Saturday, August 25, 2012

Free Market Money, According to Hayek

Once again I return to the subject of money (call it money, banking, credit, and currency), this time via F.A. Hayek, and a lecture he delivered in 1977 entitled “A Free-Market Monetary System.”

…a little over two years ago, at the second Lausanne Conference of this group, I threw out, almost as a sort of bitter joke, that there was no hope of ever again having decent money, unless we took from government the monopoly of issuing money and handed it over to private industry…

So begins Hayek’s discussion into free market money.  Wherever this lecture may lead, it seems certain Hayek will at minimum endorse the abandonment of the government monopoly over money.  As regular readers know, this has been my conclusion regarding the fundamental problem of the current monetary system (at least for this time given my current understanding).  Perhaps I am in the rut of finding reading material that fits my desired conclusions, however given that the company I am currently keeping includes Mises, Sennholz, Ron Paul, and now (presumably) Hayek, I guess that is a pretty good rut ot be in.

Hayek makes an interesting observation about the value of gold when used as backing for money:

…we must free ourselves from what is a widespread but basically wrong belief. Under the Gold Standard, or any other metallic standard, the value of money is not really derived from gold. The fact is, that the necessity of redeeming the money they issue in gold, places upon the issuers a discipline which forces them to control the quantity of money in an appropriate manner…

This statement adds one more deathblow to those who suggest that the price of gold is too volatile to use for backing money (as if the price of gold when it isn’t used as money is meaningful for this concern in any case).   The value of gold as backing for a currency is in the discipline it forces upon the issuer, not in the metal.  It is the discipline that provides the (relative) stability.  Certainly, gold has the most important characteristics that have proven valuable in causing it to be most often selected as backing for currency; however Hayek sees the discipline on the issuer as key.

Gold, as any other commodity, has no intrinsic value.  Gold, when used as backing for money, has value in the discipline of properly limiting the note and credit creation backed by the metal.  Hayek is convinced at this point that there is no hope for government to ever again maintain a discipline of money management, even with a gold standard.  He makes several comments in regard to this point, including explaining why it is only in the private sector that any such hope would lie:

I am more convinced than ever that if we ever again are going to have a decent money, it will not come from government: it will be issued by private enterprise, because providing the public with good money which it can trust and use can not only be an extremely profitable business; it imposes on the issuer a discipline to which the government has never been and cannot be subject. It is a business which competing enterprise can maintain only if it gives the public as good a money as anybody else.

I am afraid I am convinced that the hope of ever again placing on government this discipline is gone.

My conviction is that the hope of returning to the kind of gold standard system which has worked fairly well over a long period is absolutely vain. Even if, by some international treaty, the gold standard were reintroduced, there is not the slightest hope that governments will play the game according to the rules.

I am not familiar with Hayek’s earlier work on this subject.  Perhaps there was a time when he supported the idea of a government managed gold standard – this would not be uncharacteristic for Hayek, given that he has written regarding the need for government action in other spheres (as he did, for example, in “Road to Serfdom”).  It would seem the inflationary episodes of the 1970s and perhaps the final abandonment of Bretton Woods convinced Hayek that any such government managed system was doomed to manipulation and ultimately failure.

In any case, by this point in his career, he certainly sees no reason to have hope in looking to a government monopoly for good money.  He sees that competition and the profit motive offer the best hope for providing good money.

Hayek gives a clue as to why he believes government can no longer be relied upon to deliver good money:

I do not see the slightest prospect that with the present type of, I emphasize, the present type of democratic government under which every little group can force the government to serve its particular needs, government, even if it were restricted by strict law, can ever again give us good money.

I cannot say if Hayek believed money could be better trusted in the hand of government forms other than the present form of democracy.  There are many examples under monarchs where this also was not achieved.  One of the few examples of success in this regard was in Byzantium, where (to my understanding) for a period of perhaps 800 years a gold coin standard was maintained.

Hayek sees competition as the key – competition on two grounds: 1) the standard, and 2) the issuers.  Regarding the standard, Hayek is open to the possibility that, if left fully free, it is possible the market would settle on a standard other than gold.  Whatever the final outcome, it seems quite likely to me that the market will coalesce around a specific standard, at least for trade beyond the immediate locality.  The desire by market actors toward efficiency would certainly cause a push in such a direction. 

As to the issuers, this seems quite straightforward – whose stamp is trusted?  Which coin is recognized for purity to the standard?  The market will determine the answers to these questions, and over time good money will drive out bad – or more likely, two different monies will trade in value relative to each other based on, among other factors, the reputation of the respective issuers.

Hayek returns to the impossibility of the expectation that a government monopoly could give us good money.  He makes the point that government didn’t get into the business of issuing money in order to give the people good money, but for other (not so righteous) reasons:

I think it is very urgent that it become rapidly understood that there is no justification in history for the existing position of a government monopoly of issuing money. It has never been proposed on the ground that government will give us better money than anybody else could. It has always, since the privilege of issuing money was first explicitly represented as a Royal prerogative, been advocated because the power to issue money was essential for the finance of the government— not in order to give us good money, but in order to give to government access to the tap where it can draw the money it needs by manufacturing it. That, ladies and gentlemen, is not a method by which we can hope ever to get good money. To put it into the hands of an institution which is protected against competition, which can force us to accept the money, which is subject to incessant political pressure, such an authority will not ever again give us good money.

Given the purpose Hayek describes, it is impossible to expect good money.  If good money is not the target, why would it ever be expected that the target is hit?

Hayek concludes that it is competition that must be allowed for money.  The public must learn how to differentiate and choose among competing products here just as it does in other areas of the market.  He believes if truly left free to compete, the market might not again settle on gold. 

Hayek spends some time in this lecture hinting at the idea that even gold money was not developed in a fully free manner.  This is news to me, and I have not seen this explained anywhere else.  Perhaps one day I will come across a thorough discussion of this idea.

He sees that money derived in a free market would minimize, if not eliminate, the major distortions in economic activity:

I think if the capitalists had been allowed to provide themselves with the money which they need, the competitive system would have long overcome the major fluctuations in economic activity and the prolonged periods of depression.

Ever since I wrapped my brain around this idea of competing currencies in a free market, I came to the conclusion that the topic of inflation would no longer be discussed – certainly not in a systemic way.  Individuals would make choices in currency and banking, just as they make choices in automobiles or steel.  Good choices would contribute to profit, bad choices to loss.  The choice of currency would be just another factor in the economic calculation.

At the present moment we have of course been led by official monetary policy into a situation where it has produced so much misdirection of resources that you must not hope for a quick escape from our present difficulties, even if we adopted a new monetary system.

Sadly, as true as this was thirty five years ago, it is infinitely truer today.  There is no way to avoid the bust, even if a sound path is chosen.  The least bad outcome is one that gets it over with sooner, without further compounding the misallocations in the economy.

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