The Theory of Money and Credit
By Ludwig Mises
Ludwig von Mises (1881-1973) first published
The Theory of Money and Credit in German, in 1912. The edition presented here is that published by Liberty Fund in 1980, which was translated from the German by H. E. Batson originally in 1934, with additions in 1953. Only a few corrections of obvious typos were made for this website edition. One character substitution has been made: the ordinary character “C” has been substituted for the “checked C” in the name Cuhel.
H. E. Batson, trans.
First Pub. Date
Indianapolis, IN: Liberty Fund, Inc. Liberty Classics
First published in German. Foreword by Murray Rothbard and Introduction by Lionel Robbins not available online
The text of this edition is under copyright. Picture of Ludwig von Mises: file photo, Liberty Fund, Inc.
- Historical Prefaces
- Part I,Ch.1
- Part I,Ch.2
- Part I,Ch.3
- Part I,Ch.4
- Part I,Ch.5
- Part I,Ch.6
- Part II,Ch.7
- Part II,Ch.8
- Part II,Ch.9
- Part II,Ch.10
- Part II,Ch.11
- Part II,Ch.12
- Part II,Ch.13
- Part II,Ch.14
- Part III,Ch.15
- Part III,Ch.16
- Part III,Ch.17
- Part III,Ch.18
- Part III,Ch.19
- Part III,Ch.20
- Part IV,Ch.21
- Part IV,Ch.22
- Part IV,Ch.23
- Appendix A
- Appendix B
1 Monetary Policy and the Present Trend Toward All-round Planning
The Return to Sound Money
The people of all countries agree that the present state of monetary affairs is unsatisfactory and that a change is highly desirable. However, ideas about the kind of reform needed and about the goal to be aimed at differ widely. There is some confused talk about stability and about a standard which is neither inflationary nor deflationary. The vagueness of the terms employed obscures the fact that people are still committed to the spurious and self-contradictory doctrines whose very application has created the present monetary chaos.
The destruction of the monetary order was the result of deliberate actions on the part of various governments. The government-controlled central banks and, in the United States, the government-controlled Federal Reserve System were the instruments applied in this process of disorganization and demolition. Yet without exception all drafts for an improvement of currency systems assign to the governments unrestricted supremacy in matters of currency and design fantastic images of superprivileged superbanks. Even the manifest futility of the International Monetary Fund does not deter authors from indulging in dreams about a world bank fertilizing mankind with floods of cheap credit.
The inanity of all these plans is not accidental. It is the logical outcome of the social philosophy of their authors.
Money is the commonly used medium of exchange. It is a market phenomenon. Its sphere is that of business transacted by individuals or groups of individuals within a society based on private ownership of the means of production and the division of labor. This mode of economic organization—the market economy or capitalism—is at present unanimously condemned by governments and political parties. Educational institutions, from universities down to kindergartens, the press, the radio, the legitimate theater as well as the screen, and publishing firms are almost completely dominated by people in whose opinion capitalism appears as the most ghastly of all evils. The goal of their policies is to substitute “planning” for the alleged planlessness of the market economy. The term
planning as they use it means, of course, central planning by the authorities, enforced by the police power. It implies the nullification of each citizen’s right to plan his own life. It converts the individual citizens into mere pawns in the schemes of the planning board, whether it is called Politburo, Reichswirtschaftsministerium, or some other name. Planning does not differ from the social system that Marx advocated under the names of socialism and communism. It transfers control of all production activities to the government and thus eliminates the market altogether. Where there is no market, there is no money either.
Although the present trend of economic policies leads toward socialism, the United States and some other countries have still preserved the characteristic features of the market economy. Up to now the champions of government control of business have not yet succeeded in attaining their ultimate goal.
The Fair Deal party has maintained that it is the duty of the government to determine what prices, wage rates, and profits are fair and what not, and then to enforce its rulings by the police power and the courts. It further maintains that it is a function of the government to keep the rate of interest at a fair level by means of credit expansion. Finally, it urges a system of taxation that aims at the equalization of incomes and wealth. Full application of either the first or the last of these principles would by itself consummate the establishment of socialism. But things have not yet moved so far in this country. The resistance of the advocates of economic freedom has not yet been broken entirely. There is still an opposition that has prevented the permanent establishment of direct control of all prices and wages and the total confiscation of all incomes above a height deemed fair by those whose income is lower. In the countries on this side of the Iron Curtain the battle between the friends and the foes of totalitarian all-round planning is still undecided.
In this great conflict the advocates of public control cannot do without inflation. They need it in order to finance their policy of reckless spending and of lavishly subsidizing and bribing the voters. The undesirable but inevitable consequence of inflation, the rise in prices, provides them with a welcome pretext to establish price control and thus step by step to realize their scheme of all-round planning. The illusory profits which the inflationary falsification of economic calculation makes appear are dealt with as if they were real profits; in taxing them away under the misleading label of excess profits, parts of the capital invested are confiscated. In spreading discontent and social unrest, inflation generates favorable conditions for the subversive propaganda of the self-styled champions of welfare and progress. The spectacle that the political scene of the last two decades has offered has been really amazing. Governments without any hesitation have embarked upon vast inflation and government economists have proclaimed deficit spending and “expansionist” monetary and credit management as the surest way toward prosperity, steady progress, and economic improvement. But the same governments and their henchmen have indicted business for the inevitable consequences of inflation. While advocating high prices and wage rates as a panacea and praising the administration for having raised the “national income” (of course, expressed in terms of a depreciating currency) to an unprecedented height, they blamed private enterprise for charging outrageous prices and profiteering. While deliberately restricting the output of agricultural products in order to raise prices, statesmen have had the audacity to contend that capitalism creates scarcity and that but for the sinister machinations of big business there would be plenty of everything. And millions of voters have swallowed all this.
There is need to realize that the economic policies of self-styled progressives cannot do without inflation. They cannot and never will accept a policy of sound money. They can abandon neither their policies of deficit spending nor the help their anticapitalist propaganda receives from the inevitable consequences of inflation. It is true they talk about the necessity of doing away with inflation. But what they mean is not to end the policy of increasing the quantity of money in circulation but to establish price control, that is, futile schemes to escape the emergency arising inevitably from their policies.
Monetary reconstruction, including the abandonment of inflation and the return to sound money, is not merely a problem of financial technique that can be solved without change in the structure of general economic policies. There cannot be stable money within an environment dominated by ideologies hostile to the preservation of economic freedom. Bent on disintegrating the market economy, the ruling parties will certainly not consent to reforms that would deprive them of their most formidable weapon, inflation. Monetary reconstruction presupposes first of all total and unconditional rejection of those allegedly progressive policies which in the United States are designated by the slogans New Deal and Fair Deal.
2 The Integral Gold Standard
Sound money still means today what it meant in the nineteenth century: the gold standard.
The eminence of the gold standard consists in the fact that it makes the determination of the monetary unit’s purchasing power independent of the measures of governments. It wrests from the hands of the “economic tsars” their most redoubtable instrument. It makes it impossible for them to inflate. This is why the gold standard is furiously attacked by all those who expect that they will be benefited by bounties from the seemingly inexhaustible government purse.
What is needed first of all is to force the rulers to spend only what, by virtue of duly promulgated laws, they have collected as taxes. Whether governments should borrow from the public at all and, if so, to what extent are questions that are irrelevant to the treatment of monetary problems. The main thing is that the government should no longer be in a position to increase the quantity of money in circulation and the amount of checkbook money not fully—that is, 100 percent—covered by deposits paid in by the public. No backdoor must be left open where inflation can slip in. No emergency can justify a return to inflation. Inflation can provide neither the weapons a nation needs to defend its independence nor the capital goods required for any project. It does not cure unsatisfactory conditions. It merely helps the rulers whose policies brought about the catastrophe to exculpate themselves.
One of the goals of the reform suggested is to explode and to kill forever the superstitious belief that governments and banks have the power to make the nation or individual citizens richer, out of nothing and without making anybody poorer. The shortsighted observer sees only the things the government has accomplished by spending the newly created money. He does not see the things the nonperformance of which provided the means for the government’s success. He fails to realize that inflation does not create additional goods but merely shifts wealth and income from some groups of people to others. He neglects, moreover, to take notice of the secondary effects of inflation: malinvestment and decumulation of capital.
Notwithstanding the passionate propaganda of the inflationists of all shades, the number of people who comprehend the necessity of entirely stopping inflation for the benefit of the public treasury is increasing. Keynesianism is losing face even at the universities. A few years ago governments proudly boasted of the “unorthodox” methods of deficit spending, pump-priming, and raising the “national income.” They have not discarded these methods but they no longer brag about them. They even occasionally admit that it would not be such a bad thing to have balanced budgets and mon etary stability. The political chances for a return to sound money are still slim, but they are certainly better than they have been in any other period since 1914.
Yet most of the supporters of sound money do not want to go beyond the elimination of inflation for fiscal purposes. They want to prevent any kind of government borrowing from banks issuing banknotes or crediting the borrower on an account subject to check. But they do not want to prevent in the same way credit expansion for the sake of lending to business. The reform they have in mind is by and large bringing back the state of affairs prevailing before the inflations of World War I. Their idea of sound money is that of the nineteenth-century economists with all the errors of the British Banking School that disfigured it. They still cling to the schemes whose application brought about the collapse of the European banking systems and currencies and discredited the market economy by generating the almost regular recurrence of periods of economic depression.
There is no need to add anything to the treatment of these problems as provided in part three of this volume and also in my book
Human Action. If one wants to avoid the recurrence of economic crises, one must avoid the expansion of credit that creates the boom and inevitably leads into the slump.
Even if for the sake of argument we neglect to refer to these issues, one must realize that conditions are no longer such as the nineteenth-century champions of bank-credit expansion had in mind.
These statesmen and authors regarded the government’s financial needs as the main and practically the only threat to the privileged bank’s or banks’ solvency. Ample historical experience had proved that the government could and did force the banks to lend to them. Suspension of the banknotes’ convertibility and legal-tender provisions had transformed the “hard” currencies of many countries into questionable paper money. The logical conclusion to be drawn from these facts would have been to do away with privileged banks altogether and to subject all banks to the rule of common law and the commercial codes that oblige everybody to perform contracts in full faithfulness to the pledged word. Free banking would have spared the world many crises and catastrophes. But the tragic error of nineteenth-century bank doctrine was the belief that lowering the rate of interest below the height it would have on an unhampered market is a blessing for a nation and that credit expansion is the right means for the attainment of this end. Thus arose the characteristic duplicity of the bank policy. The central bank or banks must not lend to the government but should be free, within certain limits, to expand credit to business. The idea was that in this way one could make the central banking function independent of the government.
Such an arrangement presupposes that government and business are two distinct realms of the conduct of affairs. The government levies taxes but it does not interfere with the way the various enterprises operate. If the government meddles with central-bank affairs, its objective is to borrow for the treasury and not to induce the banks to lend more to business. In making bank loans to the government illegal, the bank’s management is enabled to gauge its credit transactions in accordance with the needs of business only.
Whatever the merits or demerits of this point of view may have been in older days,
*10 it is obvious that it is no longer of any consequence. The main inflationary motive of our day is the so-called full-employment policy, not the treasury’s incapacity to fill its empty vaults from sources other than bank loans. Monetary policy is regarded—wrongly, of course—as an instrument for keeping wage rates above the height they would have reached on an unhampered labor market. Credit expansion is subservient to the unions. If a hundred or seventy years ago the government of a Western nation had ventured to extort a loan from the central bank, the public would unanimously have sided with the bank and thwarted the plot. But for many years there has been little opposition to credit expansion for the sake of “creating jobs,” that is, for providing business with the money needed for the payment of the wage rates which the unions, strongly aided by the government, force business to grant. Nobody took notice of warning voices when England in 1931 and the United States in 1933 entered upon the policy for which Lord Keynes, a few years later in his
General Theory, tried to concoct a justification, and when in 1936 Blum, in imposing upon the French employers the so-called Matignon agreements, ordered the Bank of France to lend freely the sums business needed for complying with the dictates of the unions.
Inflation and credit expansion are the means to obfuscate the fact that there prevails a nature-given scarcity of the material things on which the satisfaction of human wants depends. The main concern of capitalist private enterprise is to remove this scarcity as much as possible and to provide a continuously improving standard of living for an increasing population. The historian cannot help noting that laissez-faire and rugged individualism have to an unprecedented extent succeeded in their endeavors to supply the common man more and more amply with food, shelter, and many other amenities. But however remarkable these improvements may be, there will always be a strict limit to the amount that can be consumed without reducing the capital available for the continuation and, even more, the expansion of production.
In older ages social reformers believed that all that was needed to improve the material conditions of the poorer strata of society was to confiscate the surplus of the rich and to distribute it among those having less. The falsehood of this formula, despite the fact that it is still the ideological principle guiding present-day taxation, is no longer contested by any reasonable man. One may neglect stressing the point that such a distribution can add only a negligible amount to the income of the immense majority. The main thing is that the total amount produced in a nation or in the whole world over a definite period of time is not a magnitude independent of the mode of society’s economic organization. The threat of being deprived by confiscation of a considerable or even the greater part of the yield of one’s own activities slackens the individual’s pursuit of wealth and thus results in a diminution of the national product. The Marxian socialists once indulged in reveries concerning a fabulous increase in riches to be expected from the socialist mode of production. The truth is that every infringement of property rights and every restriction of free enterprise impairs the productivity of labor. One of the foremost concerns of all parties hostile to economic freedom is to withhold this knowledge from the voters. The various brands of socialism and interventionism could not retain their popularity if people were to discover that the measures whose adoption is hailed as social progress curtail production and tend to bring about capital decumulation. To conceal these facts from the public is one of the services inflation renders to the so-called progressive policies. Inflation is the true opium of the people and it is administered to them by anticapitalist governments and parties.
3 Currency Reform in Ruritania
When compared with conditions in the United States or in Switzerland, Ruritania appears a poor country. The average income of a Ruritanian is below the average income of an American or a Swiss.
Once, in the past, Ruritania was on the gold standard. But the government issued little sheets of printed paper to which it assigned legal-tender power in the ratio of one paper rur to one gold rur. All residents of Ruritania were made to accept any amount of paper rurs as the equivalent of the same nominal amount of gold rurs. The government alone did not comply with the rule it had decreed. It did not convert paper rurs into gold rurs in accordance with the ratio 1 : 1. As it went on increasing the quantity of paper rurs, the effects resulted which Gresham’s law describes. The gold rurs disappeared from the market. They were either hoarded by Ruritanians or sold abroad.
Almost all the nations of the earth have behaved in the way the Ruritanian government did. But the rates of the inflationary increase of the quantities of their national fiat money have been different. Some nations were more moderate in issuing additional quantities, some less. The result is that the exchange ratios between the various nations’ local fiat-money currencies are no longer the same ratios that prevailed between their currencies in the period before they went off the gold standard. In those old days five gold rurs were equal to one gold dollar. Although today’s dollar is no longer the equivalent of the weight of gold it represented under the gold standard, that is, before 1933, 100 paper rurs are needed to buy one of these depreciated dollars. A short time ago eighty paper rurs could buy one dollar. If the present rates of inflation both in the United States and in Ruritania do not change, the paper rur will drop more and more in terms of dollars.
The Ruritanian government knows very well that all it has to do in order to prevent a further depreciation of the paper rur as against the dollar is to slow down the deficit spending it finances by continued inflation. In fact, in order to maintain a stable exchange rate against the dollar, it would not be forced to abandon inflation altogether. It would only have to reduce it to a rate in due proportion to the extent of American inflation. But, government officials say, it is impossible for Ruritania, being a poor country, to balance its budget with a smaller amount of inflation than the present one. For such a reduction would enjoin upon it the necessity of undoing some of the results of social progress and of relapsing into the conditions of “social backwardness” of the United States. The government has nationalized railroads, telegraphs, and telephones and operates various plants, mines, and branches of industry as national enterprises. Every year the conduct of affairs of almost all the public undertakings produces a deficit that must be covered by taxes collected from the shrinking group of nonnationalized and nonmunicipalized businesses. Private business is a source of the treasury’s revenue. Nationalized industry is a drain upon the government’s funds. But these funds would be insufficient in Ruritania if not swelled by more and more inflation.
From the point of view of monetary technique the stabilization of a national currency’s exchange ratio as against foreign, less-inflated currencies or against gold is a simple matter. The preliminary step is to abstain from any further increase in the quantity of domestic currency. This will at the outset stop the further rise in foreign-exchange rates and the price of gold. After some oscillations a somewhat stable exchange rate will appear, the height of which depends on the purchasing-power parity. At this rate it no longer makes any difference whether one buys or sells against currency A or currency B.
But this stability cannot last indefinitely. While an increase in the production of gold or an increase in the issuance of dollars continues abroad, Ruritania now has a currency the quantity of which is rigidly limited. Under these conditions there can no longer prevail full correspondence between the movements of commodity prices on the Ruritanian markets and those on foreign markets. If prices in terms of gold or dollars are rising, those in terms of rurs will lag behind them or even drop. This means that the purchasing-power parity is changing. A tendency will emerge toward an enhancement of the price of the rur as expressed in gold or dollars. When this trend becomes manifest, the propitious moment for the completion of the monetary reform has arrived. The exchange rate that prevails on the market at this juncture is to be promulgated as the new legal parity between the rur and either gold or the dollar. Unconditional convertibility at this legal rate of every paper rur against gold or dollars and vice versa is henceforward to be the fundamental principle.
The reform thus consists of two measures. The first is to end inflation by setting an insurmountable barrier to any further increase in the supply of domestic money. The second is to prevent the relative deflation that the first measure will, after a certain time, bring about in terms of other currencies the supply of which is not rigidly limited in the same way. As soon as the second step has been taken, any amount of rurs can be converted into gold or dollars without any delay and any amount of gold or dollars into rurs. The agency, whatever its appellation may be, that the reform law entrusts with the performance of these exchange operations needs for technical reasons a certain small reserve of gold or dollars. But its main concern is, at least in the initial stage of its functioning, how to provide the rurs necessary for the exchange of gold or foreign currency against rurs. To enable the agency to perform this task, it has to be entitled to issue additional rurs against a full—100 percent—coverage by gold or foreign exchange bought from the public.
It is politically expedient not to charge this agency with any responsibilities and duties other than those of buying and selling gold or foreign exchange according to the legal parity. Its task is to make this legal parity an effective real market rate, preventing, by unconditional redemption of rurs, a drop of their market price against legal parity, and, by unconditional buying of gold or foreign exchange, an enhancement of the price of rurs as against legal parity.
At the very start of its operations the agency needs, as has been mentioned, a certain reserve of gold or foreign exchange. This reserve has to be lent to it either by the government or by the central bank, free of interest and never to be recalled. No business other than this preliminary loan must be negotiated between the govern ment and any bank or institution dependent on the government on the one hand and the agency on the other hand.
*11 The total amount of rurs issued before the start of the new monetary regime must not be increased by any operations on the part of the government; only the agency is free to issue additional new rurs, rigidly complying in such issuance with the rule that each of these new rurs must be fully covered by gold or foreign exchange paid in by the public in exchange for them.
The government’s mint may go on to coin and to issue as many fractional or subsidiary coins as seem to be needed by the public. In order to prevent the government from misusing its monopoly of mintage for inflationary ventures and flooding the market, under the pretext of catering to peoples’ demand for “change,” with huge quantities of such tokens, two provisions are imperative. To these fractional coins only a strictly limited legal-tender power should be given for payments to any payee but the government. Against the government alone they should have unlimited legal-tender power, and the government, moreover, must be obliged to redeem in rurs, without any delay and without any cost to the bearer, any amount presented, either by any private individual, firm, or corporation or by the agency. Unlimited legal-tender power must be reserved to the various denominations of banknotes of one rur and upward, issued either before the reform or, if after the reform, against full coverage in gold or foreign exchange.
Apart from this exchange of fractional coins against legal-tender rurs the agency deals exclusively with the public and not with the government or any of the institutions dependent on it, especially not with the central bank. The agency serves the public and deals exclusively with that part of the public that wants to avail itself, of its own free accord, of the agency’s services. But no privileges are accorded to the agency. It does not get a monopoly for dealing in gold or foreign exchange. The market is perfectly free from any restriction. Everybody is free to buy or sell gold or foreign exchange. There is no centralization of such transactions. Nobody is forced to sell gold or foreign exchange to the agency or to buy gold or foreign exchange from it.
When these measures are once achieved, Ruritania is either on the gold-exchange standard or on the dollar-exchange standard. It has stabilized its currency as against gold or the dollar. This is enough for the beginning. There is no need for the moment to go further. No longer threatened by a breakdown of its currency, the nation can calmly wait to see how monetary affairs in other countries will develop.
The reform suggested would deprive the government of Ruritania of the power to spend any rur above the sums collected by taxing the citizens or by borrowing from the public, whether domestic or foreign. Once this is achieved, the specter of an unfavorable balance of payment fades away. If Ruritanians want to buy foreign products, they must export domestic products. If they do not export, they cannot import.
But, says the inflationist, what about the flight of capital? Will not unpatriotic citizens of Ruritania and foreigners who have invested capital within the country try to transfer their capital to other countries offering better prospects for business?
John Badman, a Ruritanian, and Paul Yank, an American, have invested in Ruritania in the past. Badman owns a mine, Yank a factory. Now they realize that their investments are unsafe. The Ruritanian government is committed to a policy that confiscates not only all the yields of their investments but step by step the substance too. Badman and Yank want to salvage what still can be salvaged; they want to sell against rurs and to transfer the proceeds by buying dollars and exporting them. But their problem is to find a buyer. If all those who have the funds needed for such a purchase think like them, it will be absolutely impossible to sell even at the lowest price. Badman and Yank have missed the right moment. Now it is too late.
But perhaps there are buyers. Bill Sucker, an American, and Peter Simple, a Ruritanian, believe that the prospects of the investments concerned are more propitious than Badman and Yank assume. Sucker has dollars ready; he buys rurs and against these rurs Yank’s factory. Yank buys the dollars Sucker has sold to the agency. Simple has saved rurs and invests his savings in purchasing Badman’s mine. It would have been possible for him to employ his savings in a different way, to buy producers’ or consumers’ goods in Ruritania. The fact that he does not buy these goods brings about a drop in their prices or prevents a rise which would have occurred if he had bought them. It disarranges the price structure on the domestic market in such a way as to make exports possible that could not be effected before or to prevent imports which were effected before. Thus it produces the amount of dollars which Badman buys and sends abroad.
A specter that worries many advocates of foreign-exchange control is the assumption that the Ruritanians engaged in export trade could leave the foreign-exchange proceeds of their business abroad and thus deprive their country of a part of its foreign exchange.
Miller is such an exporter He buys commodity A in Ruritania and sells it abroad. Now he chooses to go out of business and to transfer all his assets to a foreign country. But this does not stop Ruritania’s exporting A. As according to our assumption there can be profits earned by buying A in Ruritania and selling it abroad, the trade will go on. If no Ruritanian has the funds needed for engaging in it, foreigners will fill the gap. For there are always people in markets not entirely destroyed by government sabotage who are eager to take advantage of any opportunity to earn profits.
Let us emphasize this point again: If people want to consume what other people have produced, they must pay for it by giving the sellers something they themselves have produced or by rendering them some services. This is true in the relation between the people of the state of New York and those of Iowa no less than in the relation between the people of Ruritania and those of Laputania. The balance of payments always balances. For if the Ruritanians (or New Yorkers) do not pay, the Laputanians (or Iowans) will not sell.
4 The United States’ Return to a Sound Currency
With Washington politicians and Wall Street pundits the problem of a return to the gold standard is taboo. Only imbecile or ignorant people, say the professorial and journalistic apologists of inflation, can nurture such an absurd idea.
These gentlemen would be perfectly right if they were merely to assert that the gold standard is incompatible with the methods of deficit spending. One of the main aims of a return to gold is precisely to do away with this system of waste, corruption, and arbitrary government. But they are mistaken if they would have us believe that the reestablishment and preservation of the gold standard is Economically and technically impossible.
The first step must be a radical and unconditional abandonment of any further inflation. The total amount of dollar bills, whatever their name or legal characteristic may be, must not be increased by further issuance. No bank must be permitted to expand the total amount of its deposits subject to check or the balance of such deposits of any individual customer, be he a private citizen or the U.S. Treasury, otherwise than by receiving cash deposits in legal-tender banknotes from the public or by receiving a check payable by another domestic bank subject to the same limitations. This means a rigid 100 percent reserve for all future deposits; that is, all deposits not already in existence on the first day of the reform.
At the same time all restrictions on trading and holding gold must be repealed. The free market for gold is to be reestablished. Everybody, whether a resident of the United States or of any foreign country, will be free to buy and to sell, to lend and to borrow, to import and to export, and, of course, to hold any amount of gold, whether minted or not minted, in any part of the nation’s territory as well as in foreign countries.
It is to be expected that this freedom of the gold market will result in the inflow of a considerable quantity of gold from abroad. Private citizens will probably invest a part of their cash holdings in gold. In some foreign countries the sellers of this gold exported to the United States may hoard the dollar bills received and leave the balances with American banks untouched. But many or most of these sellers of gold will probably buy American products.
In this first period of the reform it is imperative that the American government and all institutions dependent upon it, including the Federal Reserve System, keep entirely out of the gold market. A free gold market could not come into existence if the administration were to try to manipulate the price by underselling. The new monetary regime must be protected against malicious acts by officials of the Treasury and the Federal Reserve System. There cannot be any doubt that officialdom will be eager to sabotage a reform whose main purpose is to curb the power of the bureaucracy in monetary matters.
The unconditional prohibition of the further issuance of any piece of paper to which legal-tender power is granted refers also to the issuance of the type of bills called silver certificates. The constitutional prerogative of Congress to decree that the United States is bound to buy definite quantities of a definite commodity, whether silver or potatoes or something else, at a definite price exceeding the market price and to store or to dump the quantities purchased must not be infringed. But such purchases are henceforth to be paid out of funds collected by taxing the people or by borrowing from the public.
It is probable that the price of gold established after some oscillations on the American market will be higher than $35 per ounce, the rate of the Gold Reserve Act of 1934. It may be somewhere between $36 and $38, perhaps even somewhat higher. Once the market price has attained some stability, the time will have come to decree this market rate as the new legal parity of the dollar and to secure its unconditional convertibility at this parity.
A new agency is to be established, the Conversion Agency. The United States government lends to it a certain amount, let us say one billion dollars, in gold bullion (computed at the new parity), free of interest and never to be recalled. The Conversion Agency has two functions only: First, to sell gold bullion at the parity price to the public against dollars without any restriction. After a short time, when the mint will have coined a sufficient quantity of new American gold coins, the Conversion Agency will be obliged to hand out such gold pieces against paper dollars and checks drawn upon a solvent American bank. Second, to buy, against dollar bills at the legal parity, any amount of gold offered to it. To enable the Conversion Agency to execute this second task it is to be entitled to issue dollar bills against a 100 percent reserve in gold.
The Treasury is bound to sell gold—bullion or new American coins—to the Conversion Agency at legal parity against any kind of American legal-tender bills issued before the start of the reform, against American token coins, or against checks drawn upon a member bank. To the extent that such sales reduce the government’s gold holdings, the total amount of all varieties of legal-tender paper sheets, issued before the start of the reform, and of member-bank deposits subject to check is to be reduced. How this reduction is to be distributed among the various classes of these types of currency can be left, apart from the problem of the banknotes of small denominations, to be dealt with later,
*12 to the discretion of the Treasury and the Federal Reserve Board.
It is essential for the reform suggested that the Federal Reserve System should be kept out of its way. Whatever one may think about the merits or demerits of the Federal Reserve legislation of 1913, the fact remains that the system has been abused by the most reckless inflationary policy. No institution and no man connected in any way with the blunders and sins of the past decades must be permitted to influence future monetary conditions.
The Federal Reserve System is saddled with an awkward problem, namely, the huge amount of government bonds held by the member banks. Whatever solution may be adopted for this question, it must not affect the purchasing power of the dollar Government finance and the nation’s medium of exchange have in the future to be two entirely separate things.
The banknotes issued by the Federal Reserve System as well as the silver certificates may remain in circulation. Unconditional convertibility and the strict prohibition of any further increase of their amount will have radically changed their catallactic character It is this alone that counts.
However, a very important change concerning the denomination of these notes is indispensable. What the United States needs is not the gold-exchange standard but the classical old gold standard, decried by the inflationists as orthodox. Gold must be in the cash holdings of everybody. Everybody must see gold coins changing hands, must be used to having gold coins in his pockets, to receiving gold coins when he cashes his paycheck, and to spending gold coins when he buys in a store.
This state of affairs can be easily achieved by withdrawing all bills of the denominations of five, ten, and perhaps also twenty dollars from circulation. There will be under the suggested new monetary regime two classes of legal-tender paper bills: the old stock and the new stock. The old stock consists of all those paper sheets that at the start of the reform were in circulation as legal-tender paper, without regard to their appellation and legal quality other than legal-tender power. It is strictly forbidden to increase this stock by the further issuance of any additional notes of this class. On the other hand, it will decrease to the extent that the Treasury and the Federal Reserve Board decree that the reduction in the total amount of legal-tender notes of this old stock plus bank deposits subject to check, existing at the start of the reform, has to be effected by the final withdrawal and destruction of definite quantities of such old-stock legal-tender notes. Moreover, the Treasury is bound to withdraw from circulation, against the new gold coins, and to destroy, within a period of one year after the promulgation of the new legal gold parity of the dollar, all notes of five, ten, and perhaps also twenty dollars.
It does not require any special mention that the new-stock legal-tender notes to be issued by the Conversion Agency must be issued only in denominations of one dollar or fifty dollars and upward.
Old British banking doctrine banned small banknotes (in their opinion, notes smaller than £5) because it wanted to protect the poorer strata of the population, supposed to be less familiar with the conditions of the banking business and therefore more liable to be cheated by wicked bankers. Today the main concern is to protect the nation against a repetition of the inflationary practices of governments. The gold-exchange standard, whatever argument may be advanced in its favor, is vitiated by an incurable defect. It offers to governments an easy opportunity to embark upon inflation unbeknown to the nation. With the exception of a few specialists, nobody becomes aware in time of the fact that a radical change in monetary matters has occurred. Laymen, that is 9,999 out of 10,000 citizens, do not realize that it is not commodities that are becoming dearer but their tender that is becoming cheaper.
What is needed is to alarm the masses in time. The workingman in cashing his paycheck should learn that some foul trick has been played upon him. The President, Congress, and the Supreme Court have clearly proved their inability or unwillingness to protect the common man, the voter, from being victimized by inflationary machinations. The function of securing a sound currency must pass into new hands, into those of the whole nation. As soon as Gres ham’s law begins to come into play and bad paper drives good gold out of the pockets of the common man, there should be a stir. Perpetual vigilance on the part of the citizens can achieve what a thousand laws and dozens of alphabetical bureaus with hordes of employees never have and never will achieve: the preservation of a sound currency.
The classical or orthodox gold standard alone is a truly effective check on the power of the government to inflate the currency. Without such a check all other constitutional safeguards can be rendered vain.
5 The Controversy Concerning the Choice of the New Gold Parity
Some advocates of a return to the gold standard disagree on an important point with the scheme designed in the preceding section. In the opinion of these dissenters there is no reason to deviate from the gold price of $35 per ounce as decreed in 1934. This rate, they assert, is the legal parity, and it would be iniquitous to devalue the dollar in relation to it.
The controversy between the two groups, those advocating the return to gold at the previous parity (whom we may call the restorers) and those recommending the adoption of a new parity consonant with the present market value of the currency that is to be put upon a gold basis (we may call them the stabilizers), is not new. It has flared up whenever a currency depreciated by inflation has had to be returned to a sound basis.
The restorers look upon money primarily as the standard of deferred payments. A consistent restorer would have to argue in this way: People have in the past, that is, before 1933, made contracts in virtue of which they promised to pay a definite amount of dollars which at that time meant standard dollars, containing 25.8 grains of gold, nine-tenths fine. It would be manifestly unfair to the creditors to give the debtors the right to fulfill such contracts by the payment of the same nominal number of dollars containing a smaller weight of gold.
However, the reasoning of such consistent restorers would be correct only if all existing claims to deferred payments had been contracted before 1933 and if the present creditors of such contracts were the same people (or their heirs) who had originally made the contracts. Both these assumptions are contrary to fact. Most of the pre-1933 contracts have already been settled in the two decades that have elapsed. There are, of course, also government bonds, corporate bonds, and mortgages of pre-1933 origin. But in many or even in most cases these claims are no longer held by the same people who held them before 1933. Why should a man who in 1951 bought a corporate bond issued in 1928 be indemnified for losses which not he himself but one of the preceding owners of this bond suffered? And why should a municipality or a corporation that borrowed depreciated dollars in 1945 be liable to pay back dollars of greater gold weight and purchasing power?
In fact there are in present-day America hardly any consistent restorers who would recommend a return to the old pre-Roosevelt dollar. There are only inconsistent restorers who advocate a return to the Roosevelt dollar of 1934, the dollar of 15 5/21 grains of gold, nine-tenths fine. But this gold content of the dollar, fixed by the President in virtue of the Gold Reserve Act of January 30, 1934, was never a legal parity. It was, as far as the domestic affairs of the United States are concerned, merely of academic value. It was without any legal-tender validity. Legal tender under the Roosevelt legislation was only various sheets of printed paper. These sheets of paper could not be converted into gold. There was no longer any gold parity of the dollar. To hold gold was a criminal offense for the residents of the United States. The Roosevelt gold price of $35 per ounce (instead of the old price of $20.67 per ounce) had validity only for the government’s purchases of gold and for certain transactions between the American Federal Reserve and foreign governments and central banks. Those juridical considerations that the consistent restorers could possibly advance in favor of a return to the pre-Roosevelt dollar parity are of no avail when advanced in favor of the rate of 1934 that was not a parity.
It is paradoxical indeed that the inconsistent restorers try to justify their proposal by referring to honesty. For the role the gold content of the dollar they want to restore played in American monetary history was certainly not honest in the sense in which they employ this term. It was a makeshift in a scheme which these very restorers themselves condemn as dishonest.
However, the main deficiency of any form of the restorers’ arguments, whether they consistently advocate the McKinley dollar or inconsistently the Roosevelt dollar, is to be seen in the fact that they look upon money exclusively from the point of view of its function as the standard of deferred payments. As they see it, the main fault or even the only fault of an inflationary policy is that it favors the debtors at the expense of the creditors. They neglect the other more general and more serious effects of inflation.
Inflation does not affect the prices of the various commodities and services at the same time and to the same extent. Some prices rise sooner, some lag behind. While inflation takes its course and has not yet exhausted all its price-affecting potentialities, there are in the nation winners and losers. Winners—popularly called profiteers if they are entrepreneurs—are people who are in the fortunate position of selling commodities and services the prices of which are already adjusted to the changed relation of the supply of and the demand for money while the prices of commodities and services they are buying still correspond to a previous state of this relation. Losers are those who are forced to pay the new higher prices for the things they buy while the things they are selling have not yet risen at all or not sufficiently. The serious social conflicts which inflation kindles, all the grievances of consumers, wage earners, and salaried people it originates, are caused by the fact that its effects appear neither synchronously nor to the same extent. If an increase in the quantity of money in circulation were to produce at one blow proportionally the same rise in the prices of every kind of commodities and services, changes in the monetary unit’s purchasing power would, apart from affecting deferred payments, be of no social consequence; they would neither benefit nor hurt anybody and would not arouse political unrest. But such an evenness in the effects of inflation—or, for that matter, of deflation—can never happen.
The great Roosevelt-Truman inflation has, apart from depriving all creditors of a considerable part of principal and interest, gravely hurt the material concerns of a great number of Americans. But one cannot repair the evil done by bringing about a deflation. Those favored by the uneven course of the deflation will only in rare cases be the same people who were hurt by the uneven course of the inflation. Those losing on account of the uneven course of the deflation will only in rare cases be the same people whom the inflation has benefited. The effects of a deflation produced by the choice of the new gold parity at $35 per ounce would not heal the wounds inflicted by the inflation of the two last decades. They would merely open new sores.
Today people complain about inflation. If the schemes of the restorers are executed, they will complain about deflation. As for psychological reasons, the effects of deflation are much more unpopular than those of inflation; a powerful proinflation movement would spring up under the disguise of an antideflation program and would seriously jeopardize all attempts to reestablish a sound-money policy.
Those questioning the conclusiveness of these statements should study the monetary history of the United States. There they will find ample corroborating material. Still more instructive is the monetary history of Great Britain.
When, after the Napoleonic wars, the United Kingdom had to face the problem of reforming its currency it chose the return to the prewar gold parity of the pound and gave no thought to the idea of stabilizing the exchange ratio between the paper pound and gold as it had developed on the market under the impact of the inflation. It preferred deflation to stabilization and to the adoption of a new parity consonant with the state of the market. Calamitous economic hardships resulted from this deflation; they stirred social unrest and begot the rise of an inflationist movement as well as the anticapitalistic agitation from which after a while Engels and Marx drew their inspiration.
After the end of World War I England repeated the error committed after Waterloo. It did not stabilize the actual gold value of the pound. It returned in 1925 to the old prewar and preinflation parity of the pound. As the labor unions would not tolerate an adjustment of wage rates to the increased gold value and purchasing power of the pound, a crisis of British foreign trade resulted. The government and the journalists, both terrorized by the union leaders, timidly refrained from making any allusion to the height of wage rates and the disastrous effects of the union tactics. They blamed a mysterious overvaluation of the pound for the decline in British exports and the resulting spread of unemployment. They knew only one remedy, inflation. In 1931 the British government adopted it.
There cannot be any doubt that British inflationism got its strength from the conditions that had developed out of the deflationary currency reform of 1925. It is true that but for the stubborn policy of the unions the effects of the deflation would have been absorbed long before 1931. Yet the fact remains that in the opinion of the masses, conditions gave an apparent justification to the Keynesian fallacies. There is a close connection between the 1925 reform and the popularity that inflationism enjoyed in Great Britain in the thirties and forties.
The inconsistent restorers advance in favor of their plans the fact that the deflation they would bring about would be small, since the difference between a gold price of $35 and a gold price of $37 or $38 is rather slight. Now whether this difference is to be regarded as slight or not is a matter of an arbitrary judgment. Let us for the sake of argument accept its qualification as slight. It is certainly true that a smaller deflation has less undesirable effects than a bigger one. But this truism is no valid argument in favor of a deflationary policy the inexpediency of which is undeniable.
6 Concluding Remarks
The present unsatisfactory state of monetary affairs is an outcome of the social ideology to which our contemporaries are committed and of the economic policies which this ideology begets. People lament over inflation, but they enthusiastically support policies that could not go on without inflation. While they grumble about the inevitable consequences of inflation, they stubbornly oppose any attempt to stop or to restrict deficit spending.
The suggested reform of the currency system and the return to sound monetary conditions presuppose a radical change in economic philosophies. There cannot be any question of the gold standard as long as waste, capital decumulation, and corruption are the foremost characteristics of the conduct of public affairs.
Cynics dispose of the advocacy of a restitution of the gold standard by calling it utopian. Yet we have only the choice between two utopias: the utopia of a market economy, not paralyzed by government sabotage on the one hand, and the utopia of totalitarian all-round planning on the other hand. The choice of the first alternative implies the decision in favor of the gold standard.
Human Action (New Haven: Yale University Press, 1949), pp. 204-6.
Human Action, pp. 463-68.
The Economics of Control (New York, 1944), pp. 307-8.
American Affairs 8 (1946): 35-36.
Human Action, pp. 55-57, 347-49.
Human Action, pp. 535-83, 787-94.
The General Theory of Employment, Interest and Money (London, 1936), p. 264.
Human Action, pp. 458-59.