Fixed Exchange Rates and Monetary Crises; G. North

To answer this, one has to ex amine the contexts. Ludwig von Mises, for instance, believes in total freedom in the monetary sphere: the government should be limited to the enforcement of con tracts, whatever the exchange medium might be in any particular contractual ,obligation. Milton Friedman also wants to see all citizens free to own gold and to make contracts in gold, but he thinks the central bank should guarantee a constant increase in the supply of money each year. Mises would reject such a proposal as inflationary, unless the legal tender provision of Federal Re serve Notes were abolished and people were thereby free to avoid doing business in fiat money. But neither man wants to see any in fringement on the right of men and women on either side of the border or ocean to make bargains with each other, even if those bargains involve the exchange of national monetary units, present or future.

The Keynesians, who would pre fer Friedman's views on monetary management to Mises' full gold coin standard, find themselves working together with conserva tive economists who support agold standard and are anti-inflationary in perspective. Both the Keyne sians and these conservatives favor the esbiblishment of govern ment-enforced limits on the range' of prices that can legally exist be tween one currency unit and any other. Unfortunately, no economist seems to be able to agree with any of his colleagues as to the precise acceptable range of price flexibil ity orthe legal mechanism used to enforce such a range; this indi cates the nature of the problem. Year after year, the publications of the International Finance Sec tion of the Department of Eco nomics of Princeton Uni versi ty pour out Essa,ysin International Finance. We read of crawling pegs and running pegs, of parities and currency swaps, of paper gold and international trust. What does it all mean? .80 far, no one has even been able to define a Eurodollar, let alone explain how it works; or if someone can, no colleague agrees with him. 2 No Faith in Freedom The Keynesian economist simply does not trust the free market's unhampered price mechanism to clear itself of supplies of scarce economic resources. Thus, we need 170 THE FREEMAN March fiscal policY,fine tuning of the econ omy, econometric models, data gathering on .a massive scale, and controls over the money supply.

Especially controls over the money supply. Naturally, certain flaws appear from time to time: a $1.5 billion predicted surplus for fiscal 1970 became a $23.3 billion deficit, but what's a few billion dollars among friends? We owe it to our selves, right? A private firm, un~ less it has a cost-plus government contract, would not long survive in terms of such a woefully in efficient economic model, but what do businessmen know about eco nomics, a faithful econometrician may ask? If reality does not con form to the model, scrap reality, by law. So reality is scrapped, and the Keynesian finds it necessary to abandon one more area of market freedom, namely the freedom· of private, voluntary international exchanges of money at prices es tablished by the market. Such a voluntary system of international exchange would reduce the pre dictability of the government's econometric model. That would al low a "bleeder" in the overall con trol device. That would allow men to measure the extent of the depre ciation of their own and other's domestic currencies, thus calling attention to the policies of infla tion and confiscation being enforced by their governments and other governments. As for the United States, floating exchange rates on a free international mar ket for currencies would end, over night, the exported inflation of our continual budgetary deficits. 3 That is why government bureaucrats do not generally approve of float ing exchange rates.

Flexible Exchange Rates: A Counsel of Despair? This does not explain why various conservative economists also oppose the extension of the market into the realm of international monetary exchange. The late William Roepke called the idea "a counsel of de spair ."4 His argument against flex ible exchange rates: "Without stability of exchange rates any in ternational monetary system would be flawed at an important point, be cause it would lack a major condi tion of international economic in tegration." This sounds plausible enough, until one reads his next sentence: "Just how important this condition is will be seen if we reflect that national economic in tegration (among the separate re gions of one country) is unimag inable with fluctuating rates of exchange between, say, regional currencies."5 The government's answer to this "unimaginable" process of regional currencies is to establish a central monopoly of 1972 FIXED EXCHANGE RATES AND MONETARY CRISES 171 money creation coupled with a legal tender law. And this is pre cisely the goal of international so cialist planners: a single world bank with a legal tender law to en force its control over the entire face of the earth. 6 The planners want a "rational" world economy, but their faith is in bureaucratic rationalization - a bureaucratic' hierarchical chain of economic command - and not the rational ization that is provided by a vol untary free market and its so phisticated computer, the free market price mechanism. 7 As yet, they have not achieved such "ra tionalization" simply because all the nations want their own domes tic, inflationary, autonomous "ra tionalizations." Fixed exchange rates are as close as they can come to centralized world planning, so they tried it, by means of the In ternational Monetary Fund, from 1947 until August 15, 1971. On December 19 they returned to the familiar policy of fixed exchange rates. Four months of international monetary freedom were all they could take.

Let the State Control Itsel', Some Conservatives Argue Why do conservative economists lend support to fixed exchange rates? Because they think that this is a form of statist interven tion into the world market which can impose restraints on the state's own policies of domestic· inflation. The state, the argument goes, will control itself by law. To some ex tent, this may be true, tempora.r ily. The fear of an international run on the dollar may have re strained the Federal Reserve Sys tern's expansion of the domestic money supply from December, 1968 through the spring of 1970. Officials may have feared the ac tion of foreign central bankers in demanding gold at the promised price fixed by 1934 law of $35 per ounce. But this slowing in the money supply created an inevitable reaction: the stock market fell by one third, and the government could no longer finance its debt through sales of bonds to individ uals or private corporations.

Therefore, the Federal Reserve stepped in once again to purchase the available government· bonds at the preferred low interest rate. A new wave of inflation began in the spring of 1970. The pressures on the American gold stock rose once again, and the President finally escaped on August 15, 1971 - or hoped that he had. He cut the dollar's official tie to gold in inter national payments and left it free to float on' the international mar kets. Of course, this act was a vio lation of International Monetary Fund rules, to which the United States is a party (or was). As 172 THE FREEMAN March Lenin said, treaties are made to be broken. For a time, fixed exchange rates seem to restrain policies of domes tic monetary inflation. But for how long? Franz Pick's report lists de valuations every year, and there are a lot of them. They are inter national violations of contract violations that call into question the whole structure of interna tional trade. The honoring of con tracts is the very foundation of free exchange. Apart from this, economic prediction becomes ex ceedingly difficult and productivity suffers. Thus writes Alfred Mala bre: International currency exchanges can transpire in various ways. One is through a system where Currency A can indefinitely be exchanged at a fixed rate for Currency B. This is the system that allegedly prevailed through most of the post-World War II era and to which most Western leaders now wish to return. Ideally, it's a magnificent system, because. it promises to eliminate uncertainty from international financial dealings.

The widget maker knows, when he gets an order from abroad, that the money he will receive will be worth as much to him in the future as at present. In practice, however, fixed-rate ar rangements provide anything but certainty. Between 1944, when the present fixed-rate system was con ceived at Bretton Woods, N.H., and mid-August [1971], when the system finally collapsed, 45 countries changed the international rates for their cur rencies. In some instances, changes were repeated many times, so that in all 74 currency-rate changes oc curred. 8 The problem with such devalua tions, as Mises has shown, is that they create incentives for retalia tory devaluations on the part of other governments. "At the end of this competition is the complete destruction of all nations' mone tary systems."9 If there were no fixed exchange rates in the first place, there would be no need for these governmentally imposed eco nomic discontinuities.

International Stability, a Myth The myth of international mone tary stability is just that, a myth. Stability can only be approached, like economic equilibrium, and then only by the free price mech anism. Exchange rates cannot be fixed without increasing the pres sures for the radical discontinui ties of revaluation and devalua tion. That is why the IMF rules allowed for a 1 per cent band, up ward or downward, of flexibility in exchange rates. That is why rules imposed since December 19 allow a currency a plus or minus 2.25 per cent band. But fiat ex change rates cannot supply, stabil1972 FIXED EXCHANGE RATES AND MONETARY CRISES 173 ity in a world of fiat currencies; they can only mask the extent of mutual inflation through an illu sion, the illusion of fiat stability. And inevitably, the illusion will be broken, sooner or later, as on August 15. Fixed exchange rates create an enormous temptation among men whose professional careers are, in a planned economy, dependent upon deception. Fixed exchange rates, themselves a practical ab surdity in a world of fiat currency, create a premium on lying. When Sir Stafford Cripps promised that the pound would not be devalued throughout the first nine months of 1949, he led the people to be lieve that no devaluation was go ing to take place. And yet it did on September 18, 1949. John Con nally had to admit his own part in a similar deception in his August 16 press conference. What else could we do, he pleaded. What else indeed? Once you start the big lie - that exchange rates can be fixed by law without serious economic consequences - you just cannot stop.

Polylogism! Any economist, of whatever school of thought, can tell you why bimetallism failed in the late nine teenth century. The legal parity between gold and silver,. unless changed continually, could not match the· true conditions of the forces of supply and demand be tween the two metals. Thus, one or the other precious metal was al ways in short supply at the fixed price..The attempt to enforce such a fixed ratio led to monetary dis equilibrium - Gresham's Law - in which the artificially overvalued currency drove the artificially un dervalued currency out of circula,;. tion and into either hoards or for eign countries. Thus it is with every attempt of government at any kind of price control. Thus it is with fixed exchange rates. Ask the economist who has just demonstrated to his own satisfac tion that bimetallism is impossi ble, since the state cannot success fully set a fixed exchange rate be tween gold money and silver money, to extend his analysis to dollars and pounds or francs· and marks. Then watch him squirm.

Logic, when applied to the case of gold and silver, somehow becomes inoperable when applied to dollars and pounds. Mises has an expres sion for this: polylogism. It is his most contemptuous expression. Mises, of course, subsumes ex change rate fixing under the gen eral theory of exchange, thus fol lowing the logic of bimetallism through to the logic of the impos sibility of permanent fixed ex change rates in international monetary transactions. 10 174 THE FREEMAN March Professor Mises long ago had demonstrated the utter bankruptcy theoretically of fixed exchange rates and their tendency to lead to national bankruptcy in practice. He did so in his 1912 classic, The Theory of Money and Credit, and in Human Action. The general theory of monetary exchange starts from a premise: For the exchange-ratio between two or more kinds of money, whether they are employed side by side in the same country (the Parallel Standard) or constitute what is popularly called foreign money and domestic money, it is the exchange-ratio between in dividual economic goods and the in dividual kinds of money that is decisive. The different kinds of money are exchanged in a ratio correspond ing to the exchange-ratios existing between each of them and the other economic goods. l1 In other words, if 1 ounce of gold is exchanged for 10 pounds of an other commodity and 1 ounce of silver is exchanged for 1 pound of that same commodity, then the exchange-ratio of gold to silver should be 1 :10. Fifty years later, Mises was still saying the same thing: The final prices of the various com modities, as expressed in each of the two or several kinds of money, are in proportion to each other. The final exchange ratio between the various kinds of money reflects their purchasing power with regard to the com modities. If any discrepancy appears, opportunity for profitable transac tions presents itself and the endeav ors of businessmen eager to take advantage of this opportunity tend to make it disappear again. The pur chasing-power parity theory of for eign exchange is merely the applica tion of the general theorems concern ing the determination of prices to the special case of the-. coexistence of various kinds of money.l2 That last sentence is crucial. Ex change rate theory is simply a subordinate application of the more general theory of price.

Mises continues: Let us consider again the practi cally very important instance of an inflation in one country only. The increase in the quantity of do mestic credit money or fiat money affects at first only the prices of some commodities and services. The prices of the other commodities remain for some time still at their previous stand. The exchange ratio between the domestic currency and the foreign currencies is determined on the bourse, a market organized and man aged according to the pattern and the commercial customs of the stock ex change. The dealers on this special market are quicker than the rest of the people in anticipating future changes. Consequently the price structure of the market for foreign exchange reflects the new money re lation sooner than the prices of many 1972 FIXED EXCHANGE RATES AND MONETARY CRISES 175 commodities and services. As soon as the domestic inflation begins to affect the prices of some commodities, at any rate long before it has exhausted all its effects upon the greater part of the prices of commodities and serv ices, the price of foreign exchange tends to rise to the point correspond ing to the final state of domestic prices and wage rates.

This fact has been entirely misin terpreted. People failed to realize that the rise in foreign exchange rates merely anticipates the movement of domestic commodity prices. They ex plained the boom in foreign exchange as an outcome of an unfavorable bal ance of payments. The demand for foreign exchange, they maintained, has been increased by a deterioration of the balance of trade or of other items of the balance' of payments, or simply by sinister machinations on the part of unpatriotic speculators. 13 The Speculator's Role The speculators perform a cru cial set of services, contrary to popular opinion. They help bal ance the supply of and demand for future moneys. In doing so, they help to reduce the zone of uncer tainty about the future. Second, they also alert citizens of any given country to the monetary policies of their own central bank. If the policies of monetary expan sion are being pursued by the cen tral bank, the speculators will re veal this fact, ~aily, to anyone wishing to consult a financial news paper. The citizen receives infor mation from an impartial source concerning the latest opinions of skilled, competitive and domestic monetary experts concerning the stability or lack of stability of his own country's money. Because of this, the freedom of the interna tional monetary speculator is as crucial to the defense of free in stitutions as one might imagine.

Hamper his activities, and you have taken a sinister step away from freedom. .The bureaucrats know this: What those; governments who com plain about a scarcity of foreign ex change have in mind is, however, something different. It is the unavoid able outcome of their policy of price fixing. It means that at the price arbitrarily fixed by the government demand exceeds supply. If the gov ernment, having by means of inflation reduced the purchasing power of the domestic monetary unit against gold, foreign exchange, and commodities and services, abstains from any at tempt at controlling foreign exchange rates, there cannot be any question of a scarcity in the sense in which the government uses this term. He who is ready to pay the market price would be in a position to buy as much foreign exchange as he wants. But the government is resolved not to tolerate any rise in foreign ex change rates (in terms of the in flated domestic currency). Relying 176 THE FREEMAN March upon its magistrates and constables, it prohibits any dealings in foreign exchange on terms different from the ordained maximum price. 14 Radical economic discontinuities are difficult to predict-far harder than economic countinuities. The steady movement of international exchange transactions in terms of an unhampered free market is basic to economic continuity. Im pose fiat exchange rates, and you create the "stability plus devalu ations" program which the Bret ton Woods agreement imposed on the world. You create the "hot money" effect, as currency specu lators are forced to anticipate rad ical jumps in the fiat exchange rates, thereby encouraging them to transfer billions of dollars or marks or pounds or francs from one country to another, trying to beat the imposition of September 18ths or August 15ths. 15 It is a huge game of musical chairs, ex cept that people's lives - econom ically, politically, and physically are at stake. In the 1949 edition of Hu,man Action, Mises wrote, con cerning "hot money": "All this refers to European conditions.

American conditions differ only technically, but not economically. However, the hot-money problem is not an American problem, as there is, under the present state 'of affairs, no country which a capitalist could deem a safer refuge than the United States."16 It is a testimony to the monetary infla tion of the past twenty years in this country that Mises saw fit to drop that footnote from the 1963 and 1966 editions of his book. Instability? Wouldn't the establishment of a totally free market for interna tional monetary transactions add elements of instability into inter national economic affairs? Em pha tic ally no ! What it would do is to present a highly accurate reflec tion of the economically irrational policies of fiat money creation that are being pursued with a venge ance by almost every government on earth. It would serve as an eco nomic mirror which would answer truthfully the question, "Mirror, mirror on the wall, who has the most honest currency of them all ?" Daily, the international mon ey mirror would answer the truth and it would also give its guess as to the answer at any point in the future concerning any given cur rency. Like the wicked witch of Snow White, domestic magicians of fiat money resent that inescap;,.

able answer. So they buy them selves a new mirror - fixed ex change rates. Unfortunately, these fiat mirrors break periodically, causing great confusion, conster nation, and windfall profits and losses to speculators. And, need we 1972 FIXED EXCHANGE RATES AND MONETARY CRISES 177 be reminded, everyone involved in foreign trade - prospective buyers of Volkswagens and Hong Kong toys included - is an international speculator. Instability is the charge that is always made against the market by statist interventionists. Marx and Engels leveled precisely this criticism of the theory of capi talistic economics. Capitalitstic distribution, they argued, is an archistic. 17 Such a view of capi talist processes stems from a fundamental misconception: sup posedly, there are no laws of eco nomics regulating the voluntary exchanges· which take place in the free market, and therefore fiat state rules must be imposed on the "disorder" of market affairs. Ev erywhere these critics look, the free market tends toward insta bility - an instability defined as anything deviating from thatmod el which a central planning board would impose on the economy.

"Pass a law! Make it stable!" Not quite. "Pass a law! Make it rigid! Watch it break!" That's it ex actly; the breaks, in international monetary affairs, are caned deval uations and revaluations. They happen all the time. The Subsidy to Business If .you do not impose fixed ex change rates, we are told by vari ous conservative economists as well. as by neo-Keynesians, you will see the destruction of inter national trade. Businessmen ap parently cannot afford to bear. the terrible uncertainties associated with forward currency specula tion. How do we know this? Be cause businessmen, who have be come used to international price controls on money - fixed ex change rates - and who have learned how to make profits under such interventionist measures, constantly tell us so. Like the farmer who wants his subsidy (fixed parity prices guaranteed to him by the state for his goods), like the domestic producers of steel who want tariff subsidies, like. the airlines that want price floors for their .flights (whether interna tional or domestic), like the labor union leader who wants compul sory bargaining legislation, the foreign trade entrepreneur wants his contract guaranteed by fixed exchange rates. He just cannot bear the uncertainties of future prediction, in spite of the fact that all entrepreneurial profit is a re sidualaccruing to· successful pre dictors. 1s Instead, the state is sup posed to bear the uncertainties of prediction. The state is supposed to worry about· the rate of ex change of its currency with any other currency, at any time. The bureaucrat in a state office is sup posed to take the responsibility 178 THE FREEMAN March that at a particular point in the future the currencies of the world will trade at certain fixed parities.

Let the violent intervention of the state compel men on both sides of any border to accept each other's currencies at a legal rate, and you have turned the economic affairs associated with international trade over to the bureaucrats. The en trepreneurs, by allowing state of ficials to bear the responsibility for certain aspects of interna tional trade, thereby.give to the state a great power over their businesses. Thus, citizens in every country lose their personal free dom to that extent. Why is it that private entrepre neurs involved in international trade want the government to take over the responsibility for organ izing the terms of the monetary exchanges which govern the oper ation of their businesses? This is a familiar tale. It is the old re spected argument of the vast ma jority of people: let my suppliers c0Ill:pete, keep my competitors out of the market. Let others bear the burden of predicting the future.

Subsidize me. I'm the important one. And governments do it. They take profits away from one group - international currency specula tors - and guarantee the price of foreign exchange - almost. Unless there is a devaluation, of course. And then it is every man for himself and any port in a storm. (The port is usually Switzerland.) Counting the Costs of Intervention A key rule was' laid down by Jesus to his disciples: count the cost (Luke 14 :27-30). He was speaking of spiritual matters, but as he so often did, he explained them in terms of familiar eco nomic affairs. That principle has been the economic foundation of Western civilization, and especially of capitalism. It is, specifically, the inability of socialist economies to count the costs of anything that constitutes the most patent eco nomic failure of socialism. 19 It is the genius of the free market that it allows voluntary, flexible pric ing of scarce economic resources.

Apart from this free pricing mechanism, there can be no free market economy, by definition, and no economic calculation. When a state inflates itsmonop olistically controlled domestic cur rency - which it could not do if it did not hold the monopoly - it creates many problems for the economy. It makes forecasting more difficult. This leads to the demand for more controls over the economy - to mitigate the effects produced by the very policies of monetary inflation. These controls are an attempt by bureaucrats to disguise these effects. The effects are called rising prices. The con1972 FIXED EXCHANGE RATES AND MONETARY CRISES 179 troIs are called price and wage controls. On August 15, 1971, the Presi dent of the United States an nounced the unmitigated failure of the IMF agreements of 1944. The gold-exchange standard no longer operated, as it had for 25 years, to shield this country from the effects of its own· policies of monetary inflation. So it was scrapped. Bretton Woods is dead, Arthur Okun announced a few hours later. Conservative econo mists - a few of them at least had been saying that since 1945.

The President announced that the cure for this unparalleled economic failure of international finance would be the complete abandon ment of fixed exchange rates in ternationally. International price controls over the free exchange of money, we were told, were clearly leading to economic disaster. In deed, that was exactly where such controls were leading, as all inter ference with prices will invariably lead. Domestically, however, volun tary pricing had led to another disaster: higher prices. The Pres ident failed to mention that Fed eral deficits financed through Fed eral Reserve fiat money creation had caused prices to rise. So to "cure" domestic economic affairs, the President imposed price and wage controls. There is a peculiar sort of irony here. In order to cure an international economic disaster which had been caused by price controls, the President allowed the dollar to float. In order to cure the domestic economic disaster, the President imposed domestic price controls.

Controls in internationa.l mone tary affairs are specifically de signed by bureaucrats to hide the effects of policies of domestic mon etary inflation. Similarly, controls on domestic prices are designed to hide the effects of those same poli cies of domestic monetary infla tion. If the purpose of controls is to hide effects rather than to re move causes, then they involve the use of fraud. What the advocates of a free market should desire is that the price system be left completely un controlled, in order that it might register the subtle and unsubtle shifts in economic external con ditions. Only then can entrepre neurs predict the future with any degree of success. Only then will those who wish to buy at the best possible price be served. Everyone should count the cost of his ac tions. Price controls interfere with such cost accounting. Exposing Inflation Advocates of floating exchange rates may be advocates of domestic monetary inflation. But so can ad180 THE FREEMAN March vocates of fixed exchange rates, as Keynes would seem to demon strate. The issue is not whether floating exchange rates will make it easier for domestic governments to inflate. The issue is whether price controls are legitimate tools of government economic policy. If .

they are, then we can begin to ex amine the specifics of the argu ments for fixed exchange rates. If they are not, then the debate .is ended. For fixed exchange rates are,· by definition, price controls. Good economic theory results in good economic practice, as Mises and Hayek have explained repeat edly. We do not apply sound eco nomic theory and produce eco nomic disaster. Thus, it is possible to argue that free pricing in inter national monetary affairs will be beneficial to all citizens who wish to enter the market in order to make voluntary exchanges. Free pricing among the various na tional currencies will help to ex pose the policies of monetary inflation in any given nation, thereby adding incentives to citi zens of that country to challenge their government's policies. This, of course, assumes that citizens generally are economically rational and prefer good consequences to bad ones. It is easier for a man to count the costs of· socialism in the monetary sphere if he can witness, daily, the statistics that chronicle the deterioration of the purchas ing power of his money.

Let Citizens Own Gold If a citizen can own gold, so much the better. If a free market in gold is allowed to operate, so much the better, for the price of gold, in relation to the citizen's paper currency, will rise as a con sequence of the continuing mone tary inflation. This gives a citizen the opportunity to make a profit by taking his paper money to the local branch of the national Treas ury and buying gold at the fixed, legal rate of exchange (which has become a legal fiction as a result of· the monetary inflation). Let citizens, rather than the state, profit from the higher price of gold. Let their desire to make a profit act as a barrier that helps to retard state officials in their in flationary policies, as the Treas ury's supply of gold decreases. A fixed rate of exchange be tween gold and a currency is not the same thing as fixed rates of exchange between currencies. A fixed ratio between gold and any particular currency is definitional: a. unit of paper money is said, by definition, to represent so much gold at a specific fineness. Free convertibility of a currency into gold requires a legalized fixed ra tio of exchange; ·free convertibil ityof one national currency with 1972 FIXED EXCHANGE RATES AND MONETARY CRISES 181 any other requires a flexible rate of exchange set by the market. The former is a definitional relation ship; the latter cannot be.

Obviously, the best possible world would be one in which no government has any monopoly of credit or money creation, where all citizens all over the globe have the right to own gold and make contracts in gold. But just because utopia has not arrived, there is no reason to abandon the theory of voluntary exchange at unhamp ered prices. The argument we hear so often today is this: "Given the government's monopoly over money, given policies of •deficit financing through monetary infla tion, given domestic legal tender laws, we therefore need price con trols over international monetary exchange." Polylogism! The fact that we find ourselves in an in creasingly socialistic economy in no way .disproves the theoretical validity of free pricing - any time, any place, under any circumstance. If the theoretical (and therefore the practical) validity of free pric ing is undercut in any way simply because of all the socialistic "givens" that we operate under, then Marx was right, Hegel was .right, the German historical school of economics was right, institu tional economics is right, histor icism is right, and economic theory is wrong.

Multiple Interventions There is a tendency, argues Mises, for one intervention by the state into the economy to lead to another intervention. The disrup tions caused by the first interven tion lead to cries for further polit ical intervention to solve them. The state takes control of .money, to "reduce the irrationality of the domestic money markets." (And to arrogate unto itself ultimate sov ereignty.) Then it inflates the cur rency in order to increase its own influence in the affairs of men by gaining access to scarce economic resoures with the inflated cur,:" rency. Then citizens refuse to ac cept the debased money. So the state's officials pass legal tender laws. The money, now artificially overvalued, drives out both gold and silver. People prefer to trade in the· artificially overvalued money and either hoard the gold and silver or send it abroad where it can purchase foreign goods cheaper than the domestic inflated currency can purchase them. As domestic goods climb in price due to the inflated paper currency, im ports increase and dollars flow out; foreign central banks then raise the price of their currencies in re lation to dollars. The United States government realizes that this ex poses its policies of domestic mone tary inflation and therefore presses for fixed exchange rates.

182 THE FREEMAN March Then foreign governments, buried in dollars (at the artificially low price), begin to demand gold (held by our government at an artifi cially low 1934 price). One inter vention leads to another, usually. But not always. The exception came on August 15. Basically, the President had three choices. First, balance the budget and stop the monetary in flation - maybe even use the sur plus of revenue over expenditures to reduce the national debt. Un fortunately for political purposes, such an action would have risked depression and high unemploy ment (given the previous policies of monetary expansion and the downwardly inflexible wage rates that prevailed in a unionized econ omy) .20 Second, continuing the deficits, he could let all of our gold (their gold, really, given our prom ise to pay on demand) flow out. Third, the President could have established floating exchange rates and cut the redeemability of the dollar in terms of gold. This is ex actly what he did. It involved a return to free market pricing of international monetary exchanges.

He believed that it was preferable to do this than to take either of the first two steps. In this sense, pressures internationally on the dollar forced the President to re turn to a policy which was closer to the free market than the policy of fixed exchange rates which. had been established by the IMF in 1947. Naturally, to make the oper ation truly conservative, he should have maintained the free conver tibility of gold provision and re established it domestically with American citizens. This did not detract from the basic move which he made ; namely, to reestablish free floating exchange rates in which voluntary transactions of money internationally can prevail. By returning to fixed exchange rates on December 19, the Presi dent thereby abandoned the ad vance made on August 15, re establishing the rigidities that lead toward economic discontinu ities. Yet what did we find between August 15 and December 19?

Many advocates of free market economics were howling bloody murder! "Free pricing is fine, and all that, but, given prior interven tions by the government. . . ." Leonard Read is right : "We are sinking in a sea of butS."21 Return to Gold What is the proper position with respect to valid international money? Clearly, a money system which is the product of free men, voluntarily exchanging scarce eco nomic resources. Professor Murray Rothbard has given us a picture of what such a system might be: 1972 FIXED EXCHANGE RATES AND MONETARY CRISES 183 Why not freely fluctuating' ex change rates? Fine, let us have freely fluctuating exchange rates on our completely free market; let the Roth bards and Browns and GMs fluctuate at whatever rate they will exchange for gold or for each other. The tI~ouble is that they would never reach this exalted state because they would never gain acceptance in exchange moneys at all, and therefore the prob lem of exchange rates would never arise.

On a really free market, then, there would be freely fluctuating exchange rates, but only between genuine com modity moneys, since the paper-name moneys could never gain enough ac ceptance to enter the field. Specifi cally,. since gold and silver have his torically been the leading commodity moneys, gold and silver would prob ably both be moneys, and would ex change at freely fluctuating rates. Different groups and communities of people would pick one or the other money as their unit of accounting. 22 Floating exchange rates reflect what the prevailing external eco nomic conditions really are. The rule governing the operation of floating exchange rates is identi cal to the rule operating in all computer affairs: "Garbage in, garbage out." If prevailing eco nomic conditions on the interna tional markets are inflationary, then floating exchange rates will respond appropriately, making' the best of a very bad situation. If a full gold coin standard exists in ternationally, then floating ex change rates will make the best of a very good situation. Floating exchange rates are nothing more and nothing less than freely fluc tuating voluntary prices, on inter national markets (even if the pri mary participants are national central banks). Like all other forms of free pricing, floating ex change rates make things better than .things would be under coer cive price controls. Floating ex change rates should not be re garded as some kind of economic panacea for the world's inflation ary conditions, except insofar as free pricing is always a panacea in relationship to the conditions which exist under government imposed prices. No matter what other external conditions may be inflationary, deflationary, rela tive ly stable, gold standard, fiat stand ard, electric money standard, or any other standard conceivable to the mind of man - free pricing is alwa,ys preferable to fiat pri,ce con trols. Always.

There is no doubt that domestic monetary inflation, especially if carried on by a majority of na tional governments, produces great uncertainties in international trade. There is also little doubt that floating exchange rates impose the burden of dealing with these eco nomic uncertainties on the shoul184 THE FREEMAN March ders of those who wish to par ticipate in international trade and who expect to profit from such voluntary exchanges. These people are precisely the ones who should bear the burdens associated with economic forecasting. They are all entrepreneurs. If they resent the uncertainties associated with in ternational trade in a world of fiat money, then they should put pres sure on their respective govern ments to restore a full gold coin standard domestically. They should not be lured by the siren call of statist price controls to reduce the visible effects of statist policies of domestic monetary in flation.

If we want stable exchange rates, then -there is one way, and only one way to get them: each government must impose upori. it self the restraint of the full gold coin standard, give up its mone: tary monopoly, return the right of gold ownership to its citizens, and spend only that money which is raised directly through taxation. That is the way to achieve the goal of international monetary sta bility - not rigidity, but calcul able, predictable, moderate stabil ity.23 The rule of gold alone has proven itself to be a producer of international monetary stability. That rule, and not the rule of government bureaucrats, is the foundation of monetary stability.24 The conclusion should be obvi ous: all advocates of free markets should call for solutions that pro mote economic freedom. If the pro posed solutions do not promote free pricing on free markets, they are fallacious solutions. Fixed ex change rates limit the voluntary economic exchange of goods among free men. Therefore, fixed ex change rates are the wrong so lution.

- FOOTNOTES1 Paul Einzig, The Case Against Float ing Exchanges (New York: Macmillan, 1970). Einzig's weekly column in The Commercial and Financial Chronicle in cludes an attack on floating exchange rates at least once a month. Cf. Brochure, Committee on Monetary Research and Education, Inc. (1971), pp. 9-10. 2 Business Week (September 25, 1971), pp. 91 ff. g On exported inflation, see Wilhelm Roepke, "The Dollar as Seen from Ge-_ neva," National Review (March 8, 1966) ; Against the Tide (Chicago: Regnery, 1969), ch. 13: "The Dilemma of Imported Inflation." 4 Against the Tide, p. 229. 5 Ibid., p. 230. 6 Ludwig von Mises, Human Action (3rd rev. ed.; Chicago: Regnery, 1966), pp.476-78. 7 Cf. Gary North, "Statist Bureaucracy in the Modern Economy," THE FREE MAN (January, 1970); Mises, Bureauc racy (New Rochelle, New York: Arling ton House, [1944] 1969); North, "The Mythology of Spaceship Earth," THE FREEMAN (November, 1969). On the nature of knowledge and the market's division of labor, see F. A. Hayek, I ndi vidualism and Economic Order (Univer sity of Chicago Press, 1948), ch. 2.

1972 FIXED EXCHANGE RATES AND MONETARY CRISES 185 8 Alfred L. Malabre, Jr., "Is It Really Time for Monetary Cheer?" Wall Street Journal (December 2,1971). Malabre's estimate of the number of devaluations is far too low. Franz Pick, in the introduc tion to the second edition of All the Monies of the World (1971), reports that at least 418 partial or full devaluations took place in 108 countries between 1954 and the end of 1970. 1971 saw an addi tional 99 devaluations: Barron's (Jan uary 3, 1972), p. 9. This, in spite of the so-called stabilizing influences of the In ternational Monetary· Fund, the organi zation drawn up at the Bretton Woods Conference in July, 1944, officially estab lished on December 27, 1945, and put into operation on March 1, 1947. 9 Mises, Human Action, p. 791. 10 Ibid., p~ 800. n The Theory of Money and Credit (Foundation for Economic Education, 1971), PP. 180-81.