admit it: I tend
to be early. The idea of private money — often referred
to as "competing
currencies" — has always fascinated
me. I persuaded Jim
Michaels, the late, great editor of Forbes Magazine,
to let me translate the little-known academic literature into
journalese in this article, which he published under the title
Do You Want To Be Paid In Rockefellers? In Wristons? Or How
About A Hayek? almost (ahem!) exactly twenty years ago. (May
30, 1988). The Great Inflation of the 1970s was then still a live
memory. For some years, my account was regularly assigned in college
courses. Now, GOP Presidential candidate Ron
Paul seems to have single-handedly revived
the issue with his relentless criticisms of the Federal Reserve.
(Click here for Google web
search). I still think it's going to happen — just as there will
be an immigration cut-off.
Reserve System will be 75
years old in December. A small but growing band of academic
economists proposes a special sort of birthday celebration: The
Fed, they say, should be abolished.
The sole bulwark we have against runaway inflation and fiscal irresponsibility?
can’t imagine life without a currency-issuing central bank, although
in fact the Fed is younger than one of its most relentless critics,
Nobel laureate Milton
Friedman, still going strong at 76 [R.
I. P. 1912–2006] and hard at work at California’s Hoover
The Fed allegedly
manages the country’s money supply in order to prevent such economic
disturbances as inflation, deflation and depression. But it is a
matter of record that, since the Fed arrived, economic disturbances
have been more severe than previously — notably the Great
Depression of 1929 and the Great Inflation of the Seventies.
In the process, the purchasing power of the dollar has almost completely
eroded. Even now, inflation is still gnawing away at around 4% a
year, compared with a mere 3.3% when President Richard Nixon first
imposed wage and price controls in 1971.
distresses some. They argue that, far from preventing these disturbances,
central banking may exacerbate them. The Fed has been accused of
too tight in the 1930s and too loose in the 1970s and of innumerable
lesser errors. After bitter debate, most economists have come to
accept at least a part of this critique.
Milton Friedman has advocated doing away with some of the Fed’s
flexibility by forcing it to expand the money supply only at a fixed
annual rate approximating the long-run growth of the economy. The
Fed’s new critics, however, go further. They think the government
should be out of the money business altogether. They argue that
money could and should be provided competitively by the private
sector — just like baked beans, business magazines or any other
is money, isn’t it? How can you have different kinds of money in
the same economy?
The idea of
Citibank and Chase Manhattan issuing their own money may indeed
seem mind-boggling. What would their currencies be called — Wristons
But the truth is that there have been several episodes of private,
competing monies in world economic history, including in the U.S.
Recent research is suggesting they worked much better than had been
financial deregulations at home and floating exchanges rates abroad
are creating an environment in which elements of a competitive system
are already emerging — without the permission of professors or politicians.
In his forthcoming book, Free
Banking and Monetary Reform, former Manhattan Institute
Glasner calls this phenomenon “the competitive breakthrough”
that might eventually lead to the complete privatization of
money monopolies were effectively universal by the early 20th century.
Even free market economists, with few exceptions, took them for
granted. But these monopolies became much easier to question after
Friedrich A. Hayek, who received the Nobel Prize for Economics in
1974, published his Denationalization
of Money in 1976 and expanded upon it in 1978.
that, on reflection, he no longer thought government money monopolies
were either necessary or desirable, given their record of inflation.
Instead, private institutions such as banks should be allowed to
issue their own monies, denominated as they wished.
wisdom had assumed that a profit-seeking bank would immediately
print too much money. But Hayek pointed out that this course would
be self-defeating. If a bank over-issued its currency, causing it
to depreciate, people wouldn’t want to accept or hold it, preferring
that of more conservative banks. The offending bank’s currency would
go to a discount and, in short order, the bank would have to curb
its enthusiasm. Competition, Hayek said, would do a better job of
compelling private institutions to maintain their money’s value
than politics had with public institutions like the Fed.
Maybe — but
let’s be practical. How would I buy my groceries? Suppose the prices
were marked in Rockefellers and all I had were Wristons? Suppose
I’m a New Yorker
Francisco? San Franciscans might prefer BankAmericas.
What good would my Wristons be? How could a merchant function if
his customers kept coming in with different kinds of currencies?
How could a businessman keep his books?
to these interesting questions depends partly on which of the several
different proposals for privatizing money is under discussion. Hayek’s
version is particularly radical. In most historical
episodes of private money, banks issued their own notes but
denominated them in the national unit of account — the dollar, the
pound. These notes usually exchanged at par and would be discounted
only as a last resort in specific circumstances, such as overissue.
But more generally
it is clear from the response of merchants in border zones like
Tijuana or Toronto, and from inflation-racked countries like Israel
or Argentina that are evolving a de facto U.S. dollar standard,
the costs of handling parallel currencies can easily be exceeded
by the benefits. Computers and hand-held calculators reduce the
confusion, just as they have helped business to handle international
floating exchange rates.
The fact is
that free markets don’t produce chaos. Efficiency will probably
dictate that just a few kinds of monies, perhaps only one, will
become universally accepted — exactly as the international computer
industry has spontaneously evolved standard operating systems.
Hayek’s proposal and the whole competing currencies concept, you
have to think about the nature of money. Most laymen, and some economists,
assume that money is a collective convenience requiring government
to organize, like national defense. But the historical evidence
seems to be that in reality money developed all by itself. Merchants
just agreed upon common stores of value and mediums of exchange
because they found using them more efficient than barter — an example
of what Hayek calls “spontaneous order.”
Coins are traditionally
supposed to have been invented in the 7th century B.C. by the Lydians,
whose King Croesus became a legend for his wealth. But significantly,
David Glasner reports, the earliest surviving coins appear to have
been privately issued. The Lydian royal minting monopoly was only
later imposed — by another king for whom the Greeks invented the
have tended to confirm the private origins of money. In one famous
case, cigarettes spontaneously evolved as the medium of exchange
in a World War II prisoner
of war camp. In much of Europe after WWII, U.S. nylon stockings
were a kind of sexual currency.
not governments were needed in the money business, however, they
undeniably found getting into it an irresistible source of revenue
and power, particularly in time of war or national emergency. Minting
coins was easy and profitable. Most convenient of all for a spendthrift
king, the coins could be debased — reissued with the same face value
but a lesser amount of precious metal — or actually clipped of some
of their gold and recirculated. Later, when money developed into
a claim on some other asset rather than being intrinsically valuable
in itself, governments discovered that they could simply overissue
all this would eventually result in too much money chasing too few
goods and rising prices — a process still going on merrily today.
But that’s in the long run. And in the meantime, monkeying about
with money produced interesting spasms in the economy that could
be very useful politically — for example, to influence elections.
can be damned but not destroyed. By the Middle Ages, even governments
that monopolized money found themselves confronted with a burgeoning
banking industry that was being summoned into existence by the growth
Banks not only
accepted deposits of money from customers, on which they paid interest,
but also made loans to other customers, on which they charged interest.
A loan was made by a bookkeeping entry that created a deposit upon
which this new debtor could draw. These new banks were able to incur
multiple liabilities against the same hard cash, because bank IOUs
were exchanged among the public in settlement of their own affairs
and rarely presented for payment. In effect, the banks were creating
tolerated this development largely because they needed to borrow
money themselves, badly. For example, the Bank of England, the ancestor
of all central banks, was first
granted its charter in 1694 because it promised to buy William
III’s government bonds and finance his wars
when Parliament would not.
in the U.S., the 1863 National Bank Act compelled qualifying banks
to hold specified amounts of federal debt, helping to pay for the
So even a government’s
monopoly over the issuance of currency gives it only indirect control
over the entire money supply. In recent years in the U.S. this control
has been exerted by a straitjacket of banking regulation — much
of it dating from the New Deal and subsequently rotted away by inflation,
and by the Fed’s ability to alter the reserves that banks are required
to maintain with it, thus affecting the size of the base upon which
they can build their pyramids of credit.
But now “financial
innovation” is producing a proliferation of irritatingly hard-to-categorize
“near monies” — for example, traveler’s checks, some of whose
issuers are bound not by reserve regulations but only by their own
self-interested prudence. Thus, in a sense, American Express is
already issuing its own private money, although denominated in and
convertible into Fed-produced dollars.
is particularly radical because it combines a number of distinct
ideas that are already quite radical enough:
banking” — banks ought to be able to issue currency and create
deposits (conceptually the same thing), choose their own reserve
ratios and generally operate entirely without regulation.
denominations — privately issued currencies need not be all denominated
in the same unit: Citibank’s Wristons and Chase Manhattan’s Rockefellers
would be traded against each other in a currency market just as
the different national currencies are today.
fiat money — these private currencies need not necessarily be
convertible into gold or any underlying commodity, but would trade
entirely on the word of the issuing bank that it would not debauch
create chaos? Is Hayek serious?
one, free banking, is very serious. New York University’s Lawrence
H. White has recently attracted much attention with his book Free
Banking in Britain, a documentation and formal analysis
of the system’s smooth working over a 128-year period in Scotland.
Scottish free banking was suppressed in 1844, not because it didn’t
work, but in the course of legislation aimed at difficulties in
the very different English banking system.
this cause chaos in the U.S.? What about the wildcat banks?
That bit of
history is far from settled. Free banking briefly flourished under
state charters in the U.S. from 1837 to the Civil War. “Wildcat
banks” were accused of locating out in the frontier forests,
with the wildcats, so that their notes could not easily be presented
for redemption. But recent studies suggest that these problems have
been much exaggerated. And most of them, it is argued, were caused
by interfering state governments and inadequate enforcement of laws
In both Scotland
and the U.S. the private money thus issued was denominated in the
national monetary unit and was theoretically interchangeable and
redeemable into gold. In the U.S., unlike in Scotland, national
branch banking was not allowed, so notes issued by unknown faraway
banks, as well as those that were suspect for other reasons, sometimes
traded at a discount. This was not, however, an impossible inconvenience:
Bill brokers sprang up to act as middlemen. It would be even less
of a problem in these days of instant communications — and, above
all, if nationwide branch banking were allowed.
wildcat banks left their clawmarks on the U.S. economics profession.
Many economists concluded that private banks had a theoretical incentive
to behave badly: They would produce money until its value had been
driven down to its cost of production, which is essentially zero.
This would cause a price explosion — severe inflation.
Glasner, however, rebuts this argument by pointing out that
a bank can make profits only to the extent that the public will
hold its money. Otherwise it will be driven into insolvency by adverse
clearings with its competitors as the public converts out of its
money and into their money. If people trust Wristons more than Rockefellers,
Chase would have to either mend its ways or be driven out of business,
and vice versa. Thus, for a bank like Chase Manhattan, the key question
would be not the cost of physically creating Rockefellers but of
keeping them in circulation. Chase’s “cost of production”
would be the resources it expended in maintaining sufficient balances
of whatever was necessary in order to convince its customers that
their Rockefellers could be redeemed whenever they wanted.
bad money drive out good?
heard of Gresham’s
law, but practically no one understands it. Queen Elizabeth
I’s financial adviser was talking
about a situation where two monies exchange at a rate fixed
by law — for example, if both are legal tender and must be accepted
in discharge of debt. Under these circumstances, people will try
to pass on the “bad” money — the money whose value is suspect,
either because of debasement or overissue — and hoard the money
that’s “good." But if the rate of exchange between the
monies is free to fluctuate, it is the debauched currency that will
depreciate and be driven out.
Nobody. A free
banking system, its advocates insist, pointing to Scotland, is not
inherently unstable. The celebrated 19th-century banking “panics”
were relatively brief and self-correcting compared with the Great
Depression, with the sound banks leading reserves to rescue unsound
ones out of their own interest in preventing general collapse, as
J.P. Morgan did in the panic
of 1907. In Scotland, banks competed for the customers of failed
banks by accepting their notes at par.
In fact, private
money proponents think the Fed’s activities as a lender of last
resort, and the New Deal’s deposit insurance programs, have actually
made the U.S. banking system’s problems worse. They have encouraged
bankers to take risks, knowing that the feds would bail them out,
and thus in effect subsidized imprudent banking. Ask
anyone in Texas.
of private monies are still arguing among themselves about other
aspects of the scheme, including Hayek’s idea number two (different
denominations) and idea number three (private fiat money). Lawrence
H. White, for example, thinks that, as in Scotland, all monies should
be denominated in the same unit, albeit visually distinguishable
so that they could trade at a discount if necessary. And he predicts
that the emerging successful money would probably turn out to be
one offering convertibility into gold or silver.
But these disputes
are not conducted with the usual academic acerbity. This is because
all private-money advocates agree that such questions can really
be settled only by allowing competition to begin. Then the free
market, to employ a key Hayekian concept, will search out the best
of money has important macroeconomic implications. It offers, according
to its advocates, a way out of the current grand impasse of monetary
For most of
its existence, the Fed has focused on interest rates, the price
of credit, assuming that the amount of money it was supplying to
the economy was less important. But interest rates are affected
by many factors, and the Fed often ended up supplying so much money
that the resulting inflation could not be ignored.
But by the
time the Fed finally admitted to the importance of the money supply,
in the early 1980s, it turned out that the demand for money — its
“velocity of circulation” — was jumping about unpredictably,
too. Thus, judged by the usual measures, the Fed supplied massive
quantities of money to the economy after 1982. But, contrary to
what Friedman and like-minded monetarists predicted, it did not
boil off into inflation. The velocity simply slowed.
So now the
Fed appears to be flying blind, following neither a price rule nor
a quantity rule, responding to ad hoc considerations such as the
beliefs of the Fed chairman or whatever exchange rate influential
politicians happen to feel would be convenient for the dollar.
would not be a problem if banks issued their own monies; it would
cease to exist. Banks would automatically extend credit to the extent
that they and their customers agree it is economically productive.
If business conditions deteriorated, loans would be liquidated,
liabilities written down to match, and the banks’ balance sheets
would shrink. Thus the quantity of money demanded by the economy
would be automatically supplied by the market, just as it now supplies
the appropriate number of automobiles. (Imagine the mess if an outfit
like the Fed were to control auto production, based on its best
guesses of what demand ought to be.)
of course, banks and customers would make mistakes. But this should
be no more disruptive than a mistake in any other business. Auto
factories do overproduce. So do builders of office buildings. But
the economy adjusts.
answer to the mystery of monetary policy is to link the dollar in
some way to gold. But gold standard advocates have always had a
problem with gold’s moderate but real fluctuations in price, which
would inflict involuntary deflations and inflations upon the economy.
Competing currencies would tend to solve this problem. Joe
Cobb, senior economist for the U.S. Congress’ Joint Economic
committee, believes that a private money convertible into gold would
eventually become dominant. “But with free banking, other types
of money would come in at the margin if there were too little or
too much gold-backed money,” Cobb says. Silver-backed, maybe,
or oil-backed. These monies would either supplement the gold-backed
currency (if the gold price had risen, causing deflation) or displace
it (if the gold price had fallen, causing inflation).
young economists in the private-money subculture have been electrified
by hints that the leader of the monetarist school, Milton Friedman
himself, is being converted. In 1986 Friedman coauthored a paper
significantly softening his view that governments necessarily have
a role in money. Even more significantly, he has abandoned his long-held
position that the Fed should aim for a fixed rate of growth in the
monetary aggregates. Now he argues that the monetary base — Fed
deposits plus currency — should be frozen and complete free banking
be allowed to pyramid upon this reserve base.
like a revised monetary rule, but in fact it isn’t. Under Friedman’s
new proposal the free market, rather than the Fed, would dictate
the size of the money supply-based on the banks’ feel for the legitimate
demand for money.
denies that his new proposal has anything to do with the volatile
velocities of the 1980s, which he blames on Fed policy. Instead,
he says he is now convinced that central bankers will never accept
moderate restraint, so he proposes to eliminate their power. However,
he agrees that under free banking the troublesome issue of velocity
would be neatly bypassed.
of private money take Friedman’s shift as confirmation that their
position is just the logical extension of market principles. “Once
the question is put, there’s only one answer,” says the University
of Sheffield’s Kevin Dowd, whose book The
State and the Monetary System is being published by the
has an estimate of the chances of money being denationalized: “Zero.”
But then, he recalls, for years economists were derided for arguing
about the feasibility of floating exchange rates. Then suddenly
the idea became reality. So, maybe the chances are better than zero.
The first victory
of the competing currency school may well be negative. By stressing
the fundamental flaws of central banking, they may help derail the
diametrically opposed proposal: to develop one world currency centrally
managed by the International Monetary Fund. This idea was the subject
of a recent cover story in the Economist magazine, and a
version of it has recently been advocated by Harvard
economist and former Carter
Administration official Richard Cooper. The single-currency
proposal appalls the private-money people, since it would mean an
immensely powerful world central bank, able to manipulate its money
without the minimal discipline existing now because investors can
flee into other currencies. The single-currency proposal, says Lawrence
H. White, would be “suicide after prolonged self-torture.”
possible that competing currencies may come into existence on their
own. Richard W. Rahn,
chief economist of the U.S. Chamber of Commerce, has actually
sketched out a proposal to launch a private currency convertible
into commodities or government currencies under prevailing laws.
He suggests using commodity futures markets to lower operating costs,
and overseas tax havens to avoid the tax problems preventing wider
use of the 1977 “gold clause” legislation that made contracts
based on gold legally enforceable. “Private money is not just
an abstract idea, but an idea whose time has come,” Rahn says.
“It’s technologically and legally feasible.”
a small network of economists attracted by competing currencies
is quietly establishing itself. Books and articles are being published,
sympathizers located (including outposts in Britain, France and
Germany) and eminent authorities intrigued. “It’s an intellectually
very respectable idea,” says Sir
Alan Walters of Johns Hopkins University, a leading monetarist
and formerly economic adviser to Prime Minister Margaret Thatcher.
“I think free banking could work quite well.”
Can a handful of thinkers change the world?
happen in the idea business. When Adam Smith (who did not regard
money as necessarily a government function) wrote The
Wealth of Nations in 1776, he commented
that to expect free trade to be established in Britain was “as
absurd as to expect that an Oceana or Utopia should be established
in it.” But his ideas prevailed in spite of the odds against
them, and some 90
years later not one British tariff was left.