Choice in Currency: A Way to Stop Inflation, by F.A. Hayek, London: Institute of Economic Affairs, 1976, 48 pp., 1.00.
The argument which Prof. Hayek develops in this very short lecture, presented before the Geneva Gold and Monetary Conference in September 1975, is that legal tender laws, and the effective monopoly on the printing of money which governments enforce in their territories, are the cause of virtually all monetary problems, including inflation. In the absence of such laws establishing a monopoly, individual citizens would make their contracts in whatever unit of account suited their purposes best. Since a rapidly depreciating unit of account would be disadvantageous to at least one of the parties to a contract, all contracts would tend to be quoted in the most stable unit of money available.
The upshot of a system of free choice would be the abandonment of any governmental monetary units which fall into disfavor with the market. The survivors, as in Darwin's theory, would become the "world currency." With floating exchange rates between various monetary units, the good will drive out the bad—just the opposite of Gresham's Law, which works only where there is a fixed exchange rate.
The logic of Prof. Hayek's proposal is straightforward, but it must be obvious to any reader that no government would voluntarily give up the power to define legal tender and to enforce its law requiring contracts to be convertible into the legal unit of account. Such an act would be tantamount to giving up the power to lay and collect taxes, and the repudiation of its national debt. It is the public debt, the "faith and credit of the State," which is the critical element in this analysis. The public debt, by definition, is made up of promises to pay "something" in the future out of future tax revenues. This "something" must be either some specific product or commodity, or it is the legal tender unit of account which the government expects to collect from the citizens. Yet, if the citizens are merrily making their contracts and paying wages in whatever they feel like (free choice in currency) the government will have a problem sorting out what it is supposed to collect. No free trader in his right mind would make tax collection easy for the government.
Some of our lovable libertarian monetary cranks have observed that Federal Reserve Notes are "I.O.U. Nothings" because they aren't payable in gold. They may be nutty, of course, in the eyes of respectable economists and businessmen, because "everybody knows" that a dollar is a dollar. The reason why you will accept it in payment for your services has nothing to do with the fact that there is a law which makes you accept it. You will take a dollar in payment because it is customary; that is, you know that everybody else will take it in trade also. You aren't taking any risk.
There is a law, however, which says that everybody must keep books and records for tax purposes. Historical costs must be documented. In the absence of a legal tender law, or of some predictable price for "dollars" in terms of something physical, how would the government collect anything if individuals decided to keep books and records in terms of barter? How many "dollars" would they owe? In the last analysis, a tax has to collect some real goods or services or else it is not really a tax, and the public debt has to be repaid in some real goods or services or else it is not really repaid. The legal tender law relates the stock of present (taxable) assets to the government's financial structure, in particular to the future liabilities of the taxpayers.
The central assumption of modern monetary theory is the postulate that the government creates the money supply, and can therefore control it. Hayek seems to subscribe to this idea. This theory assumes that there is a "supply" of something in fact, when there really isn't. The only thing which keeps the monetary system in check is the legal tender law and the tax (bookkeeping) law.
The classical quantity theory of money was built upon a commodity standard, which does not lend itself to this sort of ambiguity. A grain of gold is a grain of gold. The system of credit which was developed at the dawn of the modern era had no such problem: there was a price rule between "One Grain" on the books and one grain in physical form. Any wealthy man might create more "Grains" on the books, except that he would have to be able to pay real grains if some lousy creditor should insist. Today, there is no limit on the total number of units the central bank can put on the books. In fact, not just the central bank but anyone can put units on the books just by making a contract. This is how the "offshore" banks make a profit; this is what unutilized trade credit and credit cards are, and how Eurodollars come into existence.
The "supply" of bookkeeping entries is completely without form and void. It is an illusion to assume that society has a "supply" of something just because it is mathematically additive. Indeed, all that is contained in that pseudo-aggregate is everybody's willingness to extend credit to everybody else, or to evaluate assets at some bookkeeping number. The quantity theory of money begs the question: What quantity (of what?) at what price? Hayek's proposal for free choice in this system of accounting illusion would destroy the system, because it would eliminate the implicit "price rule" between present assets and future liabilities. Hayek argues that the imminent demise of its currency would force a government to behave responsibly, but in fact the market's economies of scale here would eliminate all but the most preferred currencies.
Yet here is where Prof. Hayek reveals himself to be a genius of the first rank—far more subtle than Lenin or Lord Keynes. What is the strongest form of money? If good money drives out bad, which is true when the right to choose good money exists, government money would soon vanish from the face of the earth and mankind might find itself forever blessed with something generally agreed to work better, like the gold coin standard. What would it take for such a market revolution? Perhaps nothing more is required than an act of will on the part of free traders in the market, with the help of a banker or two. The legal tender laws, after all, only become important in the private sector if one businessman goes into court to sue another. If a way can be found to avoid government courts, then government money and perhaps government taxes can be avoided as well.
Hayek is not yet an anarchist, however. He has not considered the effect of his proposal on the collection of taxes and the effective repudiation of the public debt. It is important to recall that the public debt includes things like future social security pensions. This is political dynamite. His proposal is clever, and it might lead directly to a new international gold standard, but nothing short of the collapse of the West is likely to bring it about spontaneously. The voluntary agreement of all governments to return to a monetary system based on gold coin would fulfill Hayek's requirement—but this also seems about as likely as the collapse of the West.
This booklet contains, in addition to the Hayek lecture, an interesting note by Sudha Shenoy on the government monopoly of money in theory and history. In this note, some of the most interesting implications of Hayek's proposal as they have occurred in the past are presented. One is led to the conclusion that the logic of history will lead us back to an international gold coin standard, but the exact path is not clear.
Whereas nothing really prevents the growth and development of a private, libertarian gold standard among individuals and businessmen who might choose to make their contracts in terms of commodities, the governments of the world probably won't leave them alone—the tax authorities will probably continue to insist that books and records be maintained in terms of "legal tender." This will put tax accountants into the business of appraising assets. An alternative would be the voluntary submission by governments (and taxpayers) to some commodity "price rule" for the units of the public debt, but the collapse of the West does seem more likely in the short run.
Joe Cobb is employed as fiscal officer of the Industrial Commission of Illinois. He has written a number of articles on economic topics since graduating from the University of Chicago in 1966. He is editor of the monthly Bulletin of the Economic Education & Research Forum.
This article originally appeared in print under the headline "Choice in Currency".