Denationalization of Money

The Argument Refined

An Analysis of the Theory and Practice of Concurrent Currencies

F.A. HAYEK

Diseases desperate grown,

By desperate appliances are reli’ved,

Or not at all.

WILLIAM SHAKESPEARE

(Hamlet, Act IV, Scene iii)

The Hobart Papers are intended to contribute a stream of authoritative, independent and lucid analyses to understanding the application of economic thinking to private and governmental activity. Their characteristic concern has been the optimum use of scarce resources to satisfy consumer preferences and the extent to which it can be achieved in markets within the appropriate legal/institutional framework created by government or by other arrangements. It has long been a common belief among economists since the classical thinkers of the eighteenth century that one of the most important functions of government was to create a monetary mechanism and to issue money.1 The debates among economists have been on how far governments have performed this function efficiently and on the means of increasing or decreasing the power of government over the supply of money. But the general assumption has been that government had to control monetary policy and that each country had to have its own structure of monetary units. This assumption is now questioned by Professor F.A. Hayek. He goes much more fully into the "somewhat startling” departure from the classical assumption that he touched on in Choice in Currency, Occasional Paper No. 48, published in February 1976. Even this short expansion of the theme indicates insights into the nature of money and its control for a wide range of readers: they should stimulate the student and suggest precepts for politicians. In effect, Professor Hayek is arguing that money is no different from other commodities and that it would be better supplied by competition between private issuers than by a monopoly of government. He argues, in the classic tradition of Adam Smith but with reference to the twentieth century, that money is no exception to the rule that self-interest would be a better motive than benevolence in producing good results. The advantages that Professor Hayek claims for competitive currencies are not only that they would remove the power of government to inflate the money supply but also that they would go a long way to prevent the destabilizing fluctuations that government monopoly of money has precipitated over the last century of "trade cycles” and, an urgent question in the 1970s, make it more difficult for government to inflate its own expenditures. Although the argument in places is necessarily abstract and requires close attention, the central theme is crystal clear: government has failed, must fail, and will continue to fail to supply good money. If government control of money is unavoidable Professor Hayek thinks a gold system better than any other; but he maintains that even gold would be found less dependable than competing paper currencies whose value would be maintained more or less stable because their issuers would have a strong inducement to limit their quantity or lose their business. The argument for competitive currencies is in the direct line of descent in the thinking of the Austrian school of economists that Professor Lord Robbins largely introduced to Britain by bringing Professor Hayek to the London School of Economics in 1931. These two helped to make the works of Menger, Wieser, Böhm-Bawerk, and Mises known to British students and teachers, but little further has been heard of the Austrian school until the last year or two. New interest in the Austrian school by economists in the USA is being followed by increasing attention in Britain, particularly by young economists. In this Hobart Paper Special, Professor Hayek refers to the writings of several of his predecessors and may further stimulate interest in the Austrian school of economics. Although italicizing is not common in IEA Papers it has been used here moderately to help especially readers new to economics to follow the steps in the argument. Professor Hayek’s Hobart Special comes at a time when, after prewar monetary blunders said to have precipitated the 1929–32 Great Depression, nearly a third of a century of postwar "monetary management” (or mismanagement) by government, and when attempts at international management have hardly been more successful, economists are again looking to means of taking money out of the control of government altogether. In Hobart Paper 69 (Gold or Paper?) Professor E. Victor Morgan and Mrs. Morgan reexamine the breakdown of monetary management since the war and reassess the case for reestablishing a link between currency and gold. Some months ago Mr. Peter Jay, the economics editor of the Times, proposed a currency commission.1 Both of these approaches reflect the anxiety to reduce or remove the power of politicians over the supply of money and will seem to younger economists and to new generations in finance, commerce, industry, and teaching to be radical departures from postwar economic thinking. Professor Hayek’s proposal that the supply of money be put into the marketplace along with other goods and services is even more revolutionary: he is arguing that the attempt for the past fifty years to depend on benevolence in government to manage money has failed and that the solution must lie in the self-interest of monetary agencies that will suffer by losing their livelihood if they do not supply currencies that users will find dependable and stable. Professor Hayek’s Hobart Special, and the works of other economists who are trying to evolve methods of "taking money out of politics," should stimulate economists and noneconomists alike to reexamine the first principles of the control of money if civilized society is to continue. The Institute is known for rapid publication — normally a few short weeks from completed ms. to copy. Professor Hayek’s movements from Austria to Scotland and then to London elongated the usual timetable of editing, processing for publication, and proofreading. Even so these stages — for a manuscript twice the length of a typical Hobart — ran from early July to late September. I should like to thank Michael Solly, who excelled himself in helping to make this timetable possible, and Goron Pro-Print, our printers, who worked rapidly and accurately. Its constitution requires the Institute to dissociate its trustees, directors, and advisers from the argument and conclusion of its authors, but it presents this new short work by Professor Hayek as an important reconsideration of a classical precept from one of the world’s leading thinkers. ______________ 1 In the Second Edition, Professor Hayek notes that it was not among those duties that Adam Smith said fell to the state (p. 33). 1 The Times, April 15, 1976.

Preface to the Second (Extended) Edition For the 2nd (extended) edition Professor Hayek has written many and sometimes lengthy additions to refine and amplify the argument. In all he has added about a third to two-fifths to the original text. (To identify the self-contained additions, both long and short, a single star is placed at the beginning and two stars at the end. There are in addition many other refinements of words, phrases, and sentences, including numerous footnotes, passim.) The Hobart Paper has now become a substantial text on the revolutionary proposal to replace state control of the money supply by competing private issuers in the market. When this principle was put to an august personage in the British banking system the urbane but complacent reply was "That may be for the day after tomorrow." This is a not-uncommon reaction of practical men to the new thinking of academics. New ideas are liable to be dismissed as the work of theorists by hardheaded men who have to face the realities of everyday life. Practical men are so near their "day-to-day problems” that they may see only the difficulties and obstacles and not the fundamental causes of error or failure. It is proper to reflect that the tree-feller cannot see the extent of the wood. Even more fundamental change may sometimes have to be by radical reform rather than by piecemeal modification of a method or policy that has been shown to be defective. And the longer reform is delayed the more disturbing it may have to be. A man sinking in a bog cannot escape by a short step; his only hope may be a long leap. The question is whether Professor Hayek’s diagnosis — that state control of money has rarely supplied a dependable means of payment but has, in practice, been responsible for destabilizing currencies and down the centuries for inflation — is correct or not. If it is correct, then tinkering with government monopoly control of money will not remove the defects and dangers. This enlarged 2nd edition should be earnestly studied not least by bankers, all the more when, as in Britain, they are not as removed from governmental — which means political — influence as they are in other countries. The additions will also make the 2nd edition all the more valuable for teachers and students of economics who are more concerned with fundamental truths than with short-term expedients. December 1977 A.S.

Author's Introduction For in every country of the world, I believe, the avarice and injustice of princes and sovereign states abusing the confidence of their subjects, have by degrees diminished the real quality of the metal, which had been originally contained in their coins. ADAM SMITH

(The Wealth of Nations (1776), bk. I, ch. iv, Glasgow edn.,

Oxford, 1976, p. 43.) In my despair about the hopelessness of finding a politically feasible solution to what is technically the simplest possible problem, namely to stop inflation, I threw out in a lecture delivered about a year ago1 a somewhat startling suggestion, the further pursuit of which has opened quite unexpected new horizons. I could not resist pursuing the idea further, since the task of preventing inflation has always seemed to me to be of the greatest importance, not only because of the harm and suffering major inflations cause, but also because I have long been convinced that even mild inflations ultimately produce the recurring depressions and unemployment that have been a justified grievance against the free enterprise system and must be prevented if a free society is to survive. The further pursuit of the suggestion that government should be deprived of its monopoly of the issue of money opened the most fascinating theoretical vistas and showed the possibility of arrangements that have never been considered. As soon as one succeeds in freeing oneself of the universally but tacitly accepted creed that a country must be supplied by its government with its own distinctive and exclusive currency, all sorts of interesting questions arise that have never been examined. The result was a foray into a wholly unexplored field. In this short work I can present no more than some discoveries made in the course of a first survey of the terrain. I am of course very much aware that I have only scratched the surface of the complex of new questions and that I am still very far from having solved all the problems that the existence of multiple concurrent currencies would raise. Indeed, I shall have to ask a number of questions to which I do not know the answer; nor can I discuss all the theoretical problems that the explanation of the new situation raises. Much more work will yet have to be done on the subject; but there are already signs that the basic idea has stirred the imagination of others and that there are indeed some younger brains at work on the problem.1 The main result at this stage is that the chief blemish of the market order that has been the cause of well-justified reproaches, its susceptibility to recurrent periods of depression and unemployment, is a consequence of the age-old government monopoly of the issue of money. I have now no doubt whatever that private enterprise, if it had not been prevented by government, could and would long ago have provided the public with a choice of currencies, and those that prevailed in the competition would have been essentially stable in value and would have prevented both excessive stimulation of investment and the consequent periods of contraction. The demand for the freedom of the issue of money will at first, with good reason, appear suspect to many, since in the past such demands have been raised again and again by a long series of cranks with strong inflationist inclinations. From most of the advocates of "free banking” in the early nineteenth century (and even a substantial section of the advocates of the "banking principle”) to the agitators for a "free money” (Freigeld) — Silvio Gesell [22] and the plans of Major C.H. Douglas [13], H. Rittershausen [51], and Henry Meulen [44] — in the twentieth, they all agitated for free issue because they wanted more money. Often a suspicion that the government monopoly was inconsistent with the general principle of freedom of enterprise underlay their argument, but without exception they all believed that the monopoly had led to an undue restriction rather than to an excessive supply of money. They certainly did not recognize that government more often than any private enterprise had provided us with the Schwundgeld (shrinking money) that Silvio Gesell had recommended. I will here merely add that, to keep to the main subject, I will not allow myself to be drawn into a discussion of the interesting methodological question of how it is possible to say something of significance about circumstances with which we have practically no experience, although this fact throws interesting light on the method of economic theory in general. In conclusion I will merely say that this task has seemed to me important and urgent enough to interrupt for a few weeks the major undertaking to which all my efforts have been devoted for the last few years and the completion of which still demands its concluding third volume.1 The reader will, I hope, understand that in these circumstances, and against all my habits, after completing a first draft of the text of the present Paper, I left most of the exacting and time-consuming task of polishing the exposition and getting it ready for publication to the sympathetic endeavors of Mr. Arthur Seldon, the editorial director of the Institute of Economic Affairs, whose beneficial care has already made much more readable some of my shorter essays published by that institute, and who has been willing to assume this burden. His are in particular all the helpful headings of the subsections and the "Questions for Discussion” at the end. And the much-improved title of what I had intended to call Concurrent Currencies was suggested by the general director of the Institute, Mr. Ralph Harris. I am profoundly grateful to them for thus making possible the publication of this sketch. It would otherwise probably not have appeared for a long time, since I owe it to the readers of Law, Legislation, and Liberty that I should not allow myself to be diverted from completing it by this rather special concern for longer than was necessary to get a somewhat rough outline of my argument on paper. A special apology is due to those of my many friends to whom it will be obvious that, in the course of the last few years when I was occupied with wholly different problems, I have not read their publications closely related to the subject of this Paper that would probably have taught me much from which I could have profited in writing it. Salzburg

30 June, 1976 F.A. HAYEK 1 See [31]. Numbers in square brackets will throughout refer to the bibliography at the end of the Paper (pp. 138–144). 1 See [35], [59], and [60]. 1 Law, Legislation, and Liberty, vol. 1 was Rules and Order, Routledge & Kegan Paul, 1973. Vol. 2, The Mirage of Social Justice, will appear about the same time as the present Paper. Vol. 3, The Political Order of a Free Society, nearing completion, will be published, I hope, in 1978.

A Note to the Second Edition It is just thirteen months after I commenced writing this study and only a little more than six months since its first publication. It is therefore perhaps not very surprising that the additions I found desirable to make in this second edition are due more to further thinking about the questions raised than to any criticisms I have so far received. The comments so far, indeed, have expressed incredulous surprise more often than any objections to my argument. Most of the additions therefore concern rather obvious points that perhaps I ought to have made more clearly in the first edition. Only one of them concerns a point on which further thought has led me to expect a somewhat different development from what I had suggested if the reform I propose were adopted. Indeed the clear distinction between two different kinds of competition, the first of which is likely to lead to the general acceptance of one widely used standard (or perhaps a very few such standards), while the second refers to the competition for the confidence of the public in the currency of a particular denomination, seems to me of ever greater importance. I have now sketched, in a somewhat longer insertion to section 24, one of the most significant probable consequences, not originally foreseen by me. I have made only minor stylistic changes to bring out more clearly what I meant to say. I have even let stand the difference between the more tentative tone at the beginning that, as will not have escaped the reader, gradually changes to a more confident tone as the argument proceeds. Further thought has so far only still more increased my confidence both in the desirability and the practicability of the fundamental change suggested. Some important contributions to the problems considered here that were made at a Mont Pèlerin Society conference held after the material for this second edition was prepared could not be used since I had immediately after to start on prolonged travels. I hope that particularly the papers presented then by W. Engels, D.L. Kemmerer, W. Stützel, and R. Vaubel will soon be available in print. I have, however, inserted at a late stage a reply to a comment by Milton Friedman that seemed to me to demand a prompt response. I should perhaps have added above to my reference to my preoccupation with other problems that have prevented me from giving the present argument all the attention that it deserves, that in fact my despair of ever again getting a tolerable money system under the present institutional structure is as much a result of the many years of study I have now devoted to the prevailing political order, and especially to the effects of government by a democratic assembly with unlimited powers, as to my earlier work when monetary theory was still one of my central interests. I ought, perhaps, also to add, what I have often had occasion to explain but may never have stated in writing, that I strongly feel that the chief task of the economic theorist or political philosopher should be to operate on public opinion to make politically possible what today may be politically impossible, and that in consequence the objection that my proposals are at present impracticable does not in the least deter me from developing them. Finally, after reading over once more the text of this second edition I feel I ought to tell the reader at the outset that in the field of money I do not want to prohibit government from doing anything except preventing others from doing things they might do better. Freiburg im Breisgau F.A. HAYEK

Introduction to the Third Edition The central argument of this Hobart Paper by Professor Hayek is that price level stability can be achieved only by removing from national governments their monopoly of money creation. Although price level performance in the years before the Paper’s publication had been unsatisfactory worldwide (in Britain, for example, the cost of living had risen by just over 500 percent during the previous quarter-century), the Paper had little apparent practical impact. Discussion continued to be of how to improve the performance of these government monopolies rather than of how to end them. If the idea of monetary competition was discussed at all, it was dismissed as "politically impossible." As Hayek observed, that objection should be irrelevant to an economist: The present political necessity ought to be no concern of the economic scientist. His task ought to be, as I will not cease repeating, to make politically possible what today may be politically impossible. To decide what can be done at the moment is the task of the politician, not of the economist. (Second edn., 1978, pp. 79–80) Fortunately, Hayek was not alone in that belief. Other scholars have followed up his analysis, and have studied episodes where there has not been a government monopoly of money. Lawrence White (1984) studied the Scottish system of competitive money issue — a system admired by Adam Smith. Eugene White (1990) examined the period during the French Revolution when there was competition in the issuing of money. Hugh Rockoff (1990) examined competitive money issue in the United States. Of course, none of these episodes emerged as one of perfect monetary performance, and none is recent. But all turned out to be more stable than government monopoly of money has been; and their age is irrelevant, for the principle they illustrate is the timeless one that incentives influence conduct. Hayek’s analysis as set out in this Hobart Paper is acquiring empirical support. At the same time, those who consider themselves practical men have started to think about what might be done to improve our monetary system. A few years ago the notion that a British chancellor of the exchequer would propose freeing the Bank of England from the authority of the Treasury would have seemed totally unbelievable. But Nigel Lawson has revealed that when chancellor he made just such a proposal. This increased attention should be no surprise. In the years since Hayek’s Paper first appeared, price level performance has not improved. Between 1978 and 1990, the cost of living has risen in Britain by 230 percent. That fall in the value of sterling has occurred despite the British economy undergoing a severe recession in an attempt to end inflation. This failure is not unique to Britain. In Germany since 1978, prices have risen by 138 percent; in Switzerland by 143 percent; and in the USA by 190 percent. All did better than Britain, but surely evidence enough that an independent central bank is, as Milton Friedman argued in 1962, no guarantee of satisfactory monetary performance. What then should and can be done? The New Zealand government has recently recognized that incentive is important, and has linked the pay of its senior central bankers to their success in delivering stable prices. In a forthcoming paper, Charles Goodhart (1991) urges the same for the Bank of England. Is this effort to harness incentives to deliver the objective worthwhile? Is the objective of sufficient importance? And if so, can anything else be done? In this Paper, Hayek sets out with great lucidity why inflation is so important and so damaging. It does of course redistribute between borrowers and lenders. That is arbitrary. It is also inefficient, for it disrupts the working of the capital market. But the problems caused by inflation go beyond that; they affect the whole economy by making future prices harder to foresee and current price movements harder to interpret. If the value of money is so regulated that an appropriate average of prices is kept constant … the unpredictability of particular future prices, inevitable in a functioning market economy, remains, [but] the fairly high long-run chances are that for people in general the effects of the unforeseen price changes will just about cancel out. (pp. 67–68) Hayek contrasts this situation with one where there is inflation: the individual enterprise … could … not base its calculations and decisions on a known median from which individual movements of prices were as likely to diverge in the one direction as in the other. Successful calculations, or effective capital and cost accounting, would then become impossible. (p. 69) And the problems are, he emphasizes, additional to the temporary changes in the structure of relative prices [that inflation] also brings about, which will cause misdirections of production. (p. 69) The instabilities produced by these distortions and by the occasional efforts of governments to slow inflation are, Hayek argues, responsible for the recurring periods of mass unemployment that characterize capitalist economies. The benefits of stable money would not end with a stable price level. How, then, to achieve monetary stability? Milton Friedman, and recently many others, have urged a monetary rule, embedded where possible in a "monetary constitution," so that the growth of money is steady and predictable.1 There can be no doubt that such a rule would end the grosser failures of monetary management. But why do we need to regulate our suppliers of money? Here competition comes in. For regulation of an industry — by government, regulatory agency, or rule — can be defended only if the industry is not regulated by competition. In general, competition will deliver the best attainable outcome. Why not in money? That is the question addressed in this Paper; and the answer is that competition in the supply of money will produce that desired outcome, just as it does in other economic activities. The republication of this Hobart Paper now is particularly timely. First, of course, because inflation has once more risen. But, secondly, because there is now an opportunity to have a substantial degree of competition in the supply of money. The countries of the EEC are committed to abolishing all exchange controls between each other. There are proposals to go further, to fix exchange rates and impose a common European currency. But if these latter proposals are resisted we will have competition between national currencies within Europe.2 By a very simple measure we will have harnessed the incentives of prestige and profit (for governments get revenue from money creation) to deliver stable money. In just twelve years, the proposal in this Paper by Professor Hayek has moved from being "politically impossible” to being within our grasp. We should seize it. October 1990 GEOFFREY E. WOOD Professor of Economics, City University Business School References Friedman, Milton (1962): "Should There Be an Independent Monetary Authority?," in Leland B. Yeager (ed.), In Search of a Monetary Constitution, Harvard University Press, Boston, Mass. Friedman, Milton, and Anna J. Schwartz (1986): "Has Government any Role in Money?," Journal of Monetary Economics 17 (1), pp. 37–62. Goodhart, Charles A.E. (1991): "British Monetary Policy: March 1990," in S.F. Frowen (ed.), Monetary Policy and Financial Innovations in Five Industrial Countries, Macmillan, London. Her Majesty’s Treasury (1989): An Evolutionary Approach to Economic and Monetary Union, HM Treasury, London. Rockoff, Hugh (1990): "Lessons from American Experience with Free Banking," in Forrest H. Capie and Geoffrey E. Wood (eds.), Unregulated Banking: Chaos or Order?, Macmillan, London. Vaubel, Roland (1979): Choice in European Monetary Union, Ninth Wincott Memorial Lecture, Occasional Paper 55, Institute of Economic Affairs, London. White, Eugene (1990): "Banking in a Revolution," in Capie and Wood (eds.), Unregulated Banking: Chaos or Order?, Macmillan, London. White, Lawrence (1984): Free Banking in Britain, Cambridge University Press, Cambridge. Wood, Geoffrey E. (1989): "Banking and Monetary Control after 1992: A Central Bank for Europe?," in Whose Europe?, IEA Readings No. 29, Institute of Economic Affairs, London:. 1 It is worth remarking that in a recent paper (1986) co-authored with Anna Schwartz, Milton Friedman has moved close to the position here advanced by Professor Hayek. 2 The benefits of monetary competition in the particular context of the EEC were set out in Vaubel (1979), revived in Wood (1989), and were subsequently urged upon EEC Finance Ministers by Nigel Lawson in a paper (HM Treasury, 1989) he presented to a meeting of these Ministers when he was chancellor.

I. THE PRACTICAL PROPOSAL The concrete proposal for the near future, and the occasion for the examination of a much more far-reaching scheme, is that the countries of the Common Market, preferably with the neutral countries of Europe (and possibly later the countries of North America) mutually bind themselves by formal treaty not to place any obstacles in the way of the free dealing throughout their territories in one another’s currencies (including gold coins) or of a similar free exercise of the banking business by any institution legally established in any of their territories. This would mean in the first instance the abolition of any kind of exchange control or regulation of the movement of money between these countries, as well as the full freedom to use any of the currencies for contracts and accounting. Further, it would mean the opportunity for any bank located in these countries to open branches in any other on the same terms as established banks. Free trade in money The purpose of this scheme is to impose upon existing monetary and financial agencies a very-much-needed discipline by making it impossible for any of them, or for any length of time, to issue a kind of money substantially less reliable and useful than the money of any other. As soon as the public became familiar with the new possibilities, any deviations from the straight path of providing an honest money would at once lead to the rapid displacement of the offending currency by others. And the individual countries, being deprived of the various dodges by which they are now able temporarily to conceal the effects of their actions by "protecting” their currency, would be constrained to keep the value of their currencies tolerably stable. Proposal more practicable than Utopian European currency This seems to me both preferable and more practicable than the Utopian scheme of introducing a new European currency, which would ultimately only have the effect of more deeply entrenching the source and root of all monetary evil, the government monopoly of the issue and control of money. It would also seem that, if the countries were not prepared to adopt the more limited proposal advanced here, they would be even less willing to accept a common European currency. The idea of depriving government altogether of its age-old prerogative of monopolizing money is still too unfamiliar and even alarming to most people to have any chance of being adopted in the near future. But people might learn to see the advantages if, at first at least, the currencies of the governments were allowed to compete for the favor of the public. Though I strongly sympathize with the desire to complete the economic unification of Western Europe by completely freeing the flow of money between them, I have grave doubts about the desirability of doing so by creating a new European currency managed by any sort of supranational authority. Quite apart from the extreme unlikelihood that the member countries would agree on the policy to be pursued in practice by a common monetary authority (and the practical inevitability of some countries getting a worse currency than they have now), it seems highly unlikely, even in the most favorable circumstances, that it would be administered better than the present national currencies. Moreover, in many respects a single international currency is not better but worse than a national currency if it is not better run. It would leave a country with a financially more-sophisticated public not even the chance of escaping from the consequences of the crude prejudices governing the decisions of the others. The advantage of an international authority should be mainly to protect a member state from the harmful measures of others, not to force it to join in their follies. Free trade in banking The suggested extension of the free trade in money to free trade in banking is an absolutely essential part of the scheme if it is to achieve what is intended. First, bank deposits subject to check, and thus a sort of privately issued money, are today of course a part, and in most countries much the largest part, of the aggregate amount of generally accepted media of exchange. Secondly, the expansion and contraction of the separate national superstructures of bank credit are at present the chief excuse for national management of the basic money. On the effects of the adoption of the proposal all I will add at this point is that it is of course intended to prevent national monetary and financial authorities from doing many things politically impossible to avoid so long as they have the power to do them. These are without exception harmful and against the long-run interest of the country doing them but politically inevitable as a temporary escape from acute difficulties. They include measures by which governments can most easily and quickly remove the causes of discontent of particular groups or sections but bound in the long run to disorganize and ultimately to destroy the market order. Preventing government from concealing depreciation The main advantage of the proposed scheme, in other words, is that it would prevent governments from "protecting” the currencies they issue against the harmful consequences of their own measures, and therefore prevent them from further employing these harmful tools. They would become unable to conceal the depreciation of the money they issue, to prevent an outflow of money, capital, and other resources as a result of making their home use unfavorable, or to control prices — all measures which would, of course, tend to destroy the Common Market. The scheme would indeed seem to satisfy all the requirements of a common market better than a common currency without the need to establish a new international agency or to confer new powers on a supranational authority. The scheme would, to all intents and purposes, amount to a displacement of the national circulations only if the national monetary authorities misbehaved. Even then they could still ward off a complete displacement of the national currency by rapidly changing their ways. It is possible that in some very small countries with a good deal of international trade and tourism, the currency of one of the bigger countries might come to predominate, but, assuming a sensible policy, there is no reason why most of the existing currencies should not continue to be used for a long time. (It would, of course, be important that the parties did not enter into a tacit agreement not to supply so good a money that the citizens of the other nations would prefer it! And the presumption of guilt would of course always have to lie against the government whose money the public did not like!) I do not think the scheme would prevent governments from doing anything they ought to do in the interest of a well-functioning economy, or that in the long run would benefit any substantial group. But this raises complex issues better discussed within the framework of the full development of the underlying principle.

II. THE GENERALIZATION OF THE UNDERLYING PRINCIPLE If the use of several concurrent currencies is to be seriously considered for immediate application in a limited area, it is evidently desirable to investigate the consequences of a general application of the principle on which this proposal is based. If we are to contemplate abolishing the exclusive use within each national territory of a single national currency issued by the government, and to admit on equal footing the currencies issued by other governments, the question at once arises whether it would not be equally desirable to do away altogether with the monopoly of government supplying money and to allow private enterprise to supply the public with other media of exchange it may prefer. The questions this reform raises are at present much more theoretical than the practical proposal because the more far-reaching suggestion is clearly not only much too strange and alien to the general public to be considered for present application. The problems it raises are evidently also still much too little understood even by the experts for anyone to make a confident prediction about the precise consequences of such a scheme. Yet it is clearly possible that there is no necessity or even advantage in the now unquestioned and universally accepted government prerogative of producing money. It may indeed prove to be harmful and its abolition a great gain, opening the way for very beneficial developments. Discussion therefore cannot begin early enough. Though its realization may be wholly impracticable so long as the public is mentally unprepared for it and uncritically accepts the dogma of the necessary government prerogative, this should no longer be allowed to act as a bar to the intellectual exploration of the fascinating theoretical problems the scheme raises. Competition in currency not discussed by economists It is an extraordinary truth that competing currencies have until quite recently never been seriously examined.1 There is no answer in the available literature to the question why a government monopoly of the provision of money is universally regarded as indispensable, or whether the belief is simply derived from the unexplained postulate that there must be within any given territory one single kind of money in circulation — which, so long as only gold and silver were seriously considered as possible kinds of money, might have appeared a definite convenience. Nor can we find an answer to the question of what would happen if that monopoly were abolished and the provision of money were thrown open to the competition of private concerns supplying different currencies. Most people seem to imagine that any proposal for private agencies to be allowed to issue money means that they should be allowed to issue the same money as anybody else (in token money this would, of course, simply amount to forgery) rather than different kinds of money clearly distinguishable by different denominations among which the public could choose freely. Initial advantages of government monopoly in money Perhaps when the money economy was only slowly spreading into the remoter regions, and one of the main problems was to teach large numbers the art of calculating in money (and that was not so very long ago), a single easily recognizable kind of money may have been of considerable assistance. And it may be argued that the exclusive use of such a single uniform sort of money greatly assisted comparison of prices and therefore the growth of competition and the market. Also, when the genuineness of metallic money could be ascertained only by a difficult process of assaying, for which the ordinary person had neither the skill nor the equipment, a strong case could be made for guaranteeing the fineness of the coins by the stamp of some generally recognized authority that, outside the great commercial centers, could be only the government. But today these initial advantages, which might have served as an excuse for governments to appropriate the exclusive right of issuing metallic money, certainly do not outweigh the disadvantages of this system. It has the defects of all monopolies: one must use their product even if it is unsatisfactory, and, above all, it prevents the discovery of better methods of satisfying a need for which a monopolist has no incentive. If the public understood what price in periodic inflation and instability it pays for the convenience of having to deal with only one kind of money in ordinary transactions, and not occasionally to have to contemplate the advantage of using other money than the familiar kind, it would probably find it very excessive. For this convenience is much less important than the opportunity to use a reliable money that will not periodically upset the smooth flow of the economy — an opportunity of which the public has been deprived by the government monopoly. But the people have never been given the opportunity to discover this advantage. Governments have at all times had a strong interest in persuading the public that the right to issue money belongs exclusively to them. And so long as, for all practical purposes, this meant the issue of gold, silver, and copper coins, it did not matter so much as it does today, when we know that there are all kinds of other possible sorts of money, not least paper, that government is even less competent to handle and even more prone to abuse than metallic money. ______________ 1 But, though I had independently arrived at the realization of the advantages possessed by independent competing currencies, I must now concede intellectual priority to Professor Benjamin Klein, who, in a paper written in 1970 and published in 1975 [35], until recently unknown to me, had clearly explained the chief advantage of competition among currencies.

III. THE ORIGIN OF THE GOVERNMENT PREROGATIVE OF MAKING MONEY For more than two thousand years the government prerogative or exclusive right of supplying money amounted in practice merely to the monopoly of minting coins of gold, silver, or copper. It was during this period that this prerogative came to be accepted without question as an essential attribute of sovereignty — clothed with all the mystery that the sacred powers of the prince used to inspire. Perhaps this conception goes back to even before King Croesus of Lydia struck the first coins in the sixth century BC, to the time when it was usual merely to punch marks on the bars of metal to certify its fineness. At any rate, the minting prerogative of the ruler was firmly established under the Roman emperors.1 When, at the beginning of the modern era, Jean Bodin developed the concept of sovereignty, he treated the right of coinage as one of the most important and essential parts of it.1 The regalia, as these royal prerogatives were called in Latin, of which coinage, mining, and custom duties were the most important, were during the Middle Ages the chief sources of revenue of the princes and were viewed solely from this angle. It is evident that, as coinage spread, governments everywhere soon discovered that the exclusive right of coinage was a most important instrument of power as well as an attractive source of gain. From the beginning the prerogative was neither claimed nor conceded on the ground that it was for the general good but simply as an essential element of governmental power.2 The coins served, indeed, largely as the symbols of might, like the flag, through which the ruler asserted his sovereignty, and told his people who their master was whose image the coins carried to the remotest parts of his realm. Government certificate of metal weight and purity The task the government was understood to assume was of course initially not so much to make money as to certify the weight and fineness of the materials that universally served as money,3 which after the earliest times were only the three metals, gold, silver, and copper. It was supposed to be a task rather like that of establishing and certifying uniform weights and measures. The pieces of metal were regarded as proper money only if they carried the stamp of the appropriate authority, whose duty was thought to be to assure that the coins had the proper weight and purity to give them their value. During the Middle Ages, however, the superstition arose that it was the act of government that conferred the value upon the money. Although experience always proved otherwise, this doctrine of the valor impositus1 was largely taken over by legal doctrine and served to some extent as justification of the constant vain attempts of the princes to impose the same value on coins containing a smaller amount of the precious metal. (In the early years of this century the medieval doctrine was revived by the German Professor G.F. Knapp; his State Theory of Money still seems to exercise some influence on contemporary legal theory.)2 There is no reason to doubt that private enterprise would, if permitted, have been capable of providing as good and at least as trustworthy coins. Indeed occasionally it did, or was commissioned by government to do so. Yet so long as the technical task of providing uniform and recognizable coins still presented major difficulties, it was at least a useful task that government performed. Unfortunately, governments soon discovered that it was not only useful but could also be made very profitable, at least so long as people had no alternative but to use the money they provided. The seigniorage, the fee charged to cover the cost of minting, proved a very attractive source of revenue, and was soon increased far beyond the cost of manufacturing the coin. And from retaining an excessive part of the metal brought to the government mint to be struck into new coins, it was only a step to the practice, increasingly common during the Middle Ages, of recalling the circulating coins in order to recoin the various denominations with a lower gold or silver content. We shall consider the effect of these debasements in the next section. But since the function of government in issuing money is no longer one of merely certifying the weight and fineness of a certain piece of metal, but involves a deliberate determination of the quantity of money to be issued, governments have become wholly inadequate for the task and, it can be said without qualifications, have incessantly and everywhere abused their trust to defraud the people. The appearance of paper money The government prerogative, which had originally referred only to the issue of coins because they were the only kind of money then used, was promptly extended to other kinds of money when they appeared on the scene. They arose originally when governments wanted money that they tried to raise by compulsory loans, for which they gave receipts that they ordered people to accept as money. The significance of the gradual appearance of government paper money, and soon of bank notes, is for our purposes complicated because for a long time the problem was not the appearance of new kinds of money with a different denomination, but the use as money of paper claims on the established kind of metallic money issued by government monopoly. It is probably impossible for pieces of paper or other tokens of a material itself of no significant market value to come to be gradually accepted and held as money unless they represent a claim on some valuable object. To be accepted as money they must at first derive their value from another source, such as their convertibility into another kind of money. In consequence, gold and silver, or claims for them, remained for a long time the only kinds of money between which there could be any competition; and, since the sharp fall in its value in the nineteenth century, even silver ceased to be a serious competitor to gold. (The possibilities of bimetallism1 are irrelevant for our present problems.) Political and technical possibilities of controlling paper money The position has become very different, however, since paper money established itself everywhere. The government monopoly of the issue of money was bad enough so long as metallic money predominated. But it became an unrelieved calamity since paper money (or other token money), which can provide the best and the worst money, came under political control. A money deliberately controlled in supply by an agency whose self-interest forced it to satisfy the wishes of the users might be the best. A money regulated to satisfy the demands of group interests is bound to be the worst possible (section 18). The value of paper money obviously can be regulated according to a variety of principles — even if it is more than doubtful that any democratic government with unlimited powers can ever manage it satisfactorily. Though historical experience would at first seem to justify the belief that only gold can provide a stable currency, and that all paper money is bound to depreciate sooner or later, all our insight into the processes determining the value of money tells us that this prejudice, though understandable, is unfounded. The political impossibility that governments will achieve it does not mean there is reason to doubt that it is technically possible to control the quantity of any kind of token money so that its value will behave in a desired manner, and that it will for this reason retain its acceptability and its value. It would therefore now be possible, if it were permitted, to have a variety of essentially different monies. They could represent not merely different quantities of the same metal, but also different abstract units fluctuating in their value relatively to one another. In the same way, we could have currencies circulating concurrently throughout many countries and offering the people a choice. This possibility appears, until recently, never to have been contemplated seriously. Even the most radical advocates of free enterprise, such as the philosopher Herbert Spencer1 or the French economist Joseph Garnier,2 seem to have advocated only private coinage, while the free-banking movement of the mid-nineteenth century agitated merely for the right to issue notes in terms of the standard currency.3 Monopoly of money has buttressed government power While, as we shall see presently, government’s exclusive right to issue and regulate money has certainly not helped to give us a better money than we would otherwise have had, and probably a very much worse one, it has of course become a chief instrument for prevailing governmental policies and profoundly assisted the general growth of governmental power. Much of contemporary politics is based on the assumption that government has the power to create and make people accept any amount of additional money it wishes. Governments will for this reason strongly defend their traditional rights. But for the same reason it is also most important that they should be taken from them. A government ought not, any more than a private person, to be able (at least in peacetime) to take whatever it wants, but be limited strictly to the use of the means placed at its disposal by the representatives of the people, and to be unable to extend its resources beyond what the people have agreed to let it have. The modern expansion of government was largely assisted by the possibility of covering deficits by issuing money — usually on the pretense that it was thereby creating employment. It is perhaps significant, however, that Adam Smith [54, p. 687] does not mention the control of the issue of money among the "only three duties [that] according to the system of natural liberty, the sovereign has to attend to." ______________ 1 W. Endemann [15], vol. 2, p. 171. 1 J. Bodin [5], p. 176. Bodin, who understood more about money than most of his contemporaries, may well have hoped that the governments of large states would be more responsible than the thousands of minor princelings and cities who, during the later part of the Middle Ages, had acquired the minting privilege and sometimes abused it even more than the richer princes of large territories. 2 The same applies to the postal monopoly, which everywhere appears to provide a steadily deteriorating service and of which in Great Britain (according to the Times, May 25, 1976) the general secretary of the Union of Post Office Workers (!) said recently that "governments of both political complexions have reduced a once great public service to the level of a music-hall joke." Politically the broadcasting monopoly may be even more dangerous, but economically I doubt whether any other monopoly has done as much damage as that of issuing money. 3 Cf. Adam Smith [54, p. 40]: "those public offices called mints: institutions exactly of the same nature with those of the aulnagers and stamp masters of woolen and linen cloth." 1 Endemann [15], p. 172. 2 Knapp [36], and compare Mann [41]. 1 Section 7, below, pp. 43–45. 1 Herbert Spencer [57]. 2 Joseph Gamier [21]. 3 Vera C. Smith [55].

IV. THE PERSISTENT ABUSE OF THE GOVERNMENT PREROGATIVE When one studies the history of money one cannot help wondering why people should have put up for so long with governments exercising an exclusive power over two thousand years that was regularly used to exploit and defraud them. This can be explained only by the myth (that the government prerogative was necessary) becoming so firmly established that it did not occur even to the professional students of these matters (for a long time including the present writer1) ever to question it. But once the validity of the established doctrine is doubted its foundation is rapidly seen to be fragile. We cannot trace the details of the nefarious activities of rulers in monopolizing money beyond the time of the Greek philosopher Diogenes who is reported, as early as the fourth century BC, to have called money the politicians’ game of dice. But from Roman times to the seventeenth century, when paper money in various forms begins to be significant, the history of coinage is an almost uninterrupted story of debasements or the continuous reduction of the metallic content of the coins and a corresponding increase in all commodity prices. History is largely inflation engineered by government Nobody has yet written a full history of these developments. It would indeed be all too monotonous and depressing a story, but I do not think it an exaggeration to say that history is largely a history of inflation, and usually of inflations engineered by governments and for the gain of governments — though the gold and silver discoveries in the sixteenth century had a similar effect. Historians have again and again attempted to justify inflation by claiming that it made possible the great periods of rapid economic progress. They have even produced a series of inflationist theories of history1 that have, however, been clearly refuted by the evidence: prices in England and the United States were at the end of the period of their most rapid development almost exactly at the same level as two hundred years earlier. But their recurring rediscoverers are usually ignorant of the earlier discussions. Early Middle Ages’ deflation local or temporary The early Middle Ages may have been a period of deflation that contributed to the economic decline of the whole of Europe. But even this is not certain. It would seem that on the whole the shrinking of trade led to the reduction of the amount of money in circulation, not the other way round. We find too many complaints about the dearness of commodities and the deterioration of the coin to accept deflation as more than a local phenomenon in regions where wars and migrations had destroyed the market and the money economy shrank as people buried their treasure. But where, as in Northern Italy, trade revived early, we find at once all the little princes vying with one another in diminishing the coin — a process that, in spite of some unsuccessful attempts of private merchants to provide a better medium of exchange, lasted throughout the following centuries until Italy came to be described as the country with the worst money and the best writers on money. But though theologians and jurists joined in condemning these practices, they never ceased until the introduction of paper money provided governments with an even cheaper method of defrauding the people. Governments could not, of course, pursue the practices by which they forced bad money upon the people without the cruelest measures. As one legal treatise on the law of money sums up the history of punishment for merely refusing to accept the legal money: From Marco Polo we learn that, in the 13th century, Chinese law made the rejection of imperial paper money punishable by death, and twenty years in chains or, in some cases death, was the penalty provided for the refusal to accept French assignats. Early English law punished repudiation as lese-majesty. At the time of the American revolution, non-acceptance of Continental notes was treated as an enemy act and sometimes worked a forfeiture of the debt.1 Absolutism suppressed merchants’ attempts to create stable money Some of the early foundations of banks at Amsterdam and elsewhere arose from attempts by merchants to secure for themselves a stable money, but rising absolutism soon suppressed all such efforts to create a nongovernmental currency. Instead, it protected the rise of banks issuing notes in terms of the official government money. Even less than in the history of metallic money can we here sketch how this development opened the doors to new abuses of policy. It is said that the Chinese had been driven by their experience with paper money to try to prohibit it for all time (of course unsuccessfully) before the Europeans ever invented it.2 Certainly European governments, once they knew about this possibility, began to exploit it ruthlessly, not to provide people with good money, but to gain as much as possible from it for their revenue. Ever since the British government in 1694 sold the Bank of England a limited monopoly of the issue of bank notes, the chief concern of governments has been not to let slip from their hands the power over money, formerly based on the prerogative of coinage, to really independent banks. For a time the ascendancy of the gold standard and the consequent belief that to maintain it was an important matter of prestige, and to be driven off it a national disgrace, put an effective restraint on this power. It gave the world the one long period — two hundred years or more — of relative stability during which modern industrialism could develop, albeit suffering from periodic crises. But as soon as it was widely understood some fifty years ago that the convertibility into gold was merely a method of controlling the amount of a currency, which was the real factor determining its value, governments became only too anxious to escape that discipline, and money became more than ever before the plaything of politics. Only a few of the great powers preserved for a time tolerable monetary stability, and they brought it also to their colonial empires. But Eastern Europe and South America never knew a prolonged period of monetary stability. But, while governments have never used their power to provide a decent money for any length of time, and have refrained from grossly abusing it only when they were under such a discipline as the gold standard imposed, the reason that should make us refuse any longer to tolerate this irresponsibility of government is that we know today that it is possible to control the quantity of a currency so as to prevent significant fluctuations in its purchasing power. Moreover, though there is every reason to mistrust government if not tied to the gold standard or the like, there is no reason to doubt that private enterprise whose business depended on succeeding in the attempt could keep stable the value of a money it issued. Before we can proceed to show how such a system would work we must clear out of the way two prejudices that will probably give rise to unfounded objections against the proposal. ______________ 1 F.A. Hayek [29], pp. 324 et seq. 1 Especially Werner Sombart [56] and before him Archibald Alison [1] and others. Cf. on them Paul Barth [4], who has a whole chapter on "History as a function of the value of money," and Marianne von Herzfeld [32]. 1 A. Nussbaum [50], p. 53. 2 On the Chinese events, see W. Vissering [61] and G. Tullock [58], who does not, however, allude to the often recounted story of the "final prohibition."

V. THE MYSTIQUE OF LEGAL TENDER The first misconception concerns the concept of "legal tender." It is not of much significance for our purposes, but is widely believed to explain or justify government monopoly in the issue of money. The first shocked response to the proposal here discussed is usually "But there must be a legal tender," as if this notion proved the necessity for a single government-issued money believed indispensable for the daily conduct of business. In its strictly legal meaning, "legal tender” signifies no more than a kind of money a creditor cannot refuse in discharge of a debt due to him in the money issued by government.1 Even so, it is significant that the term has no authoritative definition in English statute law.1 Elsewhere it simply refers to the means of discharging a debt contracted in terms of the money issued by government or due under an order of a court. Insofar as government possesses the monopoly of issuing money and uses it to establish one kind of money, it must probably also have power to say by what kind of objects debts expressed in its currency can be discharged. But that means neither that all money need be legal tender, nor even that all objects given by the law the attribute of legal tender need to be money. (There are historical instances in which creditors have been compelled by courts to accept commodities such as tobacco, which could hardly be called money, in discharge of their claims for money.2) The superstition disproved by spontaneous money The term "legal tender” has, however, in popular imagination come to be surrounded by a penumbra of vague ideas about the supposed necessity for the state to provide money. This is a survival of the medieval idea that it is the state that somehow confers value on money it otherwise would not possess. And this, in turn, is true only to the very limited extent that government can force us to accept whatever it wishes in place of what we have contracted for; in this sense it can give the substitute the same value for the debtor as the original object of the contract. But the superstition that it is necessary for government (usually called the "state” to make it sound better) to declare what is to be money, as if it had created the money that could not exist without it, probably originated in the naive belief that such a tool as money must have been "invented” and given to us by some original inventor. This belief has been wholly displaced by our understanding of the spontaneous generation of such undesigned institutions by a process of social evolution of which money has since become the prime paradigm (law, language, and morals being the other main instances). When the medieval doctrine of the valor impositus was in this century revived by the much-admired German professor Knapp it prepared the way for a policy that in 1923 carried the German mark down to a one-trillionth of its former value! Private money preferred There certainly can be and has been money, even very satisfactory money, without government doing anything about it, though it has rarely been allowed to exist for long.1 But a lesson is to be learned from the report of a Dutch author about China a hundred years ago who observed of the paper money then current in that part of the world that "because it is not legal tender and because it is no concern of the State it is generally accepted as money."2 We owe it to governments that within given national territories today in general only one kind of money is universally accepted. But whether this is desirable, or whether people could not, if they understood the advantage, get a much better kind of money without all the to-do about legal tender, is an open question. Moreover, a "legal means of payment” (gesetzliches Zahlungsmittel) need not be specifically designated by a law. It is sufficient if the law enables the judge to decide in what sort of money a particular debt can be discharged. The commonsense of the matter was put very clearly eighty years ago by a distinguished defender of a liberal economic policy, the lawyer, statistician, and high civil servant Lord Farrer. In a paper written in 18953 he contended that if nations make nothing else but the standard unit [of value they have adopted] legal tender, there is no need and no room for the operation of any special law of legal tender. The ordinary law of contract does all that is necessary without any law giving special function to particular forms of currency. We have adopted a gold sovereign as our unit, or standard of value. If I promised to pay 100 sovereigns, it needs no special currency law of legal tender to say that I am bound to pay 100 sovereigns, and that, if required to pay the 100 sovereigns, I cannot discharge the obligation by anything else. And he concludes, after examining typical applications of the legal tender conception, that Looking to the above cases of the use or abuse of the law of legal tender other than the last [i.e., that of subsidiary coins] we see that they possess one character in common — viz. that the law in all of them enables a debtor to pay and requires a creditor to receive something different from that which their contract contemplated. In fact it is a forced and unnatural construction put upon the dealings of men by arbitrary power.1 To this he adds a few lines later that "any Law of Legal Tender is in its own nature 'suspect.'"2 Legal tender creates uncertainty The truth is indeed that legal tender is simply a legal device to force people to accept in fulfillment of a contract something they never intended when they made the contract. It becomes thus, in certain circumstances, a factor that intensifies the uncertainty of dealings and consists, as Lord Farrer also remarked in the same context, in substituting for the free operation of voluntary contract, and a law which simply enforces the performance of such contracts, an artificial construction of contracts such as would never occur to the parties unless forced upon them by an arbitrary law. All this is well illustrated by the historical occasion when the expression "legal tender” became widely known and treated as a definition of money. In the notorious "legal tender cases," fought before the Supreme Court of the United States after the Civil War, the issue was whether creditors must accept at par current dollars in settlement of their claims for money they had lent when the dollar had a much higher value.1 The same problem arose even more acutely at the end of the great European inflations after the First World War when, even in the extreme case of the German mark, the principle "mark is mark” was enforced until the end — although later some efforts were made to offer limited compensation to the worst sufferers.2 Taxes and contracts A government must of course be free to determine in what currency taxes are to be paid and to make contracts in any currency it chooses (in this way it can support a currency it issues or wants to favor), but there is no reason why it should not accept other units of accounting as the basis of the assessment of taxes. In noncontractual payments such as damages or compensations for torts, the courts would have to decide the currency in which they have to be paid, and might for this purpose have to develop new rules; but there should be no need for special legislation. There is a real difficulty if a government-issued currency is replaced by another because the government has disappeared as a result of conquest, revolution, or the breakup of a nation. In that event the government taking over will usually make legal provisions about the treatment of private contracts expressed in terms of the vanished currency. If a private issuing bank ceased to operate and was unable to redeem its issue, this currency would presumably become valueless and the holders would have no enforceable claim for compensation. But the courts may decide that in such a case contracts between third parties in terms of that currency, concluded when there was reason to expect it to be stable, would have to be fulfilled in some other currency that came to the nearest presumed intention of the parties to the contract. ______________ 1 Nussbaum [50], Mann [41], and Breckinridge [6]. 1 Mann [41], p. 38. On the other hand, the refusal until recently of English courts to give judgment for paying in any other currency than the pound sterling has made this aspect of legal tender particularly influential in England. But this is likely to change after a recent decision (Miliangos v. George Frank Textiles Ltd [1975]) established that an English court can give judgment in a foreign currency on a money claim in a foreign currency, so that, for instance, it is now possible in England to enforce a claim from a sale in Swiss francs. (Financial Times, November 6, 1975: the report is reproduced in F.A. Hayek [31], pp. 45–6). 2 Nussbaum [50], pp. 54–5. 1 Occasional attempts by the authorities of commercial cities to provide a money of at least a constant metallic content, such as the establishment of the Bank of Amsterdam, were for long periods fairly successful and their money used far beyond the national boundaries. But even in these cases the authorities sooner or later abused their quasi-monopoly positions. The Bank of Amsterdam was a state agency that people had to use for certain purposes and its money even as exclusive legal tender for payments above a certain amount. Nor was it available for ordinary small transactions or local business beyond the city limits. The same is roughly true of the similar experiments of Venice, Genoa, Hamburg, and Nuremberg. 2 Willem Vissering [61]. 3 Lord Farrer [17], p. 43. 1 Ibid., p. 45. The locus classicus on this subject from which I undoubtedly derived my views on it, though I had forgotten this when I wrote the first edition of this Paper, is Carl Menger’s discussion in 1892 [43a] of legal tender under the even more appropriate equivalent German term Zwangskurs. See pp. 98–106 of the reprint, especially p. 101, where the Zwangskurs is described as "eine Massregel, die in der überwiegenden Zahl der Fälle den Zweck hat, gegen den Willen der Bevöklerung, zumindest durch einen Missbrauch der Münzhoheit oder des Notenregals entstandene pathologische (also exceptionelle[?]) Formen von Umlaufsmitteln, durch einen Missbrauch der Justizhoheit dem Verkehr aufzudrängen oder in demselben zu erhalten”; and p. 104 where Menger describes it as "ein auf die Forderungsberechtigten geübter gesetzlicher Zwang, bei Summenschulden (bisweilen auch bei Schulden anderer Art) solche Geldsorten als Zahlung anzunehmen, welche dem ausdrücklich oder stillschweigend vereinbarten Inhalte der Forderungen nicht entsprechen, oder dieselben sich zu einem Wert aufdrangen zu lassen, der ihrem Wert im freien Verkehr nicht entspricht." Especially interesting also is the first footnote on p. 102 in which Menger points out that there had been fairly general agreement on this among the liberal economists of the first half of the nineteenth century, while during the second half of that century, through the influence of the (presumably German) lawyers, the economists were led erroneously to regard legal tender as an attribute of perfect money. 2 Ibid., p. 47. 1 Cf. Nussbaum [50], pp. 586–92. 2 In Austria after 1922 the name "Schumpeter” had become almost a curse word among ordinary people, referring to the principle that "krone is krone," because the economist J.A. Schumpeter, during his short tenure as minister of finance, had put his name to an order of council, merely spelling out what was undoubtedly valid law, namely that debts incurred in crowns when they had a higher value could be repaid in depreciated crowns, ultimately worth only a fifteen-thousandth part of their original value.

VI. THE CONFUSION ABOUT GRESHAM’S LAW It is a misunderstanding of what is called Gresham’s law to believe that the tendency for bad money to drive out good money makes a government monopoly necessary. The distinguished economist W.S. Jevons emphatically stated the law in the form that better money cannot drive out worse precisely to prove this. It is true he argued then against a proposal of the philosopher Herbert Spencer to throw the coinage of gold open to free competition, at a time when the only different currencies contemplated were coins of gold and silver. Perhaps Jevons, who had been led to economics by his experience as assayer at a mint, even more than his contemporaries in general, did not seriously contemplate the possibility of any other kind of currency. Nevertheless his indignation about what he described as Spencer’s proposal that, as we trust the grocer to furnish us with pounds of tea, and the baker to send us loaves of bread, so we might trust Heaton and Sons, or some of the other enterprising firms of Birmingham, to supply us with sovereigns and shillings at their own risk and profit,1 led him to the categorical declaration that generally, in his opinion, "there is nothing less fit to be left to the action of competition than money."1 It is perhaps characteristic that even Herbert Spencer had contemplated no more than that private enterprise should be allowed to produce the same sort of money as government then did, namely gold and silver coins. He appears to have thought them the only kind of money that could reasonably be contemplated, and in consequence that there would necessarily be fixed rates of exchange (namely of 1:1 if of the same weight and fineness) between the government and private money. In that event, indeed, Gresham’s law would operate if any producer supplied shoddier ware. That this was in Jevons’s mind is clear because he justified his condemnation of the proposal on the ground that while in all other matters everybody is led by self-interest to choose the better and reject the worse; but in the case of money, it would seem as if they paradoxically retain the worse and get rid of the better.2 What Jevons, as so many others, seems to have overlooked, or regarded as irrelevant, is that Gresham’s law will apply only to different kinds of money between which a fixed rate of exchange is enforced by law.3 If the law makes two kinds of money perfect substitutes for the payment of debts and forces creditors to accept a coin of a smaller content of gold in the place of one with a larger content, debtors will, of course, pay only in the former and find a more profitable use for the substance of the latter. With variable exchange rates, however, the inferior-quality money would be valued at a lower rate and, particularly if it threatened to fall further in value, people would try to get rid of it as quickly as possible. The selection process would go on towards whatever they regarded as the best sort of money among those issued by the various agencies, and it would rapidly drive out money found inconvenient or worthless.1 Indeed, whenever inflation got really rapid, all sorts of objects of a more stable value, from potatoes to cigarettes and bottles of brandy to eggs and foreign currencies like dollar bills, have come to be increasingly used as money,2 so that at the end of the great German inflation it was contended that Gresham’s law was false and the opposite true. It is not false, but it applies only if a fixed rate of exchange between the different forms of money is enforced. ______________ 1 W.S. Jevons [34], p. 64, as against Herbert Spencer [57]. 1 Jevons, ibid., p. 65. An earlier characteristic attempt to justify making banking and note issue an exception from a general advocacy of free competition is to be found in 1837 in the writings of S.J. Loyd (later Lord Overstone) [38], p. 49: "The ordinary advantages to the community arising from competition are that it tends to excite the ingenuity and exertion of the producers, and thus to secure to the public the best supply and quantity of the commodity at the lowest price, while all the evils arising from errors or miscalculations on the part of the producers will fall on themselves, and not on the public. With respect to a paper currency, however, the interest of the public is of a very different kind; a steady and equable regulation of its amount by fixed law is the end to be sought and the evil consequence of any error or miscalculation upon this point falls in a much greater proportion upon the public than upon the issuer.” It is obvious that Loyd thought only of the possibility of different agencies issuing the same currency, not of currencies of different denominations competing with one another. 2 Jevons, ibid., p. 82. Jevons’s phrase is rather unfortunately chosen, because in the literal sense Gresham’s law of course operates by people getting rid of the worse and retaining the better for other purposes. 3 Cf. Hayek [30] and Fetter [17a]. 1 If, as he is sometimes quoted, Gresham maintained that better money quite generally could not drive out worse, he was simply wrong, until we add his probably tacit presumption that a fixed rate of exchange was enforced. 2 Cf. Bresciani-Turroni [7], p. 174: "In monetary conditions characterized by a great distrust in the national currency, the principle of Gresham’s law is reversed and good money drives out bad, and the value of the latter continually depreciates.” But even he does not point out that the critical difference is not the "great distrust” but the presence or absence of effectively enforced fixed rates of exchange.

VII. THE LIMITED EXPERIENCE WITH PARALLEL CURRENCIES AND TRADE COINS So long as coins of the precious metals were the only practicable and generally acceptable kinds of money, with all close substitutes at least redeemable in them (copper having been reduced comparatively early to subsidiary token money), the only different kinds of money that appeared side by side were coins of gold and silver. The multiplicity of coins with which the old money changers had to deal consisted ultimately only of these two kinds, and their respective value within each group was determined by their content of either metal (which the expert but not the layman could ascertain). Most princes had tried to establish a fixed legal rate of exchange between gold and silver coins, thereby creating what came to be called a bimetallic system. But since, in spite of very early suggestions that this rate be fixed by an international treaty,1 governments established different exchange rates, each country tended to lose all the coins of the metal it undervalued relatively to the rates prevailing in other countries. The system was for that reason more correctly described as an alternative standard, the value of a currency depending on the metal that for the time being was overvalued. Shortly before it was finally abandoned in the second half of the nineteenth century, a last effort was made to establish internationally a uniform rate of exchange of 15:1 between gold and silver. That attempt might have succeeded so long as there were no big changes in production. The comparatively large share of the total stocks of either metal that were in monetary use meant that, by an inflow or outflow into or from that use, their relative values could probably have been adjusted to the rate at which they were legally exchangeable as money. Parallel currencies In some countries, however, gold and silver had also been current for long periods side by side, their relative value fluctuating with changing conditions. This situation prevailed, for example, in England from 1663 to 1695 when, at last, by decreeing a rate of exchange between gold and silver coins at which gold was overvalued, England inadvertently established a gold standard.2 The simultaneous circulation of coins of the two metals without a fixed rate of exchange between them was later called, by a scholar from Hanover where such a system existed until 1857, parallel currencies (Parallelwährung), to distinguish it from bimetallism.3 This is the only form in which parallel currencies were ever widely used, but it proved singularly inconvenient for a special reason. Since for most of the time gold was by weight more than fifteen times as valuable as silver, it was evidently necessary to use the former for large and silver for the smaller (and copper for the still-smaller) units. But, with variable values for the different kinds of coins, the smaller units were not constant fractions of the larger ones. In other words, the gold and the silver coins were parts of different systems without smaller or larger coins respectively of the same system being available.1 This made any change from large to small units a problem, and nobody was able, even for his own purposes, to stick to one unit of account. Except for a few instances in the Far East in recent times,2 there seem to have been very few instances of concurrent circulation of currencies, and the memory of the parallel circulation of gold and silver coins has given the system rather a bad name. It is still interesting because it is the only important historical instance in which some of the problems arose that are generally raised by concurrent currencies. Not the least of them is that the concept of the quantity of money of a country or territory has strictly no meaning in such a system, since we can add the quantities of the different monies in circulation only after we know the relative value of the different units. Trade coins Nor are the somewhat different but more complex instances of the use of various trade coins3 of much more help: the Maria Theresa thaler in the regions around the Red Sea and the Mexican dollar in the Far East, or the simultaneous circulation of two or more national currencies in some frontier districts or tourist centers. Indeed, our experience is so limited that we can do no better than fall back upon the usual procedure of classical economic theory and try to put together, from what we know from our common experience of the conduct of men in relevant situations, a sort of mental model (or thought experiment) of what is likely to happen if many men are exposed to new alternatives. ___________ 1 In 1582 by G. Scaruffi [57]. 2 A.E. Feaveryear [16], p. 142. 3 H. Grote [23]. 1 For a time during the Middle Ages gold coins issued by the great commercial republics of Italy were used extensively in international trade and maintained over fairly long periods at a constant gold content, while at the same time the petty coins, mostly of silver, used in local retail trade suffered the regular fate of progressive debasement. (Cipolla [11], pp. 34 ff.) 2 G. Tullock [58] and [59]; compare B. Klein [35]. 3 A convenient summary of information on trade coins is in Nussbaum [50], p. 315.

VIII. PUTTING PRIVATE TOKEN MONEY INTO CIRCULATION I shall assume for the rest of this discussion that it will be possible to establish a number of institutions in various parts of the world that are free to issue notes in competition and similarly to carry check accounts in their individual denominations. I shall call these institutions simply "banks," or "issue banks” when necessary to distinguish them from other banks that do not choose to issue notes. I shall further assume that the name or denomination a bank chooses for its issue will be protected like a brand name or trademark against unauthorized use, and that there will be the same protection against forgery as against that of any other document. These banks will then be vying for the use of their issue by the public by making them as convenient to use as possible. The private Swiss "ducat” Since readers will probably at once ask how such issues can come to be generally accepted as money, the best way to begin is probably to describe how I would proceed if I were in charge of, say, one of the major Swiss joint stock banks. Assuming it to be legally possible (which I have not examined), I would announce the issue of noninterest-bearing certificates or notes, and the readiness to open current check accounts, in terms of a unit with a distinct registered trade name such as "ducat." The only legal obligation I would assume would be to redeem these notes and deposits on demand with, at the option of the holder, either five Swiss francs or five D-marks or two dollars per ducat. This redemption value would however be intended only as a floor below which the value of the unit could not fall because I would announce at the same time my intention to regulate the quantity of the ducats so as to keep their (precisely defined) purchasing power as nearly as possible constant. I would also explain to the public that I was fully aware I could hope to keep these ducats in circulation only if I fulfilled the expectation that their real value would be kept approximately constant. And I would announce that I proposed from time to time to state the precise commodity equivalent in terms of which I intended to keep the value of the ducat constant, but that I reserved the right, after announcement, to alter the composition of the commodity standard as experience and the revealed preferences of the public suggested. It would, however, clearly be necessary that, though it seems neither necessary nor desirable that the issuing bank legally commits itself to maintain the value of its unit, it should in its loan contracts specify that any loan could be repaid either at the nominal figure in its own currency, or by corresponding amounts of any other currency or currencies sufficient to buy in the market the commodity equivalent that at the time of making the loan it had used as its standard. Since the bank would have to issue its currency largely through lending, intending borrowers might well be deterred by the formal possibility of the bank arbitrarily raising the value of its currency, that they may well have to be explicitly reassured against such a possibility. * *1 These certificates or notes, and the equivalent book credits, would be made available to the public by short-term loans or sale against other currencies. The units would presumably, because of the option they offered, sell from the outset at a premium above the value of any one of the currencies in which they were redeemable. And, as these governmental currencies continued to depreciate in real terms, this premium would increase. The real value at the price at which the ducats were first sold would serve as the standard the issuer would have to try to keep constant. If the existing currencies continued to depreciate (and the availability of a stable alternative might indeed accelerate the process) the demand for the stable currency would rapidly increase and competing enterprises offering similar but differently named units would soon emerge. The sale (over the counter or by auction) would initially be the chief form of issue of the new currency. After a regular market had established itself, it would normally be issued only in the course of ordinary banking business, i.e., through short-term loans. Constant but not fixed value It might be expedient that the issuing institution should from the outset announce precisely the collection of commodities in terms of which it would aim to keep the value of the "ducat” constant. But it would be neither necessary nor desirable that it tie itself legally to a particular standard. 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. Changes in the importance of the commodities, the volume in which they were traded, and the relative stability or sensitivity of their prices (especially the degree to which they were determined competitively or not) might suggest alterations to make the currency more popular. On the whole I would expect that, for reasons to be explained later (section 13), a collection of raw-material prices, such as has been suggested as the basis of a commodity reserve standard,1 would seem most appropriate, both from the point of view of the issuing bank and from that of the effects of the stability of the economic process as a whole. Control of value by competition In most respects, indeed, the proposed system should prove a more practicable method of achieving all that was hoped from a commodity reserve standard or some other form of "tabular standard.” At the same time it would remove the necessity of making it fully automatic by taking the control from a monopolistic authority and entrusting it to private concerns. The threat of the speedy loss of their whole business if they failed to meet expectations (and how any government organization would be certain to abuse the opportunity to play with raw-material prices!) would provide a much stronger safeguard than any that could be devised against a government monopoly. Competition would certainly prove a more effective constraint, forcing the issuing institutions to keep the value of their currency constant (in terms of a stated collection of commodities), than would any obligation to redeem the currency in those commodities (or in gold). And it would be an infinitely cheaper method than the accumulation and the storing of valuable materials. The kind of trust on which private money would rest would not be very different from the trust on which today all private banking rests (or in the United States rested before the governmental deposit-insurance scheme!). People today trust that a bank, to preserve its business, will arrange its affairs so that it will at all times be able to exchange demand deposits for cash, although they know that banks do not have enough cash to do so if everyone exercised his right to demand instant payment at the same time. Similarly, under the proposed scheme, the managers of the bank would learn that its business depended on the unshaken confidence that it would continue to regulate its issue of ducats (etc.) so that their purchasing power remained approximately constant. Is the risk in the venture therefore too big to justify entry by men with the kind of conservative temper its successful conduct probably requires?1 It is not to be denied that, once announced and undertaken, the decision on how large the commitment was to grow would be taken out of the hands of the issuing institution. To achieve its announced aim of maintaining the purchasing power of its currency constant, the amount would have to be promptly adapted to any change of demand, whether increase or decrease. Indeed, so long as the bank succeeded in keeping the value of its currency constant, there would be little reason to fear a sudden large reduction of the demand for it (though successful competitors might well make considerable inroads on its circulation). The most embarrassing development might be a rapid growth of demand beyond the limits a private institution likes to handle. But we can be fairly sure that, in the event of such success, new competition would soon relieve a bank of this anxiety. The issuing bank could, at first, at no prohibitive cost keep in cash a 100 percent reserve of the currencies in terms of which it had undertaken to redeem its issue and still treat the premiums received as freely available for general business. But once these other currencies had, as the result of further inflation, substantially depreciated relative to the ducat, the bank would have to be prepared, in order to maintain the value of the ducat, to buy back substantial amounts of ducats at the prevailing higher rate of exchange. This means that it would have to be able rapidly to liquidate investments of very large amounts indeed. These investments would therefore have to be chosen very carefully if a temporary rush of demand for its currency were not to lead to later embarrassment when the institution that had initiated the development had to share the market with imitators. Incidentally, the difficulty of finding investments of an assured stable value to match similar obligations would not be anything like as difficult for such a bank as we are considering as present-day bankers seem to find it: all the loans made in its own currency would of course represent such stable assets. The curious fact that such an issuing bank would have claims and obligations in terms of a unit the value of which it determined itself, though it could not do so arbitrarily or capriciously without destroying the basis of its business, may at first appear disturbing but should not create real difficulties. What may at first appear somewhat puzzling accounting problems largely disappear when it is remembered that such a bank would of course keep its accounts in terms of its own currency. The outstanding notes and deposits of such a bank are not claims on it in terms of some other unit of value; it determines itself the value of the unit in terms of which it has debts and claims and keeps its books. This will cease to seem shocking when we remember that this is precisely what practically all central banks have been doing for nearly half a century — their notes were of course redeemable in precisely nothing. But notes that may appreciate relatively to most other capital assets may indeed present to accountants problems with which they never before had to deal. Initially the issuing bank would of course be under a legal obligation to redeem its currency in terms of the other currencies against which it was at first issued. But after it has existed for some time their value may have shrunk to very little or they may have altogether disappeared.1 ______________ 1 [To assist readers of the first edition to identify major additions, we have inserted a single asterisk at the beginning and double asterisks at the end of substantial, self-contained new passages. – ED.] 1 Cf. Hayek [30], pp. 318–20. 1 On the question of its attractiveness the discussion by S. Fischer [18] of the notorious reluctance of enterprise to issue indexed bonds is somewhat relevant. It is true that a gradual increase of the value of the notes issued by a bank in terms of other concurrent currencies might produce a situation in which the aggregate value of its outstanding notes (plus its liabilities from other sources) would exceed its assets. The bank would of course not be legally liable to redeem its notes at this value, but it could preserve this business only if it did in fact promptly buy at the current rate any of its notes offered to it. So long as it succeeded in maintaining the real value of its notes, it would never be called upon to buy back more than a fraction of the outstanding circulation. Probably no one would doubt that an art dealer who owns the plates of the engravings of a famous artist could, so long as his works remained in fashion, maintain the market value of these engravings by judiciously selling and buying, even though he could never buy up all the existing prints. Similarly, a bank could certainly maintain the value of its notes even though it could never buy back all the outstanding ones. 1 A real difficulty could arise if a sudden large increase in the demand for such a stable currency, perhaps due to some acute economic crisis, had to be met by selling large amounts of it against other currencies. The bank would of course have to prevent such a rise in the value and could do so only by increasing its supply. But selling against other currencies would give it assets likely to depreciate in terms of its own currency. It probably could not increase its short-term lending very rapidly, even if it offered to lend at a very low rate of interest — even though in such a situation it would be safer to lend even at a small negative rate of interest than to sell against other currencies. And it would probably be possible to grant long-term loans at very low rates of interest against negotiable securities (in terms of its own currency) that it should be easy to sell if the sudden increase of demand for its currency should be as rapidly reversed.

IX. COMPETITION BETWEEN BANKS ISSUING DIFFERENT CURRENCIES It has for so long been treated as a self-evident proposition that the supply of money cannot be left to competition that probably few people could explain why. As we have seen, the explanation appears to be that it has always been assumed that there must be only one uniform kind of currency in a country, and that competition meant that its amount was to be determined by several agencies issuing it independently. It is, however, clearly not practicable to allow tokens with the same name and readily exchangeable against each other to be issued competitively, since nobody would be in a position to control their quantity and therefore be responsible for their value. The question we have to consider is whether competition between the issuers of clearly distinguishable kinds of currency consisting of different units would not give us a better kind of money than we have ever had, far outweighing the inconvenience of encountering (but for most people not even having to handle) more than one kind. In this condition the value of the currency issued by one bank would not necessarily be affected by the supplies of other currencies by different institutions (private or governmental). And it should be in the power of each issuer of a distinct currency to regulate its quantity so as to make it most acceptable to the public — and competition would force him to do so. Indeed, he would know that the penalty for failing to fulfill the expectations raised would be the prompt loss of the business. Successful entry into it would evidently be a very profitable venture, and success would depend on establishing the credibility and trust that the bank was able and determined to carry out its declared intentions. It would seem that in this situation sheer desire for gain would produce a better money than government has ever produced.1 Effects of competition It seems to me to be fairly certain that (a) a money generally expected to preserve its purchasing power approximately constant would be in continuous demand so long as the people were free to use it; (b) with such a continuing demand depending on success in keeping the value of the currency constant one could trust the issuing banks to make every effort to achieve this better than would any monopolist who runs no risk by depreciating his money; (c) the issuing institution could achieve this result by regulating the quantity of its issue; and (d) such a regulation of the quantity of each currency would constitute the best of all practicable methods of regulating the quantity of media of exchange for all possible purposes. Clearly a number of competing issuers of different currencies would have to compete in the quality of the currencies they offered for loan or sale. Once the competing issuers had credibly demonstrated that they provided currencies more suitable to the needs of the public than government has ever provided, there would be no obstacle to their becoming generally accepted in preference to the governmental currencies — at least in countries in which government had removed all obstacles to their use. The appearance and increasing use of the new currencies would, of course, decrease the demand for the existing national ones and, unless their volume was rapidly reduced, would lead to their depreciation. This is the process by which the unreliable currencies would gradually all be eliminated. The condition required in order that this displacement of the government money should terminate before it had entirely disappeared would be that government reformed and saw to it that the issue of its currency was regulated on the same principles as those of the competing private institutions. It is not very likely that it would succeed, because to preven