Denationalisation of Money: The Argument Refined

I shall assume for the rest of this discussion that it will be possible to establish a number of institutions in various parts of the world which are free to issue notes in competition and similarly to carry cheque accounts in their individual denominations. I shall call these institutions simply ‘banks’, or ‘issue banks’ when necessary to distinguish them from other banks that do not choose to issue notes. I shall further assume that the name or denomination a bank chooses for its issue will be protected like a brand name or trade mark against unauthorised use, and that there will be the same protection against forgery as against that of any other document. These banks will then be vying for the use of their issue by the public by making them as convenient to use as possible.

The private Swiss ‘ducat’

Since readers will probably at once ask how such issues can come to be generally accepted as money, the best way to begin is probably to describe how I would proceed if I were in charge of, say, one of the major Swiss joint stock banks. Assuming it to be legally possible (which I have not examined), I would announce the issue of non-interest bearing certificates or notes, and the readiness to open current cheque accounts, in terms of a unit with a distinct registered trade name such as ‘ducat’. The only legal obligation I would assume would be to redeem these notes and deposits on demand with, at the option of the holder, either 5 Swiss francs or 5 D-marks or 2 dollars per ducat. This redemption value would however be intended only as a floor below which the value of the unit could not fall because I would announce at the same time my intention to regulate the quantity of the ducats so as to keep their (precisely defined) purchasing power as nearly as possible constant. I would also explain to the public that I was fully aware I could hope to keep these ducats in circulation only if I fulfilled the expectation that their real value would be kept approximately constant. And I would announce that I proposed from time to time to state the precise commodity equivalent in terms of which I intended to keep the value of the ducat constant, but that I reserved the right, after announcement, to alter the composition of the commodity standard as experience and the revealed preferences of the public suggested.

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It would, however, clearly be necessary that, though it seems neither necessary nor desirable that the issuing bank legally commits itself to maintain the value of its unit, it should in its loan contracts specify that any loan could be repaid either at the nominal figure in its own currency, or by corresponding amounts of any other currency or currencies sufficient to buy in the market the commodity equivalent which at the time of making the loan it had used as its standard. Since the bank would have to issue its currency largely through lending, intending borrowers might well be deterred by the formal possibility of the bank arbitrarily raising the value of its currency, that they may well have to be explicitly reassured against such a possibility. * *1

These certificates or notes, and the equivalent book credits, would be made available to the public by short-term loans or sale against other currencies. The units would presumably, because of the option they offered, sell from the outset at a premium above the value of any one of the currencies in which they were redeemable. And, as these governmental currencies continued to depreciate in real terms, this premium would increase. The real value at the price at which the ducats were first sold would serve as the standard the issuer would have to try to keep constant. If the existing currencies continued to depreciate (and the availability of a stable alternative might indeed accelerate the process) the demand for the stable currency would rapidly increase and competing enterprises offering similar but differently-named units would soon emerge.

The sale (over the counter or by auction) would initially be the chief form of issue of the new currency. After a regular market had established itself, it would normally be issued only in the course of ordinary banking business, i.e. through short-term loans.

Constant but not fixed value

It might be expedient that the issuing institution should from the outset announce precisely the collection of commodities in terms of which it would aim to keep the value of the ‘ducat’ constant. But it would be neither necessary nor desirable that it tie itself legally to a particular standard. Experience of the response of the public to competing offers would gradually show which combination of commodities constituted the most desired standard at any time and place. Changes in the importance of the commodities, the volume in which they were traded, and the relative stability or sensitivity of their prices (especially the degree to which they were determined competitively or not) might suggest alterations to make the currency more popular. On the whole I would expect that, for reasons to be explained later (Section XIII), a collection of raw material prices, such as has been suggested as the basis of a commodity reserve standard,2 would seem most appropriate, both from the point of view of the issuing bank and from that of the effects of the stability of the economic process as a whole.

Control of value by competition

In most respects, indeed, the proposed system should prove a more practicable method of achieving all that was hoped from a commodity reserve standard or some other form of ‘tabular standard.’ At the same time it would remove the necessity of making it fully automatic by taking the control from a monopolistic authority and entrusting it to private concerns. The threat of the speedy loss of their whole business if they failed to meet expectations (and how any government organisation would be certain to abuse the opportunity to play with raw material prices!) would provide a much stronger safeguard than any that could be devised against a government monopoly. Competition would certainly prove a more effective constraint, forcing the issuing institutions to keep the value of their currency constant (in terms of a stated collection of commodities), than would any obligation to redeem the currency in those commodities (or in gold). And it would be an infinitely cheaper method than the accumulation and the storing of valuable materials.

The kind of trust on which private money would rest would not be very different from the trust on which today all private banking rests (or in the United States rested before the governmental deposit insurance scheme!). People today trust that a bank, to preserve its business, will arrange its affairs so that it will at all times be able to exchange demand deposits for cash, although they know that banks do not have enough cash to do so if everyone exercised his right to demand instant payment at the same time. Similarly, under the proposed scheme, the managers of the bank would learn that its business depended on the unshaken confidence that it would continue to regulate its issue of ducats (etc.) so that their purchasing power remained approximately constant.

Is the risk in the venture therefore too big to justify entry by men with the kind of conservative temper its successful conduct probably requires?3 It is not to be denied that, once announced and undertaken, the decision on how large the commitment was to grow would be taken out of the hands of the issuing institution. To achieve its announced aim of maintaining the purchasing power of its currency constant, the amount would have to be promptly adapted to any change of demand, whether increase or decrease. Indeed, so long as the bank succeeded in keeping the value of its currency constant, there would be little reason to fear a sudden large reduction of the demand for it (though successful competitors might well make considerable inroads on its circulation). The most embarrassing development might be a rapid growth of demand beyond the limits a private institution likes to handle. But we can be fairly sure that, in the event of such success, new competition would soon relieve a bank of this anxiety.

The issuing bank could, at first, at no prohibitive cost keep in cash a 100 per cent reserve of the currencies in terms of which it had undertaken to redeem its issue and still treat the premiums received as freely available for general business. But once these other currencies had, as the result of further inflation, substantially depreciated relative to the ducat, the bank would have to be prepared, in order to maintain the value of the ducat, to buy back substantial amounts of ducats at the prevailing higher rate of exchange. This means that it would have to be able rapidly to liquidate investments of very large amounts indeed. These investments would therefore have to be chosen very carefully if a temporary rush of demand for its currency were not to lead to later embarrassment when the institution that had initiated the development had to share the market with imitators. Incidentally, the difficulty of finding investments of an assured stable value to match similar obligations would not be anything like as difficult for such a bank as we are considering as present-day bankers seem to find it: all the loans made in its own currency would of course represent such stable assets. The curious fact that such an issuing bank would have claims and obligations in terms of a unit the value of which it determined itself, though it could not do so arbitrarily or capriciously without destroying the basis of its business, may at first appear disturbing but should not create real difficulties. What may at first appear somewhat puzzling accounting problems largely disappear when it is remembered that such a bank would of course keep its accounts in terms of its own currency. The outstanding notes and deposits of such a bank are not claims on it in terms of some other unit of value; it determines itself the value of the unit in terms of which it has debts and claims and keeps its books. This will cease to seem shocking when we remember that this is precisely what practically all central banks have been doing for nearly half a century—their notes were of course redeemable in precisely nothing. But notes which may appreciate relatively to most other capital assets may indeed present to accountants problems with which they never before had to deal. Initially the issuing bank would of course be under a legal obligation to redeem its currency in terms of the other currencies against which it was at first issued. But after it has existed for some time their value may have shrunk to very little or they may have altogether disappeared.4

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5 [To assist readers of the First Edition to identify major additions, we have inserted a single asterisk at the beginning and double asterisks at the end of substantial, self-contained new passages. - ED.]

6 Cf. Hayek [30], pp. 318-320.

7 On the question of its attractiveness the discussion by S. Fischer [18] of the notorious reluctance of enterprise to issue indexed bonds is somewhat relevant. It is true that a gradual increase of the value of the notes issued by a bank in terms of other concurrent currencies might produce a situation in which the aggregate value of its outstanding notes (plus its liabilities from other sources) would exceed its assets. The bank would of course not be legally liable to redeem its notes at this value, but it could preserve this business only if it did in fact promptly buy at the current rate any of its notes offered to it. So long as it succeeded in maintaining the real value of its notes, it would never be called upon to buy back more than a fraction of the outstanding circulation. Probably no one would doubt that an art dealer who owns the plates of the engravings of a famous artist could, so long as his works remained in fashion, maintain the market value of these engravings by judiciously selling and buying, even though he could never buy up all the existing prints. Similarly, a bank could certainly maintain the value of its notes even though it could never buy back all the outstanding ones.

8 A real difficulty could arise if a sudden large increase in the demand for such a stable currency, perhaps due to some acute economic crisis, had to be met by selling large amounts of it against other currencies. The bank would of course have to prevent such a rise in the value and could do so only by increasing its supply. But selling against other currencies would give it assets likely to depreciate in terms of its own currency. It probably could not increase its short-term lending very rapidly, even if it offered to lend at a very low rate of interest—even though in such a situation it would be safer to lend even at a small negative rate of interest than to sell against other currencies. And it would probably be possible to grant long-term loans at very low rates of interest against negotiable securities (in terms of its own currency) which it should be easy to sell if the sudden increase of demand for its currency should be as rapidly reversed.

• 1[To assist readers of the First Edition to identify major additions, we have inserted a single asterisk at the beginning and double asterisks at the end of substantial, self-contained new passages. - ED.]
• 2Cf. Hayek [30], pp. 318-320.
• 3On the question of its attractiveness the discussion by S. Fischer [18] of the notorious reluctance of enterprise to issue indexed bonds is somewhat relevant. It is true that a gradual increase of the value of the notes issued by a bank in terms of other concurrent currencies might produce a situation in which the aggregate value of its outstanding notes (plus its liabilities from other sources) would exceed its assets. The bank would of course not be legally liable to redeem its notes at this value, but it could preserve this business only if it did in fact promptly buy at the current rate any of its notes offered to it. So long as it succeeded in maintaining the real value of its notes, it would never be called upon to buy back more than a fraction of the outstanding circulation. Probably no one would doubt that an art dealer who owns the plates of the engravings of a famous artist could, so long as his works remained in fashion, maintain the market value of these engravings by judiciously selling and buying, even though he could never buy up all the existing prints. Similarly, a bank could certainly maintain the value of its notes even though it could never buy back all the outstanding ones.
• 4A real difficulty could arise if a sudden large increase in the demand for such a stable currency, perhaps due to some acute economic crisis, had to be met by selling large amounts of it against other currencies. The bank would of course have to prevent such a rise in the value and could do so only by increasing its supply. But selling against other currencies would give it assets likely to depreciate in terms of its own currency. It probably could not increase its short-term lending very rapidly, even if it offered to lend at a very low rate of interest—even though in such a situation it would be safer to lend even at a small negative rate of interest than to sell against other currencies. And it would probably be possible to grant long-term loans at very low rates of interest against negotiable securities (in terms of its own currency) which it should be easy to sell if the sudden increase of demand for its currency should be as rapidly reversed.
• 5It would, however, clearly be necessary that, though it seems neither necessary nor desirable that the issuing bank legally commits itself to maintain the value of its unit, it should in its loan contracts specify that any loan could be repaid either at the nominal figure in its own currency, or by corresponding amounts of any other currency or currencies sufficient to buy in the market the commodity equivalent which at the time of making the loan it had used as its standard. Since the bank would have to issue its currency largely through lending, intending borrowers might well be deterred by the formal possibility of the bank arbitrarily raising the value of its currency, that they may well have to be explicitly reassured against such a possibility. * *
• 6It might be expedient that the issuing institution should from the outset announce precisely the collection of commodities in terms of which it would aim to keep the value of the ‘ducat’ constant. But it would be neither necessary nor desirable that it tie itself legally to a particular standard. Experience of the response of the public to competing offers would gradually show which combination of commodities constituted the most desired standard at any time and place. Changes in the importance of the commodities, the volume in which they were traded, and the relative stability or sensitivity of their prices (especially the degree to which they were determined competitively or not) might suggest alterations to make the currency more popular. On the whole I would expect that, for reasons to be explained later (Section XIII), a collection of raw material prices, such as has been suggested as the basis of a commodity reserve standard, would seem most appropriate, both from the point of view of the issuing bank and from that of the effects of the stability of the economic process as a whole.
• 7Is the risk in the venture therefore too big to justify entry by men with the kind of conservative temper its successful conduct probably requires? It is not to be denied that, once announced and undertaken, the decision on how large the commitment was to grow would be taken out of the hands of the issuing institution. To achieve its announced aim of maintaining the purchasing power of its currency constant, the amount would have to be promptly adapted to any change of demand, whether increase or decrease. Indeed, so long as the bank succeeded in keeping the value of its currency constant, there would be little reason to fear a sudden large reduction of the demand for it (though successful competitors might well make considerable inroads on its circulation). The most embarrassing development might be a rapid growth of demand beyond the limits a private institution likes to handle. But we can be fairly sure that, in the event of such success, new competition would soon relieve a bank of this anxiety.
• 8The issuing bank could, at first, at no prohibitive cost keep in cash a 100 per cent reserve of the currencies in terms of which it had undertaken to redeem its issue and still treat the premiums received as freely available for general business. But once these other currencies had, as the result of further inflation, substantially depreciated relative to the ducat, the bank would have to be prepared, in order to maintain the value of the ducat, to buy back substantial amounts of ducats at the prevailing higher rate of exchange. This means that it would have to be able rapidly to liquidate investments of very large amounts indeed. These investments would therefore have to be chosen very carefully if a temporary rush of demand for its currency were not to lead to later embarrassment when the institution that had initiated the development had to share the market with imitators. Incidentally, the difficulty of finding investments of an assured stable value to match similar obligations would not be anything like as difficult for such a bank as we are considering as present-day bankers seem to find it: all the loans made in its own currency would of course represent such stable assets. The curious fact that such an issuing bank would have claims and obligations in terms of a unit the value of which it determined itself, though it could not do so arbitrarily or capriciously without destroying the basis of its business, may at first appear disturbing but should not create real difficulties. What may at first appear somewhat puzzling accounting problems largely disappear when it is remembered that such a bank would of course keep its accounts in terms of its own currency. The outstanding notes and deposits of such a bank are not claims on it in terms of some other unit of value; it determines itself the value of the unit in terms of which it has debts and claims and keeps its books. This will cease to seem shocking when we remember that this is precisely what practically all central banks have been doing for nearly half a century—their notes were of course redeemable in precisely nothing. But notes which may appreciate relatively to most other capital assets may indeed present to accountants problems with which they never before had to deal. Initially the issuing bank would of course be under a legal obligation to redeem its currency in terms of the other currencies against which it was at first issued. But after it has existed for some time their value may have shrunk to very little or they may have altogether disappeared.