many computers, ensuring transparency of the money supply. Some cryptocurrencies were designed with the intention of being a meaningful unit of account for specific goods, but due to the speculative boom and extreme volatility in the sector, they have not succeeded.

The technology also makes financial transfers easier for countries with large diasporas and migrant workers around the world. In the early days of Russia’s attack on Ukraine, many donors used decentralized blockchain transfers to support the country. Do new digital technologies fulfill Hayek’s vision of “denationalizing” the monetary system?

Supporters of cryptocurrencies often argue that they strip governments of their monetary monopoly. In fact, cryptocurrencies meet several of the key criteria the Austrian School demands of currencies—above all decentralization and a predefined, limited money supply. They also align with the Austrian belief that currency quality and technological progress should be driven by competition among many independent teams and organizations. This competition has already alarmed major central banks in the eurozone and the U.S. Federal Reserve to the point where they have begun developing their own digital currencies.

Questions of trust

Nonetheless, cryptocurrencies still struggle with one central issue: trust. It is hardly surprising that cryptocurrencies are most widespread in countries where trust in state institutions is low and where governments have often failed to provide a stable monetary system.

Table 1 Adoption of cryptocurrencies in daily use or ownership

	2019	2020	2021	2022	2023
Nigeria	28%	32%	42%	45%	47%
Türkei	20%	16%	25%	40%	47%
Vereinigte Arabische Emirate	-	10%	13%	34%	31%
Indonesia	11%	13%	12%	19%	29%
Brasilien	18%	12%	12%	22%	28%
Indien	8%	8%	10%	22%	27%
Argentinien	16%	14%	21%	35%	26%
Malaysia	-	12%	16%	20%	23%
Saudi Arabien	14%	11%	12%	20%	23%
Südafrika	16%	17%	18%	23%	22%
Schweiz	10%	9%	13%	18%	21%
Südkorea	6%	8%	8%	19%	20%
Ägypten	-	8%	12%	14%	19%
Niederlande	10%	9%	10%	19%	19%
Pakistan	6%	6%	14%	19%	18%
Australien	7%	8%	9%	16%	17%
Norwegen	7%	8%	9%	15%	17%
Belgien	7%	6%	10%	15%	16%
Irland	8%	10%	13%	15%	16%
Marocko	10%	9%	10%	12%	16%
USA	5%	7%	8%	15%	16%
Chile	11%	12%	14%	14%	15%
Spanien	10%	10%	10%	15%	15%
Österreich	8%	7%	8%	14%	14%
Neuseeland	6%	5%	11%	15%	14%
Quelle: Statista, 2023

Hayek’s ideas on monetary policy were based on the historical events of 1971. At that time, the Nixon shock disrupted the global financial system. The U.S. president suspended the dollar’s convertibility into gold because too many dollars had been put into circulation for the United States to cover them with its gold reserves. The subsequent system of partly fixed exchange rates, known as the Smithsonian Agreement, also failed and was abandoned in 1973.

For Hayek, money should obviously serve as a means of payment. But he saw no reason why only a single legal tender should exist within a country. Even before the introduction of the euro in Germany and Austria, both the Austrian schilling and the Deutsche Mark were accepted along the border region. The only factor preventing German banks in Salzburg from conducting business in Deutsche Mark just like their counterparts in nearby Berchtesgaden was Austrian legislation. Most tourist regions in Austria also accepted the U.S. dollar alongside the Deutsche Mark.

Hayek’s ideas are based on the concept of currency competition, also known as free banking. In such a hypothetical system, there is no central monetary authority like a central bank that tries to control the money supply, interest rates, or inflation. Instead, commercial banks issue their own currencies. UBS might issue a “UBS dollar,” Raiffeisen banks an “R-taler,” and Deutsche Bank a “DB-gulden.” These banks would act as private central banks and could pursue whatever monetary policy they considered most advantageous. Money would be treated like any other product, and banks would compete to offer customers the most stable and attractive currency.

In the state-run monetary system, the central bank acts as a monopolist. It follows political goals passed down by policymakers. The European Central Bank prioritizes price stability above all else, while the U.S. Federal Reserve has two equal mandates: maximum employment and stable prices. For many central banks in developing countries that depend heavily on commodity exports, strict price stability is difficult because they would have to constantly adjust their money supply in response to global price fluctuations. Each central bank therefore has its own priorities, such as price stability, full employment, or export promotion. The more goals assigned to a central bank, the less control it ultimately retains over inflation. Since central banks are always subject to some degree of political influence, the risk of misuse is high. Governments may be tempted to use the monetary system for private enrichment, to finance state spending, or to fund military operations. A recent example was Turkey in 2022, when President Erdoğan pressured the central bank to keep lowering interest rates despite inflation rates above 80 percent, believing it would stimulate the construction sector. This demonstrates the constant incentive for political actors to abuse monetary power.

A private issuer can also inflate its currency. A bank could print so many R-talers that inflation and devaluation follow. But consumers who want stable money would withdraw from this currency and switch to a more stable one, such as the UBS dollar. Competition forces banks to maintain monetary stability. Competing currencies could take many forms. Some could be backed by gold. If one UBS dollar corresponded to one gram of gold and a bank held 1,000 grams of gold, it could issue 1,000 UBS dollars.

Alternatively, a bank might peg its currency to a basket of goods. The goal would be to adjust the money supply so that one UBS dollar always buys the same basket. Customers could then evaluate the currency’s stability with the help of this benchmark. Baskets could include consumer goods, energy items such as electricity and oil, or even precious metals. Banks might let their exchange rate float freely or peg it to another stable currency.

This entire system may sound extremely complex for everyday life. Who accepts which currency, and what is it currently worth? Such a system raises questions about its practicality in a globalized world with cross-border supply chains if each country has multiple competing currencies. Argentina illustrates these challenges well. Since its state bankruptcy and extreme inflation rates, the country has not only an official exchange rate but also a widely used black-market rate, reported even in major newspapers as the “dólar blue.” Additional exchange rates exist for stock transactions and international payments. One example, the “dólar turista,” imposes particularly high conversion rates on Argentinians using credit cards abroad to encourage domestic spending.

New technologies introduced cryptocurrencies into the monetary landscape. In 2009, the still anonymous Satoshi Nakamoto published the whitepaper “Bitcoin: A Peer-to-Peer Electronic Cash System,” describing a system where transactions can be carried out via decentralized networks without a central bank. Cryptocurrencies define their own monetary supply through code. Bitcoin’s supply, for example, was fixed from the beginning. Cryptocurrencies thus replace both central banks and traditional banking structures.

These digital currencies compete with each other based on different features. Some are designed to serve as stores of value, others as means of payment. Most are easy to store in digital wallets and can be transferred instantly around the world. Blockchain technology protects them from data loss because their records are stored across many computers, making the total money supply transparent. Some cryptocurrencies were created to function as stable units of account for specific goods, but high volatility prevented these concepts from becoming mainstream.

Blockchain technology also simplifies money transfers for countries with large diasporas. In the early days of Russia’s invasion of Ukraine, many donors used decentralized cryptocurrency transfers to send financial support. This raises the question of whether new digital technologies might help fulfill Hayek’s vision of denationalizing the monetary system.

Supporters of cryptocurrencies argue that they strip governments of their monetary monopoly. Indeed, cryptocurrencies reflect several key principles of the Austrian School: decentralization, limited money supply, and technological progress driven by competition among many independent actors. This competition has already alarmed major central banks in the eurozone and in the United States, prompting them to develop their own digital currencies.

However, cryptocurrencies still face one critical issue: trust. Unsurprisingly, they are most widespread in countries where trust in government institutions is low and where authorities fail to maintain monetary stability.

Table 1 Adoption of cryptocurrencies in daily use or ownership

Do the experiences from cryptocurrencies falsify Hayek’s monetary theories?

Currencies that attempted to follow Hayek’s proposal to tie their value to a basket of goods remained rare exceptions. One example is Ampleforth, which pegged its AMPL token to the purchasing power of the 2019 US dollar. Progress in the crypto space was driven mostly by technicians and software engineers who, in many cases, had limited expertise in how monetary systems function (and often were motivated by the pursuit of quick profits). Private banks likewise did not adopt such models, contrary to Hayek’s hopes—partly due to concerns about reputational damage stemming from the dubious activities associated with cryptocurrencies, and partly due to regulatory requirements that make offering such products uneconomical for banks.

The long-term market potential of cryptocurrencies does not necessarily depend on mature Western markets, where citizens already have access to a broad range of financial services. As the figures in the table above show, populations in many emerging economies—with their growing middle classes and increasing demand for capital, insurance, and credit services—represent significant potential. In a globalized world, these individuals have more opportunities to be mobile, stay connected across borders, and send small amounts of money around the world at low cost.

Growing protectionism and trade conflicts between major economic blocs further increase the demand for denationalized financial services. Blockchain technology can serve as the underlying infrastructure for new and innovative business models.