A free market monetary system and the pretense of knowledge

M ONETARY S YSTEMhen a little over twoyears ago, at the secondLausanne Conference ofthis group, I threw out,almost as a sort of bitterjoke, that there was nohope of ever again hav-ing de

M ONETARY S YSTEM

M ONETARY S YSTEM

Ludwig von Mises Institute

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to reproduce the “The Pretence of Knowledge.” Copyright © 1974 The Nobel Foundation Ludwig von Mises Institute

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met only be a government with totalitarian powers.

F.A Hayek

A Free-Market Monetary System

The Pretense of Knowledge

7 29

5

M ONETARY S YSTEM

hen a little over twoyears ago, at the secondLausanne Conference ofthis group, I threw out,almost as a sort of bitterjoke, that there was nohope of ever again hav-ing decent money, unless we took fromgovernment the monopoly of issuing moneyand handed it over to private industry, Itook it only half seriously But the sugges-tion proved extraordinarily fertile Following

A lecture delivered at the Gold and Monetary Conference, New Orleans, November 10, 1977 It made its first appear-

ance in print in the Journal of Libertarian Studies 3, no 1

(Fall 1979).

W

it up I discovered that I had opened a sibility which in two thousand years no sin-gle economist had ever studied There werequite a number of people who have sincetaken it up and we have devoted a greatdeal of study and analysis to this possibility

pos-As a result I am more convinced thanever that if we ever again are going to have

a decent money, it will not come from ernment: it will be issued by private enter-prise, because providing the public withgood money which it can trust and use cannot only be an extremely profitable busi-ness; it imposes on the issuer a discipline towhich the government has never been andcannot be subject It is a business whichcompeting enterprise can maintain only if itgives the public as good a money as any-body else

gov-Now, fully to understand this, we mustfree ourselves from what is a widespreadbut basically wrong belief Under the GoldStandard, or any other metallic standard, thevalue of money is not really derived fromgold The fact is, that the necessity ofredeeming the money they issue in gold,places upon the issuers a discipline whichforces them to control the quantity of money

in an appropriate manner; I think it is quite

as legitimate to say that under a gold dard it is the demand of gold for monetarypurposes which determines that value ofgold, as the common belief that the valuewhich gold has in other uses determines thevalue of money The gold standard is theonly method we have yet found to place adiscipline on government, and governmentwill behave reasonably only if it is forced to

stan-do so

I am afraid I am convinced that the hope

of ever again placing on government thisdiscipline is gone The public at large havelearned to understand, and I am afraid awhole generation of economists have beenteaching, that government has the power inthe short run by increasing the quantity ofmoney rapidly to relieve all kinds of eco-nomic evils, especially to reduce unemploy-ment Unfortunately this is true so far as theshort run is concerned The fact is, that suchexpansions of the quantity of money whichseems to have a short run beneficial effect,become in the long run the cause of a muchgreater unemployment But what politiciancan possibly care about long run effects if inthe short run he buys support?

My conviction is that the hope of ing to the kind of gold standard systemwhich has worked fairly well over a longperiod is absolutely vain Even if, by someinternational treaty, the gold standard werereintroduced, there is not the slightest hopethat governments will play the game accord-ing to the rules And the gold standard is not

return-a thing which you creturn-an restore by return-an return-act oflegislation The gold standard requires aconstant observation by government of cer-tain rules which include an occasionalrestriction of the total circulation which willcause local or national recession, and nogovernment can nowadays do it when boththe public and, I am afraid, all those Keyne-sian economists who have been trained inthe last thirty years, will argue that it is moreimportant to increase the quantity of moneythan to maintain the gold standard

I have said that it is an erroneous beliefthat the value of gold or any metallic basisdetermines directly the value of the money.The gold standard is a mechanism whichwas intended and for a long time did suc-cessfully force governments to control thequantity of the money in an appropriatemanner so as to keep its value equal with

that of gold But there are many historicalinstances which prove that it is certainly pos-sible, if it is in the self-interest of the issuer,

to control the quantity even of a tokenmoney in such a manner as to keep its valueconstant

There are three such interesting cal instances which illustrate this and which

histori-in fact were very largely responsible forteaching the economists that the essentialpoint was ultimately the appropriate control

of the quantity of money and not itsredeemability into something else, whichwas necessary only to force governments tocontrol the quantity of money appropriately.This I think will be done more effectivelynot if some legal rule forces government, but

if it is the self-interest of the issuer whichmakes him do it, because he can keep hisbusiness only if he gives the people a stablemoney

Let me tell you in a very few words ofthese important historical instances The firsttwo I shall mention do not refer directly tothe gold standard as we know it Theyoccurred when large parts of the world werestill on a silver standard and when in the sec-ond half of the last century silver suddenly

began to lose its value The fall in the value

of silver brought about a fall in variousnational currencies and on two occasions aninteresting step was taken The first, whichproduced the experience which I believeinspired the Austrian monetary theory, hap-pened in my native country in 1879 Thegovernment happened to have a really goodadviser on monetary policy, Carl Menger,and he told them,

Well, if you want to escape theeffect of the depreciation of silver

on your currency, stop the freecoinage of silver, stop increasingthe quantity of silver coin, and youwill find that the silver coin willbegin to rise above the value oftheir content in silver

And this the Austrian government did andthe result was exactly what Menger had pre-dicted One began to speak about the Aus-trian “Gulden,” which was then the unit incirculation, as banknotes printed on silver,because the actual coins in circulation hadbecome a token money containing muchless value than corresponded to its value Assilver declined, the value of the silver

Gulden was controlled entirely by the tation of the quantity of the coin.

limi-Exactly the same was done fourteenyears later by British India It also had had asilver standard and the depreciation of silverbrought the rupee down lower and lower tillthe Indian government decided to stop thefree coinage; and again the silver coinsbegan to float higher and higher above theirsilver value Now, there was at that time nei-ther in Austria nor in India any expectationthat ultimately these coins would beredeemed at a particular rate in either silver

or gold The decision about this was mademuch later, but the development was theperfect demonstration that even a circulatingmetallic money may derive its value from aneffective control of its quantity and notdirectly from its metallic content

My third illustration is even more esting, although the event was more shortlived, because it refers directly to gold Dur-ing World War I the great paper money infla-tion in all the belligerent countries broughtdown not only the value of paper moneybut also the value of gold, because papermoney was in the large measure substitutedfor gold, and the demand for gold fell In

inter-consequence, the value of gold fell andprices in gold rose all over the world Thataffected even the neutral countries Particu-larly Sweden was greatly worried: because ithad stuck to the gold standard, it wasflooded by gold from all the rest of theworld that moved to Sweden which hadretained its gold standard; and Swedishprices rose quite as much as prices in therest of the world Now, Sweden also hap-pened to have one or two very good econ-omists at the time, and they repeated theadvice which the Austrian economists hadgiven concerning the silver in the 1870s,

“Stop the free coinage of gold and the value

of your existing gold coins will rise abovethe value of the gold which it contains.” TheSwedish government did so in 1916 andwhat happened was again exactly what theeconomists had predicted: the value of thegold coins began to float above the value ofits gold content and Sweden, for the rest ofthe war, escaped the effects of the gold infla-tion

I quote this only as illustration of whatamong the economists who understand theirsubject is now an undoubted fact, namelythat the gold standard is a partly effective

mechanism to make governments do whatthey ought to do in their control of money,and the only mechanism which has been tol-erably effective in the case of a monopolistwho can do with the money whatever helikes Otherwise gold is not really necessary

to secure a good currency I think it isentirely possible for private enterprise toissue a token money which the public willlearn to expect to preserve its value, pro-vided both the issuer and the public under-stand that the demand for this money willdepend on the issuer being forced to keepits value constant; because if he did not do

so, the people would at once cease to usehis money and shift to some other kind

I have as a result of throwing out thissuggestion at the Lausanne Conferenceworked out the idea in fairly great detail in

a little book which came out a year ago,

called Denationalization of Money My

thought has developed a great deal since Irather hoped to be able to have at this con-ference a much enlarged second editionavailable which may already have beenbrought out in London by the Institute ofEconomic Affairs, but which unfortunately

has not yet reached this country All I have

is the proofs of the additions

In this second edition I have arrived atone or two rather interesting new conclu-sions which I did not see at first In the firstexposition in the speech two years ago, Iwas merely thinking of the effect of theselection of the issuer: that only those finan-cial institutions which so controlled the dis-tinctly named money which they issued, andwhich provided the public with a money,which was a stable standard of value, aneffective unit for calculation in keepingbooks, would be preserved I have nowcome to see that there is a much more com-plex situation, that there will in fact be twokinds of competition, one leading to thechoice of standard which may come to begenerally accepted, and one to the selection

of the particular institutions which can betrusted in issuing money of that standard

I do believe that if today all the legalobstacles were removed which prevent such

an issue of private money under distinctnames, in the first instance indeed, as all ofyou would expect, people would from theirown experience be led to rush for the onlything they know and understand, and start

using gold But this very fact would after awhile make it very doubtful whether goldwas for the purpose of money really a goodstandard It would turn out to be a verygood investment, for the reason that because

of the increased demand for gold the value

of gold would go up; but that very factwould make it very unsuitable as money.You do not want to incur debts in terms of

a unit which constantly goes up in value as

it would in this case, so people would begin

to look for another kind of money: if theywere free to choose the money, in terms ofwhich they kept their books, made their cal-culations, incurred debts or lent money, theywould prefer a standard which remains sta-ble in purchasing power

I have not got time here to describe indetail what I mean by being stable in pur-chasing power, but briefly, I mean a kind ofmoney in terms which it is equally likely thatthe price of any commodity picked out atrandom will rise as that it will fall Such astable standard reduces the risk of unfore-seen changes in the prices of particular com-modities to a minimum, because with such astandard it is just as likely that any one com-modity will rise in price or will fall in price

and the mistakes which people at large willmake in their anticipations of future priceswill just cancel each other because there will

be as many mistakes in overestimating as inunderestimating If such a money wereissued by some reputable institution, thepublic would probably first choose differentdefinitions of the standard to be adopted,different kinds of index numbers of price interms of which it is measured; but theprocess of competition would graduallyteach both the issuing banks and the publicwhich kind of money would be the mostadvantageous

The interesting fact is that what I havecalled the monopoly of government of issu-ing money has not only deprived us of goodmoney but has also deprived us of the onlyprocess by which we can find out whatwould be good money We do not evenquite know what exact qualities we wantbecause in the two thousand years in which

we have used coins and other money, wehave never been allowed to experiment with

it, we have never been given a chance tofind out what the best kind of money wouldbe

Let me here just insert briefly one vation: in my publications and in my lecturesincluding today’s I am speaking constantlyabout the government monopoly of issuingmoney Now, this is legally true in mostcountries only to a very limited extent Wehave indeed given the government, and forfairly good reasons, the exclusive right toissue gold coins And after we had given thegovernment that right, I think it was equallyunderstandable that we also gave the gov-ernment the control over any money or anyclaims, paper claims, for coins or money ofthat definition That people other than thegovernment are not allowed to issue dollars

obser-if the government issues dollars is a fectly reasonable arrangement, even if it hasnot turned out to be completely beneficial.And I am not suggesting that other peopleshould be entitled to issue dollars All thediscussion in the past about free bankingwas really about this idea that not only thegovernment or government institutions butothers should also be able to issue dollarnotes That, of course, would not work But if private institutions began to issuenotes under some other names without anyfixed rate of exchange with the official

per-money or each other, so far as I know this

is in no major country actually prohibited bylaw I think the reason why it has not actu-ally been tried is that of course we knowthat if anybody attempted it, the governmentwould find so many ways to put obstacles inthe way of the use of such money that itcould make it impracticable So long, forinstance, as debts in terms of anything butthe official dollar cannot be enforced in legalprocess, it is clearly impracticable Of course

it would have been ridiculous to try to issueany other money if people could not makecontracts in terms of it But this particularobstacle has fortunately been removed now

in most countries, so the way ought to befree for the issuing of private money

If I were responsible for the policy ofany one of the great banks in this country, Iwould begin to offer to the public both loansand current accounts in a unit which Iundertook to keep stable in value in terms of

a defined index number I have no doubt,and I believe that most economists agreewith me on that particular point, that it istechnically possible so to control the value

of any token money which is used in petition with other token monies as to fulfill

com-the promise to keep its value stable Theessential point which I can not emphasizestrongly enough is that we would get for thefirst time a money where the whole business

of issuing money could be effected only bythe issuer issuing good money He wouldknow that he would at once lose hisextremely profitable business if it becameknown that his money was threatening todepreciate He would lose it to a competitorwho offered better money

As I said before, I believe this is our onlyhope at the present time I do not see theslightest prospect that with the present type

of, I emphasize, the present type of cratic government under which every littlegroup can force the government to serve itsparticular needs, government, even if itwere restricted by strict law, can ever againgive us good money At present theprospects are really only a choice betweentwo alternatives: either continuing an accel-erating open inflation, which is, as you allknow, absolutely destructive of an eco-nomic system or a market order; but I thinkmuch more likely is an even worse alterna-tive: government will not cease inflating, butwill, as it has been doing, try to suppress the

demo-open effects of this inflation; it will bedriven by continual inflation into price con-trols, into increasing direction of the wholeeconomic system It is therefore now notmerely a question of giving us better money,under which the market system will functioninfinitely better than it has ever done before,but of warding off the gradual decline into atotalitarian, planned system, which will, atleast in this country, not come because any-body wants to introduce it, but will comestep by step in an effort to suppress theeffects of the inflation which is going on.

I wish I could say that what I propose is

a plan for the distant future, that we canwait There was one very intelligentreviewer of my first booklet who said,Well, three hundred years agonobody would have believed thatgovernment would ever give up itscontrol over religion, so perhaps inthree hundred years we can seethat government will be prepared

to give up its control over money

We have not got that much time We arenow facing the likelihood of the mostunpleasant political development, largely as

a result of an economic policy with which

we have already gone very far

My proposal is not, as I would wish,merely a sort of standby arrangement ofwhich I could say we must work it outintellectually to have it ready when the pres-ent system completely collapses It is notmerely an emergency plan I think it is veryurgent that it become rapidly understoodthat there is no justification in history for theexisting position of a government monopoly

of issuing money It has never been posed on the ground that government willgive us better money than anybody elsecould It has always, since the privilege ofissuing money was first explicitly repre-sented as a Royal prerogative, been advo-cated because the power to issue moneywas essential for the finance of the govern-ment—not in order to give us good money,but in order to give to government access tothe tap where it can draw the money itneeds by manufacturing it That, ladies andgentlemen, is not a method by which wecan hope ever to get good money To put itinto the hands of an institution which is pro-tected against competition, which can force

pro-us to accept the money, which is subject to

incessant political pressure, such an ity will not ever again give us good money.

author-I think we ought to start fairly soon, and

I think we must hope that some of the moreenterprising and intelligent financiers willsoon begin to experiment with such a thing.The great obstacle is that it involves suchgreat changes in the whole financial struc-ture that, and I am saying this from the expe-rience of many discussions, no seniorbanker, who understands only the presentbanking system, can really conceive howsuch a new system would work, and hewould not dare to risk and experiment with

it I think we will have to count on a fewyounger and more flexible brains to beginand show that such a thing can he done

In fact, it is already being tried in a ited form As a result of my publication Ihave received from all kinds of surprisingquarters letters from small banking houses,telling me that they are trying to issue goldaccounts or silver accounts, and that there

lim-is a considerable interest for these I amafraid they will have to go further, for thereasons I have sketched in the beginning

In the course of such a revolution of ourmonetary system, the values of the precious

metals, including the value of gold, aregoing to fluctuate a great deal, mostlyupwards, and therefore those of you whoare interested in it from an investor’s point

of view need not fear But those of youwho are mainly interested in a good mone-tary system must hope that in the not toodistant future we shall find generally appliedanother system of control over the monetarycirculation, other than the redeemability ingold The public will have to learn to selectamong a variety of monies, and to choosethose which are good

If we start on this soon we may indeedachieve a position in which at last capitalism

is in a position to provide itself with themoney it needs in order to function properly,

a thing which it has always been denied Eversince the development of capitalism it hasnever been allowed to produce for itself themoney it needs; and if I had more time Icould show you how the whole crazy struc-ture we have as a result, this monopoly orig-inally only of issuing gold money, is verylargely the cause of the great fluctuations incredit, of the great fluctuations in economicactivity, and ultimately of the recurringdepressions I think if the capitalists had been

allowed to provide themselves with themoney which they need, the competitivesystem would have long overcome themajor fluctuations in economic activity andthe prolonged periods of depression At thepresent moment we have of course beenled by official monetary policy into a situa-tion where it has produced so much misdi-rection of resources that you must not hopefor a quick escape from our present diffi-culties, even if we adopted a new monetarysystem ™