The Search for an Ideal Money; H. Hazlitt

But concerning the remedy, we find little agreement. Inflation is bad, some agree. Yes; put it isn't as bad as depression and unem ployment; and at least it puts off those greater evils, so we must have just a little more inflation as long as these evils threaten us. Inflation is bad, others agree; but it has nothing to do with the monetary system. Rising prices are brought about by the greed and rapacity of sellers; they could promptly be stopped by price con trols. Or, inflation is bad, still others concede; and yes, it is brought about by the increase in the quantity of money and credit.

1975 THE SEARCH FOR AN IDEAL MONEY 661 But this is not the fault of the monetary system itself, but of the blunders and misdeeds of the poli ticians or the bureaucrats in charge of it. Even those who admit that there is something wrong with the mone tary system itself cannot agree on the reforms needed in that system. Scores of such reforms have been proposed. The reformers, however, tend to fall into two main groups. One of these would have nothing to do with a gold, a silver, or any other commodity standard, but would leave the issuance and control of the currency entirely in the hands of the State. The other group would return to some form of the gold standard. Each of these two groups may again be divided into two schools. In what I shall call the statist or paper-money group, one school would leave everything to the day to-day discretion of government monetary authorities, and the other would subject these authori ties to strict quantitative controls.

And in the gold group, likewise, one school would allow discretion, within vague but wide limits, to private bankers and government authorities, while the second would impose severe and definite limits on that discretion. So we have, then, four main schools of monetary theorists. Near ly every currency proposal can be classified under one of them. Paper Money - No Controls Let us begin with School One, the paper-money statists, who would leave the power of control ling the nature, quantity and value of our money solely in the hands of the politicians in office or the bureaucrats they appoint. This is the worst imaginable monetary system, but it is the one that pre vails nearly everywhere in the world today. It has brought about practically universal inflation, un precedented uncertainty, and eco nomic disruption. None of this is accidental. It was built into the system deliber ately adopted at a conference of 44 nations at Bretton Woods in 1944, under the guidance of Harry Dexter White of the U.S. and Lord Keynes of England. The ostensible purpose of that conference was to increase "international coopera tion" and - believe it or not - to "stabilize" currencies and ex change rates.

The chief architects sincerely believed (though they did not as openly avow) that this end could best be achieved by phasing gold out of the monetary system. So they put the world, in effect, not on a gold but on a dollar standard. The value of every other currency 662 THE FREEMAN November was to be maintained by making it convertible into the American dollar at a fixed official exchange rate. The system still had one tie to gold. The dollar itself was to be kept convertible into that metal at $35 an ounce. But this tie was weakened in two ways. Other countries could keep their curren cies stabilized in terms of the dol lar, not through the operations of a free foreign exchange market (as under the pre-World War I gold standard) but by government sales or purchases of dollars - in other words by government peg ging operations. And dollars were no longer convertible into gold on demand by anybody who held them; they were convertible only by foreign central banks. The U.S.

could even (off-the-record) use its great political and economic power - which in· time it did - to indi cate to any central bank with the effrontery to ask for gold that this was not considered a friendly act. So the artificial stability that the Bretton Woods system was able to maintain for a few years was not the result of any real at tempt by each country to keep its own currency sound - by refrain ing from excessive issuance of money and credit - but of govern ment pegging operations and gen tlemen's agreements not to upset the apple cart. This arrangement proved, in the end, unwise, unsound, and unsta ble. The system was able to main tain the appearance of stability only by the stronger currencies constantly rushing to the rescue of the weaker. The U.S., say, would rush in and lend Britain millions of dollars, or buy millions of pounds. It would do the like for other cur rencies in crisis. But using the stronger currencies to support the weaker only weakened the stronger currencies. When the U.S. Treasury bought millions of pounds with dollars, it in effect got these dollars by printing them.

And so when the dollar itself, as the result of our own recklessness, began to turn bad, and when we went off the gold standard openly in August, 1971, other nations were affected. Germany, for in stance, under the terms of the Bretton Woods agreements, had to buy billions of dollars to keep the D-mark from going above its official parity. And where did Ger many get the billions of marks necessary to buy the billions of dollars? Why, by printing them. So the faster-inflating nations almost systematically exported their inflations to the slower-in flating nations. And this almost systematically brought the world toward its present inflationary chaos. True, the nations with stronger 1975 THE SEARCH FOR AN IDEAL MONEY 663 currencies, even when they felt obliged by their Bretton Woods agreement to buy weaker curren cies, did not have to increase their own money supply to buy them. Neither Germany nor any other nation that acquired dollars had to use the dollars as added central bank "reserves" against which; they could issue still more of their own currency. They could have "sterilized" their reserves of dol lars. Or they could have reduced their other government expendi tures correspondingly when they felt obliged to buy dollars, or raised the amount by added taxa tion, instead of simply printing more D-marks or whatever. But these would have been very diffi cult decisions. They might have endangered the tenure of the gov ernments that made them. What they chose seemed under the cir cumstances the path of least re sistance.

What has to be made crystal clear, if we are to lay the founda tions for any permanent sound monetary reform, is that the pres ent worldwide inflationary chaos is not a mere accident. It is not something that has happened in spite of the wonderfully modern and enlightened International Monetary Fund system. It is some thing that has happened precisely because of that. system. It is, in fact, its almost inevitable result. Steady Breakdown It was precisely the kind of "international cooperation" it set up that led to its final breakdown. The countries whose policies were chronically leading them into cur rency crises should have been obliged to pay the penalty. The faltering currencies should not have been rescued by the central banks of other countries. Itwas exactly because the soft-currency countries knew that an American or international safety net would be almost automatically spread out to save them that they chronically got themselves into more trouble.

As it was, the system kept breaking down anyway, but there was a sort of open conspiracy to ignore its fundamental unsound ness. In September, 1949, the Brit ish pound was devalued by 30 per cent, from $4.03 to $2.80. When this happened some 25 other coun tries devalued within a single week. In November, 1967 the Brit ish pound was devalued once more, this time from $2.80 to $2.40. There have been in fact hun dreds of devaluations of curren cies in the International Monetary Fund since it opened for business in 1946. In its Monthly Bulletin the Fund has printed literally mil lions of statistics a year, but it has steadfastly refused, up to now, to publish one figure - the total num ber of these devaluations.

664 THE FREEMAN November Enough of this. It should no longerbe necessary to prove how bad the Bretton Woods system turned out to be. Few people, aside from the bureaucrats whose jobs are at stake, would seriously try to glue it together again. The system is dead. Unfortunately the corpse has not been buried. The Monetarists Let us turn to the next candi date - the proposals of the so called monetarists. Two things may by said in favor of the mone tarists. First, they do recognize the close connection between the quantity of money and the pur chasing power of the monetary unit. And second, they do acknowl edge the importance of imposing strict and explicit limits on the issuance of money. But there are serious weaknesses both in their factual assumptions and in their policy proposals. It is true that there is a close relation between the outstanding supply of money and the buying power of the individual monetary unit. But it is not true that this relation is inversely proportional or in any other way fixed and de pendable. Nor is it true that there is any· fixed "lag" between an in crease of a given percentage in the "growth" of the money sup ply and an increase of the same percentage in prices. The statistics on which this conclusion is based are at best inadequate. They do not cover enough currencies over long enough periods.

What happens during a typical inflation, for example, is that in its early stages commodity prices do not rise as fast as the supply of money is increased and in its later stages prices rise much faster than the supply of money is increased. Monetarists will dismiss this whole comparison as unfair and irrelevant. They do not regard themselves as proposing inflation at all. To them inflation is defined not as an increase in the money supply, but only as a rise in prices. And their proposal, as they see it, is to increase the stock of money 3 to 5 per cent a year just to keep the price "level" from falling. They propose an annual increase in the money stock merely to compensate for an expected annual increase of 3 per cent or more In the "pro ductivity" of the economy. The monetarists' proposal rests on a false. factual assumption. There is no automatic and depend... able annual increase in "produc tivity" of 3 per cent or any other fixed rateo The increase in pro ductivity that has occurred in the U.S. in recent years is the result of saving, investment, and techni cal progress. None of these is auto matic. In fact, in the last two 1975 THE SEARCH FOR AN IDEAL MONEY 665 years or so, the usual "productiv ity" meas ures have actually been declining.

Wholly apart from the formid able mathematical and statistical problems involved, which space does not permit me to go into, the maintenance of the price "level" is a dubious goal. It is based on the assumption that falling prices are somehow "deflationary," and that in any case they tend to bring about recession. This assumption is questionable. When the stock of money is not increased, falling prices are a normal result of in creased production and economic progress. They need not bring re cession, because the falling prices are themselves the result of fall ing production costs. Real profit margins are not reduced. Money wage-rates may not increase, but real wages will increase because the same money will buy more. Falling prices with continued or rising prosperity have occurred again and again in our history. Abuses of Union Power In our present world of power ful and aggressive labor unions, with legally built-in coercive pow ers, the monetarists do have a legitimate fear that such unions will not be satisfied with increased purchasing power for the same money wages. In that case, when such unions ask and get excessive wage-rates, they may bring on un employment and recession. But this danger will exist under any monetary system whatever, as long as we retain our present one-sided labor laws and union ideology.

The central and fatal flaw of the monetarist proposal is its extreme political naivete. It puts the power of controlling the quantity, the quality, and the purchasing power of our money entirely in the hands of the State - that is, of the poli ticians and bureaucrats in office. I am tempted to add that it leaves this power entirely to the discretion, the arbitrary caprice, of the temporary holders of office in the State. The monetarists would deny this. They would limit the discretion of the monetary managers, they contend, by a strict rule. The managers would be ordered to increase the stock of money by only 2, or 3, or 4, or 5 per cent per year; and this figure would be written into the law, or into the Constitution. It is a sfgn of the monetarists' own vacillation that they have never quite decided whether this figure should be a month-to-month bureaucratic goal, or embodied in a law, or nailed into the Constitu tion. Nor have they ev.-er definitely decided whether the figure itself should be 2 or 3 or 4 or 5. They can apparently hold their ranks together only by remaining vague.

666 November Continuous Political Pressure It is obvious that once the prem ises of this system were adopted there would be continuous politi cal pressure for inflation. Those who' contended that an annual in crease of 2 per cent in the money stock would be enough would con stantly hav·e to combat the fears of their colleagues that this might be too low, and threaten to bring on recession. The 3 percenters, again, would have to fight a cease less rearguard action against the advocates of 4 per cent, or these in turn against the champions of 5 per cent. And so ad infinitum. Every time a recession seemed im minent, it would be blamed on the lowness of the existing rate of money increase. Agitation would be resumed to boost it. None of this is a figment of my imagination. It is occurring today. On February 20, 1975, Henry Ford II, in presenting the disappointing annual report of his motor com pany, emphasized the need of mea sures to "assure strong recovery."

Among these, he stipulated: "The Federal Reserve must raise the monetary growth rate to the range of 6 to 8 per cent for a short period." I cite this as only one among scores of examples. It was espe cially instructive because it came from a businessman and not. from a politician. A month later there was a far more striking illustration. On March 18 the Senate of the U.S. adopted unanimously, 86 to 0, a resolution urging the Federal Re serve Board to expand the money supply in a way "appropriate to facilitating prompt economic re covery." It also asked the board to consult with the Hous'e and Senate Banking Committee every six months on "objectives and plans" concerning the money sup ply. This was in effect an order to the Fed to continue inflating, and presumably to increase the rate of inflation. It also put the Fed on notice that whatever it may have previously supposed, it is not inde pendent, but is subject to the di rections of the politicians in office.

The substance of this resolution was later adopted by the full Con gress. The monetarists' program would inevitably make the monetary sys tem a political football.· What else could we expect? Isn't it the height of naivete deliberately to put the power of determining the money supply in the hands of the State, and then expect existing officeholders not to use that power in the way they think is most likely to assure their own tenure of office? The first requisite of a sound monetary system is that it put the least possible power over the 1975 THE SEARCH FOR AN IDEAL MONEY 667 quantity or quality of money in the hands of the politicians. This brings us to gold. It is the outstanding merit of gold as the money standard that it makes the supply and the purchasing power of the monetary unit independent of government, of office holders, of political parties, and of pres sure groups. The great merit of gold is precisely that it is scarce; that its quantity is limited by na ture; that it is costly to discover, to mine, and to process; and that it cannot be created by political fiat or caprice. It is precisely the merit of the gold standard, finally, that it puts a limit on credit ex pansion.

Fractional or Full Reserve? But there are two major kinds of gold standard. One is the frac tional-reserve system, and the other the pure gold or 100 per cent reserve system. The fractional-reserve system is the one that developed and pre vailed in the Western world in the century from 1815 to 1914. It is what we now call the classicalgold standard. It had the so-called ad vantage of elasticity. And it made possible - we might justly say it was responsible for - the business cycle, the recurrent round of pros perity and recession, of boom and bust. With the fractional-reserve systern what typically happened is that in a given country -let us say Ruritania - borrowers would be given credit by the banks, in the form of demand deposits, and they would launch upon various enterprises. The new money so created, perhaps after taking up any slack in business and employ ment, would increase Ruritanian prices. Ruritania would pecome a better place to sell to, and a poorer place to buy from. The balance of trade or payments would begin to turn against it. This would be re flected in a fall in the exchange rate of the Ruritanian currency until the "gold export point" was reached. Gold would then flow out to other countries. In order to stop it, interest rates in Ruritania would have to be raised. With a higher interest rate or a smaller gold base, the volume of currency would be contracted. This would often mean a deflation or a crisis followed by a slump.

In brief, the gold standard with a fractional-reserve system tended almost systematically to bring about the cycle of boom and slump. Under such a system, there is constant political pressure to re duce interest rates or the reserve requirements so that credit ex pansion - i.e., inflation --:- may be encouraged or continued. It is supposed to be the great advan tage of a fractional-reserve sys668 THE FREEMAN November tern that it allows credit expan sion. But what is overlooked is that, no matter how long the re quired legal reserve is set, there must eventually come a point when the permissible legal credit expansion has been reached. There is then inevitable politic,al pres sure to reduce the percentage of required reserves still further. This has been the history of the system in the United States. The effect - and partly the intention - of the Federal Reserve Act was enormously to increase the poten tial volume of credit expansion.

The required reserves for member banks were reduced under the new Federal Reserve Act from a range of 15 to 25 per cent for the pre vious national banks to 12 to 18 per cent for the new Federal Re serve member banks. In 1917 the required reserves for member banks were reduced still further to a range of 7 to 13 per cent. Pyramiding Credit \But on top of the inverted pyra mid of credit that the member banks were allowed to create, the newly established Federal Reserve Banks, which now held the reserves of the member banks, were permi t ted to erect a still further inverted credit pyramid of their own. The Reserve Banks were required to carry only a 35 per cent reserve against their deposits and a 40 per cent gold reserve against their notes. Later the Federal Reserve au thorities became more strict in im.;, posing reserve requirements on the member banks (they raised these sharply beginning in 1936, for example). But they continued to be very lenient in setting their own reserve requirements. Between June of 1945 and ~arch of 1965 the reserve requirements were re duced from 35 and 40 per cent to a flat 25 per cent. And then they were dropped altogether.

'So much for history. What of the future? If the world, or at least this country, ever returns to its senses, and decides to re-establish a gold standard, the fractional-reserve system ought to be abandoned. If by some miracle the U.S. govern ment were to make this decision tomorrow, it could not of course wipe out the already existing sup ply of fiduciary money and credit, or any substantial part of it, with out bringing on a devastating and needless deflation. But the govern ment would 'at least have to re frain from any further increase in the supply of such fiduciary cur rency. Assuming that the govern ment were then able to fix upon a workable conversion rate of the dollar into gold - a rate that ,vas sustainable and would not in it self lead to either inflation or de1975 THE SEARCH FOR AN IDEAL MONEY 669 flation - the U.S. could then return to a sound currency and a sound gold basis.

But in the world as it has now become - sunk in hopeless confu sion, inflationism, and demagogy - the likelihood of any such devel opment in the foreseeable future is practically nil. The remedy I have suggested rests on the as sumption that our government and other governments will become re sponsible, and suddenly begin do ing what is in the long-run interest of the whole body of the citizens, instead of only in the . short-run interest - or apparent interest of special pressure groups. Today this is to expect a mIracle. But the outlook is not hopeless. I began by pointing out th.at for more than a century individual economists have tried to design an ideal money. Why have they not agreed? Why have their schemes come to nothing? They have failed, I think, because they have prac tically all begun with the same false assumption - the assumption that the creation and "manage ment" of a monetary system is and ought to be the prerogative of the State.

This has become an almost uni versal superstition. It is tanta mount to agreeing that a monetary system should be made the play thing of the politicians in power. The proposals of the would-be monetary reformers have failed, in fact, for two main reasons. They have failed partly because they have misconceived the primary functions thata'monetary system has to serve. Too many monetary reformers have assumed that the chief qual ity to be desired in a money is to be "neutral." And too many have' assumed that this "neutrality" would be best achieved if they could create a money that would lead to a constant and unchanging "price level." This was the goal of Irving Fisher in the 1920's, with his "compensated dollar." It is the goal of his present-day disciples, the "monetarists," and their pro posal for a government-managed increase in the money supply of 3 to 5 per cent a year to keep the "price-level" stable.

I believe that this goal itself is a Quep,tionable one. But what is an even nlore serious and harmful error on their part is the method by which they propose tO~tchieve this goal. They propose to achieve it by giving the power to the pol iticians in office to manipulate the currency according to the formula prescribed in advance by the mon etarists. Sell-Serving Politicians What such reformers fail to rec ognize is that once the politicians and their appointees are granted 670 THE FREEMAN November such powers, they are less likely to use them to pursue the objec tives of the reformers than they are to pursue their own objectives. The politicians' own objectives will be those that seem best cal culated to keep them in power. The particular policy they will assume is most likely to keep them in pow er is to keep increasing the issu ance of money; because this will (1) increase "purchasing power"

and so presumably increase the volume of trade and employment; (2) keep prices going up as fast as union pressure pushes up wages, so that continued employment will be possible; and (3) give subsidies and other handouts to special pres sure groups without immediately raising taxes to pay for them. In other words, the best immediate policy for the politicians in power will always appear to them to be inflation. In sum, the belief that the cre ation and management of a mone tary system ought to be the pre rogative of the State - i.e., of the politicians in power - is not only false but harmful. For the real solution is just the opposite. It is to get government, as far as pos sible, out of the monetary sphere. And the first step libertarians should insist on is to get our government and the courts not only to permit, but to enforce, voluntary private contracts providing for payment in gold or in terms of gold value.

A Movement Toward Gold Let us see what would happen if this were done. As the rate of inflation increased, or became more uncertain, Americans would tend increasingly to make long term contracts payable in gold. This is because sellers and lenders would become increasingly reluc tant to make long-term contracts payable in paper dollars, or in irredeemable money-units of any other kind. This would apply particularly to international contracts. The buyer or debtor would either have to keep a certain amount of gold in reserve, or make a forward con tract to buy gold, or depend on buying gold in the open spot mar ket with his paper money on the date th~t his contract fell due. In time, if inflation continued, even current transactions would in creasingly be made in gold. Thus there would grow up, side by side with fiat paper money, a private domestic and international gold standard. Each country that permitted this would then be on a dual monetary system, with a daily changing market relation be tween the· two monies. And there would be a private gold system ready to take 'Over completely on the very day that the govern1975 THE SEARCH FOR AN IDEAL MONEY 671 ment's paper money became abso lutely worthless - as it did in Ger many in November 1923, and in scores of other countries at vari ous times.

A Private Gold Standard? Could there be such a private gold standard? To ask such a question is to forget that history and prehistory have already an swered it. Private gold coins, and private gold currencies, existed centuries before governments de cided to take them over - to na tionalize them, so to speak. The argument that the kings and gov ernments put forward for doing this - and it was a plausible one - was that the existing private coins were not of uniform and easily recognizable size, weight, and imprint; that the fineness of their gold content, or whether they were gold at all, could not be easily tested; that the private coins were crude and easily coun terfeited; and finally that the legal recourse of the recei ver, if he found a coin to be underweight or debased, was. uncertain and diffi cult. But, the kings went on to argue, if the coins were uniform, and bore the instantly recogniza ble stamp of the realm, and if the government itself stood ever ready to prosecute all clippers or coun terfeiters, the people could depend on their money. Business transactions would become more efficient and certain, and enormously less time-consuming.

Still another specious argument for a government coinage applied especially to subsidiary coins. It was impossible, it was contended, or ridiculously inconvenient, to make gold coins small enough for use in the millions of necessary small transactions, like buying a quart of milk or a loaf of hread. What was needed was a subsidiary coinage, which represented halves, quarters, tenths, or hundredths of the standard unit. These coins, regardless of what they were made of, or what their intrinsic value might be, would be legally accept table and convertible, at the rates stamped on them, into the stan dard gold coins. It would be very difficult, I ad mit, to provide for this with a purely private currency, with everybody having the legal power to stamp out his own coins and guarantee their conversion by him into gold. A private coinage sys tem might conceivably be able to solve this problem, but I confess I personally have been unable to think of any solution that would not be complicated, cumbersome, or undependable.

It is clear, in short, that a gov ernment-ptovided or a government regulated coinage has some ad vantages. But these advantages 672 THE FREEMAN November are bought at a price. That, price seemed comparatively low in the nineteenth century and until 1914 ; but today the price of government control of money has become ex cessive practically everywhere. The basic problem that con fronts us is not one that is con fined to, the monetary sphere. It is a problem of government. It is in fact the problem of government in every sphere. We need govern~ent to prevent or minimize internal and external violence and aggres sion and to keep the peace. But we are obliged to recognize that no group of men can be completely trusted with power. All power is liable to be abused, and the greater the power the greater the likeli hood of abuse. For that reason, only minimum powers should be granted to government. But the tendency of government everywhere has been to use even mini mum powers to increase its pow ers. And any government is cer tain to use great powers to usurp still greater powers. There is no doubt that the two great World Wars since 1914 brought on the present prevalence of the quasi omnipotent State.

But the solution of the overall problem of government is beyond the province of this articJe. To de cide what would be the best ob tainable monetary system, if we could get it, would be a sufficiently formidable problem in itself. But a major part of the solution to this problem, to repeat once more, will be how to get the monetary system out of the hands of the politicians. Certainly as long as we retain our nearly omnipotent redistributive State, no sound cur rency will be possible. , IDEAS ON LIBERTY Start When Ready ANYONE can begin the practice of freedom whenever' he chooses to do so. It is easy, and one need not wait upon other persons to agree before he begins. No committee resolutions or elections or laws a:re needed for a person to begin the practice of freedom. One need merely resolve not to impose his will-legally or illegally - upon his peaceful fellow men in their religions, their economic theories, their attitudes, their morals, their mores, or whatever. And then start to practice it.

DEAN RUSSELL RONALD F. COONEY EXCEPT for perhaps the question of whether or not to legalize abor tion, no public issue of recent years has absorbed more interest or stirred the violent emotions of thoughtful people (and of those less SO) than the prickly matter of gun control. In the editorial pages of newspapers, before the commit tees of Congress, the battle has been joined. As in the abortion controversy, the lines have been clearly and firmly marked between the combatants. On one side stand those who see a comprehensive and strictly enforced national gun law as the sine qua non in an ef fective campaign to halt a crime rate raging out of control. On the other side stand those who are im placably opposed to any attempt to restrict, for no matter how Mr. Cooney is a freelance writer in Reno, Nevada. UnderFire high-minded an end, what they re gard a~ their right to possess fire arms.