Denationalisation of Money: The Argument Refined

XIX. A BETTER DISCIPLINE THAN FIXED RATES OF EXCHANGE

Readers who know of my consistent support over more than 40 years of fixed rates of exchange between national currencies, and of my critique of a system of flexible rates of foreign exchange,1 even after most of my fellow defenders of a free market had become converts to this system, will probably feel at first that my present position is in conflict with, or even represents a complete reversal of, my former views. This is not so. In two respects my present proposal is a result of the further development of the considerations which determined my former position.

In the first instance, I have always regarded it as thoroughly undesirable that the structure of the prices of commodities and services in one country should be lifted and lowered as a whole relatively to the price structure of other countries in order to correct some alteration in the supply of or demand for a particular commodity. This was erroneously thought to be necessary chiefly because the availability of statistical information in the form of index numbers of the average movement of prices in one country gave the misleading impression that ‘the internal value’ of one currency as such had to be changed relatively to the value of other currencies, while what was required were primarily changes of the relations between particular prices in all the countries concerned. So far as the assumed necessity of changes in relation between general prices in the countries was true, this was an artificial and undesirable effect of the imperfection of the international monetary system which the gold standard with a superstructure of deposit money produced. We will consider these questions further in the next section.

Remove protection of official currency from competition

Secondly, I had regarded fixed rates of exchange as necessary for the same reason for which I now plead for completely free markets for all kinds of currency, namely that it was required to impose a very necessary discipline or restraint on the agencies issuing money. Neither I, nor apparently anybody else, then thought of the much more effective discipline that would operate if the providers of money were deprived of the power of shielding the money they issued against the rivalry of competing currencies.

The compulsion to maintain a fixed rate of redemption in terms of gold or other currencies has in the past provided the only discipline that effectively prevented monetary authorities from giving in to the demands of the ever-present pressure for cheap money. The gold standard, fixed rates of exchange, or any other form of obligatory conversion at a fixed rate, served no other purpose than to impose upon the issuers of money such a discipline and, by making its regulation automatic, to deprive them of the power arbitrarily to change the quantity of money. It is a discipline that has proved too weak to prevent governments from breaking it. Yet, though the regulations achieved by those automatic controls were far from ideal or even tolerably satisfactory, so long as currencies were thus regulated they were much more satisfactory than anything the discretionary powers of governmental monopolies have ever achieved for any length of time. Nothing short of the belief that it would be a national disgrace for a country not to live up to its obligations has ever sufficed adequately to strengthen the resistance of monetary authorities against pressures for cheap money. I should never have wanted to deny that a very wise and politically independent monetary authority might do better than it is compelled to do in order to preserve a fixed parity with gold or another currency. But I can see no hope of monetary authorities in the real world prevailing for any length of time in their good intentions.

Better even than gold—the ‘wobbly anchor’

It ought by now of course to be generally understood that the value of a currency redeemable in gold (or in another currency) is not derived from the value of that gold, but merely kept at the same value through the automatic regulation of its quantity. The superstition dies only slowly, but even under a gold standard it is no more (or perhaps even less) true that the value of the currency is determined by the value in other uses of the gold it contains (or by its costs of production) than is the converse, that the value of gold is determined by the value of the currencies into which it can be converted. Historically it is true that all the money that preserved its value for any length of time was metallic (or money convertible into metal—gold or silver); and governments sooner or later used to debase even metallic money, so that all the kinds of paper money of which we have experience were so much worse. Most people therefore now believe that relief can come only from returning to a metallic (or other commodity) standard. But not only is a metallic money also exposed to the risks of fraud by government; even at its best it would never be as good a money as one issued by an agency whose whole business rested on its success in providing a money the public preferred to other kinds. Though gold is an anchor—and any anchor is better than a money left to the discretion of government—it is a very wobbly anchor. It certainly could not bear the strain if the majority of countries tried to run their own gold standard. There just is not enough gold about. An international gold standard could today mean only that a few countries maintained a real gold standard while the others hung on to them through a gold exchange standard.

Competition would provide better money than would government

I believe we can do much better than gold ever made possible. Governments cannot do better. Free enterprise, i.e. the institutions that would emerge from a process of competition in providing good money, no doubt would. There would in that event also be no need to encumber the money supply with the complicated and expensive provision for convertibility which was necessary to secure the automatic operation of the gold standard and which made it appear as at least more practicable than what would ideally seem much more suitable—a commodity reserve standard. A very attractive scheme for storing a large variety of raw materials and other standard commodities had been worked out for such a standard to ensure the redeemability of the currency unit by a fixed combination of such commodities and thereby the stability of the currency. Storage would however be so expensive, and practicable only for such a small collection of commodities, as to reduce the value of the proposal.2 But some such precaution to force the issuer to regulate the amount of his currency appears necessary or desirable only so long as his interest would be to increase or decrease its value above or below the standard. Convertibility is a safeguard necessary to impose upon a monopolist, but unnecessary with competing suppliers who cannot maintain themselves in the business unless they provide money at least as advantageous to the user as anybody else.

Government monopoly of money unnecessary

Not so very long ago, in 1960, I myself argued that it is not only impracticable but probably undesirable even if possible to deprive governments of their control over monetary policy.3 This view was still based on the common tacit assumption that there must be in each country a single uniform kind of money. I did not then even consider the possibility of true competition between currencies within any given country or region. If only one kind of money is permitted, it is probably true that the monopoly of its issue must be under the control of government. The concurrent circulation of several currencies might at times be slightly inconvenient, but careful analysis of its effects indicates that the advantages appear to be so very much greater than the inconveniences that they hardly count in comparison, though unfamiliarity with the new situation makes them appear much bigger than they probably would be.

Difference between voluntarily accepted and enforced paper money

Much as all historical experience appears to justify the deep mistrust most people harbour against paper money, it is well founded only with regard to money issued by government. Frequently the term ‘fiat money’ is used as if it applied to all paper money, but the expression refers of course only to money which has been given currency by the arbitrary decree or other act of authority. Money which is current only because people have been forced to accept it is wholly different from money that has come to be accepted because people trust the issuer to keep it stable. Voluntarily accepted paper money therefore ought not to suffer from the evil reputation governments have given paper money.

Money is valued because, and in so far as, it is known to be scarce, and is for this reason likely to be accepted at the going value by others. And any money which is voluntarily used only because it is trusted to be kept scarce by the issuer, and which will be held by people only so long as the issuer justifies that trust, will increasingly confirm its acceptability at the established value. People will know that the risk they run in holding it will be smaller than the risk they run in holding any other good on which they do not possess special information. Their willingness to hold it will rest on the experience that other people will be ready to accept it at an approximately known range of prices because they also have learnt to hold the same expectation, and so on. This is a state of affairs that can continue indefinitely and will even tend to stabilise itself more and more as confirmed expectations increase the trust.

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Some people apparently find it difficult to believe that a mere token money which did not give the holder a legal claim for redemption in terms of some object possessing an intrinsic value (equal to its current value) could ever be generally accepted for any length of time or preserve its value. They seem to forget that for the past 40 years in the whole Western World there has been no other money than such irredeemable tokens. The various paper currencies we have had to use have preserved a value which for some time was only slowly decreasing not because of any hope of ultimate redemption, but only because the monopolistic agencies authorised to issue the exclusive kind of currency of a particular country did in some inadequate degree restrict its amount. But the clause on a pound-note saying ‘I promise to pay to the bearer on demand the sum of one pound’, or whatever the figure be, signed for the Governor and Company of the Bank of England by their Chief Cashier, means of course no more than that they promise to exchange that piece of paper for other pieces of paper.

It is entirely at the discretion of these institutions or governments to regulate the total amount of their issues in circulation by exchanging some of the notes for other kinds of money or for securities. This sort of redemption is just a method of regulating the quantity of money in the hands of the public, and, so long as public opinion was not misguided by specious theories, it has always been taken as a matter of course that, e.g., ‘the value of [greenbacks] changes as the government chooses to enlarge or to contract the issue’.4

History certainly disproves the suggestion that in this respect government, which only profits from excessive issues, can be trusted more than a private issuer whose whole business depends on his not abusing that trust. Does anyone really believe that in the industrial countries of the West, after the experience of the last half-century, anybody trusts the value of government-sponsored money more than he would trust money issued by a private agency whose business was understood to depend wholly on its issuing good money?

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5 The first systematic exposition of my position will be found in my 1937 Geneva lectures on Monetary Nationalism and International Stability [27]. It contains a series of lectures hastily and badly written on a topic to which I had earlier committed myself but which I had to write when I was pre-occupied with other problems. I still believe that it contains important arguments against flexible exchange rates between national currencies which have never been adequately answered, but I am not surprised that few people appear ever to have read it.

6 Cf. Friedman [19].

7 Hayek [29], pp. 324 et seq.

8 W. Bagehot [3], p. 12.

• 1Ibid., p. 45. The locus classicus on this subject from which I undoubtedly derived my views on it, though I had forgotten this when I wrote the First Edition of this Paper, is Carl Menger’s discussion in 1892 [43a] of legal tender under the even more appropriate equivalent German term Zwangskurs. See pp. 98-106 of the reprint, especially p. 101, where the Zwangskurs is described as ‘eine Massrege1, die in der überwiegenden Zahl der Fälle den Zweck hat, gegen den Willen der Bevöklerung, zumindest durch einen Missbrauch der Münzhoheit oder des Notenregals entstandene pathologische (also exceptionelle[?]) Formen von Umlaufsmitteln, durch einen Missbrauch der Justizhoheit dem Verkehr aufzudrängen oder in demselben zu erhalten’; and p. 104 where Menger describes it as ‘ein auf die Forderungsberechtigten geübter gesetzlicher Zwang, bei Summenschulden (bisweilen auch bei Schulden anderer Art) solche Geldsorten als Zahlung anzunehmen, welche dem ausdrücklich oder stillschweigend vereinbarten Inhalte der Forderungen nicht entsprechen, oder dieselben sich zu einem Wert aufdrangen zu lassen, der ihrem Wert im freien Verkehr nicht entspricht’. Especially interesting also is the first footnote on p. 102 in which Menger points out that there had been fairly general agreement on this among the liberal economists of the first half of the 19th century, while during the second half of that century, through the influence of the (presumably German) lawyers, the economists were led erroneously to regard legal tender as an attribute of perfect money.
• 2Cf. Nussbaum [50], pp. 586-592.
• 3W. S. Jevons [34], p. 64, as against Herbert Spencer [57].
• 4Jevons, ibid., p. 65. An earlier characteristic attempt to justify making banking and note issue an exception from a general advocacy of free competition is to be found in 1837 in the writings of S. J. Loyd (later Lord Overstone) [38], p.49: ‘The ordinary advantages to the community arising from competition are that it tends to excite the ingenuity and exertion of the producers, and thus to secure to the public the best supply and quantity of the commodity at the lowest price, while all the evils arising from errors or miscalculations on the part of the producers will fall on themselves, and not on the public. With respect to a paper currency, however, the interest of the public is of a very different kind ; a steady and equable regulation of its amount by fixed law is the end to be sought and the evil consequence of any error or miscalculation upon this point falls in a much greater proportion upon the public than upon the issuer.’ It is obvious that Loyd thought only of the possibility of different agencies issuing the same currency, not of currencies of different denominations competing with one another.
• 5‘Looking to the above cases of the use or abuse of the law of legal tender other than the last [i.e. that of subsidiary coins] we see that they possess one character in common—viz. that the law in all of them enables a debtor to pay and requires a creditor to receive something different from that which their contract contemplated. In fact it is a forced and unnatural construction put upon the dealings of men by arbitrary power’.
• 6All this is well illustrated by the historical occasion when the expression ‘legal tender’ became widely known and treated as a definition of money. In the notorious ‘legal tender cases’, fought before the Supreme Court of the United States after the Civil War, the issue was whether creditors must accept at par current dollars in settlement of their claims for money they had lent when the dollar had a much higher value. The same problem arose even more acutely at the end of the great European inflations after the First World War when, even in the extreme case of the German Mark, the principle ‘Mark is Mark’ was enforced until the end—although later some efforts were made to offer limited compensation to the worst sufferers.
• 7‘that, as we trust the grocer to furnish us with pounds of tea, and the baker to send us loaves of bread, so we might trust Heaton and Sons, or some of the other enterprising firms of Birmingham, to supply us with sovereigns and shillings at their own risk and profit’,
• 8led him to the categorical declaration that generally, in his opinion, ‘there is nothing less fit to be left to the action of competition than money’.