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The Classical Economists on Gold

January 27, 2003

With the dollar down and gold up, both trends obviously related to growing fear of economic troubles ahead, the question again arises: why shouldn't the dollar itself be defined as a fixed quantity of gold? It would be if the views of the classical liberal tradition held sway. This tradition stands solidly behind a commodity money standard, like silver or gold, as the very embodiment of sound money.

Money must have value   

The general case for commodity money rests on the uncontestable assertion, repeated constantly by classical economists, that in order to fulfill the various functions of money, a thing must possess value. And because metals do have value, and a note of paper does not, it is then natural for a metal, which is also endowed with a number of other qualities, like being divisible, portable, cognizable, etc., to be the general medium of exchange.

On these grounds, John Locke already dismissed the idea of paper money, "because a law cannot give to bills that intrinsic value, which the universal consent of mankind has annexed to silver and gold."[2]

It is true that a promissory note, or any form of bank credit, provides the same functions as money does, but the explanation for this lies in the representative-of-money nature of the note, which, otherwise, would never be accepted in exchange.

David Ricardo goes as far as erecting this principle into a norm when he undertakes to "show what is the standard measure of value in this country, and of which, therefore, our paper currency ought to be the representative."[3] And for the norm to be respected, a strict redemption of paper in money, which can be nothing but a commodity, is necessary.

Under J.S. Mill's pen, the value argument against paper money achieves its most accomplished shape. If the paper currency is convertible at will into specie, then its value springs from the cost of production of the commodity money. This is not the case of "a paper currency not convertible into the metals at the option of the holder" whose quantity "can be arbitrarily fixed; especially if the issuer is the sovereign power of the state. The value, therefore, of such a currency is entirely arbitrary."[4]

Thus, the choice between commodity and inconvertible paper is that between determined or undetermined exchange value of the money. Therefore, clinging to commodity money is indeed the only possible choice, since any money must possess a determined value.

Classical economists thus rejected inconvertible paper money from the very beginning, because they thought it was lacking the most important attribute a thing must possess in order to be used as money, namely it was lacking value. This argument, of course, is not invalidated by the falsity of the objective value theory; the marginal revolution, to be sure, changes its content, but leaves its essence unchanged. In addition to their essentialist approach, and building their point of view upon a careful examination of the repercussions brought about by an increase of the stock of media of exchange in the economy, the classical liberals developed an equally convincing set of arguments against any augmentation of paper currency, convertible as well as inconvertible.

Paper money is harmful to the economy 

Prior to the analysis of the consequences driven by an increase of the stock of media of exchange is the very important classical consideration that the given quantity of money is immaterial for the functioning of the economy. David Hume explicitly states, "The absolute quantity of the precious metals is a matter of great indifference."[5] Ricardo exposes the futility of the quest for a optimal quantity of money, since "the smaller quantity of money would perform the functions of a circulating medium, as well as the larger."[6]

Having explained that whatever its quantity, money renders its services equally well, classical economists emphasized that the primary, and most important consequence of an additional quantity of media of exchange is the subsequent rising of prices, be it strictly proportional or not. And because rising prices produce a series of detrimental effects on the economy, these should not be engineered artificially by more paper.

For Hume, paper currency makes things dearer, and hence it hinders commerce, especially with foreigners who "will never accept" the "counterfeit money." The conclusion is then immediate, "it must be allow’d, that no bank cou’d be more advantageous than such a one as lockt up all the money it receiv’d, and never augmented the circulating coin, as is usual, by returning part of its treasure into commerce."[7] Richard Cantillon and Ricardo also stressed that paper currency, unlike commodity money, is of a serviceability limited to a narrow range of nationals, but Hume went as far as to state that great undertakings can be done conveniently only in specie, not in paper.

Ricardo pointed out that, because the paper currency arbitrarily depreciates the medium of exchange, the "equitable state" of the currency must be restored, by "the total overthrow of our paper credit" if necessary.[8] All other pernicious repercussions, like the instability and unpredictability of the future purchasing power of a paper currency, to be emphasized later by George Goschen and Dennis Robertson, are, as a matter of fact, deduced from this economic law that more credit in general, and more paper in particular, necessarily heightens prices.

The classical liberals were aware of, and disclosed in their writings, all the imperfections of paper currency; Ricardo did not omit even the uncertainty as to the future interest on public and private debts, potentially paid in a money of lower exchange value.

To sum up the second classical argument against paper currency: because the quantity of money in the economy is irrelevant, and since each increase of the stock of media of exchange produces harmful effects, the quantity of paper currency should not be increased beyond the amount of specie for which it is a substitute. Besides, the opposition to fiat paper money stems from the insight that in such a system the harmful effects are more likely to occur, since interested groups will push the money producer to abuse his power and to issue more money at others’ expense. The third argument for commodity money classical liberals expounded is an elaboration of this point.

Paper money: a threat to property rights   

Although they lacked a complete analytical system based on the concept of property rights, the classical liberals emphasized that the monetary system, which does not allow for arbitrary political interferences with the market economy, is that of a commodity money. Eighteenth and nineteenth century economists have already warned against the possibility offered by paper currency to privilege the particular interests of one special group and hurt those of others. That an additional issue of paper currency robs the creditors is beyond doubt for Locke.

Examining the debtor's position, Cantillon alerts us that " a Banker with the complicity of a Minister is able to… pay off the State debt"[9] by means of new banknotes. The nineteenth century suspicion on those, and similar corrupted practices must have been really significant for Malthus to express it so vividly: "In fact, what security have we, except in this integrity, that the Bank Directors may not agree to create and divide 24 millions in notes among them for their private fortunes?"[10]

Although the early classical economists realized that paper money vests its issuer with the power to destroy contract engagements and individual fortunes, they did not really recognize the institution that is most interested in capturing the opportunity to provide an economy with a medium of exchange. Even Ricardo, who observed that "experience, however, shows that neither a State nor a Bank ever have had the unrestricted power of issuing paper money, without abusing that power," seems to put the emphasis on the probable "indiscretion of the Bank", not on the expectedly systematic recourse to this evident source of revenue on the part of the state.[11]

Mill did not come exactly to Rothbard’s insight that "the natural tendency of the state is inflation," but at least he made it clear that governments were those who first seized the opportunity to finance themselves through paper money, simply by "emancipating themselves" from the "unpleasant obligation" to redeem the banknotes in specie. And because the producer of inconvertible paper will try to "pay off the national debt, defray the expenses of government without taxation," in short to levy a tax "for his benefit" on the expense of the holders of currency, Mill discarded this form of monetary organization.[12] No other but commodity money prevents all schemes for silent and resitance-proof expropriation: that is the final conclusion of the classical liberals.

The case for commodity money in general, and for silver and gold in particular, was established, authoritatively, long ago. It is true that the subtleness and some errors of the classical economists’ thought are partially responsible for the present-day ideological reversal in quasi-total support of paper money. However, there is no excuse, even not the sheer ignorance, for completely erasing what the classicals said in defense of gold from contemporary textbooks in monetary theory. 


[1] Nikolay Gertchev is a Ph. D. candidate at Université Panthéon-Assas, Paris, France and Massey Fellow at the Ludwig von Mises Institute. n_gertchev@hotmail.com. See also the Study Guide on Money and Banking.

[2] William Rees-Mogg (ed. by). 2002. The Case for Gold. London: Pickering & Chatto (I, p. 34).    

[3] Ibid., II, p. 66.  

[4] Ibid., II, pp. 155-6.

[5] Ibid., I, p. 121.

[6] Ibid., II, p. 60.

[7] Ibid., I, p. 115.

[8] Ibid., II, p. 82.

[9] Ibid., I, p. 182.

[10] Ibid., II, p. 44.

[11] Ibid., II, pp. 83-91.

[12] Ibid., II, pp. 155-9.


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