"Constitution or Competition? Alternative Views on Monetary Reform"

Brown, Pamela J.
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First Pub. Date
Autumn 1982
Literature of Liberty. Vol. v, no. 3, pp. 7-52. Arlington, VA: Institute for Humane Studies
Pub. Date

C. A Free Market Money System: The Competing Currencies Alternative


For decades, programs for a rule-restrained government monopoly had no serious rivals in the area of proposals for reform of the existing, politically dominated monetary system. In the literature of monetary policy, the constitutionalists' suggestions were the only seriously proposed alternative to the status quo—the gold standard aside—that promised to insure stability in the circulating medium's exchange-value. Then, in 1976, F. A. Hayek published a short but professionally shocking book entitled Denationalisation of Money: An Analysis of the Theory and Practice of Concurrent Currencies. Hayek seriously proposed the exciting, challenging possibility of a spontaneous monetary order providing for its own token currency needs, without the involvement of government. The result was a major explosion of research into this new—free market—alternative to the state's historically exclusive right to issue currency for the economy.

From "Bitter Joke" to "Crucial Issue"


First presented by Hayek "as a sort of bitter joke,"*48 the proposition that the free market might provide the best institutional vehicle for the production of monetary services has emerged as the single most important development in the area of monetary reform in recent years. This free market approach to money is not to be confused with the so-called "Free Money" policies advocated earlier in this century by such inflationists as Silvio Gesell in The Natural Economic Order and Henry Meulen in Free Banking, an Outline of a Policy Individualism (1934). Those policies were designed to permit abundant rather than sound private monies. The program behind the "Free Money Movement" called for by Hayek requires, by contrast, nothing less than a radical switch from the government's traditionally closed monopoly in the token currency industry to a regime of free trade in the production and choice of exchange media. Hayek would allow government to continue to produce currency only as one competitor among many: "What is so dangerous and ought to be done away with is not governments' right to issue money but the exclusive right to do so and their power to force people to use it and accept it at a particular price."*49


Proponents of free trade in currency predict that a program for monetary reform which places competitive rather than "constitutional" constraints on the individual money producer will prove to be far more effective in orienting managerial activities toward satisfying the needs of a currency-consuming public. Given the success of the market system in other realms of production, Hayek argues that the appropriate control of monetary aggregates to meet the demands of transactors "will be done more effectively not if some legal rule forces government, but if it is in the self-interest of the issuer which makes him do it, because he can keep his business only if he gives the people a stable money." Raising the informational as well as the motivation problems of monetary central planning and nationalization, he adds that "the monopoly of government of issuing money has not only deprived us of good money but has also deprived us of the only process by which we can find out what would be good money."*50


It would be difficult to overstate the seriousness and urgency with which Hayek advocates the denationalization of money as a means for reforming the existing system. He does not propose the end of the monetary monopoly merely as a temporary expedient, to tide us over until we are able to design a constitutional mechanism that will channel the government monopoly into more commendable modes of behavior; nor as a standby plan in case the present system collapses. His alternative of monetary self-organization requires nothing less than the permanent removal of all barriers to entry and free competition in the currency and banking industries. And what is more, it promises nothing less than an end to the catastrophic effects of central-bank-caused business cycles:

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... (T)his monopoly... is very largely the cause of the great fluctuations in credit, of the great fluctuations in economic activity, and ultimately of the recurring depressions.... (I)f 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.*51

Earlier Advocates of Free Trade in Money: From Smith to Spencer


Earlier discussions of the nature and consequences of a regime of free trade in the money and banking industries may be found in the works of several classical political economists.*52 Adam Smith, for example, in his unsurpassed Inquiry into the Nature and Causes of the Wealth of Nations (1776), expressed support for Scotland's policy of laissez faire towards the issue and circulation of private bank notes used in commercial exchange. Smith explained that substantial economies could be gained by employing redeemable paper currencies in place of gold and silver coin, as the displaced coin could then be exported in exchange for productive capital goods. Nevertheless, he was also aware of the potential dangers of such paper monies:

The gold and silver money which circulates in any country, and by means of which, the produce of its land and labour is annually circulated and distributed to the proper consumers, is... all dead stock. It is a very valuable part of the capital of the country, which produces nothing to the country. The judicious operations of banking, by substituting paper in the room of a great part of this gold and silver, enables the country to convert a great part of this dead stock into... stock which produces something to the country.... The commerce and industry of the country, however,... though they may be somewhat augmented, cannot be altogether so secure, when they are thus, as it were, suspended upon the Daedalian wings of paper money, as when they travel about upon the solid ground of gold and silver.*53

The insecurity for domestic banknote users was, in Smith's words, mainly due to "the accidents to which they are exposed from the unskillfulness of the conductors (issuers) of this paper money." Smith's solution, not surprisingly, was free competition:

(The) multiplication of banking companies..., an event by which many people have been much alarmed, instead of diminishing, increases the security of the publick. It obliges all of them to become more circumspect in their conduct, and... to guard themselves against those malicious runs, which the rivalship of so many competitors is always ready to bring upon them.... By dividing the whole circulation into a greater number of parts, the failure of any one company, an accident which, in the course of things, must sometimes happen, becomes of less consequence to the publick. This free competition too obliges all bankers to be more liberal in their dealings with their customers, lest their rivals should carry them away. In general, if any branch of trade, or any division of labour, be advantageous to the publick, the freer and more general the competition, it will always be the more so.*54


John Stuart Mill, in his Principles of Political Economy (1848), also offered arguments for relying—with some qualifications—upon private sector competition in the production of money and banking services. He noted:

The reason ordinarily alleged in condemnation of the system of plurality of issuers... is that the competition of these different issuers induces them to increase the amount of their notes to an injurious extent.... (But) the extraordinary increase in banking competition occasioned by the establishment of the joint-stock banks, a competition often of the most reckless kind, has proved utterly powerless to enlarge the aggregate mass of the banknote circulation; that aggregate circulation having, on the contrary, actually decreased. In the absence of any special case for an exception to freedom of industry, the general rule ought to prevail.*55


The irrepressible Herbert Spencer, in Social Statics, also voiced his support for private enterprise in servicing the public's credit and currency needs. Spencer wrote:

Thus, self-regulating as is a currency when let alone, laws cannot improve its arrangements, although they may, and continually do, derange them. That the state should compel every one who has given promises to pay, be he merchant, private banker, or shareholder in a joint-stock bank, duly to discharge the responsibilities he has incurred, is very true. To do this, however, is merely to maintain men's rights—to administer justice; and therefore comes within the state's normal function. But to do more than this—to restrict issues, or forbid notes below a certain denomination, is no less injurious than inequitable...

When, therefore, we find a priori reason for concluding that in any given community the due balance between paper and coin will be spontaneously maintained—when we also find that three-fourths of our own paper circulation is self-regulated—that the restrictions on the other fourth entail a useless sinking of capital—and further, that facts prove a self-regulated system to be both safer and cheaper, we may fairly say... that legislative interference is... needless.*56

Recent Discussions of the Competitive Supply of Money


Scholarly analysis of the properties of a competitive system of privately issued "token" monies—monies not redeemable on demand for precious metals—appears to be confined to recent decades. One of the first major theoretical discussions of such a system is William P. Gramm's "Laissez-Faire and the Optimum Quantity of Money," which appeared in 1974.*57 Developing a model of the currency industry characterized by a "perfectly" competitive market structure, Gramm counters the claims made by monetary economists Harry Johnson, Paul Samuelson, as well as Boris Pesek and Thomas Saving. These scholars claim that competition in the production of nominal money balances wastes resources and results in a non-optimal quantity of money, implying, therefore, that the currency industry is subject to "market failure."*58 In his excellent "Theory of Money and Income Consistent with Orthodox Value Theory," also appearing in 1974, Earl Thompson also analyzes the efficiency and macroeconomic stability properties of a system in which "competitive money creators" or "bankers" supply the needs of currency-using transactors. Thompson demonstrates the beneficial consequences that follow when we properly apply the standard assumptions of orthodox neoclassical value theory to a perfectly competitive production-and-exchange economy in which the provision of money is also subject to perfect competition. The result is an equilibrium quantity of real money balances which is: (1) determinate; (2) "Pareto optimal" (i.e., all resources go to their highest-valued uses); and (3) consistent with Say's Law of Markets (i.e., inconsistent with permanent, aggregate resource unemployment).*59


In November of 1974, another major work on the competing currencies question was published in the Journal of Money, Credit, and Banking. In his article "The Competitive Supply of Money," Benjamin Klein dealt the final blow to those arguments against monetary competition. Klein refutes the criticism that such a system would necessarily generate a hyper-inflation, leading to an infinitely high level of money prices. He demonstrates that we could expect such a result only when the "brand names" or "trademarks" of the various privately issued token monies are not protected from counterfeiting. He provides an excellent discussion of the process by which the competitive system would punish a money-producing firm that attempted to cheat its customers by deceitfully manipulating the supply of its brand of money, and how, correspondingly, it would reward a firm that operated to preserve its customers' trust. Klein concludes with a short historical discussion and a consideration of the pros and cons of competition, but he comes to no strong conclusions concerning the preferability of a competitive market structure over the existing closed government monopoly.*60 In two later articles, Klein applies his theoretical apparatus to the questions of European monetary unification and the seignorage profits earned by currency issuers.*61


Shortly after Klein's first article, Gordon Tullock's "Competing Monies" appeared in the Journal of Money, Banking, and Credit (1975). This fascinating article, after suggesting some possible examples of historical precedents in the use of competing private token issues, offers an important theoretical analysis of the microeconomic process by which a depreciating currency might gradually be given up in favor of another more stable one.*62 Tullock's article triggered an interesting exchange between himself and Klein concerning the authenticity and frequency of historical instances of competing private monies.*63

Hayek and the Denationalization of Money


F. A. Hayek's 1976 pamphlet, Choice in Currency: A Way to Stop Inflation, represented the beginnings of the first major attempt toinvestigate seriously the practical possibilities of a system of competing paper issues. It was here that Hayek began to address the question, "Why should we not let people choose freely what money they want to use?"—and to answer it: "There is no reason whatever why people should not be free to make contracts, including ordinary purchases and sales, in any kind of money they choose, or why they should be obliged to sell against any particular kind of money."*64


The program presented in Choice in Currency involves domestic competition among different national government monies, each of whose circulation is presently confined almost exclusively to its country of origin. But over a period of eight months, the program quickly evolved into a full-blown scheme of competing private (as well as governmental) monies. The result of this development was Hayek's pathbreaking Denationalisation of Money: An Analysis of the Theory and Practice of Concurrent Currencies. First published in 1976, this work was subsequently revised and extended.*65 It provides the best existing account of, and the best case for, free competition in the production and control of privately issued token monies. Hayek's analysis of the hypothetical working of a laissez-faire monetary system may seem deceptively simple, due to its brief treatment of a novel idea. The analysis should be closely read and carefully considered by the interested reader, as it has been misunderstood by more than one writer in the area.*66 The author comes to the firm conclusion that "the past instability of the market economy is the consequence of the exclusion of the most important regulator of the market mechanism, money, from itself being regulated by the market process."*67


Since Hayek's Denationalisation of Money was first published, several other authors have made significant contributions to the small but rapidly growing discipline of currency competition. These include Lance Girton and Don Roper, whose "Substitutable Monies and the Monetary Standard" (1979) gives a clear and concise statement of the "theory of multiple monies" and discusses some of the major issues connected with the choice-in-currencies question.*68 Roland Vaubel's "Free Currency Competition" (1977) is an excellent study offering an extremely thorough overview of the subject and its controversies. In addition, it provides some personal predictions concerning what Vaubel believes to be the most likely outcome of a competitively determined currency industry.*69 Vaubel refers to two as-yet-unpublished works, Wolfram Engels' "Note Issue as a Branch of Banking" and Wolfgang Stutzel's "Who Should Issue Money? Private Instead of Public Institutions? Bankers Instead of Politicians!", that further discuss and argue for a free market in money.


Among lay audiences concern with understanding the existing monetary mess has reached a high level of intensity in recent months. In order to satisfy this popular demand, a number of nontechnical introductory articles on the competing token monies alternative have recently appeared. Among these are pieces by economists Martin Bronfenbrenner, F. A. Hayek, Lawrence H. White, and Peter Lewin.*70 In addition, a number of works have examined historical incidents of privately-issued monies (token, fiduciary, and commodity), complementing research done on the purely theoretical level.*71

The Competitive Process of Currency Production


The hypothetical day-to-day operation of an established competitive token monetary system is in fact no more (or less) mysterious than is the working of the market process in any other production domain. Private issuers would compete in a number of dimensions to meet the community's demands for monetary services: purchasing-power behavior over time, convenience of use in exchange, convenience of use in accounting, and so on. Depending upon the preferences of currency consumers, the producer would adjust the existing supply of nominal units of his money so as to provide the appropriate degree of appreciation or constancy in his money's value. The purchasing-power control technique (or "rule") employed in actual practice by any given firm is, under a competitive system, a matter to be determined exclusively by the subjective judgments of the monetary entrepreneur.


Because people's exchange needs are different, preferences with respect to changes in the exchange-value of currencies can be expected to vary over the population of money users. This would result in issuer specialization to meet the unique requirements of particular user interests. Similarly, tastes may differ with respect to the index of commodity prices devised to monitor deviations from the desired level or rate of change of the purchasing power of a money. On this point, Hayek explains: "Experience of the response of the public to competing offers would gradually show which combination of commodities constituted the most desired standard at any time and place."*72 In short, under competitive conditions, the monetary standard, the monetary rule, and the purchasing-power behavior of money are all determined by expressed choice in the marketplace rather than by arbitrary political command.


Over time, those issuers who most effectively satisfy the demand for monetary services would profit and expand their market shares. Others who, for example, increase the value of their currencies when most money-holders prefer stable tokens, or stabilize their monies when most users prefer appreciating tokens, would be driven out of business or be forced to maintain a more modest circulation due to reduced profits. Which sort of monies would actually prove most popular, only the competitive market process can tell. For instance, Roland Vaubel points out, while purchasing-power appreciation tends to enhance a money's desirability as an asset (or "store of value"), purchasing-power constancy may enhance its desirability as an accounting device (or "standard of value").*73


The case for competition appears the logically superior one. However, doubts and queries about the operation of the system have nevertheless been expressed. Critics have especially emphasized potential problems concerning the stability and emergence of efficient supplies of currency when competition is allowed to regulate its production.

Is a Free-Market Monetary System Stable?


The issue of stability centers on the question of the controlability of a currency's value under a "perfectly" competitive scheme. This is sometimes framed, inversely, as the problem of "infinite" levels of money prices presumably resulting from a laissez-faire regime. Boris Pesek, for example, expresses the belief that in the long run a competitive paper currency system would generate a situation in which "money is so 'abundant' as to sell for a zero price and be a free good," producing a "regression into full-time barter since free money is worthless money, incapable of performing its task of facilitating exchange of goods among persons."*74 Benjamin Klein, as noted earlier, has demonstrated that such a result depends on improperly specified or protected property rights in the currency industry, and would emerge in any market in which brand names could be counterfeited. In such a market, producers and consumers lack a signaling mechanism by which to identify the outputs of different firms in the industry, so that a low-quality product cannot be identified and shunned in advance. Explains Klein:

It is true that if, for example, a new money producer could issue money that was indistinguishable from an established money, competition would lead to an overissue of the particular money and the destruction of its value. The new firm's increase in the supply of money would cause prices in terms of that money to rise and, if anticipated, leave real profit derived from the total production of the money unchanged. But there has been a distribution effect—a fall in the established firm's real wealth. The larger the new firm's money issue the greater its profit; therefore profit maximization implies that the new firm will make unlimited increases in the supply of the money, reducing the established firm's profit share close to zero (unless it too expands.)

If the established firm legally posseses a trademark on its money, this "externality" of the new firm's production represents a violation of the established firm's property right and is called counterfeiting. Lack of enforcement of an individual's firm's property right to his particular name will permit unlimited competitive counterfeiting and lead to an infinite price level. This merely points up the difficulties in the usual specification of competitive conditions. If buyers are unable to distinguish between the products of competing firms in an industry, competition will lead each firm to reduce the quality of the product it sells since the costs of such an action will be borne mainly by the other firms in the industry.... [I]ndistinguishability of the output of competing firms will lead to product quality depreciation in any industry.*75

Thus, in order to solve the paradox of infinite price levels, we need only introduce into a competitive currency model that was designed to prove the instability of free trade in money an assumption implicit in all standard analyses of competitive industry: the premise that products are distinguishable with respect to origin. (This is not inconsistent with another assumption of "perfect competition" models: that products are completely indistinguishable or identical with respect to their flow of services.) On making this assumption the proof is reversed, and we may deduce stability properties typically found in a perfectly competitive world. Criticisms of the stability properties of a free-market monetary system in this case point up a potential problem concerning the appropriate legal structure necessary for a properly functioning competitive system, rather than a problem of the competitive market structure itself, given a well-defined system of property rights.

Could Private Token Currencies Emerge? Would They?


The emergence of a competitive token monetary system from the existing domestic government monopoly raises two questions. First, there is the issue of how in theory a system of multiple monies could emerge; and second, there is the question of whether in practice such an evolution should be expected to take place once the requisite property rights structure has been established for the industry.


Posing the first question, Henry Hazlitt asks:

(H)ow does a private issuer establish the value of his money unit in the first place? Why would anybody take it? Who would accept his certificates for their own goods and services? And at what rate? Against what would the private banker issue his money? With what would the would-be user buy it from him? Into what would the issuer keep it constantly convertible? These are essential questions.*76

Indeed, new currencies would not appear or be accepted overnight. During the gradual process of establishing a private currency, the issued certificates would not immediately be greeted by money-users as currency. At the outset they would be supplied to the public in the form of money substitutes. These money substitutes would be supplied under an explicit contract guaranteeing the bearer some minimum rate of exchange between these certificates and one or more commodities or pre-existing currencies. Currency entrepreneurs would of course decide which commodities or monies to use in this process, and money-users would then choose from among the alternatives offered.*77


Only later, after the issuing firm had fostered sufficient consumer confidence in its trademarked tokens by making the necessary investments in the firm's "brand-name capital,"*78 would the issued notes begin to take on a monetary life of their own. The point marking this transformation is reached when currency-users effectively acknowledge the new currency as "monetized" by no longer routinely demanding that it be converted into another more liquid asset. Instead transactors begin circulating the notes as an independent exchange medium in their daily business.


Empirical doubts about the second question—whether a competitive currency system would in fact spontaneously emerge under the right legal conditions—are almost without exception framed in terms of the economic concept of "transactions costs." They are presented on the basis of a number of confusions, widespread within the economics profession, concerning the notions of "cost," "choice," and "competition." Such confusions are all too familiar to Austrian economists.


Arguments that deny the likely emergence of concurrent privately issued monies under laissez faire typically run as follows. People employ goods "having currency" for a variety of reasons, the most important among these being the purpose of transacting economic exchanges. In its capacity as a medium of exchange, a monetized commodity, due to its quality of being highly marketable, provides the transactor with a device which allows him to economize on the time and resources required to complete his desired set of exchanges. Thus far the argument is unobjectionable. Confusion enters in the form of a non sequitur when the argument leaps to the conclusion that, to the individual agent, "money is more useful the larger its transactions domain." On this basis Roland Vaubel argues that

Since the cost of using money falls as its domain expands, the quality (and, hence, the value) of the product money and, consequently, the marginal value productivity of the factors engaged in its production increase so that the money industry must be viewed as a (permanently) declining-cost industry.*79


This argument leads Vaubel to conclude: "Ultimately, currency competition destroys itself because the use of money is subject to very sizeable economies of scale. The money-industry must be viewed as a 'natural monopoly,' which at some stage must be nationalized." He adds that since it is "undisputed that lines of production that are subject to permanently declining cost must at some stage be nationalized (or, in an international context, be 'unified'), the fact that currency competition will lead to currency union must be regarded as desirable."*80


This argument labors under some rather common misconceptions. First, only individuals transact, and they do so only with one other individual or organization at a time, rather than with the entire economic order or "transactions domain." Further, there are likely to be many sectors of the monetized system with which these actors have little or no interest in dealing. These submarginal transactions areas vary from person to person. It is not at all obvious, then, that a money will be "more useful" to any given agent, the more universal or extensive the domain within which the money (or monies) he uses circulates. Some degree of specialization and heterogeneity in the currency industry's supply of services may in fact persist indefinitely because of persistence of differences in the needs and purposes of the various money-using members of a community.*81 In that case, several different issues may circulate side by side, each servicing the individuated demands of a separate subset or "neighborhood" of the "global" transactions domain. And, of course these currency areas may overlap.


The exact configuration of the resulting monetary mosaic is unpredictable under a competitive monetary arrangement since each currency consumer's choice from among the array of currencies available to him is made according to purely subjective benefit-cost calculations. Accordingly, the aggregate impact of consumers' choices in determining a given currency's domain will be revealed only after the execution of the particular plans that are based upon these calculations. Since their requirements may, for example, be highly localized geographically, it seems unreasonable to conclude a priori that a system of several concurrently circulating monies is "likely to be purely transitory, and that the only lasting—and again desirable—result will be currency union."*82


A second problem with the prediction of a "spontaneous monopolization" of the currency industry concerns the misconception of the competitive process that underlies this forecast. Surely, no one can resist reaching the conclusion that "competition destroys itself" in any industry in which marginal costs of production are continuously falling; no one, that is, who has adopted the entrepreneurially static notion of "perfect competition" as a benchmark. In that conceptual framework, the criterion of a "competitive" industry refers to a specific magnitude or pattern ("many" firms or price equal to marginal and average costs), rather than to the end-independent (and unceasing) process (rivalrous pursuit of profits) that characterizes the operation of the system. It naturally follows that any industry not obeying the perfectly competitive "pattern" must by definition exhibit "monopolistic tendencies."*83


Once we recognize, however, that real-life competition is a dynamic and unending discovery process, we no longer can meaningfully judge an actual industry's competitiveness by comparing it with some final static state of "optimality," "perfection," or "equilibrium." So long as the necessary legal framework is in force, the competitive process is at work whether one firm or many firms persist. In Brian Loasby's words: "[T]he critical question is, not what should the pattern of resource allocation look like, but how is it to be achieved; and the perfectly competitive model, which has defined the terms of the argument, provides no recipe for achieving anything. Actual competition is a process, not a state; and perfect competition can exist only as the description of a state.*84


Vaubel goes on to offer one more criticism of the efficiency of competing currencies. He argues that because "a good like money['s]... precise purpose is to reduce transaction cost, information cost and risk (as compared with barter), a diverse plethora of private issuers in the industry is likely to be "particularly inconvenient" due to the "diseconomies of small scale." He further argues that these effects "do not disappear if all banks of issue are led or forced to denominate their monies in the same standard of value."*85 The issue of whether several concurrently circulating exchange media would present an inconvenience to currency-users depends, again, on the individual users' subjective evaluations of the benefits and costs involved. The outcome cannot be conclusively determined a priori by the theorist. What is more, it is of interest to note that economic historian Hugh Rockoff has offered evidence which suggests by analogy that the benefits of a multi-issuer system may in fact outweigh the possible inconvenience in the estimations of consumers:

[I]t seems unlikely that the heterogeneous nature of the currency (of the nineteenth century) was a major brake on economic growth, for in many crucial respects the system was little different from that which prevails today. Locally we use demand deposits. But these are not generally acceptable as a means of payment. Each time we wish to make a purchase by check from a businessman we force him to make some judgement about the quality of the money we are offering. Instead of having to worry about different kinds of bank notes a merchant today must worry about different kinds of deposits which could be as numerous as his customers. Counterfeiting currency is now rare, but forged checks and insufficient balances are a constant irritation. Yet no one today would argue that the heterogeneity of our deposit money is a serious impediment to the growth of national income... [T]he inefficiency of a heterogeneous currency should not be exaggerated.*86

Skepticism From Gold Standard Advocates


It should be mentioned that a few advocates of the gold standard have questioned the feasibility of privately circulated issues of explicitly "token" form.*87 Their criticisms are clearly directed not against market-oriented monetary reform per se (as the gold standard they advocate is itself a market-controlled monetary system), but rather against a system of irredeemable and exclusively paper monies. According to these skeptics, the Hayekian paper regime could never exist. A purely fiduciary money is simply not possible in a world of free and rational agents; and it follows, they argue, that a system of competing paper issues is also impossible:

In a truly free society,... Professor Hayek and his bank would be allowed to issue paper certificates. So would we and our neighbors down the street. The real question is: Who would accept such certificates for their goods or services? Remember, they are not legal tender. Their value could not be insured... It is difficult to believe that sophisticated businessmen would long accept such paper certificates when, in a free society, they could ask for and receive gold or certificates redeemable in gold....

Given the fact that few people now alive have ever known sound money and given the general ignorance of sound monetary theory, it is possible that some established banks might find some who would accept their privately issued paper certificates. But, as Hans Christian Andersen tells the story of the illusion of "The Emperor's Clothes," sooner or later some innocent bystander would point out that such paper certificates are not the most marketable commodity in a free society and hence not "money."*88


It is surprising how many basic confusions concerning the theories of subjective valuation, money, and the spontaneous order have been included in such a short passage. The implication that an established token issue's acceptability is necessarily dependent upon its possessing a governmentally sanctioned "legal tender" status ("Remember they are not legal tender") is false. In contrast to these would-be Misesian writers, Mises himself notes:

The law may declare anything it likes to be a medium of payment... But bestowing the property of legal tender on a thing does not suffice to make it money in the economic sense. Goods can become common media of exhange only through the practice of those who take part in commercial transactions.... Quite possibly, commerce may take into use those things to which the State has ascribed the power of payment; but it need not do so. It may, if it likes, reject them.*89

If these writers mean to suggest that token money is exclusively a "creature of the State," perhaps they should say so directly.


The bald assertion that a newly issued private money's value "could not be insured" is also incorrect. More than one author has explained how and why such "value insurance" for new monies might hypothetically be made available to interested-but-wary potential customers.*90. What is worse, the assertion represents a disconcertingly unannounced jump in logic. It leaps from a general and objective analytical discussion of the issues to a highly specific and essentially entrepreneurial judgment concerning the dimensions in which the market for insurance services could or could not operate in the future. An economist oversteps his bounds in going beyond purely scientific explanations of the operations of the competitive process in the currency industry into the realm of concrete predictions concerning the industry's future organization ("supply-side") and qualitative ("demand-side") features. Such prediction is the concern of entrepreneurs. In these instances, criticism seems to reveal a basic misunderstanding of the literature concerning the Hayekian private paper money system in particular, and of the theory of the spontaneous order as a fluid discovery process in general.


The fact of the matter is that individuals do transact with and are willing to hold merely "token" currencies.*91 Even more generally, we may note that presumably rational, valuing agents, when situated within the context of a social system, continuously engage in various "customary" activities or follow established "norms" or procedures that do not yield obvious and direct benefits to them. These modes of behavior have evolved to facilitate social intercourse, though frequently those practicing them may be incapable of articulating or rationalizing those functions explicitly.*92 The question is, should we deny or ignore the actual existence of certain forms of money or various other "products of human action but not of human design" simply because their acceptability seems "difficult to believe"? Or should we recognize that such structures do indeed exist, although to date their occurrence remains to be satisfactorily explained? To the inquiring mind, the answer seems obvious.


Additional and more practical objections to a system of free-market paper monies have been developed in the literature.*93 A number of these have come (somewhat surprisingly) from the program's chief proponent, F.A. Hayek.*94

Rules and Commands: Their Confusion by the Constitutionalists


Finally, one of the most important arguments against monetary competition is implicit in a leading defense of a constitutionally constrained monopoly. This argument, which has been frequently invoked by monetary constitutionalists of both the Monetarist and Public Choice camps, seems, again, to rest on some rather serious misconceptions: The use of money, it is argued, is directly analogous to the following of legal rules of conduct within a civilization. Further, both the law and money come under the category of highly social "multi-purpose instruments."*95 Since the extra-market constitutional mechanisms devised in the past appear to facilitate the successful functioning and development of the legal order, it seems naturally to follow that the creation of such a mechanism for the monetary order would serve to enhance its operation and progress as well. The creators and practitioners of law are continuously guided in their deliberations by a metal-legal framework of general principles that provides a point of reference for "producing" proper legislation. Similarly, might not the creators and practitioners (managers) of the currency system be disciplined in their day-to-day activities by a set of principles? A monetary constitution would thereby insure that the "proper" monetary services would be produced and made available to market participants.*96


Two rather basic errors mar this argument. The first is that an analogy per se demonstrates nothing. It may indeed be true the use of currency in economic interactions has characteristics similar to those of the adherence to legal rules in social interactions. But it does not follow that it is therefore necessary for efficiency that the production of money be carried out within an institutional framework analogous to that created for the production of laws—a closed, govermentally controlled, jurisdictional monopoly. If this conclusion really were thought to follow, moreover, it would prove too much. That is, it would be unclear why its proponents have not also endorsed the socialization of religion, say, or the development of a constitution mandating and defining an overall set of principles for the production and use of language in society. If the evolution of optimal "supplies" of languages and language areas is allowed to be determined by spontaneous order, why then should not optimal money supplies and currency areas be so determined as well?


The second and more serious problem with the above argument is that the specific analogy used is flawed. It overlooks a crucial difference between currency and rules: laws (written down explicitly or not) are prerequisites for market activity. Money, while it does facilitate such activity, is not a prerequisite. Money is a good with a distinct demand and supply. Being an economic commodity capable of providing specific services to its users, there is no apparent reason why its production cannot be regulated by the same rules which guide the creation of all goods—the body of laws protecting competitive activity.


When it is claimed that currency production must be supervised by its own "special" legal framework and protected from the competitive process by being manufactured only by government, whereas other goods may be produced competitively under the standard legal framework calling for free and equal exchange, a confusion between the notion of abstract rules and that of particular commands is apparent. Those advocating a monetary constitution propose not an abstract rule for the promotion of the general welfare of those who manage their affairs within the nexus of the monetized exchange system, but what is in essence a monetary command—a command being defined as a rule "for the performance of assigned, specific, tasks"—for centrally planned money production. They, in short, take a "constructivistic" approach to monetary matters.*97 Indeed, money and law are both "multipurpose" tools facilitating social interchange. But whereas laws are procedural dictates, money is an economic good.


As Hayek has pointed out on numerous occasions,*98 what generalized "principles of justice" or "rules of just conduct" are intended to generate is not a command society (which would be the result if these "rules" were defined according to the endspecific criterion implied by the monetary constitutionalists), but rather a competitive society. The proper role of constitutional laws or principles is that of arbitrarily defining the set-up of the apparatus (government) by which the generalized rules of conduct of the liberal social order may be enforced. The French classical liberal Frederic Bastiat put the entire matter succinctly in The Law: "liberty means competition."*99 And, as Girton and Roper state clearly with respect to the monetary system of an open society in particular: "Competition in money issue provides a rule enforced by the market, and a monetary standard that is attractive compared to current monopoly paper money standards."*100

Monetary Constitutionalists as Entrepreneurs in Scientists' Clothing


By denying currency the status of a privately producible "good" capable of being regulated by the pressures of market competition (and instead elevating it to the status of a supramarket social tool which needs by its very nature to be supplied by a non-market governmental agency), the monetary constitutionalists are in fact stepping out of realm of scientific conjecture and into the domain of entrepreneurial conjecture. In the case of each program for a monetary constitution or "rule," the author has tacitly adopted the approach of the hypothetical currency producer-entrepreneur seeking the best production method. But rather than admit this, and in the process acknowledge that the only objective test of the correctness of such conjectures is the profit-and-loss test of market competition, each author continues to use the rhetoric of scholarship in the development of a "scientific" argument for his own particular "brand" of currency and its production design. What we have here is a case of entrepreneurs in scientists' clothing.

IV. Conclusion: Competition as the Proper Response to Ignorance


Economists have clearly articulated the need for reform of the existing monetary system. The available alternatives for change have in recent years also taken clear and unambiguous shape: either continued yet constrained monopoly or free-market competition in the supply of currency. The case for competition rather than constitutional restriction seems at present to be far stronger. The essence of the argument for free currency competition has perhaps been best expressed by Brian Loasby, who writes:

The argument for competition rests on the belief that people are likely to be wrong.... In the end, the case against an authoritarian system of resource allocation rests on the same principle as the case against an authoritarian structure in any discipline: part of the case... is that no person or body of persons is fit to be trusted with such power; the (other) part... is that no one person or group of persons can say for sure what new knowledge tomorrow will bring. Competition is a proper response to ignorance.*101

Notes for this chapter

F.A. Hayek, "Toward a Free Market Monetary System," Journal of Libertarian Studies 3 (Spring 1979): 1.
Hayek, Choice in Currency: A Way to Stop Inflation (London: Institute of Economic Affairs, 1976), p. 16.
Hayek, "Toward a Free Market Monetary System," pp. 2, 5.
Hayek, "Toward a Free Market Monetary System," pp. 7-5.
For secondary accounts see Vera C. Smith, The Rationale of Central Banking (London: P.S. King, 1936), chs. 6-10; Lawrence H. White, "Free Banking in Britain: Theory, Experience, and Debate" (Ph.D. dissertation, UCLA, 1982), chs. 2-3; and Phillipe Nataf, "Free Banking: A Workable System," paper presented at the 10th annual conference of the Committee for Monetary Research and Education, Harriman, NY, 14 March 1982.
Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations, Campbell-Skinner-Todd edition. (Oxford: Oxford University Press, 1976), I, pp. 320-321.
Smith, Wealth of Nations, I, pp. 321, 329. Smith added the two qualifications that issuers be restricted from issuing (1) notes below some minimum denomination and (2) notes not unconditionally payable on demand. Both restrictions had been imposed on the Scottish banks in 1765.
John Stuart Mill, Principles of Political Economy (London: John W. Parker, 1848), p. 675. Mill believed in having a non-market authority act as a central holder of bank reserves.
Herbert Spencer, Social Statics (New York: D.Appleton and Co., 1881), pp. 434, 436. Spencer placed no qualifications on his support for free banking.
William P. Gramm, "Laissez-Faire and the Optimum Quantity of Money," Economic Inquiry 12 (March 1974): 125-133.
Harry G. Johnson, "Equilibrium Under Fixed Exchanges," American Economic Review 53 (May 1963): 113; Paul A. Samuelson, "What Classical and Neoclassical Monetary Theory Really Was," Canadian Journal of Economics 1 (Feb. 1968): 9-10; Boris P. Pesek and Thomas R. Saving, Money, Wealth and Economic Theory (New York: Macmillan, 1970), pp. 69 ff.
Earl A. Thompson, "The Theory of Money and Income Consistent With Orthodox Value Theory," in P.A. Samuelson and G. Harwich, eds., Trade, Stability, and Macroeconomics: Essays in Honor of Lloyd Meltzer (New York: Academic Press, 1974), pp. 427-453. On Say's Law see William H. Hutt,A Rehabilitation of Say's Law; and Axel Leijonhufvud, Information and Coordination, pp. 79-101.
Benjamin Klein, "The Competitive Supply of Money," Journal of Money, Credit, and Banking 6 (Nov. 1974): 423-453.
Benjamin Klein, "Competing Monies, European Monetary Union, and the Dollar," in M. Fratianni and T. Peeters, eds., One Money for Europe (London: Macmillan 1978); Klein, "Money, Wealth, and Seignorage," in Kenneth Boulding and Thomas Frederick Wilson, eds., Redistribution Through the Financial System (New York: Praeger, 1978).
Gordon Tullock, "Competing Monies," Journal of Money, Credit, and Banking 7 (Nov. 1975): 491-498.
Benjamin Klein, "Competing Monies: A Comment," Journal of Money, Credit, and Banking 8 (Nov. 1976): 513-519; Gordon Tullock, "Competing Monies: A Reply," Journal of Money, Credit, and Banking 8 (Nov. 1976): 521-525.
F.A. Hayek, Choice in Currency: A Way to Stop Inflation (London: Institute of Economic Affairs, 1976), pp. 17-18. The pamphlet's text has subsequently been reprinted in Hayek, New Studies in Philosophy, Politics, and the History of Ideas, pp. 218-231.
Hayek, Denationalisation of Money—The Argument Refined, 2nd ed. (London: Institute of Economic Affairs, 1978).
For example Henry Hazlitt, in The Inflation Crisis, and How to Resolve It, p. 184, mistakenly interprets Hayek as contemplating private monies each convertible into a basket of commodities. Hayek, Denationalisation of Money, pp. 106-107, clearly denies that convertibility would be necessary.
Hayek, Denationalisation of Money, p. 98.
Lance Girton and Don Roper, "Substitutable Monies and the Monetary Standard," in Michael P. Dooley, Herbert M. Kaufman, and Raymond E. Lombra, eds., The Political Economy of Policy-Making (Beverly Hills: Sage Publications, 1979), pp. 233-246. See also Girton and Roper, "Theory and Implications of Currency Substitution," Journal of Money, Credit, and Banking 13 (Feb. 1981): 12-30.
Roland Vaubel, "Free Currency Competition," Weltwirtschaftliches Archiv 112 (1977): 435-459.
Martin Bronfenbrenner, "The Currency-Choice Defense," Challenge (Jan.-Feb. 1980): 31-36; F.A. Hayek, "Toward a Free Market Monetary System" Lawrence H. White, "Gold, Dollars, and Private Currencies," Policy Report (June 1981): 6-11; Peter Lewin, "The Denationalization of Money," unpublished ms. (June 1981).
Outstanding among these are Gordon Tullock, "Paper Money—A Cycle in Cathay," Economic History Review 9 (August 1957): 393-407; Luigi Einaudi, "Medieval Practice of Managed Currency," in Arthur D. Gayer, ed., The Lessons on Monetary Experience (New York: Augustus M. Kelley, 1970), pp. 259-268; Roland Vaubel, "Currency Competition in Monetary History," paper presented at the Institutum Europaeum conference on European Monetary Union and Currency Competition (December 1980); Bray Hammond, Banks and Politics in America from the Revolution to the Civil War (Princeton: Princeton University Press, 1957): Richard H. Timberlake, "Denominational Factors in Nineteenth-Century Currency Experience," Journal of Economic History 34 (December 1974): 835-884; William Woolridge, "Every Man His Own Mintmaster," in Uncle Sam, The Monopoly Man (New Rochelle, NY:Arlington House, 1970), pp. 54-74; Hugh Rockoff, "The Free Banking Era: A Reexamination," Journal of Money, Credit, and Banking 6 (May 1974): 141-168; Yu Ching Jao, Banking and Currency in Hong Kong (London: Basingstoke, 1974); and Lawrence H. White, "Free Banking in Britain: Theory, Experience, and Debate," ch. 2.
Hayek, Denationalisation of Money, p. 44.
Vaubel, "Free Currency Competition," pp. 445-446.
Boris Pesek, "[Optimal Monetary Growth:] Comment," Journal of Political Economy 76 (July-Aug. 1968): 889.
Klein, "The Competitive Supply of Money," pp. 429-430.
Henry Hazlitt, The Inflation Crisis, and How to Resolve It, p. 185.
See Hayek, Denationalisation of Money, pp. 42 ff; and Girton and Roper, "Substitutable Monies and the Monetary Standard," pp. 238-239.
See Klein, "The Competitive Supply of Money," pp. 432-438, for elaboration of the "brand-name capital" concept.
Vaubel, "Free Currency Competition," pp. 453, 458.
Vaubel, "Free Currency Competition," pp. 437, 458. For similar "natural monopoly" arguments see Harry G. Johnson, "Problems of Efficiency in Monetary Management," Journal of Political Economy 76 (Sept.-Oct. 1968): 971-990; Richard N. Cooper, "European Monetary Unification and Integration of the World Economy," in Lawrence B. Krause and Walter S. Salant, eds., European Monetary Unification and Its Meaning for the United States (Washington, 1973); C.P. Kindleberger, "The Benefits of International Money," Journal of International Economics 2 (Nov. 1972): 425-442; R.I. McKinnon, "Optimum Currency Areas," American Economic Review 53 (Sept. 1963): 717-724.
Such heterogeneity within any given "industry" is inconsistent with models of "perfect competition." Compare Hayek, Denationalisation of Money, pp. 72 ff.
Vaubel, "Free Currency Competition," p. 440.
This is Vaubel's characterization of the currency industry: "Free Currency Competition," p. 458.
Loasby, Choice, Complexity and Ignorance, pp. 189-190. On competition as a process see also F.A. Hayek, "The Meaning of Competition," in Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 92-106; Hayek, "Competition as a Discovery Procedure," in New Studies, pp. 179-190; and Israel Kirzner, Competition and Entrepreneurship (Chicago: University of Chicago Press, 1973).
Vaubel, "Free Currency Competition," pp. 457-458.
Hugh Rockoff, "The Free Banking Era: A Reexamination," Journal of Money, Credit, and Banking 6 (May 1974): 144-145.
Bettina Greaves and Percy Greaves, "On Private Paper Money," in Ludwig von Mises, On the Manipulation of Money and Credit, pp. 275-279; Henry Hazlitt, The Inflation Crisis, ch. 24.
Greaves and Greaves, "On Private Paper Money," pp. 278-279, emphasis added.
Mises, The Theory of Money and Credit, p. 70, emphasis in the original. On legal tender see also Herbert Spencer, Social Statics, p. 339; Thomas H. Farrer, Studies in Currency (London: 1898), p. 399; C.P. Kindleberger, "The Benefits of International Money," p. 426; and especially Vaubel, "Free Currency Competition," p. 438.
See F.A. Hayek, Denationalisation of Money, p. 42; Lance Girton and Don Roper, "Substitutible Monies and the Monetary Standard," p. 238.
See, for example, the discussions in Milton Friedman, "Should There Be an Independent Monetary Authority?," pp. 221 ff.; and Richard H. Timberlake, "The Significance of Unaccounted Currencies" unpublished ms. (1980), p. 17.
See F.A. Hayek, The Constitution of Liberty (Chicago: University of Chicago Press, 1960); Hayek, Law, Legislation and Liberty (Chicago: University of Chicago Press, 1973-79); Alexander James Field, "On the Explanation of Rules Using Rational Choice Models," Journal of Economic Issues 13 (March 1979): 49-72; John Rawls, A Theory of Justice (Cambridge: Harvard University Press, 1971).
Henry Hazlitt, in The Inflation Crisis, p. 185, for example, objects that "you cannot make a currency convertible into an abstraction" such as an index number. For fascinating historical evidence to the contrary see Luigi Einaudi, "The Medieval Practice of Managed Currency." See also Dennis W. Richardson, "The Emerging Era of Electronic Money: Some Implications for Monetary Policy," Journal of Bank Research 3 (Winter 1973): 261-264.
Hayek, Denationalisation of Money, discusses such potential problems as "parasitic" currencies (pp. 60-62), as well as the problems of transition to multiple currencies (sec. XXII).
See F.A. Hayek, Law, Legislation and Liberty, vol. I, for this concept. Other such social institutions include moral codes, language, writing, and the convention of market exchange itself.
Milton Friedman, "Should There Be an Independent Monetary Authority?," p. 242; Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1965), pp. 39, 53; Friedman, A Program for Monetary Stability, pp. 7-8; James M. Buchanan, "Predictability: The Criterion of Monetary Policy," p. 192; James M. Buchanan and T. Nicholaus Tideman, "Gold, Money and the Law," in Henry Manne and Roger Miller, eds., Gold, Money and the Law (Chicago: Aldine, 1975), pp. 42-43; and Henry Simons, "Rules Versus Authorities in Monetary Policy," p. 162.
For this distinction between rules and commands see Hayek, Law, Legislation and Liberty, vol. I, pp. 48, 149 ff. On constructivism see ch. I of that volume.
Hayek, The Constitution of Liberty; Hayek, Law, Legislation and Liberty; Hayek, "Economic Freedom and Representative Government" and "The Constitution of a Liberal State" in New Studies; Hayek, "Toward a Free Market Monetary System." See also Bruno Leoni, Freedom and the Law (Los Angeles: Nash Publishing, 1972).
Frederic Bastiat, The Law (Irvington-on-Hudson, NY: Foundation for Economic Education, 1950), p. 60, emphasis added.
Girton and Roper, "Substitutable Monies and the Monetary Standard," p. 234.
Loasby, Choice, Complexity and Ignorance, p. 192.

End of Notes

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