The True Gold Standard (Second Edition)
Why Private Banks and Not Central Banks Should Issue Currency, Especially in Less Developed Countries
In all but a few areas of the world today (Northern Ireland, Scotland, and for the time being Hong Kong), currency is a nationalized industry. Treasury departments issue coins; the state-owned enterprises known as central banks issue paper notes. It was not always so. Private banks were the main issuers of paper currency in the United States and Canada a century ago, and were the sole issuers in virtually every country two centuries ago.
Nationalization of currency is largely taken for granted today, but it shouldn't be. Adam Smith praised private currency for the benefits it had brought to his native Scotland. Most economists would agree that a legally enforced government monopoly is generally an inefficient way to produce private goods and services. The post office is a prime example; other examples range from state-owned plantations to national railroads. Currency is no exception to the rule. As with other nationalized products, quality is lower than it would be under private competition. The inefficiencies associated with government monopoly in currency are especially large in developing countries, where the reliability of the exchange rate (an important aspect of currency quality) is often quite low.
The Murray Rothbard both of us knew was committed to a frank and vigorous contest of ideas. He understood that an expression of disagreement was not an expression of disrespect—quite the contrary.
The rational choice would seem to lie between either a system of “free banking,” which not only gives all banks the right of note issue and at the same time makes it necessary for them to rely on their own reserves, but also leaves them free to choose their field of operation and their correspondents without regard to national boundaries, and on the other hand, an international central bank.
Two basic types of international monetary regimes are possible: those based on various independent national base moneys, and those based on a unified international base money. Regimes of the unified type can differ in at least two dimensions: (1) There may be distinct national deposit-transfer and currency systems variously regulated by national governments, that is, national “inside moneys.” Alternatively, checkable deposits and banknotes denominated in international money may be provided by private banks operating internationally. The former option exhibits what Hayek in 1937 called “monetary nationalism.” The latter option allows international inside moneys. (2) A common international base money can emerge from the free acceptance in various nations of a common base money supplied apolitically (for example, a commodity money such as gold). Joined to transnational banking, the result is international free banking: a global payment system with a single monetary standard, regulated by market institutions, that is, not dependent on any national or supranational government. Alternatively, an international money can be created by an international central bank. This is the “rational choice” Hayek describes in the epigraph above: international free banking or an international central bank.
This report explores these distinctions and the practical differences associated with them. As a vehicle for doing so, it critically reconstructs the arguments of Hayek’s 1937 book Monetary Nationalism and International Stability, a largely neglected work on the topic by one of this century’s leading economists. Hayek set out, more than half a century ago, to dissect the policy doctrine he labeled “monetary nationalism” in a series of lectures. The lectures were given at the Graduate Institute of International Studies in Geneva and were subsequently published as a slim volume. At that time, monetary nationalism was a leading belief system in the world of economic policy ideas and an incipient trend in the world of realpolitik.
Critics have raised a number of theoretical and historical objections to the gold standard. Some have called the gold standard a "crazy" idea.
The gold standard is not a flawless monetary system. Neither is the fiat money alternative. In light of historical evidence about the comparative magnitude of these flaws, however, the gold standard is a policy option that deserves serious consideration.
In a study covering many decades in a large sample of countries, Federal Reserve Bank economists found that "money growth and inflation are higher" under fiat standards than under gold and silver standards. Nor is the gold standard a source of harmful deflation. Alan Greenspan has testified before Congress that "a central bank properly functioning will endeavor to, in many cases, replicate what a gold standard would itself generate."
This study addresses the leading criticisms of the gold standard, relating to the costs of gold, the costs of transition, the dangers of speculation, and the need for a lender of last resort. One criticism is found to have some merit. The United States would not enjoy the benefits of being on an international gold standard if it were the first and only country whose currency was linked to gold.
A gold standard does not guarantee perfect steadiness in the growth of the money supply, but historical comparison shows that it has provided more moderate and steadier money growth in practice than the present-day alternative, politically empowering a central banking committee to determine growth in the stock of fiat money. From the perspective of limiting money growth appropriately, the gold standard is far from a crazy idea.
The Federal Reserve System is a major sponsor of monetary economics research by American economists. I provide some measures of the size of the Fed’s research program (both inputs and published outputs) and consider how the Fed’s sponsorship may directly and indirectly influence the character of academic research in monetary economics. In particular, I raise the issue of status quo bias in the Fed-sponsored research.
BY LAWRENCE H. WHITE