Denationalisation of Money: The Argument Refined

XVIII. MONETARY POLICY NEITHER DESIRABLE NOR POSSIBLE

It is true that under the proposed arrangements monetary policy as we now know it could not exist. It is not to be denied that, with the existing sort of division of responsibility between the issues of the basic money and those of a parasitic circulation based on it, central banks must, to prevent matters from getting completely out of hand, try deliberately to forestall developments they can only influence but not directly control. But the central banking system, which only 50 years ago was regarded as the crowning achievement of financial wisdom, has largely discredited itself. This is even more true since, with the abandonment of the gold standard and fixed exchange rates, the central banks have acquired fuller discretionary powers than when they were still trying to act on firm rules. And this is true no less where the aim of policy is still a reasonable degree of stability, as in countries overwhelmed by inflation.

Government the major source of instability

We have it on the testimony of a competent authority who was by no means unsympathetic to those modern aspirations that, during the recent decade 1962 to 1972 when the believers in a ‘fine tuning’ of monetary policy had an influence which we must hope they will never have again, the larger part of the fluctuations were a consequence of budgetary and monetary policy.1 And it is certainly impossible to claim that the period since the abandonment of the semi-automatic regulation of the quantity of money has generally been more stable or free from monetary disturbances than the periods of the gold standard or fixed rates of exchange.

We indeed begin to see how completely different an economic landscape the free issue of competitive currencies would produce when we realise that under such a system what is known today as monetary policy would neither be needed nor even possible. The issuing banks, guided solely by their striving for gain, would thereby serve the public interest better than any institution has ever done or could do that supposedly aimed at it. There neither would exist a definable quantity of money of a nation or region, nor would it be desirable that the individual issuers of the several currencies should aim at anything but to make as large as possible the aggregate value of their currency that the public was prepared to hold at the given value of the unit. If we are right that, being able to choose, the public would prefer a currency whose purchasing power it could expect to be stable, this would provide a better currency and secure more stable business conditions than have ever existed before.

The supposed chief weakness of the market order, the recurrence of periods of mass unemployment, is always pointed out by socialists and other critics as an inseparable and unpardonable defect of capitalism.2 It proves in fact wholly to be the result of government preventing private enterprise from working freely and providing itself with a money that would secure stability. We have seen that there can be no doubt that free enterprise would have been both able to provide a money securing stability and that striving for individual gain would have driven private financial institutions to do so if they had been permitted. I am not sure that private enterprise would adopt the manner of performing the task I have suggested, but I am inclined to think that, by its habitual procedure of selecting the most successful, it would in time throw up better solutions to these problems than anyone can foresee today.

Monetary policy a cause of depressions

What we should have learned is that monetary policy is much more likely to be a cause than a cure of depressions, because it is much easier, by giving in to the clamour for cheap money, to cause those misdirections of production that make a later reaction inevitable, than to assist the economy in extricating itself from the consequences of overdeveloping in particular directions. The past instability of the market economy is the consequence of the exclusion of the most important regulator of the market mechanism, money, from itself being regulated by the market process.

A single monopolistic governmental agency can neither possess the information which should govern the supply of money nor would it, if it knew what it ought to do in the general interest, usually be in a position to act in that manner. Indeed, if, as I am convinced, the main advantage of the market order is that prices will convey to the acting individuals the relevant information, only the constant observation of the course of current prices of particular commodities can provide information on the direction in which more or less money ought to be spent. Money is not a tool of policy that can achieve particular foreseeable results by control of its quantity. But it should be part of the self-steering mechanism by which individuals are constantly induced to adjust their activities to circumstances on which they have information only through the abstract signals of prices. It should be a serviceable link in the process that communicates the effects of events never wholly known to anybody and that is required to maintain an order in which the plans of participating persons match.

Government cannot act in the general interest

Yet even if we assumed that government could know what should be done about the supply of money in the general interest, it is highly unlikely that it would be able to act in that manner. As Professor Eckstein, in the article quoted above, concludes from his experience in advising governments:

‘Governments are not able to live by the rules even if they were to adopt the philosophy [of providing a stable framework]’.3

Once governments are given the power to benefit particular groups or sections of the population, the mechanism of majority government forces them to use it to gain the support of a sufficient number of them to command a majority. The constant temptation to meet local or sectional dissatisfaction by manipulating the quantity of money so that more can be spent on services for those clamouring for assistance will often be irresistible. Such expenditure is not an appropriate remedy but necessarily upsets the proper functioning of the market.

In a true emergency such as war, governments would of course still be able to force upon people bonds or other pieces of paper for unavoidable payments which cannot be made from current revenues. Compulsory loans and the like would probably be more compatible with the required rapid readjustments of industry to radically changed circumstances than an inflation that suspends the effective working of the price mechanism.

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No more balance-of-payment problems

With the disappearance of distinct territorial currencies there would of course also disappear the so-called ‘balance-of-payment problems’ believed to cause intense difficulties to present-day monetary policy. There would, necessarily, be continuous redistributions of the relative and absolute quantities of currency in different regions as some grew relatively richer and others relatively poorer. But this would create no more difficulties than the same process causes today within any large country. People who grew richer would have more money and those who grew poorer would have less. That would be all. The special difficulties caused by the fact that under existing arrangements the reduction of the distinct cash basis of one country requires a contraction of the whole separate superstructure of credit erected on it would no longer exist.

Similarly, the closer connections of the structure of the prices prevailing within any one country as against prices in neighbouring countries, and with it the statistical illusion of the relative movement of distinct national price levels, would largely disappear. Indeed it would be discovered that ‘balance-of-payment problems’ are a quite unnecessary effect of the existence of distinct national currencies, which is the cause of the wholly undesirable closer coherence of national prices than of international prices. From the angle of a desirable international economic order the ‘balance-of-payment problem’ is a pseudo-problem about which nobody need worry but a monopolist of the issue of money for a given territory. And not the least advantage of the disappearance of distinct national currencies would be that we could return to the happy days of statistical innocence in which nobody could know what the balance of payment of his country or region was and thus nobody could worry or would have to care about it.

The addictive drug of cheap money

The belief that cheap money is always desirable and beneficial makes inevitable and irresistible the pressure on any political authority or monopolist known to be capable of making money cheap by issuing more of it. Yet loanable funds made artificially cheap by creating more money for lending them, not only help those to whom they are lent, though at the expense of others, but for a while have a general stimulating effect on business activity. That at the same time such issues have the effect of destroying the steering mechanism of the market is not so easily seen. But supplies of such funds for additional purchases of goods produce a distortion of the structure of relative prices which draws resources into activities that cannot be lastingly maintained and thereby become the cause of an inevitable later reaction. These indirect and slow effects are, however, in their nature very much more difficult to recognise or understand than the immediate pleasant effects and particularly the benefits to those to whom the additional money goes in the first instance.

To provide a medium of exchange for people who want to hold it until they wish to buy an equivalent for what they have supplied to others is a useful service like producing any other good. If an increase in the demand for such cash balances is met by an increase of the quantity of money (or a reduction of the balances people want to hold by a corresponding decrease of the total amount of money), it does not disturb the correspondence between demand and supply of all other commodities or services. But it is really a crime like theft to enable some people to buy more than they have earned by more than the amount which other people have at the same time foregone to claim.

When committed by a monopolistic issuer of money, and especially by government, it is however a very lucrative crime which is generally tolerated and remains unpunished because its consequences are not understood. But for the issuer of a currency which has to compete with other currencies, it would be a suicidal act, because it would destroy the service for which people did want to hold his currency.

Because of a lack of general understanding, the crime of over-issue by a monopolist is still not only tolerated but even applauded. That is one of the chief reasons why the smooth working of the market is so frequently upset. But today almost any statesman who tries to do good in this field, and certainly anyone forced to do what the large organised interests think good, is therefore likely to do much more harm than good. On the other hand, anyone who merely knows that the success of his business of issuing money rests wholly on his ability to keep the buying power of his currency constant, will do more for the public good by aiming solely at large profits for himself than by any conscious concern about the more remote effects of his actions.

The abolition of central banks

Perhaps a word should be explicitly inserted here about the obvious corollary that the abolition of the government monopoly of the issue of money should involve also the disappearance of central banks as we know them, both because one might conceive of some private bank assuming the function of a central bank and because it might be thought that, even without a government monopoly of issue, some of the classic functions of central banks, such as that of acting as ‘lender of last resort’ or of ‘holder of the ultimate reserve’,4 might still be required.

The need for such an institution is, however, entirely due to the commercial banks incurring liabilities payable on demand in a unit of currency which some other bank has the sole right to issue, thus in effect creating money redeemable in terms of another money. This, as we shall have still to consider, is indeed the chief cause of the instability of the existing credit system, and through it of the wide fluctuations in all economic activity. Without the central bank’s (or the government’s) monopoly of issuing money, and the legal tender provisions of the law, there would be no justification whatever for the banks to rely for their solvency on the cash to be provided by another body. The ‘one reserve system’, as Walter Bagehot called it, is an inseparable accompaniment of the monopoly of issue but unnecessary and undesirable without it.

It might still be argued that central banks are necessary to secure the required ‘elasticity’ of the circulation. And though this expression has probably in the past been more abused than any other to disguise inflationist demands, we must not overlook its valid kernel. The manner in which elasticity of supply and stability of value of the money can be reconciled is a genuine problem, and it will be solved only if the issuer of a given currency is aware that his business depends on so regulating the quantity of his currency that the value of its unit remains stable (in terms of commodities). If an addition to the quantity would lead to a rise of prices, it would clearly not be justified, however urgently some may feel that they need additional cash—which then will be cash to spend and not to add to their liquidity reserves. What makes a currency a universally acceptable, that is really liquid, asset will be precisely that it is preferred to other assets because its buying power is expected to remain constant.

What is necessarily scarce is not liquidity but buying power—the command over goods for consumption or use in further production, and this is limited because there is no more than a given amount of these things to buy. So far as people want more liquid assets solely to hold them but not to spend them, they can be manufactured without thereby depreciating their value. But if people want more liquid assets in order to spend them on goods, the value of such credits will melt between their fingers.

No fixing of rates of interest

With the central banks and the monopoly of the issue of money would, of course, disappear also the possibility of deliberately determining the rate of interest. The disappearance of what is called ‘interest policy’ is wholly desirable. The rate of interest, like any other price, ought to record the aggregate effects of thousands of circumstances affecting the demand for and supply of loans which cannot possibly be known to any one agency. The effects of most price changes are unpleasant to some, and, like other price changes, changes in the rate of interest convey to all concerned that an aggregate of circumstances which nobody knows has made them necessary. The whole idea that the rate of interest ought to be used as an instrument of policy is entirely mistaken, since only competition in a free market can take account of all the circumstances which ought to be taken account of in the determination of the rate of interest.

So long as each separate issue bank in its lending activity aimed at regulating the volume of its outstanding currency so as to keep its buying power constant, the rate of interest at which it could do so would be determined for it by the market. And, on the whole, the lending for investment purposes of all the banks together, if it was not to drive up the price level, could not exceed the current volume of savings (and conversely, if it was not to depress the price level, must not fall short of the current volume of savings) by more than was required to increase aggregate demand in step with a growing volume of output. The rate of interest would then be determined by balancing the demand for money for spending purposes with the supply required for keeping the price level constant. I believe this would assure as close an agreement between saving and investment as we can hope to achieve, leaving a balance of change in the quantity of money to take account of changes in the demand for money caused by changes in the balances people want to hold.

Of course, government would still affect this market rate of interest by the net volume of its borrowing. But it could no longer practise those most pernicious manipulations of the rate of interest which are intended to enable it to borrow cheaply—a practice which has done so much harm in the past that this effect alone would seem an adequate reason why government should be kept away from the tap.

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5 O. Eckstein [14], especially p. 19: ‘Traditionally, stabilisation theory has viewed private, capitalist economy as a mechanism which produces fluctuations. ...There is no question that government is a major source of instability.’ And p. 25: ‘The rate of inflation [in the US between 1962 and 1972] would have been substantially less, real growth would have been smoother, the total amount of unemployment experienced would have been little changed but the variations would have been milder, and the terminal conditions at the end of the period would have made it possible to avoid the wage and price controls.’

6 The long depression of the 1930s, which led to the revival of Marxism (which would probably have been dead today without it), was wholly due to the mismanagement of money by government—before as well as after the crisis of 1929.

7 O. Eckstein [14], p. 26.

8 The standard description of this function and of how it arose is still W. Bagehot, who could rightly speak [3, p. 142] of ‘a natural state of banking, that in which all the principal banks kept their own reserve’.

• 1Nussbaum [50], Mann [41] and Breckinridge [6].
• 2Nussbaum [50], pp. 54-5.
• 3Mann [41], p. 38. On the other hand, the refusal until recently of English Courts to give judgement for paying in any other currency than the pound sterling has made this aspect of legal tender particularly influential in England. But this is likely to change after a recent decision (Miliangos v. George Frank Textiles Ltd [1975]) established that an English Court can give judgement in a foreign currency on a money claim in a foreign currency, so that, for instance, it is now possible in England to enforce a claim from a sale in Swiss francs. (Financial Times, 6 November, 1975: the report is reproduced in F. A. Hayek [31], pp. 45-6).
• 4Occasional attempts by the authorities of commercial cities to provide a money of at least a constant metallic content, such as the establishment of the Bank of Amsterdam, were for long periods fairly successful and their money used far beyond the national boundaries. But even in these cases the authorities sooner or later abused their quasi-monopoly positions. The Bank of Amsterdam was a state agency which people had to use for certain purposes and its money even as exclusive legal tender for payments above a certain amount. Nor was it available for ordinary small transactions or local business beyond the city limits. The same is roughly true of the similar experiments of Venice, Genoa, Hamburg and Nuremberg.
• 5In its strictly legal meaning, ‘legal tender’ signifies no more than a kind of money a creditor cannot refuse in discharge of a debt due to him in the money issued by government. Even so, it is significant that the term has no authoritative definition in English statute law. Elsewhere it simply refers to the means of discharging a debt contracted in terms of the money issued by government or due under an order of a court. In so far as government possesses the monopoly of issuing money and uses it to establish one kind of money, it must probably also have power to say by what kind of objects debts expressed in its currency can be discharged. But that means neither that all money need be legal tender, nor even that all objects given by the law the attribute of legal tender need to be money. (There are historical instances in which creditors have been compelled by courts to accept commodities such as tobacco, which could hardly be called money, in discharge of their claims for money.)
• 6In its strictly legal meaning, ‘legal tender’ signifies no more than a kind of money a creditor cannot refuse in discharge of a debt due to him in the money issued by government. Even so, it is significant that the term has no authoritative definition in English statute law. Elsewhere it simply refers to the means of discharging a debt contracted in terms of the money issued by government or due under an order of a court. In so far as government possesses the monopoly of issuing money and uses it to establish one kind of money, it must probably also have power to say by what kind of objects debts expressed in its currency can be discharged. But that means neither that all money need be legal tender, nor even that all objects given by the law the attribute of legal tender need to be money. (There are historical instances in which creditors have been compelled by courts to accept commodities such as tobacco, which could hardly be called money, in discharge of their claims for money.)
• 7In its strictly legal meaning, ‘legal tender’ signifies no more than a kind of money a creditor cannot refuse in discharge of a debt due to him in the money issued by government. Even so, it is significant that the term has no authoritative definition in English statute law. Elsewhere it simply refers to the means of discharging a debt contracted in terms of the money issued by government or due under an order of a court. In so far as government possesses the monopoly of issuing money and uses it to establish one kind of money, it must probably also have power to say by what kind of objects debts expressed in its currency can be discharged. But that means neither that all money need be legal tender, nor even that all objects given by the law the attribute of legal tender need to be money. (There are historical instances in which creditors have been compelled by courts to accept commodities such as tobacco, which could hardly be called money, in discharge of their claims for money.)
• 8There certainly can be and has been money, even very satisfactory money, without government doing anything about it, though it has rarely been allowed to exist for long. But a lesson is to be learned from the report of a Dutch author about China a hundred years ago who observed of the paper money then current in that part of the world that ‘because it is not legal tender and because it is no concern of the State it is generally accepted as money’. We owe it to governments that within given national territories today in general only one kind of money is universally accepted. But whether this is desirable, or whether people could not, if they understood the advantage, get a much better kind of money without all the to-do about legal tender, is an open question. Moreover, a ‘legal means of payment’ (gesetzliches Zahlungsmittel) need not be specifically designated by a law. It is sufficient if the law enables the judge to decide in what sort of money a particular debt can be discharged.