Human Action: A Treatise on Economics

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  1. For the sake of simplicity we deal in the further disquisitions of this section only with maximum prices for commodities and in the next section only with minimum wage rates. However, our statements are, mutatis mutandis, equally valid for minimum prices for commodities and maximum wage rates.

  2. Cf. above, pp. 392–394.

  3. Cf. Rostovtzeiï, The Social and Economic History of the Roman Empire (Oxford, 1926), p. 187.

  4. Corpus Juris Civilis, 1. un. C. X. 37.

  5. Cf. W. II. Beveridge, Full Employment in a Free Society (London, 1944), pp. 362–371.

  6. Cf, Hutt, The Theory of Collective Bargaining pp. 10–21.

  7. Cf. Marx, Value, Price and Profit, ed. E. Marx Aveling (Chicago, Charles H. Kerr & Company), p. 125.

  8. Cf. A. Lozovsky, Marx and the Trade Unions (New York, 1935), p. 17.

  9. Cf. Marx, op. cit., pp. 126–127.

  10. Cf. below, pp. 800–816.

  11. Cf. above, pp. 298–299.

  12. Cf. Ricardo, Principles of Political Economy and Taxation, chap, i, sec. v. The term “Ricardo effect” is used by Hayek, Profits, Interest and Investment (London, 1939), p. 8.

  13. As we are dealing here with the conditions of the unhampered market economy, we may disregard the capital-consuming effects of government borrowing.

  14. See above, pp. 519–520.

  15. The example is merely hypothetical. Such a powerful union would probably prohibit the employment of mechanical devices in the loading and unloading of ships in order to “create more jobs.”

  16. Cf. Keynes, The General Theory of Employment, Interest and Money (London, 1936), p. 264. For a critical examination of this idea see Albert Hahn, Deficit Spending and Private Enterprise, Postwar Readjustments Bulletin No. 8, U.S. Chamber of Commerce, pp. 28–29. About the success of the Keynesian stratagem in the ‘thirties, cf. below, pp. 786–787.

  XXXI. CURRENCY AND CREDIT MANIPULATION

  1. The Government and the Currency

  MEDIA of exchange and money are market phenomena. What makes a thing a medium of exchange or money is the conduct of parties to market transactions. An occasion for dealing with monetary problems appears to the authorities in the same way in which they concern themselves with all other objects exchanged, namely, when they are called upon to decide whether or not the failure of one of the parties to an act of exchange to comply with his contractual obligations justifies compulsion on the part of the government apparatus of violent oppression. If both parties discharge their mutual obligations instantly and synchronously, as a rule no conflicts arise which would induce one of the parties to apply to the judiciary. But if one or both parties' obligations are temporally deferred, it may happen that the courts are called to decide how the terms of the contract are to be complied with. If payment of a sum of money is involved, this implies the task of determining what meaning is to be attached to the monetary terms used in the contract.

  Thus it devolves upon the laws of the country and upon the courts to define what the parties to the contract had in mind when speaking of a sum of money and to establish how the obligation to pay such a sum is to be settled in accordance with the terms agreed upon. They have to determine what is and what is not legal tender. In attending to this task the laws and the courts do not create money. A thing becomes money only by virtue of the fact that those exchanging commodities and services commonly use it as a medium of exchange. In the unhampered market economy the laws and the judges in attributing legal tender quality to a certain thing merely establish what, according to the usages of trade, was intended by the parties when they referred in their deal to a definite kind of money. They interpret the customs of the trade in the same way in which they proceed when called to determine what is the meaning of any other terms used in contracts.

  Mintage has long been a prerogative of the rulers of the country. However, this government activity had originally no objective other than the stamping and certifying of weights and measures. The authority's stamp placed upon a piece of metal was supposed to certify its weight and fineness. When later princes resorted to substituting baser and cheaper metals for a part of the precious metals while retaining the customary face and name of the coins, they did it furtively and in full awareness of the fact that they were engaged in a fraudulent attempt to cheat the public. As soon as people found out these artifices, the debased coins were dealt with at a discount as against the old better ones. The governments reacted by resorting to compulsion and coercion. They made it illegal to discriminate in trade and in the settlement of deferred payments between “good” money and “bad” money and decreed maximum prices in terms of “bad” money. However, the result obtained was not that which the governments aimed at. Their decrees failed to stop the process which adjusted commodity prices (in terms of the debased currency) to the actual state of the money relation. Moreover, the effects appeared which Gresham's Law describes.

  The history of government interference with currency is, however, not merely a record of debasement practices and of abortive attempts to avoid their inescapable catallactic consequences. There were governments that did not look upon their mintage prerogative as a means of cheating that part of the public who placed confidence in their rulers' integrity and who, out of ignorance, were ready to accept the debased coins at their face value. These governments considered the manufacturing of coins not as a source of surreptitious fiscal lucre but as a public service designed to safeguard a smooth functioning of the market. But even these governments—out of ignorance and dilettantism—often resorted to measures which were tantamount to interference with the price structure, although they were not deliberately planned as such. As two precious metals were used side by side as money, the authorities naively believed that it was their task to unify the currency system by decreeing a rigid exchange ratio between gold and silver. The bimetallic system proved a complete failure. It did not bring about bimetallism, but an alternating standard. That metal which, compared with the instantaneous state of the fluctuating market exchange rate between gold and silver, was overvalued in the legally fixed ratio, predominated in domestic circulation, while the other metal disappeared. Finally the governments abandoned their vain attempts and acquiesced to monometallism. The present silver purchase policy of the American Government is not seriously a device of monetary policy. It is merely a device for raising the price of silver for the benefit of the owners of silver mines, their employees, and the states within whose boundaries the mines are located. It is a hardly disguised subsidy. Its monetary significance consists exclusively in the fact that it is financed by issuing additional dollar notes whose legal tender quality does not differ essentially from that of the Federal Reserve notes, although they bear the practically meaningless imprint “Silver Certificate.”

  Yet economic history also provides instances of well-designed and successful monetary policies on the part of governments whose only intention was to equip their countries with a smoothly working currency system. Laissez-faire liberalism did not abolish the traditional government prerogative of mintage. But in the hands of the liberal governments the character of this state monopoly was completely altered. The ideas which considered it an instrument of interventionist policies were discarded. No longer was it used for fiscal purposes or for favoring some groups of the people at the expense of other groups. The government's monetary activities aimed at one objective only: to facilitate and to simplify the use of the medium of exchange which the conduct of the people had made money. A nation's currency system, it was agreed, should be sound. The principle of soundness meant that the standard coins—i.e., those to which unlimited legal tender power was assigned by the laws—should be properly assayed and stamped bars of bullion coined in such a way as to make the detection of clipping, abrasion, and counterfeiting easy. To the government's stamp no function was attributed other than to certify the weight and the fineness of the metal contained. Pieces worn by usage or in
any other way reduced in weight beyond the very narrow limits of tolerated allowance lost their legal tender quality; the authorities themselves withdrew such pieces from circulation and reminted them. For the receiver of an undefaced coin there was no need to resort to the scales and to the melting pot in order to know its weight and content. On the other hand, individuals were entitled to bring bullion to the mint and to have it transformed into standard coins either free of charge or against payment of a seigniorage generally not surpassing the actual expenses of the process. Thus the various national currencies became genuine gold currencies. Stability in the exchange ratio between the domestic legal tender and that of all other countries which had adopted the same principles of sound money was thus brought about. The international gold standard came into being without intergovernmental treaties and institutions.

  In many countries the emergence of the gold standard was effected by the operation of Gresham's Law. The role that government policies played in the process in Great Britain consisted merely in ratifying the results brought about by the operation of Gresham's Law; it transformed a de facto state of affairs into a legal state. In other countries the governments deliberately abandoned bimetallism just at the moment when the change in the market ratio between gold and silver would have brought about a substitution of a de facto silver currency for the then prevailing de facto gold currency. With all these nations the formal adoption of the gold standard required no other contribution on the part of the administration and the legislature than the enactment of laws.

  It was different in those countries which wanted to substitute the gold standard for a—de facto or de jure—silver or paper currency. When the German Reich in the ‘seventies of the nineteenth century wanted to adopt the gold standard, the nation’s currency was silver. It could not realize its plan by simply imitating the procedure of those countries in which the enactment of the gold standard was merely a ratification of the actual state of affairs. It had to exchange the silver standard coins in the hands of the public against gold coins. This was a time-absorbing and complicated financial operation involving vast government purchases of gold and sales of silver. Conditions were similar in those countries which aimed at the substitution of gold for credit money or fiat money.

  It is important to realize these facts because they illustrate the difference between conditions as they prevailed in the liberal age and those prevailing today in the age of interventionism.

  2. The Interventionist Aspect of Legal Tender Legislation

  The simplest and oldest variety of monetary interventionism is debasement of coins or diminution of their weight or size for the sake of debt abatement. The authority assigns to the cheaper currency full legal tender power. All deferred payments can be legally discharged by payment of the amount due in the meaner coins according to their face value. Debtors are favored at the expense of creditors. But at the same time future credit transactions are made more onerous for debtors. A tendency for gross market rates of interest to rise ensues as the parties take into account the chances for a repetition of such measures of debt abatement. While debt abatement improves the conditions of those who were already indebted at the moment, it impairs the position of those eager or obliged to contract new debts.

  The antitype of debt abatement—debt aggravation through monetary measures—has also been practiced, though rarely. However, it has never deliberately been planned as a device to favor the creditors at the expense of the debtors. Whenever it came to pass, it was the unintentional effect of monetary changes considered as peremptory from other points of view. In resorting to such monetary changes governments put up with their effects upon deferred payments either because they considered the measures unavoidable or because they assumed that creditors and debtors, in determining the terms of the contract, had already foreseen these changes and duly taken them into account. The best examples are provided by British events after the Napoleonic wars and again after the first World War. In both instances Great Britain some time after the end of hostilities returned, by means of a deflationary policy, to the prewar gold parity of the pound sterling. The idea of engineering the substitution of the gold standard for the war-time credit-money standard by acquiescing in the change in the market exchange ratio between the pound and gold, which had already taken place, and of adopting this ratio as the new legal parity, was rejected. This second alternative was scorned as a kind of national bankruptcy, as a partial repudiation of the public debt, and as a malicious infringement upon the rights of all those whose claims had originated in the period preceding the suspension of the unconditional convertibility of the banknotes of the Bank of England. People labored under the delusion that the evils caused by inflation could be cured by a subsequent deflation. Yet the return to the prewar gold parity could not indemnify the creditors for the damage they had suffered as far as the debtors had repaid their old debts during the period of money depreciation. Moreover, it was a boon to all those who had lent during this period and a blow to all those who had borrowed. But the statesmen who were responsible for the deflationary policy were not aware of the import of their action. They failed to see consequences which were, even in their eyes, undesirable, and if they had recognized them in time, they would not have known how to avoid them. Their conduct of affairs really favored the creditors at the expense of the debtors, especially the holders of the government bonds at the expense of the taxpayers. In the ‘twenties of the nineteenth century it aggravated seriously the distress of British agriculture and a hundred years later the plight of British export trade. Nonetheless, it would be a mistake to call these two British monetary reforms the consummation of an inrerventionism intentionally aiming at debt aggravation. Debt aggravation was merely an attending phenomenon of a policy aiming at other ends. Whenever debt abatement is resorted to, its authors protest that the measure will never be repeated. They emphasize that extraordinary conditions which will never again present themselves have created an emergency which makes indispensable recourse to noxious devices, absolutely reprehensible under any other circumstances. Once and never again, they declare. It is easy to conceive why the authors and supporters of debt abatement are compelled to make such promises. If total or partial nullification of the creditors' claims becomes a regular policy, lending of money will stop altogether. The stipulation of deferred payments depends on the expectation that no such nullification will be decreed.

  It is therefore not permissible to look upon debt abatement as a device of a system of economic policies which could be considered as an alternative to any other system of society's permanent economic organization. It is by no means a tool of constructive action. It is a bomb that destroys and can do nothing but destroy. If it is applied only once, a reconstruction of the shattered credit system is still possible. But if the blows are repeated, total destruction results.

  It is not correct to look upon inflation and deflation exclusively from the point of view of their effects upon deferred payments. It has been shown that cash-induced changes in purchasing power do not affect the prices of the various commodities and services at the same time and to the same extent, and what role this unevenness plays in the market.1 But if one regards inflation and deflation as means of rearranging the relations between creditors and debtors, one cannot fail to realize that the ends sought by the government resorting to them are attained only in a very imperfect degree and that, besides, consequences appear which, from the government's point of view, are highly unsatisfactory. As is the case with every other variety of government interference with the price structure, the results obtained not only are contrary to the intentions of the government but produce a state of affairs which, in the opinion of the government, is more undesirable than conditions on the unhampered market.

  As far as a government resorts to inflation in order to favor the debtors at the expense of the creditors, it succeeds only with regard to those deferred payments which were stipulated before. Inflation does not make it cheaper to contract new loa
ns; it makes it, on the contrary, more expensive by the appearance of a positive price premium. If inflation is pushed to its ultimate consequences, it makes any stipulation of deferred payments in terms of the inflated currency cease altogether.

  3. The Evolution of Modern Methods of Currency Manipulation

  A metallic currency is not subject to government manipulation. Of course, the government has the power to enact legal tender laws. But then the operation of Gresham's Law brings about results which may frustrate the aims sought by the government. Seen from this point of view, a metallic standard appears as an obstacle to all attempts to interfere with the market phenomena by monetary policies.

  In examining the evolution which gave governments the power to manipulate their national currency systems, we must begin by mentioning one of the most serious shortcomings of the classical economists. Both Adam Smith and David Ricardo looked upon the costs involved in the preservation of a metallic currency as a waste. As they saw it, the substitution of paper money for metallic money would make it possible to employ capital and labor, required for the production of the quantity of gold and silver needed for monetary purposes, for the production of goods which could directly satisfy human wants. Starting from this assumption, Ricardo elaborated his famous Proposals for an Economical ana Secure Currency, first published in 1816. Ricardo's plan fell into oblivion. It was not until many decades after his death that several countries adopted its basic principles under the label gold exchange standard in order to reduce the alleged waste involved in the operation of the gold standard nowadays decried as “classical” or “orthodox.”