Academic journal article The Cato Journal

Privatizing Money

Academic journal article The Cato Journal

Privatizing Money

Article excerpt

Restoring global financial stability requires attention to the currencies themselves that circulate at home and abroad. I'll focus attention on that aspect of the problem.

Be Prepared

The dollar's continuing role as the world's key currency has come into doubt. What might replace the dollar if it collapses or becomes unmanageable? Let's hope it doesn't, but we should be ready with ideas just in case. Even if our current system survives, contemplating radical alternatives can provide a new perspective on it and on possible improvements. Just as conjectural or "what-if?" history can improve our understanding of the actual course of events, so "what if?" monetary systems may help us better understand, by contrast, what we now have.

How would a system function without a dominant issuer whose banknotes and deposits defined the unit of account? How would the system work if the unit ("dollar") were defined, separately from any particular medium of exchange, to have a stable value? What if no base money existed distinct from ordinary means of payment, so that questions of reserves, reserve ratios, and the money multiplier could not arise? Would the quantity theory of money still apply?

According to Milton Friedman and Anna Schwartz (1987: 313), if our present system does fail, "what happens will depend critically on the options that have been explored by the intellectual community and have become intellectually respectable. That--the widening of the range of options and keeping them available--is, we believe, the major contribution of the burst of scholarly interest in monetary reform."

A system without government money and with competing private issuers rules out central control of the quantity of money and requires some other way of giving a definite value to the dollar. The dollar must then be linked to some single good or a combination of goods and services. The present article urges no specific reform along these lines, but it does sketch one out as an example and as an introduction to aspects requiring attention.

Inflation is one danger to our current system. It may emerge once recovery from the current recession carries further and banks make use of their total and excess reserves, which the Federal Reserve had greatly expanded to fight the crisis. Activating idle reserves will multiply total money. Businesses and consumers will become readier to spend from their cash balances (velocity will recover). In principle, the Federal Reserve, if clever enough and sheltered enough from politics, could reverse its anti-crisis measures in good time. A worry for the longer run is that the government may quasi-repudiate its soaring debt, both explicit and implicit under entitlements, by pressuring the Federal Reserve to inflate it away by monetizing it.

Talk about deflation, instead, as today's pressing short-run problem was familiar until recently. On this view, inflation can be dealt with if and when the time comes; and inflation is easier to deal with anyway. Robert Reich said so on Lawrence Kudlow's TV program in May 2009. An editorial in The Economist (May 2009) recognized "something to both fears. But inflation is distant and containable, while deflation is at hand and pernicious." Many of us here could argue just the opposite.

Perhaps the dollar will escape inflationary destruction. Benjamin Friedman explains a related worry. It concerns the central-bank base money that banks hold as reserves against their ordinarily much larger volume of deposit liabilities. Central banks exercise their power by manipulating this reserve base, indirectly through interest rates if not by directly controlling its size. Yet these bank reserves (not total base money, including currency held at home and abroad) have become small in crisis-free times, not small in dollar amount but relative to national and international money flows, total output, and ordinary checking accounts, near-moneys, and innovative means of payment. …

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