Choice in Currency

Ivor Pearce

Professor of Economics and Head of Department, University of Southampton, 1962–72
Director of Research, Econometric Model Building Unit, University of Southampton, 1973–75
Author of A Model of Output, Employment, Wages and Prices in the UK (1976)

If I had the temerity, which I do not, to claim the existence of a fault in Professor Hayek’s superb Choice in Currency, it would be a fault of omission rather than commission. Professor Hayek correctly identifies the secret of Keynes’s success with a pseudo-exact ‘sanction of scientific authority’, but he does not explain in the same pseudo-exact terms the precise point of the neo-Keynesian error. Until this is done the ‘lost generation’ who were taught nothing but Keynes may very well remain unconvinced. Being myself one of the lost generation, now enlightened, I offer the following argument.

Neo-Keynesians hold that the act of saving takes money out of the circulation flow — income to purchases to income — whilst the act of investment adds money to that flow. To maintain a constant rate of flow, that is, a steady demand for goods, it is necessary that desired saving should equal desired investment. According to the Keynesian argument saving will vary with the level of employment, so that changes in the level of employment serve as a mechanism equating saving and investment. But, if this is the mechanism, the desire to save may be matched with the desire to invest at a level of employment less than full. The apparent remedy is to print and give away money to spend or to invest, that is, to stimulate artificially the desire to spend or to invest.

But the truth is that the act of saving does not ordinarily hold up the circular flow of money at all. If I choose to save more, I buy a bond with my new savings, an act which is possible only if someone sells a bond. The money I have saved is immediately available to the seller of the bond to buy goods. There is no failure of demand. A failure of demand occurs only if someone chooses not to pass the money on but to hold a larger stock of money than usual.

This will cause unemployment. But such unemployment must be transient. No part of the stock of money is destroyed. Failing some fundamental change in institutional conventions the very sum hoarded will eventually be released and demand restored. If, at the moment of each transient failure of demand, governments rush to create and put into circulation new money in accordance with the Keynesian prescription, inflation will occur as soon as the temporary hold-up in the flow of the old money ceases.

Nor is this the worst of it. Keynesian theory affords a cloak of respectability to acts of currency debasement formerly universally recognised as evil. The very institution—the British Parliament originally founded to control the monetary excesses of the Sovereign, itself now engages in acts of currency debasement far beyond any thing that Henry VIII could have imagined, much less planned and executed. The watchdog has become the wolf.

Professor Hayek proposes that a free-market watchdog should be legalised so that good private money might drive out bad government money, if it is bad. There is room for argument whether this would prove more or less effective than, say, control by a revitalised and independent Bank of England; but there can be no dispute whatever that some kind of watchdog must be appointed, and quickly.

Harold Rose

Esmée Fairbairn Professor of Finance, London Graduate School of Business Studies
Economic Adviser to Barclays Bank
Author of Management Education in the I970s: Growth and Issues (1969)

Professor Hayek’s prescription involves abolition of all exchange control and allowing exchange rates to move freely. But then it would not be necessary to eliminate the monopolistic title of legal tender as well. For the movement of interest rates and forward exchange rates would fully reflect the degree of trust in different currencies, and the price mechanism would enable contracts to be made to no disadvantage even in a weak currency, thus avoiding all the costs of inconvenience and uncertainty the absence of legal tender would entail.

Put in this way, Professor Hayek’s prescription becomes less revolutionary than it sounds, and I have correspondingly less faith in its efficacy. For sustained inflation has not been confined to countries whose governments have surrounded them with the wall of exchange control, and there is in any event nothing to prevent several countries from inflating together, as they have done during the past few years.

Whether governments would in practice be any more ready to affirm their financial virtue by abolishing exchange control than by submitting themselves to more direct financial disciplines, such as the limitation of the money supply, is to be doubted. But Professor Hayek’s analysis is undoubtedly correct in pointing to the operation of a kind of Gresham’s Law if our inflation continues. Sooner or later the evasion of exchange control will spread; and the ordinary citizen, with no means of defending himself, will have the worst of all worlds.

Douglas Jay, PC, MP

Fellow of All Souls College, Oxford, 1930–37, 1968-
Economic Secretary to the Treasury, 1947–50
Financial Secretary, 1950–51
President of the Board of Trade, 1964–67
Author of The Socialist Case (1937)

In his paper, Choice in Currency, Professor Hayek seems to have been led astray either by his life-long quarrel with Lord Keynes, or else by the ancient fallacy—now common—of believing that if one system does not yield ideal results, anything else would do better. He wants governments to refrain from declaring anything legal tender, and all individuals to use what money they like. He says that people should be ‘free to refuse any money they distrusted and to prefer money in which they had confidence’.

But suppose I offer one paper rouble in payment of a bus fare, and the conductor refuses to accept it; what happens? Is the bus stopped while the conductor and I seek a ruling which nobody can give? And imagine the controversies in the bus over the latest exchange rate between one currency and any other. Professor Hayek’s new scheme would produce chaos and slow down the whole business of production and exchange in a welter of disputation. That is why history has forced governments to legislate on legal tender. Professor Hayek might nearly as well ask for the abolition of all law courts and indeed governments, and let every individual prosecute his own disputes. Such an argument has, no doubt, a superficial appeal. But human history argues rather strongly against it.

Of course, Professor Hayek is right in saying that many governments (and banking systems) have for most of history abused their right to issue money. He rather forgets the banking systems. Yet in the Great Barber Credit Inflation of 1972–73 in the UK, it was the banks tolerated, not instigated, by the Government which engineered the inflation.

But in thinking you can take control of the currency out of the hands of modern elected governments, and put it in the hands of some mysterious wise men meditating in some ivory tower, Professor Hayek is flying in the face of reality. The public simply will not allow control of money to be put beyond their control any more than control of laws or taxes. The only hope, even if a frail one, is to educate governments to act sensibly.

Sir Keith Josepth, BT., PC, MP

Fellow of All Souls College, Oxford, 1946–60, 1972-
Secretary of State for Social Services, Dept. of Health and Social Security, 1970–74
Economic Adviser to Mrs Margaret Thatcher and member of the Shadow Cabinet
Author of Reversing the Trend (1975)

Professor Hayek’s elegant, penetrating and humane argument will teach most of us that if governments will not cure inflation, then they can at least enable the people to safeguard themselves from the horrors of currency collapse—by allowing a free choice of currency.

No doubt the Treasury would object—on balance of payments and currency control grounds, for, unlike what I understand to be the legality of sterling payments merely indexed to a foreign currency, this would end exchange control. No doubt some politicians and some trade union leaders would object. But voters and wage-earners would not necessarily agree with their nominal spokesmen. They long for a stable medium of exchange and store of value. A minority at all levels of income can and will protect themselves against inflation. Most will not be able to do so. The humanity of Professor Hayek’s proposal is that it could partly at least safeguard all our people against the incompetence or irresolution of their own government.

The relevance may become intense if the pending deceleration of inflation proves only to be a false dawn. And anyway the looming obligation to ease exchange control under the EEC rules will before long revive the need to discuss the constraints under which we have become used to living—and the self-correcting mechanisms that would be brought into play by a dose of freedom.

I hope that the implications of Professor Hayek’s proposal will be explored so that we may the better judge its potency and potential.