4. Replies to Possible Objections to our Proposal for Monetary Reform

Although no integrated, coherent, systematic critique of our plan to reform the banking system has yet been produced,⁶¹ there have been certain isolated, unsystematic objections to the proposal to establish a banking system with a 100-percent reserve requirement. We will now present and analyze these challenges one by one.

1. “Banks would disappear, because they would lose their raison d'être and main source of income.” Such criticism is unfounded. All that banks would lose by adopting a 100-percent reserve requirement is the possibility of creating loans ex nihilo; i.e., loans unbacked by a rise in voluntary saving. The suggested reform would make it impossible for the banking system as a whole to expand credit artificially, and with it the money supply, and thereby trigger recurrent cycles of boom and recession.

A significant number of totally legitimate activities would remain to sustain the banking business, and bankers could continue to pursue these activities, thus fulfilling the needs of consumers. One such activity would be true credit intermediation, which consists of loaning, with a differential, funds previously lent banks by their customers (not demand deposits). In addition, as deposit banks (with a 100-percent reserve requirement), institutions could provide custody and safekeeping, while charging the corresponding market price for this service and even combining it with other peripheral ones (the making of payments, transfers, records of customers' operations, etc.). If to this we add the custody and management of securities, the rental of safe deposit boxes, etc., we get a reasonably good idea of the extensive range of legitimate functions banks could continue to perform.

Therefore the belief that the reestablishment of a 100-percent reserve requirement would mean the death of private banks is unjustified. There would simply be a modification, itself largely evolutionary and non-traumatic, to their structure and operations. We have already mentioned the strong probability of the spontaneous development of a banking system comprised of a network of mutual funds, deposit institutions that maintain a 100-percent reserve ratio, and companies that specialize in providing accounting and cashier services to their customers. Hence we conclude with Ludwig von Mises:

It is clear that prohibition of fiduciary media would by no means imply a death sentence for the banking system, as is sometimes asserted. The banks would still retain the business of negotiating credit, of borrowing for the purpose of lending.⁶²

In short, banks could continue to engage in a large number of activities, thus satisfying the needs of consumers and obtaining a legitimate profit in return.

2. “The proposed system would largely decrease the amount of available credit, thereby pushing up the interest rate and hindering economic development.” This is the popular criticism most often expressed, and it mainly comes from those economic agents (businessmen, politicians, journalists, etc.) who allow themselves to be influenced chiefly by the external and most visible characteristics of the economic system. According to this objection, if we prevent banks from creating loans ex nihilo, many companies will meet significantly greater difficulties in obtaining financing, and hence, ceteris paribus, the interest rate will rise and obstacles to economic development will appear. This objection stems from the fact that presently, due to credit expansion, businessmen face little difficulty in securing financing for almost any investment project, no matter how outlandish, assuming the economy is in a phase in which bankers are not afraid to expand their loans. Credit expansion has altered the traditional habits associated with the “entrepreneurial culture,” habits which rested on much more prudent, responsible, and careful consideration prior to a decision on whether or not to launch a particular investment project.

At any rate, it is a grave error to suppose credit would disappear in a banking system governed by a 100-percent reserve requirement. Quite the opposite is true. Banks would still loan funds, but only those funds previously and voluntarily saved by economic agents. In short, the proposed system would guarantee that only that which has been saved would be lent. The new arrangement would thus ensure coordination between the supply and demand of present and future goods in the market and, consequently, prevent the profound maladjustments which the current banking system produces and which ultimately generate economic crises and recessions.

Moreover the notion that the loan funds devoted to investment in the current system can ultimately exceed society's voluntary saving is a fallacy. As we know, ex post, saving is always equal to investment, and if, ex ante, banks grant loans (through a process of credit expansion) at a faster pace than that of voluntary saving, entrepreneurs will simply tend to err en masse and allot the scarce, real resources saved by society to disproportionate investment projects which they will never be able to successfully complete.

Therefore this second objection is unfounded: with a 100-percent reserve requirement, banks would continue to loan what is saved, yet entrepreneurs would tend to invest saved funds in a much more prudent, realistic manner. If, from the start, businessmen were to encounter greater obstacles to financing certain entrepreneurial projects, such difficulties would be the logical manifestation of the healthy functioning of the only market mechanism capable of halting the initiation of unprofitable investment projects in time, and thus avoiding their unwise and discoordinated execution, which the current system promotes during credit booms.

As to the interest rate, there is no indication that in the long term it would be higher in the proposed system than in the current one. Indeed the interest rate ultimately depends on economic agents' subjective valuations of time preference. In our model, economic agents would not be affected by the massive squandering of capital goods which accompanies recurrent economic recessions. Furthermore it is clear that, other things being equal, in a system like the one we recommend, the interest rate would tend to be quite low in nominal terms, since the corresponding premium for the expected evolution of the purchasing power of money would in most cases be negative. Also, the component of risk would depend on the precariousness of each specific investment project undertaken and, following a period without economic recessions, would tend to fall as well. Hence we conclude that there is absolutely no theoretical basis for the assumption that the interest rate would be higher in the proposed system than it is now. Quite the reverse would be true. There are very powerful reasons to believe that in both real and nominal terms, the market rates of interest would be lower than those we are presently accustomed to.⁶³

Therefore a system composed of a pure gold standard and a 100-percent reserve requirement would not weaken economic development. In fact, such a system would give rise to a model of stable, continuous development, free from the manic-depressive reactions which we have, with difficulty, become used to and which, unfortunately, involve the regular malinvestment of a huge quantity of society's scarce resources, to the serious detriment of sustainable economic growth and harmony in society.

3. “The proposed model would penalize those who profit from the current banking and financial system.” It has at times been argued that the recommended system would unjustly penalize all those who profit from the present financial and banking system. Among its chief beneficiaries we must first list the government, which, as we know, manages to finance its expenditures (directly and indirectly) via credit expansion, without having to resort to the politically painful measure of raising taxes. Next we could mention bankers themselves (who line their pockets by the same procedures as the government, yet directly and privately), and also depositors, if they receive interest on their deposits and “do not pay” for the set of peripheral services banks perform.⁶⁴

Nevertheless those who voice this objection do not take into account that many of the supposed “profits” individuals obtain from the banking system are not truly profits. Indeed it is inaccurate to argue that depositors currently enjoy substantial benefits (in the form of cashier, payment and bookkeeping services) without paying for them, since depositors themselves actually bear the full cost (explicitly or implicitly) of these benefits.

As to the explicit interest often available on deposits, such payments are usually compensated for by the continual decline in the purchasing power of depositors' monetary units. In the proposed system, which includes a 100-percent reserve requirement, the purchasing power of deposited monetary units would not only not decline, but, as we have seen, would grow gradually and constantly. This enormous benefit to all citizens would be remarkably superior to the supposed “advantage” of receiving explicit interest which hardly compensates for the devaluation of money. Hence today in most cases the real interest rate on deposits (after deducting the drop in the purchasing power of money) is almost null or even negative.

In a society with a pure gold standard and a 100-percent reserve requirement, all citizens would gain from the gradual, continuous increase in the purchasing power of their monetary units. They would receive interest on effective savings and be openly and explicitly obliged to pay the market price for those legitimate banking services they chose to use. The proposed system would thus be much more coherent and almost certainly more advantageous to the people in general than the present financial and banking system.⁶⁵

As to the argument that governments and bankers would be unable to continue profiting from the current system, more than a defect and motive for criticizing our proposal, this would be a positive result which would offer prima facie justification for it. Indeed, above we emphasized the great importance of preventing governments from using inflation and credit expansion to finance their expenditures in a concealed manner. Moreover we need not reiterate the details of the obscure legal basis and harmful effects of private banks' power to issue loans and deposits.

4. “A 100-percent reserve requirement is an example of state intervention and jeopardizes the contractual freedom of the parties.” Modern neo-banking advocates of fractional-reserve free banking often argue that it is “inadmissible” from a “libertarian” standpoint to limit the contractual freedom of the parties, specifically, the ability of depositors to freely enter into pacts with their bankers by which the former agree to open demand-deposit accounts on which only a fractional reserve is to be maintained. In the first three chapters we saw that a 100-percent reserve requirement on demand deposits would not at all constitute intolerable government interference (“legislation through commands,” in Hayekian terminology). Instead, it would merely represent the natural application of traditional property-law principles to the monetary irregular-deposit contract (“substantive or material law,” in Hayekian terminology).⁶⁶ Furthermore a voluntary decision by two parties to enter into a contract and full knowledge of its cause (which, incidentally, is not usually the case in the present financial and banking system) are necessary conditions for the legitimacy of an operation, but they alone are in no way sufficient to grant this legitimacy in keeping with traditional legal principles. In fact if third parties suffer harm as a result of such a contract, the contract is illegitimate, null, and void, because it disrupts the public order.⁶⁷ According to the analysis we present in this book, it is precisely this lack of legitimacy which pertains to fractional-reserve banking. This practice not only gives rise to the creation of additional means of payment to the detriment of all citizens, who watch as their monetary units decline in purchasing power;⁶⁸ it also deceives entrepreneurs on a broad scale, leading them to invest where and when they should not, and triggering recurrent cycles of boom and recession with a very heavy cost in human, economic and social terms.

Finally, we must counter the oft-heard argument⁶⁹ which centers around the claim that economic agents are unwilling to voluntarily establish a banking system based on a 100-percent reserve requirement and that their unwillingness is evidenced by the fact that nowadays they could freely agree to a similar arrangement (but do not) by using the safe deposit boxes banks rent out in the market. In contrast to this argument, we must point out that safe-deposit-box services are in no way associated with the contract governing the irregular-deposit of a fungible good such as money (rather, they are connected with a typical regular-deposit contract concerning specific goods). In addition, the safe-deposit-box business (which entails a cost to customers, and in their subjective view, does not provide the same services as a monetary bank-deposit contract) could never really compete on equal terms with the current fractional-reserve deposit system. In fact banks commonly pay interest on deposits nowadays (which suggests improper use is made of them). Also, banks offer valuable services at no explicit cost, which makes it impossible for voluntary deposit contracts that include a 100 percent reserve to compete and prosper, especially in an inflation-ridden environment in which the purchasing power of money declines continuously. A very similar counter-argument is called for concerning the public goods the state provides at no apparent direct cost to the consumer. It is notoriously difficult in a free-market environment for any private company with plans to offer the same services at market prices to thrive, due to this unfair, privileged competition from government agencies. These agencies supply “free” benefits to citizens and generate heavy losses which we all ultimately cover with our taxes via the national budget (inflationary tax).⁷⁰

5. “Financial ‘innovations’ will inevitably trigger the resurgence of fractional-reserve banking.” According to this argument, any legal precautions taken to prohibit fractional-reserve banking and, thus, to establish a 100-percent reserve requirement on demand deposits will be insufficient; such measures will always, ultimately be circumvented via new forms of business and financial “innovations” which, in evasion of the law or not, in one way or another, will tend to achieve the same end as fractional-reserve banking. Hence as early as 1937 even Hayek affirmed:

It has been well remarked by the most critical among the originators of the scheme that banking is a pervasive phenomenon and the question is whether, when we prevent it from appearing in its traditional form, we will not just drive it into other and less easily controllable forms.⁷¹

Hayek cited Peel's Act of 1844 as the most notable precedent. Because those who introduced this act neglected to impose a 100-percent reserve requirement on deposits, from that point on, monetary expansion mainly took the form of deposits, rather than banknotes.⁷²

To begin with, even if this objection were justified, it would not constitute even a hint of an argument against the attempt to reach the ideal goal: a proper definition and defense of traditional private-property-law principles in connection with demand deposits. In fact in many other contexts, for example that of criminal activities, we see that, although from a technical standpoint it is often very difficult to correctly apply and defend the corresponding traditional legal principles, an all-out effort should still be made to appropriately define and defend the legal framework.⁷³

Furthermore, contrary to the view of some, fractional-reserve banking is not so “omnipresent” that it is impossible to fight in practice. It is true that throughout this book we have considered different legal forms of business which, in evasion of the law, have been devised in an attempt to disguise monetary, irregular bank deposits as other contracts. We have touched on operations with an agreement of repurchase at their nominal value; different transactions with “American” put options; so-called time “deposits,” which in practice act as true demand deposits; and demand deposits carried out through the completely unrelated institution of life insurance. The specific combinations of these legal forms of business, and any other similar form or combination which might be developed in the future, are easily identifiable and classifiable under civil and criminal law, just as we proposed in the second section (footnote 39) of this chapter. For it is relatively easy for any impartial judge or observer to ascertain whether the essence of an operation permits the withdrawal at any time of the funds initially deposited and whether, from a subjective viewpoint, human behavior shows that people regard certain claims as money, i.e., a generally accepted medium of exchange which is perfectly available (i.e., liquid) at all times.

Moreover the creation of new businesses and “contracts” in an effort to circumvent the basic legal principles which should govern banking has taken place in an environment in which economic agents have been unable to identify the extent to which such “novelties” are illegitimate and cause great harm to the economy and society. If from now on judicial and public authorities clearly identify the issues we analyze in this book, it will be much easier to combat the deviant behaviors which may arise in the financial sector. It is unsurprising that Peel's Act of 1844 was followed by a disproportionate expansion of bank deposits, since at that time economic theorists had not yet established the absolute equivalence between bank deposits and banknotes, in terms of their nature and effects. Peel's Act did not fall short of its objective due to the “omnipresent” nature of fractional-reserve banking, but precisely to humans' failure to realize that banknotes and deposits have the same nature and produce the same economic effects. In contrast, today economic theory has provided judges with analytical tools of incalculable value to guide them toward the correct identification of criminal behaviors and the pronouncement of fair, studied jurisprudential rulings with respect to all “doubtful” cases which may arise in practice.

Finally, we must make a few important clarifications regarding the concept of “innovation” in the financial market and the essential difference between so-called “financial innovations” and the technological and entrepreneurial innovations introduced in the sectors of industry and commerce. While any technological innovation adopted successfully in commerce and industry should be welcome from the beginning, since such changes tend to increase productivity and better satisfy the desires of consumers, in the financial sector, where activities should always take place within an unchanging framework of stable, predictable legal principles, “innovations” should initially be viewed with suspicion. Indeed, in the sphere of banking and finance, innovations may be considered positive when, for example, they consist of new computer equipment and software, channels of distribution, etc. However when “innovations” directly influence the role essential legal principles must play in providing the inviolable framework for the functioning of the entire market, these changes will tend to inflict serious harm on society, which should reject and crack down on them. Hence it is a bad joke to term a “financial innovation” that which is ultimately designed to circumvent general legal principles vital for the healthy functioning and maintenance of a market economy.⁷⁴

Financial products conform to the different contract types which have traditionally developed within the law, and the fundamental structure of these types cannot be modified without distorting and violating the most basic legal principles. Therefore the only conceivable way to introduce “new” financial products is to make different combinations of legitimate, existing legal contracts, though innovation possibilities in this field are quite limited. We must also remember that on many occasions “innovations” are forced into existence by the fiscal voracity of governments and the welter of fiscal legislation they introduce in all historical periods. In many cases, such “innovations” are aimed at diminishing as far as possible the payment of taxes, and they lead to the strangest and most forced, complicated and juridically unnatural forms of business. At this point the direct violation of traditional legal principles is only one step away,⁷⁵ and experience shows that the temptation to cash in on the large profits fractional-reserve banking generates prompts many to take this step without hesitation. Therefore it is essential in this field to maintain an attitude of constant, rigorous vigilance and prevention with respect to the infringement of traditional legal principles.

6. “The proposed system would not allow the money supply to grow at the same rate as economic development.” Economic agents have become accustomed to the current inflationary environment and believe economic development is impossible without a certain amount of credit expansion and inflation. Moreover various schools of economic thought have praised increases in effective demand and tend to reinforce ever popular inflationary appeals. Nevertheless, just as economic agents have adapted to an inflationary environment, they would adjust to one in which the purchasing power of the monetary unit rose gradually and continuously.

Here again it is important to distinguish between two different meanings of the term “deflation” (and “inflation”) which are often confused in theoretical discussion and analysis. Deflation refers to either an absolute decrease or contraction in the money supply or to the result such a contraction generally (but not always) tends to produce, i.e., a rise in the purchasing power of the monetary unit, or in other words, a fall in the general price “level.” The proposed system of a pure gold standard and a 100-percent reserve requirement would obviously be completely inelastic with respect to contractions, and therefore would prevent any deflation understood as a decrease in the money supply, something the present “flexible monetary system” cannot guarantee, as economic crises repeatedly remind us.⁷⁶

If by “deflation” we understand a drop in the general price level or a rise in the purchasing power of the monetary unit, it is clear that to the extent that general economic productivity increased faster than the money supply, such “deflation” would be present in the monetary system we recommend. We described this model of economic development above, and it offers the great advantage of not only preventing economic crises and recessions, but also spreading the benefits of economic development to all citizens by stimulating gradual, continuous growth in the purchasing power of each person's monetary units and a parallel decrease in each person's demand for money.

We must recognize that the proposed system would not guarantee a monetary unit of unchanging purchasing power. This is an unattainable goal, and even if it were achieved, it would present no other advantage than to eliminate the premium which is included in the interest rate depending on the expected future evolution of the purchasing power of money. However in this respect it is only important that in practice economic agents be able to easily predict the evolution of the purchasing power of money and to take it into account when making decisions. This would be sufficient to avert the sudden, unjustified redistribution of income between creditors and debtors which in the past has always accompanied the expansionary credit or monetary shocks economic agents have failed to foresee in time.

It has been argued that if the supply of specie grows less rapidly than economic productivity, the consequent rise in the purchasing power of the monetary unit (or decrease in the general price level) may, under certain circumstances, even exceed the social rate of time preference incorporated in the market rate of interest.⁷⁷ Although the social rate of time preference depends on humans' subjective valuations, and thus its evolution cannot be theoretically ascertained in advance, we must recognize that if it drops to very low levels, due to a substantial rise in society's tendency to save, the above effect could actually appear on occasion. However market rates of interest would under no circumstances reach zero, much less a negative number. To begin with, the well-known Pigou effect would become evident: the increase in the purchasing power of the monetary unit would boost the value of the real cash balances held by economic agents, whose wealth would grow in real terms and who would increase their consumption, thus pushing the social rate of time preference back up.⁷⁸ In addition, entrepreneurs would always find financing, via a positive interest rate, for all investment projects which generated the expected accounting profits in excess of the rate prevailing in the market at any given moment, no matter how low. We should keep in mind that gradual reductions in the market rate of interest tend to drive up the present value of capital goods and investment projects: a decrease from 1 to 0.5 percent will double the present value of durable capital goods, and this value will double again if rates fall from 0.5 to 0.25 percent. Therefore it is inconceivable that nominal interest rates should reach zero: as they approach that limit, growth in the present value of capital goods will give rise to fantastic opportunities to earn considerable entrepreneurial profits, which will always guarantee an inexhaustible flow of entrepreneurial profits and investment opportunities.

Consequently one aspect we can foresee is that in the proposed model, nominal interest rates would reach historically low levels. Indeed, if on average we can predict an increase in productivity of around 3 percent and growth in the world's gold reserves of 1 percent each year, there would be slight annual “deflation” of approximately 2 percent. If we consider a reasonable real interest rate, including the risk component, to be between 3 and 4 percent, then we could expect the market rate of interest to be between 1 and 2 percent per year and to oscillate within a very narrow margin of around one-eighth of a point. Economic agents who have only lived in environments of inflation based on monetary and credit expansion may feel we have just described a panorama from outer space, but it would be a highly favorable situation, and economic agents would become accustomed to it with no major problem.⁷⁹

Even various members of the Neo-Banking School of fractional-reserve free banking have exaggerated the supposed dangers of “deflation.” For example, Stephen Horwitz questions the gradual, continuous decline in prices in our model and states that just as sudden changes affect growth in prices today, abrupt decreases in prices would be inevitable in the system we propose (!). Horwitz fails to see that a monetary standard inflexible to contractions would render such abrupt decreases practically impossible, except under the extraordinary circumstances of natural disasters, wars and other similar phenomena. Under normal conditions, there would be no reason for the demand for money to ever increase traumatically; in fact it would gradually decrease as the rise in the purchasing power of the monetary unit made it unnecessary for economic agents to hold such high cash balances.⁸⁰

The model of slight, gradual, and continuous “deflation” which would appear in a system that rests on a pure gold standard and a 100-percent reserve requirement would not only not prevent sustained, harmonious economic development, but would actively foster it. Furthermore this has taken place in the past on various occasions. For example, we have already mentioned the case of the United States during the period from 1867, following the Civil War, until 1879. Even Milton Friedman and Anna J. Schwartz have had to admit that this period

was a vigorous stage in the continued economic expansion that was destined to raise the United States to a first rank among the nations of the world. And their coincidence casts serious doubts on the validity of the now widely held view that secular price deflation and rapid economic growth are incompatible.⁸¹

7. “The maintenance of a pure gold standard and a 100-percent reserve requirement would be very costly in terms of economic resources and would therefore inhibit economic development.” The argument that a pure gold standard would be quite expensive in terms of economic resources was raised by John Maynard Keynes, who viewed such a standard as no more than a “barbarous relic” of the past. This argument then found its way into the most commonly used textbooks. For instance, Paul A. Samuelson indicates: “(It) is absurd to waste resources digging gold out of the bowels of the earth, only to inter it back again in the vaults of Fort Knox.”⁸² It is obvious that a pure gold standard, with slight “deflation,” i.e., a constant, gradual increase in the purchasing power of the monetary unit, would offer a continuous incentive to find and mine larger quantities of gold, thus employing valuable, scarce economic resources in the search for, extraction and distribution of the yellow metal. Although there is no unanimous estimate of the economic cost of this monetary standard, for the sake of argument we might even admit, as Leland B. Yeager does, that it would be equal to about 1 percent of the gross domestic product of each nation.⁸³ It is obviously much “cheaper” to issue paper money than to mine the earth for gold at a cost of around 1 percent of the gross domestic product of all countries throughout the world.

Nevertheless to reject this monetary system based on the supposed cost of the gold standard, as Keynes and Samuelson do, is to be deceived. It is not correct to merely compare the costs of gold production with those of issuing paper money; instead, it is necessary to compare the overall (direct and indirect) costs involved in both monetary systems. In doing so, we must weigh not only the serious harm cyclical economic recessions inflict on the economy and society, but also the range of costs associated with a monetary standard that is elastic, entirely fiduciary, and controlled by the state. Required reading on this topic includes Roger W. Garrison's “The Costs of a Gold Standard.”⁸⁴ In this article, Professor Garrison estimates the opportunity costs of a purely fiduciary monetary standard and compares them with those of a pure gold standard and a 100-percent reserve requirement. Garrison states:

The true costs of the paper standard would have to take into account (1) the costs imposed on society by different political factions in their attempts to gain control of the printing press, (2) the costs imposed by special-interest groups in their attempts to persuade the controller of the printing press to misuse its authority (print more money) for the benefit of special interests, (3) the costs in the form of inflation-induced misallocation of resources that occur throughout the economy as a result of the monetary authority succumbing to the political pressures of the special interests, and (4) the costs incurred by businesses in their attempts to predict what the monetary authority will do in the future and to hedge against likely, but uncertain, consequences of monetary irresponsibility. With these considerations in mind, it is not difficult to believe that a gold standard costs less than a paper standard.⁸⁵

In addition, we would add the high cost of maintaining the entire worldwide network of central banks and their well-paid employees, and the substantial economic resources used in gathering statistics and financing “research” projects, international conferences and meetings (the International Monetary Fund, World Bank, etc.). We should also bear in mind the significant cost involved in the excessive provision of banking services; specifically, the exaggerated proliferation of new branches and the sheer squandering of human and economic resources it entails.⁸⁶ Therefore it comes as no surprise that even Milton Friedman, who for many years agreed with the majority that the cost of a pure gold standard was too high, has changed his mind and now feels that economically speaking, a pure gold standard poses no problem of opportunity cost.⁸⁷

In short, we conclude that a monetary and banking system based on a pure gold standard and a 100-percent reserve requirement for banking is a “social institution” essential to the correct functioning of any market economy. A social institution can be defined as any set of behavior patterns which has spontaneously evolved over a very prolonged period of time, as a result of the contributions multiple generations of people have made to social processes through their participation in them. Thus such institutions, like the pure gold standard, private-property law, and the family, carry with them an enormous volume of information and have been successfully proven in the most varied historical contexts and circumstances of time and place. That is why we cannot innocuously dispense with these institutions, nor can we sacrifice moral principles without incurring inordinate social costs. For behavior patterns, traditions, and moral principles, far from being “repressive or inhibitory social traditions” (as authors like Rousseau and, in general, “scientistic” theorists have irresponsibly called them), have made the development of civilization possible. When human beings deify reason and come to believe they can modify and “improve” social institutions or even reconstruct them ex novo (Keynesians and monetarists have most fostered this attitude among economic theorists), they lose sight of vital guidelines and points of reference and invariably rationalize their most atavistic and primitive passions, thus jeopardizing society's spontaneous processes of cooperation and coordination. The gold standard and the principle of a 100-percent reserve ratio constitute an integral part of those vital social institutions which must act as an autopilot or guide for practical human behavior in the processes of social cooperation. The irresponsible elimination of these institutions generates excessive, unpredictable costs in the form of social tensions and maladjustments which endanger the peaceful, harmonious progress of civilization and humanity.

8. “The establishment of a system like the one proposed would leave the world too dependent on countries which, like South Africa and the former Soviet Union, have always been the largest producers of gold.” The danger that a pure gold standard might come to rely too heavily on the gold production of South Africa and the nations which today make up the former Soviet Union has been highly exaggerated. Furthermore such warnings are based on a mistaken disregard for the fact that though these countries mine a substantial proportion of the new gold extracted each year (South Africa with 34 percent and the former Soviet Union with 18 percent of the annual production of new gold),⁸⁸ the relative importance of the volumes they produce, in comparison with the existing stock of gold in the world (which has accumulated throughout the history of civilization because gold is immutable and indestructible), is practically insignificant (no more than 0.5 percent per year). In fact most of the worldwide stock of gold is spread among the countries of the European Union, America, and Southern Asia. Moreover now that the Cold War has ended, it is unclear how nations like South Africa and the former Soviet Union, whose annual gold production amounts to only a tiny fraction of the world's total, could play a disruptive role, especially when they would be the first nations to suffer from the effects of any policy aimed at artificially reducing the production of gold.

In any case we must recognize, as we will see in the next section, that the transition toward a monetary system such as the one we recommend would inevitably raise by several times (maybe more than twenty) the market value of gold today in terms of current monetary units. This increase in value would initially and inevitably lead to a significant, one-time capital gain for the current holders of gold and in particular, companies which mine and distribute it. However the desire to prevent certain third parties from profiting (perhaps) undeservedly from the reestablishment of a monetary system with so many benefits for society as the one proposed constitutes no prima facie argument whatsoever against such a system.⁸⁹

9. “The supposed failure of a 100-percent reserve requirement in Argentina during the regime of General Perón.” The twentieth century provides one historic attempt, at least in a rhetorical sense, to establish a 100-percent reserve requirement for banking. However in this case, the reform was not accompanied by an overall privatization of the monetary system and the elimination of the central bank. Instead, credit was completely nationalized, a step which drove inflation to a high level and caused profound credit distortions which devastated the Argentinian economy. Therefore this example does not illustrate any disadvantage of the reform we have proposed. On the contrary, it offers a perfect historical confirmation of the harmful effects public-sector intervention exerts on the financial, monetary and credit sector. Let us analyze the history of the Argentinian “experiment” in greater detail.

The reform was introduced shortly after General Perón took office in Argentina in 1946; it was implemented via decree-law number 11554, which was ratified by law 12962. These legal provisions nationalized bank deposits, as they contained the official declaration that the nation of Argentina would guarantee all deposits from that point on. The explanatory statement of these texts included, among other considerations, the following:

Indeed, now that all deposits remain in the banks at the expense of the central bank, which defrays the financial and administrative expenses, and now that recipient banks can no longer use deposits in the absence of an agreement with the central bank, those deposits have ceased to “weigh on” banks, so to speak, and they have stopped impelling banks to expand loans beyond useful limits. This is the road to healthy credit, credit geared more to long-term economic goals than to banks' accomplishment of purely financial purposes.⁹⁰

Nevertheless despite this apparently sound rhetoric, Perón's banking reform was condemned to failure from the start. In fact, the reform was based on a complete nationalization of the monetary and banking sector, such that the responsibility for granting new loans fell on the central bank, and central bank officials depended directly on the government. In other words, not only did the state not completely privatize financial and monetary institutions and permit credit to spontaneously coincide with the country's rate of saving; but the central bank actually embarked on a reckless campaign of expansionary loans to privileged recipients. These loans reached the economic system through open-market operations on the stock exchange, and especially through the discount rate offered those banks most in tune with the administration.

The reform gave the central bank the power to carry out open-market operations each year for an amount of up to 15 percent of the total money supply. It also entirely divested the Argentinian currency of its gold backing and abolished the preexisting relationship between this currency and gold. In 1949, law 13571 modified the constitution of the central bank's council of directors and designated the finance minister himself president of this council, thus converting the institution into a mere appendage of the government. Finally, the reform established that from that point on, credit would be granted by the central bank in the form of a discount to the different banks, with no limit on volume or expansionary capacity. Hence this enormous power would be used to favor those institutions most sympathetic to the current political regime. Consequently, and despite its initial rhetoric, Perón's reform fostered unprecedented growth in the volume of credit, a tremendous expansion of means of payment, and severe inflation which grossly distorted the country's productive structure and gave rise to a profound economic recession from which Argentina has taken many years to recover. For example, during the nine years of Perón's first period in office (from 1946 to 1955), the money supply increased by more than 970 percent, and the gold and foreign exchange backing of bills issued fell from 137 percent in 1946 to slightly over 3.5 percent in 1955.

The reform was abolished by the revolutionaries who ousted General Perón in 1956 and again privatized deposits. Nonetheless this measure was inadequate to end financial chaos, and private banks resumed their expansionary policies with new enthusiasm, thus following the example set by the central bank under Perón. As a result, Argentinian hyperinflation became chronic and infamous all over the world.⁹¹

We may conclude that the designers of the Argentinian experiment sought merely to reserve the advantages of credit expansion for the government, and hence to prevent private banks from profiting from a substantial portion of this expansion, as had been the norm until then. In any case, the intention was never to privatize the monetary system and do away with the central bank. The Peronist reform confirms a fact we have acknowledged here, i.e., that a 100-percent reserve ratio combined with a central-bank monopoly on the issuance of currency and loans can distort the economy just as seriously if monetary authorities decide for political reasons to embark on a policy of credit expansion (either by directly creating and granting loans or by making open-market purchases on the stock exchange). Therefore the failure of Argentina's experiment under General Perón does not constitute any historical illustration of the disadvantages of a 100-percent reserve ratio. Rather, it confirms the need to consistently couple such a reform with a complete privatization of money and the elimination of the central bank.

In short, Perón's system was aimed at precluding the expansionary creation of loans by private banks. However, it replaced this activity with an even greater expansion of unbacked loans at the hands of central bankers and the government itself, and thus it ultimately harmed the country's monetary, financial, and economic system even more seriously. Therefore nothing is gained by eliminating one process of credit expansion (that of private fractional-reserve banking) if the very state applies another directly and on an even larger scale.⁹²

10. “The proposed reform could not be accomplished by any single country, but would require a difficult and costly international agreement.” Although the most advantageous course of action would be to establish a pure gold standard and 100-percent reserve requirement on an international level, and though an agreement to do so would tremendously facilitate a transition to the new system, there is no reason the different states should not work separately toward the ideal monetary system until such an international agreement is possible. This is precisely what Maurice Allais recommended for France (before that country decided to be included in the European Monetary Union).⁹³ Allais indicates that the establishment of a 100-percent reserve requirement and the maintenance of a highly rigorous monetary policy on the part of the central bank (a policy which would permit the monetary base to grow by no more than 2 percent per year) would be an initial step in the right direction, and the United States, the European Union, Japan, Russia, or any other country could take it alone. Moreover we must keep this idea in mind when evaluating the different programs for monetary unification which have been established in certain prominent economic areas, specifically the European Monetary Union. We will consider again this matter in the following section.

Furthermore the establishment of fixed, yet revisable exchange rates between the different countries might oblige the nations of an economic area to follow the leadership of those states which most clearly and steadily advance in the ideal direction. Thus an irresistible trend toward the achievement of the proposed goal may arise.⁹⁴