Denationalisation of Money: The Argument Refined

We are so used to the existence in each country of a distinct currency in which practically all internal transactions are conducted that we tend to regard it also as natural and necessary for the whole structure of internal prices to move together relatively to the price structure of other countries. This is by no means a necessary or in any sense natural or desirable state of affairs.

National currencies not inevitable or desirable

At least without tariffs or other obstructions to the free movement of goods and men across frontiers, the tendency of national prices to move in unison is an effect of, rather than a justification for, maintaining separate national currency systems. And it has led to the growth of national institutions, such as nation-wide collective bargaining, which have intensified these differences. The reason for this development is that the control over the supply of money gives national governments more power over actions which are wholly undesirable from the point of view of international order and stability. It is the kind of arrangement of which only étatists of various complexions can approve but which is wholly inimical to frictionless international relations.

There is indeed little reason why, apart from the effects of monopolies made possible by national protection, territories that happen to be under the same government should form distinct national economic areas which would benefit by having a common currency distinct from that of other areas. In an order largely dependent on international exchange, it was rather absurd to treat the often accidental agglomeration of different regions under the same government as a distinct economic area. The recognition of this truth has however only recently led a few economists to ask what would be desirable currency areas—a question they found rather difficult to answer.1

While historically distinct national currencies were simply an instrument to enhance the power of national governments, the modern argument for monetary nationalism favours an arrangement under which all prices in a region can simultaneously be raised or lowered relatively to all prices in other regions. This is regarded as an advantage because it avoids the necessity to lower a group of particular prices, especially wages, when foreign demand for the products concerned has fallen and shifted to some other national region. But it is a political makeshift; in practice it means that, instead of lowering the few prices immediately affected, a very much larger number of prices will have to be raised to restore international equilibrium after the international price of the local currency has been reduced. The original motive for the agitation for flexible rates of exchange between national currencies was therefore purely inflationist, although a foolish attempt was made to place the burden of adjustment on the surplus countries. But it was later also taken up in countries which wanted to protect themselves against the effects of the inflationist policies of others.

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There is no better case for preventing the decrease of the quantity of money circulating in a region or sector of a larger community than there is for governmental measures to prevent a decrease of the money incomes of particular individuals or groups—even though such measures might temporarily relieve the hardships of the groups living there. It is even essential for honest government that nobody should have the power of relieving groups from the necessity of having to adapt themselves to unforeseen changes, because, if government can do so, it will be forced by political necessity to do so all the time.

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Rigidity of wage-rates: raising national price structure is no solution

Experience has shown that what was believed to be the easy way out from the difficulties created by the rigidity of wages, namely, raising the whole national price level, is merely making matters worse, since in effect it relieves trade unions of the responsibility for the unemployment their wage demands would otherwise cause and creates an irresistible pressure on governments to mitigate these effects by inflation. I remain therefore as opposed to monetary nationalism2 or flexible rates of exchange between national currencies as ever. But I prefer now abolishing monetary frontiers altogether to merely making national currencies convertible into each other at a fixed rate. The whole conception of cutting out a particular sector from the international structure of prices and lifting or lowering it, as it were, bodily against all the other prices of the same commodities still seems to me an idea that could be conceived only in the brains of men who have come to think exclusively in terms of national (‘macro’) price levels, not of individual (‘micro’) prices. They seem to have thought of national price levels as the acting determinants of human action and to have ceased to understand the function of relative prices.

Stable national price level could disrupt economic activity

There is really no reason why we should want the price level of a region interconnected by a large number of commodity streams with the rest of the world economy to have a stable price level. To keep this price level stable in spite of shifts of demand towards or away from the region only disturbs and does not assist the functioning of the market. The relation between regions or localities is in this respect not essentially different from the relations between countries. The transfer of demand for airplanes from Seattle to Los Angeles will indeed lead to a loss of jobs and a decline of incomes and probably of retail prices in Seattle ; and if there is a fall in wages in Seattle, it will probably attract other industries. But nothing would be gained, except perhaps for the moment, by increasing the quantity of money in Seattle or the State of Washington. And it would not ease the problem if the whole North West of the United States had a currency of its own which it could keep constant or even increase to meet such a misfortune for some of its inhabitants.

But while we have no foundations for desiring particular areas to have their individual currencies, it is of course an altogether different question whether the free issue of competitive currencies in each area would lead to the formation of currency areas—or rather of areas where different currencies were predominant, although others could be used. As we have seen (Section XII), there might develop different preferences as regard the commodity equivalent of the currency that should be kept constant. In a primitive country where people used little but rice, fish, pork, cotton and timber, they would be chiefly concerned about different prices—though local tendencies of this sort would probably be offset by those of the users to be guided in their preferences by the greater trust they had in an internationally-reputed issuer of money than in one who adapted his currency specially to local circumstances. Nor would I be surprised to find that in large areas only one currency was generally used in ordinary dealings, so long as potential competition made its issuer keep it stable. As everywhere else, so long as it does not come to trying out innovations or improvements, competition in posse3 is likely to be nearly as effective as competition in esse.4And the ready convertibility of the generally used currency would make all those who had any traffic beyond the region change their holdings quickly enough into another currency if their suspicions about the commonly accepted one were aroused.

Such areas in which one currency predominates would however not have sharp or fixed boundaries but would largely overlap, and their dividing lines would fluctuate. But once the principle were generally accepted in the economically leading countries, it would probably spread rapidly to wherever people could choose their institutions. No doubt there would remain enclaves under dictators who did not wish to let go their power over money—even after the absence of exchange control had become the mark of a civilised and honest country.

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5 McKinnon [40] and Mundell [49].

6 The historical origin of the preoccupation with national price levels as well as the other aspects of Monetary Nationalism were discussed in my book with that title [27], especially p. 43.

7 [In posse: potential; in esse: in being.—ED.]

• 1If, as he is sometimes quoted, Gresham maintained that better money quite generally could not drive out worse, he was simply wrong, until we add his probably tacit presumption that a fixed rate of exchange was enforced.
• 2In 1582 by G. Scaruffi [57].
• 3For a time during the Middle Ages gold coins issued by the great commercial republics of Italy were used extensively in international trade and maintained over fairly long periods at a constant gold content, while at the same time the petty coins, mostly of silver, used in local retail trade suffered the regular fate of progressive debasement. (Cipolla [11], pp. 34 ff.)
• 4For a time during the Middle Ages gold coins issued by the great commercial republics of Italy were used extensively in international trade and maintained over fairly long periods at a constant gold content, while at the same time the petty coins, mostly of silver, used in local retail trade suffered the regular fate of progressive debasement. (Cipolla [11], pp. 34 ff.)
• 5With variable exchange rates, however, the inferior quality money would be valued at a lower rate and, particularly if it threatened to fall further in value, people would try to get rid of it as quickly as possible. The selection process would go on towards whatever they regarded as the best sort of money among those issued by the various agencies, and it would rapidly drive out money found inconvenient or worthless. Indeed, whenever inflation got really rapid, all sorts of objects of a more stable value, from potatoes to cigarettes and bottles of brandy to eggs and foreign currencies like dollar bills, have come to be increasingly used as money, so that at the end of the great German inflation it was contended that Gresham’s law was false and the opposite true. It is not false, but it applies only if a fixed rate of exchange between the different forms of money is enforced.
• 6The multiplicity of coins with which the old money-changers had to deal consisted ultimately only of these two kinds, and their respective value within each group was determined by their content of either metal (which the expert but not the layman could ascertain). Most princes had tried to establish a fixed legal rate of exchange between gold and silver coins, thereby creating what came to be called a bimetallic system. But since, in spite of very early suggestions that this rate be fixed by an international treaty, governments established different exchange rates, each country tended to lose all the coins of the metal it under-valued relatively to the rates prevailing in other countries. The system was for that reason more correctly described as an alternative standard, the value of a currency depending on the metal which for the time being was over-valued. Shortly before it was finally abandoned in the second half of the 19th century, a last effort was made to establish internationally a uniform rate of exchange of 15 between gold and silver. That attempt might have succeeded so long as there were no big changes in production. The comparatively large share of the total stocks of either metal that were in monetary use meant that, by an inflow or outflow into or from that use, their relative values could probably have been adjusted to the rate at which they were legally exchangeable as money.
• 7This is the only form in which parallel currencies were ever widely used, but it proved singularly inconvenient for a special reason. Since for most of the time gold was by weight more than 15 times as valuable as silver, it was evidently necessary to use the former for large and silver for the smaller (and copper for the still smaller) units. But, with variable values for the different kinds of coins, the smaller units were not constant fractions of the larger ones. In other words, the gold and the silver coins were parts of different systems without smaller or larger coins respectively of the same system being available. This made any change from large to small units a problem, and nobody was able, even for his own purposes, to stick to one unit of account.