Modern coinage feels like trash and looks like trash. It is an appropriate medium on which to immortalize modern statesmen. It would be a worthy tribute to some recent president to strike his likeness on the first hundred-dollar piece to be made from recycled aluminum beer cans. In the matter of inflation, however, we have developed a weary tolerance for the perilous. In the past four years, the M2 money supply has been increasing at around 10 percent a year; the average maturity of the public debt has shortened from eight years to three since the Korean War; and a peacetime deficit in excess of 70 billion is to be dropped into a surfeited securities market. With inflation risks exceeding interest rates, the Keynesian "money illusion" has been replaced by a "quiddity preference" in the form of a general desire to exchange money for tangibles—precious metals, antiques, seashells, real estate, or, for that matter, oil in the ground.
NO GOVERNMENTAL SOLUTION
There are a number of institutional reasons why Western governments are unlikely to do anything about inflation without forceful prompting—competition in the provision of money being one such instigation. First, some governments have accumulated large national debts that, along with other obligations, are an unproductive burden on the resources of their countries. With ordinary government expenditures running at or beyond the limits of taxation, when things have come to such a pass that a country's productive assets are insufficient to carry the load of government indebtedness, then inflation is a means of effecting the equivalent of bankruptcy. In the long run it becomes better to write off the debt through inflation than to try to support it through taxation. For example, the German inflations were catastrophic, but of limited duration, after which currencies were established on a firmer and more realistic foundation. Recovery after either war might have been impossible if more than token payment of debt had been made. In this sense, although hardly desirable in the first place, inflation is a means of wiping the slate clean.
Second, the past wisdom has been to frame government policies in such a way as to implement the positive goals of an unofficial coalition of dominant groups. This is what is meant by government leadership in the modern liberal vision, and inflation has, in fact, turned out to be one such goal. Inflation is generally kind to the large, mature corporation because it lightens the burden of competition and innovation by drumming up demand. It also makes poor managers appear more effective and poor investments appear more profitable than might otherwise be the case. Inflation has a similar effect on labor union hierarchies. It is the means by which an impressive series of wage increases can be won without incurring the unemployment that comparable increases in real terms would bring. The great bureaucracies are favorably inclined toward inflation because their growth is, in good measure, financed by it. On the other hand, those who are hurt by inflation constitute a rather timid minority—pensioners and holders of bonds, life insurance policies, and savings accounts, who only gradually become aware that their capital is being confiscated.
Any serious attempt to halt inflation would require (at least) a sustained effort at refunding the government debt at longer maturities. It would mean paying out higher interest charges in harder coin over longer periods of time in order to make up for past laxities. But governments have painted themselves into a corner in this matter by refusing to match monetary restraint with fiscal restraint when business activity is contracting. Thus it is that anti-inflationary measures have been superficial, spasmodic, and thrown into reverse at the first promising wiggle of the price index figures or the prospect of an election.
When it comes to the point that money can no longer be used as a yardstick for evaluating economic performance and drawing up plans, when it can no longer be used in contract specifications, and when holders of money are anxious to exchange it for something else as quickly as possible, then a variation of Gresham's Law comes into effect. Floods of paper drive goods from markets, and trade stagnates. Stable money is economically useful in its own right, and its provision is a vital service—one that need not be the much-abused monopoly of government, however. The issue of official paper currencies, backed by coercion and meaningless promises, is a modern replay of the debasement routine, coincident with the ascendancy of nationalism and mass politics as popular religions. In the West, this is a spent force, and given the incapacity or unwillingness of political authorities to solve the problem of inflation, it is only natural that the provision of high-quality money should be assumed by other bodies that are not subject to the constraints and temptations of modern politics.
A number of expedients have been adopted to meet demands for money of stable value. One supposed stopgap remedy has been the creation of artificial money units by the International Monetary Fund. These Special Drawing Rights, units of account made up of a mixed bag of separate national currencies, are used in transactions between central banks. Although SDR's do not fluctuate in value, since component currency fluctuations tend to average out, they do follow the collective decline in component values. Moreover, it may be argued that they contribute to inflation by the creation of still greater amounts of money on a defective base. SDR's are not a viable alternative because they are intimately tied to governmental monetary policies, which are the root of the problem.
A more promising innovation is adjusting the monetary values of loans and bank accounts upward in accordance with some standard cost of living index. Brazil has managed to tolerate a severe inflation via indexation, which has a growing number of advocates. "Rollover Credits" are medium-term loans at variable interest rates. They are somewhat similar to indexed loans and are finding favor in European money markets. Indexation is a cumbersome subterfuge, but it can provide a transition to a new, and in some ways superior, form of money, namely, any kind of indexed money.
One practical drawback to indexation is that there must be considerable inflation before authorities find themselves sufficiently pressured to accept its use in internal transactions. But it may be the only way in which money can be borrowed on a long-term basis, and then tax laws, for example, must be altered so that interest is taxed on the basis of true, rather than nominal, earnings. As a tentative step in this direction, the British Government offered 5-year, .8 percent, tax-exempt, indexed bonds on a restricted basis in June 1975.
Standardizing money values by means of a price index is an attractive idea. Even in the golden age of the gold standard, the amount of credit supported by a given gold base varied considerably, depending on political and psychological factors. The rise in prices in the U.S. from 1914 to 1919 was on the order of 80 percent, and the return to normalcy turned out to be an arduous task. One scheme that received attention was Irving Fisher's "Compensated Dollar"—a money unit whose gold content would be varied in such a way as to oppose changes in an official price index. A later idea was Graham's "Commodity Reserve Dollar," whereby the government would agree to buy or sell a standard assortment of commodities for $100, thus providing an indexed currency by setting up a giant Commodity Credit Corporation. Neither of these plans was effected.
STABILITY THROUGH COMMODITIES
Indexation and private forms of money are complementary. The fact is, people do change their monetary assets into indexed ones when they buy commodities futures. A contract to accept a bag of coffee at some future date in exchange for so many dollars laid out in advance is to change dollars for coffee units and to loan out the coffee units for a certain length of time. The arrangement may be perpetuated without having to take delivery by selling spot and buying ahead as the contracts fall due. Whenever money is being created in such amounts as to drive interest rates below the rate of inflation, speculation in futures becomes a paying proposition.
This suggests that private banks could establish indexed currencies of their own by setting up commodities mutual funds. Each unit of the bank's currency would be good for so many bushels of wheat, flasks of mercury, barrels of oil, etc., on specified world markets. Depositors would exchange their money for the bank's at ratios determined by prevailing prices. These funds would be used by the bank to make indexed loans, to meet withdrawals, and to buy futures in the indexed commodities.
To the extent that deposits could not be offset by bank-unit loans, resort to commodity markets would be expensive and carry risks, especially since monetary authorities are capable of imposing tactical pauses in the growth of the money supply, thereby raising interest rates to more realistic levels. The key to success in the long run would be to make use of the commodity markets only as it is expeditious or convenient and to concentrate on loans secured by claims to productive assets and yielding a moderate, predictable return in real terms. The inflation of present currencies has turned gilt-edge investments into speculative ones, with unpleasant surprises for borrowers or lenders when the rate of inflation is less or more than expected. Private-money banks would be able to perform a valuable service by eliminating some of the uncertainty in financing long-term, capital-intensive undertakings.
A private money scheme on similar lines has been proposed by Ralph Borsodi, an economic consultant, an associate of Irving Fisher, and a polymath author of 15 books. He and some friends set up an organization, Arbitrage International, that conducted a dry run to test a private-money plan in Exeter, New Hampshire, between June 1972 and January 1974. With the help of local banks, a new currency called constants was issued, and special accounts were set up in constant units. Rates of exchange were determined by an index of commodity prices. In the course of the experiment, the dollar value of the new money increased by 17 percent—a feature that was appreciated by the local businessmen, who accepted constants, and by the public. But because of the small scale of the operation—only $100,000 in constants was issued—the dollars traded were invested in Treasury notes instead of in the index commodities, and the promoters had to make up the difference in yields at the conclusion. In addition to its publicity value, the experiment did show that private, indexed money is a workable concept, as far as public acceptance and initiation are concerned.
One ingenious refinement of the Borsodi scheme is that, instead of investing in commodities futures, Arbitrage International would make loans on commodities in transit. This would be less hazardous and would be a means of holding claims on index commodities without having to pay the cost of storage.
As long as debtors and creditors tend to reside in the same country, and as long as economic patterns are local in scope, there is considerable opportunity for the political games that have brought us to the present pass. This is no longer the situation, however: economic patterns now transcend frontiers, certain basic rules of economics can make themselves felt quickly, and politicians are more vulnerable to external pressure. In particular, some of the oil-exporting nations have an interest in maintaining the value of money, and this tends to counterbalance the domestic political advantages of inflating it. In the past, countries like Saudi Arabia traded physical assets, whose value has appreciated, for financial ones, whose value has declined sharply, especially after the breaking of the gold link to the dollar. One element in the present price of oil is a premium for having to exchange oil for dollar securities of uncertain real value. The oil creditors are in a position reasonably to demand payment in money units of firmer value. Creation of such units, the consequent export of capital, and their adoption in other areas would establish a new and more stable basis of world finance. Surprising as it may seem to a generation catechized in Keynesianism, in which government indebtedness is a font of everlasting credit, the creation of money requires the creation of wealth. The oil surpluses, once changed into sounder money units, could serve the same purposes as did the British trade surpluses in the first part of the 19th century.
The wealthier OPEC nations do not have an interest in the adoption of their own national currencies as international ones. It would be feasible, however, for some of them to underwrite the creation of private-money banks with some of their idle gold and oil reserves. Large-scale joint ventures on these lines would leapfrog some of the difficulties in starting the operation from scratch. With conservative reserve levels, it would not be necessary to invest in the index commodities themselves, and by requiring payment in bank units, the oil exporters would establish a demand for bank-unit loans.
It would be important, however, to keep the control of the banks a few steps removed from their sponsors. For one thing, the more independent the bank, the more attractive it would be to fugitive capital and multinational corporations. The growth of business not related to oil and the mixing of funds and activities in an anonymous way would also protect the banks from avaricious governments: confiscation of Saudi assets would be a small matter in comparison to the confiscation of assets belonging to Frenchmen, Japanese, and Germans, as well. For their part, the OPEC countries do not require captive central banks to take their IOU's and print money: they merely require an honest broker to act as a leakproof conduit for their surplus funds (Borsodi's group has, in fact, been making approaches to the OPEC countries).
A LITTLE COMPETITION GOES A LONG WAY
Perhaps the ultimate function of private-money banks would be to precipitate political reform by speeding up the responses to political dabbling in economic matters. Contrary to common prudence, whereby an individual will make decisions in anticipation of the future and so save time or money, political decisions are reactive, cosmic banalities that dissipate money to buy time until events dictate a course of action to be undertaken—on the worst possible terms. Moreover, the planning horizon is very short: next year is never for all political purposes. If, however, there are arrangements to facilitate speculative countermeasures, then the unpleasant results of unsound policy can be brought forward into the political time reference—with sobering consequences.
For example, if private-money banks had been available in the silly sixties, when the United States was printing the world's money supply, holders of shrinking dollars could have voted their (non)confidence in policy by switching to currency whose value was steady and not tied to the dollar. This would have led to pressures toward contraction and higher interest rates well before the surge that closed the gold window.
If governments are forced to borrow real money to cover overrun budgets, if they are hammered when their credit becomes suspect, and if capital becomes more difficult to confiscate, then, obviously, new rules will have to be learned and a choice will be forced: either a country must become a socialist, autarchic state, with all the implications, or it must accommodate its political policies to the standards imposed by the growing, supranational economic order.
G.H. Tichenor graduated from MIT and received a master's degree from Cal Tech in mechanical engineering. He also studied at Trinity College, Dublin, and completed a diploma course in operational research at Imperial College, London. He is an inventor and is currently lecturing in statistics and computer applications at San Francisco State University.
This article originally appeared in print under the headline "Private Money".
Start your day with Reason. Get a daily brief of the most important stories and trends every weekday morning when you subscribe to Reason Roundup.