Professor Yeager and 100 Percent Gold

One of the most important discussions of the 100 percent gold standard in recent years is by Professor Leland Yeager.[35] Professor Yeager, while actually at the opposite pole as an advocate of freely-fluctuating fiat moneys, recognizes the great superiority of 100 percent gold over the usual pre-1933 type of gold standard. The main objections to the gold standard are its vulnerability to great and sudden deflations and the difficulties that national authorities face when a specie drain abroad threatens domestic bank reserves and forces contraction. With 100 percent gold, Yeager recognizes, none of these problems would exist:

Under a 100 percent hard-money international gold standard, the currency of each country would consist exclusively of gold (or of gold plus fully-backed warehouse receipts for gold in the form of paper money and token coins). The government and its agencies would not have to worry about any drain on their reserves. The gold warehouses would never be embarrassed by requests to redeem paper money in gold, since each dollar of paper money in circulation would represent a dollar of gold actually in a warehouse. There would be no such thing as independent national monetary policies; the volume of money in each country would be determined by market forces. The world’s gold supply would be distributed among the various countries according to the demands for cash balances of the individuals in the various countries. There would be no danger of gold deserting some countries and piling up excessively in others for each individual would take care not to let his cash balance shrink or expand to a size which he considered inappropriate in view of his own income and wealth.

Under a 100 percent gold standard... the various countries would have a common monetary system, just as the various states of the United States now have a common monetary system. There would be no more reason to worry about disequilibrium in the balance of payments of any particular country than there is now reason to worry about disequilibrium in the balance of payments of New York City. If each individual (and institution) took care to avoid persistent disequilibrium in his personal balance of payments, that would be enough The actions of individuals in maintaining their cash balances at appropriate levels would “automatically” take care of the adequacy of each country’s money supply.

The problems of national reserves, deflation, and so forth, Yeager points out, are due to the fractional-reserve nature of the gold standard, not to gold itself. “National fractional reserve systems are the real source of most of the difficulties blamed on the gold standard.” With fractional reserves, individual actions no longer suffice to assure automatically the proper distribution of the supply of gold. “The difficulties arise because the mixed national currencies—currencies which are largely paper and only partly gold—are insufficiently international. The main defect of the historical gold standard is the necessity of ‘protecting’ national gold reserves.” Central banking and its management only make things worse: “In short, whether a Central Bank amplifies the effects of gold flows, remains passive in the face of gold flows, or ‘offsets’ gold flows, its behavior is incompatible with the principles of the full-fledged gold standard. Indeed, any kind of monetary management runs counter to the principles of the pure gold standard.”[36]

In view of this eloquent depiction of the 100 percent gold standard, why does Yeager flatly reject it and call instead for freely fluctuating fiat money? Largely because only with fiat money can each governmental unit stabilize the price level in its own area in times of depression. Now I cannot pause to discuss further the policy of stabilization, which I believe to be both fallacious and disastrous. I can only point out that contrary to Professor Yeager, price declines and exchange rate depreciation are not simple alternatives. To believe this is to succumb to a fatal methodological holism and to abandon the sound path of methodological individualism. If, for example, a steel union in a certain area is causing unemployment in steel by insisting on keeping its wage rates up though prices have fallen, I consider it at once unjust, a cause of misallocations and distortions of production, and positively futile to try to remedy the problem by forcing all the consumers in the area to suffer by paying higher prices for their imports (through a fall in the area’s exchange rate).

One problem that every monetary statist and nationalist has failed to face is the geographical boundary of each money. If there should be national fluctuating fiat money, what should be the boundaries of the “nation”? Surely political frontiers have little or no economic meaning. Professor Yeager is courageous enough to recognize this and to push fiat money almost to a reductio by advocating, or at least considering, entirely separate moneys for each region or even locality in a nation.

Yeager has not pushed the reductio far enough, however. Logically, the ultimate in freely fluctuating fiat moneys is a different money issued by each and every individual. We have seen that this could not come about on the free market. But suppose that this came about by momentum from the present system or through some other method. What then? Then we would have a world chaos indeed, with “Rothbards,” “Yeagers,” “Joneses,” and billions of other individual currencies freely fluctuating on the market. I think it would be instructive if some economist devoted himself to an intensive analysis of what such a world would look like. I think it safe to say that the world would be back to an enormously complex and chaotic form of barter and that trade would be reduced to a virtual standstill. For there would no longer be any sort of monetary medium for exchanges. Each separate exchange would require a different “money.” In fact, since money means a general medium of exchanges, it is doubtful if the very concept of money would any longer apply. Certainly the indispensable economic calculation provided by the money and price system would have to cease, since there would no longer be a common unit of account.[37] This is a serious and not farfetched criticism of fiat-money proposals, because all of them introduce some of this chaotic element into the world economy. In short, fluctuating fiat moneys are disintegrative of the very function of money itself. If every individual had his own money, the disintegration of the very existence of money would be complete; but national—and still more regional and local—fiat moneys already partially disintegrate the money medium. They contradict the essence of the monetary function.

Finally, Professor Yeager wonders why such “orthodox liberals” as Mises, Hayek, and Robbins should have insisted on the “monetary internationalism” of the gold standard. Without presuming to speak for them, I think the answer can be put in two parts: (1) because they favor monetary freedom rather than government management and manipulation of money, and (2) because they favored the existence of money as compared to barter—because they believed that money is one of the greatest and most significant features of the modern market economy, and indeed of civilization itself. The more general the money, the greater the scope for division of labor and for the interregional exchange of goods and services that stem from the market economy. A monetary medium is therefore critical to the free market, and the wider the use of this money, the more extensive the market and the better it can function. In short, true freedom of trade does require an international commodity money—as the history of the market economy of recent centuries has shown—gold and silver. Any breakup of such an international medium by statist fiat paper inevitably cripples and disintegrates the free market, and robs the world of the fruits of that market. Ultimately, the issue is a stark one: we can either return to gold or we can pursue the fiat path and return to barter. It is perhaps not hyperbole to say that civilization itself is at stake in our decision.[38]