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Currency Choice

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Published : April 24th, 2019
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Category : Editorials

We have been looking at Friedrich Hayek’s monetary writings, compiled by Stephen Kresge in Good Money, in two volumes.

January 13, 2019: Good Money, Part I: The New World, by Friedrich Hayek
February 10, 2019: Good Money Part I #2: Hayek’s Early Enthusiasms
February 16, 2019: Good Money Part I #3: The Depression Years
March 3, 2019: Good Money Part I #4: Nothing To Say About The “Business Cycle” In The Middle Of The Great Depression
March 10, 2019: Good Money Part II: The Standard, by Friedrich Hayek

Today, we come to two of Hayek’s well-remembered papers from the 1970s, “Choice in Currency,” and “The Denationalization of Money.” This is of course after the floating currency era erupted in 1971, followed by a long streak of currency debauchery worldwide causing “stagflation.” Hayek lamented that it seemed that political solutions would be difficult. The tendency of the political system would be toward constant “easy money” to lower unemployment (supposedly), and finance deficit spending on socialistic welfare programs, Hayek argued — basically, the arguments of today’s “modern monetary theory” advocates. And indeed that was the tendency of the late 1970s (“accommodation”), so his observations have much relevance. But somehow, the political system got itself together in 1979-1981, and the trend toward currency depreciation was halted.

“Choice in Currency” is from 1978. I like a lot of his speechifying, which reiterates some basic principles:

I must confess that in the course of a long life my opinion of governments has steadily worsened: The more intelligently they try to act (as distinguished from simply following an estsablished rule), the more harm they seem to do–because once they are known to aim at particular goals (rather than simply maintaining a self-correcting spontaneous order) the less they can avoid serving sectional interests. …

The pressure for more and cheaper money is an ever-present political force which monetary authorities have never been able to resist, unless they were in a position credibly to point to an absolute obstacle which made it impossible for them to meet such demands. And it will become even more irresistible when these interests can appeal to an increasingly unrecognizable image of St. Maynard. There will be no more urgent need than to erect new defences against the onslaughts of popular forms of Keynesianism, that is, to replace or restore those restraints which, under the influence of his theory, have been systematically dismantled. It was the main function of the gold standard, of balanced budgets, and of the limitation of the supply of “international liquidity,” to make it impossible for the monetary authorities to capitulate to the pressure for more money. And it was exactly for that reason that all these safeguards against inflation, which had made it possible for representative governments to resist the demands of powerful pressure groups for more money, have been removed at the instigation of economists who imagined that, if governments were released from the shackles of mechanical rules, they would be able to act wisely for the general benefit.
(p. 199-120)

There are some interesting topics in “public choice theory” here as it pertains to monetary concerns — I wonder if that has been followed up in detail by someone.

Hayek then goes on, in the short paper, to propose “currency choice.” I have argued that people have generally had a choice in these matters: there is little today preventing a corporation like WalMart from issuing debt in euros, or Mexican pesos, or a variety of other currencies, from making contracts (such as employment agreements) in many currencies, or buying and selling in many currencies; and this actually happens. Governments whose currencies are perceived to be unreliable find that they cannot issue debt in those domestic currencies; investors will only take debt denominated in dollars or euros, or yuan or whatever the lender prefers. Thus governments themselves engage in “currency choice,” rejecting their own domestic currencies out of sheer necessity. In most countries with a history of currency unreliability (that is, most of them), there is a domestic junk currency and an international currency (usually dollars or euros) in common use, from the smallest street vendor to the largest corporations. There is not so much, from a legal standpoint, preventing people from buying and selling, and making contracts, in gold bullion; and this does take place. However, there are many restrictions on gold, such as taxes or onerous capital gains treatment, and also outright suppression as in the case of the Liberty Dollar, which make it less attractive than it might otherwise be.

I actually testified before the House Financial Services Committee, Subcommittee on Domestic Monetary Policy on this topic, at the invitation of Ron Paul who was then the head of the committee. Here is my presentation:

August 5, 2012: My Testimony in Congress

In this paper, Hayek made some favorable comments toward currencies based on gold.

But why should we not let people choose freely what money they want to use? By ‘people’ I mean the individuals who ought to have the right to decide whether they want to buy or sell for francs, pounds, dollars, D-marks or ounces of gold. …

It seems not unlikely that gold would ultimately re-assert its place as “the universal prize in all countries, in all cultures, in all ages,” as Jacob Bronowski was recently called it in his brilliant book on The Ascent of Man, if people were given complete freedom to decide what to use as their standard and general medium of exchange–more likely, at any rate, than as the result of any organized attempt to restore the gold standard.
(p. 123-124)

This short missive was followed in 1978 by “The Denationalization of Money: An Analysis of the Theory and Practice of Concurrent Currencies.” The paper is 101 pages long in the book, so I will have to summarize aggressively.

One interesting thing in this paper is that Hayek gave a detailed and correct account of how an issuing bank can maintain the value of its currency against some defined benchmark (whatever that may be).

The issuing bank will have two methods of altering the volume of its currency in circulation: it can sell of buy its currency against other currencies (or securities or possibly some commodities); and it can contract or expand its lending activities. …

To assure the constancy of the value of its currency the main consideration would have to be never to increase it beyond the total the public is prepared to hold … it must also never reduce its supply below what the public is prepared to hold …

A 1,002 appearing on the screen
[0.2% over the parity of 1,000] would tell them to contract or tighten controls, i.e., restrict loans by making them dearer or being more selective, and selling other currencies more freely; 997 would tell them that they could slightly relax and expand. (p. 165-166)

This is all very familiar to us, as I went into it in much more detail than Hayek in Gold: The Monetary Polaris. The interesting thing here is that Hayek had a rather long history of not understanding this process as it applied to the gold standard, instead claiming a “price/specie flow mechanism” and many other imaginary convolutions. It seems to me that these confusions continued for Hayek, to perhaps a lesser degree, into the 1970s. It is hard for some people to accept that the ideas that they held for decades, during that time prancing about as a “monetary expert,” were actually completely wrong. Thus, they attempt to smush them together in an uncomfortable mental detente, holding both contradictory ideas simultaneously and trying not to think about it too much. Nevertheless, it is interesting to see that Hayek, who somehow had difficulty applying these notions to a gold standard when central banks were doing exactly as he suggests here, in real life and real time and over a period of decades, seemed to have no difficulty applying them (correctly) to a hypothetical commodity basket standard (his “1,000” parity), in which there is also no element of “redeemability.”

This brings us to “Section XII: What sort of currency would the public select?” Here you might say: “gold, duh,” since that is in fact what people did prefer, for millennia previous, in that time also abandoning all other commodities. Rome was on a gold and silver standard in 1 A.D. — and so were Persia, India, and China. (See Gold: The Final Standard for all the details.) But, as you have already guessed, Hayek is making an argument for a commodity basket currency — this time managed as a “tabular standard” as William Jevons put it, not as a “100% warehouse receipt” system as Hayek proposed in the 1940s. (In other words, there is little or no “reserve holding” of commodities.)

The basic argument by which Hayek arrived at this conclusion was one that we have already become familiar with (before reading Hayek), and that has come up again and again over the years at least as far back as when David Ricardo mentioned it in 1816. Proponents of commodity basket standards tend to assume that “value” is equivalent to “purchasing power,” and since “purchasing power” is a somewhat fuzzy concept, the practical alternative is some commodity basket index. From this it naturally follows that the ideal currency is one that is linked to a currency basket, since we have already determined by definition (i.e., without any argument but rather simple assertion) that stability of value is defined as “purchasing power,” and that “purchasing power” is defined as the relationship to a commodity basket. Hayek explicitly argued (p. 179) that “purchasing power” could not be defined as something like the Consumer Price Index, because the “purchasing power” of a currency vs. a CPI varies from country to country, and indeed from region to region and even neighborhood to neighborhood within the same city. Thus, a commodity basket serves as an internationally-acceptable version of “purchasing power.”

The better economists, including Ricard and also von Mises, as we have already seen, explicitly rejected these assumptions and definitions.

Hayek went into his arguments in some detail:

XIII: Which Value of Money?

Strictly speaking, in a scientific sense, there is no such thing as a perfectly stable value of money–or of anything else. Value is a relationship … which can be stated only by naming the quantity of one object that is valued equally with the ‘equivalent’ quantity of another object. … When we apply the term ‘value’ to money itself what is meant is that the price of most commodities will not tend to change predominantly in one direction, or will change only very little, over long periods. … What then do we call, in a world of constantly changing individual prices, a stable value of money? In a rough sense, it is of course fairly obvious that the command over commodities in general conferred by a sum of money has decreased if it brings a smaller amount of most of them and more of only a few of them. … But for our purposes we need, of course, a more precise definition of “a stable value of money” …

The reason why people will tend to prefer a currency with a value stable in terms of commodities will thus be that it will help them to minimise the effects of the unavoidable uncertainty about price movements because the effect of errors in the opposite directions will tend to cancel each other out.
(p. 175-177)

Do you see what I mean by assumptions and definitions? We already talked about this in some detail in the first post of this series, which also has links to more on the topic:

January 13, 2019: Good Money, Part I: The New World, by Friedrich Hayek

Hayek rejected the idea of a “neutral money,” which gold standard advocates have long talked about (he cited Wicksell as one source). This is often expressed by comparing the ideal money to unchanging weights and measures like the kilogram or meter.

I have long come to the conclusion that no real money could ever possess this property, and not as a model to be aimed at by monetary policy. … The nearest approach to such a condition which we can hope to achieve would appear to me to be one in which the average prices of the ‘original factors of production’ were kept constant. (p. 190)

Hayek kept up the disparaging talk about the gold standard:

Better Even Than Gold — the ‘Wobbly Anchor’

It ought by now of course to be generally understood that the value of a currency redeemable in gold (or in another currency) is not derived from the value of that gold, but merely kept at the same value through the automatic regulation of its quantity. (p. 209)

So far so good. I think Hayek was addressing ideas, still common today alas, that a currency obtains its value from the magical qualities of gold in vaults (or foreign exchange reserves in vaults), rather than the regulation of its supply as Hayek correctly described earlier.

Though gold is an anchor–and any anchor is better than a money left to the discretion of government–it is a very wobbly anchor. (p. 209)

And how did he determine this? He did not say. I perceive that it is “by definition.” The value of commodities, compared to gold, has some substantial variation. Since Hayek already defined “stability” as “stable purchasing power,” and “purchasing power” as a basket of commodities, it follows, by definition (that is, without argument) that gold’s value “wobbles” by the degree that it varies vs. a commodity basket, which would indeed be “very wobbly.” Gold fans say that it is the commodity basket that is doing most of the wobbling, and have some arguments by which they come to that conclusion. It is never by definition.

It [gold] certainly could not bear the strain if the majority of countries tried to run their own gold standard. There is just not enough gold about. An international gold standard could today mean only that a few countries maintained a real gold standard while the others hung on to them through a gold exchange standard. (p. 209)

And this was indeed how the world monetary system was organized, from the late 19th century up to 1971, as I showed in detail in Gold: The Final Standard. And, it worked, very well. If you do not like this arrangement, you could create other arrangements that would also work, and Gold: The Monetary Polaris shows you how to do so to your own heart’s content. Hayek (only a few sentences earlier) argued that you could have a gold standard without any gold reserves at all, simply using gold as a “standard of value” by which the supply of money was adjusted — substantially the same argument that David Ricardo made in 1816, and which John Stuart Mill explored in depth in 1848. Indeed, this was precisely how Hayek intended to run his “tabular standard” commodity basket currency. So we see that these arguments are disingenuous. Hayek knows that they hold no water, because he spent several pages earlier explaining why. Hayek just wanted you to accept his commodity basket standard, and dismiss the gold standard, without asking too many pointed questions, as we are doing here.

You would think that a long paper on “currency choice” would conclude with some advocacy of currency choice. But, it appears that Hayek did not imagine that people could make their own decisions, instead of letting Hayek tell them what is best for them. Hayek’s “choice” seemed to consist only of existing monopoly fiat currencies, or Hayek’s currency basket proposal. At least, that is how it was presented, although Hayek did not explicitly propose a ban other options.

Gold Standard Not The Solution

… The very same fact which at present makes gold more trusted than government-controlled paper money … would in the long run make it appear inferior to token money used by competing institutions whose business rested on successfully so regulating the quantity of their uses as to keep the value of the units approximately constant. (p. 227)

In other words, people were already voting with their feet (in the late 1970s), and they preferred gold, just as they had down through the centuries previous. But Hayek is certain that this is the wrong choice, because obviously it won’t work, even though there is not one historical example of it not working–that gold was so intolerably unstable in value that it made a poor medium of exchange, and had to be abandoned for better solutions.

And so we see, up to the end of his life just as at the beginning of his career, Hayek was always an advocate of some kind of commodity basket money. At first, in the 1920s, this was overtly subversive: obviously, counter to the organizing principle of all monetary affairs, during that time and in the centuries previous. In the 1970s it was also somewhat subversive, since it amounted to a counterargument to efforts at that time to return to a gold standard system, as Ronald Reagan and others wished for. It is certainly a bit of an odd position for someone who is remembered as an advocate for nineteenth century-style Liberalism.

I started this talk by describing how, when I first started to read about these things around 1997, I preferred Mises to Hayek. I still do.

We will finish up the remainder of Good Money soon.


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Nathan Lewis was formerly the chief international economist of a firm that provided investment research for institutions. He now works for an asset management company based in New York. Lewis has written for the Financial Times, Asian Wall Street Journal, Japan Times, Pravda, and other publications. He has appeared on financial television in the United States, Japan, and the Middle East.
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