De-nationalising Money: The Emergence of 'Brand Name' Capital
by Jerry Jordan
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The 'brand name' of money used to denominate contracts and trade assets is becoming more important than 'local content' or the 'national origin' of currency.

Economists talk about producing output��goods and services��from combinations of land, labour and capital inputs, where capital is taken to mean tools, machines, buildings and so on. We say that productivity�or productive efficiency�improves when the same amount of output can be obtained with less of at least one input.

Sometimes economists treat money as a factor of production that is separate from and in addition to land, labour or capital. This is not a useful way to think about the role of money in society. It is derived from the idea that there must be enough money in circulation to �meet the needs of trade�. While this view originated in the 19th century, more recent forms are manifest today in claims that central bank policy is starving the US economy of money, which makes interest rates rise. This false diagnosis is dangerous because it produces a prescription that a central bank can make people better off by creating money at a faster rate.

A more fruitful way to think about the role of money in a market economy is one in which money liberates resources, especially those used to gather information and to conduct private transactions. This view draws attention to the quality dimension of money. That money facilitates transactions appears clear to everyone. The role of money in enhancing market knowledge about relative prices, however, is less well understood.

Why quality matters

Money�s effectiveness depends largely on its quality. The quality of money is high when the value of money is stable. Money prices provide households and businesses with reliable information about the relative costs of goods and services. They can make sound economic decisions, and this in turn fosters economic prosperity. The quality of money is low when the value of money is unstable. Money prices provide households and businesses with unreliable information, so they must devote some of their resources to further investigation of the relative costs of goods and services. Low quality money wastes resources that otherwise could have added to the welfare of people.

The economic efficiency that comes from a stable monetary unit of account is one of the pieces of a Hayekian infrastructure that a market economy requires.1 That is, a market economy requires a foundation of enforceable property rights, generally accepted accounting principles, sound financial institutions, and a stable currency.

Where public contracts are not honoured and private contracts are not enforced, markets are impaired. Where title to property is not certain, normal banking is not possible. Where financial statements are not reliable, investment opportunities are obscured. Where the purchasing power of money is not stable, resources are wasted in gathering information or in producing and consuming the wrong things.

Although governments generally understand the benefits of stable money, they also have strong incentives to finance government budget deficits through unanticipated inflation. This is especially true of politically weak governments, which attach a low probability to a long tenure and therefore heavily discount the more distant gains of economic growth.

Yet neither inflation nor deflation enhances economic performance, as true changes in the relative prices of things cannot be observed from stated prices when the purchasing power of money is not stable. False signals are sent to businesses and households, and bad decisions are made. Standards of living fail to rise at the potential rate.

The same is also true of administered devaluations and revaluations of the external value of a currency. If the domestic purchasing power of a currency falls, the external value must eventually fall relative to stable currencies. The notion that a country can maintain a permanently fixed exchange rate while tolerating domestic inflation has been proven to be false numerous times. That reality has led to increasing advocacy of floating external exchange rates, especially for developing countries that do not have the essential fiscal discipline to resist domestic inflation.

Merely allowing the value of a currency to float does not eliminate the problems that would be encountered in a fixed exchange rate regime confronted by financial crises. International capital flows have proven to be a mixed blessing to many economies in the post-WWII era. But investing the savings from foreign sources for economic development is not a new phenomenon. It would not be desirable to erect obstructions to the free flow of savings, even if that were feasible. The challenge is to find ways to ensure that access to foreign capital does not so frequently appear to have been a curse. It is important to get the labels right. In economics, as in medicine, if the diagnosis is wrong, it is unlikely the prescription will cure the malady.

Promises, promises

At bottom, most financial crises are neither monetary crises nor exchange rate crises. Instead, what is common to most crisis episodes were government guarantees or promises that turned out to be unreliable. The prior presence of government guarantees or implicit promises induced behaviour�relying on the guarantees or promises�that altered incentives to the point that risk/ reward relationships became distorted. Sometimes the guarantees were in the form of financial instruments� such as tesabonos in Mexico�sometimes in exchange rate pegs, sometimes in guaranteed loans to domestic banks, sometimes in government agency or nationalised industry borrowing. The failures of such arrangements in crisis countries often became a monetary crisis or an exchange rate crisis. Market-corroding practices already were undermining sustainable prosperity even before a flight of foreign capital magnified the distortions.

There is little doubt that such crises reflect the increased scrutiny or financial discipline imposed on a country�s policies and institutions by foreign investors and lenders. Indeed, it is becoming apparent that government promises�whether in the form of pegged exchange rates or in the form of deposit, loan, or investment guarantees�are on the endangered species list.

Global market participants represent a class of stateless voters who roam the world�s economies seeking the best wealth-creating institutions and conducting a continuous plebiscite on political and economic policies and developments in the numerous nation states of the world. They represent an irresistible force.

There is, however, a core tension between the interests of market participants and the incentives of local politicians to redistribute rather than to create wealth. In the end, the forces of wealth creation will dominate those of wealth redistribution. The adjustment process has not been, and will not be, a smooth one, but achieving discipline will have a positive effect. The restructuring and reforming of banking institutions in Asia, for instance, will leave them better off. It would have taken much longer to bring about these much needed reforms without the �crisis atmosphere�.

Challenging sacred cows

Joseph Schumpeter once pointed out that �the essential point to grasp is that in dealing with capitalism, we are dealing with an evolutionary process. . . . Capitalism, then, is by nature a form or method of economic change and not only never is, but never can be, stationary.� 2

Schumpeter�s observation about capitalism applies equally well to all of the institutions that define the parameters of our global economy. Propelled by technological change and chance economic events, these institutions undergo a continual process of change. Those qualities that enhance economic well being tend to survive, and those that do not eventually disappear. People adopt institutions�laws, rules, conventions, and customs�to define and enforce property rights and, more generally, to reduce the costs of economic exchange.

The idea that tangible manufactured goods must compete not only in the local shops but also increasingly in the global town square is obvious to everyone. Yet the thought that institutional arrangements are also tested against others in the international arena is not so well understood. Ideas must face competition no less than goods and services. Politicians have long known that they must compete. But their focus was on rivals in their own party or other political parties in their country. What has been changing is the competition they face from policies and institutional arrangements in other countries. Voters are not only the citizens at a local ballot box, but also financial asset managers in global capital markets.

We are witnessing the difficulty of winning and maintaining the support of these two quite different groups of voters. Domestic ballot-box voters respond well to politicians who pander to their craving for wealth-sharing programmes. Capital-market voters survey the world for those who pursue the best wealth-creation policies. Gaining the support of one is almost surely to diminish support from the other.

Powerful economic forces are also challenging ossified domestic institutions. Among the 20th-century institutional arrangements that are coming under increasing scrutiny are central banks and national currencies. Certainly there are national vested interests in maintaining a domestic currency, not least of which is that control of a central bank gives a government a safety valve for financing government budget deficits through inflation. Beyond that, the idea persists that a country has something called �monetary sovereignty� and should therefore pursue an �independent monetary policy.� History demonstrates, however, that national currencies inevitably compete in the international arena.

If prosperity requires sound, high quality money, and sound money means maintaining stable purchasing power, and maintaining stable purchasing power means that the external exchange rate will remain stable with respect to other currencies with stable purchasing power, wherein lies the benefit of �monetary sovereignty� to a nation in pursuit of an �independent monetary policy?� How much can �independence� be worth if, as someone has said, �freedom is a long string at the end of which one does what one otherwise would have done at the beginning?� The expression �independent monetary policy� is used in several ways. Sometimes it reflects resignation that national monetary polices can be dominated by an undisciplined fiscal policy. Bad experiences with massive debt monetisations and consequent inflations have fostered efforts to find ways to insulate monetary authorities from the pressures arising from deficit financing and unfunded pension liabilities of governments. As The Economist magazine once put it, �a government that insists on access to the printing press cannot be trusted with it.�

In more globally oriented discussions, however, �monetary independence� is used to refer to an institutional setting that permits a central bank to choose independently �the appropriate rate of inflation� for the national currency. It is increasingly difficult to understand what such a statement means. If it means the �politically acceptable� rate of inflation from the standpoint of domestic constituencies, then it suggests that the inherent inefficiencies of policies that debase the purchasing power of money have greater value than the potential wealth creations they preclude. There are unavoidable wealth redistributions and dead-weight wealth losses that result from debasement of the currency, whether intended or not. Traditional rationalisations for deliberate inflation�such as claims of rigid wages or implications for real exchange rates�seem increasingly quaint. Who can imagine a politician appealing for systematic inflation in today�s stable money setting?

The importance of branding

If monetary sovereignty or independence is not worth much in today�s global capital markets, and if seigniorage�the interest income generated when central banks issue currency�is quite small in a non-inflationary world, then the costs and risks associated with a national central bank and a national currency become harder to justify.

Whatever the views of domestic politicians and central banks, the trend in the behaviour of businesses and households around the world is unmistakable. Gresham�s law has been turned on its head. What we now see� where not prohibited by effective severe punishment�is the use of �high confidence monies� driving out the everyday use of �low confidence monies.� 3 Just as the �brand name� of running shoes is more important to consumers than the location of the assembly plant, so too the �brand name� of currency used to denominate contracts and trade assets is more important than the �local content� or �national origin� of the standard of value.

The erosion of barriers to trade in goods and services offers clues to what we can expect in monetary affairs. Today, brand name recognition and identification of goods are more important than ever. When a company like Sony produces a new product�a CD player�that is better and less costly than other brands, consumers will want to buy it. Consumers everywhere are the same�they want the best product for the lowest price! Only barriers to trade might prevent a superior product from gaining global market share.

�Brand name� identification is also becoming evident in financial and monetary affairs. Lack of global specialisation in the production of goods was due to governmental and technological constraints. International brand identification evolved as these constraints diminished. As we are now seeing in the monetary arena, brand identification of standards of value�money�also becomes more pervasive as falling costs of information and communication technologies make it increasingly easy to compare the quality dimension of money. Individuals living in most free societies can therefore choose whatever currency they want to use as a standard of value, as a medium of exchange, and as a store of value. Over half of international trade is denominated in US dollars. More than two-thirds of US dollar currency is not used in the US, but by people in other nations, even where prohibited by national laws.

Countries whose monetary policies in the past have resulted in large fluctuations in the value of their currency have come under pressure to adopt a system to prevent recurrent inflation and devaluation. Once caught off guard, the public becomes more wary in the future. For their own protection, they reduce their holdings of financial assets denominated in the domestic currency.

Currency boards and �dollarisations� are two arrangements forced upon governments by their inability to provide a domestic currency with stable purchasing power. Ecuador and El Salvador, for instance, have adopted the US dollar while, a decade ago, Argentina replaced its central bank with a currency board that ties the value of the peso to the dollar.

Anna Schwartz has documented the role of currency boards in the development of central banks.4 A currency board operates to maintain a stock of foreign exchange reserves equal to the government�s issue of domestic currency. A loss of reserves automatically reduces domestic currency by an equivalent amount, which operates to counteract the forces causing the currency drain.

Central banks embody the presumption that human or government discretion can produce better results than an automatic system. Some central banks were created when a currency board was permitted to run down the reserve ratio of domestic money to external reserves from 100% to something less. Now the process may be reversing. Nations find that central bank discretion� monetary sovereignty�simply delays the inevitable and necessary response to external imbalance. A currency board has the advantages of eliminating discretion and tying the currency to the strong monetary unit of another nation.

Let private currencies compete

An alternative would provide a setting in which private currencies might compete with the government�s official money. Recent interest in the possibility of private currencies competing with government-issued fiat/fiduciary currencies has included the potential for reintroduction in specie-backed currencies.

Professor Richard Timberlake has put forth a specific proposal for the United States. He argues, �sound money advocates should not waste their resources lobbying for a gold standard, which by definition would include the state as overseer and manager of a gold currency, specifier of a gold price in terms of dollars, custodian of the gold, and manipulator of a central-bank issued paper money. No. The only way to ensure that gold becomes a viable money is first to separate the gold from the state and the state from any further role in the operation of a gold money.� 5

It happens that U. S. official gold holdings are over 260 million ounces, approximately one ounce for every man, woman and child in the country. The Timberlake proposal would envisage awarding a certificate worth one ounce of gold to every person as his or her �birthright.� A market for the certificates would emerge, and the certificate holders could redeem them for bars of gold (400 certificates per bar). The gold bars would then be deposited in a private gold repository that would issue certificates/warehouse receipts, as well as create bank accounts for the transfer of title to gold as a means of payment. Legislation requiring specific performance of contracts would allow parties to choose to negotiate settlement of obligations in gold-backed certificates or gold-denominated balances. Clearly, this possibility would provide competition for the central bank-issued currencies. Whether such a private specie-backed currency could become a dominant standard of value would depend on the performance of the central banks that continue to supply fiat currencies.

International monetary relations would benefit from competition among major alternative currency units. This would be more likely to enhance world welfare than systems like Bretton Woods that mandate direction by supranational governmental bodies, which tend to ossify over time.

Countries can take specific steps to allow and even encourage this competition. The first step is to remove any capital and exchange controls, including prohibitions on deposits denominated in foreign currencies. Argentina went a step further and clearly signalled its intention to maintain monetary stability by granting people the legal right to contract under any and all circumstances in any currency they might choose. Legislation in Argentina requires courts to enforce contracts in the currency specified therein. This �specific performance� law 6 provides a level playing field for competition among domestic and foreign currencies.

Conclusion

Permitted the choice, people prefer high quality money. Currency competition offers the best process for maintaining high quality money. Yet the past century is littered with instances where national central banks failed to provide a stable standard of value. It now seems that the era of government monopolies of the domestic standards of value is drawing to a close. Competition among competing private and public suppliers should be permitted to provide consumers with a choice, a choice that economists declare will enhance wellbeing.

Endnotes

1 Monetary stability�a stable standard of value�is not the same thing as a stable �price level�, nor does it mean �zero inflation.� For a classic treatment of these terms, see Ludwig von Mises, Human Action: A Treatise on Economics (New Haven: Yale University Press, 1949). For an excellent contemporary discussion, see George A. Selgin, Less that Zero: The Case for a Falling Price Level in a Growing Economy, Hobart Papers vol. 132 (London: Institute of Economic Affairs, 1997). An important conclusion is that the wealth gains emanating from a favourable productivity surprise should be reflected in rising purchasing power of money.

2 Joseph Alois Schumpeter, Capitalism, Socialism and Democracy (New York: Harper, 1950).

3 Benjamin Klein,�The Competitive Supply of Money�, in Free Banking [vol. 3]: Modern Theory and Policy, Lawrence H. White ed., Elgar Reference Collection, International Library of Macroeconomics and Financial History, no. 11, (Aldershot, UK: Elgar).

4 Anna J. Schwartz, �Currency boards: their past, present, and possible future role�, Carnegie-Rochester Conference Series on Public Policy 39 (North Holland, 1993).

5 Dr Richard H. Timberlake, �How Gold Was Money�How Gold Could Be Money Again,� The Freeman (April 1995), 204-209.

6 Specific performance legislation is not a �legal tender law.� Legal tender laws require that residents of a country accept a certain currency in settlement of a financial obligation, even if they are owed a foreign currency, gold, or bales of hay. Specific performance legislation means the courts must require delivery of what was promised in the contract, even if that is the currency of another country, gold, or bales of hay.

Jerry Jordan is President and Chief Executive Officer of the Federal Reserve Bank of Cleveland (USA).This article is based on a paper presented to the Mont P�lerin Society General Meeting in Santiago,Chile,in November 2000.

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