The Standard, by Friedrich Hayek

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Published : March 12th, 2019
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Category : Editorials

As promised, we continue now with Friedrich Hayek’s post-WWII monetary papers, as compiled by Stephen Kresge in Good Money Part II: The Standard. As I’ve warned, “the standard” is, alas, not gold. Let’s see what Hayek has to say about it.

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

As before, with Good Money Part I, I will adopt a somewhat glancing approach, which will disappoint those who would rather have me deal with Hayek’s arguments in proper depth, and also those who find even this to be more detail (it took us four posts to deal with Part I) than they really have a stomach for. Nevertheless, I think it is useful to give at least the character of Hayek’s arguments, and also my views on that. The book has six papers.

The first, “Monetary Nationalism and International Stability,” dates from 1937, and is comprised of five lectures apparently given at the London School of Economics, where Hayek was employed at the time. We have already mentioned that LSE was founded by the Fabians, a socialist group (that is, communist) of the sort that professor Carroll Quigley wrote about in books like The Anglo-American Establishment. John Maynard Keynes was also a Fabian, as was science fiction writer H. G. Wells, who wrote a nonfiction book called The Open Conspiracy (1928) and later, The New World Order (1940), both of which Wells was an enthusiastic supporter. Yes, those people.

This brief biography of Hayek, from the Foundation for Economic Education, says that Hayek himself had Fabian attachments in his early years:

During the early years of the 20th century the theories of the Austrian School of Economics, sparked by Menger’s Principles of Economics (1871), were gradually being formulated and refined by Eugen von Boehm-Bawerk, his brother-in-law, Friedrich Wieser, and Ludwig von Mises. When Hayek attended the University of Vienna, he sat in on one of Mises’ classes, but found Mises’ anti-socialist position too strong for his liking. Wieser was a Fabian socialist whose approach was more attractive to Hayek at the time, and Hayek became his pupil. Yet, ironically it was Mises, through his devastating critique of socialism published in 1922, who turned Hayek away from Fabian socialism.

In 1937, “monetary nationalism” — basically, this means domestic macroeconomic manipulation via floating currencies — had been tried and found wanting. Virtually every country had devalued its currency, and in 1937, many currencies continued to float against gold. There was an effort to reassemble the world gold standard system, notably at the Tripartite Agreement in 1936, but this was not really accomplished until Bretton Woods in 1944. Even after Bretton Woods, things didn’t really stabilize until about 1950.

Hayek, to summarize, was in favor of “international stability,” basically a unified global currency system, without independently-floating national currencies. But, he did not want one based on gold:

A truly International Monetary System would be one where the whole world possessed a homogeneous currency such as obtains within separate countries and where its flow between regions was left to be determined by the results of the action of all individuals. … I should like to make it clear at the outset that I do not believe that the gold standard as we knew it conformed to that ideal and that I regard this as its main defect. (p. 41)

Basically, Hayek’s main argument against the gold standard, in this paper, was the fact that the banknotes based on gold were not usable internationally, but remained national currencies. Hayek imagined that some kind of consequences resulted from this — what they were, in actual historical experience, in other words to provide any evidence that his various cogitations had any basis in reality, he declined to say, retaining his typically Austrian aloofness toward any kind of real-world analysis.

We know that this “problem” is basically imaginary: if the values of various banknotes are the same, and can be traded one for another at a given fixed exchange rate, then they are functionally identical. Hayek argued that, for example, the fact that Florida and Georgia both use dollar banknotes means that the supply of banknotes can flow between Florida and Georgia, thus guaranteeing uniformity between the two regions, and insuring that the supply of banknotes in each region corresponds to this uniformity. Between Britain and France this did not take place (let’s argue), because British banknotes are not accepted in France, and French banknotes are not accepted in Britain. Rather, what happened is: if the demand for banknotes in Britain declines, and that in France increases, then banknote issuers (by way of the mechanisms of any fixed-value system such as a gold standard, as I described in a lot of detail in Gold: The Monetary Polaris) would reduce supply in Britain and increase supply in France, to maintain the market values of each at their gold parities. The end result is the same: fewer banknotes in Britain, more in France. Banknotes in both Britain and France thus retain the same value, and parity with gold.

The result of this misunderstanding — I am tempted to call it a “misunderstanding” (with quotes) since I wonder if Hayek was really so confused, or if he was intentionally trying to confuse the reader — was that Hayek concluded that “International Stability” could be best accomplished, not with a gold standard — the means by which real-life “international stability” had been achieved for generations and indeed centuries up to that time, to the general satisfaction of everyone — but with a unified global central bank, whose uniform banknotes circulated globally; banknotes whose value was expressly not based on gold.

The first, but by no means the most important or most interesting question which I must consider, is the question whether the international standard need be gold. On purely economic grounds it must be said that there are hardly any arguments which can be advanced for, and many serious objections which can be raised against, the use of gold as the international money. (p. 87)

We know that a “unified global central bank divorced from gold” has been a goal of the “globalists” (they were known as “international bankers” in those days) for a long time, and was also Keynes’ goal at Bretton Woods, with his bancor proposal which included a world central bank; although Hayek goes one step further than Keynes, who presented the bancor as an international unit of account, for the time preserving national banknotes. We should recognize that this view of Hayek’s was still rather radical at the time — something you would find discussed at lefty-radical-subversive LSE. Most people thought that basing the international monetary system on gold was a good idea; and in 1944, they ignored Hayek and Keynes, and did exactly that.

Much of the paper consists of banter about “international flows of capital” and “bank credit,” once again billows of confusion that arise when credit is swirled with money into one bewildering stew. That is why I carefully segregate the two. This is easiest to see perhaps with bullion coins. Nothing that the banking system does can change the amount of silver or gold in the coin. Whether credit boom or credit bust, the coin is unchanged. Much the same is true of a banknote that is convertible to a coin on demand.

Hayek did mention something that appeared later with Murray Rothbard:

A possible, although perhaps somewhat fantastic, solution would seem to be to reduce proportionately the gold equivalents of all the different national monetary units to such an extent that all the money in all countries could be covered 100 per cent by gold, and from that date onwards to allow variations in the national circulations only in proportion to changes in the quantity of gold in the country. …

The undeniable attractiveness of this proposal lies exactly in the feature which makes it appear somewhat impracticable, in the fact that in effect it amounts, as is fully realized by at least one of its sponsors, to an abolition of deposit banking as we know it. (p. 91.)

This is, of course, very dopey; and Hayek had little to say about the fact that it would amount to a devaluation of all currencies worldwide on the order of 90%-95%, as Rothbard later calculated it. Remember, when judging Hayek’s promotion of this plan, that Hayek was, at no time, a supporter of the gold standard. The paper ends with several pages further demonstrating that Hayek had little practical notion of how a gold standard worked.

“A Commodity Reserve Currency” dates from 1943 — basically, the prep phase for Bretton Woods. The “commodity” that Hayek refers to is basically: anything but gold; in practice, a commodity basket. In this paper Hayek proposes to actually hold commodities “in reserve,” that is, in warehouses. In 1943, an ounce of gold would buy about 50 bushels of wheat; a bushel of wheat contained 60 lbs. So, for an ounce of gold in reserve, we might instead substitute 3000 lbs of wheat. Unlike gold, wheat does not just sit there inertly for decade after decade. It can be attacked by rats, insects, mold, fungus, dampness, and other such things. Foodstuffs have “qualitative losses” even if intact, losing their nutritional value, edibility, or viability as seed; consequently, the market value of such grain also declines. Central banks held about 800 million ounces of gold in 1943; the equivalent in wheat (or other grains) would be 1200 million tons. In 1960 — well after 1943, and well into the “green revolution” in agriculture — world grain production (all grains, not just wheat) was 824 million tons. And all of this was already being eaten, consumed each year and disappearing entirely. To do this required all the cropland in production in the world (639 million hectares); and still many starved. A secondary question might be: what would happen to the world price of wheat, or other grains, if central banks suddenly (or gradually) demanded 1.5 years’ worth of global production, for which there was no additional supply; indeed, while every private individual had to outbid the central banks simply to eat? Like all things practical, this does not interest Hayek; he does not even mention it, once again disdaining to have any involvement in any kind of real human affairs in the real world. In Hayek’s imaginary world, gold and wheat are just interchangeable data entries in a ledger.

Hayek proposed that banknotes would be 100% reserve warehouse receipts against these agricultural and industrial commodities. In Hayek’s favor, he at least admits that the idea was not his, but attributes it to Benjamin Graham (apparently Warren Buffett’s mentor, I kid you not) and Frank Graham of Princeton.

The basic idea is that currency should be issued solely in exchange against a fixed combination of warehouse warrants for a number of storable commodities and be redeemable in the same ‘commodity unit.’ For example, 100 [British pounds], 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. … 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. (p. 109)

It appears that some of these practical points were later brought to Hayek’s attention, which perhaps explains why he later abandoned the “100% reserve warehouse receipt” model.

We will continue with Hayek’s postwar monetary thoughts 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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