Austrian economics is a scholarly tradition that consists of a body of theory that explains how an economy works. Austrian economists develop theory a priori, meaning explanations are derived logically from sound starting points (i.e., the “action axiom” to Mises). This means the theory is true and can therefore be used to uncover the actual causalities behind observable phenomena. Economics is, therefore, to “Austrians” a framework for understanding what we see.
Other traditions in economics rely on data to formulate theory, which means their theory is a set of corroborated hypotheses. They thus make a much weaker claim because the data analyzed are always a selection (a sample, not an entire population), the measures and metrics are not the actual concepts but mere proxies, and the theory is about correlations not causal relationships. Such theories are neither true nor universal.
Because it is a priori, Austrians can rely on their economic theory as a framework to interpret and understand what is going on in the economy. This is why Austrians can say without any doubt that, for example, credit expansion—an increase of the money in circulation—will cause market prices to increase if nothing else changes. However, Austrian economic theory cannot tell how quickly this happens or what exact prices will be affected to what extent. Only that this must be so.
This also means that Austrian theory is much narrower in scope than mainstream economics. Whereas the latter presumes to develop “theory” to explain anything that is related to the data at hand, such theory can and will be debunked (falsified) whenever data are collected that point in another direction. Austrians cannot and do not go beyond what can be derived logically, which means economic theory remains true, but also cannot be used to explain specific phenomena in detail or predict precise outcome magnitudes (such as “measured price inflation next year will be 4.6 percent”). Austrians do predict, but only using established causal relationships. Austrian theory disallows predictions that are quantitative or state exact times.
The Meaning of Money
As Austrian economics is theory and deductive, definitions must be clear, concise, and used consistently. It also means some phenomena that we rely on in everyday interactions that are quantitative in nature do not have unambiguous definitions. “Money” is such a concept, which is defined as that medium of exchange that is commonly accepted (i.e., universally used). Bitcoin is certainly a medium of exchange, but many things are. Bitcoin has also become much more widely used as a medium of exchange, but it is not yet money. That “many” stores accept Bitcoin as a means of payment is not quite enough and neither is that many of your friends accept it for paying what you owe.
A money is what you can use to exchange for things without having to search for those who accept it. A money also doesn’t need to be converted to some other medium of exchange (such as dollars or euros) to buy things.
It is also not any “properties” of the thing that is a medium of exchange that makes it money. Mainstream economics confusingly teaches that money typically has certain properties such as divisibility, fungibility, and a store of value. Those are indeed common (and perhaps important) functions of the money good, but are not what makes it money. What makes something money is that it is used as a medium of exchange and that it is rather universally accepted as such. It is money’s moneyness that makes it money.
Carl Menger explained what money is and where it comes from in his essay “On the Origins of Money” from 1892. He notes that barter trade (direct exchange) is difficult and costly, which means there are great gains available from using indirect trade to exchange for what you want. If I have apples to spare and would love some oranges, whereas you have oranges but don’t want apples in exchange, then we cannot trade directly. However, if you would accept bananas and someone else has bananas and will accept apples in exchange, then I can trade my apples for bananas and then bananas for oranges—even if I have no personal use for bananas. In other words, bananas here serve as a medium of exchange.
Menger notes that goods have different saleability (marketability) in the economy, which means some goods are more widely accepted in exchange (demanded) than others. It may be that pears can be used instead of bananas and that pears also are useful if I wish to trade for bread and eggs. But the sellers of bread and eggs may not accept my apples or bananas (or even oranges). This means I would be better off trading my surplus apples for pears to then exchange them for what I want. Both bananas and pears in this case are media of exchange, but pears have the greater saleability.
He goes on: because pears have greater saleability, more people will trade their goods for pears and, therefore, its demand as a medium of exchange greatly increases. This, in turn, makes it even more useful as a medium of exchange. At some point, most or all people in an economy will trade goods for pears. This is when pears become money.
The example may be clear, but it is ambiguous when exactly a medium of exchange becomes money. Thus far (in November 2024), Bitcoin is not generally money. But it may be money in some specific circumstances or groups.
The Regression Theorem
Monetary theory is not complete simply because the meaning and usefulness of money have been established, however. We must also explain the value of money. Simply put, money is worth what it can purchase, which means money has many prices (as many prices as there are goods it can be used to purchase) that change over time. The question is, where does this value as a medium of exchange come from—what determines it?
Ludwig von Mises wrestled with this question and answered that people’s demand for money (meaning they are willing and able to give up goods for cash) is based on their expectations of its purchasing power. We choose to hold money because we expect to use it in exchange. We base our expectations on what it will buy in the future (“tomorrow”) based on what it buys in the present (“today”). The same thing happened in the past (“yesterday”): we formed expectations about money’s purchasing power today based on what it could buy yesterday, and so on.
Mises showed that this does not constitute an infinite regress but that there must logically have been a starting point—a time before the money-good was money. In the example above, I place value in bananas not because I want bananas, but because I expect to be able to use them in exchange. I speculate on the use and value of bananas as a medium of exchange and I base my hunch on what I’ve heard about (or from) the person with oranges. Because pears turn out to be even more saleable, I value them higher than bananas as a medium of exchange and, therefore, sell my apples for pears instead. When “everybody” uses pears for exchange, they are money. And they are valued because of their expected purchasing power.
By logically going back in time, we can see that pears-as-money have much greater market value than pears-as-consumption good (before it was money) because it is money—its demand is much greater because people use it as a go-to medium of exchange. How much greater? This can be answered by noting the difference between the demand (and thus market price) for pears when it is money and the demand for pears as a consumption good (when it is not money).
The same is true for bananas although they never became money. Because I expected to be able to use bananas to exchange for oranges, I valued (and demanded) bananas and sold apples to acquire them (even though I did not want to consume bananas). Because bananas were a medium of exchange, market demand (and therefore price) increased.
Back to Bitcoin
How does this apply to Bitcoin? Theory is used to uncover and understand what is actually going on. Bitcoin is certainly a medium of exchange, but it is not yet money. Some (perhaps many) expect it to become money, and therefore acquire it. This increases its demand. Many others invest in Bitcoin as an asset, speculating that it will go up or at a minimum not lose value. This also increases its demand. But there is a difference between being in high demand and being a money: the latter implies the former, but the former does not imply the latter. High demand only means higher price, not that it is therefore generally accepted and used as a medium of exchange.
Many things are in high demand, but are not therefore media of exchange, but instead used as, for example, consumption goods or assets. The former because they directly satisfy our wants and the latter because they are expected to serve as stores of value (stable or increasing). Our demand for money (cash) is neither for consumption nor as a speculative asset—it is (primarily) to be used in exchange. In other words, we demand (and acquire) money to get rid of it. It’s a means to get what we really want—it is a medium of exchange.
We can apply this reasoning to “holders” of Bitcoin, who sell their fiat currency (cash) or take out loans in it in order to acquire Bitcoin, which they then hold as an asset. Perhaps the intent is to use it in exchange when it becomes money or just to ride the tide (or bubble, depending on who you ask) to earn a speculative profit. In both cases, they do not use Bitcoin as a medium of exchange—they use the cash (dollars, euros, whatever) as a medium for acquiring Bitcoin.
The decision to buy-and-hold could (and does) increase demand for Bitcoin, but the same was true for toilet paper under the pandemic. That didn’t mean toilet paper became a medium of exchange. Even if demand for toilet paper had exceeded supply to such an extent that people engaged in black-market trade for it, toilet paper still would not have been a medium of exchange—only a highly sought-after good.
Certainly, high demand can lead to people using a good as a medium of exchange. But it is quite roundabout to buy-and-hold a good in order to increase its demand (and therefore market price) as a means for making it money. There are better and more effective ways. Including the obvious one: to use it in and for exchange, that is, to use it as money.
