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July 23, 2011

The Separation of Money and State

Who came up with the idea of a free market in money?

There may have been many scholars who’ve proposed it over the years, but I would presume the Austrian economist F.A. Hayek was the most prominent. The Nobel laureate began talking about it in the 1970’s. Hayek was an intellectual influence on Presidential candidate Rep. Ron Paul, who has introduced the Free Competition in Currency Act in Congress.

In a 1977 speech, Hayek said, [Note: in two instances I added commas for readbility that are not found in the link – JW]

If we start on this soon, we may indeed achieve a position in which at last capitalism is in a position to provide itself with the money it needs in order to function properly, a thing which it has always been denied. Ever since the development of capitalism, it has never been allowed to produce for itself the money it needs; . . . I think if the capitalists had been allowed to provide themselves with the money which they need, the competitive system would have long overcome the major fluctuations in economic activity and the prolonged periods of depression.

Interestingly, Hayek was skeptical that gold would prevail as the standard form of money in a free-market system. Until the 20th century, gold was the preferred form of money of rulers, and brilliant free-market economists such as Hayek’s mentor Ludwig von Mises assumed a gold standard as a matter of course.

But is what the rulers want necessarily what the public would prefer?

Hayek had his doubts:

I do believe that if today all the legal obstacles were removed which prevent such an issue of private money under distinct names, in the first instance indeed, as all of you would expect, people would from their own experience be led to rush for the only thing they know and understand, and start using gold. But this very fact would after a while make it very doubtful whether gold was for the purpose of money really a good standard. It would turn out to be a very good investment, for the reason that because of the increased demand for gold the value of gold would go up; but that very fact would make it very unsuitable as money. You do not want to incur debts in terms of a unit which constantly goes up in value as it would in this case, so people would begin to look for another kind of money: if they were free to choose the money, in terms of which they kept their books, made their calculations, incurred debts or lent money, they would prefer a standard which remains stable in purchasing power.

I think this is a valuable observation. Hayek believes the important thing is that the supply, and therefore the value, of a money is stable:

I think it is entirely possible for private enterprise to issue a token money which the public will learn to expect to preserve its value, provided both the issuer and the public understand that the demand for this money will depend on the issuer being forced to keep its value constant; because if he did not do so, the people would at once cease to use his money and shift to some other kind.

If the Free Competition in Currency Act passed, I think Hayek is correct that gold would be the first thing people would use as money — provided they had gold in the first place. And I agree that its value might appreciate steadily. The person as a consumer would benefit, but as a debtor or a seller of goods the effect of drastic price “deflation” in relation to gold could be ruinous.

But this underscores gold’s worthiness as the “ultimate” form of money, even if it’s not used on a day-to-day basis. Every other form of currency that might originate in a free market, whether based on another precious metal or a “scrip” or “token” money created by banks or businesses, will ultimately be judged by the stability of its price in relation to gold. A weak currency unit would buy less and less gold over time. A strong currency unit would have a stable gold price or a gradually lower gold price over time.

I predict there would a “gold standard” — not in the sense of other currencies being “pegged” to gold, but in the sense that they will be judged by the market as a worthy currency based on the stability of its gold price.

But how could a non-State, non-gold currency even come into existence?

One interesting example is the scrip issued by mining companies in the first half of the 20th centuries. In a 1987 paper, economics professor Richard H. Timberlake explored the phenomenon.

You might think this is about the infamous “company stores.” You would be right. But, as Timberlake explains in the paper, they weren’t remotely as “exploitive” as the myth suggests.

The scrip issued by mining companies were interest-free advances on an employee’s paycheck, so they could make needed purchases at the store owned by that same mining company. (The reason these companies owned the stores is that mining locations were so remote that it wasn’t in anyone else’s interest to start a business there.) Timberlake notes:

The self-sustaining nature of the scrip system, without recourse to standard money, stemmed from the fact that both the demander and supplier of scrip were active participants in both the labor market and the household goods market at the company store. This intimacy in two markets by both participants enabled them to evaluate wages paid and received in real terms, that is, by the quantity of household goods that the scrip wages could purchase. A decline in the purchasing power of scrip at the company store would simply have indicated to the miner that the real value of his services to the company had declined. He thereupon would have moved to an other location or occupation. If the decline in real wages was due to an industrial depression or the competitive decline of the coal industry, as occurred simultaneously in the 1930s, both mine workers and mine operators would realize reduced real returns in the mode of any resource owners under similar circumstances.

He also notes:

Had the scrip system become intercommunal and given rise to scrip-on-deposit in scrip banks necessitating bank reserves and clearing operations, some high-powered scrip into which local scrips could be converted would probably have appeared.

As it is, anything that had too many characteristics of the State’s money is illegal, so no “intercommunal” money has developed.

But under Free Competition in Currency, businesses could experiment with issuing their own money. Retail chains, for instance, would accept their own scrip money whether the store is in Maine or California.

Under Free Competition in Currency, the opportunities and possibilities would be endless, but in a brief time producers and consumers would come to recognize the best forms of money. Gold would likely be the judge of the value and stability of a currency. Prices would be stable over time, and gradually fall as productivity increases.

Under our current laws and policies, however, we are all at the mercy of the inflationary Fed.

I will conclude with an (unknown) reviewer of one of Hayek’s booklets, whom Hayek quotes:

“Well, three hundred years ago nobody would have believed that government would ever give up its control over religion, so perhaps in three hundred years we can see that government will be prepared to give up its control over money.”

I don’t think we can wait another 300 years. We need the Separation of Money and State NOW.


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