Choice in Currency

The Author

Friedrich August Hayek, Dr Jur, Dr Sc Pol (Vienna), DSc (Econ.) (London), Visiting Professor at the University of Salzburg, Austria, 1970–74. Educated at the University of Vienna, Director of the Austrian Institute for Economic Research, 1927–31, and Lecturer in Economics at the University of Vienna, 1929–31. 1931–50 Tooke Professor of Economic Science and Statistics, University of London. 1950–62 Professor of Social and Moral Science, University of Chicago. Professor of Economics, University of Freiburg i.Brg., West Germany, 1962–68. He was awarded the Alfred Nobel Memorial Prize in Economic Sciences in 1974.

Professor Hayek's most important publications include Monetary Theory and the Trade Cycle (1933), The Pure Theory of Capital (1941), The Road to Serfdom (1944), Individualism and Economic Order (1948), The Counter-Revolution of Science (1952), and The Constitution of Liberty (1960). His latest works are col1ections of his writings under the titles Studies in Philosophy, Politics and Economics (1967) and Law, Legislation and Liberty (Vo1. I, 1973). He has also edited several books and has published artic1es in the Economic Journal, Economica and other journals. The IEA has published his The Confusion of Language in Political Thought (Occasional Paper 20, 1968), his Wincott Memoria1 Lecture, Economic Freedom and Representative Government (Occasiona1 Paper 39, 1973), a collection of his writings with a new essay (assembled by Sudha Shenoy), A Tiger by the Tail (Hobart Paperback 4, 1972), an essay in Verdict on Rent Control (IEA Readings NO.7, 1972), and Full Employment at Any Price? (Occasional Paper 45, 1975).

1. Money, Keynes, and History2

The chief root of our present monetary troubles is, of course, the sanction of scientific authority which Lord Keynes and his disciples have given to the age-old superstition that by increasing the aggregate of money expenditure we can lastingly ensure prosperity and full employment. It is a superstition against which economists before Keynes had struggled with some success for at least two centuries.3 It had governed most of earlier history. This history, indeed, has been largely a history of inflation; significantly, it was only during the rise of the prosperous modern industrial systems and during the rule of the gold standard, that over a period of about two hundred years (in Britain from about 1714 to 1914, and in the United States from about 1749 to 1939) prices were at the end about where they had been at the beginning. During this unique period of monetary stability the gold standard had imposed upon monetary authorities a discipline which prevented them from abusing their powers, as they have done at nearly all other times. Experience in other parts of the world does not seem to have been very different: I have been told that a Chinese law attempted to prohibit paper money for all times (of course, ineffectively), long before the Europeans ever invented it!

Keynesian rehabilitation

It was John Maynard Keynes, a man of great intellect but limited knowledge of economic theory, who ultimately succeeded in rehabilitating a view long the preserve of cranks with whom he openly sympathised. He had attempted by a succession of new theories to justify the same, superficially persuasive, intuitive belief that had been held by many practical men before, but that will not withstand rigorous analysis of the price mechanism: just as there cannot be a uniform price for all kinds of labour, an equality of demand and supply for labour in general cannot be secured by managing aggregate demand. The volume of employment depends on the correspondence of demand and supply in each sector of the economy, and therefore on the wage structure and the distribution of demand between the sectors. The consequence is that over a longer period the Keynesian remedy does not cure unemployment but makes it worse.

The claim of an eminent public figure and brilliant polemicist to provide a cheap and easy means of permanently preventing serious unemployment conquered public opinion and, after his death, professional opinion too. Sir John Hicks has even proposed that we call the third quarter of this century, 1950 to 1975, the age of Keynes, as the second quarter was the age of Hitler.4 I do not feel that the harm Keynes did is really so much as to justify that description. But it is true that, so long as his prescriptions seemed to work, they operated as an orthodoxy which it appeared useless to oppose.

Personal Confession

I have often blamed myself for having given up the struggle after I had spent much time and energy criticising the first version of Keynes's theoretical framework. Only after the second part of my critique had appeared did he tell me he had changed his mind and no longer believed what he had said in the Treatise on Money of 1930 (somewhat unjustly towards himself, as it seems to me, since I still believe that volume II of the Treatise contains some of the best work he ever did). At any rate, I felt it then to be useless to return to the charge, because he seemed so likely to change his views again. When it proved that this new version—the General Theory of 1936—conquered most of the professional opinion, and when in the end even some of the colleagues I most respected supported the wholly Keynesian Bretton Woods agreement, I largely withdrew from the debate, since to proclaim my dissent from the near-unanimous views of the orthodox phalanx would merely have deprived me of a hearing on other matters about which I was more concerned at the time. (I believe, however, that, so far as some of the best British economists were concerned, their support of Bretton Woods was determined more by a misguided patriotism—the hope that it would benefit Britain in her post-war difficulties than by a belief that it would provide a satisfactory international monetary order.)

2. The Manufacture of Unemployment

I wrote 36 years ago on the crucial point of difference:

It may perhaps be pointed out that it has, of course, never been denied that employment can be rapidly increased, and a position of "full employment" achie ved in the shortest possible time, by means of monetary expansion—least of all by those economists whose outlook has been influenced by the experience of a major inflation. All that has been contended is that the kind of full employment which can be created in this way is inherently unstable, and that to create employment by these means is to perpetuate fluctuations. There may be desperate situations in which it may indeed be necessary to increase employment at all costs, even if it be only for a short period—perhaps the situation in which Dr Brüning found himself in Germany in 1932 was such a situation in which desperate means would have been justified. But the economist should not conceal the fact that to aim at the maximum of employment which can be achieved in the short run by means of monetary policy is essentially the policy of the desperado who has nothing to lose and everything to gain from a short breathing space.5

To this I would now like to add, in reply to the constant deliberate misrepresentation of my views by politicians, who like to picture me as a sort of bogey whose influence makes conservative parties dangerous, what I regularly emphasize and stated nine months ago in my Nobel Memorial Prize Lecture at Stockholm in the following words:

The truth is that by a mistaken theoretical view we have been led into a precarious position in which we cannot prevent substantial unemployment from re-appearing: not because, as my view is sometimes misrepresented, this unemployment is deliberately brought about as a means to combat inflation, but because it is now bound to appear as a deeply regrettable but inescapable consequence of the mistaken policies of the past as soon as inflation ceases to accelerate.6

Unemployment via 'full employment policies'

This manufacture of unemployment by what are called 'full employment policies' is a complex process. In essence it operates by temporary changes in the distribution of demand, drawing both unemployed and already employed workers into jobs which will disappear with the end of inflation. In the periodically recurrent crises of the pre-1914 years the expansion of credit during the preceding boom served largely to finance industrial investment, and the over-development and subsequent unemployment occurred mainly in the industries producing capital equipment. In the engineered inflation of the last decades things were more complex.

What will happen during a major inflation is illustrated by an observation from the early 1920s which many of my Viennese contemporaries will confirm: in the city many of the famous coffee houses were driven from the best comer sites by new bank offices and returned after the 'stabilization crisis', when the banks had contracted or collapsed and thousands of bank clerks swelled the ranks of the unemployed.

The lost generation

The whole theory underlying the full employment policies has by now of course been thoroughly discredited by the experience of the last few years. In consequence the economists are also beginning to discover its fatal intellectual defects which they ought to have seen all along. Yet I fear the theory will still give us a lot of trouble: it has left us with a lost generation of economists who have learnt nothing else. One of our chief problems will be to protect our money against those economists who will continue to offer their quack remedies, the short-term effectiveness of which will continue to ensure them popularity. It will survive among blind doctrinaires who have always been convinced that they have the key to salvation.

The 1863 penny

In consequence, though the rapid descent of Keynesian doctrine from intellectual respectability can be denied no longer, it still gravely threatens the chances of a sensible monetary policy. Nor have people yet fully realised how much irreparable damage it has already done, particularly in Britain, the country of its origin. The sense of financial respectability which once guided British monetary policy has rapidly disappeared. From a model to be imitated Britain has in a few years descended to be a warning example for the rest of the world. This decay was recently brought home to me by a curious incident: I found in a drawer of my desk a British penny dated 1863 which a short 12 years ago, that is, when it was exactly a hundred years old, I had received as change from a London bus conductor and had taken back to Germany to show to my students what long-run monetary stability meant. I believe they were duly impressed. But they would laugh in my face if I now mentioned Britain as an instance of monetary stability.

3. The Weakness of Political Control of Money

A wise man should perhaps have foreseen that less than 30 years after the nationalisation of the Bank of England the purchasing power of the pound sterling would have been reduced to less than one-quarter of what it had been at that date. As has sooner or later happened everywhere, government control of the quantity of money has once again proved fatal. I do not want to question that a very intelligent and wholly in dependent national or international monetary authority might do better than an international gold standard, or any other sort of automatic system. But I see not the slightest hope that any government, or any institution subject to political pressure, will ever be able to act in such a manner.

Group interests harmful

I never had much illusion in this respect, but I must confess that in the course of a long life my opinion of governments has steadily worsened: the more intelligently they try to act (as distinguished from simply following an established rule ), the more harm they seem to do—because once they are known to aim at particular goals (rather than merely maintaining a self correcting spontaneous order) the less they can avoid serving sectional interests. And the demands of all organised group interests are almost invariably harmful—except only when they protest against restrictions imposed upon them for the benefit of other group interests. I am by no means re-assured by the fact that, at least in some countries, the civil servants who run affairs are mostly intelligent, well-meaning, and honest men. The point is that, if governments are to remain in office in the prevailing political order, they have no choice but to use their powers for the benefit of particular groups—and one strong interest is always to get additional money for extra expenditure. However harmful inflation is in general seen to be, there are always substantial groups of people, including some for whose support collectivist-inclined governments primarily look, which in the short run greatly gain by it—even if only by staving off for some time the loss of an income which it is human nature to believe will be only temporary if they can tide over the emergency.

Rebuilding the resistances to inflation

The pressure for more and cheaper money is an ever-present political force which monetary authorities have never been able to resist, unless they were in a position credibly to point to an absolute obstacle which made it impossible for them to meet such demands. And it will become even more irresistible when these interests can appeal to an increasingly unrecognisable image of St Maynard. There will be no more urgent need than to erect new defenses against the onslaughts of popular forms of Keynesianism, that is, to replace or restore those restraints which, under the influence of his theory, have been systematic ally dismantled. It was the main function of the gold standard, of balanced budgets, of the necessity for deficit countries to contract their circulation, and of the limitation of the supply of 'international liquidity', to make it impossible for the monetary authorities to capitulate to the pressure for more money. And it was exactly for that reason that all these safeguards against inflation, which had made it possib le for representative governments to resist the demands of powerful pressure groups for more money, have been removed at the instigation of economists who imagined that, if governments were released from the shackle s of mechanical rules, they would be able to act wisely for the general benefit.

I do not believe we can now remedy this position by constructing some new international monetary order, whether a new international monetary authority or institution, or even an international agreement to adopt a particular mechanism or system of policy, such as the classical gold standard. I am fairly convinced that any attempt now to re-instate the gold standard by international agreement would break down within a short time and merely discredit the ideal of an international gold standard for even longer. Without the conviction of the public at large that certain immediately painful measures are occasionally necessary to preserve reasonable stability, we cannot hope that any authority which has power to determine the quantity of money will long resist the pressure for, or the seduction of, cheap money.

Protecting money from politics

The politician, acting on a modified Keynesian maxim that in the long run we are all out of office, does not care if his successful cure of unemployment is bound to produce more unemployment in the future. The politicians who will be blamed for it will not be those who created the inflation but those who stopped it. No worse trap could have been set for a democratic system in which the government is forced to act on the beliefs that the people think to be true. Our only hope for a stable money is indeed now to find a way to protect money from politics.

With the exception only of the 200-year period of the gold standard, practically all governments of history have used their exclusive power to issue money in order to defraud and plunder the people. There is less ground than ever for hoping that, so long as the people have no choice but to use the money their government provides, governments will become more trustworthy. Under the prevailing systems of government, which are supposed to be guided by the opinion of the majority but under which in practice any sizeable group may create a 'political necessity' for the government by threatening to withhold the votes it needs to claim majority support, we cannot entrust dangerous instruments to it. Fortunately we need not yet fear, I hope, that governments will start a war to please some in dispensable group of supporters, but money is certainly too dangerous an instrument to leave to the fortuitous expediency of politicians—or, it seems. economists.

A dangerous monopoly

What is so dangerous and ought to be done away with is not governments' right to issue money but the exclusive right to do so and their power to force people to use it and to accept it at a particular price. This monopoly of government, like the postal monopoly, has its origin not in any benefit it secures for the people but solely in the desire to enhance the coercive powers of government. I doubt whether it has ever done any good except to the rulers and their favorites. All history contradicts the belief that governments have given us a safer money than we would have had without their cla iming an exclusive right to issue it.

4. Choice of Money in Contracts

But why should we not let people choose freely what money they want to use? By 'people' I mean the individuals who ought to have the right to decide whether they want to buy or sell for francs, pounds, dollars, D-marks, or ounces of gold. I have no objection to governments issuing money, but I believe their claim to a monopoly, or their power to limit the kinds of money in which contracts may be concluded within their territory, or to determine the rates at which monies can be exchanged, to be wholly harmful.

At this moment it seems that the best thing we could wish governments to do is for, say, all the members of the European Economic Community, or, better still, all the governments of the Atlantic Community, to bind themselves mutually not to place any restrictions on the free use within their territories of one another's—or any other—currencies, including their purchase and sale at any price the parties decide upon, or on their use as accounting units in which to keep books. This, and not a utopian European Monetary Unit, seems to me now both the practicable and the desirable arrangement to aim at. To make the scheme effective it would be important, for reasons I state later, also to provide that banks in one country be free to establish branches in any of the others.

Government and legal tender

This suggestion may at first seem absurd to all brought up on the concept of 'legal tender'. Is it not essential that the law designate one kind of money as the legal money? This is, however, true only to the extent that, if the government does issue money, it must also say what must be accepted in discharge of debts incurred in that money. And it must also determine in what manner certain non-contractual legal obligations, such as taxes or liabilities for damage or torts, are to be discharged. But there is no reason whatever why people should not be free to make contracts, including ordinary purchases and sales, in any kind of money they choose, or why they should be obliged to sell against any particular kind of money.

There could be no more effective check against the abuse of money by the government than if people were free to refuse any money they distrusted and to prefer money in which they had confidence. Nor could there be a stronger inducement to governments to ensure the stability of their money than the knowledge that, so long as they kept the supply below the demand for it, that demand would tend to grow. Therefore, let us deprive governments (or their monetary authorities) of all power to protect their money against competition: if they can no longer conceal that their money is becoming bad, they will have to restrict the issue.

The first reaction of many readers may be to ask whether the effect of such a system would not according to an old rule be that the bad money would drive out the good. But this would be a misunderstanding of what is called Gresham's Law. This indeed is one of the oldest insights into the mechanism of money, so old that 2,400 years ago Aristophanes, in one of his comedies, could say that it was with politicians as it is with coins, because the bad ones drive out the good.7 But the truth which apparently even today is not generally understood is that Gresham's Law operates only if the two kinds of money have to be accepted at a prescribed rate of exchange. Exactly the opposite will happen when people are free to exchange the different kinds of money at whatever rate they can agree upon. This was observed many times during the great inflations when even the most severe penalties threatened by governments could not prevent people from using other kinds of money&emdash;even commodities like cigarettes and bottles of brandy rather than the government money—which clearly meant that the good money was driving out the bad.8

Benefits of free currency system

Make it merely legal and people will be very quick indeed to refuse to use the national currency once it depreciates noticeably, and they will make their dealings in a currency they trust. Employers, in particular, would find it in their interest to offer, in collective agreements, not wages anticipating a foreseen rise of prices but wages in a currency they trusted and could make the basis of rational calculation. This would deprive government of the power to counteract excessive wage increases, and the unemployment they would cause, by depreciating their currency. It would also prevent employers from conceding such wages in the expectation that the national monetary authority would bail them out if they promised more than they could pay.

There is no reason to be concerned about the effects of such an arrangement on ordinary men who know neither how to handle nor how to obtain strange kinds of money. So long as the shopkeepers knew that they could turn it instantly at the current rate of exchange into whatever money they preferred, they would be only too ready to sell their wares at an appropriate price for any currency. But the malpractices of government would show themselves much more rapidly if prices rose only in terms of the money issued by it, and people would soon learn to hold the government responsible for the value of the money in which they were paid. Electronic calculators, which in seconds would give the equivalent of any price in any currency at the current rate, would soon be used everywhere. But, unless the national government all too badly mismanaged the currency it issued, it would probably be continued to be used in everyday retail transactions. What would be affected mostly would be not so much the use of money in daily payments as the willingness to hold different kinds of money. It would mainly be the tendency of all business and capital transactions rapidly to switch to a more reliable standard (and to base calculations and accounting on it) which would keep national monetary policy on the right path.

5. Long-Run Monetary Stability

The upshot would probably be that the currencies of those countries trusted to pursue a responsible monetary policy would tend to displace gradually those of a less reliable character. The reputation of financial righteousness would become a jealously guarded asset of all issuers of money, since they would know that even the slightest deviation from the path of honesty would reduce the demand for their product.

I do not believe there is any reason to fear that in such a competition for the most general acceptance of a currency there would arise a tendency to deflation or an increasing value of money. People will be quite as reluctant to borrow or incur debts in a currency expected to appreciate as they will hesitate to lend in a currency expected to depreciate. The convenience of use is decidedly in favour of a currency which can be expected to retain an approximately stable value. If governments and other issuers of money have to compete in inducing people to hold their money, and make long-term contracts in it, they will have to create confidence in its long-run stability.

'The universal prize'

Where I am not sure is whether in such a competition for reliability any government-issued currency would prevail, or whether the predominant preference would not be in favour of some such units as ounces of gold. It seems not unlikely that gold would ultimately re-assert its place as 'the universal prize in all countries, in all cultures, in all ages', as Jacob Bronowski has recently called it in his brilliant book on The Ascent of Man,9 if people were given complete freedom to decide what to use as their standard and general medium of exchange&emdash;more likely, at any rate, than as the result of any organized attempt to restore the gold standard.

The reason why, in order to be fully effective, the free international market in currencies should extend also to the services of banks is, of course, that bank deposits subject to cheque represent today much the largest part of the liquid assets of most people. Even during the last hundred years or so of the gold standard this circumstance increasingly prevented it from operating as a fully international currency, because any inflow or outflow in or out of a country required a proportionate expansion or contraction of the much larger super-structure of the national credit money, the effect of which falls indiscrimin ately on the whole economy instead of merely increasing or decreasing the demand for the particular goods which was required to bring about a new balance between imports and exports. With a truly international banking system money could be transferred directly without producing the harmful process of secondary contractions or expansions of the credit structure.

It would probably also impose the most effective discipline on governments if they felt immediately the effects of their policies on the attractiveness of investment in their country. I have just read in an English Whig tract more than 250 years old: 'Who would establish a Bank in an arbitrary country, or trust his money constantly there?'10 The tract, incidentally, tells us that yet another 50 years earlier a great French banker, Jean Baptist Tavernier, invested all the riches he had amassed in his long rambles over the world in what the authors described as 'the barren rocks of Switzerland'; when asked why by Louis XIV, he had the courage to tell him that 'he was willing to have something which he could call his own!' Switzerland, apparently, laid the foundations of her prosperity earlier than most people realise.

Free dealings in money better than monetary union

I prefer the freeing of all dealings in money to any sort of monetary union also because the latter would demand an international monetary authority which I believe is neither practicable nor even desirable -and hardly to be more trusted than a national authority. It seems to me that there is a very sound element in the widespread disinclination to confer sovereign powers, or at least powers to command, on any international authority. What we need are not international authorities possessing powers of direction, but merely international bodies (or, rather, international treaties which are effectively enforced) which can prohibit certain actions of governments that will harm other people. Effectively to prohibit all restrictions on dealings in (and the possession of) different kinds of money (or claims for money) would at last make it possible that the absence of tariffs, or other obstacles to the movement of goods and men, will secure a genuine free trade area or common market -and do more than anything else to create confidence in the countries committing themselves to it. It is now urgently needed to counter that monetary nationalism that I first criticized almost 40 years ago11 and which is becoming even more dangerous when, as a consequence of the close kinship between the two views, it is turning into monetary socialism. I hope it will not be too long before complete freedom to deal in any money one likes will be regarded as the essential mark of a free country.12

You may feel that my proposal amounts to no less than the abolition of monetary policy; and you would not be quite wrong. As in other connections, I have come to the conclusion that the best the state can do with respect to money is to provide a framework of legal rules within which the people can develop the monetary institutions that best suit them. It seems to me that if we could prevent governments from meddling with money, we would do more good than any government has ever done in this regard. And private enterprise would probably have done better than the best they have ever done.

  • 2[The main section and sub-headings have been inserted to help readers, especially non economists unfamiliar with Professor Hayek's writings, to follow the argument; they were not part of the original lecture.-ED.]
  • 3[This observation is amplified by Professor Hayek in a note, 'A Comment on Keynes, Beveridge and Keynesian Economics'. -ED.]
  • 4John Hicks, The Crisis in Keynesian Economics, Oxford University Press, 1974, p. 1.
  • 5F.A. Hayek, Profits, Interest and Investment, Routledge & Kegan Paul, London, 1939, p. 63n.
  • 6F.A. Hayek, 'The Pretence of Knowledge', Nobel Memorial Prize Lecture 1974, reprinted in Full Employment at An y Price?, Occasional Paper 45, IEA, 1975, p. 37.
  • 7Aristophanes, Frogs, 891–898, in Frere's translation:

    Oftentimes we have reflected on a similar abuse
    In the choice of men for office, and of coins for common use,
    For our old and standard pieces, valued and approved and tried,
    Here among the Grecian nations, and in all the world besides,
    Recognised in every realm for trusty stamp and pure assay,
    Are rejected and abandoned for the trash of yesterday,
    For a vile adulterated issue, drossy, counterfeit and base,
    Which the traffic of the city passes current in their place.

    About the same time, the philosopher Diogenes called money "the legislators' game of dice"!
  • 8During the German inflation after the First World War, when people began to use dollars and other solid currencies in the place of marks, a Dutch financier (if I rightly remember, Mr Vissering) asserted that Gresham's Law was false and the opposite is true.
  • 9Jacob Bronowski, The Ascent of Man, BBC Publications, London 1973.
  • 10Thomas Gordon and John Trenchard, The Cato Letters, letters dated 12 May, 1722, and 3 February, 1721 respectively, published in collected editions, London, 1724, and later.
  • 11Monetary Nationalism and International Stability, Longmans, London, 1937.
  • 12It may at first seem as if this suggestion were in conflict with my general support of fixed exchange rates under the present system. But this is not so. Fixed exchange rates seem to me to be necessary so long as national governments have a monopoly of issuing money in their territory in order to place them under a very necessary discipline. But this is of course no longer necessary when they have to submit to the discipline of competition with other issuers of money equally current within their territory.