Bitcoin and the Austrian School: What About Inflation?

By MichDon | MichDon | 1 May 2020

Last week I wrote an article about bitcoin (BTC) and the Austrian school where the essence of the Austrian philosophy is discussed. The movement has also been compared to the Keynesian school and we have seen why Bitcoin and the Austrian school go together so well. This week I'd like to cover the topic of Inflation.

Bitcoin and the Austrian School: Inflation

For this part there is a controversial topic on the program: widening the money supply or inflation. At its core, the views of Austrian thinkers on widening the money supply mean that it does not advance society. But why not?

According to them, it only ensures a redistribution of wealth. In order to understand that, we must first establish the Austrian definition of money and then the function and role of money within the economy.

Ludwig von Mises, one of the greatest thinkers of the Austrian school, used the definition of money as "the easiest commodity to trade". The easier it is to resell a good without loss of value, the more suitable it is as money.

This is in line with the concept of salability devised by Carl Menger. The higher the degree of salability, the better a good is suitable as money. In line with the definition of Mises, salability sees the ease with which reselling a good can be done without losing value.

Money as a product

These definitions describe how a good can function as money. It must meet a number of conditions:

For example, a large network of acceptors is required. The more people accept a good as a payment method, the easier you can pay with it. Would you rather get your salary in a form of money that 100,000 people accept? Or one that 1,000 people accept? The larger the network of users, the more attractive and dominant the form of money becomes. In theory, this network effect should ultimately result in one form of money remaining. I therefore expect that the dominance of bitcoin over altcoins will continue to increase.
It must also be difficult to produce. The price of a good is a matter of supply and demand. In order to preserve the value of a good, the sudden increase in the supply is decisive. The big problem with fiat money is that it is not covered and that governments create billions of extra fiat money at the touch of a button. They are simply numbers in a database. The total amount of bitcoins has been set at 21 million and the schedule of the issue of new bitcoins has also been laid down in a proof-of-work protocol.

Definition

This is a somewhat simplified explanation of money according to the Austrian school, but we do have the crux of it. Money is a stand-alone category of goods. A category that is stable and durable and whose trade is easy.

Now that we have a basic understanding of the Austrian definition of money, we can discuss the role that money they believe plays within the economy. The total value of the economy, according to the Austrians, is the added social value of all goods (consumer and production goods).

Money falls into a separate category of goods that do not add social value to the economy. This is easiest to explain by means of an example.

Satoshi, Vitalik and Roger in one country

Suppose that the entire production of a country consists of one large cream cake, from which 10 tasty pieces can be obtained. Only three people live in the country. Satoshi, Vitalik and Roger. Satoshi has 10 bitcoin, Vitalik has 10 bitcoin and Roger has 10 bitcoin.

This ensures that the price of one pie slice is 3 bitcoins (30 bitcoins / 10 pie slices). Satoshi comes up with a way to magically create 10 new bitcoins. He now has 20 bitcoin and Vitalik and Roger still only 10.

Now the total money supply has increased from 30 to 40 bitcoin. The men do everything they can to buy as many pie slices as possible for themselves and therefore go to great lengths when bidding on the annual pie slice auction.

In theory, this would mean that the price of pie slices increases from 3 bitcoin per pie slice to 4 bitcoin per pie slice (40 bitcoin / 10 pie slices). Satoshi can now buy 5 with his 20 bitcoins and Vitalik and Roger have to make do with 2.5 points per person.

Higher prices and distribution of wealth

This simple example shows that increasing the money supply only leads to higher prices and a different distribution of the pie. In any case, it does not lead to a bigger cake. After which money partly loses its value. And the people who get first access to the new money will benefit the most.

In this example, Satoshi was suddenly able to buy more pieces of cake. The same process is currently going on around the world. Governments are pumping new money into the economy in hopes of stimulating it and getting it going again. However, this policy mainly has the effect of eroding the value of money.

In general, the wealthiest in society are the first to have access to the new money. And they want their property to yield the best possible return. To make it pay off, they invest it in real estate and shares, among other things, with the result that prices have risen to unprecedented heights in recent years.

Broadening the money supply: no effect

This is why Austrians believe that widening the money supply by governments has no effect. It only results in a different distribution of the cake, but does not make the cake bigger. Limitless money creation is at the expense of the salability of our money and makes it less able to fulfill the fundamental functions of money.

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MichDon

Crypto entousiast, father, taekwondo

MichDon

Crypto-enthousiast dad with an aim to try to inform readers of new and interesting projects, upgrades and updates to projects and of course any news of interest on the Crypto spectrum.