The Great Depression was something spurred up from the very actions the government took to prevent it. To Austrian economists, if the Federal Reserve has handled the monetary policy differently, the entire situation could have been prevented. Now the way Austrian Economics piqued my interests is in the way they seem to value deflationary economies over Keynesian economics. Although by far the less popular form of thinking about the economy, it seems as those the deflationary characteristic of Bitcoin align well with the Austrian. Another evident similarity is that the very core ideology of Austrian economics is that governments should stay as hands off as possible and let the market reach an equilibrium with itself.

There’s a lot to discuss about how these two relate, but I wanted to focus on one specific aspect, and that is the regression theory that Ludwig Von Mises, a renown economist, used to apply the subjective theory of money to the objective-exchange value. In other words, he tried to explore the value of money. For products and services in a market, the price heavily depends on the supply and demand of whatever item in focus. Money, however, doesn’t fit into this model very well. After all, it isn’t a product that can be used, or a service that can be provided. Money is simply something that is traded for with the future prospect that someone else would likewise exchange for. The supply is taken care of as there is a “finite” amount distributed in a market, but you can’t possible attach a demand to money as it’s merely a proxy. Furthermore, currency such as silver and gold are different from the type of currency in discussion since they themselves can be melted down into a commodity that has demand. Gold and silver have both been used to make jewelry and home decor for centuries if not longer. This brings us to the main idea of regression theory, which is the idea of how currency must originate from a previous non-monetary state that had a meaningful value in society, thus the value today is derived from that previous value.

Perhaps to look at it in a different way in order to better understand it; Money seems objective in a way, since my $10 equals your $10. However, I could use my $10 to buy a nice meal, and you could use your $10 to buy a hat. The subjective value in this case might seem different. Mises’ view was that the objective value and subjective value must have been correlated at some point, so the value would be derived from the value as a commodity before it was a monetary use.

Now according to this theory, it’s understandable how the gold and silver standards came about, but is fiat currency in this same boat? What value as a commodity did fiat currency serve before it was fiat money? Obviously nothing since it’s simply paper and paper is undoubtedly abundant. So I’m just as confused as those who thought about this before me. How can such a thing still retain such strong “value” and why? Some people have taken a different view, for example, Hal Varian, who proposed that people give fiat value because of social acceptance. Based on the network effect, once some people adopt the currency, others will carry the same expectation. However, another Austrian economist Frank Shostak made a cogent objection to Varian’s explanation. “And yet that still doesn’t tell us why the dollar bill in our pocket has value. To say that the value of money is on account of social convention is to say very little. In fact, what Varian has told us is that money has value because it is accepted, and why is it accepted? . . . because it is accepted! Obviously this is not a good explanation of why money has value. To bolster his thesis Varian suggests that the value of the dollar is a result of the “network effect.” According to him, “Just as a fax machine is valuable to you only if lots of other people you correspond with also have fax machines, a currency is valuable to you only if a lot of people you transact with are willing to accept it as payment.”

Now who’s right? I certainly can’t say for sure. Fiat money seems like a paradox as it has no natural upbringing and clearly fails to satisfy the regression theorem. Well consider this thought experiment: A medium of exchange has to be accepted by someone else in order to carry some “value”. Without this key characteristic, fiat could not have inherent value. Some time in the future, although I can’t say how long, there will be a time when either the world is ending or some terrible disease kills off the human race. At this point, there will be no one to trade your money with. If this is an inevitable event, then it’s also inevitable that fiat will lose its value. Logically, backwards induction indicates that fiat must lose its value now.

To me the inflated “value” of fiat currency seems much like the Tulip bubble, and money is truly the perfect scenario of the greater fool theory. I don’t think Bitcoin is much different, but it adheres to a different set of rules than the current ones we have now. In a way both currencies are driven by extreme irrationality in terms of economics, created in a path dependent society that has no way of changing its ways (except over great periods of time). If this is the case with fiat, then we’re all playing the role of the fool, accepting money only with the false hope that there will always be a greater fool who will accept it. But in this case, I don’t see why people criticize cryptocurrencies. After all they’re one and the same, and neither has greater inherent value than the other.

There are other things to consider of course when determining which one is better. For example is fractional reserve banking really a big issue? And how much fraud is happening similar to what caused the 2008 crash? I don’t really think I’m qualified to say one’s better than another, but I will definitely keep exploring the topic.