II Monetary Reconstruction

Monetary Reconstruction JKESTORATION of international cooperation and division of labor requires sound monetary systems. The prevailing doctrine among economists of the nineteenth century asserted that the individual could not be coerced into accepting depreciated media of exchange at an arbitrary value decreed by government. The present world of economic disintegration, however, offers the comfortless picture of governments fixing prices and controlling foreign exchange operations to prevent transactions that would recognize the depreciation of paper currencies. The depreciation of money by central banks and national treasuries naturally causes faith in such currencies to wane. Governments then attempt to substitute coercion for waning faith, which contributes to the spread of government controls over other aspects of individual action. The inevitable final outcome is the disintegration of the world economy. As soon as the detrimental effects of the depreciation of national currencies and disintegration of the world economy become apparent, the advocates of such policies begin to recommend international cooperation of governments in the regulation of monetary systems. They assume that the undesirable effects of policies of depreciation can be avoided through concerted action on the part of all governments conducting such policies. Based on the very principles of economic disintegration, international agreements on monetary cooperation are concluded that deal with the inevitable effects of inflationary policies while the causes themselves are left unchanged. But monetary depreciation and clamor for monetary cooperation are merely different aspects of the same phenomenon.

The idea of sound money originates from the principle of decency and justice without which there can be no exchange economy based on voluntary exchange and division of labor. The modern ideology 292 MONETARY RECONSTRUCTION 293 of sound money was devised to force decency and justice upon reluctant governments and sovereigns practicing debasement of currencies and to protect the civil liberties of individuals from destructive inroads on the part of governments. The idea of sound money, like constitutional guarantees and bills of individual rights, was the reaction of weary people against arbitrary rule of governments and sovereigns ruling to the detriment of the people. It was derived from the experience of the American Continental Currency, the paper money of the French Revolution, and the British Restriction period. The liberal philosophers and economists of this and following periods carefully elaborated and perfected the ideology of sound money.1 The principle of sound money is the liberty to choose the media of exchange that individuals see fit and the defense of such liberty from the rulers' propensity to debase the currency in order to facilitate policies of easy spending. Thus the sound-money idea is one of the essential postulates of individual liberty and liberal policy.

Sound money means metallic money which can be tested with scales and with acids. It needs no endorsement and no government stamp upon it. It calls for no act of faith, and no compulsion for acceptance is required. Men everywhere accept it in exchange for goods or services. The gold standard is a standard providing for metallic money in the form of standard coins of a definite quantity of gold as precisely determined by the laws of a country. It provides that all token coins and kinds of paper money and other promissory notes should be redeemed, upon presentation, in standard money. The gold standard thus renders debasement of the currency by governments impossible and keeps the purchasing power of money independent of the wishes and ambitions of "monetary authorities/' Substitution of paper money for the gold standard and of fictitious money rates for free market values brings about the effects described by Gresham's Law. That is to say, gold is hoarded or leaves the country. Gold and redeemable currencies cease to circulate, leaving the dishonored paper money in possession of the field. Gold is hoarded or escapes from countries where governments and central banks are not honest, where they fail to keep their promises on demand or at maturity. Gold demands that central banks keep their demand liabilities within the limits of their gold reserves and that governments balance their budgets and refrain from creating debts 1 L. von Mises, The Theory of Money and Credit, Yale University Press, 1953, p.

414.

294 AN ALLIANCE OF FREEMEN without considering their repayment. Only under these conditions can a flight of gold and good currency be avoided.2 The flight of gold from countries whose governments are depreciating their currencies is a major calamity to such countries because gold has maintained its position as the international or world standard. While paper money has replaced gold in the domestic markets through the operation of Gresham's Law, it has failed to eliminate gold in international transactions between governments and central banks. They rightly distrust each others' paper issues and promissory notes. Just as there is honor among thieves, so do they insist upon paying promptly and redeeming their paper currencies in gold on demand. Thus the impregnable position of gold as the world's standard of exchange is built on the very principles of monetary depreciation and waning faith in the various paper currencies. Gold will maintain its position as long as there is a world economy in which goods and services are exchanged and various "monetary authorities" practice inflation and depreciation.

Unsound monetary policy causes gold and gold currencies to leave the country. Foreigners withdraw their liquid funds and citizens endeavor to exchange their funds for gold and better currencies and send them away for safety. Governments and "monetary authorities" then attempt to counteract the detrimental effects of their own policies by imposing strict controls upon capital and foreign exchange transactions. But government controls and regulations according to principles of "national necessity" and "essentiality" are identical with disintegration of the international capital and money market. Monetary disintegration then leads to disintegration of world trade and thereby to the economic isolation of each country. Thus the international division of labor is destroyed and the well-being of nations is injured. The most decisive instrument of destruction of the world economy is government control over the individual's foreign exchange transactions. It all starts when the government decrees that its domestic paper currency should have a certain value and that it is to be exchanged at a certain parity to gold or foreign exchange. If the government-decreed exchange rate corresponds to the purchasing power value of the currency, neither law nor decree is required to induce the individual to exchange at this parity. However, if the purchasing power of the domestic currency is lower than the parity decreed by the monetary authorities, undesirable effects ensue. If 2 B. M. Anderson, Economics and the Public Welfare, Van Nostrand, 1949, p. 421 et seq.

MONETARY RECONSTRUCTION 295 the individual is forced by the power of the court to exchange his money against foreign money (or vice versa) at a rate at which the individual is shortchanged, he will discontinue his transactions with foreign countries to avoid foreign exchange losses. Or he will conduct his monetary transactions through illegal channels. That is to say, he will attempt to receive the full and true value for his media of exchange on what governments enjoy labeling "black markets." Of course, these effects are undesirable for the "monetary authorities." They counteract these "unpatriotic" attempts by expropriating all gold and foreign exchange held by individuals and creating monopolies owned by the state and run by civil servants to deal with gold and foreign exchange. "Now we can stabilize the national currency!" say the monetary planners—and they continue to depreciate it and wreck it.

Naturally, the government monopoly fails to solve the fundamental shortcoming of the regulation of money value. Forced sales of foreign exchange to the foreign exchange monopoly against an indemnity below the market 'price which reflects its true purchasing power, is identical with a special tax or duty on the sale of gold or foreign exchange to the monopoly. It is obvious that such a special duty on the sale of foreign exchange to the government monopoly tends to burden exporters and reduce the volume of their business. On the other hand, sale of foreign exchange to importers at a price below that of the market constitutes a lucrative transaction for importers. The spread between market price and the price fixed by the monetary authorities is identical with a subsidy to importers and encourages them in their business. The final result of this policy of foreign exchange regulation and control by monetary authorities is what is commonly called a shortage of foreign exchange. It is a special kind of shortage which we may properly call a "planned" or "socialist shortage" which inevitably arises when a government enforces a maximum price below the true market price.

The foreign exchange shortage provides the advocates of public control with a welcome excuse for other controls. Step by step, the demand for foreign exchange is reduced by foreign exchange officials allocating the dwindling foreign exchange supply. A multiplicity of import quotas is imposed, transfer of funds from one country to another is prohibited or regulated, foreign capital is blocked, numerous price controls are established, and other schemes of planning and government intervention are devised to counteract the inevitable effects of these policies. It is obvious that all these measures are measures of economic nationalism which is tantamount to 296 AN ALLIANCE OF FREEMEN the disintegration of the world market and the international division of labor. The Return to Sound Monet/. The return to sound money policies is of utmost importance. Without sound money there can be no economic recovery, no prosperity, no economic cooperation, no international division of labor, no unification. Sound money is the cornerstone of individual liberty. Sound money is metallic money. It is the gold standard.

The furious opposition against the gold standard by the advocates of central planning and government inflation results from its natural attribute of not allowing free printing by the government printing office. The gold standard forces governments to refrain from spending more than tax revenues or funds borrowed from the public. The gold standard forces governments to balance their budgets and refrain from policies of credit expansion which create booms and inevitably lead to periods of depression. The stabilization of a national currency is a simple matter.3 All that is required is for a government to abstain from any further increase in the quantity of its currency. That is to say, in order to bring about stabilization, a government must do precisely nothing. Inactivation of the government printing presses and monetary authorities will immediately stop the rise in foreign exchange and gold prices. Within a short time the exchange rate of domestic money as to foreign money and gold will settle at the purchasing power parity of gold and the various kinds of foreign exchange. Of course, in order to stop the printing presses, government must learn to balance its budgets, and live on the tax revenue authorized by parliament.

As soon as the stabilization of the national currency has been completed, the gold standard may return. In his book The Theory of Money and Credit Ludwig von Mises describes the return to the gold standard by an imaginary country called "Ruritania." The unit of its domestic money is the "rur." Having described the stabilization of the "rur," L. von Mises proceeds as follows:4 "While an increase in the production of gold or an increase in the issuance of dollars continues abroad, Ruritania now has a currency the quantity of which is rigidly limited. Under these conditions there can no longer prevail full correspondence between the movements of commodity prices on the Ruritanian markets and those on foreign mar3 For an excellent presentation of the principles of sound money and the problems of monetary reconstruction, see L. von Mises, The Theory of Money and Credit, p. 413 et seq. 4 Ibid., p. 444 et seq.

MONETARY RECONSTRUCTION 297 kets. If prices in terms of gold or dollars are rising, those in terms of rurs will lag behind them or even drop. This means that the purchasing power parity is changing. A tendency will emerge towards an enhancement of the price of the rur as expressed in gold or dollars. When this trend becomes manifest, the propitious moment for the completion of the monetary reform has arrived. The exchange rate that prevails on the market at this juncture is to be promulgated as the new legal parity between the rur and either gold or the dollar. Unconditional convertibility at this legal rate of every paper rur against gold or dollars and vice versa is henceforward to be the fundamental principle. "The reform thus consists of two measures," L. von Mises continues. "The first is to end inflation by setting an insurmountable barrier to any further increase in the supply of domestic money.

The second is to prevent the relative deflation that the first measure will, after a certain time, bring about in terms of other currencies the supply of which is not rigidly limited in the same way. As soon as the second step has been taken, any amount of rurs can be converted into gold or dollars without any delay and any amount of gold or dollars. But its main concern is, at least in the initial stage of its functioning, how to provide the rurs necessary for the exchange of gold or foreign currency against rurs. To enable the agency to perform this task, it has to be entitled to issue additional rurs against a full—100 per cent—coverage by gold or foreign exchange bought from the public." According to Mises, "it is politically expedient not to charge this agency with any responsibilities and duties other than those of buying and selling gold or foreign exchange according to the legal parity. Its task is to make this legal parity an effective real market rate, preventing, by unconditional redemption of rurs, a drop of their market price against legal parity, and, by unconditional buying of gold or foreign exchange, an enhancement of the price of rurs as against legal parity.

"At the very start of its operations the agency needs, as has been mentioned, a certain reserve of gold or foreign exchange. This reserve has to be lent to it either by the government or by the central bank, free of interest and never to be recalled. No business other than this preliminary loan must be negotiated between the government and any bank or institution dependent on the goverment on the one hand and the agency on the other hand. The total amount of rurs issued before the start of the new monetary regime must not be increased by any operations on the part of the govern298 AN ALLIANCE OF FREEMEN ment; only the agency is free to issue additional new rurs, rigidly complying in such issuance with the rule that each of these new rurs must be fully covered by gold or foreign exchange paid in by the public in exchange for them." As to subsidiary coins, Mises recommends that "the government's mint may go on to coin and to issue as many fractional or subsidiary coins as seem to be needed by the public. In order to prevent the government from misusing its monopoly of mintage for inflationary ventures and flooding the market, under the pretext of catering to peoples' demand for 'change/ with huge quantities of such tokens, two provisions are imperative. To these fractional coins only a strictly-limited legal-tender power should be given for payments to any payee but the government. Against the government alone they should have unlimited legal-tender power, and the government moreover must be obliged to redeem in rurs, without any delay and without any cost to the bearer, any amount presented, either by any private individual, firm, or corporation or by the agency. Unlimited legal-tender power must be reserved to the various denominations of bank-notes of one rur and upwards, issued either before the reform or, if after the reform, against full coverage in gold or foreign exchange.

"Apart from this exchange of fractional coins against legal-tender rurs," Ludwig von Mises continues, "the agency deals exclusively with the public and not with the government or any of the institutions dependent on it, especially not with the central bank. The agency serves the public and deals exclusively with that part of the public that wants to avail itself, of its own free accord, of the agency's services. But no privileges are accorded to the agency. It does not get a monopoly for dealing in gold or foreign exchange. The market is perfectly free from any restriction. Everybody is free to buy or sell gold or foreign exchange. There is no centralization of such transactions. Nobody is forced to sell gold or foreign exchange to the agency or buy gold or foreign exchange from it. "When these measures are once achieved, Ruritania is either on the gold-exchange standard or on the dollar-exchange standard. It has stabilized its currency as against gold or the dollar. This is enough for the beginning. There is no need for the moment to go further. No longer threatened by a breakdown of its currency, the nation can calmly wait to see how monetary affairs in other countries will develop."

This stabilization and return to the gold standard, as outlined by Ludwig von Mises, would at once solve the multiplicity of monetary MONETARY RECONSTRUCTION 299 problems of Europe. If the individual in each European country is perfectly free from government restriction, if he is free to buy or sell gold or foreign exchange at their purchasing power parity, if the numerous exchange restrictions connected with the alleged gold and dollar shortages and "unfavorable balances of payments," which are merely other names and aspects of the same monetary phenomenon, are removed, indeed a great deal of contemporary disunity of European nations will be overcome and the monetary foundation for European cooperation will be laid. European cooperation is cooperation of individuals, not governments versus individuals. If the individuals are free to trade and hold gold or any kind of foreign currency they please, and the free market for gold and foreign exchange is reestablished, individuals may and will cooperate. They will buy and sell gold and foreign exchange, they will lend and borrow them, use them for exports and imports and for traveling abroad.

Once again Europe would become an integrated community of trade and prosperity, a community of peace and civilization.