22: Contemporary Currency Systems
Prior to the first World War, all currencies had some parity to a reserve of gold maintained by national governments. Banknotes were redeemable for some quantity of gold, and central banks would in fact redeem them on demand. As such, state-issued currencies were accepted in trade by virtue of the value of the gold they represented.
It might be said that the world was on a gold standard, however, no standard existed for the amount of metal a unit of currency represented. A florin, mark, or shilling represented some quantity of gold, but that quantity was subject to change as currencies were debased. However, any change to the value of currency required an act of legislature, and was open to public scrutiny, so such changes would occur slowly and with ample advanced notice.
In this sense, the author draws a distinction between the classical gold standard (in which coins were made of precious metals) and the gold-exchange standard (in which coins represented gold that they did not contain, as did various forms of paper money, checks, fiduciary media, and the like). So long as issuers redeemed their currency for a predictable amount of gold, the two remain functionally equivalent.
The Flexible Standard
Between the two world wars, there arise a "flexible" gold standard, marked by four characteristics:
- The value of currency in exchange for gold is not fixed by law, but managed by a government agency that could be flexible in altering the rate without act of parliament
- The exchange rate is subject to sudden changes without previous notice to the public. Typically, though not necessarily, these changes are relatively minor adjustments.
- The notion of redeeming currency remained, but the actual act of redemption was to be discouraged. It could be said that a given bill was "worth" a given amount of gold, but the right to redeem it was at the discretion of the issuing agency. This gave rise to the term "pegging" - a nominal redemption rate.
- The determination of pegging amounts was relegated to the government agency in charge of currency. In effect, such agencies held power to devalue currency, though it was publicly referred to as "increasing the price of gold" rather than "debasing the currency"
In effect, national currencies could claim to be based on a gold standard, but it was a flexible rather than fixed standard. So again, the actual amount of gold represented by a unit of currency was subject to change, the difference being it was managed by an agency and could occur quickly and without any advanced notice. That is, issues would still redeem their currency for gold, if they were so inclined, but the amount was not predictable.
A government-regulated currency system can perpetuate only so long as it is tolerable to the market. If the currency remains fairly stable, and inflation is moderate, the public may tolerate such a currency system "for a series of years."
Freely Vacillating Currency
The distinguishing characteristic of a vacillating currency is that the bearer has no right whatsoever to redeem the currency with the issuing bank or treasury. The pieces are intended to function not as money substitutes, but as money proper, which carries only exchange value.
In the 1920's, certain European nations attempted to bolster their domestic currency by prohibiting the redemption of their currency while, at the same time, selling on the international market the commodities on which these currencies were based, with the intention of later buying them back to amend the resulting weakness in their currency. This was a "nonsensical operation," which could have been effected merely by issuing additional currency and retiring it at a later time. The effect was essentially the same.
The author also refers to the "new deal" dollar of the United States, which was not redeemable, though intended to be valued by the market in exact proportion to the nation's gold-backed currency. This could well have meant the death of the dollar, had its proponents failed to exercise restraint in its issuance.
The Illusive Standard
The "illusive" standard is, simply stated, based entirely on falsehood. Government decrees a parity of exchange against a gold standard or a foreign currency and maintains by means of force a factitious exchange rate: anyone who values the currency by an other ration is pursued as a criminal.
While such a policy can be enforced in a domestic market, it is unenforceable in the international market, as foreign nationals are not subject to the degrees of government. To prevent unauthorized trade, government must confiscate all goal and foreign currencies and prohibit private ownership, such that it may become the sole source of exchange and enforce an ratio of exchange that is contrary to what would arise from free trade.
That is to say that domestic subjects are prohibited from trading to obtain gold or foreign currency when the exchange rate is favorable, though the government may do so to its own benefit. No force of law is necessary to prevent exchange when the rate is unfavorable, as no holder of gold or sound currency would be interested in participating in such an exchange; though again, government may do so and draw the necessary premium from taxation.
A policy that mean to control foreign exchange is effectively an attempt to deviate from purchasing-power parity among currencies, and generally "fails lamentably." Foreign traders reject the currency, as would domestic subjects had they the ability to do so, and most often, the domestic market becomes alienated from the world markets.
Any good whose demand is far exceeded by supply is considered by economists to be a "free good" - that is, they have no economic value and are of no interest. Conversely, any economic good is, by its very nature, scarce and si valued by its scarcity. Thus to claim that there is a shortage of goods, or gold, or currency, is virtually a tautology.
A currency (like any other good) ceases to be an economic good and becomes a free good under two circumstances: when it is supplied at a level far beyond which it is demanded, or when demand falls to a level below which it can be supplied. Market equilibrium encourages economic goods to remain between these extremes - but only by virtue of the cost of production (if the cost to produce is greater than the price it will fetch, it becomes self-destructive to produce, and suppliers leave the market until the quantity supplied decreases, scarcity results, and those who demand it are willing to pay a price at which it is profitable to supply.)
Currency that is based on an illusive standard has no such constraint: the cost to produce currency (paper bills and token coinage) is negligible. Moreover, because currency has exchange value but no use-value, there is no natural need for it outside of market exchange (one will suffer starvation for lack of food, but lack of currency causes no ill effect in and of itself).
Historically, foreign-exchange control has not merely failed, but has exacerbated the problem it was intended to achieve. Instead of granting strength to domestic currency to foster trade among nations, it has weakened currency and damaged trade. And historically, proponents of such a policy tend to ignore these effects, blaming other factors or seeking to amend the problem by further adjustments to the illusive standard, until such time as their domestic economies have collapsed from the practice.