6. Rothbard on Money: The Vindication of Gold

ROTHBARDON MONEY:
THE VINDICATIONOF GOLD

Rothbard devoted close attention to monetary theory. Here he emphasized the virtues of the classical gold standard and supported 100 percent reserve banking. This system, he held, would prevent the credit expansion that, according to the Austrian theory of the business cycle developed by Mises and Friedrich Hayek, led to inevitable depression. His views on money feature prominently in Man, Economy, and State. He summarized his ideas for the general public in the often-reprinted pamphlet What Has Government Done to Our Money? (1963)⁷³ and also wrote a textbook, The Mystery of Banking (1983);⁷⁴ several of the essays in Making Economic Sense also discuss monetary policy.⁷⁵ His The Case Against the Fed (1994)⁷⁶ is another popular exposition of his views. His most important theoretical essays on the subject are contained in the first volume of The Logic of Action.

He explains with crystal clarity the essentials of Mises’s account of money. Monetary theory, for Mises and the Austrians, does not stand isolated from the rest of economics. Through the use of the regression theorem, Mises (following Menger) showed how money develops from barter. Money is properly a commodity, whose value, like that of any other commodity, is determined by the market. Some commodities are much easier to market than others, and “[o]nce any particular commodity starts to be used as a medium, this very process has a spiraling, or snowballing, effect.”⁷⁷ Soon one or two commodities emerge into general use as a medium of exchange. And this, precisely, is money. Gold and silver have almost always been the commodities that win the competition for marketability. “Accordingly, every modern currency unit originated as a unit of weight of gold or silver.”⁷⁸

This process was no accident; according to the regression theorem, money could not have originated by government fiat. There would be no means to determine the purchasing power of money that was not initially a commodity.

One of the important achievements of the regression theory is its establishment of the fact that money must ... develop out of a commodity already in demand for direct use, the commodity then being used as a more and more general medium of exchange. Demand for a good as a medium of exchange must be predicated on a previously existing array of prices in terms of other goods.⁷⁹

We can already respond to the following question: what is the optimum quantity of money? If one has understood the explanation of money’s genesis, the answer is apparent. An increase in the supply of money does not increase real wealth, since money is used only in exchange.⁸⁰“Any quantity of money in society is ‘optimal’.”⁸¹ The answer remains the same when paper money has been introduced.

A problem now arises for the analysis so far presented. If an increase in the supply of money does not increase real wealth, why have governments continually resorted to inflation? Rothbard’s response involves another fundamental insight of Austrian economics. Inflation does not affect everyone equally: quite the contrary, those who first obtain new money gain a great advantage, since they can purchase goods and services before most people become aware that the purchasing power of money has fallen. Politicians use inflation to benefit themselves and their supporters.

Another dubious monetary practice arose out of deposit banking. Because of the inconvenience of carrying gold and silver, people often deposited their money in banks, obtaining in return a receipt. These receipts, since they are promises to pay gold and silver, soon began to circulate as money substitutes. But a temptation presented itself to the bankers. The receipts normally did not specify particular gold or silver coins to be returned to the depositor; they were rather entitlements to specified amounts of the money commodity.⁸² Since they are required only to return the amount of money specified in the receipt, bankers might give out more receipts than they had gold and silver on hand, trusting that not all depositors would demand redemption at the same time. For those willing to assume this risk, the prospect of vast profits called appealingly.

But is not this practice a blatant instance of fraud? So it would appear, and so Rothbard firmly avers that it is. Unfortunately, several British legal decisions held otherwise, and the American courts adopted these verdicts as well.

Our banker-counterfeiter, one might assume, can now proceed happily on his way to illicit fortune. But an obstacle confronts him: if he issues more receipts than he can redeem, the clients of other banks might ruin him through demands for payment that he cannot make good. Hence the bankers worked to establish a central banking system. Under a centralized system, the danger of bank runs would diminish. If Rothbard is correct, the entire basis of modern deposit banking, the fractional reserve system, is a type of counterfeiting that must be abolished. Under present arrangements, “the Fed has the well-nigh absolute power to determine the money supply if it so wishes.”⁸³ In response, the Federal Reserve System must be liquidated and the gold standard restored “at one stroke.”⁸⁴

In the course of his exposition, Rothbard states: “The Austrian theory of money virtually begins and ends with Mises’s monumental Theory of Money and Credit,⁸⁵ published in 1912.”⁸⁶ Here Rothbard underestimates himself. He made major advances in monetary theory. In particular, he favored a broader definition than customary of the supply of money—money includes whatever is redeemable at par in standard money.

Rothbard’s insistence on conceptual precision contrasts with the pragmatic, “anything goes” position of the Chicago School. In “Austrian Definitions of the Supply of Money” (1978), he castigates that group’s “desire to avoid essentialist concepts.”⁸⁷ Unconcerned with what money is in itself, to the Chicagoites an aridly scholastic question, they call money whatever most closely correlates with national income. Such unconcern with clarity makes Rothbard recoil in horror.

As always with Rothbard, his pursuit of clarity in theory remains closely tied to practice. Given a correct account of theory, various suggestions for monetary reform can at once be seen to be fallacious. Thus, in “The Case for a Genuine Gold Dollar” (1985),⁸⁸ Rothbard objects to Hayek’s call for denationalization of money. Hayek’s call for a multitude of privately issued monies ignores the implications of the regression theorem. Owing to the advantages of a common medium of exchange, barter leads to money; Hayek’s proposal would reverse that evolution.

Rothbard demolishes freely fluctuating exchange rates with a simple conceptual point. As he notes in “Gold vs. Fluctuating Fiat Exchange Rates” (1975),⁸⁹ a “free market for money,”⁹⁰ as proposed by Milton Friedman, is on a correct account of money senseless. Money, in the Austrian view, is a commodity: a specific amount of money, then, is a quantity of a commodity, usually (as names such as “pound” suggest) measured by weight. The content of the monetary unit is no more a matter for negotiation on the market than is, say, the length of a foot.

To Rothbard, Keynesian economics was responsible for much of what was wrong with contemporary monetary policy, and he often does battle with it. Lord Keynes and his disciples spurned the gold standard, which Rothbard sees as the only basis for a sound currency. Instead, the Keynesians endeavored to establish a worldwide fiat currency, under the control of an international bank. To achieve this, the Keynesians thought, would eliminate a principal obstacle to their economic plans.

As everyone knows, the Keynesian system often prescribes inflation. But if one country inflates and others do not, or do so only to a lesser extent, it will, under a gold standard, lose gold to them. A Keynesian World Bank would permit all countries to inflate together: gone would be the check that independent monetary systems would impose on radical Keynesianism.

Of course, there is the minor matter that a world Keynesian monetary system spells disaster. “At the end of the road would be a horrendous world-wide hyper-inflation, with no way of escaping into sounder or less inflated currencies.”⁹¹ Fortunately, Keynesians have been unable to put their schemes into full operation: but the manifest failure of their system has not deterred them, and they must ever be combated anew. Rothbard’s unique combination of political and economic analysis is an indispensable weapon in the struggle.

But if Keynesianism leads to disaster, wherein lies salvation? One false step, appealing to many, is to cast away theory altogether. The National Bureau of Economic Research has famously attempted to study the business cycle through strict reliance on fact; and Rothbard’s teacher Arthur Burns, long associated with the National Bureau, was a partisan of this approach. The Bureau’s “proclaimed methodology is Baconian: that is, it trumpets the claim that it has no theories, that it collects myriads of facts and statistics, and that its cautiously worded conclusions arise slowly, Phoenix-like, out of the data themselves.”⁹²

Rothbard subjects the alleged scientific approach of the Bureau to devastating attack. Rothbard, although of course firmly committed to Austrian economics, had a detailed knowledge of statistics, at one time his college major; and he could meet the measurement devotees on their own ground.

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⁷³What Has Government Done to Our Money? (Colorado Springs, Colo.: Pine Tree Press, 1963).

⁷⁴The Mystery of Banking (New York: Richardson and Snyder, 1983).

⁷⁵Making Economic Sense (Auburn, Ala.: Ludwig von Mises Institute, 1995).

⁷⁶The Case Against the Fed (Auburn, Ala.: Ludwig von Mises Institute, 1994).

⁷⁷Ibid., p. 13.

⁷⁸Ibid., p. 17; emphasis in the original.

⁷⁹Man, Economy, and State with Power and Market, pp. 274–75.

⁸⁰The exception of nonmonetary uses of gold and silver can for our purposes be ignored.

⁸¹Case Against the Fed, p. 20; emphasis in the original.

⁸²Rothbard noted that the great nineteenth-century economist William Stanley Jevons warned against these “general deposit warrants.”

⁸³The Case Against the Fed, p. 144.

⁸⁴Ibid., p. 146.

⁸⁵Logic of Action I, p. 297.

⁸⁶Ludwig von Mises, The Theory of Money and Credit (Indianapolis: LiberyClassics, 1980).

⁸⁷Logic of Action I, p. 337.

⁸⁸Ibid., pp. 364–83.

⁸⁹Ibid., pp. 350–63.

⁹⁰Ibid., p. 389.

⁹¹Making Economic Sense, p. 254.

⁹²Ibid., p. 232.