Denationalisation of Money: The Argument Refined

Neither a general increase nor a general decrease of prices appears to be possible in normal circumstances so long as several issuers of different currencies are allowed freely to compete without the interference of government. There will always be one or more issuers who find it to their advantage to regulate the supply of their currency so as to keep its value constant in step with the aggregate price of a bundle of widely used commodities. This would soon force any less provident issuers of competing currencies to put a stop to a slide in the value of their currency in either direction if they did not wish to lose the issue business altogether or to find the value of their currency falling to zero.

No such thing as oil-price (or any other) cost-push inflation

It is, of course, taken for granted here that the average prices in terms of a currency can always be controlled by appropriate adjustments of its quantity. Theoretical analysis and experience seem to me alike to confirm this proposition. We need therefore pay no attention to the views always advanced in periods of prolonged inflation in attempts to exculpate governments by contending that the continued rise in prices is not the fault of policy but the result of an initial rise in costs. To this claim it must be replied emphatically that, in the strict sense, there is simply no such a thing as a ‘cost-push’ inflation. Neither higher wages nor higher prices of oil, or perhaps of imports generally, can drive up the aggregate price of all goods unless the purchasers are given more money to buy them. What is called a cost-push inflation is merely the effect of increases in the quantity of money which governments feel forced to provide in order to prevent the unemployment resulting from a rise in wages (or other costs), which preceded it and which was conceded in the expectation that government would increase the quantity of money. They mean thereby to make it possible for all the workers to find employment through a rise in the demand for their products. If government did not increase the quantity of money such a rise in the wages of a group of workers would not lead to a rise in the general price level but simply to a reduction in sales and therefore to unemployment.

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It is, however, worth considering a little more fully what would happen if a cartel or other monopolistic organisation, such as a trade union, did succeed in substantially raising the price of an important raw material or the wages of a large group of workers, fixing them in terms of a currency which the issuer endeavours to keep stable. In such circumstances the stability of the price level in terms of this currency could be achieved only by the reduction of a number of other prices. If people have to pay a larger amount of money for the oil or the books and printed papers they consume, they will have to consume less of some other things.

The problem of rigid prices and wages

No currency, of course, can remove the rigidity of some prices which has developed. But it can make impossible the policies which have assisted this development by making it necessary for those who hold prices rigid in the face of a reduced demand to accept the consequent loss of sales.

The whole difference of approach between the dominant ‘Keynesian’ school and the view underlying the present exposition rests in the last resort on the position taken with regard to the phenomenon of rigid prices and wages. Keynes was largely led to his views by his belief that the increasing rigidity of wages was an unalterable fact which had to be accepted and the effect of which could be mitigated only by accommodating the rate of money expenditure to the given rate of wages. (This opinion was in some measure justified in the British position in the 1920s, when, as a result of an injudicious attempt to raise the external value of the pound, most British wages had become out of line with international commodity prices.) I have maintained ever since that such an adaptation of the quantity of money to the rigidity of some prices and particularly wages would greatly extend the range of such rigidities and must therefore, in the long run, entirely destroy the functioning of the market.

The error of the ‘beneficial mild inflation’

All inflation is so very dangerous precisely because many people, including many economists, regard a mild inflation as harmless and even beneficial. But there are few mistakes of policy with regard to which it is more important to heed the old maxim principiis obsta.1 Apparently, and surprisingly, the self-accelerating mechanism of all engineered inflation is not yet understood even by some economists. The initial general stimulus which an increase of the quantity of money provides is chiefly due to the fact that prices and therefore profits turn out to be higher than expected. Every venture succeeds, including even some which ought to fail. But this can last only so long as the continuous rise of prices is not generally expected. Once people learn to count on it, even a continued rise of prices at the same rate will no longer exert the stimulus that it gave at first.

Monetary policy is then faced with an unpleasant dilemma. In order to maintain the degree of activity it created by mild inflation, it will have to accelerate the rate of inflation, and will have to do so again and again at an ever increasing rate every time the prevailing rate of inflation comes to be expected. If it fails to do so and either stops accelerating or ceases to inflate altogether, the economy will be in a much worse position than when the process started. Not only has inflation allowed the ordinary errors of judgement to accumulate which are normally promptly eliminated and will now all have to be liquidated at the same time. It will in addition have caused misdirection of production and drawn labour and other resources into activities which could be maintained only if the additional investment financed by the increase in the quantity of money could be maintained.

Since it has become generally understood that whoever controls the total supply of money of a country has thereby power to give in most situations almost instantaneous relief to unemployment, even if only at the price of much unemployment later, the political pressure on such an agency must become irresistible. The threat of that possibility has always been understood by some economists, who for this reason have ever been anxious to restrain the monetary authorities by barriers they could not break. But since the betrayal, or ignorance, of this insight by a school of theorists which thereby bought themselves temporary popularity, political control of the supply of money has become too dangerous to the preservation of the market order to be any longer tolerated. However much political pressure might be brought on the most important private banks of issue to make them relax their credit conditions and extend their circulation, if a non-monopolistic institution gave in to such pressure it would soon cease to be one of the most important issuers.

The ‘money illusion’, i.e. the belief that money represents a constant value, could arise only because it was useless to worry about changes in the value of money so long as one could not do anything about it. Once people have a choice they will become very much aware of the different changes of the value of the different currencies accessible to them. It would, as it should, become common knowledge that money needs to be watched, and would be regarded as a praiseworthy action rather than as an unpatriotic deed to warn people that a particular currency was suspect. **

Responsibility for unemployment would be traced back to trade unions

Depriving government of the power of thus counteracting the effects of monopolistically enforced increases in wages or prices by increasing the quantity of money would place the responsibility for the full use of resources back to where it belongs: where the causally effective decisions are taken—the monopolists who negotiate the wages or prices. We ought to understand by now that the attempt to combat by inflation the unemployment caused by the monopolistic actions of trade unions will merely postpone the effects on employment to the time when the rate of inflation required to maintain employment by continually increasing the quantity of money becomes unbearable. The sooner we can make impossible such harmful measures, probably unavoidable so long as government has the monetary power to take them, the better for all concerned.

The scheme proposed here would, indeed, do somewhat more than prevent only inflations and deflations in the strict sense of these terms. Not all changes in the general level of prices are caused by changes in the quantity of money, or its failure to adapt itself to changes in the demand for holding money; and only those brought about in this manner can properly be called inflation or deflation. It is true that there are nowadays unlikely to be large simultaneous changes in the supply of many of the most important goods, as happened when variations in harvests could cause dearths or gluts of most of the main foodstuffs and clothing materials. And, even today, perhaps in wartime in a country surrounded by enemies or on an island, an acute scarcity (or glut) of the products in which the country has specialised is perhaps conceivable. At least if the index number of commodity prices that guided the issue of the currency in the country were based chiefly on national prices, such a rule might lead to changes in the supply of currency designed to counteract price movements not caused by monetary factors.

Preventing general deflation

The reader may not yet feel fully reassured that, in the kind of competitive money system we are here contemplating, a general deflation will be as impossible as a general inflation. Experience seems indeed to have shown that, in conditions of severe uncertainty or alarm about the future, even very low rates of interest cannot prevent a shrinking of a bank’s outstanding loans. What could a bank issuing its own distinct currency do when it finds itself in such a situation, and commodity prices in terms of its currency threaten to fall? And how strong would be its interest in stopping such a fall of prices if the same circumstances affected the competing institutions in the same way?

There would of course be no difficulty in placing additional money at a time when people in general want to keep very liquid. The issuing bank, on the other hand, would not wish to incur an obligation to maintain by redemption a value of its currency higher than that at which it had issued it. To maintain profitable investments, the bank would presumably be driven to buy interest-bearing securities and thereby put cash into the hands of people looking for other investments as well as bring down the long-term rates of interest, with a similar effect. An institution with a very large circulation of currency might even find it expedient to buy for storage quantities of commodities represented in the index that tended to fall particularly strongly in price.

This would probably be sufficient to counteract any downward tendency of general prices produced by the economic process itself, and if it achieved this effect it is probably as much as can be accomplished by any management of money. But it is of course not to be wholly excluded that some events may cause such a general state of discouragement and lethargy that nothing could induce people to resume investment and thereby stop an impending fall of prices. So far as this were due to extraneous events, such as the fear of an impending world catastrophe or of the imminent advent of communism, or in some region the desire to convert all private possessions into cash to be prepared for flight, probably nothing could prevent a general fall in the prices of possessions that are not easily portable. But so long as the general conditions for the effective conduct of capitalist enterprise persisted, competition would provide a money that caused as little disturbance to its working as possible. And this is probably all we can hope.2

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3 [‘Resist beginnings’ (or, colloquially, ‘nip it in the bud’) : Ovid, Remedia Amoris, 91, trans. Showerman, Oxford Dictionary of Quotations, OUP.-ED.]

4 The remaining doubt concerns the question whether in such circumstances the holders of cash might wish to switch towards an appreciating currency, but such a currency would then probably not be available.

• 1Especially Werner Sombart [56] and before him Archibald Alison [1] and others. Cf. on them Paul Barth [4], who has a whole chapter on ‘History as a function of the value of money’, and Marianne von Herzfeld [32].
• 2A. Nussbaum [50], p. 53.
• 3Nobody has yet written a full history of these developments. It would indeed be all too monotonous and depressing a story, but I do not think it an exaggeration to say that history is largely a history of inflation, and usually of inflations engineered by governments and for the gain of governments—though the gold and silver discoveries in the 16th century had a similar effect. Historians have again and again attempted to justify inflation by claiming that it made possible the great periods of rapid economic progress. They have even produced a series of inflationist theories of history which have, however, been clearly refuted by the evidence: prices in England and the United States were at the end of the period of their most rapid development almost exactly at the same level as two hundred years earlier. But their recurring rediscoverers are usually ignorant of the earlier discussions.
• 4‘From Marco Polo we learn that, in the 13th century, Chinese law made the rejection of imperial paper money punishable by death, and twenty years in chains or, in some cases death, was the penalty provided for the refusal to accept French assignats. Early English law punished repudiation as lese-majesty. At the time of the American revolution, non-acceptance of Continental notes was treated as an enemy act and sometimes worked a forfeiture of the debt.’