Individualism and Economic Order

X. A Commodity Reserve Currency1

1

THE gold standard as we knew it undoubtedly had some grave defects. But there is some danger that the sweeping condemnation of it which is now the fashion may obscure the fact that it also had some important virtues which most of the alternatives lack. A wisely and impartially controlled system of managed currency for the whole world might, indeed, be superior to it in all respects. But this is not a practical proposition for a long while yet. Compared, however, with the various schemes for monetary management on a national scale, the gold standard had three very important advantages: it created in effect an international currency without submitting national monetary policy to the decisions of an international authority; it made monetary policy in a great measure automatic and thereby predictable; and the changes in the supply of basic money which its mechanism secured were on the whole in the right direction.

2

The importance of these advantages should not be lightly underestimated. The difficulties of a deliberate co-ordination of national policies are enormous, because our present knowledge gives us unambiguous guidance in only a few situations, and decisions in which nearly always some interests must be sacrificed to others will have to rest on subjective judgments. Unco-ordinated national policies, however, directed solely by the immediate interests of the individual countries, may in their aggregate effect on every country well be worse than the most imperfect international standard. Similarly, though the automatic operation of the gold standard is far from perfect, the mere fact that under the gold standard policy is guided by known rules, and that, in consequence, the action of the authorities can be foreseen, may well make the imperfect gold standard less disturbing than a more rational but less comprehensible policy. The general principle that the production of gold is stimulated when its value begins to rise and discouraged when its value falls is right at least in the direction, if not in the way in which it operates in practice.

It will be noticed that none of these points claimed in favor of the gold standard is directly connected with any property inherent to gold. Any internationally accepted standard based on a commodity whose value is regulated by its cost of production would possess essentially the same advantages. What in the past made gold the only substance on which in practice an international standard could be based was mainly the irrational, but no less real, factor of its prestige—or, if you will, of the ruling superstitious prejudice in favor of gold, which made it universally more acceptable than anything else. So long as this belief prevailed, it was possible to maintain an international currency based on gold without much design or deliberate organization to support it. But if it was prejudice which made the international gold standard possible, the existence of such a prejudice at least made an international money possible at a time when any international system based on explicit agreement and systematic co-operation was out of the question.

3

The decisive change which has occurred in recent times, and which has fundamentally altered our prospects and opportunities in this field, is the psychological one that the unreasoning prejudice in favor of gold, which gave gold what special advantage it possessed, has been gravely shaken—though perhaps not so much as many people imagine; that in many quarters it has even been replaced by an equally strong and unreasoned prejudice against gold; and that people generally are much more ready to consider rational alternatives. It is therefore important that we should seriously reconsider alternative systems which preserve the advantages of an automatic international standard with freedom from the special defects of gold. One such alternative in particular, which has recently been worked out in its practical detail by competent students of monetary problems, is of a kind which makes it appeal to many who in the past have defended the gold standard—not because they regarded it as ideal, but because it seemed to them superior to anything else which was practical politics.

Before describing this new proposal, it is necessary briefly to consider the real faults of the gold standard which we want to avoid. They are not mainly those which are most generally recognized. The much-discussed “vagaries” in the production of gold can easily be exaggerated. The great increases in the supply of gold in the past have in fact occurred when a prolonged scarcity had created a real need for them. The really serious objection against gold is rather the slowness with which its supply adjusts itself to genuine changes in demand. A temporary increase in the general demand for highly liquid assets, or the adoption of the gold standard by a new country, was bound to cause great changes in the value of gold while the supply adjusted itself only slowly. By a sort of delay action the increased supplies often became available only when they were no longer needed. Not only did these new supplies thus tend to become an embarrassment rather than a relief, but the increase of the stock of gold in response to a temporary increase in demand remained permanent and provided the basis for an excessive expansion of credit as soon as the demand again fell.

This last point is closely connected with the one really paradoxical feature of the gold standard: namely, the fact that the striving of all individuals to become more liquid did not put society into a more liquid position at all. “Yet there are times when the desire of the individuals to put themselves in a more liquid position expresses a real social need. There will always be periods in which increased uncertainty about the future will make it desirable that a larger portion of our assets should be given forms in which they can be readily converted to the needs of what are still unpredictable circumstances. A rational arrangement of our affairs would require that at such times production is in some measure switched from things of more restricted usefulness to the kind of things which will be needed in all conditions, such as the most widely used raw materials. The true irony of the gold standard is that under its rule a general increase in the desire for liquidity leads to the increase in the production of the one thing which can be used for practically no other purpose than to provide a liquidity reserve to individuals; and of a thing, moreover, which not only has few other uses but which can be supplied in increased quantity only so slowly that an increase in the demand for it will act much more on its value than on its quantity or, in other words, will cause a general fall in prices; while once the supply has increased and the demand again falls, the excess supply can be worked off only by a fall in its value or by a general rise of prices.

4

More rational schemes relying on the use of commodities other than gold have often been proposed, but so long as the universal prejudice was in favor of gold they were scarcely of practical interest. In the present situation, however, at least one of these proposals, recently elaborated in detail by two American scholars, deserves close attention for its successful combination of great theoretical and practical merits. Benjamin Graham, of New York, and Frank D. Graham, of Princeton, who had, unknown to each other, arrived at very similar ideas, have in recent years fully elaborated their proposal in a series of important publications.2 Though at first their plan may appear strange and complicated, it is in fact very simple and eminently practical.

The basic idea is that currency should be issued solely in exchange against a fixed combination of warehouse warrants for a number of storable raw commodities and be redeemable in the same “commodity unit.” For example, £100, instead of being defined as so-and-so many ounces of gold, would be defined as so much wheat, plus so much sugar, plus so much copper, plus so much rubber, etc. Since money would be issued only against the complete collection of all the raw commodities in their proper physical quantities (twenty-four different commodities in Benjamin Graham’s plan), and since money would also be redeemable in the same manner, the aggregate price of this collection of commodities would be fixed, but only the aggregate price and not the price of any one of them. In this respect the different commodities would be connected with money not in the way in which gold and silver were connected with it under bimetallism, so that a unit of money was obtainable either for a fixed quantity of gold or for a fixed quantity of silver; but rather as if (according to the plan suggested by Alfred Marshall under the name of “symmetallism”) only the price of a certain weight of gold and a certain weight of silver together were fixed, but the price of each metal by itself was allowed to fluctuate.

With this system in operation an increase in the demand for liquid assets would lead to the accumulation of stocks of raw commodities of the most general usefulness. The hoarding of money, instead of causing resources to run to waste, would act as if it were an order to keep raw commodities for the hoarder’s account. As the hoarded money was again returned to circulation, and demand for commodities increased, these stocks would be released to satisfy the new demand. Since the collection of commodities could always be exchanged against a fixed sum of money, its aggregate price could never fall below that figure; and, since money would be redeemable at the same (or an only slightly different) rate, their aggregate price could never rise above that figure. In this respect the aim of the proposal is similar to that of the “tabular standard” or the “index currencies,” which were at one time much discussed. But it differs from them in its direct and automatic operation. It is at least doubtful whether the price level of any selection of commodities could be effectively kept constant by deliberate adjustments of the quantity of money. But there can be no doubt that the aggregate price of the selected raw commodities could not vary so long as the monetary authority stood ready to sell and buy the commodity unit at a fixed price.

As proposed by its American protagonists, the plan is designed primarily for adoption on a national scale by the United States. The arguments in its favor apply, however, no less to other countries. As the adoption of the plan by several countries, who based it, however, on different collections of commodities, would produce a new cause of serious instability, it would appear that the plan not only could but, to achieve its ends, ought to be adopted internationally—or, what comes in practice to the same thing, that it ought to be operated on the same principle by all the major countries. The particular collection of raw commodities on which Benjamin Graham’s scheme is based (five grains, four fats and oilseeds, three other foodstuffs, four metals, three textile fibers, tobacco, hides, rubber, and petroleum) and certain other details would have to be modified; but the principle raises no serious difficulties to international application. In the following outline of the way in which the scheme would operate it will be assumed that commodity units of the same composition are adopted as the basis of currency at least in the British Empire and the United States.

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For reasons which will presently appear, the plan is most easily put into operation when a fall of demand threatens. It can be made automatically to come into effect at such a time by fixing beforehand a buying price for the commodity unit slightly below the ruling market value. Once the demand for raw commodities then begins to slacken and their prices to fall, the monetary authorities of the participating countries will be offered any commodity units which cannot be disposed in the market at the fixed price. Their purchases will make up for the fall of the industrial demand—and for every amount of money that is being accumulated in private hands a corresponding amount of raw commodities is accumulated in the warehouses. The demand for raw commodities in general is thus maintained—but only the demand for the group as a whole and not that for any particular commodity, the output of which may well be excessive and in need of curtailment.

It will be readily seen how the operation of the scheme would tend to stabilize the demand for raw commodities. As in the past gold-mining used to be the only industry that regularly prospered during periods of depression, so the producers of raw commodities might under this plan enjoy in the same circumstances even a moderate increase in prosperity through being able to exchange their products at more favorable terms against manufactures. But while gold-mining is far too small an industry for its prosperity to have significant effects outside it, the secure income of the producers of raw commodities would also go far to stabilize the demand for manufactures and to prevent the depression from becoming serious. The benefit would indeed not be confined to the producers of the commodities included in the commodity unit. Even a country in which none of these commodities was produced would gain from its operation hardly less than the others. So long as it stood ready to buy commodity units at a fixed price in its national currency, any money thus issued to the producers of raw commodities would be of no use to them except for buying the products of the country to which they had sold their raw produce.

6

At first it may appear as if the operation of the plan might create the danger of serious inflationary expansion. But on examination it proves that its effect could not be really inflationary in any significant sense of that word; whatever monetary expansion it would permit could hardly lead either to a general rise of prices or to that shortage of consumers’ goods through which the most harmful effects of inflation operate. It is, in fact, one of the great merits of the scheme that it provides an automatic check to any expansion before it can become dangerous. We have considered its operation during a depression first, because its effectiveness during a boom depends on the previous accumulation of commodity stocks such as would take place during a period of slackening activity. The manner in which the scheme would operate while an improvement in the general outlook leads to a mobilization of the idle cash reserves is, however, no less important.

The aggregate price of the raw commodities making up the commodity unit could not rise so long as the monetary authorities are able to sell from their stocks at the fixed figure. Instead of a rise in prices and a consequent increase in output as demand increased, and pari passu with the return into circulation of the accumulated money hoards, raw commodities would be released from the stocks and the money received for them impounded. The savings made by individuals in the form of cash during the slack period would not have run to waste but would be waiting in the form of raw commodities ready to be used. In consequence, the revival of activity will not lead to an extra stimulus to the production of raw commodities which would continue on an even keel. There is reason to regard the temporary stimulus to an excessive expansion of the production to raw commodities, which used to be given by the sharp rise of their prices in boom periods, as one of the most serious causes of general instability. This would be entirely avoided under the proposed scheme—at least so long as the monetary authority had any stocks from which to sell. But since it would necessarily possess sufficient reserves to redeem all the extra cash accumulated during the period of slackness (and considerably more if the commodity stocks held by governments at the initiation of the scheme were brought in), the boom would almost certainly be damped down by the contraction of the circulation before the reserves are exhausted.

7

As has been remarked before, the scheme sounds complicated, but is, in fact, exceedingly simple to operate. There would, in particular, be no need for the monetary authorities or the government in any way directly to handle the many commodities of which the commodity unit is composed. Both the bringing-together of the required assortment of warrants and the actual storing of the commodities could be safely left to private initiative. Specialist brokers would soon take care of the collecting and tendering of warrants as soon as their aggregate market price fell ever so little below the standard figure and of withdrawing and redistributing the warrants to their various markets if their aggregate price rose above that figure. In this respect the business of the monetary authority would be as mechanical as the buying and selling of gold under the gold standard.

This is not to say that the proposal does not raise numerous problems, which cannot be fully discussed in this short outline. At least the more important of these problems have been considered and practicable solutions suggested in the publications already referred to. To mention only a few of these points: the cost of the physical storage of the commodities could be defrayed out of the difference between the prices at which the monetary authority buys and sells commodity units. (It should be noticed that the cost of storage would not include any interest charge, because the loss of interest would be voluntarily borne by the holders of the money issued against the commodities.) The problems raised by the composition of the commodity unit and the periodical changes in it which will become necessary can also be solved by the adoption of an objective principle which would lift it out of the sphere of political wrangle. Similarly the problems of the differences of quality and distinctions according to the place of storage and the like do not raise insuperable difficulties. It should be remembered in this connection that for the purposes of the plan the inclusion of the most important variety of any commodity would have nearly the same effect on the prices of its close substitutes as if they were themselves included.

Two special points must, however, be mentioned even in so brief a survey. The first is the important feature of the plan that the monetary authority shall be empowered in precisely defined circumstances to accept in place of (or substitute for) warrants for stored commodities contracts for future delivery of any commodity. This meets the difficulties which would otherwise be caused by a temporary shortage of any one commodity included in the unit and makes it possible to use the reserves for some measure of stabilization even of individual commodity prices. This would be achieved, for example, by substituting “futures” for present commodities whenever the current price rose by more than a fixed percentage over the “future” price.

The second point is that, if it were wished to preserve the value of gold or to prevent a too rapid decline of it, it would not be difficult to link up the value of gold in such a way with the commodity scheme that, though gold would have no significant effect on the value of money, the value of gold would be stabilized at the same time with the value of money. Whether this is desirable in view of the interest whole nations have in the preservation of the value of gold, and whether it ought to be used to maintain the production of gold indefinitely near its present level or rather to bring about a gradual but predictable decline of the resources devoted to it, is a political problem we need not consider here. The important point is merely that there are many ways in which gold could be linked with the new scheme if desired without thereby impairing the advantages of the scheme.

It is probably true to say that all the rational arguments which can be advanced in favor of the gold standard apply even more strongly to this proposal, which is at the same time free from most of the defects of the former. In judging the feasibility of the plan, it must, however, not be regarded solely as a scheme for currency reform. It must be borne in mind that the accumulation of commodity reserves is certain to remain part of national policy and that political considerations render it unlikely that the markets for raw commodities will in any future for which we can now plan be left entirely to themselves. All plans aiming at the direct control of the prices of particular commodities are, however, open to the most serious objections and certain to cause grave economic and political difficulties. Even apart from monetary consideration, the great need is for a system under which these controls are taken from the separate bodies which can but act in what is essentially an arbitrary and unpredictable manner and to make the controls instead subject to a mechanical and predictable rule. If this can be combined with the reconstruction of an international monetary system which would once more secure to the world stable international currency relations and a greater freedom in the movement of raw commodities, a great step would have been taken in the direction toward a more prosperous and stable world economy.

• 1[*] The twelfth Finlay Lecture, delivered at University College, Dublin, on December 17, 1945. Published by Hodges, Figgis & Co., Ltd., Dublin, and B. H. Blackwell, Ltd., Oxford, 1946.
• 2Both the term “individualism” and the term “socialism” are originally the creation of the Saint-Simonians, the founders of modern socialism. They first coined the term “individualism” to describe the competitive society to which they were opposed and then invented the word “socialism” to describe the centrally planned society in which all activity was directed on the same principle that applied within a single factory. See on the origin of these terms the present author’s article on “The Counter-Revolution of Science,” Economica, VIII (new ser., 1941), 146.