For more than a century economists have toyed with the
idea of designing or inventing an ideal money. So far no two of them
seem to have precisely agreed on the detailed nature of such a money.
But they do seem at the moment to agree on at least one negative point.
I doubt that there is any economist today who would defend the
international or American monetary system just as it is. No one openly
defends the violent daily and hourly fluctuations in exchange rates, the
steadily increasing unpredictability of future import, export, or
domestic prices. Every newspaper reader fears that commodity prices will
be higher next year and still higher the year after that, Even the man
in the street, in brief, senses that the world is drifting toward
monetary chaos.
But concerning the remedy, we find little agreement.
Inflation is bad, some agree. Yes; but it isn't as bad as depression and
unemployment; and at least it puts off those greater evils, so we must
have just a little more inflation as long as these evils threaten us.
Inflation is bad, others agree; but it has nothing to do with the
monetary system. Rising prices are brought about by the greed and
rapacity of sellers; they could promptly be stopped by price controls.
Or, inflation is bad, still others concede; and yes, it is brought about
by the increase in the quantity of money and credit.
But this is not the fault of the monetary system
itself, but of the blunders and misdeeds of the politicians or the
bureaucrats in charge of it.
Even those who admit that there is something wrong with
the monetary system itself cannot agree on the reforms needed in that
system. Scores of such reforms have been proposed.
The reformers, however, tend to fall into two main
groups. One of these would have nothing to do with a gold, a silver, or
any other commodity standard, but would leave the issuance and control
of the currency entirely in the hands of the State. The other group
would return to some form of the gold standard.
Each of these two groups may again be divided into two
schools. In what I shall call the statist or paper-money group, one
school would leave everything to the day-to-day discretion of government
monetary authorities, and the other would subject these authorities to
strict quantitative controls. And in the gold group, likewise, one
school would allow discretion, within vague but wide limits, to private
bankers and government authorities, while the second would impose severe
and definite limits on that discretion.
So we have, then, four main schools of monetary
theorists.
Nearly every currency proposal can be classified under
one of them.
Paper Money - No Controls
Let us begin with School One, the paper-money statists,
who would leave the power of controlling the nature, quantity and value
of our money solely in the hands of the politicians in office or the
bureaucrats they appoint. This is the worst imaginable monetary system,
but it is the one that prevails nearly everywhere in the world today. It
has brought about practically universal inflation, unprecedented
uncertainty, and economic disruption.
None of this is accidental. It was built into the
system deliberately adopted at a conference of 44 nations at Bretton
Woods in 1944, under the guidance of Harry Dexter White of the U.S. and
Lord Keynes of England. The ostensible purpose of that conference was to
increase "international cooperation" and - believe it or not - to
"stabilize" currencies and exchange rates.
The chief architects sincerely believed (though they
did not as openly avow) that this end could best be achieved by phasing
gold out of the monetary system. So they put the world, in effect, not
on a gold but on a dollar standard. The value of every other currency
was to be maintained by making it convertible into the American dollar
at a fixed official exchange rate.
The system still had one tie to gold. The dollar itself
was to be kept convertible into that metal at $35 an ounce. But this tie
was weakened in two ways. Other countries could keep their currencies
stabilized in terms of the dollar, not through the operations of a free
foreign exchange market (as under the pre-World War I gold standard) but
by government sales or purchases of dollars-in other words by government
pegging operations. And dollars were no longer convertible into gold on
demand by anybody who held them; they were convertible only by foreign
central banks. The U.S. could even (off-the-record) use its great
political and economic power -which in time it did-to indicate to any
central bank with the effrontery to ask for gold that this was not
considered a friendly act.
So the artificial stability that the Bretton Woods
system was able to maintain for a few years was not the result of any
real attempt by each country to keep its own currency sound - by
refraining from excessive issuance of money and credit - but of
government pegging operations and gentlemen's agreements not to upset
the apple cart.
This arrangement proved, in the end, unwise, unsound,
and unstable. The system was able to maintain the appearance of
stability only by the stronger currencies constantly rushing to the
rescue of the weaker. The U.S., say, would rush in and lend Britain
millions of dollars, or buy millions of pounds. It would do the like for
other currencies in crisis. But using the stronger currencies to support
the weaker only weakened the stronger currencies. When the U.S. Treasury
bought millions of pounds with dollars, it in effect got these dollars
by printing them.
And so when the dollar itself, as the result of our own
recklessness, began to turn bad, and when we went off the gold standard
openly in August, 1971, other nations were affected. Germany, for
instance, under the terms of the Bretton Woods agreements, had to buy
billions of dollars to keep the D-mark from going above its official
parity. And where did Germany get the billions of marks necessary to buy
the billions of dollars? Why, by printing them.
So the faster-inflating nations almost systematically
exported their inflations to the slower-inflating nations. And this
almost systematically brought the world toward its present inflationary
chaos.
True, the nations with stronger currencies, even when
they felt obliged by their Bretton Woods agreement to buy weaker
currencies, did not have to increase their own money supply to buy them.
Neither Germany nor any other nation that acquired dollars had to use
the dollars as added central bank "reserves" against which they could
issue still more of their own currency. They could have "sterilized"
their reserves of dollars. Or they could have reduced their other
government expenditures correspondingly when they felt obliged to buy
dollars, or raised the amount by added taxation, instead of simply
printing more D-marks or whatever. But these would have been very
difficult decisions. They might have endangered the tenure of the
governments that made them. What they chose seemed under the
circumstances the path of least resistance.
What has to be made crystal clear, if we are to lay the
foundations for any permanent sound monetary reform, is that the present
worldwide inflationary chaos is not a mere accident. It is not something
that has happened in spite of the wonderfully modern and enlightened
International Monetary Fund system. It is something that has happened
precisely because of that, system. It is, in fact, its almost inevitable
result.
Steady Breakdown
It was precisely the kind of "international
cooperation" it set up that led to its final breakdown. The countries
whose policies were chronically leading them into currency crises should
have been obliged to pay the penalty. The faltering currencies should
not have been rescued by the central banks of other countries. It was
exactly because the soft-currency countries knew that an American or
international safety net would be almost automatically spread out to
save them that they chronically got themselves into more trouble.
As it was, the system kept breaking down anyway, but
there was a sort of open conspiracy to ignore its fundamental
unsoundness. In September, 1949, the British pound was devalued by 30
per cent, from $4.03 to $2.80. When this happened some 25 other
countries devalued within a single week. In November, 1967 the British
pound was devalued once more, this time from $2.80 to $2.40. There have
been in fact hundreds of devaluations of currencies in the International
Monetary Fund since it opened for business in 1946. In its Monthly
Bulletin the Fund has printed literally millions of statistics a year,
but it has steadfastly refused, up to now, to publish one figure - the
total number of these devaluations.
Enough of this. It should no longer be necessary to
prove how bad the Bretton Woods system turned out to be. Few people,
aside from the bureaucrats whose jobs are at stake, would seriously try
to glue it together again. The system is dead. Unfortunately the corpse
has not been buried.
The Monetarists
Let us turn to the next candidate-the proposals of the
so called monetarists. Two things may by said in favor of the
monetarists. First, they do recognize the close connection between the
quantity of money and the purchasing power of the monetary unit. And
second, they do acknowledge the importance of imposing strict and
explicit limits on the issuance of money. But there are serious
weaknesses both in their factual assumptions and in their policy
proposals.
It is true that there is a close relation between the
outstanding supply of money and the buying power of the individual
monetary unit. But it is not true that this relation is inversely
proportional or in any other way fixed and dependable. Nor is it true
that there is any fixed "lag" between an increase of a given percentage
in the "growth" of the money supply and an increase of the same
percentage in prices. The statistics on which this conclusion is based
are at best inadequate. They do not cover enough currencies over long
enough periods.
What happens during a typical inflation, for example,
is that in its early stages commodity prices do not rise as fast as the
supply of money is increased and in its later stages prices rise much
faster than the supply of money is increased.
Monetarists will dismiss this whole comparison as
unfair and irrelevant. They do not regard themselves as proposing
inflation at all. To them inflation is defined not as an increase in the
money supply, but only as a rise in prices. And their proposal, as they
see it, is to increase the stock of money 3 to 5 per cent a year just to
keep the price "level" from falling. They propose an annual increase in
the money stock merely to compensate for an expected annual increase of
3 per cent or more in the "productivity" of the economy.
The monetarists' proposal rests on a false factual
assumption. There is no automatic and dependable annual increase in
"productivity" of 3 per cent or any other fixed rate. The increase in
productivity that has occurred in the U.S. in recent years is the result
of saving, investment, and technical progress. None of these is
automatic. In fact, in the last two years or so, the usual
"productivity" measures have actually been declining.
Wholly apart from the formidable mathematical And
statistical problems involved, which space does not permit me to go
into, the maintenance of the price "level" is a dubious goal. It is
based on the assumption that falling prices are somehow "deflationary,"
and that in any case they tend to bring about recession. This assumption
is questionable. When the stock of money is not increased, falling
prices are a normal result of increased production and economic
progress. They need not bring recession, because the falling prices are
themselves the result of falling production costs. Real profit margins
are not reduced. Money wage-rates may not increase, but real wages will
increase because the same money will buy more. Falling prices with
continued or rising prosperity have occurred again and again in our
history.
Abuses of Union Power
In our present world of powerful and aggressive labor
unions, with legally built-in coercive powers, the monetarists do have a
legitimate fear that such unions will not be satisfied with increased
purchasing power for the same money wages. In that case, when such
unions ask and get excessive wage-rates, they may bring on unemployment
and recession. But this danger will exist under any monetary system
whatever, as long as we retain our present one-sided labor laws and
union ideology.
The central and fatal flaw of the monetarist proposal
is its extreme political naivete. It puts the power of controlling the
quantity, the quality, and the purchasing power of our money entirely in
the hands of the State - that is, of the politicians and bureaucrats in
office.
I am tempted to add that it leaves this power entirely
to the discretion, the arbitrary caprice, of the temporary holders of
office in the State. The monetarists would deny this. They would limit
the discretion of the monetary managers, they contend, by a strict rule.
The managers would be ordered to increase the stock of money by only 2,
or 3, or 4, or 5 per cent per year; and this figure would be written
into the law, or into the Constitution.
It is a sign of the monetarists' own vacillation that
they have never quite decided whether this figure should be a
month-to-month bureaucratic goal, or embodied in a law, or nailed into
the Constitution. Nor have they ever definitely decided whether the
figure itself should be 2 or 3 or 4 or 5. They can apparently hold their
ranks together only by remaining vague.
Continuous Political Pressure
It is obvious that once the premises of this system
were adopted there would be continuous political pressure for inflation.
Those who contended that an annual increase of 2 per cent in the money
stock would be enough would constantly have to combat the fears of their
colleagues that this might be too low, and threaten to bring on
recession. The 3 percenters, again, would have to fight a ceaseless
rearguard action against the advocates of 4 per cent, or these in turn
against the champions of 5 per cent. And so ad infinitum. Every time a
recession seemed imminent, it would be blamed on the lowness of the
existing rate of money increase. Agitation would be resumed to boost it.
None of this is a figment of my imagination. It is
occurring today. On February 20, 1975, Henry Ford II, in presenting the
disappointing annual report of his motor company, emphasized the need of
measures to "assure strong recovery." Among these, he stipulated: "The
Federal Reserve must raise the monetary growth rate to the range of 6 to
8 per cent for a short period."
I cite this as only one among scores of examples. It
was especially instructive because it came from a businessman and not
from a politician.
A month later there was a far more striking
illustration. On March 18 the Senate of the U.S. adopted unanimously, 86
to 0, a resolution urging the Federal Reserve Board to expand the money
supply in a way "appropriate to facilitating prompt economic recovery."
It also asked the board to consult with the House and Senate Banking
Committee every six months on "objectives and plans" concerning the
money supply. This was in effect an order to the Fed to continue
inflating, and presumably to increase the rate of inflation. It also put
the Fed on notice that whatever it may have previously supposed, it is
not independent, but is subject to the directions of the politicians in
office. The substance of this resolution was later adopted by the full
Congress.
The monetarists' program would inevitably make the
monetary system a political football. What else could we expect? Isn't
it the height of naivete deliberately to put the power of determining
the money supply in the hands of the State, and then expect existing
officeholders not to use that power in the way they think is most likely
to assure their own tenure of office ?
The first requisite of a sound monetary system is that
it put the least possible power over the quantity or quality of money in
the hands of the politicians.
This brings us to gold. It is the outstanding merit of
gold as the money standard that it makes the supply and the purchasing
power of the monetary unit independent of government, of office holders,
of political parties, and of pressure groups. The great merit of gold is
precisely that it is scarce; that its quantity is limited by nature;
that it is costly to discover, to mine, and to process; and that it
cannot be created by political fiat or caprice. It is precisely the
merit of the gold standard, finally, that it puts a limit on credit
expansion.
Fractional or Full Reserve?
But there are two major kinds of gold standard. One is
the fractional-reserve system, and the other the pure gold or 100 per
cent reserve system.
The fractional-reserve system is the one that developed
and prevailed in the Western world in the century from 1815 to 1914. It
is what we now call the classical gold standard. It had the so-called
advantage of elasticity. And it made possible - we might justly say it
was responsible for - the business cycle, the recurrent round of
prosperity and recession, of boom and bust.
With the fractional-reserve system what typically
happened is that in a given country-let us say Ruritania - borrowers
would be given credit by the banks, in the form of demand deposits, and
they would launch upon various enterprises. The new money so created,
perhaps after taking up any slack in business and employment, would
increase Ruritanian prices. Ruritania would become a better place to
sell to, and a poorer place to buy from. The balance of trade or
payments would begin to turn against it. This would be reflected in a
fall in the exchange rate of the Ruritanian currency until the "gold
export point" was reached. Gold would then flow out to other countries.
In order to stop it, interest rates in Ruritania would have to be
raised. With a higher interest rate or a smaller gold base, the volume
of currency would be contracted. This would often mean a deflation or a
crisis followed by a slump.
In brief, the gold standard with a fractional-reserve
system tended almost systematically to bring about the cycle of boom and
slump.
Under such a system, there is constant political
pressure to reduce interest rates or the reserve requirements so that
credit expansion - i.e., inflation - may be encouraged or continued. It
is supposed to be the great advantage of a fractional-reserve system
that it allows credit expansion. But what is overlooked is that, no
matter how long the required legal reserve is set, there must eventually
come a point when the permissible legal credit expansion has been
reached. There is then inevitable political pressure to reduce the
percentage of required reserves still further.
This has been the history of the system in the United
States. The effect - and partly the intention - of the Federal Reserve
Act was enormously to increase the potential volume of credit expansion.
The required reserves for member banks were reduced under the new
Federal Reserve Act from a range of 15 to 25 per cent f or the previous
national banks to 12 to 18 per cent for the new Federal Reserve member
banks, In 1917 the required reserves for member banks were reduced still
further to a range of 7 to 13 per cent.
Pyramiding Credit
But on top of the inverted pyramid of credit that the
member banks were allowed to create, the newly established Federal
Reserve Banks, which now held the reserves of the member banks, were
permitted to erect a still further inverted credit pyramid of their own.
The Reserve Banks were required to carry only a 35 per cent reserve
against their deposits and a 40 per cent gold reserve against their
notes.
Later the Federal Reserve authorities became more
strict in imposing reserve requirements on the member banks (they raised
these sharply beginning in 1936, for example). But they continued to be
very lenient in setting their own reserve requirements. Between June of
1945 and March of 1965 the reserve requirements were reduced from 35 and
40 per cent to a flat 25 per cent. And then they were dropped
altogether.
So much for history. What of the future?
If the world, or at least this country, ever returns to
its senses, and decides to re-establish a gold standard, the
fractional-reserve system ought to be abandoned. If by some miracle the
U.S. government were to make this decision tomorrow, it could not of
course wipe out the already existing supply of fiduciary money and
credit, or any substantial part of it, without bringing on a devastating
and needless deflation. But the government would at least have to
refrain from any further increase in the supply of such fiduciary
currency. Assuming that the government were then able to fix upon a
workable conversion rate of the dollar into gold - a rate that was
sustainable and would not in itself lead to either inflation or
deflation - the U.S. could then return to a sound currency and a sound
gold basis.
But in the world as it has now become-sunk in hopeless
confusion, inflationism, and demagogy - the likelihood of any such
development in the foreseeable future is practically nil. The remedy I
have suggested rests on the assumption that our government and other
governments will become responsible, and suddenly begin doing what is in
the long-run interest of the whole body of the citizens, instead of only
in the short-run interest - or apparent interest of special pressure
groups. Today this is to expect a miracle.
But the outlook is not hopeless. I began by pointing
out that for more than a century individual economists have tried to
design an ideal money. Why have they not agreed? Why have their schemes
come to nothing? They have failed, I think, because they have
practically all begun with the same false assumption - the assumption
that the creation and "management" of a monetary system is and ought to
be the prerogative of the State.
This has become an almost universal superstition. It is
tantamount to agreeing that a monetary system should be made the
plaything of the politicians in power.
The proposals of the would-be monetary reformers have
failed, in fact, for two main reasons. They have failed partly because
they have misconceived the primary functions that a monetary system has
to serve. Too many monetary reformers have assumed that the chief
quality to be desired in a money is to be "neutral." And too many have
assumed that this "neutrality" would be best achieved if they could
create a money that would lead to a constant and unchanging "price
level."
This was the goal of Irving Fisher in the 1920's, with
his "compensated dollar." It is the goal of his present-day disciples,
the "monetarists," and their proposal for a government-managed increase
in the money supply of 3 to 5 per cent a year to keep the "price-level"
stable.
I believe that this goal itself is a questionable one.
But what is an even more serious and harmful error on their part is the
method by which they propose to achieve this goal. They propose to
achieve it by giving the power to the politicians in office to
manipulate the currency according to the formula prescribed in advance
by the monetarists.
Self- Serving Politicians
What such reformers fail to recognize is that once the
politicians and their appointees are granted such powers, they are less
likely to use them to pursue the objectives of the reformers than they
are to pursue their own objectives. The politicians' own objectives will
be those that seem best calculated to keep them in power. The particular
policy they will assume is most likely to keep them in power is to keep
increasing the issuance of money; because this will (1) increase
"Purchasing power" and so presumably increase the volume of trade and
employment; (2) keep prices going up as fast as union pressure pushes up
wages, so that continued employment will be possible; and (3) give
subsidies and other handouts to special pressure groups without
immediately raising taxes to pay for them. In other words, the best
immediate policy for the politicians in power will always appear to them
to be inflation.
In sum, the belief that the creation and management of
a monetary system ought to be the prerogative of the State - i.e., of
the politicians in power -is not only false but harmful. For the real
solution is just the opposite. It is to get government, as far as
possible, out of the monetary sphere. And the first step libertarians
should insist on is to get our government and the courts not only to
permit, but to enforce, voluntary private contracts providing for
payment in gold or in terms of gold value.
A Movement Toward Gold
Let us see what would happen if this were done. As the
rate of inflation increased, or became more uncertain, Americans would
tend increasingly to make long-term contracts payable in gold. This is
because sellers and lenders would become increasingly reluctant to make
long-term contracts payable in paper dollars, or in irredeemable
money-units of any other kind.
This would apply particularly to international
contracts. The buyer or debtor would either have to keep a certain
amount of gold in reserve, or make a forward contract to buy gold, or
depend on buying gold in the open spot market with his paper money on
the date that his contract fell due. In time, if inflation continued,
even current transactions would increasingly be made in gold.
Thus there would grow up, side by side with fiat paper
money, a private domestic and international gold standard. Each country
that permitted this would then be on a dual monetary system, with a
daily changing market relation between the two monies. And there would
be a private gold system ready to take over completely on the very day
that the government's paper money became absolutely worthless - as it
did in Germany in November 1923, and in scores of other countries at
various times.
A Private Gold Standard?
Could there be such a private gold standard? To ask
such a question is to forget that history and prehistory have already
answered it. Private gold coins, and private gold currencies, existed
centuries before governments decided to take them over-to nationalize
them, so to speak. The argument that the kings and governments put
forward for doing this - and it was a plausible one - was that the
existing private coins were not of uniform and easily recognizable size,
weight, and imprint; that the fineness of their gold content, or whether
they were gold at all, could not be easily tested; that the private
coins were crude and easily counterfeited; and finally that the legal
recourse of the receiver, if he found a coin to be underweight or
debased, was uncertain and difficult. But, the kings went on to argue,
if the coins were uniform, and bore the instantly recognizable stamp of
the realm, and if the government itself stood ever ready to prosecute
all clippers or counterfeiters, the people could depend on their money.
Business transactions would become more efficient and certain, and
enormously less time-consuming.
Still another specious argument for a government
coinage applied especially to subsidiary coins. It was impossible, it
was contended, or ridiculously inconvenient, to make gold coins small
enough for use in the millions of necessary small transactions, like
buying a quart of milk or a loaf of bread. What was needed was a
subsidiary coinage, which represented halves, quarters, tenths, or
hundredths of the standard unit. These coins, regardless of what they
were made of, or what their intrinsic value might be, would be legally
acceptable and convertible, at the rates stamped on them, into the
standard gold coins.
It would be very difficult, I admit, to provide for
this with a purely private currency, with everybody having the legal
power to stamp out his own coins and guarantee their conversion by him
into gold. A private coinage system might conceivably be able to solve
this problem, but I confess I personally have been unable to think of
any solution that would not be complicated, cumbersome, or undependable.
It is clear, in short, that a government-provided or a
government regulated coinage has some advantages. But these advantages
are bought at a price. That price seemed comparatively low in the
nineteenth century and until 1914; but today the price of government
control of money has become excessive practically everywhere.
The basic problem that confronts us is not one that is
confined to the monetary sphere. It is a problem of government. It is in
fact the problem of government in every sphere. We need government to
prevent or minimize internal and external violence and aggression and to
keep the peace. But we are obliged to recognize that no group of men can
be completely trusted with power. All power is liable to be abused, and
the greater the power the greater the likelihood of abuse. For that
reason, only minimum powers should be granted to government. But the
tendency of government everywhere has been to use even minimum powers to
increase its powers. And any government is certain to use great powers
to usurp still greater powers. There is no doubt that the two great
World Wars since 1914 brought on the present prevalence of the
quasi-omnipotent State.
But the solution of the overall problem of government
is beyond the province of this article. To decide what would be the best
obtainable monetary system, if we could get it, would be a sufficiently
formidable problem in itself. But a major part of the solution to this
problem, to repeat once more, will be how to get the monetary system out
of the hands of the politicians. Certainly as long as we retain our
nearly omnipotent redistributive State, no sound currency will be
possible.
Mr. Hazlitt, noted economist, journalist and author,
here examines perhaps the most Important question facing us today.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
November, 1975, Vol. 25, No. 11.
Yourname@libertyhaven.com
