On Central Banks, Inflation and the Case for Competing Currencies
The following essay was Kurt R. Leube’s* introductionary talk to the XVII. Gottfried von Haberler Conference, May 12, 2023.
‘The government monopoly of the issue of money was bad enough so long as metallic money predominated. But it became an unrelieved calamity since paper money (or other token money), which can provide the best and the worst money, came under political control.’ F. A. von Hayek
For centuries on end, roughly all governments have acquired and reserved for themselves the power of monopoly for the creation and issuance of money. Over time the ruling classes discovered and developed elusive methods to inflate the currency which they control. And as a consequence they briskly declared it ‘legal tender’ or ‘fiat’ money. What makes this autocratic privilege politically and socially such a grave threat is not just the governments’ power, but more to the point their exclusive privilege to produce money and to force their people to use and accept it at a set price.
During the course of time there were numerous accounts of cruel punishment for any attempt to question this prerogative. Among them we can find reports about the execution of those who declined to use the paper money issued by 13-century Chinese rulers. In medieval England similar acts of rejections quite often were sentenced as a majesty insult or, somewhat later in France with up to 20 years in a dungeon and shackled in chains.
Although a currency monopoly appears to have hardly ever generated good or beneficial results except for the rulers and their desire to enhance their unopposed coercive powers, the money prerogative apparently grew into an almost universally accepted and deep-rooted legend. Indeed, the vast majority of economists, of monetary professionals or sociologists almost never seriously pondered to challenge this somewhat dazing fabrication. In other words, the privilege of issuing money is virtually unchecked and became synonymous with economic power, despite the fact that governments everywhere and at all times were and still are the chief cause of currency depreciation. Faced with expenditures beyond control, staggering debts and a raging inflation, most governments find it impossible to resist the political pressures. Indeed, the temptation to interfere with the coinage, thereby assuming to gain some short-lived economic boost through creative fiscal policy measures, is usually too strong to resist.
Thus, in times of inflation it seems only natural that people start thinking about alternatives and feel they could be better off if governments were deprived of their control over monetary policy and their primary means of wrecking the economy. History clearly shows, that even under the threat of serious fines, people always rejected government’s inflated currency and resorted instead to cigarettes, whiskey or other useful commodities as a medium of exchange and thus drove out the bad money. As ‘Lucky Strike’ cigarettes were included in the ‘C-Rations’ provided to US combat troops during WW II, through the spontaneously established black market they gained a wide circulation during the months after the war. It took people in Germany and Austria not much more than a few weeks to establish some sort of Zigarettenwaehrung. In any case, money proved to be too serious an instrument as to leave the state authorities in charge of the monetary system.
It was Carl Menger (1840-1921), the founder of the Austrian School who discovered that money is not created by government decree, rather it is the people acting and trading in spontaneously developing markets. After all, only individuals decide what the most marketable good is for them to use as a medium of exchange. Some 20 years after Menger’s Grundsätze der Volkswirtschaftslehre were published in Vienna in 1871, Ludwig von Mises continued the work on monetary theory in his celebrated Theorie des Geldes und der Umlaufsmittel, Leipzig 1911. About 20 years thereafter, Richard von Strigl, an eminent but regretfully lesser known scholar of the 4th generation of the Austrians suggested that one way to restrain government abuse of a currency is to allow individuals to contract among themselves in any currency they choose. In 1933 F. A. von Hayek followed with his seminal essay on ‘Über Neutrales Geld’ and in 1937 his equally seminal book, Monetary Nationalism and International Stability was published in Geneva. In an often over looked but important footnote in his magnum opus The Constitution of Liberty, Hayek suggested that it is neither vital nor desirable that a government ‘should have a monopoly of the issue of all kinds of money’. The culmination of his monetary ideas however F.A. von Hayek published his revolutionary ‘Denationalization of Money’ in London in 1976. Although there are countless arguments in favor of the state power of monopoly for the creation and issuance of money, it is doubtful whether it is necessary or even desirable that governments or central banks should have such exclusive capability.
As the concept of competing currencies is not really new, it should not surprise that history is replete with examples of successful currency competition, both within countries and between them. For example in China, home of the world’s first paper money, currencies issued by private merchants and provincial governments competed for many centuries. Indeed, bills issued by governmental and private banks coexisted there as late as the first half of the 20th century. And in Europe, under the free banking systems in Scotland between 1716 and 1844, private banks routinely issued their own paper money or ‘banknotes’ that were redeemable for underlying real or basic monies, like gold or silver. And competition among those basic monies pitted gold against silver and copper. There were relatively unrestricted monetary systems also in New England (1820-60) or in Canada (1817-1914). Other successful episodes of the competitive provision of banknotes took place in Sweden, in Switzerland, France, in Ireland, Spain, or Australia. In parts of the US, predominately between 1825 and 1858 several systems of private issuance and bill discounting were well received by the fast growing population.
At first glance this topic may sound unusual or even somewhat incomprehensible to all students of conventional monetary theory and to all those who have been brought up on the concept of ‘legal tender’ it seems that a solution could be the self-interest of monetary agencies. These banking institutions will suffer by losing their livelihood if they do not supply currencies that users will find dependable and stable.
In such a revolutionary system, in which private financial institutions create currencies that compete for acceptance, the stability in value is presumed to be the decisive factor for acceptance. Since unlike other commodities, money does not serve by being used up, but by being handed on, competition will favor currencies with the greatest solidity in value due to the fact that a devalued currency hurts creditors, and an upward-revalued currency will hurt debtors. As a consequence, the chief attraction the issuer of a competitive currency has to offer customers is the assurance that its value will be kept stable or otherwise made to behave in a predictable manner. In others words, issuers of notes would be careful to maintain a constant price between a predetermined basket of goods and their currency with the intention of retaining their existing customers and gaining new ones. Monetary institutions may find through experimentation that an extensive basket of commodities, etc. forms the ideal monetary base. Such baskets are part of the assurance that the value of their currencies will be kept stable or otherwise made to perform in a foreseeable fashion. Institutions would issue and regulate their currency primarily through loan-making, and secondarily through currency buying and selling activities. It is postulated that specialized electronic platform would report daily or hourly information on whether institutions are managing their currencies within a previously-defined tolerance. Issuers who fail to maintain a stable exchange rate are then expected to lose market share. The maintenance of exchange rates in the quest for market share would better regulate monetary value than a central bank. After all, money is the only object that will never get ‘cheaper’ through competition, because its desirability and appeal are exclusively based on its staying ‘expensive’. So – whom should we trust regarding our money? Politicians, economists or the people?
Whatever the chances of political success for a radical ‘Denationalization of Money’ will be in the near future, it seems necessary to consider the feasibility of free banking in order to gain a proper perspective on the role of central banks play in a market economy. If the market is competent to evolve a stable and self-regulating monetary order in the absence of a privileged central bank, then central banking cannot be regarded as a necessary framework without which a free market economy would collapse. It must instead become evident that central banks exist for a different reason. By shrouding monetary policy with fiscal policy measures, central banks serve governments as an effective source of revenue through money creation.
In times of worldwide raging inflations it is long overdue, essential and worthwhile to reconsider the purpose of central banks and promote the revolutionary idea of applying the principles of free markets to the creation of money and its consequences. At the forthcoming XVII. Gottfried von Haberler Conference on May 12, 2023, internationally leading scholars will discuss this intriguing and promising topic.
*Kurt R. Leube is Professor Emeritus and Research Fellow at the Hoover Institution, Stanford University (USA) and Academic Director at ECAEF (European Center of Austrian Economics Foundation) in Vaduz, Liechtenstein.