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What Is the Connection Between Bitcoin and Austrian Economics

What Is the Connection Between Bitcoin and Austrian Economics

Explainers Cryptocurrencies

08 Mar 2021

Nearly everyone in the crypto community knows what Bitcoin is as well as how cryptocurrencies and the underlying blockchain technology work. However, there's an interesting connection between Bitcoin and the Austrian school of economics that most people are not familiar with.

The world's top cryptocurrency and Austrian economics share a very similar ideology, which for those who hold strong opinions about today's economic setup might be very appealing.

In this article, we will explore the Austrian school of economics and its main principles while investigating its connection with Bitcoin.

What Is the Austrian School of Economics?

If you think economics can only be boring, then you should take a look at the Austrian school.

Unlike mainstream economics (e.g., Keynesians or the neoclassical school) where data and mathematical models are used to prove a point objectively, the Austrian school of economics utilizes the logic of priori thinking.

Referring to coming up with a new idea without relying on external sources or the outside world, Austrians use priori thinking to reveal economic laws that can be applied universally.

Originating from Vienna, the Austrian school of economics dates back to 1871 when economist Carl Menger published his Principles of Economics book.

In the book, Menger stated that the economic values of products and services are subjective, meaning that something can be more valuable to you than it is to your friend or a neighbor. The author also argued that the subjective value of a good decreases for an individual upon increasing its supply.

Soon after Menger's book, the Austrian school of economics was formed, with prominent names including Ludwig von Mises, Eugen von Bohm-Bawerk, and Friedrich Hayek.

While the school's original center was in Vienna at first, its influence has now spread across the world.

What Are the Main Principles of Austrian Economics?

Before we deep-dive into its connection with Bitcoin, let's first explore the Austrian school of economics's main principles.

Price Determination

According to Austrian economists, prices are determined using subjective factors, such as someone's preferences whether or not to purchase a product.

This theory contrasts what the mainstream school upholds, namely that the equilibrium of supply and demand is the main factor behind determining product prices.

Capital Goods and Market Creation

Austrians believe that capital goods – physical assets used to manufacture goods for consumers – are not homogenous, meaning that one tool (e.g., a hammer) can't be replaced with another (e.g., a saw).

In contrast, Keynesian economics doesn't take this into account when calculating the output (by multiplying capital with labor), which can lead to economic waste by failing to create the right capital goods, according to the Austrian school.

Austrians also argue that markets are not created by a conscious decision; instead, it's the outcome of a process.

For example, people stuck on a deserted island are likely to create a market mechanism at some point by interacting with each other to improve the quality of their lives.

Interest Rates and Inflation

The classical view of capital argues that the supply and demand of capital is the factor behind determining interest rates.

On the other hand, Austrians believe that borrowers' and lenders' subjective time preference – to spend money now or later in the future – is used for determining interest rates.

For example, if individuals are increasingly saving money, it's a signal that they are reducing their consumption and they will have more funds available to spend in the future.

Austrians have also shared their views on the impacts of inflation. According to them, an increase in the money supply not supported by an expansion of goods production will lead to inflation.

However, the school believes that the price increase of different goods varies during inflationary periods, with some products' value surging faster than others.

Business Cycles

One of the most important principles of Austrian economics is the theory of business cycles.

According to the school's thinkers, business cycles are created artificially when the government adjusts interest rates in an attempt to control the money supply.

Austrian economists believe that a recession will occur when capital is misallocated due to the government's intervention to keep interest rates artificially high or low.

When capital is allocated into an inappropriate industry (e.g., construction and remodeling during the 2008 financial crisis), a short-term business adjustment must be made to redeploy labor and investment into more viable sectors from an economic point of view.

As a result of a short-term business adjustment, real investment will fall and unemployment will grow significantly, triggering a recession.

To avoid a recession, governments may decide to (further) decrease interest rates or provide support to failed industries. However, according to Austrian economists, doing so triggers increased malinvestment, making the recession's impacts on the economy even worse.

What Is the Connection Between Austrian Economics and Bitcoin?

In summary, Austrian economists believe in a free market, opposing intervention from governments while encouraging full economic freedom for individuals.

Also, the thinkers of the school argue that recessions are triggered by central banks that seek to keep interest rates artificially low or high.

It seems like the 2008 financial crisis has proved the Austrians' points as the Federal Reserve's easy money policy, artificially low interest rates, and lack of proper real estate regulation was behind the economic downfall and the recession after.

Similar to what the Austrian school of economics believes in, Bitcoin also promotes financial sovereignty as well as increased privacy and freedom from third-parties, such as banks that have been dominating the traditional finance industry.

Furthermore, Bitcoin was created in 2009 in the wake of the global financial crisis. In fact, BTC's genesis block (the first block ever generated in a blockchain network) included the dated title of a The Times article about the second government bailout of banks during the 2008 crisis.

Also, unlike fiat money, no one can tamper with the Bitcoin supply as the cryptocurrency's maximum supply is capped at 21 million coins and uses a disinflationary mechanism (the halving event) that cuts the new BTC mined in every block to half.

For that reason, in a theoretical case when Bitcoin gets adopted as the world's reserve currency, governments would be unable to artificially distort the money supply. From the perspective of Austrian economists, this would minimize (or completely eliminate) recessions triggered by governmental intervention.

Furthermore, like gold, Bitcoin qualifies as sound money according to the Austrian school of economics.

Since Bitcoin and Austrian economics share very similar principles and ideologies, many followers of the school were attracted to the crypto space.

Bitcoin and Austrian Economics Remain Interconnected

Bitcoin and Austrian economics share the same values: opposition to governmental intervention, financial sovereignty, and free banking.

For that reason, even though Bitcoin is now rather used as store of value rather than a peer-to-peer (P2P) electronic payment system, the crypto community and the Austrian school of economics are interconnected, and as Bitcoin continue to evolve into and become suitable as a medium of exchange and unit of account, only then will we really know the impact and of this ongoing paradigm shift.

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