Choice in Currency - Hayek

8/8/2019 Choice in Currency - Hayek

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Choice in Currency

A WAY TO STOP INFLATION

F. A. HAYEK

Nobel Laureate 1974

with Commentaries by

IVOR F. PEARCE HAROLD B. ROSE

DOUGLAS JAY SIR KEITH JOSEPH

Published by

THE INSTITUTE OF ECONOMIC AFFAIRS

1976

Web Edition prepared in 2007. There may be minor differences from the original.


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First published February 1976 by

THE INSTITUTE OF ECONOMIC AFFAIRS

@ The Institute of Economic Affairs 1976

All rights reserved

SBN 255 36078-9

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Contents

PREFACE.Arthur Seldon 5

THE AUTHOR..8

I MONEY, KEYNES AND HISTORY...9

Keynesian rehabilitation..10

Personal confession.10

II THE MANUFACTURE OF UNEMPLOYMENT11

Unemployment via full employment policies...12

The lost generation..13

The 1863 penny...13

III THE WEAKNESS OF POLITICAL CONTROL OF MONEY.....14

Group interests harmful..14Rebuilding the resistances to i nflation15

Protecting money from politics..16A dangerous monopoly..16

IV CHOICE OF MONEY FOR PAYMENT IN CONTRACTS....17

Government and legal t ender..17Benefits of free currency system19

V LONG-RUN MONETARY STABILITY.....20

The universal prize..20Free dealings in money better than monetary unions21

A COMMENT ON KEYNES, BEVERIDGE AND KEYNESIAN

ECONOMICS 23


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COMMENTARIES:

Professor Ivor Pearce...25

Professor Harold Rose.26

Rt. Hon. Douglas Jay...27

Rt. Hon. Sir Keit h Joseph28

A NOTE ON GOVERNMENT MONOPOLY OF MONEY IN

THEORY AND HISTORY Sudha Shenoy.30

I.THEORY.30II. HISTORY...34

France, 1789 ....34USA, before and after 1857.38Germany, 1920-23...39

AND A PORTENT?

Currency Option for Foreign Creditors.. 45

Preface

THE Occasional Papers are intended to make essays or addresses,of outstanding importance, accessible to a wider readership thanthat to which they were originally addressed. The 47 so far haveincluded Papers by some of Britain's, and the world's, leading

economists but also some important Papers by less well-knownnames. .No. 48 is an edited version of an address by Professor F. A.

Hayek to a conference in Switzerland. In a sense it is a sequel toOccasional Paper 45, in which Professor Hayek argued that thecause of unemployment was not inadequate demand, arising frominadequate total income, but disproportions in relative wagesrequired to equate the demand for labour and its supply in eachsector of the economy. The error of supposing that fullemployment, high output and prosperity could be maintained byenlarging total money expenditure is described in this Paperas anage-old superstition to which Keynes and his followers have giventhe sanction of scientific authority.

In this PaperProfessor Hayek considers the conditions underwhich it is possible for government to enlarge total expenditure byincreasing the quantity of money. He argues that history indicatesthat, sooner or later, the control of the supply of money bygovernment has ended in inflation. Hence the development ofnational and international monetary systems based on gold andother devices designed to remove from government the powers itinvariably abused.

The opposite view, argued strongly in recent years in Britain,is that, if government was released from rigid mechanical rulesin domestic or overseas monetary management, such as fixedexchange rates, it would be better able to act for the general

good. This expectation, it is now evident, has not been realisedbecause, although the rules were reasonably clear, governmenthas found them politically tempting to break in practice. This isnot a theoretical doubt whether government can improve onan automatic or semi-automatic monetary system, such as agold or gold-exchange standard, in which the supply and value


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of money is beyond domestic political control. It is a practical judgement in political economy that a government subject toelectoral pressures will not be able to observe the rules if to do sobrings transitionary dislocation and unemployment.

Professor Hayek therefore argues that the time may have cometo remove from government the power to require its citizens to usethe money under its control. And in the last resort this wouldrequire that government be deprived of the power to define legal

tender. The requirement is not to deprive government of the powerto issue money but to deny it the exclusive right to do so and toforce the citizenry to use it at the price it specifies. It is thus thegovernment monopoly of money that is objectionable, and historyis full of examples of governments that have attempted to enforcetheir power by extreme measures, including the ultimate sanctionof death.

The solution is therefore to allow people to use the money theyfind most convenient, whether the money issued by their owngovernment or by other governments. Professor Hayek argues thatthis system would be more desirable and practicable than autopian European Monetary Unit.

This proposal, Professor Hayek recognises, may seem far-fetched after centuries in which it has been considered that one ofthe proper, or essential, functions of government is to provide acurrency on which the citizens could depend as a reliable unit ofaccount and means of exchange, a function which has included theconcept of legal tender. Professor Hayek denies that legal tender isan essential part of the monetary function of government. Heargues that people should be free to refuse money they distrust infavour of money in which they have confidence. It is this newpower of the people to refuse the national money that wouldinduce national governments to ensure that their money was stablein value. Hence Professor Hayek argues the case for a new kind ofinternational money.

In this Occasional Paper Professor Hayek has providedstimulating analysis of a contemporary problem and emergedwith a radical solution. He considers ways in which the systemmight work in practice, and replies to objections to it. Hediscusses the effects it will have on banking systems, and in sodoing he provides a commentary on the current debate on money

and inflation and on the desired national and internationalinstitutions. Here it will come as no surprise to learn that hebelieves an international monetary authority is hardly to be trustedmore than a national authority: he would confine government to 'aframework of legal roles in which the people could develop themonetary institutions that best suit them'.

To indicate the possibly varying views on the importance andthe practicality of Professor Hayek's proposals we invited com-

ments from two economists and two senior politicians who haveheld high government office. The economists are Professor IvorPearce and Professor Harold Rose. Both politicians, Mr DouglasJay and Sir Keith Joseph, are Fellows of All Souls College,Oxford, and are especially interested in economic affairs.

To illustrate the argument Miss Sudha Shenoy has assembledextracts from economic and historical writings on the failure ofgovernments in France and Germany to confine the use of moneyto legal tender despite severe penalties and on the fall in the valueof paper legal tender as its supply was increased during periods ofinflation, and on the exclusion by the US Government ofcurrencies other than the dollar.

November 1975 ARTHUR SELDON


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The Author

FRIEDRICH AUGUST HAYEK, Dr Jur, Dr Sc Pol (Vienna),DSc (Econ.) (London), Visiting Professor at the University ofSalzburg, Austria, 1970-74. Educated at the University ofVienna, Director of the Austrian Institute for Economic

Research, 1927-31, and Lecturer in Economics at the Universityof Vienna, 1929-31. 1931-50 Tooke Professor of EconomicScience and Statistics, University of London. 1950-62 Professorof Social and Moral Science, University of Chicago. Professor ofEconomics, University of Freiburg i.Brg., West Germany, 1962-68. He was awarded the Alfred Nobel Memorial Prize inEconomic Sciences in 1974.

Professor Hayek's most important publications includeMone-tary Theory and the Trade Cycle (1933), The Pure Theory ofCapital (1941), The Road to Serfdom (1944),Individualism andEconomic Order (1948), The Counter-Revolution of Science.(1952), and The Constitution of Liberty (1960). His latest works

are col1ections of his writings under the titles Studies inPhilosophy, Politics and Economics (1967) and Law, Legislation and Liberty (Vo1. I, 1973). He has also editedseveral books and has published artic1es in the EconomicJournal, Economica and other journals. The IEA has publishedhis The Confusion of Language in Political Thought(Occasional Paper 20, 1968), his Wincott Memoria1 Lecture, Economic Freedom and Representative Government(Occasiona1 Paper 39, 1973), a collection of his writings with anew essay (assembled by Sudha Shenoy), A Tiger by the Tail(Hobart Paperback 4, 1972), an essay in Verdict on RentControl (IEA Readings NO.7, 1972), and Full Employment atAny Price? (Occasional Paper 45, 1975).

Choice in Currency:A Way to Stop Inflation

1

F.A.HAYEK

I.MONEY, KEYNES AND HISTORY2

THE CHIEF ROOT of our present monetary troubles is, of course,the sanction of scientific authority which Lord Keynes andhis disciples have given to the age-old superstition that byincreasing the aggregate of money expenditure we can lastinglyensure prosperity and full employment. It is a superstition againstwhich economists before Keynes had struggled with some success

for at least two centuries.3

It had governed most of earlier history.This history, indeed, has been largely a history of inflation;significantly, it was only during the rise of the prosperous modernindustrial systems and during the rule of the gold standard, thatover a period of about two hundred years (in Britain from about1714 to 1914, and in the United States from about 1749 to 1939)prices were at the end about where they had been at the beginning.During this unique period of monetary stability the goldstandard had imposed upon monetary authorities a discipline whichprevented them from abusing their powers, as they have done

1Based on an Address entitled International Money delivered to the Geneva Gold and

Monetary Conference on 25 September, 1975, at Lausanne, Switzerland.

2[The main section and sub-headings have been inserted to help readers, especially non-

economists unfamiliar with Professor Hayeks writings, to follow the argument; they were

not part of the original lecture.-ED.]

3[This observation is amplified by Professor Hayek in a note, A Comment on Keynes,

Beveridge and Keynesian Economics, page 23.-ED.]


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at nearly all other times. Experience in other parts of the worlddoes not seem to have been very different: I have been told that aChinese law attempted to prohibit paper money for all times (ofcourse, ineffectively), long before the Europeans ever invented it!

Keynesian rehabilitationIt was John Maynard Keynes, a man of great intellect but limitedknowledge of economic theory, who ultimately succeeded inrehabilitating a view long the preserve of cranks with whom he

openly sympathised. He had attempted by a succession of newtheories to justify the same, superficially persuasive, intuitivebelief that had been held by many practical men before, but thatwill not withstand rigorous analysis of the price mechanism: justas there cannot be a uniform price for all kinds of labour, anequality of demand and supply for labour in general cannot besecured by managing aggregate demand. The volume ofemployment depends on the correspondence of demand andsupply in each sectorof the economy, and therefore on the wagestructure and the distribution of demand between the sectors. Theconsequence is that over a longer period the Keynesian remedydoes not cure unemployment but makes it worse.

The claim of an eminent public figure and brilliant polemicistto provide a cheap and easy means of permanently preventingserious unemployment conquered public opinion and, after hisdeath, professional opinion too. Sir John Hicks has evenproposed that we call the third quarter of this century, 1950 to1975, the age of Keynes, as the second quarter was the age ofHitler.

1I do not feel that the harm Keynes did is really so much

as to justify that description. But it is true that, so long as hisprescriptions seemed to work, they operated as an orthodoxywhich it appeared useless to oppose.

Personal confessionI have often blamed myself for having given up the struggle

after I had spent much time and energy criticising the firstversion of Keynes's theoretical framework. Only after thesecond part of my critique had appeared did he tell me he had

1John Hicks, The Crisis in Keynesian Economics , Oxford University Press,

1974, p.1.

changed his mind and no longer believed what he had said in theTreatise on Money of 1930 (somewhat unjustly towards himself,as it seems to me, since I still believe that volume II of theTreatise contains some of the best work he ever did). At anyrate, I felt it then to be useless to return to the charge, because heseemed so likely to change his views again. When it proved thatthis new version - the General Theory of 1936 - conquered mostof the professional opinion, and when in the end even some ofthe colleagues I most respected supported the wholly KeynesianBretton Woods agreement, I largely withdrew from the debate,since to proclaim my dissent from the near-unanimous views ofthe orthodox phalanx would merely have deprived me of ahearing on other matters about which I was more concerned atthe time. (I believe, however, that, so far as some of the bestBritish economists were concerned, their support of BrettonWoods was determined more by a misguided patriotism - thehope that it would benefit Britain in her post-war difficulties -than by a belief that it would provide a satisfactory internationalmonetary order.)

IITHE MANUFACTURE OF UNEMPLOYMENT

I WROTE 36 years ago on the crucial point of difference:

'It may perhaps be pointed out that it has, of course, never beendenied that employment can be rapidly increased, and a positionof "full employment" achieved in the shortest possible time, bymeans of monetary expansion - least of all by those economistswhose outlook has been influenced by the experience of a majorinflation. All that has been contended is that the kind of fullemployment which can be created in this way is inherentlyunstable, and that to create employment by these means is to

perpetuate fluctuations. There may be desperate situations inwhich it may indeed be necessary to increase employment at allcosts, even if it be only for a short period - perhaps the situationin which Dr Brning found himself in Germany in 1932 wassuch a situation in which desperate means would have been justified. But the economist should not conceal the fact that to


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aim at the maximum of employment which can be achieved inthe short run by means of monetary policy is essentially thepolicy of the desperado who has nothing to lose and everythingto gain from a short breathing space.

1

To this I would now like to add, in reply to the constant deliberatemisrepresentation of my views by politicians, who like to pictureme as a sort of bogey whose influence makes conservative partiesdangerous, what I regularly emphasize and stated nine months

ago in my Nobel Memorial Prize Lecture at Stockholm in thefollowing words:

'The truth is that by a mistaken theoretical view we have beenled into a precarious position in which we cannot preventsubstantial unemployment from re-appearing: not because, asmy view is sometimes misrepresented, this unemployment isdeliberately brought about as a means to combat inflation, butbecause it is now bound to appear as a deeply regrettable butinescapable consequence of the mistaken policies of the past assoon as inflation ceases to accelerate.'

2

Unemployment via 'full employment policies'

This manufacture of unemployment by what are called 'fullemployment policies' is a complex process. In essence it operatesby temporary changes in the distribution of demand, drawing bothunemployed and already employed workers into jobs which willdisappear with the end of inflation. In the periodically recurrentcrises of the pre-1914 years the expansion of credit during thepreceding boom served largely to finance industrial investment,and the over-development and subsequent unemploymentoccurred mainly in the industries producing capital equipment. Inthe engineered inflation of the last decades things were morecomplex.

What will happen during a major inflation is illustrated by

1F.A. Hayek, Profits, Interest and Investment, Routledge & Kegan Paul,

London, 1939, p. 63n.

2F.A. Hayek, The Pretence of Knowledge, Nobel Memorial Prize Lecture

1974, reprinted in Full Employment at Any Price?, Occasional Paper 45, IEA,

1975, p. 37.

an observation from the early 1920s which many of my Viennesecontemporaries will confirm: in the city many of the famouscoffee houses were driven from the best comer sites by new bankoffices and returned after the 'stabilization crisis', when the bankshad contracted or collapsed and thousands of bank clerks swelledthe ranks of the unemployed.

The lost generation

The whole theory underlying the full employment policies has bynow of course been thoroughly discredited by the experience ofthe last few years. In consequence the economists are alsobeginning to discover its fatal intellectual defects which theyought to have seen all along. Yet I fear the theory will still give usa lot of trouble: it has left us with a lost generation of economistswho have learnt nothing else. One of our chief problems will beto protect our money against those economists who will continueto offer their quack remedies, the short-term effectiveness ofwhich will continue to ensure them popularity. It will surviveamong blind doctrinaires who have always been convinced thatthey have the key to salvation.

The 1863 pennyIn consequence, though the rapid descent of Keynesian doctrinefrom intellectual respectability can be denied no longer, it stillgravely threatens the chances of a sensible monetary policy. Norhave people yet fully realised how much irreparable damage ithas already done, particularly in Britain, the country of its origin.The sense of financial respectability which once guided Britishmonetary policy has rapidly disappeared. From a model to beimitated Britain has in a few years descended to be a warningexample for the rest of the world. This decay was recentlybrought home to me by a curious incident: I found in a drawer ofmy desk a British penny dated 1863 which a short 12 years ago,

that is, when it was exactly a hundred years old, I had received aschange from a London bus conductor and had taken back toGermany to show to my students what long-run monetarystability meant. I believe they were duly impressed. But theywould laugh in my face if I now mentioned Britain as an instanceof monetary stability.


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IIITHE WEAKNESS OF POLITICAL CONTROL OF MONEY

A WISE MAN should perhaps have foreseen that less than 30years after the nationalisation of the Bank of England the pur-chasing power of the pound sterling would have been reduced toless than one-quarter of what it had been at that date. As hassooner or later happened everywhere, government control of the

quantity of money has once again proved fatal. I do not want toquestion that a very intelligent and wholly independent national

or international monetary authority might do better than aninternational gold standard, or any other sort of automatic system.But I see not the slightest hope that any government, or any

institution subject to political pressure, will ever be able to act insuch a manner.

Group interests harmfulI never had much illusion in this respect, but I must confess thatin the course of a long life my opinion of governments hassteadily worsened: the more intelligently they try to act (as

distinguished from simply following an established rule), themore harm they seem to do -because once they are known toaim at particular goals (rather than merely maintaining a self -correcting spontaneous order) the less they can avoid servingsectional interests. And the demands of all organised groupinterests are almost invariably harmful - except only when theyprotest against restrictions imposed upon them for the benefit ofother group interests. I am by no means re-assured by the factthat, at least in some countries, the civil servants who run affairsare mostly intelligent, well-meaning, and honest men. The pointis that, if governments are to remain in office in the prevailingpolitical order, they have no choice but to use their powers for

the benefit of particular groups - and one strong interest isalways to get additional money for extra expenditure. Howeverharmful inflation is in general seen to be, there are alwayssubstantial groups of people, including some for whose supportcollectivist-inclined governments primarily look, which in theshort run greatly gain by it -even if only by staving off for sometime the loss of an income which it is human nature to believe

will be only temporary if they can tide over the emergency.

Rebuilding the resistances to inflationThe pressure for more and cheaper money is an ever-presentpolitical force which monetary authorities have never been able toresist, unless they were in a position credibly to point to anabsolute obstacle which made it impossible for them to meet suchdemands. And it will become even more irresistible when these

interests can appeal to an increasingly unrecognisable image of StMaynard. There will be no more urgent need than to erect newdefenses against the onslaughts of popular forms of Keynesianism,that is, to replace or restore those restraints which, under theinfluence of his theory, have been systematic ally dismantled. It wasthe main function of the gold standard, of balanced budgets, of thenecessity for deficit countries to contract their circulation, and ofthe limitation of the supply of 'international liquidity', to make itimpossible for the monetary authorities to capitulate to the pressurefor more money. And it was exactly for that reason that all thesesafeguards against inflation, which had made it possible forrepresentative governments to resist the demands of powerfulpressure groups for more money, have been removed at the

instigation of economists who imagined that, if governments werereleased from the shackles of mechanical rules, they would be ableto act wisely for the general benefit.

I do not believe we can now remedy this position by con-structing some new international monetary order, whether a newinternational monetary authority or institution, or even aninternational agreement to adopt a particular mechanism orsystem of policy, such as the classical gold standard. I am fairlyconvinced that any attempt now to re-instate the gold standard byinternational agreement would break down within a short timeand merely discredit the ideal of an international gold standard foreven longer. Without the conviction of the public at large that

certain immediately painful measures are occasionally necessaryto preserve reasonable stability, we cannot hope that any authoritywhich has power to determine the quantity of money will longresist the pressure for, or the seduction of, cheap money.


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Protecting money from politicsThe politician, acting on a modified Keynesian maxim that in thelong run we are all out of office, does not care if his successfulcure of unemployment is bound to produce more unemploymentin the future. The politicians who will be blamed for it will not bethose who created the inflation but those who stopped it. Noworse trap could have been set for a democratic system in which

the government is forced to act on the beliefs that the people thinkto be true. Our only hope for a stable money is indeed now to finda way to protect money from politics.

With the exception only of the 2oo-year period of the goldstandard, practically all governments of history have used theirexclusive power to issue money in order to defraud and plunderthe people. There is less ground than ever for hoping that, so longas the people have no choice but to use the money theirgovernment provides, governments will become more trust-worthy. Under the prevailing systems of government, which aresupposed to be guided by the opinion of the majority but underwhich in practice any sizeable group may create a 'politicalnecessity' for the government by threatening to withhold the votes

it needs to claim majority support, we cannot entrust dangerousinstruments to it. Fortunately we need not yet fear, I hope, thatgovernments will start a war to please some indispensable groupof supporters, but money is certainly too dangerous an instrumentto leave to the fortuitous expediency of politicians -or, it seems.economists.

A dangerous monopolyWhat is so dangerous and ought to be done away with is notgovernments' right to issue money but the exclusive right to do soand their power to force people to use it and to accept it at aparticular price. This monopoly of government, like the postalmonopoly, has its origin not in any benefit it secures for the

people but solely in the desire to enhance the coercive powers ofgovernment. I doubt whether it has ever done any good except tothe rulers and their favorites. All history contradicts the belief thatgovernments have given us a safer money than we would havehad without their cla iming an exclusive right to issue it.

IV

CHOICE OF MONEY FOR PAYMENT IN CONTRACTS

BUT WHY should we not let people choose freely what moneythey want to use? By 'people' I mean the individuals who ought tohave the right to decide whether they want to buy or sell forfrancs, pounds, dollars, D-marks, or ounces of gold. I have noobjection to governments issuing money, but I believe their claim

to a monopoly, or their power to limit the kinds of money inwhich contracts may be concluded within their territory, or todetermine the rates at which monies can be exchanged, to bewholly harmful.

At this moment it seems that the best thing we could wishgovernments to do is for, say, all the members of the EuropeanEconomic Community, or, better still, all the governments of theAtlantic Community, to bind themselves mutually not to placeany restrictions on the free use within their territories of oneanother's -or any other -currencies, including their pur chase andsale at any price the parties decide upon, or on their use as

accounting units in which to keep books. This, and not a utopianEuropean Monetary Unit, seems to me now both the practicableand the desirable arrangement to aim at. To make the schemeeffective it would be important, for reasons I state later, also toprovide that banks in one country be free to establish branches inany of the others.

Government and legal tenderThis suggestion may at first seem absurd to all brought up onthe concept of 'legal tender'. Is it not essential that the lawdesignate one kind of money as the legal money? This is, how-ever, true only to the extent that, if the government does issue

money, it must also say what must be accepted in discharge ofdebts incurred in that money. And it must also determine inwhat manner certain non-contractual legal obligations, such astaxes or liabilities for damage or torts, are to be discharged. Butthere is no reason whatever why people should not be free tomake contracts, including ordinary purchases and sales, in any


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kind of money they choose, or why they should be obliged to sellagainst any particular kind of money.

There could be no more effective check against the abuse ofmoney by the government than if people were free to refuse anymoney they distrusted and to prefer money in which they hadconfidence. Nor could there be a stronger inducement to govern-ments to ensure the stability of their money than the knowledge

that, so long as they kept the supply below the demand for it, thatdemand would tend to grow. Therefore, let us deprive governments(or their monetary authorities) of all power to protect their moneyagainst competition: if they can no longer conceal that their moneyis becoming bad, they will have to restrict the issue.

The first reaction of many readers may be to ask whether theeffect of such a system would not according to an old rule be thatthe bad money would drive out the good. But this would be amisunderstanding of what is called Gresham's Law. This indeed isone of the oldest insights into the mechanism of money, so old that2,400 years ago Aristophanes, in one of his comedies, could say thatit was with politicians as it is with coins, because the bad ones driveout the good.

1But the truth which apparently even today is not

generally understood is that Gresham's Law operates only if the twokinds of money have to be accepted at a prescribed rate ofexchange. Exactly the opposite will happen when people are free toexchange the different kinds of money at whatever rate they canagree upon. This was observed many times during the greatinflations when even the most severe penalties threatened bygovernments could not prevent people from using other kinds ofmoney - even commodities like cigarettes and bottles of brandy

1 Aristophanes, Frogs, 891-898, in Frere's translation:Oftentimes we have reflected on a similar abuseIn the choice of men for office, and of coins for common use,For our old and standard pieces, valued and approved and tried,Here among the Grecian nations, and in all the world besides,Recognised in every realm for trusty stamp and pure assay,Are rejected and abandoned for the trash of yesterday,For a vile adulterated issue, drossy, counterfeit and base,Which the traffic of the city passes current in their place.

About the same time, the philosopher Diogenes called money 'the legislators' game ofdice'!

rather than the government money - which clearly meant that thegood money was driving out the bad.

1

Make it merely legal and people will be very quick indeed torefuse to use the national currency once it depreciates noticeably,and they will make their dealings in a currency they trust.Employers, in particular, would find it in their interest to offer, incollective agreements, not wages anticipating a foreseen rise ofprices but wages in a currency they trusted and could make thebasis of rational calculation. This would deprive government ofthe power to counteract excessive wage increases, and the un-employment they would cause, by depreciating their currency. Itwould also prevent employers from conceding such wages in theexpectation that the national monetary authority would bail themout if they promised more than they could pay.

There is no reason to be concerned about the effects of such anarrangement on ordinary men who know neither how to handlenor how to obtain strange kinds of money. So long as theshopkeepers knew that they could turn it instantly at the currentrate of exchange into whatever money they preferred, they would

be only too ready to sell their wares at an appropriate price forany currency. But the malpractices of government would showthemselves much more rapidly if prices rose only in terms of themoney issued by it, and people would soon learn to hold thegovernment responsible for the value of the money in which theywere paid. Electronic calculators, which in seconds would givethe equivalent of any price in any currency at the current rate,would soon be used everywhere. But, unless the nationalgovernment all too badly mismanaged the currency it issued, itwould probably be continued to be used in everyday retailtransactions. What would be affected mostly would be not somuch the use of money in daily payments as the willingness toholddifferent kinds of money. It would mainly be the tendency

of all business and capital transactions rapidly to switch to a

1During the German inflation after the First World War, when people began touse dollars and other solid currencies in the place of marks, a Dutch financier (if

I rightly remember, Mr Vissering) asserted that Greshams Law was false and

the opposite is true.

Benefits of free currency system


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more reliable standard (and to base calculations and accountingon it) which would keep national monetary policy on the rightpath.

vLONG-RUN MONETARY STABILITY

THE UPSHOT would probably be that the currencies of thosecountries trusted to pursue a responsible monetary policy wouldtend to displace gradually those of a less reliable character. The

reputation of financial righteousness would become a jealouslyguarded asset of all issuers of money, since they would know thateven the slightest deviation from the path of honesty wouldreduce the demand for their product.

I do not believe there is any reason to fear that in such acompetition for the most general acceptance of a currency therewould arise a tendency to deflation or an increasing value ofmoney. People will be quite as reluctant to borrow or incur debtsin a currency expected to appreciate as they will hesitate to lendin a currency expected to depreciate. The convenience of use isdecidedly in favour of a currency which can be expected to retainan approximately stable value. If governments and other issuers

of money have to compete in inducing people to hold theirmoney, and make long-term contracts in it, they will have tocreate confidence in its long-run stability.

'The universal prize'Where I am not sure is whether in such a competition forreliability any government-issued currency would prevail, orwhether the predominant preference would not be in favour ofsome such units as ounces of gold. It seems not unlikely that goldwould ultimately re-assert its place as 'the universal prize in allcountries, in all cultures, in all ages', as Jacob Bronowski hasrecently called it in his brilliant book on The Ascent of Man,

1if

people were given complete freedom to decide what to use as

their standard and general medium of exchange - more likely, atany rate, than as the result of any organized attempt to restore thegold standard.

The reason why, in order to be fully effective, the free

1Jacob Bronowski, The Ascent of Man, BBC Publications, London 1973.

international market in currencies should extend also to theservices of banks is, of course, that bank deposits subject tocheque represent today much the largest part of the liquid assetsof most people. Even during the last hundred years or so of thegold standard this circumstance increasingly prevented it fromoperating as a fully international currency, because any inflow oroutflow in or out of a country required a proportionate expansionor contraction of the much larger super-structure of the nationalcredit money, the effect of which falls indiscriminately on the

whole economy instead of merely increasing or decreasing thedemand for the particular goods which was required to bringabout a new balance between imports and exports. With a trulyinternational banking system money could be transferred directlywithout producing the harmful process of secondary contractionsor expansions of the credit structure.

It would probably also impose the most effective discipline ongovernments if they felt immediately the effects of their policieson the attractiveness of investment in their country. I have justread in an English Whig tract more than 250 years old: 'Whowould establish a Bank in an arbitrary country, or trust his moneyconstantly there?

1The tract, incidentally, tells us that yet another

50 years earlier a great French banker, Jean Baptist Tavernier,invested all the riches he had amassed in his long rambles overthe world in what the authors described as 'the barren rocks ofSwitzerland'; when asked why by Louis XIV, he had the courageto tell him that 'he was willing to have something which he couldcall his own!' Switzerland, apparently, laid the foundations of herprosperity earlier than most people realise.

Free dealings in money better than monetary union sI prefer the freeing of all dealings in money to any sort ofmonetary union also because the latter would demand an inter-national monetary authority which I believe is neitherpracticable nor even desirable - and hardly to be more trusted

than a national authority. It seems to me that there is a verysound element in the widespread disinclination to confersovereign powers, or at least powers to command, on any

1Thomas Gordon and John Trenchard, The Cato Letters, letters dated 12 May,1722, and 3 February, 1721 respectively, published in collected editions,

London, 1724, and later.


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international authority. What we need are not internationalauthorities possessing powers of direction, but merelyinternational bodies (or, rather, international treaties which areeffectively enforced) which can prohibit certain actions ofgovernments that will harm other people. Effectively to prohibitall restrictions on dealings in (and the possession of) differentkinds of money (or claims for money) would at last make itpossible that the absence of tariffs, or other obstacles to themovement of goods and men, will secure a genuine free trade

area or common market - and do more than anything else tocreate confidence in the countries committing themselves to it. Itis now urgently needed to counter that monetary nationalism thatI first criticized almost 40 years ago

1and which is becoming

even more dangerous when, as a consequence of the closekinship between the two views, it is turning into monetarysocialism. I hope it will not be too long before complete freedomto deal in any money one likes will be regarded as the essentialmark of a free country.

2

You may feel that my proposal amounts to no less than theabolition of monetary policy; and you would not be quite wrong.As in other connections, I have come to the conclusion that the

best the state can do with respect to money is to provide aframework of legal rules within which the people can developthe monetary institutions that best suit them. It seems to me thatif we could prevent governments from meddling with money, wewould do more good than any government has ever done in thisregard. And private enterprise would probably have done betterthan the best they have ever done.

1Monetary Nationalism and International Stability, Longmans, London, 1937.

2 It may at first seem as if this suggestion were in conflict with my generalsupport of fixed exchange rates under the present system. But this is not so.

Fixed exchange rates seem to me to be necessary so long as nationalgovernments have a monopoly of issuing money in their territory in order to

place them under a very necessary discipline. But this is of course no longer

necessary when they have to submit to the discipline of competition with other

issuers of money equally current within their territory.

A Comment on Keynes,Beveridge, and Keynesian

Economics

LORD KEYNES has always appeared to me a kind of new JohnLaw. Like Law, Keynes was a financial genius who made somereal contributions to the theory of money. (Apart from an in-teresting and original discussion of the factors determining thevalue of money, Law gave the first satisfactory account of thecumulative growth of acceptability once a commodity waswidely used as a medium of exchange.) But Keynes could neverfree himself from the popular false belief that, as Law expressedit, 'as the additional money will give work to people who wereidle and enabled those already working to earn more, the outputwill increase and industry will prosper'.

1

It was against this sort of view that Richard Cantillon andDavid Hume began the development of modern monetarytheory. Hume in particular put the central point at issue bysaying that, in the process of inflation, 'it is only in this intervalor intermediate situation between the acquisition of money andthe rise of prices, that the increasing quantity of gold and silveris favourable to industry'.

2It is this work we shall have to do

again after the Keynesian flood.In one sense, however, it would be somewhat unfair to

blame Lord Keynes too much for the developments after hisdeath. I am certain he would have been -whatever he had saidearlier - a leader in the fight against the present inflation. But

1 John Law,Money and Trade Considered with a Proposal for Supplying the

Nations with Money, W. Lewis, London, 1705. [A Collection of Scarce and

Valuable Tracts (the Somers Collection of Tracts, Vol. XIII), John Murray,

London, 1815, includes John Laws tract (1720 edition) at pp. 775-817; an

extract from p. 812 reads: But as this addtion to the money will employ thepeople that are now idle, and those now employed to more advantage, so the

product will be increased, and manufacture advanced.- ED.]

2 David Hume, On Money (Essay III).


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developments, at least in Britain, were also mainly determinedby the version of Keynesianism published under the name ofLord Beveridge for which (since he himself understood noeconomics whatever) his scientific advisers must bear theresponsibility.

I have been blamed for charging Lord Keynes with a some-what limited knowledge of economic theory, but the defective-ness of his views on the theory of international trade, for example,have often been pointed out. And the clearest proof seems to me

to be the caricature of other theories which he presented,presumably in good faith, in order to refute them.

F.A.H.

Commentaries

IVOR PEARCEProfessor of Economics and Head of Department, University of

Southampton, 1962-72Director of Research, Econometric Model Building Unit,

University of Southampton, 1973-75

Author ofA Model of Output, Employment, Wages and Prices inthe UK (1976)

IF I HAD the temerity, which I do not, to claim the existence of afault in Professor Hayek's superb Choice in Currency, it would be afault of omission rather than commission. Professor Hayek correctlyidentifies the secret of Keynes's success with a pseudo-exact'sanction of scientific authority', but he does not explain in the samepseudo-exact terms the precise point of the neo-Keynesian error.Until this is done the 'lost generation' who were taught nothing butKeynes may very well remain unconvinced. Being myself one of thelost generation, now enlightened, I offer the following argument.

Neo-Keynesians hold that the act of saving takes money out of the

circulation flow - income to purchases to income - whilst the act ofinvestment adds money to that flow. To maintain a constant rate offlow, that is, a steady demand for goods, it is necessary that desiredsaving should equal desired investment. According to the Keynesianargument saving will vary with the level of employment, so thatchanges in the level of employment serve as a mechanism equatingsaving and investment. But, if this is the mechanism, the desire tosave may be matched with the desire to invest at a level ofemployment less than full. The apparent remedy is to print and giveaway money to spend or to invest, that is, to stimulate artificially thedesire to spend or to invest.

But the truth is that the act of saving does not ordinarily hold upthe circular flow of money at all. If I choose to save more, I buy abond with my new savings, an act which is possible only ifsomeone sells a bond. The money I have saved is immediatelyavailable to the seller of the bond to buy goods. There is no failureof demand. A failure of demand occurs only if someone choosesnot to pass the money on but to hold a larger stock of money thanusual.


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This will cause unemployment. But such unemployment must betransient. No part of the stock of money is destroyed. Failing somefundamental change in institutional conventions the very sum hoardedwill eventually be released and demand restored. If, at the moment ofeach transient failure of demand, governments rush to create and putinto circulation new money in accordance with the Keynesianprescription, inflation will occur as soon as the temporary hold-up inthe flow of the old money ceases.

Nor is this the worst of it. Keynesian theory affords a cloak of

respectability to acts of currency debasement formerly universallyrecognised as evil. The very institution - the British Parliament -originally founded to control the monetary excesses of the Sovereign,itself now engages in acts of currency debasement far beyond anything that Henry VIII could have imagined, much less planned andexecuted. The watchdog has become the wolf.

Professor Hayek proposes that a free-market watchdog should belegalised so that good private money might drive out bad governmentmoney, if it is bad. There is room for argument whether this wouldprove more or less effective than, say, control by a revitalised andindependent Bank of England; but there can be no dispute whateverthat some kind of watchdog must be appointed, and quickly.

HAROLD ROSE

Esme Fairbairn Professor of Finance, London Graduate Schoolof Business Studies

Economic Adviser to Barclays BankAuthor ofManagement Education in the I970s: Growth and

Issues (1969)PROFESSOR HAYEK'S prescription involves abolition of allexchange control and allowing exchange rates to move freely. Butthen it would not be necessary to eliminate the monopolistic title oflegal tender as well. For the movement of interest rates and forwardexchange rates would fully reflect the degree of trust in differentcurrencies, and the price mechanism would enable contracts to be

made to no disadvantage even in a weak currency, thus avoiding allthe costs of inconvenience and uncertainty the absence of legaltender would entail.

Put in this way, Professor Hayek's prescription becomes lessrevolutionary than it sounds, and I have correspondingly less faith in

its efficacy. For sustained inflation has not been confined tocountries whose governments have surrounded them with the wall ofexchange control, and there is in any event nothing to prevent severalcountries from inflating together, as they have done during the pastfew years.

Whether governments would in practice be any more ready toaffirm their financial virtue by abolishing exchange control than bysubmitting themselves to more direct financial disciplines, such asthe limitation of the money supply, is to be doubted. But Professor

Hayek's analysis is undoubtedly correct in pointing to the operationof a kind of Gresham's Law if our inflation continues. Sooner or laterthe evasion of exchange control will spread; and the ordinary citizen,with no means of defending himself, will have the worst of allworlds.

DOUGLAS JAY, PC, MP

Fellow of All Souls College, Oxford, 1930-37, 1968-Economic Secretary to the Treasury, 1947-50,

Financial Secretary, 1950-51President of the Board of Trade, 1964-67

Author ofThe Socialist Case (1937)

IN HIS PAPER, Choice in Currency, Professor Hayek seems tohave been led astray either by his life-long quarrel with LordKeynes, or else by the ancient fallacy - now common - of believingthat if one system does not yield ideal results, anything else woulddo better. He wants governments to refrain from declaring anythinglegal tender, and all individuals to use what money they like. Hesays that people should be 'free to refuse any money they distrustedand to prefer money in which they had confidence'.

But suppose I offer one paper rouble in payment of a bus fare,and the conductor refuses to accept it; what happens? Is the busstopped while the conductor and I seek a ruling which nobody cangive? And imagine the controversies in the bus over the latestexchange rate between one currency and any other. Professor

Hayek's new scheme would produce chaos and slow down thewhole business of production and exchange in a welter ofdisputation. That is why history has forced governments to legislateon legal tender. Professor Hayek might nearly as well ask for theabolition of all law courts and indeed governments, and let everyindividual prosecute his own disputes. Such an argument has, no


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doubt, a superficial appeal. But human history argues rather stronglyagainst it.

Of course, Professor Hayek is right in saying that many governments(and banking systems) have for most of history abused their right toissue money. He rather forgets the banking systems. Yet in the GreatBarber Credit Inflation of 1972-73 in the UK, it was the banks -tolerated, not instigated, by the Government which engineered theinflation.

But in thinking you can take control of the currency out of the handsof modern elected governments, and put it in the hands of somemysterious wise men meditating in some ivory tower, Professor Hayekis flying in the face of reality. The public simply will not allow controlof money to be put beyond their control any more than control of lawsor taxes. The only hope, even if a frail one, is to educate governments toact sensibly.

SIR KEITH JOSEPH, BT., PC, MP

Fellow of All Souls College, Oxford, 1946-60, 1972-Secretary of State for Social Services, Dept. of Health and Social

Security, 1970-74Economic Adviser to Mrs Margaret Thatcher and member of the

Shadow CabinetAuthor ofReversing the Trend (1975)

PROFESSOR HAYEK'S elegant, penetrating and humane argumentwill teach most of us that if governments will not cure inflation, thenthey can at least enable the people to safeguard themselves from thehorrors of currency collapse - by allowing a free choice of currency.

No doubt the Treasury would object - on balance of payments andcurrency control grounds, for, unlike what I understand to be the legalityof sterling payments merely indexed to a foreign currency, this wouldend exchange control. No doubt some politicians and some trade unionleaders would object. But voters and wage-earners would notnecessarily agree with their nominal spokesmen. They long for a stable

medium of exchange and store of value. A minority at all levels ofincome can and will protect themselves against inflation. Most will notbe able to do so. The humanity of Professor Hayek's proposal is that itcould partly at least safeguard all our people against the incompetence orirresolution of their own government.

The relevance may become intense if the pending deceleration of

inflation proves only to be a false dawn. And anyway the loomingobligation to ease exchange control under the EEC rules will before longrevive the need to discuss the constraints under which we have becomeused to living and the self-correcting mechanisms that would bebrought into play by a dose of freedom.

I hope that the implications of Professor Hayeks proposal will beexplored so that we may the better judge its potency and potential.


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Government Monopoly of Money inTheory and History

Compiled and introduced by

SUDHA SHENOY

Lecturer in Economics, University of Newcastle,New South Wales, 1973-74

Lecturer in Economics, Cranfield School of Management, 1974-

I. THEORY

(i) Political Law or Commercial Acceptability?

Professor Ludwig von Mises made the essential point in this extract: a

currency is used as a medium of exchange not because it is declared to

be legal tender but because it is generally acceptable.

. . . The law may declare anything it likes to be a medium of payment,and this ruling will be binding on all courts and on all those who enforce the

decisions of the courts. But bestowing the property of legal tender on a thing

does not suffice to make it money in the economic sense. Goods canbecome common media of exchange only through the practice of those who

take part in commercial transactions; and it is the valuations of these persons

alone that determine the exchange-ratios of the market. Quite possibly,commerce may take into use those things to which the state has ascribed the

power of payment; but it neednot do so. It may, if it likes, reject them.

Three situations are possible when the state has declared an object to bea legal means of fulfilling an outstanding obligation. First, the legal means

of payment may be identical with the medium of exchange that the

contracting parties had in mind when entering into their agreement; or, if

not identical, it may yet be of equal value with this medium at the time ofpayment. For example, the state may proclaim gold as a legal medium for

settling obligations contracted in terms of gold, or, at a time when therelative values of gold and silver are as 1 to 15, it may declare that

liabilities in terms of gold may be settled by payment of 15 times the

quantity of silver. Such an arrangement is merely the legal formulationof the presumable intent of the agreement. It damages the interests of

neither party. It is economically neutral. The case is otherwise when the

state proclaims as medium of payment something that has a higher orlower value than the contractual medium. The first possibility may be

disregarded; but the second, of which numerous historical examples

could be cited, is important. From the legal point of view, in which thefundamental principle is the protection of vested rights, such a procedure

on the part of the state can never be justified, although it might

sometimes be vindicated on social or fiscal grounds. But it alwaysmeans, not the fulfilment of obligations, but their complete or partial

cancellation. When notes that are appraised commercially at only half

their face-value are proclaimed legal tender, this amounts fundamentallyto the same thing as granting debtors legal relief from half of their

liabilities.

Depreciation and commercial prudence

State declarations of legal tender affect only those monetary obligations

that have already been contracted. But commerce is free to choosebetween retaining its old medium of exchange or creating a new one for

itself, and when it adopts a new medium, so far as the legal power of the

contracting parties reaches, it will attempt to make it into a standard ofdeferred payments also, in order to deprive of its validity, at least for the

future, the standard to which the state has ascribed complete powers ofdebt-settlement. When, during the last decade of the 19th century, thebi-metallist party in Germany gained so much power that the possibility

of experiment with its inflationist proposals had to be reckoned with,

gold clauses began to make their appearance in long-term contracts. Therecent period of currency depreciation has had a similar effect. If the

state does not wish to render all credit transactions impossible, it must

recognise such devices as these and instruct the courts to acknowledgethem. And, similarly, when the state itself enters into ordinary business

dealings, when it buys or sells, guarantees loans or borrows, makes

payments or receives them, it must recognise the common businessmedium of exchange as money. The legal standard, the particular group

of things that are endued with the property of unlimited legal tender, is

in fact valid only for the settlement of existing debts, unless businessusage itself adopts it as a general medium of exchange.

(Ludwig von Mises, Theory of Money and Credit, Foundation forEconomic Education, Irvington-on-Hudson, New York, 1971reprint of 1953 edition, pp. 70-71.)


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(ii)Bad Money Drives out Good- Gresham's Law orGovernment Price-Fixing?

Gresham's Law is usually formulated as bad money driving good out of

circulation. But this phenomenon occurs only where the government

fixes the exchange rate between the two currencies. As circumstances

change, one currency or the other becomes over-valued or under-

valued. The under -valued currency then disappears from circulation.

Mintage has long been a prerogative of the rulers of the country.

However, this government activity had originally no objective other than

the stamping and certifying of weights and measures. The authority's

stamp placed upon a piece of metal was supposed to certify its weight

and fineness. When later princes resorted to substituting baser and

cheaper metals for a part of the precious metals while retaining the

customary face and name of the coins, they did it furtively and in full

awareness of the fact that they were engaged in a fraudulent attempt to

cheat the public. As soon as people found out these artifices, the debased

coins were dealt with at a discount as against the old better ones. The

governments reacted by resorting to compulsion and coercion. They

made it illegal to discriminate in trade and in the settlement of deferred

payments between 'good' money and 'bad' money and decreed maximumprices in terms of 'bad' money. However, the result obtained was not that

which the governments aimed at. Their decrees failed to stop the process

which adjusted commodity prices (in terms of the debased currency) to

the actual state of the money relation. Moreover, the effects appeared

which Gresham's Law describes.

(Ludwig von Mises, Human Action, Regnery, Chicago, Thirdrevised edition, 1966, pp. 780-781.)

Champions of the government's coinage monopoly have claimed thatmoney is different from all other commodities, because 'Gresham's Law'

proves that 'bad money drives out good' from circula tion. Hence, the free

market cannot be trusted to serve the public in supplying good money. But

this formulation rests on a misinterpretation of Gresham's famous law.The law really says that 'money overvalued artificially by government will

drive out of circulation artificially undervalued money'. Suppose, forexample, there are 1ounce gold coins in circulation. After a few years of

wear-and-tear, let us say that some coins weigh only 0.9 oz. Obviously, on

the free market, the worn coins would circulate at only 90 per cent of the

value of the full-bodied coins, and the nominal face-value of the formerwould have to be repudiated. If anything, itwill be the 'bad' coins that

will be driven from the market. But suppose the government decrees that

everyone must treat the worn coins as equal to new, fresh coins, andmust accept them equally in payment of debts. What has the government

really done? It has imposedprice control by coercion on the 'exchange

rate' between the two types of coin. By insisting on a par-ratio when theworn coins should exchange at a 10 per cent discount , it artificially

overvalues the worn coins and undervalues new coins. Consequently,

everyone will circulate the worn coins, and hoard or export the new.'Bad money drives out good money', then, noton the free market, but

as the direct result of governmental intervention in the market.

Legal tender.. . . How was the government able to enforce its price controls on

monetary exchange rates? By a device known as legal tender laws.

Money is used for payment of past debts, as well as for present 'cash'transactions. With the name of a country's currency now prominent in

accounting instead of its actual weight, contracts began to pledge

payment in certain amounts of 'money'. Legal tender laws dictated whatthat 'money' could be. When only the original gold or silver was

designated 'legal tender', people considered itharmless, but they should

have realised that a dangerous precedent had been set for governmentcontrol of money. If the government sticks to the original money, its

legal tender law is superfluous and unnecessary .1 On the other hand, the

government may declare as legal tender a lower-quality currency side-by-side with the original. Thus, the government may decree worn coins

as good as new ones in paying off debt, or silver and gold equivalent to

each other in the fixed ratio. The legal tender laws then bring Gresham'sLaw into being.

(Murray N. Rothbard, What Has Government Done to Our

Money?, Rampart College, Santa Ana, California, 1974, pp. 9-10,35.)

1 The ordinary law of contract does all that is necessary without any law giving

special functions to particular forms of currency. We have adopted a goldsovereign as our unitIf I promise to pay 100 sovereigns, it needs no special

currency law of legal tender to say that I am bound to pay 100 sovereigns, andthat, if required to pay 100 sovereigns, I cannot discharge my obligation by

paying anything else. (Lord Farrer, Studies in Currency 1898, MacMillan and

Co. London, 1898, p. 43. On the legal tender laws, see also Mises, Human

Action, Yale University Press, New Haven, 1949, pp. 432n, 444.)


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(iii) The SolutionProfessor Hayek first advocated the use of alternative currenciesin 1960.

Though I am convinced that modern credit banking as it has

developed requires some public institutions such as the central banks, Iam doubtful whether it is necessary or desirable that they (or the

government) should have the monopoly of the issue of all kinds of

money. The state has, of course, the right to protect the name of the unitof money which it (or anybody else) issues and, if it issues 'dollars', toprevent anybody else from issuing tokens with the same name. And as it

is its function to enforce contracts, it must be able to determine what is'legal tender' for the discharge of any obligation contracted. But there

seems to be no reason whatever why the state should ever prohibit the

use of other kinds of media of exchange, be it some commodity ormoney issued by another agency, domestic or foreign. One of the most

effective measures for protecting the freedom of the individual might

indeed be to have constitutionsprohibiting all peacetime restrictions ontransactions in any kind of money or the precious metals. (Editorial

italics.)

(F. A. Hayek, The Constitution of Liberty, University of Chicago

Press, Chicago, and Routledge & Kegan Paul, London, 1960, pp.520-521.)

II. HISTORY

(i) FRANCE, 1789. . .Assignats and Legal Tenderby Penalty of Death

This extract is taken from an account of the French experience with the

assignats issued after the French Revolution. As larger and larger

quantities were issued, their value declined progressively - i.e. prices

rose. Attempts at price control failed despite the severest penalties.

Since gold and silver coins were also in circulation, the French began to

reject assignats in their favour because they retained their value.

Professor Andrew Dickson White here chronicles the failure of theFrench government to force the French to accept assignats at the same

value as the metallic currencies.

. . . As far back as November 1792, the Terrorist associate of

Robespierre, St Just, in view of the steady ri se in prices of the

necessaries of lif e, had proposed a scheme by which these prices

should be established by law, at a rate proportionate to the wages of the

working classes. This plan lingered in men's minds, taking shape in

various resolutions and decrees until the whole culminated on 29

September, 1793, in the Law of the Maximum.. . . Committees of experts were appointed to study the whole subject

of prices, and at last there were adopted the great 'four rules' which

seemed to statesmen of that time a masterly solution of the whole

difficulty.

The Law of the Maximum

First, the price of each article of necessity was to be fixed at one and

one-third its price in 1790. Secondly, all transportation was to be

added at a fixed rate per league. Thirdly, 5 per cent was to be addedfor the profit of the wholesaler. Fourthly, 10 per cent was to be added

for the profit of the retailer. Nothing could look more reasonable.

Great was the jubilation. The report was presented and supported byBarrere - 'the tiger monkey' - then in all the glory of his great orations:

now best known from his portrait by Macaulay. Nothing could

withstand Barrere's eloquence. He insisted that France had beensuffering from a 'Monarchical commerce which only sought wealth',

while what she needed and what she was now to receive was a

'Republican commerce - a commerce of moderate profits and virtuous'.He exulted in the fact that 'France alone enjoys such a commerce - that

it exists in no other nation'. He poured contempt over political

economy as 'that science which quacks have corrupted, which pedantshave obscured, and which academicians have depreciated'. France, he

said, has something better, and he declared in conclusion, 'The needs

of the people will no longer be spied upon in order that the commercialclasses may arbitrarily take advantage'.

The first result of the Maximum was that every means was taken to

evade the fixed price imposed, and the farmers brought in as littleproduce as they possibly could. This increased the scarcity, and the

people of the large cities were put on an allowance. Tickets were

issued authorising the bearer to obtain at the official prices a certainamount of bread or sugar or soap or wood or coal to cover immediate

necessities.

Price-fixing a failure

But it was found that the Maximum, with its divinely revealed four rules,

could not be made to work well - even by the shrewdest devices. In thegreater part of France it could not be enforced. As to merchandise of


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foreign origin or merchandise into which any foreign product entered, thewar had raised it far above the price allowed under the first ru1e, namely,

the price of 1790 with an addition of one-third. Shopkeepers therefore

could not sell such goods without ruin. The result was that very manywent out of business, and the remainder forced buyers to pay enormous

charges under the very natural excuse that the seller risked his life in

trading at all. That this excuse was valid is easily seen by the daily listsof those condemned to the guillotine, in which not infrequently figure

the names of men charged with violating the Maximum laws. Manu-

factures were very generally crippled and frequently destroyed, andagriculture was fearfully depressed. To detect goods concealed by

farmers and shopkeepers, a spy system was established with a reward to

the informer of one-third of the value of the goods discovered. To spreadterror, the Criminal Tribunal at Strassburg was ordered to destroy the

dwelling of anyone found guilty of selling goods above the price set by

law. The farmer often found that he could not raise his products atanything like the price required by the new law; and when he tried to

hold back his crops or cattle, alleging that he could not afford to sell

them at the prices fixed by law, they were frequently taken from him byforce and he was fortunate if paid even in the depreciated fiat money -fortunate, indeed, if he finally escaped with his life.

Death for refusal of legal tender

Involved in all these perplexities, the Convention tried to cut theGordian knot. It decreed that any person selling gold or silver coin, or

making any difference in any transaction between paper and specie,

should be imprisoned in irons for six years; that anyone who refused to

accept a payment in assignats, or accepted assignats at a discount,

should pay a fine of 3,000 francs; and that anyone committing this

crime a second time shou1d pay a fine of 6,000 francs and suffer

imprisonment 20 years in irons. Later, on 8 September, 1793, the

penalty for such offences was made death, with confiscation of the

criminal's property, and a reward was offered to any person informing

the authorities regarding any such criminal transaction. To reach the

climax of ferocity, the Convention decreed, in May 1794, that the

death penalty should be inflicted on any person convicted of 'having

asked, before a bargain was concluded, in what money payment was tobe made'. Nor was this all. The great finance minister, Cambon, soon

saw that the worst enemies of his policy were gold and silver.

Therefore it was that, under his lead, the Convention closed the

Exchange and finally, on 13 November, 1793, under terrifying

penalties, suppressed all commerce in the precious metals.

. . . All this vast chapter in financial folly is sometimes referred to as

if it resulted from the direct action of men utterly unskilled in finance.

This is a grave error. That wild schemers and dreamers took a leading

part in setting the fiat money system going is true; that specu1ation and

interested financiers made it worse is also true; but the men who had

charge of French finance during the Reign of Terror and who made

these experiments, which seem to us so monstrous, in order to rescue

themselves and their country from the flood which was sweeping

everything to financial ruin were universally recognised as among themost skilful and honest financiers in Europe. Cambon, especially,

ranked then and ranks now as among the most expert in any period. The

disastrous results of all his courage and ability in the attempt to stand

against the deluge of paper money show how powerless are the most

skilfu1 masters of finance to stem the tide of fiat money calamity when

once it is fairly under headway; and how useless are all enactments

which they can devise against the underlying laws of nature.

Month after month, year after year, new issues went on. Meanwhile,

everything possible was done to keep up the value of paper. The city

authorities of Metz took a solemn oath that the assignats should bear the

same price whether in paper or specie, and whether in buying or selling,

and various other official bodies throughout the nation followed thisexample. In obedience to those who believed with the market women of

Paris, as s tated in their famous petiti on, that 'l aws should be passed

making paper money as good as gold', Couthon, in August 1793, had

proposed and carried a law punishing any person who should sell

assignats at less than their nominal value with imprisonment for 20 years

in chains, and later carried a law making investments in foreign

countries by Frenchmen punishable with death.

'Fiat' money obeyed natural laws of finance

But to the surprise of the great majority of the French people, the value

of the assignats was found, after the momentary spasm of fear had

passed, not to have been permanently increased by these measures. On

the contrary, this 'fiat' paper persisted in obeying the natural laws of

finance and, as new issues increased, their value decreased.

. . . The issues of paper money continued. Toward the end of 1794 seven

thousand millions in assignats were in circulation. By the end of May 1795,

the circulation was increased to ten thousand millions; at the end of July,


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to fourteen thousand millions; and the value of one hundred francs

in paper fell steadily, first to four francs in gold, then to three, then to

two and one-half.

The powerless guillotine and the power of gold. . . Interesting is it to note in the midst of all this the steady action ofanother simple law in finance. Prisons, guillotines, enactments inflicting

20 years' imprisonment in chains upon persons twice convicted of

buying or selling paper money at less than its nominal value, and death

upon investors in foreign securities, were powerless. The NationalConvention, fighting a world in arms and with an armed revolt on its

own soil, showed titanic power, but in its struggle to circumvent onesimple law of nature its weakness was pitiable. The louis d'orstood in

the market as a monitor, noting each day, with unerring fidelity, the

decline in value of the assignat; a monitor not to be bribed, not to bescared. As well might the National Convention try to bribe or scare

away the polarity of the mariner's compass. On 1 August, 1795, this

gold louis of 25 francs was worth in paper, 920 francs; on 1 September,1,200 francs; on 1 November, 2,600 francs; on 1 December, 3,050

francs. In February 1796, it was worth 7,200 francs or one franc in gold

was worth 288 francs in paper. Prices of all commodities went up nearlyin proportion.

(Andrew Dickson White, Fiat Money: Inflation in France,Foundation for Economic Education, Irvington-on-Hudson, NewYork, 1959, pp. 75-89; first published in 1912 as revised versionof 1876 lecture.)

(ii) USA, before 1857 (five foreign currencies legal tender) andafter (only the dollar)

The United States up to the 1850s offers an important historical instance

of the use of a wide variety of currencies. Dutch, English, French,

Portuguese, and Spanish coins circulated freely as legal tender. Prices

were quoted in Spanish dollars. After 1834 increasing quantities of

American coins were minted, and in 1857foreign coins were declared to

be legal tender no longer.(Based on Ernest L. Bogart and Donald L. Kemmerer, AnEconomic History of the American People, Longmans Green andCo, New York, 1942, pp. 360-361; and Hermann E. Knooss, American Economic Development,Prentice Hall, EnglewoodCliffs, N.]., 1974, pp. 271-272.)

(iii) GERMANY, 1920-23We now take two extracts from Professor Constantino Bresciani-

Turroni's book, The Economics of Inflation, on the great German

inflation of1920-23. Together, they illustrate how foreign currencies, and

a host of illegal monies, replaced the hyper-inflated paper mark, in the

last stages of the inflation. These alternative currencies were replaced, in

turn, by the stabilised rentenmark. Although the hyper-inflated mark was

legal tender, it was eventually rejected by the Germans. Its rejection

forced the government to stabilise the currency.Professor Bresciani-Turroni here describes how substantial

quantities of foreign exchange and various illegal paper currencies

began to circulate in Germany towards the end of the inflation. As there

were no quantitative restraints on these illegal monies, they too

depreciated in value. But they continued to be accepted in preference to

the mark, which was depreciating even faster. Before the issue of the

stabilised rentenmark (in November 1923), emergency notes were

introduced, printed with the words 'stable value'. The phrase was

fictitious, but by now the Germans were ready to accept any currency

other than the hyper-inflated mark.

In this last phase the legal paper money was replaced by other monies

(which had no legal recognition), not only as 'a store of value' and as 'a

standard of value', but also as a means of payment. Little by littleforeign money, or the old national metallic money (which had been

hoarded), or new money created by private firms, entered the

circulation. The legal money was rejected by the public . . . .The replacements of the legal money by other monies in Germany

developed in an interesting way. In the summer of 1922, at a time when

the external value of the mark was falling rapidly, causing a revolution

of internal prices, the most important industries, one after another,

adopted the practice of expressing prices in a foreign 'appreciated'

money (dollars, Swiss francs, Dutch florins, etc.) or in gold marks. . . .

Later the paper mark continually lost importance as a means of payment

also. Wholesale trade, which badly needed a means of payment, resorted

to foreign exchange.

In the summer of 1923, the need for a circulating medium being attimes very acute, because of the rapid fall in the total real value of

paper marks, the 'emergency monies' (which h ad from time to time


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appeared in the circulation... regulated by the law of 17 July, 1922) were

multiplied. State and local governments, industrial associations,chambers of commerce, and private traders issued great quantities of

paper 'money'. Sometimes the issues were authorised and came under

certain guarantees (see the decree of 26 October, 1923), but most wereillegal issues, which, thanks to the rapid depreciation of notes, yielded

considerable profits to the issuers. Illegal issues were especially frequent

in the occupied territories. It is said that in the autumn of 1923 therewere two thousand different kinds of emergency money in circulation!

The abuses which arose from these issues constitute one of the most

unhappy chapters in the history of the mark.

From the mark to the rentenmarkTow ards mid-October 1923 it was obvious that the monetary chaos

could not go on any longer without involving the entire economic

system in complete catastrophe. On 13 October the law granting fullpowers was passed, and on 15 October the decree which instituted the

'Rentenbank' provided for the issue of a new money, the rentenmark,

beginning from 15 November, 1923.But, in the meantime, among the German population the need for a

stable-value currency had become greater than ever. The working

classes especially declared further delays to be intolerable and im-periously demanded a means of payment with a stable value. It being

impossible, for technical reasons, to anticipate the date of the issue of

the rentenmark, it was necessary to look elsewhere for an immediatesolution of the urgent monetary problem, in order to avoid the dangers

arising from the threatening attitude of the working classes. The

Government put into circulation some small denominations (up to atenth of a dollar) of 'Gold Loan' and some 'Dollar Treasury Bonds'.

However, as the notes immediately available were very limited, the

Government authorised and even encouraged the issue of 'emergencymonies with a constant value' (wertbestndiges Notgeld).

The issuers - who were principally the provinces, towns, andchambers of commerce - had to cover completely the paper moneyissued by depositing an equivalent sum in Gold Loan securities or by a

special type of Gold Treasury Bond, which was created for the purpose

(see decree of 26 October, 1923, and successive modifications,published by the Press on 4 November).

The railway administration was authorised to issue 'emergency

monies with a constant value', up to the amount of 200 million

gold marks, which were 'guaranteed' by a deposit of Gold Loan and of

Gold Treasury Bonds of equivalent value.It is unnecessary to state that the guarantee of the so-called 'money

with a stable value' was purely fictitious. Actually the Gold Loan and

the Gold Treasury Bonds were mere paper without any cover. (Editorialitalics.)

Indeed, the law of 14 August, 1923, on the Gold Loan of 500

million gold marks, contained only this limited promise:'In order to guarantee the payment of interest and the redemption of

the loan of 500 million gold marks, the Government of the Reich is

authorised, if the ordinary receipts do not provide sufficient cover, toraise supplements to the tax on capital, in accordance with detailed

regulations to be determined later.'

These vague words constituted the entire guarantee behind the GoldLoan! Nevertheless, the Gold Loan Bonds and the notes issued against

the Gold Loan deposits did not depreciate in value. The public allowed

itself to be hypnotised by the word 'wertbestndig; (stable-value) writtenon the new paper money. And the public accordingly accepted and

hoarded these notes (the Gold Loan Bonds almost disappeared from

circulation) even whilst it rejected the old paper mark - preferring not totrade rather than receive a currency in which it had lost all faith.

1

Rejection of legal tenderTogether with the introduction of foreign currencies and exchange, the

creation of the 'emergency money' (which became important in the German

circulation in the autumn of 1923 - indeed, the total value of the emergencymoney became considerably higher than the total value of the legal tender

money) was evidence ofthe spontaneous reaction of the economic organism

against the depreciation of the legal currency.2 (Editorial italics.)

1 It is not possible to estimate the value of the emergency money which circulated

in Germany just before the introduction of the rentenmark, because the illegal issues

cannot be estimated. According to official estimates, the authorised Notgeld and

Goldanleihe amounted to 728 million gold marks on 31 December, 1923.According to an estimate of the Statistical Bureau of the Reich (see Wirtschaft und

Statistik, 1924, p.121) the issue of unauthorised subsidiary money amounted, at its

maximum, to 332 trillion paper marks. In itsReportfor 1923 the Reichsbank gave aconsiderably higher figure: 400-500 trillion paper marks.

2 According to Professor Hirsch the phenomenon of the repudiation of thepaper mark was clearly apparent towards the end of June 1923, at first in the

occupied territory and later in other parts of Germany. Instead the Goldanleihe

was accepted by the country people. A considerable part of the harvest of 1923


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It is impossible to show in any precise fashion the amount of foreign

exchange circulating in Germany before the introduction of therentenmark. Estimates vary very much. According to an estimate of the

Cuno Government the foreign exchange and currencies in Germany in

December 1922 amounted to 3 milliard gold marks. But the amounteffectively circulating is not known. Accepting the opinion of some

business men, Schacht estimated in October 1923 at 1.5 to 2 milliards

the amount of foreign exchange and currencies circulating in Germany.According to Professor Hirsch, in the inflation years much foreign

money entered Germany, part being hoarded and part being used as ameans of payment. He maintains that this reserve of exchange in theautumn of 1923 was worth between three and four milliard gold marks.

However, all these estimates are unreliable.

(C. Bresciani-Turroni, The Economics of Inflation, Augustus M.Kelley, New York, 1968 reprint of 1937 edition, pp. 341-345.)

The rentenmark was accepted only because its issue was strictly limited.

It replaced not the old hyper-inflated mark but all the 'emergencymonies' issued in the last stages of the hyper-inflation as well as the

foreign exchange also circulating illegally.

... In October and in the first half of November [1923] lack ofconfidence in the German legal currency was such that, as Luther wrote,

'any piece of paper, however problematical its guarantee, on which was

written "constant value" was accepted more willingly than the papermark'.

. . . But on the basis of the simple fact that the new paper money [the

rentenmark] had a different name from the old, the public thought it wassomething different from the paper mark, believed in the efficacy of the

mortgage guarantee and had confidence. The new money was accepted,

despite the fact it was an inconvertible paper currency. It was held andnot spent rapidly, as had happened in the last months with the paper

mark.

was bought by consumers with Gold Loan securities ( Die deutsche

Whrungsfrage , Berlin, 1924, pp. 121, 129). But in the cities, as the present

author discovered personally, the paper mark was not rejected, although the

appreciated foreign currencies were more willingly accepted.

Confidence in rentenmark dependent on limited issue

Undoubtedly this confidence, thanks to which the rentenmark could enter

the channels of circulation immediately, would have been quickly dissipated

if the public had been led to expect that, despite the obligation imposed on

the Rentenbank by decree, the Government would exceed the pre-arranged

limit to issues.1

An attempt to violate these obligations was made by the

Government in December 1923, but it was confronted by a determined

refusal by the management of the Rentenbank. The incident helped to

strengthen confidence in the new money. The limitation of the quantity was

then of primary and fundamental importance.. . . the rentenmark and the new paper marks took the place of the various

auxiliary monies, legal and illegal, which had been issued in the autumn of

192], and of foreign exchange.

In fact, from German monetary statistics it appears that the circulation of

the 'Notgeld' and of the 'Goldanleihe' notes fell continually after the

introduc

Choice in Currency - Hayek

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