Demsetz concludes his paper by suggesting further lines of inquiry, for example intellectual property:

Consider the problems of copyright and patents. If a new idea is freely appropriable by all, if there exist communal rights to new ideas, incentives for developing such ideas will be lacking. The benefits derivable from these ideas will not be concentrated on their originators. If we extend some degree of private rights to the originators, these ideas will come forth at a more rapid pace. But the existence of the private rights does not mean that their effects on the property of others will be directly taken into account. A new idea makes an old one obsolete and another old one more valuable. These effects will not be directly taken into account, but they can be called to the attention of the originator of the new idea through market negotiations. All problems of externalities are closely analogous to those which arise in the land ownership example. The relevant variables are identical.

The analysis is compelling, both historically and logically. However, one of the difficulties with the Stiglerian “exists-ergo-optimal” type analysis is that it takes process for granted. The ordering forces that lead humans to realize optimal solutions given costs are simply assumed to exist. Thus, once the negative externalities of the commons outweigh the costs of instituting a set of rights, it’s practically inevitable that property rights come into being.

This is, of course, the primary Austrian critique of Chicago-style economics. These processes cannot simply be assumed, for their operation is part of the question. How can we assume that the lowest-cost solution will be obvious? Introducing information costs only deals partially with this problem; serendipitous discoveries or epiphanies are not “costly” but to a large extent unpredictable. Hence we see the necessity of the idea of entrepreneurship not only in an economic theory of the market, but in institutional analysis as well. Before any spontaneously adjusting forces can come into play, someone has to have the idea to privatize his property.

From here, several things can happen. The primal privatizer can privatize his own land, taking on the negotiating and policing costs himself and convincing others to join him. As he succeeds or fails, he will either get others to follow his example, or those whom he had initially convinced will abandon the project. The important feature here is, it doesn’t matter whether the institutional entrepreneur has the right reasons for doing something: his success or failure speaks for itself. In this way, the development of land rights in Northeastern tribes can indeed be said to be an institutional adjustment to a new optimum.

But this is not the only way institutions are shaped. If the tribal leader suddenly makes a change to the set of property rights heretofore enforced, and if he has a police force to do so, the adjusting forces are seriously weakened. Here, it matters a great deal if the leader uses right reason: a suboptimal decree can only be overturned when its costs outweigh the costs of overturning his rule (whether by changing his mind or deposing him), and an entrepreneur exists to accomplish it.

Thus we would expect socially optimal property rights to emerge from something like a common-law or polycentric system, with small jurisdictions and many examples to follow. The Indian tribes had nothing resembling modern political authority structures, so one could reasonably expect their customary rights to be somewhat optimal. There is no reason, however, to expect statutory rights under a central political authority structure to be anything close to optimal. Democratic deliberation has much higher information costs than experimentation.

Thus we return to intellectual property. Intellectual property rights are by necessity statutory. They require wide police powers over a large area, an area which must become larger as the costs of information reproduction decline in they are to be effective. Hence we see the United States government pressuring foreign governments to adopt its own stricter intellectual property laws, since with practically costless reproduction over the internet, their laxer laws render its own ineffective.

There is simply no way for intellectual property rights to arise without a central and far-reaching decree. Without that, they are unenforceable. Self-defense of one’s intellectual property is a nonsensical idea. One cannot mark off an intellectual boundary and police it, and negotiation would be useless without the consent of every potential violator. To defend intellectual property requires a police apparatus and a central authority, making it practically impossible that such laws could ever reflect a social optimum in the same way that land rights did for the Indian tribes.

Intellectual property laws increase the incentive to create by hindering the ability to improve. By hinting at the former and ignoring the latter, and by ignoring the processes by which the contours of rights emerge, Demsetz is able to treat intellectual property as if it were “closely analogous” to land property, and as if “the relevant variables are identical”. In fact, the relevant variables between these two cases are not the costs at all, but the processes.

This is the saving grace of piracy, that it adjusts our economy to changes made necessary by technology. Despite desperate attempts to stop the hemorrhaging with legal band-aids like the DMCA, ACTA, a number of copyright term extensions, and most recently SOPA and PIPA, the market continues to adjust around them. There already exists a professional class of distributors – “pirates” – which are taking over the markets of the old distributors with increased efficiency and variety. As the old habits of physical distribution become more and more anachronistic, jobs will move from the old distributors to other places where they are more needed. Unemployment will not rise with the demise of the intellectual property industry, even in the short term, because piracy will have already adjusted our economy to the new state of affairs.

This is indeed the saving grace of speculators, entrepreneurs, and anyone whose business it is to predict the future: they change the market to reflect changed or changing conditions. They give us soft landings instead of hard crashes. The price rises they appear to cause in fact cause us to save in anticipation of a shortage. Changes in supply and demand will happen with or without speculators and entrepreneurs; the only question is, will they take us by surprise, or will we be prepared?

Thus the proliferation of anti-piracy laws serve only to leave the world economy brittle and ill-prepared for the changes being brought about by advances in technology. If there is mass unemployment resulting from the demise of the intellectual property industry, it will be because they have used the strong arm of government to prevent the necessary adjustments in the economy from occurring beforehand. If their predictions pan out, it will be their fault.

It’s come to my attention that Peter Leeson has a book by the same title as this post. But that book is about real pirates, so I will keep the title.

The idea of coercion is central to many strands of Libertarian thought, held up as the summum malum and opposed to voluntarism. But to actually define coercion precisely enough to build a political theory on it is a bit trickier. In general, definitions can be grouped into two broad categories:

1) Rights-based definitions
One starts with a series of rights, and coercion is defined as the violation of these. Such a definition, however, just moves the problem to the definition or delineation of rights. Natural rights don’t stop the buck; their assertion must be backed up with a further “why”. Nor is the distinction between positive and negative rights viable as anything but a rule of thumb.

The problem may be solved by the empirical (or evolutionary) natural rights approach, in which rights evolve through institutional selection toward the best bundle. In doing so it makes irrelevant many classic moral dilemmas. This evolutionary process is in fact thwarted by the kind of rationalistic philosophizing used in traditional rights theories: to derive and institute a set of rights from pure reason erases all institutional memory. The consistent application of a rationally derived ethical theory to edge cases¹ is profoundly dissatisfying, and awkward to explain away. The margin at which any ethical principle becomes inappropriate is a question only such a process can settle (which suggests that such ethical theories are not axiomatic and cannot be derived from pure reason).

If, therefore, rights are defined or found to include life, liberty, and property, then coercion is identified with aggression, and comports with the classic Libertarian treatment. If (according to the various theories of rights, respectively) reason were to show or institutions prevailed in which employment were a right, then to threaten termination would be coercion as well. And in Finland, the threat to terminate internet service would count too. In short, the concept of coercion is exactly as clear cut as the theory of rights behind it.

2) Rights-prior definitions
Alternatively coercion can be defined as a thing-in-itself, without reference to rights.

[W]e are tempted to define “coercion” by the use of such terms as “the interference with legitimate expectations,” or “infringement of rights,” or “arbitrary interference”. But in defining coercion we cannot take for granted the arrangements intended to prevent it. . . . Coercion not only would exist, but would be much more common if no such protected sphere existed [i.e. if there were no rights]. Only in a society that has already attempted to prevent coercion by some demarcation of a protected sphere can a concept like “arbitrary interference” have any meaning.²

Hayek identifies the first definition with “arbitrary interference”, but maintains the concept of coercion itself as something independent of rights and institutions. But an independent definition comes at the cost of clear delineation between “coercion” and “not coercion”. Notwithstanding the (not unproblematic³) examples earlier in the chapter which read as an attempt to draw such a line,⁴ Hayek admits that “coercion is, in the last resort, a matter of degree”⁵. Any definition independent of a clear-cut series of rights permits only that more or less severe coercion be spoken of.

Hayek’s own definition, being subjected to the arbitrary will of another, is problematic for Libertarian theory. For many things subject us to the arbitrary will of another which a natural rights theorist would not consider coercive. To return to the threat of termination, this sanction is great enough that the employee is generally pliable under the direction of his superior, even to be directed to do specific things, something Hayek indicates as a sine qua non of coercion.⁶ The employer need not be a monopsonist to exercise a great deal of control this way. And given his admission that a monopolist of necessities may be coercive (see footnote 3), it would be somewhat inconsistent to call the threat of termination noncoercive.

Indeed, from the perspective of the employee, for the purposes of his action the employer is not much different from a government. Yes, one can find another employer, but one can also leave the country. The fact that the latter is usually much more difficult only shows again that the difference is one of degree, not of kind.

Coercion’s opposite therefore, voluntarism, must likewise be a matter of degree. Hayek refers at the beginning to the case where “my handed is guided by physical force to trace my signature”,⁷ somehow distinguishing this from “coercion proper” by the fact that one has not acted, but treating it as essentially the same. It would perhaps be more apt to call this perfect coercion, in that all options but one have been removed from the array of choices. Further down the scale are situations he calls the more severe forms of coercion – the threat of physical force. “While we may pity the weak or the very sensitive person whom a mere frown may “compel” to do what he would not do otherwise, we are concerned with coercion that is likely to affect the normal, average person.”⁸ And below his threshold of relevance to policy lie voluntarily entered coercion: “A morose husband, a nagging wife, or a hysterical mother may make life intolerable unless their every mood is obeyed. But here society can do little to protect the individual beyond making such associations with others truly voluntary.”

But as we have seen, “voluntary” must be as much a matter of degree as coercion. If there is no “true coercion”, then there is nothing “truly voluntary”. We are all forced to a greater or lesser extent to adapt our actions to the outside world. In another work Hayek even speaks of the “impersonal coercion” of the market.⁹ His argument appears to be that a line is impossible to draw, but we have to draw one somewhere. Perhaps the impossibility indicates instead that the justification for liberty must rest on a more solid foundation than its juxtaposition against coercion. To thus define liberty as the absence of coercion is, as he (rightly) accuses John Stuart Mill of doing in On Liberty, and for the same reasons, to “overstate the case for liberty.”¹⁰

As a final note, Coase saw the firm as an island of central planning in a sea of voluntary market operations. In the same way, we might see the morose husband and nagging wife as islands of coercion in a more broadly voluntary system. Besides identifying the poles at a particular level, the distinction between planned and emergent must also be a matter of degree, for even a truly free market is made up of many plans. Even a series of planned economies could conceivably arrive at some sort of emergent order (market-like, though not a market) from competition with one another. Hayek’s vision of pervasive small-scale coercion existing within and supporting a broader voluntary framework is the more general version of Coase’s vision, generalized outside the firm and stripped of the language of intention. The firm centrally plans by coercing, in a sense, and coerces in order to plan.

It is misleading therefore to rail against coercion as such, as Mill did in On Liberty, and as Hayek does in The Constitution of Liberty. Mill saw that social opprobrium, for the purposes of human action, is not essentially different from coercion by force. Hayek saw that the obliteration of this distinction inevitably led to the centralization and expansion of coercion to prevent the smaller forms. But neither was willing to conclude that coercion as such is not the problem. Coercion in a sense exists everywhere we are required to adjust our actions to the existence of others. Economics should teach us, therefore, to look for an optimum at the margin, and to seek institutions which may approximate that optimum through spontaneous processes. A categorical opposition to coercion is ultimately a poor foundation for a political philosophy.

1. The classic example for the non-aggression principle is the misanthrope whose genome fortuitously contains the cure for cancer. Unfortunately he will not part with a single hair for any price, and it would violate the non-aggression principle to retrieve it against his will.
2. Hayek, F.A. The Constitution of Liberty (1960), p. 139.
3. For example, in the discussion of resource control (Ibid., pp. 135f), any line between the “coercive” water monopolist and the “noncoercive” portrait monopolist must be arbitrary. Necessity is relative.
4. For example immediately prior to the initial discussion of the coercive monopolist he says “Coercion should be carefully distinguished from the conditions or terms on which our fellow men are willing to render us specific services or benefits,” as if there were indeed a clear categorical line (Ibid., p. 135). Later he speaks of “true coercion” (p. 137) implying the same thing.
5. Ibid., p. 146.
6. “So long as the act that has placed me in my predicament is not aimed at making me do or not do specific things, so long as the intent of the act that harms me is not to make me serve another person’s ends, its effect on my freedom is not different from that of any natural calamity.” (Ibid., p. 137) The employer-employee relationship would appear to satisfy both these conditions of coercion.
7. Ibid., p. 133.
8. Ibid., p. 138.
9. Competition as a Discovery Procedure (1968).
10. The Constitution of Liberty, p. 146.

Yesterday I looked briefly at Bitcoin in the context of various conceptions of money. Today, with the benefit of having an actual Bitcoin economy to look at, I’d like to expand on that with a more thorough analysis, and some prediction thrown in for good measure.

First of all, as a commenter pointed out on the last article, a strict distinction between token money and specie money is, well, specious. Hayek explains in A Free-Market Monetary System:

I have said that it is an erroneous belief that the value of gold or any metallic basis determines directly the value of the money. The gold standard is a mechanism which was intended and for a long time did successfully force governments to control the quantity of the money in an appropriate manner so as to keep its value equal with that of gold. But there are many historical instances which prove that it is certainly possible, if it is in the self-interest of the issuer, to control the quantity even of a token money in such a manner as to keep its value constant.

That is to say, if the subjective theory of value means anything, “unique cryptographic hash” is not inherently less valuable than “shiny rock”, even if it has no representation in physical space. Each has only the value that people give to it.

In fact, Bitcoin has more in common with gold than the Dollar, even as a virtual currency. By definition a Bitcoin is “found” rather than “created” – a value is found whose hash satisfies a certain criterion. And since there are only 21 million or so solutions to the problem, there can never be more than 21 million or so Bitcoins. Solving the problem and finding new Bitcoins is even called “mining”, an analogue to gold. Dollars are created; gold and Bitcoins are found. The total stock, therefore, is subject to no one’s discretion.

Predictions for the Mature Bitcoin Economy

The strong parallels between gold and Bitcoin, both praxeologically and historically (detailed below), mean that the history and theory around gold can give us a pretty good idea of the future of Bitcoin.

Most of Bitcoin’s naysayers focus on its price-deflation. Even though the stock of Bitcoins will inflate until it hits 21 million, this inflation has not kept up with, and will not likely increase to match, the demand for Bitcoins – hence price-deflation.

As far as cycle-inducing distortions go, it’s stock-inflation relative to money demand that matters. The boom preceding the Great Depression, for example, saw a huge dollar stock-inflation at the same time as a slight price-deflation,¹ the difference being mainly due to productivity gains. Of course, if we are to be strict on this count, even gold mining in a gold-backed economy can cause inflationary booms and busts.²

Now price deflation is certainly not the death spiral bugaboo that the Keynesians imagine, and it is certainly necessary in recessions for the economy to readjust after an inflationary boom. But neither is it hunky dory in a healthy economy. Stable prices are a good,³ however foolish it would nevertheless be to buy it at the cost of inflation.

We could expect, then, that if government pressure eases to where formal institutions can form around Bitcoin, that its development will follow gold’s, so far as the latter was free from hindrances to its spontaneous evolution.⁴ We will likely see fractional-reserve Bitcoin banks which begin to lend in their own Bitcoin-convertible currency. Establishments dealing in Bitcoins could then accept Bitcoin deposits as easily as Bitcoins themselves.

This of course has its advantages and drawbacks. It centralizes transactions, which gives governments an easy target should they become hostile again. The privacy of transactions reverts to the old model described in the Bitcoin Whitepaper.⁵ However, with fractional-reserve lending able to quickly match the money supply with fluctuations in demand, much price-volatility could be avoided, even with a steadily falling median price level.⁶ No doubt the formation of banking institutions around the Bitcoin economy would on the whole be a great boon to its acceptance, as its price-volatility is one of the main factors preventing more general use. This price stability and accommodation to money demand will lead to Bitcoin notes or Bitcoin deposits superseding actual Bitcoins in transactions, much as banknotes standing for a certain amount of gold superseded gold coins – and not just for the convenience of carrying them.

And Bitcoin has an added advantage over gold in that the transfer mechanisms will be nearly costless. Mechanisms sprung up during the gold standard era to limit the amount of actual gold transported to settle accounts (some benign, some malign), but as long as any gold is transported for the purpose of settling accounts, a virtual settling will cost less, freeing scarce resources for other endeavors.

Will History Repeat Itself?

So far, we have Bitcoin following a pretty familiar path: from currency itself, to mainly reserves for other currency. But gold’s history has its sordid moments – from debasement, to centralized reserves, to the outright repudiation of convertibility. How do we know governments won’t simply monopolize the printing of Bitcoin notes, and eventually, repudiate the “Bitcoin standard”?

The possibility becomes even more worrisome considering that concentration of Bitcoin servers, as might happen if it became a reserve currency, increases the chance of fraudulent transactions. The current network is based on the assumption that an attacker will never be able to out-compute all the honest nodes. If the majority of computing power on the Bitcoin network is controlled by a few banks, it would be a much simpler task to harness more than half the network’s power to generate fraudulent chains, which would then be accepted as legitimate by the other servers according to the Bitcoin protocol. And if somehow a central bank were established warehousing a majority of bitcoins, such an institution could unilaterally reverse transactions. And of course, a fractional-reserve monopoly has an almost unlimited power to inflate, even with non-inflationary specie.

There are two main factors preventing this – a short-term and a long-term factor. In the short term, the cost of moving an entire economy to a different currency is huge. More feasibly, even the process of adjusting a currency to a certain parity to achieve convertibility can be very painful, economically and (especially) politically, as Britain found out while trying to achieve pre-war gold parity for the Pound after World War I. Governments will therefore be more likely to busy themselves fighting Bitcoin head-on rather than adopting it, which ironically, is Bitcoin’s better chance for survival. By the time it becomes apparent that saving the old currencies is a lost cause, governments will hopefully have lost the means or the will to reconstitute their monopolistic currencies in Bitcoins.

In the long term, however, even in the worst-case scenario where a government decides to back its currency with Bitcoin and all Bitcoin reserves flow to a central bank, Bitcoin’s power is its non-uniqueness. Change a few parameters of the cryptographic functions and you have an identical replacement for Bitcoin. Change the number of zero bytes required at the beginning of the hash and you control how many total coins can be found. Gold’s vulnerability was that it had few alternatives: silver, and in a few cases copper. All of these are relatively easy to identify and monopolize. The strength of a virtual currency is that you can create a nearly infinite variety of them. If in fact Bitcoin’s 21 million coin limitation proves inconvenient or if its hash function is broken, it can fall out of use as another cryptocurrency with more solutions and better cryptography takes its place, either in transactions or as specie. And most importantly, if one becomes too centralized, people can opt for – or create – a new cryptocurrency easily enough.^{7 8}

Conclusion

Though Bitcoin is indeed a technical solution to the problem of money, its main strength is institutional. Could we design a system from the ground up without worrying about incentives or politics, gold would suffice just fine – and did for many years – despite minor drawbacks of resource cost. Given a choice between gold-backed freebanking and Bitcoin-backed freebanking, each has minor advantages and drawbacks, but nothing which would tip the scale definitively one way or the other.

However, given institutional and political realities, the limitations of gold become apparent. Despite the demonstrated beneficence of a gold monetary standard, it’s all too easy to centralize reserves and “cheat” the system for political gain. Bitcoin, though it behaves economically very similarly to gold, is by nature institutionally much more robust, because it is more replaceable. There are clear reasons to prefer gold over silver, or one physical commodity over another, but there are not necessarily any such reasons to prefer one cryptocurrency over another. This very fact makes it very easy to “escape” should the cryptography of a series of currencies be compromised, or should a government attempt to monopolize or centralize reserves.

1. Rothbard, Murray. America’s Great Depression (1965).
2. Also cited in Hayek vs. Rothbard on Free Market Money. Ludwig von Mises, Human Action (1949, 1996), p. 414: “Changes in the money relation are not only caused by governments issuing additional paper money. An increase in the production of the precious metals employed as money has the same effects.”
3. That is, a stable median price; not necessarily stable particular prices. Hayek in Denationalisation of Money, p. 73 argues that “a known median from which individual movements of prices were as likely to diverge in the one direction as in the other” is necessary for long-term capital and cost accounting.
4. Bitcoin has several advantages over gold here – for example, it cannot be debased.
5. Satoshi, Nakamoto. Bitcoin – A Peer-to-Peer Electronic Cash System, section 10. That is, privacy of transactions will again have to rely on bank secrecy. This is not a clear step forward or backward with regard to privacy, however, and will depend on the preferences of the people using Bitcoins. As they gain wider acceptance, however, people used to current-model banks will more than likely be satisfied with the bank-secrecy arrangement.
6. See figure two in Selgin, George. “Central Banks as Sources of Financial Instability” (2010) in The Independent Review 14.4. With a flexible and relatively free banking system, Canadian banks in the 1880s and 90s were able to adjust currency supply to accommodate seasonal demand, and thus avoided numerous recessions that plagued the US, which had a smoother money supply, during that time.
7. This process would be essentially analogous to a run on the bank. A severe credit contraction would occur in the disfavored currency as people redeemed their deposits, and the Bitcoins themselves would plummet in value as they were traded for an alternative cryptocurrency.
8. This does not constitute inflation of the money supply, for the very idea of “the” money supply presupposes a one-currency economy. This presupposition does not apply in a world of competitive cryptocurrencies. We can only speak of the supply of particular currencies.

It was the failure of Rothbard to distinguish between prediction and prescription in Hayek’s work that led him to reject Hayek’s predictions on what free-market money could look like.¹ It is this important distinction which lets us imagine the reactions of the two men to a very new monetary development – Bitcoin – even though it looks nothing like either of their predictions.

First, let’s look at the main schools of Austrian thought as to what free-market money would look like:

• Rothbard: 100% reserve specie-backed money issued by banks, which leads to continuously falling prices.
• Selgin: Fractional reserve specie-backed money in a competitive free-banking economy.
• Hayek: Competitive token money based on a “market basket”, with the goal of general price stability.

All of the analysis that then follows is only ever conditionally valid – that is, if these particular monetary arrangements come to pass

There are, of course, pretty safe predictive bets, which the theories have in common. A central bank could not exist in a free market. Without legal tender laws, there will be some degree of competition among currencies. And all of the theories involve banks issuing currency. Pretty solid assumption, right? How else could it be done?

Enter Bitcoin. Bitcoin is issued by no bank – made possible by advances in peer to peer networking. It is completely decentralized. It is not backed by hard specie, and yet it is noninflationary – made possible by advances in cryptography applied on several levels. It is nearly impossible to create illegitimate coins (though “mining” is possible by hashing values, but the electricity costs make it generally not worth the investment), and the possibility of fraudulent transactions decreases with the number of people connected to the network.² That is, as the value of the Bitcoin goes up, the possibility of fraud should diminish.

The technology which allows Bitcoin to exist is very new. And since computational cryptography and monetary economics haven’t typically had much to do with one another, it wouldn’t be very fair to fault any mid-century economist for failing to predict its possibility.

Bitcoin should demonstrate then that monetary arrangement is a technical problem – not something which can be deduced a priori. We can say certain things about certain types of money a priori, but the economist can no more talk about the absolute “best” type of money than he can about the “best” type of computer chip. An iMac is obviously a better computer than ENIAC, but it would be foolish to rule out further innovation in the field for this fact. And of course, a state monopoly is no better at solving technical monetary problems than it is at solving technical industrial problems. Things can plod along passably well (as economies have done since the rise of central banking), but it’s still no substitute for market innovation and competition.

The fundamental difference between Hayek and Rothbard then, is that Hayek believed money to be a technical problem, best solved by the market, where Rothbard believed it to be an institutional problem, best solved by an economist. This is why the vagueness of Hayek’s predictions and their allowance for human discretion in regulating monies seemed distasteful to Rothbard. And this is why, even though it comports with neither of their predictions, Hayek would welcome Bitcoin into the market, where Rothbard would scorn it.

In fact, Bitcoin takes the denationalisation of money a step further than Hayek did. Where Hayek’s system requires government to remove legal tender laws and Rothbard’s requires governments to return to the gold standard, cryptocurrencies like Bitcoin have no such political prerequisites. There is no bank to shut down, no specie to seize (the downfall of the ill-fated Liberty Dollar) – nothing at all for governments to aim at, except individual users. And as the war on internet piracy should demonstrate, such a campaign cannot be other than costly and ineffective.

In short, if we believe the recurrence of inflationary cycles is a problem too urgent to leave to the political process, Bitcoin could be our best bet in the fight to divest government of its monetary monopoly.

1. Rothbard, Murray. “The Case for a Genuine Gold Dollar” (1985). In The Gold Standard: Perspectives in the Austrian School (1992): “It would have to be imposed (to use a derogatory term from Hayek himself) as a ‘constructivist’ scheme from the top, from government to be inflicted upon the market.”
2. See the Bitcoin whitepaper by Satoshi Nakamoto, especially section 11.