Denationalisation of Money: The Argument Refined
XV. The Desirable Behaviour of the Supply of Currency
We have so far provisionally assumed that the kind of money individuals will prefer to use will also be most conducive to the smooth functioning of the market process as a whole. Although this is plausible and, as we shall see, approximately true in practice, it is not self-evident. We have still to examine the validity of this belief. It is at least conceivable that the use of one particular kind of currency might be most convenient for each separate individual but that each might be better off if all the others used a different kind.
We have seen (Section XIII) that successful economic action (or the fulfilment of the expectations which prompted it) depends largely on the approximately correct prediction of future prices. These predictions will be based on current prices and the estimation of their trend, but future prices must always be to some degree uncertain because the circumstances which determine them will be unknown to most individuals. Indeed, the function of prices is precisely to communicate, as rapidly as possible, signals of changes of which the individual cannot know but to which his plans must be adjusted. This system works because on the whole current prices are fairly reliable indications of what future prices will probably be, subject only to those ‘accidental’ deviations which, as we have seen, if average prices remain constant, are likely to offset each other. We have also seen how such an offsetting of opposite disappointments becomes impossible if a substantial general movement of prices in one direction takes place.
But the current prices of particular commodities or groups of commodities can also be positively misleading if they are caused by non-recurring events, such as temporary inflows or outflows of money to the system. For such apparent changes in demand from a particular direction are in a peculiar manner self-reversing: they systematically channel productive efforts into directions where they cannot be maintained. The most important recurrent misdirections of the use of resources of this sort occur when, by the creation (or withdrawal) of amounts of money, the funds available for investment are increased substantially above (or decreased substantially below) the amounts currently transferred from consumption to investment, or saved.
Although this is the mechanism by which recurrent crises and depressions are caused, it is not a specific effect of a particular kind of currency which the users are likely to be aware of and which might therefore lead them to switch to another. We can expect the selection of the currency they use to be influenced only by such attributes as recognisably affect their actions, but not by indirect effects of changes of its amount which will operate largely through their effects on the decisions of others.
The supply of currency, stable prices, and the equivalence of investment and saving
While the modern author who first drew attention to the crucial importance of these divergences between investment and saving, Knut Wicksell, believed that they would disappear if the value of money were kept constant, this has unfortunately proved to be not strictly correct. It is now generally recognised that even those additions to the quantity of money that in a growing economy are necessary to secure a stable price level may cause an excess of investment over saving. But though I was among those who early pointed out this difficulty,1 I am inclined to believe that it is a problem of minor practical significance. If increases or decreases of the quantity of money never exceeded the amount necessary to keep average prices approximately constant, we would come as close to a condition in which investment approximately corresponded to saving as we are likely to do by any conceivable method. Compared, anyhow, with the divergences between investment and saving which necessarily accompany the major swings in the price level, those which would still occur under a stable price level would probably be of an order of magnitude about which we need not worry.
‘Neutral money’ fictitious
My impression is that economists have become somewhat over-ambitious concerning the degree of stability that is either achievable or even desirable under any conceivable economic order, and that they have unfortunately encouraged political demands concerning the certainty of employment at a hoped-for wage which in the long run no government can satisfy. That perfect matching or correspondence of the individual plans, which the theoretical model of a perfect market equilibrium derives on the assumption that the money required to make indirect exchange possible has no influence on relative prices, is a wholly fictitious picture to which nothing in the real world can ever correspond. Although I have myself given currency to the expression ‘neutral money’ (which, as I discovered later, I had unconsciously borrowed from Wicksell), it was intended to describe this almost universally made assumption of theoretical analysis and to raise the question whether any real money could ever possess this property, and not as a model to be aimed at by monetary policy.2 I have long since come to the conclusion that no real money can ever be neutral in this sense, and that we must be content with a system that rapidly corrects the inevitable errors. The nearest approach to such a condition which we can hope to achieve would appear to me to be one in which the average prices of the ‘original factors of production’ were kept constant. But as the average price of land and labour is hardly something for which we can find a statistical measure, the nearest practicable approximation would seem to be precisely that stability of raw material and perhaps other wholesale prices which we could hope competitively issued currencies would secure.
I will readily admit that such a provisional solution (on which the experimentation of competition might gradually improve), though giving us an infinitely better money and much more general economic stability than we have ever had, leaves open various questions to which I have no ready answer. But it seems to meet the most urgent needs much better than any prospects that seemed to exist while one did not contemplate the abolition of the monopoly of the issue of money and the free admission of competition into the business of providing currency.
Increased demand for liquidity
To dispel one kind of doubt which I myself at one stage entertained about the possibility of maintaining a stable price level, we may briefly consider here what would happen if at one time most members of a community wished to keep a much larger proportion of their assets in a highly liquid form than they did before. Would this not justify, and even require, that the value of the most liquid assets, that is, of all money, should rise compared with that of commodities?
The answer is that such needs of all individuals could be met not only by increasing the value of the existing liquid assets, money, but also by increasing the amounts they can hold. The wish of each individual to have a larger share of his resources in a very liquid form can be taken care of by additions to the total stock of money. This, paradoxically, increases the sum of the value to the individuals of all existing assets and thereby also the share of them that is highly liquid. Nothing, of course, can increase the liquidity of a closed community as a whole, if that concept has any meaning whatsoever, except, perhaps, if one wishes to extend its meaning to a shift from the production of highly specific to very versatile goods which would increase the ease of adaptation to unforeseen events.
There is no need to be afraid of spurious demands for more money on the ground that more money is needed to secure adequate liquidity. The amount required of any currency will always be that which can be issued or kept in circulation without causing an increase or decrease of the aggregate (direct or indirect) price of the ‘basket’ of commodities supposed to remain constant. This rule will satisfy all legitimate demands that the variable ‘needs of trade’ be satisfied. And this will be true in so far as the stated collection of goods can be bought or sold at the stated aggregate price, and the absorption or release of currency from cash balances does not interfere with this condition.
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It remains true, however, that so long as good and bad currencies circulate side by side, the individual cannot wholly protect himself from the harmful effects of the bad currencies by using only the good ones in his own transactions. Since the relative prices of the different commodities must be the same in terms of the different concurrent currencies, the user of a stable currency cannot escape the effects of the distortion of the price structure by the inflation (or deflation) of a widely used competing currency. The benefit of a stable course of the economic activities which, we shall argue, the use of a stable money would produce, would therefore be achieved only if the great majority of transactions were effected in stable currencies. Such a displacement of most bad money by good would, I believe, come about fairly soon, but occasional disturbances of the whole price structure and in consequence of general economic activity cannot be wholly excluded until the public has learnt rapidly to reject tempting offers of cheap money. **
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3 Hayek [25], pp. 114 ff.
4 Hayek [26].
- 1W. Endemann [15], Vol. II, p. 171.
- 2J. Bodin [5], p. 176. Bodin, who understood more about money than most of his contemporaries, may well have hoped that the governments of large states would be more responsible than the thousands of minor princelings and cities who, during the later part of the Middle Ages, had acquired the minting privilege and sometimes abused it even more than the richer princes of large territories.
- 3At any rate, the minting prerogative of the ruler was firmly established under the Roman emperors. When, at the beginning of the modern era, Jean Bodin developed the concept of sovereignty, he treated the right of coinage as one of the most important and essential parts of it. The regalia, as these royal prerogatives were called in Latin, of which coinage, mining, and custom duties were the most important, were during the Middle Ages the chief sources of revenue of the princes and were viewed solely from this angle. It is evident that, as coinage spread, governments everywhere soon discovered that the exclusive right of coinage was a most important instrument of power as well as an attractive source of gain. From the beginning the prerogative was neither claimed nor conceded on the ground that it was for the general good but simply as an essential element of governmental power. The coins served, indeed, largely as the symbols of might, like the flag, through which the ruler asserted his sovereignty, and told his people who their master was whose image the coins carried to the remotest parts of his realm.
- 4At any rate, the minting prerogative of the ruler was firmly established under the Roman emperors. When, at the beginning of the modern era, Jean Bodin developed the concept of sovereignty, he treated the right of coinage as one of the most important and essential parts of it. The regalia, as these royal prerogatives were called in Latin, of which coinage, mining, and custom duties were the most important, were during the Middle Ages the chief sources of revenue of the princes and were viewed solely from this angle. It is evident that, as coinage spread, governments everywhere soon discovered that the exclusive right of coinage was a most important instrument of power as well as an attractive source of gain. From the beginning the prerogative was neither claimed nor conceded on the ground that it was for the general good but simply as an essential element of governmental power. The coins served, indeed, largely as the symbols of might, like the flag, through which the ruler asserted his sovereignty, and told his people who their master was whose image the coins carried to the remotest parts of his realm.
