Lecture by Thorsten Polleit at the Vinson Centre at the University of Buckingham.
I.
The title of my talk is “Hayek’s ‘Denationalization Of Money’. Some critical remarks”. It is about a book written by the economist and social philosopher Friedrich August von Hayek.
Friedrich August von Hayek was born in 1899 in Vienna, Austria, and he is one of the most prominent representatives of the so-called ‘Austrian School of Economics’. Hayek received in 1974 “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel” (together with the Swedish economist Gunnar Myrdal) for his work on “the theory of money and economic fluctuations” and his “penetrating analyses of the interdependence of economic, social, and institutional phenomena”.
In a nutshell, Hayek, in his “Denationalization Of Money” calls for putting an end to the state’s (or government’s) monopoly of money production, replacing it by a free market in money.
At first glance, this seems to be a rather radical proposal. At a second glance, however, we would realize that there is actually strong economic and ethical support for Hayek’s idea.
And Hayek is actually not alone. Quite a few economists have challenged and even opposed the status quo, namely that money production is monopolized by the state(s).
On this slide a give you some literature on the issue we will be discussing tonight. You find, of course, Hayek’s “Denationalisation of Money” from 1976, but you may also be interested in the earlier version of the study, namely “Currency Choice. A Way To Stop Inflation” from 1975.
I also refer you to the work of Ludwig von Mises and Murray N. Rothbard on money and free banking. Also of interest could be my critique of Hayek’s more technical considerations from 2016. L. J. Sechrest’s Free Banking: Theory, History, and a Laissez-Faire Model from 1993 might also be insightful reading for you.
In his “Denationalisation Of Money”, Hayek proposes to give people the freedom of choice in money affairs: You and I, we all, should be free to choose the kind of money we think is best for our purposes; and, at the same time, people should be free to provide their fellow man with “things” they voluntarily wish to use as money.
That said, Hayek rejects the monetary status quo. Just to remind you: Today the world over we find state-controlled monetary systems. State-owned central banks hold the monopoly of the production of money, to be precise: central bank money.
Private commercial banks have received a state license, so to speak, allowing them to produce their own money, that is commercial bank money, on top of central banks’ central bank money.
II.
So let us ask the question: Why does Hayek come up with his proposal to end state money production monopolies, replace it with a free market in money?
Well, when Hayek published his “Denationalization Of Money” in the 1970s, goods price inflation was very high, unacceptably high.
The US administration had ended the gold redeemability of the US dollar on 14 August 1971.
This unilateral decision on the part of the US administration effectively established a world-wide fiat currency system – a system in which every currency was no longer redeemable into anything.
As a result, the quantity of money could be increased in any amount at any time seen politically expedient. Many states made use of this capacity: They run up enormous deficits, financed by newly created fiat money.
The strong increase in the quantity of money made good price inflation go up. People in the US, for instance, experienced what they latter called the “Great Inflation” – with annual consumer goods price inflation running in the double digits. Similar developments unfolded in many European countries, most noticeable in the United Kingdom.
Being an economist in the tradition of the Austrian School of Economics, Hayek has a special interest in monetary theory and, of course, the monetary theory of the business cycle, the causes of the recurrence of boom and bust, that is.
What is more, Hayek is acutely aware of the destructive forces set into motion by inflation. So it doesn’t take wonder that Hayek reacted most sensibly to the inflationary tendencies of this time.
Austrians typically consider inflation – that is chronically rising goods prices as a consequence of a relentless increase in the quantity of money – as an economic and societal evil.
Inflation destroys the purchasing power of money. If goods prices rise, you can buy less and less with your money unit.
Also, inflation is socially unjust: It enriches some (namely the first receivers of the newly created money) at the expense of the many (the late receivers of the newly created money). In that sense, we can even say that inflation is socially unjust.
What is more, inflation undermines the effectiveness of using money in economic calculation: It induces consumers and entrepreneurs to make bad decisions, disrupting the process of wealth creation.
Most importantly, inflation – caused by an expansion of the fiat money quantity – leads to boom and bust cycles, economic and financial crises, which, in turn, result in hardship for many people.
And finally, the issuance of fiat money helps the state, the government, to expand – at the expense of the freedom and liberty of people and firms.
In fact, Hayek – in his critique of the state’s money production monopoly – emphasises that inflation is typically the result of governments spending too much relative to tax revenues, and increasing the issuance of fiat money to finance the deficit.
Hayek put it succinctly, when he writes: “With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people.”
So now we know why Hayek calls for a ‘denationalisation of money’: He makes a proposal to give people better, good, or sound, money – compared to money that is produced under a state monopoly.
III.
Speaking of money: Do you know what money is? Most of you do, I guess: You know that money is the universally accepted means of payment. But there is more to know about money.
Ludwig von Mises pointed out that (and this may perhaps surprise many) money has just one function, and that is the means of exchange function.
The unit of account function and store of value function are just derivatives of money’s means of exchange function.
Money is the most liquid goods of all, it has the highest marketability, so to speak. But is it really ‘special’?
Austrians would say: No it isn’t. Aside being the most liquid good around, money is a good like any other. And most important in this context: The value of money is determined by the law of diminishing marginal utility – like all goods are.
At the individual level this law says that 1) a higher stock of money is preferrable to a smaller stock of money, as the former allows for achieving more objectives than the latter; and 2) the marginal utility of the money unit declines, the more money units there are available to the actor.
That said, a change in the quantity of money in my hands leads to (other things being equal) changes in the marginal utilities of money units and all other vendible non-money items.
If you agree, then the conclusion is: All an increase in the amount of money does is lowering the purchasing power of the money unit (compared to a situation in which there had been no increase in the stock of money).
We also come to the following conclusion: It doesn’t matter what the magnitude of money is in the economy, and that any currently prevailing money stock is so to speak ‘optimal’.
A large amount of money is as good or a as bad in providing money services as a small amount of money. A money supply of, for example, €15 billion is as good or as bad as a money supply of, say, €5 billion. If the quantity of money is large, goods prices will be relatively high; if it is small, goods prices will be relatively low. Again, any quantity of money is just as good or bad for financing a given transaction of goods and services as any other.
In sum, we can say that an increase in the quantity of money does not – unlike the increase in all other goods – confer a social benefit; and that a growing economy does not necessarily need an expanding quantity of money – and insight from the Austrian school, which is diametrically opposed to today’s mainstream economic thinking.
IV.
Let us return to Hayek’s proposal, and let us ask the question: How would a ‘free market in money’ work?
I guess most of you like free choice – when buying, say, food, sport shoes, books, computers, furniture, cars, houses, etc. And I guess it doesn’t take much to convince you that a free market caters best to the needs of the consumers, providing them with goods of the highest quality at the lowest possible prices.
But when it comes to money, you may be asking yourself: How could a free market in money possibly work? Well, it would presumably work like this:
People, making exchanges, would preferably use that type of medium that is most widely accepted, that has the highest marketability.
I, for instance, would seek to get hold of a medium which is, from the viewpoint of my trading partner (say, a baker), most highly valued. And my baker, in turn, would seek to hold a medium that can most easily be exchanged at the shoemaker. And so on.
In other words, in a free market in money it would be the demand for money that determines what money is. It is the people in the free marketplace that make this choice.
But what about money supply, you may ask? When seeking good or sound money, people will realize that a “thing” that should serve as sound money must meet certain characteristics:
For instance, it must the scarce, homogeneous, durable, divisible, mintable, transportable, it must represent a relatively high exchange value per unit, etc.
When we look into monetary history, we see that people mostly, if they had the freedom to do so, opted for precious metals as money, preferably gold and silver, even copper to a degree – because precious metals were, from the viewpoint of money users, considered the best option.
Of course, we wouldn’t know what kind of money would emerge if we open up a free market in money. As you know, the free market is a discovery process, as Hayek put it, and its outcome cannot be predicted with certainty.
However, in view of what we have just said, it is highly likely that people would, if we open up a free market in money, opt for gold and silver as money, perhaps even for a crypto unit such as bitcoin.
V.
But before we explore this idea any further, let me ask you the following question: Is Hayek’s proposal for a denationalisation of money, for opening up a free market in money, convincing?
It is fair to say that Hayek’s study drew a lot of criticism. Most argued his concept would be unrealistic, undesirable. Among economists, Hayek’s idea had indeed remained a sideshow for many years.
This might be, and in no small part, due to some inconsistencies, which permeates his line of argumentation. Let me give you some examples.
Example No. 1: Hayek confuses money proper with money substitutes. He thinks that in a free market there would be competition between private money issuers, each issuing its own currency – and this could lead to monetary chaos.
In this context, however, it is important to distinguish between money proper and money substitutes. In a free market in money, people with free choice would decide what good(s) will become money proper (such as, for instance, gold or silver or a crypto unit). Then, under free banking, money warehouses would spring up, offering services in terms of storage, settlement and safeguarding money proper.
If, for instance, Mr. Smith decides to deposit 10 gold ounces with a money warehouse (say, the Polleit Money Warehouse), he will receive in return a money warehouse receipt (a money substitute). That said, money warehouses will compete in terms of money substitutes, not in money proper. In a truly free market in money, people freely choose the kind of money they wish to use, and once this has been decided, the remaining competition is among money substitutes issued by competing money warehouses.
Example No.2: Hayek fails to factor in a crucial lesson from the ABCT. He thinks that in a free market in money, new money can be produced through 1) literally printing up new money and 2) loaning new money into existence.
Ad 1): New money cannot be created ex machina. This we know from Ludwig von Mises’s regression theorem. Just think of a scenario in which I take little paper tickets, write the name ‘Polleit’ on it and the number 100. No one who is in his right mind will accept my paper ticket as money. No one would know what the exchange value of these pieces of paper would be, so that no one would accept them. It is the regression theorem that tells us that unbacked (paper) money cannot emerge voluntarily and spontaneously.
Ad 2) If the new money is loaned into existence, Hayek’s competing currencies would basically amount to monies created ‘out of thin ‘air’. They would suffer from the same economic and ethical deficiencies as state controlled fiat monies. These monies would be inflationary and set into motion a boom-bust-cycle.
Admittedly, however, money produced through credit expansion under free market conditions might be less harmful compared to state monopolized fiat money: People would have a choice in terms of money, and in a free market for money the incentive for money issuers engaging in fractional banking would be diminished as there would be no central bank acting a ‘lender of last resort’ and so the incentive for banks to overissue would be restricted.
Be that as it may, however, Hayek’s ideas of creating new money by printing it up or loaning it into existence do either not work, or they cause economic and societal damage – and must therefore be rejected, for they would not pave the way towards better, or sound, money.
VI.
In view of the criticisms, I have levelled against Hayek’s “Denationalisation Of Money” I hasten to make clear that my criticisms merely refer to technicalities, they are by no means imply an outright rejection of the idea of denationalizing money.
However, the numerous technical, money-theoretical inconsistencies we find in Hayek’s study seem to have backfired: The suspicion cannot be dismissed that they have done more harm than good to popularize the idea of replacing the state’s coercive money monopoly by a free market in money.
Be that as it may, there are still important lessons that can be learned from Hayek’s “Denationalization Of Money” for us today.
No. 1: Hayek reminds us that that there is no compelling economic or ethical reason why the state should hold the money monopoly; in fact, that providing the state (and thus the special interest groups that use the state’s coercive power for their purposes) with the authority over money will lead to inflation and its accompanying economic and societal evils.
No. 2: Hayek rightfully points out that a free market for money is possible – and that it is, no doubt about that, economically and ethically superior to today’s states’ controlled money monopoly regimes.
No. 3: Hayek’s free market for money can be set into motion by a) ending the ‘legal tender status’ of official currencies, b) ending capital gain taxes and VAT on potential money candidates such as gold, silver and crypto units, and c) ending all remaining regulations that stands in the way of using other means for payment purposes than official currencies.
No. 4: Hayek brings to our attention what Carl Menger (the ‘founding father’ of the Austrians) had pointed out already in his book “Principles of Economics” in 1871: namely that money is a free market phenomenon, that it emerged spontaneously from the free market, and out of a commodity (such as, say, gold and silver).
According to Carl Menger, money did not, and Ludwig von Mises explained this in 1912 with his regression theorem, through state action. It did not, and does not, require a state (as we know it today) for money coming into existence. And this insight, in turn, should make us understand better the developments in the markets for crypto units.
Namely that people have become disenchanted with today’s official fiat currencies, which are inflationary and cause boom and bust, triggering economic and financial crises, encouraging policies that make the states become larger and larger and thus increasingly destroy individual liberties and freedoms and the wealth of the nations.
I hope my critical remarks have been encouraging and inspiring for the reader, increasing his/her interest in Hayek’s idea of “denationalisation of money”.
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