Economist Friedrich Hayek Prophesied a Solution for Inflation through Cryptocurrency
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Inflation has become a regular part of household discussions. No longer just a term thrown around by political pundits and financial reporters, the negative effects of inflation are experienced by everyone who eats, shops or drives in everyday life.
The Federal Reserve has set a target inflation rate of 2%, which it considers commensurate with “normal” business cycles in the United States and around the world. However, March 2022 saw the Consumer Price Index increase 8.5%—”the largest 12-month advance since December 1981,” according to the U.S. Bureau of Labor Statistics.
Most economists see inflation as a healthy part of business, economic and innovation cycles. However, not all would agree. In the mid 1970s, at a time like today when inflation was of increasing concern, a Nobel Prize-winning economist named Friedrich Hayek published a paper entitled “Denationalisation of Money,” which has become a prophecy among crypto pundits. Before there were blockchains, decentralized networks or even the figment of an Internet-connected world, Hayek outlined a better plan for the issuance and circulation of money. He advocated for the creation of private currency rather than a government-controlled monopoly on the minting of money. He also applied the popular idea of free markets to the creation of currency in which private entities could compete for acceptance.
Hayek argued that stability in value, one of the critical properties of money, would ultimately be the deciding factor for acceptance in a free market. He assumed that competition would favor currencies with the greatest stability since a devalued currency hurts creditors and an inflated currency hurts debtors.
This gets to the core of Hayek’s goal, which is back in focus today: managing inflation.
At the risk of oversimplifying his theory, what we are experiencing today is the result of a design that Hayek generally argued against—allowing monetary policy (creation of money) and fiscal policy (government’s spending of money) to be monopolized by government entities whose internal activities are poorly coordinated. Government spending is increasingly politically motivated, while monetary policy is academically driven and almost always in response to changes in fiscal policy.
Reacting to the global pandemic, the U.S. government has spent trillions to prop up the economy, increasing deficit spending and running up the national debt to more than $30 trillion. The Federal Reserve has been forced to respond, effectively printing more money to make up the shortfall. The result of this expansionary posture is inflation. In response, the Federal Reserve has taken additional measures by raising interest rates to fight rising prices—the death knell for an economy and the maximum pain point for average consumers. Welcome to the new world!
Hayek would argue that the way to solve this is to decouple fiscal policy from monetary policy by introducing competition to the government’s monopoly on the issuance of currency. If the government is not the primary issuer of money (the supply of which drives prices), then government spending must operate within a balanced budget or risk bankruptcy like any other business.
Some have suggested that governments should not operate like businesses and should not be required to maintain a balanced budget. They argue that there are times when it is necessary to spend at deficit levels in order to counteract adverse economic conditions that occur from time to time. Hayek’s notion of decoupled fiscal and monetary policy certainly forces discipline on a Federal system that appears to be severely broken today.
In short, Hayek’s solution calls for less regulation and more decentralization, which is where cryptocurrencies come in. The advent of blockchain technology and the exchange of monetary value on decentralized global networks are the prime applications of Hayek’s theory, though we’re not quite there yet.
The current “crypto winter” is intertwined with some high profile failures, including FTX, Celsius, Voyager Digital, BlockFi and more. The result of bad actors and nonexistent controls has led to a temporary crisis of confidence, but these are just the growing pains of the nascent industry of decentralized financial services that’s here to stay. As the industry works through these issues without the intervention of central banks, the outcome will confirm the paradigm shift in banking, lending, payments and investments that many believe is well underway.
In the meantime, finding the right balance between decentralization and regulatory controls, without government overreach, is priority number one. “At Sprocket, we’re embracing radical ideas without abandoning conventional wisdom by bringing the regulators on the journey,” Sprocket’s Chief Marketing Officer Mollie Martin says. Innovation with prudent regulation is the hallmark of Sprocket’s value proposition, converging conventional banking with digital assets and decentralized finance on a global scale.
Come take a look at Sprocket. Come experience a new way to bank. sprocket.financial.
NO FINANCIAL ADVICE: This article is provided for informational purposes only and should not be interpreted as investment advice. All investments involve the risk of loss. Any reference to an investment’s past or potential performance is not, and should not be construed as, a recommendation or as a guarantee of any specific outcome or profit.
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