Monetary Reform: A Bibliographical Essay by Pamela J. Brown
Source: This essay first appeared in the journal Literature of Liberty: A Review of Contemporary Liberal Thought , vol. 5, No. 3, Autumn 1982, published by the Cato Institute (1978-1979) and the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio. It is republished with thanks to the original copyright holders.
Pamela J. Brown taught at Auburn University.
Constitution or Competition? Alternative Views on Monetary Reform: A Bibliographical Essay by Pamela J. Brown
Table of Contents
- I. Money: Medium of Exchange or Policy Instrument?
- II. The Problem Plaguing Monetized Systems: Government Mismanagement of Currency Production
III. The Proposed Remedies to Bureacratic Corruption of Token Currency
- A. Gold: A Note on the "Classical" Solution
- B. Monetary Rules:
C. A Free Market Money System: The Competing Currencies Alternative
- From "Bitter Joke" to "Crucial Issue"
- Earlier Advocates of Free Trade in Money: From Smith to Spencer
- Recent Discussions of the Competitive Supply of Money
- Hayek and the Denationalization of Money
- The Competitive Process of Currency Production
- Is a Free-Market Monetary System Stable?
- Could Private Token Currencies Emerge? Would They?
- Skepticism From Gold Standard Advocates
- Rules and Commands: Their Confusion by the Constitutionalists
- Monetary Constitutionalists as Entrepreneurs in Scientists' Clothing
- IV. Conclusion: Competition as the Proper Response to Ignorance
Money, for practically as long as it has existed, has been employed to realize two fundamentally different sorts of goals: production or plunder. In a market economy, private individuals routinely use monetary institutions in a cooperative way to achieve voluntary exchanges of goods and services. Political authorities, by contrast, use monetary institutions in a non-cooperative way to achieve involuntary transfers of wealth.
As a means for realizing cooperatively achieved ends, the use of money signals a great social advance over its predecessor, direct barter exchange. Carl Menger provided the classical invisible hand or spontaneous order explanation of the process of natural social evolution from barter to commodity money.1 The emergence of money was an unplanned or "spontaneous" event. No one person invented money; it gradually evolved as individuals, seeking to minimize the number of barter transactions necessary to obtain the commodities they wanted, learned that certain goods were more marketable than others and began to accumulate trading inventories for the exclusive purposes of exchange.
Money's usefulness as a general medium of exchange is clear in contrast to the inconvenience of direct exchange: money eliminates the would-be trader's need to search among the sellers of the commodities he wants to acquire in order to find those few sellers who, in turn, want to acquire the particular commodity or service that he has to offer. The use of money thereby serves, in the words of Karl Brunner and Allan H. Meltzer, as a "substitute for investment in information and labor allocated to search."2 Brian Loasby aptly comments: "Money, like the firm, is a means of handling the consequences of the excessive cost or sheer impossibility of abolishing ignorance."3 It may be added that money, again like the firm, permits a far greater degree of specialization and division of labor because it reduces the need to search through markets. Without the institution of money, the modern economy could hardly have grown to its current level of complexity.
The use of money as a medium of exchange brings with it the widespread practice of quoting prices in a common currency unit. As a consequence, money becomes a tool of economic calculation —a "means of appraisal" in addition to its medium-of-exchange role as a "means of adjustment." It facilitates the formation of economic plans as well as their execution.
The corrective feedback processes of a complex exchange system crucially depend upon these social functions that money performs. The informational and operational constraints that block both the individual decision-maker and the whole economic order from better coordination of plans would be far more severe had not the institution of money spontaneously emerged. The emergence of money was itself an adaptive response to those obstacles.
The single most important book which has to date been written on the subject of money is Ludwig von Mises' Theory of Money and Credit, first published in 1912. If the reader wanted to read just one work for general instruction, this would be the text to choose. It offers still today the most comprehensive and sophisticated system of theory on monetary phenomena. There are of course a number of other important works discussing the nature, evolution, and functions of money.4
In its contrasting role as a means for realizing non-cooperative ends, a government-issued circulating currency provides political agencies with an instrument for redistributing wealth. Wealth transfers are achieved through the manipulation of money and credit production, specifically through the injection of new money.5 For its first spenders the new money represents fresh additional command over goods and services; but, as the monetary injection does nothing to increase the available supplies of goods and services, the first spenders' command of these goods and services comes at the expense of other participants in the monetary economy. Such money-facilitated government interventions may either transfer wealth from one group of private individuals to others within the private sector of the economy, or transfer wealth to the government itself from the private sector as a whole, depending on whether the initial recipients of the new money represent public or private agencies.6 Economists refer to the first type of transfer as the use of "monetary instruments" in pursuit of macroeconomic "policy targets," and to the second as government revenue creation via an "inflation tax."
Discussion of the currently competing theories of macro-economic policy can be found in a number of textbooks.7 The books of Arthur Marget, The Theory of Prices (1942), and Axel Leijonhufvud, On Keynesian Economics and the Economics of Keynes (1968), provide valuable doctrine-historical perspectives on macro-economic theory. Of the many extensive analyses of the nature and implications of the revenue-generating potential of a government fiat currency monopoly, two works co-authored by H. Geoffrey Brennan and James M. Buchanan deserve special attention: "Money Creation and Taxation," which appears in The Power to Tax: Analytical Foundations of a Fiscal Constitution (1980); and Monopoly in Money and Inflation: The Case for a Constitution to Discipline Government (1981).8
One point is worth noting in passing. There seems to exist a unidirectional ('one-way street') dependence between the feasibility of utilizing a currency's universal acceptability for facilitating economic exchange and the feasibility of exploiting this property for political ends. In other words, it appears possible for money to serve the needs of market participants without at the same time necessarily having to serve the interests of political agencies; yet it seems impossible for money to serve the non-cooperative currency controller without it already having been adopted for use by the cooperative social order. The relationship, in other words, is like that of host to parasite.9
As S. Herbert Frankel has noted in his Money: Two Philosophies; The Conflict of Trust and Authority (1977), the cooperative and non-cooperative uses of money do not simply coexist peacefully. There exists a "trade-off" between the cultivation of a monetary order best suited to the purposes of microeconomic adjustment (processes based on the ability of individuals to calculate and exchange effectively), and the manipulation of the monetary system to achieve macroeconomic adjustment. Government impairs monetary reliability (i.e., the reliability of money price signals for calculation and exchange) when it manipulates money and credit flows in pursuit of "full employment" levels of output. Frankel has described the situation as one of "conflict between money as a tool of state action and money as a symbol of social trust."10
Crucial to the economic usefulness of money is the predictability of its exchange-value or purchasing power. The greater the general stability of monetary conditions of the economy, the more efficiently does resource allocation based upon subjective valuation and availability of economic goods take place. Unpredictability in the value of the money unit, on the contrary, is the quality of a money that proves most valuable for political purposes. Government may most profitably expand the number of money units in circulation when the inflationary consequences are unanticipated, especially by the economic sectors which are destined to experience the greatest loss of wealth due to the actions of the authorities. Where inflationary expectations of market participants underestimate the effects of politically expedient monetary disturbances on the system, the resulting changes in the distribution of wealth and income, and the unanticipated transfers of capital, are an indication that political goals are, by a crude process, being achieved at the expense of economic ends. Alternatively, if such monetary manipulations for political purposes are being unsuccessfully executed, this may indicate that individual agents in the market sector are successfully anticipating and, as a result, guarding themselves against movements in the currency's purchasing power. In this event, economic activities requiring the use of money are then succeeding at the expense of political programs.
In sum, the economic role of money within the market order is that of a general means serving no one particular end but rather an ever-changing set of private ends.11 In order for this role to be most efficiently filled, the value of the money unit must be stable, or, at least predictable. By serving "economic" interests, money serves social interests in general.
In its political role, however, currency serves as an instrument to advance special interests. Unlike the market function of money, the political function of money is not end-independent, but endspecific. Whether the end consists of implementing full-employment policy or creating revenue, monetary systems that have been set up to permit manipulation of the money stock for the benefit of special rather than general interests tend to systematically destabilize the market. The resulting disturbances are the consequence of the falsification of economic calculations caused by price distortions. The distortions, in turn, result from the unpredictable changes in, and consequent uncertainty about, the structure of relative prices affected by policy decisions.
Several important works by economists and accountants have discussed the negative consequences of monetary expansion undertaken for political ends, as those consequences fall on particular private groups or individuals.12 Others have considered the burden of such manipulations in terms of their disruption of the overall orderliness of a monetized exchange system.13 Axel Leijon-hufvud has cogently summarized the way in which inflationary monetary policies interfere with microeconomic coordination:
Transactors will not be able to sort out the relevant "real" price signals from the relative price changes due to…inflationary leads and lags. How could they? Messages of changes in "real scarcities" come in through a cacophony of noises signifying nothing…and "sound" no different. To assume that agents generally possess the independent information required to filter the significant messages from the noise would…amount to assuming knowledge so comprehensive that reliance on market prices for information should have been unnecessary in the first place.14
The economics profession generally acknowledges that use of monetary policy for full-employment purposes involves some sacrifice. There is little consensus, however, concerning the nature and significance of this "trade-off." The properties of the "Phillips curve" —the graphic representation of a supposed trade-off between lower inflation and lower unemployment—have been the subject of extensive theoretical and empirical investigation. Economists of the Austrian School have recently been joined on one issue by those of the Monetarist School, and especially the "Rational Expectations" wing of the latter. Both groups advance the proposition that any increase in output or employment that is induced by monetary expansion must be temporary and self-reversing. Such an increase results only from mistaken actions influenced by the false price signals generated by the monetary expansion. Unexpectedly rapid money growth may bring greater measured output and employment today, but it does not bring greater output or employment tomorrow, and is indeed likely to depress aggregate productivity in the long run due to its structurally disruptive impact.15 Unquestionably, it brings greater inflation of prices.
The contrary belief that discretionary money and credit management can achieve positive policy outcomes has been associated with Keynesian economic thought. The literature in support of discretionary policy is vast, as is the literature in opposition.16 The issue is still very much alive in the economic journals.
The questions of the feasibility of generating (short-run) increases in employment and output through monetary expansion, and of the consequences of such a policy for the (long-run) reliability of money and money price signals, are matters for an impartial wertfrei economic science to investigate. However, the question of the relative desirability of such various policy-dependent outcomes, no matter what theoretical and empirical propositions one may accept, calls for a normative, value-oriented appraisal. The non-value-free nature of such an appraisal might have been emphasized by placing between quotation marks the words "problem" and "mismanagement" in the subtitle above.
A preference for long-term stability in the purchasing power of a community's monetary unit—as opposed to policy-induced changes of dubious duration in levels of aggregate resource utilization—is a major impetus behind recent arguments for reform of existing monetary arrangements. An even greater impetus to reform is a perception of the injustice inherent in a system that enables those in authority to systematically plunder the real wealth of the citizenry via an "inflation tax" —clearly a most insidious form of "taxation without representation." Economists in the field of monetary political economy have concluded that an extremely serious problem of design exists in the present organization of the governmentally controlled money supply system. In their view the money-using public's demand for long-term monetary stability is not being met. The task remaining for specialists in the field is therefore clear: to discover and develop a more appropriate means for realizing of the goal of monetary stability.
Let us now consider what these writers have proposed.A. Gold: A Note on the "Classical" Solution
The oldest and certainly most familiar solution to the corrupting effects of state-controlled paper money is a return to a gold standard. To many of us, the idea of reintroducing the use of specie (coined precious metals) and specie-convertible bank liabilities as exchange media is practically synonymous with a return to stable money. The essential virtue of a monetary system based on "hard" currency is perhaps best expressed by one of the leading proponents of the gold standard, Hans F. Sennholz. He writes, in his Inflation or Gold Standard:
It is undoubtedly true that the fiat standard is more workable for economic planners and money managers. But this is the very reason why we prefer the gold standard. Its excellence is its unmanageability by government. And we also deny that the fiat standard, which is characterized by rapid self-destruction and has failed wherever it was tried, compares favorably on purely scientific grounds with the gold standard, which is as old as man's civilization. Out of the ashes of fiat money the gold standard always springs anew because it is no technical creation of a few expert advisers, but a social institution that flows from economic freedom and economic law.17
As anyone pursuing the question of monetary reform soon discovers, a mountain of literature—both popular and technical —has been published over the years on the nature and benefits of commodity money. Ludwig von Mises, in The Theory of Money and Credit, has deeply explored the distinctions among the three types of money: commodity money, credit money, and fiduciary, fiat, or "token" money. Of late, the leading advocates of the reinstitution of a gold standard have included Murray N. Rothbard, Henry Hazlitt, and Hans F. Sennholz.18
Of related interest is the concept of a "commodity reserve" currency convertible not into coin but into a wide "basket" of standardized goods. Unlike a gold coin standard, a commodity reserve system would necessarily have to be the technical creation of a few expert advisers. This proposal has been discussed by Friedrich Hayek and Milton Friedman among others.19
Although much has been written on the pros and cons of a return to gold as the solution to the chaos of politically controlled fiat money, this classic debate will not be considered in further detail here. Instead we turn to reform proposals not based on re-establishment of convertibility for government-issued currencies. In this context, two alternative means of preventing continued government mismanagement of currency production have been suggested: imposing legislated constraints on the behavior of the monetary authority or, more radically, abolishing the government's monopoly in currency production. An extremely significant literature has grown up in recent years out of the debate between these two camps concerning the most appropriate structure for a purely token money system. The first group supposes continued government monopolization, while the second argues for a free market in the issue of private currency.B. Monetary Rules: The Call for a "Constitutionally Constrained" Government Monopoly
The by-now-mainstream response among monetary economists to the need for reform of the existing currency arrangements is the proposal that a "monetary constitution" be constructed and imposed upon those authorities who are vested with the responsibility for managing the nation's money supply. Such a "constitution" would lay down binding rules defining in detail the money-supply procedure to be followed. Fundamental to this program is a perpetuation of the existing market structure in currency production, namely government-run or nationalized monopoly.
At present, the United States clearly lacks any explicit legal rule restricting the federal government's money-creation behavior. Indeed, it lacks even general constitutional limitation upon governmental efforts to "manage" the economic system overall. As Neil H. Jacoby notes, "It is a remarkable fact that the federal Constitution says practically nothing about the role of the President in guiding the national economy. Present institutions of control have evolved outside the Constitution and to a considerable extent outside of federal statutes." Jacoby conjectures that the Founding Fathers neglected "problems of economic stabilization" due to the fact that [s]uch problems did not exist in the predominantly rural and agricultural society of about four million souls that was the United States in 1789."20
Existing statutes concerning the federal government's control over the monetary system are so vague that they may be interpreted in almost any fashion. They are therefore of little help in legally constraining the monetary authorities. This ambiguity is apparent in the original Federal Reserve Act of 1913, which broadly directed the monetary authorities to regulate the nation's currency so as to "accommodate commerce and business."21 The Act was initially designed to guide the authorities within the context of the gold reserve standard that existed at the time. The elimination of the gold standard brought about by World War I, however, rendered the Act inadequate to constrain bureaucratic behavior.22
With the end of the gold standard, money-creation authorities in the United States and other nations became free to follow more "activist" macroeconomic policy measures. The Keynesian intellectual underpinnings of such monetary policies as they have evolved in the last half-century have been dissected by "Public Choice" economists James M. Buchanan and Richard E. Wagner, and by Austrian economists F.A. Hayek and Murray N. Rothbard.23Two Rationales for Rules
As already suggested, the various programs that monetary constitutionalists have proposed rest on two basic planks. First, they propose to maintain the existing government-run monopoly of the currency industry. Secondly, they advocate that a binding money-creation "rule" be imposed on the monopoly authority. As we shall see below, a number of different rules have found advocates.
Imposing a strictly defined and inflexible rule of monetary discipline, of whatever kind, is taken by monetary constitutionalists to represent "nothing more than the replacement of an undefined and potentially biased system of monetary policy by a defined system."24 They share the belief, as expressed by Milton Friedman, that "the monetary structure needs a kind of monetary constitution, which takes the form of rules establishing and limiting the central bank as to the powers that it is given, its reserve requirements, and so on." By defining the "rules of the game" of currency production, the monetary constitution will supposedly require that the government execute plans affecting the money supply "by law instead of by men." It will remove the "extraordinary dependence on personalities, which fosters instability arising from accidental shifts in the particular people and the character of people who are in charge."25 As a result, such a monetary constitution will greatly diminish the wide fluctuations in economic activity which in the past have allegedly resulted from "the granting of wide and important responsibilities that are neither limited by clearly defined rules for guiding policy nor subjected to test by external criteria of performance."26
Before discussing some of the specifics of the various monetary constitutionalists' programs for institutional reform, it is interesting to note that there appear to exist two very different theoretical rationales behind the advocacy of these reforms.
Many proponents of a binding monetary rule argue for its necessity on the grounds that those in control of the currency production apparatus are faced with insurmountable limitations of knowledge. They argue that the authorities' inability to forecast precisely the lagged responses of the economic system to their policy actions renders the achievement of monetary stability via discretionary "fine-tuning" technically impossible. Given the present state of knowledge, then, some sort of inflexible and binding managerial "constitution" is perhaps the most reasonable procedure available. Most notable among those advancing this "informational limitations" argument are the Monetarist authors Phillip Cagan, Anna J. Schwartz, and Milton Friedman. Friedman expresses this position in the following way:
[A "simple" monetary rule] is also likely to strike many of you as simpleminded. Surely, you will say, it is easy to do better. Surely, it would be better to "lean against the wind," in the expressive phrase of a Federal Reserve Chairman, rather than to stand straight upright whichever way the wind is blowing…[T]he matter is not so simple. We seldom in fact know which way the economic wind is blowing until several months after the event, yet to be effective, we need to know which way the wind is going to be blowing when the measures we take now will be effective, itself a variable date that may be a half year or a year or two years from now. Leaning today against next year's wind is hardly an easy task in the present state of meteorology.27
An alternative framework for analyzing the problematical behavior and consequences of an "unconstrained" government monopoly in currency production, though it leads to the same policy conclusions, has been developed and utilized by James M. Buchanan and other Public Choice theorists.28 These writers emphasize the monetary authorities' motivational shortcomings, rather than their informational limitations. The authorities, according to this viewpoint, actually lack the proper intentions to be allowed to exercise discretionary powers in the day-to-day management of the supply of currency. Buchanan and H. Geoffrey Brennan, for example, base the case for a rule constraining government's currency-creating activities on "government behavior in the 'worst-case' setting," a setting in which the "natural proclivities" of politicians and bureaucrats predominate. The "natural proclivities" of political functionaries involve, according to these theorists, the tendency to make decisions and take actions based upon a "narrowly-defined self-interest" which "run[s] counter to the basic desires of the citizenry."29
Richard E. Wagner argues in the same vein: "Existing monetary institutions create a link between politics and monetary control. The consequence of monetary monopoly combined with the pursuit of political self-interest can be macroeconomic discoordination." More specifically, given the government's notorious and seemingly irresistible tendency to consistently overspend and contribute annually to an already enormous federal deficit, its monopoly over the production of currency "alters the constraints within which government conducts its activities, and alters them systematically by creating the bias toward monetary expansion."30 As Gordon Tullock notes, monetary administrators are
…people who have no great security of tenure. Under the circumstances, maximizing the present value of income over the next few years, rather than over the entire income stream, is their objective. In general, inflation is a better way of achieving this objective than is an effort to give a good reputation to your currency…31
In short, monetary systems granting monopoly privileges and permitting the wide use of discretion to those in power will most certainly function in a manner which maximizes the prospects for achieving political ends through monetary means. As a result, such systems tend to do "maximum, rather than minimum violence, to the logic of the market economy, sufficing to transform it from a harmonious to a self-destructive system."32 As Wagner has emphasized, "it is contrary to reason and to history to expect that a monopoly position will fail to be exploited for the benefit of those in a position to practice such an exploitation."33Suggestions Concerning the Rule's Content
Constitutionally constrained monetary systems are, as John Culbertson defines them, "token money systems with explicitly defined behavioral properties." Various monetary rules differ according to the particular economic variable whose behavior is singled out for explicit control. There are basically two sorts of rules: (1) those that focus on the behavior of some monetary statistic, such as Milton Friedman's well-known proposal for a fixed annual growth rate in some measure of the stock of money; and (2) those that focus on the behavior of some non-monetary statistic, such as proposals for stabilizing the price level or interest rates. In either case, the monetary authority is required to manipulate the monetary variable(s) under its immediate control—for the Federal Reserve System this is the sum of currency plus bank reserves—so as to keep the economic "target" variable on track.
Upon closer examination of proposals involving the first sort of rule, it becomes evident that their long-run aim is usually identical to those rules which directly focus on maintaining a constant consumer price index. Friedman's proposal, for example, calls for a three to five percent annual growth rate in a particular measure of the money stock. This growth-rate interval is chosen, he acknowledges, "so that on average it could be expected to correspond with a roughly stable long-run level of final product prices…A rate of 3% to 5% per year might be expected to correspond with [such a] price level."34 Elsewhere Friedman argues that the "optimal" growth rate of the quantity of money would be that rate expected to correspond with a falling price level, specifically a price level falling at a percentage rate equal to the real rate of interest.35
Friedman and others have extensively discussed the details of possible programs incorporating a constant-money-growth-rate rule.36 E. S. Shaw has elaborated a version of the program specifying a 4% growth rate.37 In all cases, inflexibility inherent in such programs has come under criticism. Martin Bronfenbrenner claims greater efficiency on behalf of a "lag" rule, "according to which the growth rate of the money supply is adjusted to prior fluctuations in the growth rates of real national output and the velocity of the circulation of money." He argues that such a rule "may be worthy of consideration as a compromise between the rigidity of the Friedman-Shaw proposals and complete reliance on that combination of forecasting ability, political pressure, and administrative routine which passes as 'judgment' or 'discretion.'"38 Other writers suggest that the rule adopted should be a "flexible" one, containing "override provisions" which permit it to be subjected to "frequent review" and "modification…as may be needed for maintenance of stability in the value of money."39 Yet inflexibility also has its defenders. They contend that the monetary rule, once put into operation, should function so "mechanically" and serve its purpose so effectively, that "hereafter, we may hold to it unrationally—on faith—as a religion, if you please."40
Several authors have proposed and examined rules which constrain the monetary authorities by directing them specifically to maintain a constant price level rather than a constant money growth rate. Foremost among these authors are Jacob Viner, Henry Simons, Clark Warburton, and William H. Hutt.41 James M. Buchanan's prescription for monetary management more broadly emphasizes predictability rather than simple constancy in the level of money prices.42
The number of different monetary rules which could be devised is virtually infinite. Those which have been engineered to date suggest just a few of the many possibilities. Yet, despite disagreement among these theorists on the specific content of the constitutional constraint proposed, unanimity reigns concerning the necessity and importance of the constitutional construct itself. All would agree with Milton Friedman where he writes,
Suggestions Concerning the Money Monopoly's Organization
The main point…is not so much…the content of these or alternative rules as to suggest that the device of legislating a rule about the stock of money can effectively achieve what an independent central bank is designed to achieve but cannot. Such a rule seems to me the only feasible device currently available for converting monetary policy into a pillar of a free society rather than a threat to its foundations.43
The passing years have witnessed numerous and detailed suggestions concerning the specific content of a constitution or rule that would define the appropriate procedure for money creation and control. The same cannot be said, however, of recommendations concerning the internal organization of the currency management apparatus. Although monetary constitutionalists concur on the necessity of concentrating the control of the currency industry in the hands of a single producer, there have been few detailed suggestions concerning this monopoly's specific setup and day-to-day internal operation. Henry Simons, in his classic article, "Rules Versus Authorities in Monetary Policy," proposed placing the money-creation power presently "dispersed indefinitely, among governmental agencies and private institutions, not to mention Congress itself," under the jurisdiction of the Treasury, which might then be "given freedom within wide limits to alter the form of the public debt—to shift from long term to short term borrowing or vice-versa, to issue and retire debt obligations in a legal tender form."44 In order to "eliminate…the private creation and destruction of money," Milton Friedman suggests that the right to produce and control the supply of token units in circulation be granted exclusively to "the Central Bank" or "the Reserve System."45 In general, though, the various authors offer no clear prescriptions concerning the possible internal structure or appropriate bureaucratic characteristics of the monopoly agency that they advocate. W. H. Hutt merely refers to "a monetary Authority,"46 without giving details on the possible nature of this agency, while H. Geoffrey Brennan and James Buchanan speak simply of "government," in their recent book The Power to Tax. Lack of descriptive precision on this matter is not surprising, however, since the monetary constitutionalists believe that the content of rule constraining the privileged producer, rather than the set-up of the producing agency, is crucial to the success of their proposals.The Anticipated Results of a Monetary Constitution
With constitutionally constrained monetary management, its advocates contend, the currency industry will no longer be a primary source of uncertainty and structural discoordination for the economy. Instead, the management will conduct its activities in such a way that monetary conditions become economically "neutral," permitting the emergence of what John M. Culbertson refers to as a "zero-feedback" monetary system. Such a system does not add to "the net positive feedback of the economic system" which tends to make it "prone to excessive self-feeding movements" away from equilibrium. It does not create inflations and recessions in the name of stabilization policy. Instead it allows the "financial side of the economy" to operate as the "feedback-control" or coordinating mechanism.47
In sum, the legislation and enforcement of a monetary constitution, by appropriately restricting the actions of those with jurisdiction over the money production apparatus, will, it is believed, create a framework wherein the circulating medium behaves in harmony rather than in conflict with the exchange system.C. A Free Market Money System:
The Competing Currencies Alternative
For decades, programs for a rule-restrained government monopoly had no serious rivals in the area of proposals for reform of the existing, politically dominated monetary system. In the literature of monetary policy, the constitutionalists' suggestions were the only seriously proposed alternative to the status quo —the gold standard aside—that promised to insure stability in the circulating medium's exchange-value. Then, in 1976, F. A. Hayek published a short but professionally shocking book entitled Denationalisation of Money: An Analysis of the Theory and Practice of Concurrent Currencies. Hayek seriously proposed the exciting, challenging possibility of a spontaneous monetary order providing for its own token currency needs, without the involvement of government. The result was a major explosion of research into this new—free market—alternative to the state's historically exclusive right to issue currency for the economy.From "Bitter Joke" to "Crucial Issue"
First presented by Hayek "as a sort of bitter joke,"48 the proposition that the free market might provide the best institutional vehicle for the production of monetary services has emerged as the single most important development in the area of monetary reform in recent years. This free market approach to money is not to be confused with the so-called "Free Money" policies advocated earlier in this century by such inflationists as Silvio Gesell in The Natural Economic Order and Henry Meulen in Free Banking, an Outline of a Policy Individualism (1934). Those policies were designed to permit abundant rather than sound private monies. The program behind the "Free Money Movement" called for by Hayek requires, by contrast, nothing less than a radical switch from the government's traditionally closed monopoly in the token currency industry to a regime of free trade in the production and choice of exchange media. Hayek would allow government to continue to produce currency only as one competitor among many: "What is so dangerous and ought to be done away with is not governments' right to issue money but the exclusive right to do so and their power to force people to use it and accept it at a particular price."49
Proponents of free trade in currency predict that a program for monetary reform which places competitive rather than "constitutional" constraints on the individual money producer will prove to be far more effective in orienting managerial activities toward satisfying the needs of a currency-consuming public. Given the success of the market system in other realms of production, Hayek argues that the appropriate control of monetary aggregates to meet the demands of transactors "will be done more effectively not if some legal rule forces government, but if it is in the self-interest of the issuer which makes him do it, because he can keep his business only if he gives the people a stable money." Raising the informational as well as the motivation problems of monetary central planning and nationalization, he adds that "the monopoly of government of issuing money has not only deprived us of good money but has also deprived us of the only process by which we can find out what would be good money."50
It would be difficult to overstate the seriousness and urgency with which Hayek advocates the denationalization of money as a means for reforming the existing system. He does not propose the end of the monetary monopoly merely as a temporary expedient, to tide us over until we are able to design a constitutional mechanism that will channel the government monopoly into more commendable modes of behavior; nor as a standby plan in case the present system collapses. His alternative of monetary self-organization requires nothing less than the permanent removal of all barriers to entry and free competition in the currency and banking industries. And what is more, it promises nothing less than an end to the catastrophic effects of central-bank-caused business cycles:
Earlier Advocates of Free Trade in Money: From Smith to Spencer
It is very urgent that it become rapidly understood that there is no justification in history for the existing position of a government monopoly of issuing money…(T)his monopoly…is very largely the cause of the great fluctuations in credit, of the great fluctuations in economic activity, and ultimately of the recurring depressions…. (I)f the capitalists had been allowed to provide themselves with the money which they need, the competitive system would have long overcome the major fluctuations in economic activity and the prolonged periods of depression.51
Earlier discussions of the nature and consequences of a regime of free trade in the money and banking industries may be found in the works of several classical political economists.52 Adam Smith, for example, in his unsurpassed Inquiry into the Nature and Causes of the Wealth of Nations (1776), expressed support for Scotland's policy of laissez faire towards the issue and circulation of private bank notes used in commercial exchange. Smith explained that substantial economies could be gained by employing redeemable paper currencies in place of gold and silver coin, as the displaced coin could then be exported in exchange for productive capital goods. Nevertheless, he was also aware of the potential dangers of such paper monies:
The gold and silver money which circulates in any country, and by means of which, the produce of its land and labour is annually circulated and distributed to the proper consumers, is…all dead stock. It is a very valuable part of the capital of the country, which produces nothing to the country. The judicious operations of banking, by substituting paper in the room of a great part of this gold and silver, enables the country to convert a great part of this dead stock into…stock which produces something to the country…. The commerce and industry of the country, however,…though they may be somewhat augmented, cannot be altogether so secure, when they are thus, as it were, suspended upon the Daedalian wings of paper money, as when they travel about upon the solid ground of gold and silver.53
The insecurity for domestic banknote users was, in Smith's words, mainly due to "the accidents to which they are exposed from the unskillfulness of the conductors (issuers) of this paper money." Smith's solution, not surprisingly, was free competition:
(The) multiplication of banking companies…, an event by which many people have been much alarmed, instead of diminishing, increases the security of the publick. It obliges all of them to become more circumspect in their conduct, and…to guard themselves against those malicious runs, which the rivalship of so many competitors is always ready to bring upon them…. By dividing the whole circulation into a greater number of parts, the failure of any one company, an accident which, in the course of things, must sometimes happen, becomes of less consequence to the publick. This free competition too obliges all bankers to be more liberal in their dealings with their customers, lest their rivals should carry them away. In general, if any branch of trade, or any division of labour, be advantageous to the publick, the freer and more general the competition, it will always be the more so.54
John Stuart Mill, in his Principles of Political Economy (1848), also offered arguments for relying—with some qualifications —upon private sector competition in the production of money and banking services. He noted:
The reason ordinarily alleged in condemnation of the system of plurality of issuers…is that the competition of these different issuers induces them to increase the amount of their notes to an injurious extent…. (But) the extraordinary increase in banking competition occasioned by the establishment of the joint-stock banks, a competition often of the most reckless kind, has proved utterly powerless to enlarge the aggregate mass of the banknote circulation; that aggregate circulation having, on the contrary, actually decreased. In the absence of any special case for an exception to freedom of industry, the general rule ought to prevail.55
The irrepressible Herbert Spencer, in Social Statics, also voiced his support for private enterprise in servicing the public's credit and currency needs. Spencer wrote:
Recent Discussions of the Competitive Supply of Money
Thus, self-regulating as is a currency when let alone, laws cannot improve its arrangements, although they may, and continually do, derange them. That the state should compel every one who has given promises to pay, be he merchant, private banker, or shareholder in a joint-stock bank, duly to discharge the responsibilities he has incurred, is very true. To do this, however, is merely to maintain men's rights—to administer justice; and therefore comes within the state's normal function. But to do more than this—to restrict issues, or forbid notes below a certain denomination, is no less injurious than inequitable…
When, therefore, we find α priori reason for concluding that in any given community the due balance between paper and coin will be spontaneously maintained—when we also find that three-fourths of our own paper circulation is self-regulated—that the restrictions on the other fourth entail a useless sinking of capital—and further, that facts prove a self-regulated system to be both safer and cheaper, we may fairly say…that legislative interference is…needless.56
Scholarly analysis of the properties of a competitive system of privately issued "token" monies—monies not redeemable on demand for precious metals—appears to be confined to recent decades. One of the first major theoretical discussions of such a system is William P. Gramm's "Laissez-Faire and the Optimum Quantity of Money," which appeared in 1974.57 Developing a model of the currency industry characterized by a "perfectly" competitive market structure, Gramm counters the claims made by monetary economists Harry Johnson, Paul Samuelson, as well as Boris Pesek and Thomas Saving. These scholars claim that competition in the production of nominal money balances wastes resources and results in a non-optimal quantity of money, implying, therefore, that the currency industry is subject to "market failure."58 In his excellent "Theory of Money and Income Consistent with Orthodox Value Theory," also appearing in 1974, Earl Thompson also analyzes the efficiency and macroeconomic stability properties of a system in which "competitive money creators" or "bankers" supply the needs of currency-using transactors. Thompson demonstrates the beneficial consequences that follow when we properly apply the standard assumptions of orthodox neoclassical value theory to a perfectly competitive production-and-exchange economy in which the provision of money is also subject to perfect competition. The result is an equilibrium quantity of real money balances which is: (1) determinate; (2) "Pareto optimal" (i.e., all resources go to their highest-valued uses); and (3) consistent with Say's Law of Markets (i.e., inconsistent with permanent, aggregate resource unemployment).59
In November of 1974, another major work on the competing currencies question was published in the Journal of Money, Credit, and Banking. In his article "The Competitive Supply of Money," Benjamin Klein dealt the final blow to those arguments against monetary competition. Klein refutes the criticism that such a system would necessarily generate a hyper-inflation, leading to an infinitely high level of money prices. He demonstrates that we could expect such a result only when the "brand names" or "trademarks" of the various privately issued token monies are not protected from counterfeiting. He provides an excellent discussion of the process by which the competitive system would punish a money-producing firm that attempted to cheat its customers by deceitfully manipulating the supply of its brand of money, and how, correspondingly, it would reward a firm that operated to preserve its customers' trust. Klein concludes with a short historical discussion and a consideration of the pros and cons of competition, but he comes to no strong conclusions concerning the preferability of a competitive market structure over the existing closed government monopoly.60 In two later articles, Klein applies his theoretical apparatus to the questions of European monetary unification and the seignorage profits earned by currency issuers.61
Shortly after Klein's first article, Gordon Tullock's "Competing Monies" appeared in the Journal of Money, Banking, and Credit (1975). This fascinating article, after suggesting some possible examples of historical precedents in the use of competing private token issues, offers an important theoretical analysis of the microeconomic process by which a depreciating currency might gradually be given up in favor of another more stable one.62 Tullock's article triggered an interesting exchange between himself and Klein concerning the authenticity and frequency of historical instances of competing private monies.63Hayek and the Denationalization of Money
F. A. Hayek's 1976 pamphlet, Choice in Currency: A Way to Stop Inflation, represented the beginnings of the first major attempt toinvestigate seriously the practical possibilities of a system of competing paper issues. It was here that Hayek began to address the question, "Why should we not let people choose freely what money they want to use?" —and to answer it: "There is no reason whatever why people should not be free to make contracts, including ordinary purchases and sales, in any kind of money they choose, or why they should be obliged to sell against any particular kind of money."64
The program presented in Choice in Currency involves domestic competition among different national government monies, each of whose circulation is presently confined almost exclusively to its country of origin. But over a period of eight months, the program quickly evolved into a full-blown scheme of competing private (as well as governmental) monies. The result of this development was Hayek's pathbreaking Denationalisation of Money: An Analysis of the Theory and Practice of Concurrent Currencies. First published in 1976, this work was subsequently revised and extended.65 It provides the best existing account of, and the best case for, free competition in the production and control of privately issued token monies. Hayek's analysis of the hypothetical working of a laissez-faire monetary system may seem deceptively simple, due to its brief treatment of a novel idea. The analysis should be closely read and carefully considered by the interested reader, as it has been misunderstood by more than one writer in the area.66 The author comes to the firm conclusion that "the past instability of the market economy is the consequence of the exclusion of the most important regulator of the market mechanism, money, from itself being regulated by the market process."67
Since Hayek's Denationalisation of Money was first published, several other authors have made significant contributions to the small but rapidly growing discipline of currency competition. These include Lance Girton and Don Roper, whose "Substitutable Monies and the Monetary Standard" (1979) gives a clear and concise statement of the "theory of multiple monies" and discusses some of the major issues connected with the choice-in-currencies question.68 Roland Vaubel's "Free Currency Competition" (1977) is an excellent study offering an extremely thorough overview of the subject and its controversies. In addition, it provides some personal predictions concerning what Vaubel believes to be the most likely outcome of a competitively determined currency industry.69 Vaubel refers to two as-yet-unpublished works, Wolfram Engels' "Note Issue as a Branch of Banking" and Wolfgang Stutzel's "Who Should Issue Money? Private Instead of Public Institutions? Bankers Instead of Politicians!", that further discuss and argue for a free market in money.
Among lay audiences concern with understanding the existing monetary mess has reached a high level of intensity in recent months. In order to satisfy this popular demand, a number of nontechnical introductory articles on the competing token monies alternative have recently appeared. Among these are pieces by economists Martin Bronfenbrenner, F. A. Hayek, Lawrence H. White, and Peter Lewin.70 In addition, a number of works have examined historical incidents of privately-issued monies (token, fiduciary, and commodity), complementing research done on the purely theoretical level.71The Competitive Process of Currency Production
The hypothetical day-to-day operation of an established competitive token monetary system is in fact no more (or less) mysterious than is the working of the market process in any other production domain. Private issuers would compete in a number of dimensions to meet the community's demands for monetary services: purchasing-power behavior over time, convenience of use in exchange, convenience of use in accounting, and so on. Depending upon the preferences of currency consumers, the producer would adjust the existing supply of nominal units of his money so as to provide the appropriate degree of appreciation or constancy in his money's value. The purchasing-power control technique (or "rule") employed in actual practice by any given firm is, under a competitive system, a matter to be determined exclusively by the subjective judgments of the monetary entrepreneur.
Because people's exchange needs are different, preferences with respect to changes in the exchange-value of currencies can be expected to vary over the population of money users. This would result in issuer specialization to meet the unique requirements of particular user interests. Similarly, tastes may differ with respect to the index of commodity prices devised to monitor deviations from the desired level or rate of change of the purchasing power of a money. On this point, Hayek explains: "Experience of the response of the public to competing offers would gradually show which combination of commodities constituted the most desired standard at any time and place."72 In short, under competitive conditions, the monetary standard, the monetary rule, and the purchasing-power behavior of money are all determined by expressed choice in the marketplace rather than by arbitrary political command.
Over time, those issuers who most effectively satisfy the demand for monetary services would profit and expand their market shares. Others who, for example, increase the value of their currencies when most money-holders prefer stable tokens, or stabilize their monies when most users prefer appreciating tokens, would be driven out of business or be forced to maintain a more modest circulation due to reduced profits. Which sort of monies would actually prove most popular, only the competitive market process can tell. For instance, Roland Vaubel points out, while purchasing-power appreciation tends to enhance a money's desirability as an asset (or "store of value"), purchasing-power constancy may enhance its desirability as an accounting device (or "standard of value").73
The case for competition appears the logically superior one. However, doubts and queries about the operation of the system have nevertheless been expressed. Critics have especially emphasized potential problems concerning the stability and emergence of efficient supplies of currency when competition is allowed to regulate its production.Is a Free-Market Monetary System Stable?
The issue of stability centers on the question of the controlability of a currency's value under a "perfectly" competitive scheme. This is sometimes framed, inversely, as the problem of "infinite" levels of money prices presumably resulting from a laissez-faire regime. Boris Pesek, for example, expresses the belief that in the long run a competitive paper currency system would generate a situation in which "money is so 'abundant' as to sell for a zero price and be a free good," producing a "regression into full-time barter since free money is worthless money, incapable of performing its task of facilitating exchange of goods among persons."74 Benjamin Klein, as noted earlier, has demonstrated that such a result depends on improperly specified or protected property rights in the currency industry, and would emerge in any market in which brand names could be counterfeited. In such a market, producers and consumers lack a signaling mechanism by which to identify the outputs of different firms in the industry, so that a low-quality product cannot be identified and shunned in advance. Explains Klein:
It is true that if, for example, a new money producer could issue money that was indistinguishable from an established money, competition would lead to an overissue of the particular money and the destruction of its value. The new firm's increase in the supply of money would cause prices in terms of that money to rise and, if anticipated, leave real profit derived from the total production of the money unchanged. But there has been a distribution effect—a fall in the established firm's real wealth. The larger the new firm's money issue the greater its profit; therefore profit maximization implies that the new firm will make unlimited increases in the supply of the money, reducing the established firm's profit share close to zero (unless it too expands.)
If the established firm legally posseses a trademark on its money, this "externality" of the new firm's production represents a violation of the established firm's property right and is called counterfeiting. Lack of enforcement of an individual's firm's property right to his particular name will permit unlimited competitive counterfeiting and lead to an infinite price level. This merely points up the difficulties in the usual specification of competitive conditions. If buyers are unable to distinguish between the products of competing firms in an industry, competition will lead each firm to reduce the quality of the product it sells since the costs of such an action will be borne mainly by the other firms in the industry…. [I]ndistinguishability of the output of competing firms will lead to product quality depreciation in any industry.75
Thus, in order to solve the paradox of infinite price levels, we need only introduce into a competitive currency model that was designed to prove the instability of free trade in money an assumption implicit in all standard analyses of competitive industry: the premise that products are distinguishable with respect to origin. (This is not inconsistent with another assumption of "perfect competition" models: that products are completely indistinguishable or identical with respect to their flow of services.) On making this assumption the proof is reversed, and we may deduce stability properties typically found in a perfectly competitive world. Criticisms of the stability properties of a free-market monetary system in this case point up a potential problem concerning the appropriate legal structure necessary for a properly functioning competitive system, rather than a problem of the competitive market structure itself, given a well-defined system of property rights.Could Private Token Currencies Emerge? Would They?
The emergence of a competitive token monetary system from the existing domestic government monopoly raises two questions. First, there is the issue of how in theory a system of multiple monies could emerge; and second, there is the question of whether in practice such an evolution should be expected to take place once the requisite property rights structure has been established for the industry.
Posing the first question, Henry Hazlitt asks:
(H)ow does a private issuer establish the value of his money unit in the first place? Why would anybody take it? Who would accept his certificates for their own goods and services? And at what rate? Against what would the private banker issue his money? With what would the would-be user buy it from him? Into what would the issuer keep it constantly convertible? These are essential questions.76
Indeed, new currencies would not appear or be accepted overnight. During the gradual process of establishing a private currency, the issued certificates would not immediately be greeted by money-users as currency. At the outset they would be supplied to the public in the form of money substitutes. These money substitutes would be supplied under an explicit contract guaranteeing the bearer some minimum rate of exchange between these certificates and one or more commodities or pre-existing currencies. Currency entrepreneurs would of course decide which commodities or monies to use in this process, and money-users would then choose from among the alternatives offered.77
Only later, after the issuing firm had fostered sufficient consumer confidence in its trademarked tokens by making the necessary investments in the firm's "brand-name capital,"78 would the issued notes begin to take on a monetary life of their own. The point marking this transformation is reached when currency-users effectively acknowledge the new currency as "monetized" by no longer routinely demanding that it be converted into another more liquid asset. Instead transactors begin circulating the notes as an independent exchange medium in their daily business.
Empirical doubts about the second question—whether a competitive currency system would in fact spontaneously emerge under the right legal conditions—are almost without exception framed in terms of the economic concept of "transactions costs." They are presented on the basis of a number of confusions, widespread within the economics profession, concerning the notions of "cost," "choice," and "competition." Such confusions are all too familiar to Austrian economists.
Arguments that deny the likely emergence of concurrent privately issued monies under laissez faire typically run as follows. People employ goods "having currency" for a variety of reasons, the most important among these being the purpose of transacting economic exchanges. In its capacity as a medium of exchange, a monetized commodity, due to its quality of being highly marketable, provides the transactor with a device which allows him to economize on the time and resources required to complete his desired set of exchanges. Thus far the argument is unobjectionable. Confusion enters in the form of a non sequitur when the argument leaps to the conclusion that, to the individual agent, "money is more useful the larger its transactions domain." On this basis Roland Vaubel argues that
Since the cost of using money falls as its domain expands, the quality (and, hence, the value) of the product money and, consequently, the marginal value productivity of the factors engaged in its production increase so that the money industry must be viewed as a (permanently) declining-cost industry.79
This argument leads Vaubel to conclude: "Ultimately, currency competition destroys itself because the use of money is subject to very sizeable economies of scale. The money-industry must be viewed as a 'natural monopoly,' which at some stage must be nationalized." He adds that since it is "undisputed that lines of production that are subject to permanently declining cost must at some stage be nationalized (or, in an international context, be 'unified'), the fact that currency competition will lead to currency union must be regarded as desirable."80
This argument labors under some rather common misconceptions. First, only individuals transact, and they do so only with one other individual or organization at a time, rather than with the entire economic order or "transactions domain." Further, there are likely to be many sectors of the monetized system with which these actors have little or no interest in dealing. These submarginal transactions areas vary from person to person. It is not at all obvious, then, that a money will be "more useful" to any given agent, the more universal or extensive the domain within which the money (or monies) he uses circulates. Some degree of specialization and heterogeneity in the currency industry's supply of services may in fact persist indefinitely because of persistence of differences in the needs and purposes of the various money-using members of a community.81 In that case, several different issues may circulate side by side, each servicing the individuated demands of a separate subset or "neighborhood" of the "global" transactions domain. And, of course these currency areas may overlap.
The exact configuration of the resulting monetary mosaic is unpredictable under a competitive monetary arrangement since each currency consumer's choice from among the array of currencies available to him is made according to purely subjective benefit-cost calculations. Accordingly, the aggregate impact of consumers' choices in determining a given currency's domain will be revealed only after the execution of the particular plans that are based upon these calculations. Since their requirements may, for example, be highly localized geographically, it seems unreasonable to conclude a priori that a system of several concurrently circulating monies is "likely to be purely transitory, and that the only lasting—and again desirable—result will be currency union."82
A second problem with the prediction of a "spontaneous monopolization" of the currency industry concerns the misconception of the competitive process that underlies this forecast. Surely, no one can resist reaching the conclusion that "competition destroys itself" in any industry in which marginal costs of production are continuously falling; no one, that is, who has adopted the entrepreneurially static notion of "perfect competition" as a benchmark. In that conceptual framework, the criterion of a "competitive" industry refers to a specific magnitude or pattern ("many" firms or price equal to marginal and average costs), rather than to the end-independent (and unceasing) process (rivalrous pursuit of profits) that characterizes the operation of the system. It naturally follows that any industry not obeying the perfectly competitive "pattern" must by definition exhibit "monopolistic tendencies."83
Once we recognize, however, that real-life competition is a dynamic and unending discovery process, we no longer can meaningfully judge an actual industry's competitiveness by comparing it with some final static state of "optimality," "perfection," or "equilibrium." So long as the necessary legal framework is in force, the competitive process is at work whether one firm or many firms persist. In Brian Loasby's words: "[T]he critical question is, not what should the pattern of resource allocation look like, but how is it to be achieved; and the perfectly competitive model, which has defined the terms of the argument, provides no recipe for achieving anything. Actual competition is a process, not a state; and perfect competition can exist only as the description of a state.84
Vaubel goes on to offer one more criticism of the efficiency of competing currencies. He argues that because "a good like money['s]…precise purpose is to reduce transaction cost, information cost and risk (as compared with barter), a diverse plethora of private issuers in the industry is likely to be "particularly inconvenient" due to the "diseconomies of small scale." He further argues that these effects "do not disappear if all banks of issue are led or forced to denominate their monies in the same standard of value."85 The issue of whether several concurrently circulating exchange media would present an inconvenience to currency-users depends, again, on the individual users' subjective evaluations of the benefits and costs involved. The outcome cannot be conclusively determined a priori by the theorist. What is more, it is of interest to note that economic historian Hugh Rockoff has offered evidence which suggests by analogy that the benefits of a multi-issuer system may in fact outweigh the possible inconvenience in the estimations of consumers:
Skepticism From Gold Standard Advocates
[I]t seems unlikely that the heterogeneous nature of the currency (of the nineteenth century) was a major brake on economic growth, for in many crucial respects the system was little different from that which prevails today. Locally we use demand deposits. But these are not generally acceptable as a means of payment. Each time we wish to make a purchase by check from a businessman we force him to make some judgement about the quality of the money we are offering. Instead of having to worry about different kinds of bank notes a merchant today must worry about different kinds of deposits which could be as numerous as his customers. Counterfeiting currency is now rare, but forged checks and insufficient balances are a constant irritation. Yet no one today would argue that the heterogeneity of our deposit money is a serious impediment to the growth of national income…[T]he inefficiency of a heterogeneous currency should not be exaggerated.86
It should be mentioned that a few advocates of the gold standard have questioned the feasibility of privately circulated issues of explicitly "token" form.87 Their criticisms are clearly directed not against market-oriented monetary reform per se (as the gold standard they advocate is itself a market-controlled monetary system), but rather against a system of irredeemable and exclusively paper monies. According to these skeptics, the Hayekian paper regime could never exist. A purely fiduciary money is simply not possible in a world of free and rational agents; and it follows, they argue, that a system of competing paper issues is also impossible:
In a truly free society,…Professor Hayek and his bank would be allowed to issue paper certificates. So would we and our neighbors down the street. The real question is: Who would accept such certificates for their goods or services? Remember, they are not legal tender. Their value could not be insured…It is difficult to believe that sophisticated businessmen would long accept such paper certificates when, in a free society, they could ask for and receive gold or certificates redeemable in gold….
Given the fact that few people now alive have ever known sound money and given the general ignorance of sound monetary theory, it is possible that some established banks might find some who would accept their privately issued paper certificates. But, as Hans Christian Andersen tells the story of the illusion of "The Emperor's Clothes," sooner or later some innocent bystander would point out that such paper certificates are not the most marketable commodity in a free society and hence not "money."88
It is surprising how many basic confusions concerning the theories of subjective valuation, money, and the spontaneous order have been included in such a short passage. The implication that an established token issue's acceptability is necessarily dependent upon its possessing a governmentally sanctioned "legal tender" status ("Remember they are not legal tender") is false. In contrast to these would-be Misesian writers, Mises himself notes:
The law may declare anything it likes to be a medium of payment…But bestowing the property of legal tender on a thing does not suffice to make it money in the economic sense. Goods can become common media of exhange only through the practice of those who take part in commercial transactions…. Quite possibly, commerce may take into use those things to which the State has ascribed the power of payment; but it need not do so. It may, if it likes, reject them.89
If these writers mean to suggest that token money is exclusively a "creature of the State," perhaps they should say so directly.
The bald assertion that a newly issued private money's value "could not be insured" is also incorrect. More than one author has explained how and why such "value insurance" for new monies might hypothetically be made available to interested-but-wary potential customers.90 What is worse, the assertion represents a disconcertingly unannounced jump in logic. It leaps from a general and objective analytical discussion of the issues to a highly specific and essentially entrepreneurial judgment concerning the dimensions in which the market for insurance services could or could not operate in the future. An economist oversteps his bounds in going beyond purely scientific explanations of the operations of the competitive process in the currency industry into the realm of concrete predictions concerning the industry's future organization ("supply-side") and qualitative ("demand-side") features. Such prediction is the concern of entrepreneurs. In these instances, criticism seems to reveal a basic misunderstanding of the literature concerning the Hayekian private paper money system in particular, and of the theory of the spontaneous order as a fluid discovery process in general.
The fact of the matter is that individuals do transact with and are willing to hold merely "token" currencies.91 Even more generally, we may note that presumably rational, valuing agents, when situated within the context of a social system, continuously engage in various "customary" activities or follow established "norms" or procedures that do not yield obvious and direct benefits to them. These modes of behavior have evolved to facilitate social intercourse, though frequently those practicing them may be incapable of articulating or rationalizing those functions explicitly.92 The question is, should we deny or ignore the actual existence of certain forms of money or various other "products of human action but not of human design" simply because their acceptability seems "difficult to believe"? Or should we recognize that such structures do indeed exist, although to date their occurrence remains to be satisfactorily explained? To the inquiring mind, the answer seems obvious.
Additional and more practical objections to a system of free-market paper monies have been developed in the literature.93 A number of these have come (somewhat surprisingly) from the program's chief proponent, F.A. Hayek.94Rules and Commands: Their Confusion by the Constitutionalists
Finally, one of the most important arguments against monetary competition is implicit in a leading defense of a constitutionally constrained monopoly. This argument, which has been frequently invoked by monetary constitutionalists of both the Monetarist and Public Choice camps, seems, again, to rest on some rather serious misconceptions: The use of money, it is argued, is directly analogous to the following of legal rules of conduct within a civilization. Further, both the law and money come under the category of highly social "multi-purpose instruments."95 Since the extra-market constitutional mechanisms devised in the past appear to facilitate the successful functioning and development of the legal order, it seems naturally to follow that the creation of such a mechanism for the monetary order would serve to enhance its operation and progress as well. The creators and practitioners of law are continuously guided in their deliberations by a metal-legal framework of general principles that provides a point of reference for "producing" proper legislation. Similarly, might not the creators and practitioners (managers) of the currency system be disciplined in their day-to-day activities by a set of principles? A monetary constitution would thereby insure that the "proper" monetary services would be produced and made available to market participants.96
Two rather basic errors mar this argument. The first is that an analogy per se demonstrates nothing. It may indeed be true the use of currency in economic interactions has characteristics similar to those of the adherence to legal rules in social interactions. But it does not follow that it is therefore necessary for efficiency that the production of money be carried out within an institutional framework analogous to that created for the production of laws—a closed, govermentally controlled, jurisdictional monopoly. If this conclusion really were thought to follow, moreover, it would prove too much. That is, it would be unclear why its proponents have not also endorsed the socialization of religion, say, or the development of a constitution mandating and defining an overall set of principles for the production and use of language in society. If the evolution of optimal "supplies" of languages and language areas is allowed to be determined by spontaneous order, why then should not optimal money supplies and currency areas be so determined as well?
The second and more serious problem with the above argument is that the specific analogy used is flawed. It overlooks a crucial difference between currency and rules: laws (written down explicitly or not) are prerequisites for market activity. Money, while it does facilitate such activity, is not a prerequisite. Money is a good with a distinct demand and supply. Being an economic commodity capable of providing specific services to its users, there is no apparent reason why its production cannot be regulated by the same rules which guide the creation of all goods—the body of laws protecting competitive activity.
When it is claimed that currency production must be supervised by its own "special" legal framework and protected from the competitive process by being manufactured only by government, whereas other goods may be produced competitively under the standard legal framework calling for free and equal exchange, a confusion between the notion of abstract rules and that of particular commands is apparent. Those advocating a monetary constitution propose not an abstract rule for the promotion of the general welfare of those who manage their affairs within the nexus of the monetized exchange system, but what is in essence a monetary command—a command being defined as a rule "for the performance of assigned, specific, tasks" —for centrally planned money production. They, in short, take a "constructivistic" approach to monetary matters.97 Indeed, money and law are both "multipurpose" tools facilitating social interchange. But whereas laws are procedural dictates, money is an economic good.
As Hayek has pointed out on numerous occasions,98 what generalized "principles of justice" or "rules of just conduct" are intended to generate is not a command society (which would be the result if these "rules" were defined according to the endspecific criterion implied by the monetary constitutionalists), but rather a competitive society. The proper role of constitutional laws or principles is that of arbitrarily defining the set-up of the apparatus (government) by which the generalized rules of conduct of the liberal social order may be enforced. The French classical liberal Frederic Bastiat put the entire matter succinctly in The Law: "liberty means competition."99 And, as Girton and Roper state clearly with respect to the monetary system of an open society in particular: "Competition in money issue provides a rule enforced by the market, and a monetary standard that is attractive compared to current monopoly paper money standards."100Monetary Constitutionalists as Entrepreneurs in Scientists' Clothing
By denying currency the status of a privately producible "good" capable of being regulated by the pressures of market competition (and instead elevating it to the status of a supramarket social tool which needs by its very nature to be supplied by a non-market governmental agency), the monetary constitutionalists are in fact stepping out of realm of scientific conjecture and into the domain of entrepreneurial conjecture. In the case of each program for a monetary constitution or "rule," the author has tacitly adopted the approach of the hypothetical currency producer-entrepreneur seeking the best production method. But rather than admit this, and in the process acknowledge that the only objective test of the correctness of such conjectures is the profit-and-loss test of market competition, each author continues to use the rhetoric of scholarship in the development of a "scientific" argument for his own particular "brand" of currency and its production design. What we have here is a case of entrepreneurs in scientists' clothing.
Economists have clearly articulated the need for reform of the existing monetary system. The available alternatives for change have in recent years also taken clear and unambiguous shape: either continued yet constrained monopoly or free-market competition in the supply of currency. The case for competition rather than constitutional restriction seems at present to be far stronger. The essence of the argument for free currency competition has perhaps been best expressed by Brian Loasby, who writes:
The argument for competition rests on the belief that people are likely to be wrong…. In the end, the case against an authoritarian system of resource allocation rests on the same principle as the case against an authoritarian structure in any discipline: part of the case…is that no person or body of persons is fit to be trusted with such power; the (other) part…is that no one person or group of persons can say for sure what new knowledge tomorrow will bring. Competition is a proper response to ignorance.101
Comments and suggestions from Gary Anderson, James Buchanan, Robert Tollison, Gordon Tullock and Daniel Orr on earlier drafts of this essay are gratefully acknowledged. Of course they are absolved of responsibility for any errors or omissions that remain. Lawrence H. White contributed extensive editorial services to the final draft.
1. [C]arl Menger, "On the Origin of Money," Economic Journal 2 (June 1892): 239–255. A modern version of Menger's theory has been developed by Robert A. Jones, "The Origin and Development of Media of Exchange," Journal of Political Economy 84 (Nov. 1976): 757–775.
2. Karl Brunner and Allan H. Meltzer, "The Uses of Money: Money in the Theory of an Exchange Economy," American Economic Review 61 (Sept. 1973): 799.
3. Brian Loasby, Choice, Complexity and Ignorance (New York, Cambridge: Cambridge University Press, 1976) p. 165.
4. In addition to those already cited, see W.W. Carlile,The Evolution of Modern Money (London: Macmillan, 1901); W. Stanley Jevons, Money and the Mechanisms of Exchange (London: Kegan Paul, 1905); W.T. Newlyn, The Theory of Money (London: Oxford University Press, 1971); Boris P. Pesek and Thomas R. Saving, Money, Wealth and Economic Theory (New York: Macmillan, 1970); C.A.E. Goodhart, "The Role, Functions, and Definition of Money," in G.C. Harcourt, ed., The Microfoundations of Macroeconomics (Boulder, Co.: Westview Press, 1977), pp. 205–277; Leland Yeager, "Essential Properties of the Medium of Exchange," Kyklos 21 (Jan. 1968): 45–68; William H. Hutt, "The Nature of Money," South African Journal of Economics 20 (March 1952): 50–64; Hutt, "The Yield from Money Held," in Mary Sennholz, ed., The Economics of Free Enterprise (Princeton: Van Nostrand, 1956): pp. 196–216; Hutt, "The Notion of the Volume of Money," South African Journal of Economics 20 (Sept. 1952): 231–241; Hutt, "The Notion of Money of Constant Value," South African Journal of Economics (Sept.–Dec. 1953); Hutt, "The Concept of Idle Money," in The Theory of Idle Resources (Indianapolis: Liberty Press, 1977); Murray N. Rothbard, "The Austrian Theory of Money," in Edwin G. Dolan, editor, The Foundations of Modern Austrian Economics (Kansas City: Sheed and Ward, 1976), pp. 160–184; Joseph M. Ostroy and Ross M. Starr, "Money and the Decentralization of Exchange," Econometrica 42 (Nov. 1974): 1093–1113; Morris Perlman, "The Roles of Money in an Economy and the Optimum Quantity of Money," Economics 38 (Aug. 1971): 233–252; Jack Hirshleifer, "Exchange Theory: The Missing Chapter," Western Economic Journal(Economic Inquiry) (June 1973): 129–146; Robert Clower, "A Reconsideration of the Microfoundations of Monetary Theory," Western Economic Journal (Economic Inquiry) 6 (Dec. 1967): 1–8; Harold Demsetz, "The Cost of Transacting," Quarterly Journal of Economics 82 (Feb. 1968): 33–53; and R.A. Radford, "Money in a Prisoner-of-War Camp," in Jonas Prager, ed., Monetary Economics: Controversies in Theory and Policy (New York: Random House, 1971), pp. 6–8.
5. In the case of the U.S. Federal Reserve System, this is only a shorthand way of describing the usual process of monetary expansion. More precisely, the Fed injects new bank reserves into the system, enabling commercial banks to issue new money.
6. An especially important transfer of the first type, namely to capitalist investors from other income groups, occurs when new money is injected as loanable funds made available by the central bank. This transfer, known as "forced savings" because it involuntarily restricts the availability of resources for consumption, plays an important role in the Austrian theory of the trade cycle. See F.A. Hayek, "A Note on the Development of the Doctrine of 'Forced Saving'," in Profits, Interest and Investment (New York: Augustus M. Kelley, 1975), pp. 183–197; and Prices and Production (New York: Augustus M. Kelley, 1967), pp. 18–22, 85–91.
7. See John Culbertson, Macroeconomic Theory and Stabilization Policy (New York: McGraw-Hill, 1968); Nancy Smith Barrett, The Theory of Macroeconomic Policy (Englewood Cliffs, NJ: Prentice Hall, 1975); Michael R. Darby, Macroeconomics (New York: McGraw-Hill, 1976); and Rudiger Dornbusch and Stanley Fischer, Macroeconomics (New York: McGraw-Hill, 1978). Also relevant are E.S. Phelps et. al., Microeconomic Foundations of Employment and Inflation Theory (New York: W.W. Norton, 1970); and Don Patinkin, Money, Interest, and Prices (New York: Harper & Row, 1965). For a survey of recent developments by a pioneering "Rational Expectations" theorist, see Robert E. Lucas, Jr., "Methods and Problems in Business Cycle Theory," in Studies in Business-Cycle Theory (Cambridge: MIT Press, 1981), pp. 271–296.
8. See also Milton Friedman, "Government Revenue from Inflation," Journal of Political Economy 79 (July–Aug., 1971): 846–856; Eamonn Butler, "How Government Profits from Inflation," Policy Review 6 (Fall 1978): 73–76; Leonardo Auernheimer, "The Honest Government's Guide to the Revenue from the Creation of Money," Journal of Political Economy 82 (May–June 1974): 598–606; Martin Bailey,"The Welfare Cost of Inflationary Finance," Journal of Political Economy 64 (April 1956): 93–110; and Michael Mussa, "The Welfare Cost of Inflation and the Role of Money as a Unit of Account," Journal of Money, Credit, and Banking 9 (May 1977): 276–286.
9. But for an alternative view—that of monetary statism—see G.F. Knapp,The State Theory of Money (London: Macmillan, 1924); and Abba P. Lerner, "Money as a Creature of the State," American Economic Review 37 (May 1947 supplement): 312–317.
10. S. Herbert Frankel, Money: Two Philosophies (England: Basil Blackwell, 1977), p. 86. See also this book's recent sequel, Money and Liberty (Washington: American Enterprise Institute, 1980).
11. On the importance of such institutions see F.A. Hayek, Law, Legislation and Liberty, vol. II (Chicago: University of Chicago Press, 1978), ch. 7.
12. These include William T. Baxter, Solomon Fabricant, et al., Economic Calculation Under Inflation (Indianapolis: Liberty Press, 1976); Ludwig von Mises, Human Action: A Treatise on Economics (Chicago: Henry Regnery, 1966), pp. 550–565; Axel Leijonhufvud, "Costs and Consequences of Inflation," in Information and Coordination (New York: Oxford University Press, 1981), pp. 227–269; William D. Bradford, "Monetary Position, Unanticipated Inflation, and Changes in the Value of the Firm," Quarterly Review of Economics and Business 16 (Winter 1976): 47–53; and Benjamin Klein, "The Social Costs of the Recent Inflation: The Mirage of Steady 'Anticipated' Inflation," in Karl Brunner and Allan H. Meltzer, eds., Institutional Arrangements and the Inflation Problem (New York: North Holland, 1976), pp. 185–212.
13. See Constantino Bresciani-Turroni, The Economics of Inflation (London: George Allen and Unwin, 1937); C.A. Phillips, T.F. McManus and R. W. Nelson, Banking and the Business Cycle (New York: Arno Press, 1972); Ludwig von Mises, On the Manipulation of Money and Credit (Dobbs Ferry, NY: Free Market Books, 1978); F.A. Hayek, Monetary Theory and the Trade Cycle (Clifton, NJ:Augustus M. Kelley, 1975); Hayek, Full Employment at Any Price? (London: Institute of Economic Affairs, 1975); Hayek, "Full Employment, Planning and Inflation," in Studies in Philosophy, Politics and Economics (New York: Simon and Schuster, 1967), pp. 270 –279; Milton Friedman, "The Effects of a Full-Employment Policy on Economic Stability," in Essays in Positive Economics (Chicago: University of Chicago Press 1966), pp. 117–132; Otto Eckstein, "Instability in the Private and Public Sectors," Swedish Journal of Economics 75 (March 1973): 19–26; and Benjamin Klein, "Our New Monetary Standard: The Measurement and Effects of Price Uncertainty, 1880–1973," Economics Inquiry 13 (Dec. 1973): 461–484.
14. Axel Leijonhufvud, Information and Coordination, p. 259. Italics in the original deleted.
15. The long-run Phillips Curve, to use that manner of speaking, is said to be positively sloped rather than negatively sloped. See Hayek, Full Employment at Any Price?; Milton Friedman, "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy 85 (June 1977): 451–472; Robert E. Lucas, "Some International Evidence on Output-Inflation Tradeoffs," in Studies in Business Cycle Theory, pp. 131–145. On the Rational Expectations theorists as "neo-Austrians," see David Laidler, "Monetarism: An Interpretation and an Assessment," Economic Journal 91 (March 1981): 1–28.
16. For evidence and discussion supportive of reliance upon "discretionary" money and credit management for the achievement of policy objectives, see for example, Phillip J. Copper and Stanley Fischer, "Simulations of Monetary Rules in the FRB-MIT-Penn Model," Journal of Money, Credit, and Banking 4 (May 1972): 384–396; C.R. Whittlesey, "Rules, Discretion, and Central Bankers," in C.R. Whittlesey and J.S.G. Wilson, editors, Essays in Money and Banking in Honor of R.S. Sayers (Oxford: Clarendon Press, 1968), pp. 252–265; L.R. McPheters and M.B. Redman, "Rule, Semirule, and Discretion During Two Decades of Monetary Policy," Quarterly Review of Economics and Business 15 (Spring 1975): 53–64; D.A. Peel, "Some Implications of Alternative Monetary Rules," Indian Economic Journal 27 (July–Sept. 1979): 81–94; Daniel Ahearn, "Automatic Increases in the Money Supply: Some Problems," in Jonas Prager, ed., Monetary Economics: Controversies in Theory and Policy, pp. 352–355; and Franco Modigliani, "Some Empiricial Tests of Monetary Management and of Rules Versus Discretion," Journal of Political Economy 72 (June 1964): 211–245.
Analyses critical of credit and currency control characterized by discretionary "fine tuning" can be found in Henry C. Simons, "Rules Versus Authorities in Monetary Policy," in Economic Policy for a Free Society (Chicago: University of Chicago Press, 1973), pp. 160–183; Martin Bronfenbrenner, "Statistical Tests of Rival Monetary Rules," Journal of Political Economy 69 (Feb. 1961): 1–14; Bron-fenbrenner, "Statistical Tests of Rival Monetary Rules: Quarterly Data Supplement," Journal of Political Economy 69 (Dec. 1961): 621–625; Milton Friedman, A Program for Monetary Stability (New York: Fordham University Press, 1975); Edward S. Shaw, "The Positive Case for Automatic Monetary Control," in Jonas Prager, editor, Monetary Economics: Controversies in Theory and Policy, pp. 348 –351; and Bennett T. McCallum, "Price Level Stickiness and the Feasibility of Monetary Stabilization Policy with Rational Expectations," Journal of Political Economy 85 (June 1977): 627–634.
Further discussions of both the pros and cons of discretionary money management are contained in Edward Gramlich, "The Usefulness of Monetary and Fiscal Policy as Discretionary Stabilization Tools," Journal of Money, Credit, and Banking (May 1971); Richard H. Puckett and Susan B. Vroman, "Rules Versus Discretion: A Simulation Study," Journal of Finance 28 (Sept. 1973): 853–865; Victor Argy, "Rules, Discretion in Monetary Management, and Short-Term Stability," Journal of Money, Credit and Banking 3 (Feb. 1971): 102–122; Ronald S. Koot and David A. Walker, "Rules Versus Discretion: An Analysis of Income Stability and the Money Supply," Journal of Money, Credit, and Banking 6 (May 1974): 253–262; Wilfred Lewis, Jr., "The Relative Effectiveness of Automatic and Discretionary Fiscal Stabilizers," in Robert W. Crandall and Richard S. Eckhaus, eds., Contemporary Issues in Economics: Selected Readings (Boston: Little, Brown, and Company, 1972), pp. 178–181; and Erich Schneider, "Automatism or Discretion in Monetary Policy?," Banca Nazionale del Lavoro (June 1970): 111–127.
17. Hans F. Sennholz, Inflation or Gold Standard, p. 57.
18. See Murray N. Rothbard, "The Case for a 100 Percent Gold Dollar," in: Leland B. Yeager, editor, In Search of a Monetary Constitution (Cambridge: Harvard University Press, 1962), pp. 94–136; Rothbard, What Has Government Done to Our Money? (Novato, CA: Libertarian Publishers, 1978); Henry Hazlitt, The Inflation Crisis and How to Resolve It (New York: Arlington House, 1978); See also Joseph T. Salerno, "A Proposal for Monetary Reform:The 100% Gold Standard," Policy Report (July 1981): 6–11. For an analysis and defense of free banking on a species standard see Lawrence H. White, "Free Banking as an Alternative Monetary System," in M. Bruce Johnson and Gerald P. O'Driscoll, Jr., eds., Inflation of Deflation? (Cambridge, MA: Ballinger Publishing Co., forthcoming).
19. See F.A. Hayek, "A Commodity Reserve Currency," in Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 92–106; Benjamin Graham, "The Commodity Reserve Currency Proposal Reconsidered," in Leland Yeager, ed., In Search of a Monetary Constitution; Milton Friedman, "Commodity Reserve Currency," in Essays in Positive Economics; and Robert E. Hall, "Explorations in the Gold Standard and Related Policies for Stabilizing the Dollar," in Hall, ed., Inflation (Cambridge, MA: National Bureau of Economic Research, forthcoming).
The interested reader will also want to peruse "A Proposal for Monetary Reform" (unpublished ms., Sept. 1980) by John F.O. Bilson, in which an "equity" reserve standard is proposed. Under Bilson's scheme, the Federal Reserve System is transformed into a "type of Mutual Fund" which maintains a monetary base incorporating reserves composed of a diversified portfolio of "internationally traded" financial assets.
20. Neil H. Jacoby, "The President, the Constitution, and the Economist in Economic Stabilization," History of Political Economy 3 (Fall 1971): 398.
21. Cited in Friedman,A Program for Monetary Stability p. 85. An earlier version of the Act prepared by the Senate Banking and Currency Committee did contain a clause specifically instructing the Fed to manage the currency system for the clear and unambiguous co-purpose of "accommodating the commerce of the country and promoting a stable price level." (Hearings before the Committee on Banking and Currency, U.S. Senate, 63rd Congress, 1st session on S. 2639, 1913, vol. 2, p. 1730, sec. 15 of the bill.) It was deleted from the bill while in committee because it was believed that such a provision was an unnecessary precaution. It appears that a genuine ignorance of the potential importance of such an explicit provision caused its removal from the Act. See Irving Fisher, Stabilized Money: A History of its Movement (London: George Allen and Unwin, 1935), pp. 148 ff.
22. For a detailed historical discussion see Milton Friedman and Anna J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton: Princeton University Press, 1971), pp. 189 ff. See also Irving Fisher, Stabilized Money; and C.A. Phillips, T.F. McManus, and R.W. Nelson, Banking and the Business Cycle.
23. James M. Buchanan and Richard E. Wagner, Democracy in Deficit (New York: Academic Press, 1977); James M. Buchanan, Richard E. Wagner, and John Burton. The Consequences of Mr. Keynes (London: Institute of Economic Affairs, 1978); F.A. Hayek, "The Campaign Against Keynesian Inflation" in New Studies in Philosophy, Politics, Economics, and the History of Ideas (Chicago: University of Chicago Press, 1978), pp. 191–231; and Murray N. Rothbard, For a New Liberty (New York: Collier Books, 1978), ch. 9.
24. John M. Culbertson, Macroeconomic Theory and Stabilization Policy, p. 453.
25. Milton Friedman, "Should There Be an Independent Monetary Authority?," in Leland B. Yeager, ed., In Search of a Monetary Constitution, pp. 224–225, 239, 236.
26. Milton Friedman, A Program for Monetary Stability, p. 86.
27. Friedman, A Program for Monetary Stability, p. 93. See also Friedman, "The Effects of a Full-Employment Policy on Economic Stability: A Formal Analysis"; and Phillip Cagan and Anna J. Schwartz, "How Feasible is a Flexible Monetary Policy?," in Richard Selden, ed., Capitalism and Freedom—Problems and Prospects (Charlottesville: University Press of Virginia, 1975), pp. 262–310.
28. See H. Geoffrey Brennan and James M. Buchanan, Monopoly in Money and Inflation: The Case for a Constitution to Discipline Government (London: Institute of Economic Affairs, 1981); Brennan and Buchanan, "Money Creation and Taxation," in The Power to Tax: Analytical Foundations of a Fiscal Constitution (New York: Cambridge University Press, 1980), pp. 109–134; Richard E. Wagner, "Economic Manipulation for Political Profit: Macroeconomic Consequences and Constitutional Implications," Kyklos 30 (1977): 395–410; and Keith Acheson and John F. Chant, "Bureaucratic Theory and Choice of Central Bank Goals," Journal of Money, Credit, and Banking 5 (May 1973): 637–655.
29. Brennan and Buchanan, Monopoly in Money and Inflation, p. 23.
30. Richard E. Wagner, "Politics, Monetary Control, and Economic Performance: A Comment," Mario J. Rizzo, ed., Time, Uncertainty, and Disequilibrium (Lexington, MA: D.C. Heath, 1979), pp. 178, 180.
31. Gordon Tullock, "Competing Monies," Journal of Money, Credit, and Banking 7 (November 1975), pp. 496–497.
32. John M. Culbertson, Macroeconomic Theory and Stabilization Policy, p. 148.
33. Wagner, "Politics, Monetary Control, and Economic Performance," p. 179.
34. Milton Friedman, A Program for Monetary Stability, p. 19.
35. Milton Friedman, "The Optimum Quantity of Money," in The Optimum Quantity of Money and Other Essays (Chicago: Aldine Publishing Co., 1970), p. 34.
36. In addition to Friedman's above-cited works see Milton Friedman, Monetary Correction (London: Institute of Economic Affairs, 1974), and Friedman, "A Monetary and Fiscal Framework for Economic Stability," in Essays in Positive Economics, pp. 133–156. Also see Richard T. Selden, "Stable Monetary Growth," in Leland B. Yeager, ed., In Search of a Monetary Constitution.
37. E.S. Shaw, "Monetary Stability in a Growing Economy," in Moses Abramovitz, ed., The Allocation of Economic Resources (Standford: Standford University Press, 1959).
38. Martin Bronfenbrenner, "Statistical Tests of Rival Monetary Rules," pp. 1–2; "Statistical Tests of Rival Monetary Rules: Quarterly Data Supplement," pp. 624 –625.
39. Clark Warburton, "Rules and Implements for Monetary Policy," Journal of Finance 8 (March 1953): 8; John M. Culbertson, Macroeconomic Theory and Stabilization Policy, p. 432.
40. Henry C. Simons, "Rules Versus Authorities in Monetary Policy," pp. 164, 169; Willford King, "Sound Money—Why Needed and How Obtained," in Leland B. Yeager, ed., In Search of a Monetary Constitution, pp. 315–316.
41. Jacob Viner, "The Necessary and the Desirable Range of Discretion to be Allowed to a Monetary Authority," in Leland B. Yeager, ed., In Search of a Monetary Constitution, pp. 244–274; Henry Simons, "Rules Versus Authorities in Monetary Policy"; Clark Warburton, "Rules and Implements for Monetary Policy"; William H. Hutt, Keynesianism—Retrospect and Prospect: A Critical Restatement of Basic Economic Principles (Chicago: Henry Regnery, 1963), pp. 100–101; and Hutt, A Rehabilitation of Say's Law (Athens, OH: Ohio University Press, 1974), pp. 61–62. For Friedman's case against a fixed price-level rule, see his "The Role of Monetary Policy," American Economic Review 58 (March 1968): 1–17.
42. James M. Buchanan, "Predictability: The Criterion of Monetary Constitutions" in Leland B. Yeager, ed., In Search of a Monetary Constitution, pp. 155–183.
43. Friedman, "Should There Be an Independent Monetary Authority?," p. 243. Emphasis added.
44. Simons, "Rules Versus Authorities in Monetary Policy," pp. 175–176. This article first appeared in 1936.
45. Friedman, "A Monetary and Fiscal Framework for Economic Stability," p. 135; "Should There Be an Independent Monetary Authority?," pp. 233–234; A Program for Monetary Stability, p. 99.
46. Hutt, Keynesianism, Retrospect and Prospect, p. 100.
47. John M. Culbertson, Macroeconomic Theory and Stabilization Policy, p. 423.
48. F.A. Hayek, "Toward a Free Market Monetary System," Journal of Libertarian Studies 3 (Spring 1979): 1.
49. Hayek, Choice in Currency: A Way to Stop Inflation (London: Institute of Economic Affairs, 1976), p. 16.
50. Hayek, "Toward a Free Market Monetary System," pp. 2, 5.
51. Hayek, "Toward a Free Market Monetary System," pp. 7–5.
52. For secondary accounts see Vera C. Smith, The Rationale of Central Banking (London: P.S. King, 1936), chs. 6–10; Lawrence H. White, "Free Banking in Britain: Theory, Experience, and Debate" (Ph.D. dissertation, UCLA, 1982), chs. 2–3; and Phillipe Nataf, "Free Banking: A Workable System," paper presented at the 10th annual conference of the Committee for Monetary Research and Education, Harriman, NY, 14 March 1982.
53. Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations, Campbell-Skinner-Todd edition. (Oxford: Oxford University Press, 1976), I, pp. 320–321.
54. Smith, Wealth of Nations, I, pp. 321, 329. Smith added the two qualifications that issuers be restricted from issuing (1) notes below some minimum denomination and (2) notes not unconditionally payable on demand. Both restrictions had been imposed on the Scottish banks in 1765.
55. John Stuart Mill, Principles of Political Economy (London: John W. Parker, 1848), p. 675. Mill believed in having a non-market authority act as a central holder of bank reserves.
56. Herbert Spencer, Social Statics (New York: D.Appleton and Co., 1881), pp. 434, 436. Spencer placed no qualifications on his support for free banking.
57. William P. Gramm, "Laissez-Faire and the Optimum Quantity of Money," Economic Inquiry 12 (March 1974): 125–133.
58. Harry G. Johnson, "Equilibrium Under Fixed Exchanges," American Economic Review 53 (May 1963): 113; Paul A. Samuelson, "What Classical and Neoclassical Monetary Theory Really Was," Canadian Journal of Economics 1 (Feb. 1968): 9–10; Boris P. Pesek and Thomas R. Saving, Money, Wealth and Economic Theory (New York: Macmillan, 1970), pp. 69 ff.
59. Earl A. Thompson, "The Theory of Money and Income Consistent With Orthodox Value Theory," in P.A. Samuelson and G. Harwich, eds., Trade, Stability, and Macroeconomics: Essays in Honor of Lloyd Meltzer (New York: Academic Press, 1974), pp. 427–453. On Say's Law see William H. Hutt,A Rehabilitation of Say's Law; and Axel Leijonhufvud, Information and Coordination, pp. 79–101.
60. Benjamin Klein, "The Competitive Supply of Money," Journal of Money, Credit, and Banking 6 (Nov. 1974): 423–453.
61. Benjamin Klein, "Competing Monies, European Monetary Union, and the Dollar," in M. Fratianni and T. Peeters, eds., One Money for Europe (London: Macmillan 1978); Klein, "Money, Wealth, and Seignorage," in Kenneth Boulding and Thomas Frederick Wilson, eds., Redistribution Through the Financial System (New York: Praeger, 1978).
62. Gordon Tullock, "Competing Monies," Journal of Money, Credit, and Banking 7 (Nov. 1975): 491–498.
63. Benjamin Klein, "Competing Monies: A Comment," Journal of Money, Credit, and Banking 8 (Nov. 1976): 513–519; Gordon Tullock, "Competing Monies: A Reply," Journal of Money, Credit, and Banking 8 (Nov. 1976): 521–525.
64. F.A. Hayek, Choice in Currency: A Way to Stop Inflation (London: Institute of Economic Affairs, 1976), pp. 17–18. The pamphlet's text has subsequently been reprinted in Hayek, New Studies in Philosophy, Politics, and the History of Ideas, pp. 218–231.
65. Hayek, Denationalisation of Money—The Argument Refined, 2nd ed. (London: Institute of Economic Affairs, 1978).
66. For example Henry Hazlitt, in The Inflation Crisis, and How to Resolve It, p. 184, mistakenly interprets Hayek as contemplating private monies each convertible into a basket of commodities. Hayek, Denationalisation of Money, pp. 106–107, clearly denies that convertibility would be necessary.
67. Hayek, Denationalisation of Money, p. 98.
68. Lance Girton and Don Roper, "Substitutable Monies and the Monetary Standard," in Michael P. Dooley, Herbert M. Kaufman, and Raymond E. Lombra, eds., The Political Economy of Policy-Making (Beverly Hills: Sage Publications, 1979), pp. 233–246. See also Girton and Roper, "Theory and Implications of Currency Substitution," Journal of Money, Credit, and Banking 13 (Feb. 1981): 12–30.
69. Roland Vaubel, "Free Currency Competition," Weltwirtschaftliches Archiv 112 (1977): 435–459.
70. Martin Bronfenbrenner, "The Currency-Choice Defense," Challenge (Jan.–Feb. 1980): 31–36; F.A. Hayek, "Toward a Free Market Monetary System" Lawrence H. White, "Gold, Dollars, and Private Currencies," Policy Report (June 1981): 6–11; Peter Lewin, "The Denationalization of Money," unpublished ms. (June 1981).
71. Outstanding among these are Gordon Tullock, "Paper Money—A Cycle in Cathay," Economic History Review 9 (August 1957): 393–407; Luigi Einaudi, "Medieval Practice of Managed Currency," in Arthur D. Gayer, ed., The Lessons on Monetary Experience (New York: Augustus M. Kelley, 1970), pp. 259–268; Roland Vaubel, "Currency Competition in Monetary History," paper presented at the Institutum Europaeum conference on European Monetary Union and Currency Competition (December 1980); Bray Hammond, Banks and Politics in America from the Revolution to the Civil War (Princeton: Princeton University Press, 1957): Richard H. Timberlake, "Denominational Factors in Nineteenth-Century Currency Experience," Journal of Economic History 34 (December 1974): 835–884; William Woolridge, "Every Man His Own Mintmaster," in Uncle Sam, The Monopoly Man (New Rochelle, NY:Arlington House, 1970), pp. 54–74; Hugh Rockoff, "The Free Banking Era: A Reexamination," Journal of Money, Credit, and Banking 6 (May 1974): 141–168; Yu Ching Jao, Banking and Currency in Hong Kong (London: Basingstoke, 1974); and Lawrence H. White, "Free Banking in Britain: Theory, Experience, and Debate," ch. 2.
72. Hayek, Denationalisation of Money, p. 44.
73. Vaubel, "Free Currency Competition," pp. 445–446.
74. Boris Pesek, "[Optimal Monetary Growth:] Comment," Journal of Political Economy 76 (July–Aug. 1968): 889.
75. Klein, "The Competitive Supply of Money," pp. 429–430.
76. Henry Hazlitt, The Inflation Crisis, and How to Resolve It, p. 185.
77. See Hayek, Denationalisation of Money, pp. 42 ff; and Girton and Roper, "Substitutable Monies and the Monetary Standard," pp. 238–239.
78. See Klein, "The Competitive Supply of Money," pp. 432–438, for elaboration of the "brand-name capital" concept.
79. Vaubel, "Free Currency Competition," pp. 453, 458.
80. Vaubel, "Free Currency Competition," pp. 437, 458. For similar "natural monopoly" arguments see Harry G. Johnson, "Problems of Efficiency in Monetary Management," Journal of Political Economy 76 (Sept.–Oct. 1968): 971–990; Richard N. Cooper, "European Monetary Unification and Integration of the World Economy," in Lawrence B. Krause and Walter S. Salant, eds., European Monetary Unification and Its Meaning for the United States (Washington, 1973); C.P. Kindleberger, "The Benefits of International Money," Journal of International Economics 2 (Nov. 1972): 425–442; R.I. McKinnon, "Optimum Currency Areas," American Economic Review 53 (Sept. 1963): 717–724.
81. Such heterogeneity within any given "industry" is inconsistent with models of "perfect competition." Compare Hayek, Denationalisation of Money, pp. 72 ff.
82. Vaubel, "Free Currency Competition," p. 440.
83. This is Vaubel's characterization of the currency industry: "Free Currency Competition," p. 458.
84. Loasby, Choice, Complexity and Ignorance, pp. 189–190. On competition as a process see also F.A. Hayek, "The Meaning of Competition," in Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 92–106; Hayek, "Competition as a Discovery Procedure," in New Studies, pp. 179–190; and Israel Kirzner, Competition and Entrepreneurship (Chicago: University of Chicago Press, 1973).
85. Vaubel, "Free Currency Competition," pp. 457–458.
86. Hugh Rockoff, "The Free Banking Era: A Reexamination," Journal of Money, Credit, and Banking 6 (May 1974): 144–145.
87. Bettina Greaves and Percy Greaves, "On Private Paper Money," in Ludwig von Mises, On the Manipulation of Money and Credit, pp. 275–279; Henry Hazlitt, The Inflation Crisis, ch. 24.
88. Greaves and Greaves, "On Private Paper Money," pp. 278–279, emphasis added.
89. Mises, The Theory of Money and Credit, p. 70, emphasis in the original. On legal tender see also Herbert Spencer, Social Statics, p. 339; Thomas H. Farrer, Studies in Currency (London: 1898), p. 399; C.P. Kindleberger, "The Benefits of International Money," p. 426; and especially Vaubel, "Free Currency Competition," p. 438.
90. See F.A. Hayek, Denationalisation of Money, p. 42; Lance Girton and Don Roper, "Substitutible Monies and the Monetary Standard," p. 238.
91. See, for example, the discussions in Milton Friedman, "Should There Be an Independent Monetary Authority?," pp. 221 ff.; and Richard H. Timberlake, "The Significance of Unaccounted Currencies" unpublished ms. (1980), p. 17.
92. See F.A. Hayek, The Constitution of Liberty (Chicago: University of Chicago Press, 1960); Hayek, Law, Legislation and Liberty (Chicago: University of Chicago Press, 1973–79); Alexander James Field, "On the Explanation of Rules Using Rational Choice Models," Journal of Economic Issues 13 (March 1979): 49–72; John Rawls, A Theory of Justice (Cambridge: Harvard University Press, 1971).
93. Henry Hazlitt, in The Inflation Crisis, p. 185, for example, objects that "you cannot make a currency convertible into an abstraction" such as an index number. For fascinating historical evidence to the contrary see Luigi Einaudi, "The Medieval Practice of Managed Currency." See also Dennis W. Richardson, "The Emerging Era of Electronic Money: Some Implications for Monetary Policy," Journal of Bank Research 3 (Winter 1973): 261–264.
94. Hayek, Denationalisation of Money, discusses such potential problems as "parasitic" currencies (pp. 60–62), as well as the problems of transition to multiple currencies (sec. XXII).
95. See F.A. Hayek, Law, Legislation and Liberty, vol. I, for this concept. Other such social institutions include moral codes, language, writing, and the convention of market exchange itself.
96. Milton Friedman, "Should There Be an Independent Monetary Authority?," p. 242; Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1965), pp. 39, 53; Friedman, A Program for Monetary Stability, pp. 7–8; James M. Buchanan, "Predictability: The Criterion of Monetary Policy," p. 192; James M. Buchanan and T. Nicholaus Tideman, "Gold, Money and the Law," in Henry Manne and Roger Miller, eds., Gold, Money and the Law (Chicago: Aldine, 1975), pp. 42–43; and Henry Simons, "Rules Versus Authorities in Monetary Policy," p. 162.
97. For this distinction between rules and commands see Hayek, Law, Legislation and Liberty, vol. I, pp. 48, 149 ff. On constructivism see ch. I of that volume.
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