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The End of National Currencies?

November 24, 2007

Tags Gold Standard

The May/June issue of Foreign Affairs, the organ of establishment policy, published The End of National Currency by Benn Steil. Steil begins with a discussion of currency crisis and the incompetence of central banks in managing them; then proceeds to ask:

Are markets failing, and will restoring lost sovereignty to governments put an end to financial instability? This is a dangerous misdiagnosis. In fact, capital flows became destabilizing only after countries began asserting "sovereignty" over money -- detaching it from gold or anything else considered real wealth. Moreover, even if the march of globalization is not inevitable, the world economy and the international financial system have evolved in such a way that there is no longer a viable model for economic development outside of them.

From there, Steil reviews the history of the international gold standard, which he deems supportive of global capital accumulation and monetary stability:

Capital flows were enormous, even by contemporary standards, during the last great period of "globalization," from the late nineteenth century to the outbreak of World War I. Currency crises occurred during this period, but they were generally shallow and short-lived. That is because money was then — as it has been throughout most of the world and most of human history — gold, or at least a credible claim on gold. Funds flowed quickly back to crisis countries because of confidence that the gold link would be restored. At the time, monetary nationalism was considered a sign of backwardness, adherence to a universally acknowledged standard of value a mark of civilization. Those nations that adhered most reliably (such as Australia, Canada, and the United States) were rewarded with the lowest international borrowing rates. Those that adhered the least (such as Argentina, Brazil, and Chile) were punished with the highest. This bond was fatally severed during the period between World War I and World War II. Most economists in the 1930s and 1940s considered it obvious that capital flows would become destabilizing with the end of reliably fixed exchange rates. Friedrich Hayek noted in a 1937 lecture that under a credible gold-standard regime, "short-term capital movements will on the whole tend to relieve the strain set up by the original cause of a temporarily adverse balance of payments. If exchanges, however, are variable, the capital movements will tend to work in the same direction as the original cause and thereby to intensify it" -- as they do today. The belief that globalization required hard money, something foreigners would willingly hold, was widespread. The French economist Charles Rist observed that "while the theorizers are trying to persuade the public and the various governments that a minimum quantity of gold ... would suffice to maintain monetary confidence, and that anyhow paper currency, even fiat currency, would amply meet all needs, the public in all countries is busily hoarding all the national currencies which are supposed to be convertible into gold." This view was hardly limited to free marketeers.

The trend toward "monetary nationalistm", which Steil sees as ultimately destructive, grew out of the Keynesian macro-economic management framework. Monetary policy makers in each nation, it was argued, had to have the ability to fine tune the growth of money and credit in each national economy, in order to provide macro-economic stability. The present debate, growing out of the increasing frequency and severity of financial crises, pits on the one hand a new breed of monetary nationalists who equate nationalistic money with national sovereignty against the globalist-IMF macro types who want a global central bank based on a dollar standard. But is there alternative to fluctuating national fiat monies?

So what about gold? A revived gold standard is out of the question. In the nineteenth century, governments spent less than ten percent of national income in a given year. Today, they routinely spend half or more, and so they would never subordinate spending to the stringent requirements of sustaining a commodity-based monetary system.

From the context, I believe that Steil means the international gold standard as an institution managed by a coordinated agreement of central banks acting with a common purpose. Instead, Steil raises a far more interesting alternative: the privatization of money:

But private gold banks already exist, allowing account holders to make international payments in the form of shares in actual gold bars. Although clearly a niche business at present, gold banking has grown dramatically in recent years, in tandem with the dollar's decline. A new gold-based international monetary system surely sounds far-fetched. But so, in 1900, did a monetary system without gold. Modern technology makes a revival of gold money, through private gold banks, possible even without government support.

Stiel would find common ground with many Austrians in his contention that capital flow are not per se destabilizing:

The lessons of gold-based globalization in the nineteenth century simply must be relearned. Just as the prodigious daily capital flows between New York and California, two of the world's 12 largest economies, are so uneventful that no one even notices them, capital flows between countries sharing a single currency, such as the dollar or the euro, attract not the slightest attention from even the most passionate antiglobalization activists.

The article is rather extraordinary piece to appear in such a mainstream journal. I suspect that Steil is correct in his rejection of a centrally planned gold standard. Surely the central bankers of the world will not all get together and decide, at once, to put themselves out of the business of monetary policy. The effectiveness of national monetary policy is still largely accepted by most economists. But I do see it as with in the realm of possibility that the market will choose gold as a parallel currency -- not for small retail transactions -- but for international capital flows. What I see driving this transition is the unfolding debt crisis and the ongoing rejection of the dollar as the world's currency. The national currencies might continue to exist in this scenario, but gold would either be accumulated by central banks as a reserve asset, much as dollars are now, or international corporation would start to price their products in gold oz or grams, or perhaps to offer two prices, one a national currency and the other in gold. Private payment systems to facilitate these transactions do exist on a small scale already.

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