Human Action
3. The Evolution of Modern Methods of Currency Manipulation
A metallic currency is not subject to government manipulation. Of course, the government has the power to enact legal tender laws. But then the operation of Gresham’s Law brings about results which may frustrate the aims sought by the government. Seen from this point of view, a metallic standard appears as an obstacle to all attempts to interfere with the market phenomena by monetary policies.
In examining the evolution which gave governments the power to manipulate their national currency systems, we must begin by mentioning one of the most serious shortcomings of the classical economists. Both Adam Smith and David Ricardo looked upon the costs involved in the preservation of a metallic currency as a waste. As they saw it, the substitution of paper money for metallic money would make it possible to employ capital and labor, required for the production of the quantity of gold and silver needed for monetary purposes, for the production of goods which could directly satisfy human wants. Starting from this assumption, Ricardo elaborated his famous Proposals for an Economical and Secure Currency, first published in 1816. Ricardo’s plan fell into oblivion. It was not until many decades after his death that several countries adopted its basic principles under the label gold exchange standard in order to reduce the alleged waste involved in the operation of the gold standard nowadays decried as “classical” or “orthodox.”
Under the classical gold standard a part of the cash holdings of individuals consists in gold coins. Under the gold exchange standard the cash holdings of individuals consist entirely in money-substitutes. These money-substitutes are redeemable at the legal par in gold or foreign exchange of countries under the gold standard or the gold exchange standard. But the arrangement of monetary and banking institutions aims at preventing the public from withdrawing gold from the Central Bank for domestic cash holdings. The first objective of redemption is to secure the stability of foreign exchange rates.
In dealing with problems of the gold exchange standard all economists--including the author of this book--failed to realize the fact that it places in the hands of governments the power to manipulate their nations’ currency easily. Economists blithely assumed that no government of a civilized nation would use the gold exchange standard intentionally as an instrument of inflationary policy. Of course, one must not exaggerate the role that the gold exchange standard played in the inflationary ventures of the last decades. The [p. 787] main factor was the proinflationary ideology. The gold exchange standard was merely a convenient vehicle for the realization of the inflationary plans. Its absence did not hinder the adoption of inflationary measures. The United States was in 1933 by and large still under the classical gold standard. This fact did not stop the New Deal’s inflationism. The United States at one stroke--by confiscating its citizens’ gold holdings--abolished the classical gold standard and devalued the dollar against gold.
The new variety of the gold exchange standard as it developed in the years between the first and the second World Wars may be called the flexible gold exchange standard or, for the sake of simplicity, the flexible standard. Under this system the Central Bank or the Foreign Exchange Equalization Account (or whatever the name of the equivalent governmental institution may be) freely exchanges the money-substitutes which are the country’s national legal tender either against gold or against foreign exchange, and vice versa. The ratio at which these exchange deals are transacted is not invariably fixed, but subject to changes. The parity is flexible, as people say. This flexibility, however, is almost always a downward flexibility. The authorities used their power to lower the equivalence of the national currency in terms of gold and of those foreign currencies whose equivalence against gold did not drop; they never ventured to raise it. If the parity against another nation’s currency was raised, the change was only the consummation of a drop that had occurred in that other currency’s equivalence (in terms of gold or of other nations’ currencies which had remained unchanged). Its aim was to bring the appraisal of this definite foreign currency into agreement with the appraisal of gold and the currencies of other foreign nations.
If the downward jump of the parity is very conspicuous, it is called a devaluation. If the alteration of the parity is not so great, editors of financial reports describe it as a weakening in the international appraisal of the currency concerned.2 In both cases it is usual to refer to the event by declaring that the country concerned has raised the price of gold.
The characterization of the flexible standard from the catallactic point of view must not be confused with its description from the legal point of view. The catallactic aspects of the issue are not affected by the constitutional problems involved. It is immaterial whether the power to alter the parity is vested in the legislative or in the administrative branch of the government. It is immaterial whether the authorization [p. 788] given to the administration is unlimited or, as was the case in the United States under New Deal legislation, limited by a terminal point beyond which the officers are not free to devalue further. What counts alone for the economic treatment of the matter is that the principle of flexible parities has been substituted for the principle of the rigid parity. Whatever the constitutional state of affairs may be, no government could embark upon “raising the price of gold” if public opinion were opposed to such a manipulation. If, on the other hand, public opinion favors such a step, no legal technicalities could check it altogether or even delay it for a short time. What happened in Great Britain in 1931, in the United States in 1933, and in France and Switzerland in 1936 clearly shows that the apparatus of representative government is able to work with the utmost speed if public opinion endorses the so-called experts’ opinion concerning the expediency and necessity of a currency’s devaluation.
One of the main objectives of currency devaluation--whether large-scale or small-scale--is, as will be shown in the next section, to rearrange foreign trade conditions. These effects upon foreign trade make it impossible for a small nation to take its own course in currency manipulation irrespective of what those countries are doing with whom its trade relations are closest. Such nations are forced to follow in the wake of a foreign country’s monetary policies. As far as monetary policy is concerned they voluntarily become satellites of a foreign power. By keeping their own country’s currency rigidly at par against the currency of a monetary “suzerain-country,” they follow all the alterations which the “suzerain” brings about in its own currency’s parity against gold and the other nations’ currencies. They join a monetary bloc and integrate their country into a monetary area. The most talked about bloc or area is the sterling bloc or area.
The flexible standard must not be confused with conditions in those countries in which the government has merely proclaimed an official parity of its domestic currency against gold and foreign exchange without making this parity effective. The characteristic feature of the flexible standard is that any amount of domestic money-substitutes can in fact be exchanged at the parity chosen against gold or foreign exchange, and vice versa. At this parity the Central Bank (or whatever the name of the government agency entrusted with the task may be) buys and sells any amount of domestic currency and of foreign currency of at least one of these countries which themselves are either under the gold standard or under the flexible standard. The domestic banknotes are really redeemable.
In the absence of this essential feature of the flexible standard, [p. 789] decrees proclaiming a definite parity have a quite different meaning and bring about quite different effects.3
