Law, legislation, and the gold standard.

• Author: Selgin, George
• Position: Essay

Isn't it perplexing that people who advocate a return to the gold standard are often against big government and supposedly pro-market? After all, the term "gold standard" is just a euphemism for government price fixing where the government sets an arbitrary, non-market price for the currency/gold conversion. By now humans should have learned that government price fixing almost always leads to a host of bad, unintended consequences.

--The Motley Fool (2010)

More than a half century ago, in October 1961, Milton Friedman's "Real and Pseudo Gold Standards" appeared in the Journal of Law and Economics. In that article, Friedman argued that versions of the gold standard erected after 1914, if not some earlier ones, were "pseudo" gold standards, differing from "real" ones in dispensing with actual gold coins and allowing monetary authorities to sterilize international gold movements, instead of letting those movements automatically regulate national money stocks. Such pseudo gold standards, Friedman argued, amounted to particularly dangerous instances of government price-fixing, and as such ought to be anathema to believers in free markets.

Here I wish to suggest a different distinction, inspired by the 40th anniversary of Friedrich Hayek's Nobel Prize in Economics in October 1984. The distinction I wish to emphasize is based on the one that forms the subject of the opening volume of Hayek's ambitious post-Nobel Prize work, Law, Legislation, and Libertij. It is that between a gold standard founded on custom-based or "private" law, and one resting upon statute or "public" law, that is, on government legislation.

I plan to argue that this Hayekian distinction is related to, but more fundamental than, the one Friedman insisted upon. But before I can do so I must first review the difference between custom-based law and legislation, and then show how the development and flourishing of the historical gold standard depended more on the former than the latter. I will then go on to argue that any gold standard based on legislation only, and not on customary law, is unlikely to endure. Because a spontaneous return to gold-based payments is itself highly unlikely, I conclude that, even setting general opposition to the idea aside, there is little prospect for an enduring gold standard revival.

Customary versus Statute-Based Law

Law, according to Hayek, must not be identified with legislation. Although legislation (the corpus of edicts, statutes, and regulations enacted or adopted by government authorities) is itself a source of law, it is neither the most important nor the oldest source. "Law," Hayek (1982: 73) reminds us, "existed for ages before it occurred to man that he could make or alter it." Instead of being imposed by political authorities, such traditional or custom-based law, the best examples of which are the common law and law merchant (itself absorbed into the English common law during the 17th century), is "discovered" by judges though their attempts, in adjudicating cases, to determine how pre-existing, if tacit, rules of just conduct appertain to them. (1) Though legislation may also codify customary laws, it consists by and large, not of generally applicable rules of just conduct, but "of directions concerning what particular officers or agencies of government are required to do" (ibid.: 133). Because custom-based law instead mainly governs relationships between private individuals, the distinction between it and legislation conforms roughly to that between "private" and "public" law (ibid.: 131).

Because it is "discovered" rather than "made," customary law differs from legislation in being backward-looking and largely "purpose independent": it seeks to discern and enforce established if implicit codes of conduct. Legislation in contrast tends to look forward to the accomplishment of some particular end or ends, and as such is necessarily based on the perceived expedience of the rules it puts into effect. Because of this, legislation is always subject to reconsideration and revision. It is, in other words, inherently provisional. The likelihood that it will go unaltered tends, furthermore, to decline over time as circumstances change from those that prevailed at the time of its adoption. Customary law, in contrast, is subject at most to very gradual or evolutionary, but never sudden, change. "Public law passes," Hayek (ibid.: 135) succinctly observes, "but private law persists."

The difference between private or customary law and public law or legislation is, I submit, one of great importance for a proper understanding of the gold standard's success. For, despite both appearances to the contrary and conventional wisdom, that success depended crucially upon the gold standard's having been upheld by customary law rather than by legislation. It follows that any scheme for recreating a durable gold standard by means of legislation calling for the Federal Reserve or other public monetary authorities to stand ready to convert their own paper notes into fixed quantities of gold cannot be expected to succeed.

The Essence of a Gold Standard

The general employment of particular goods in making payments, whether in trade or tribute, was itself, so far as can be determined, an outgrowth of pre-monetary customs rather than a product of any deliberate planning or legislation. "It is apparent," the Victorian classicist and archeologist Sir William Ridgeway (1892: 47) observed, "that the doctrine of a primal convention with regard to the use of any one particular article as a medium of exchange is just as false as the old belief in an original convention at the first beginning of Language or Law." (2) Although no one knows when gold and other precious metals first acquired the status of generally accepted exchange media (i.e., money), that status was well established among the civilizations of early antiquity. (3)

We owe to Sir William as well what remains the most compelling explanation of the origin of the earliest known gold units (Mundell 2002: 7). He is quick to dismiss the view that ancient weight units "had been obtained scientifically" (Ridgeway 1892: 1), which he attributes to a false analogy with the metric system established by the French Republic. "Reflection," Ridgeway says, "might have shown scholars that even the French system was not a wholly independent outcome of science, for beyond doubt the metre and litre and hectare were only varieties of older measures of length, capacity and surface, then for the first time scientifically adjusted." Instead, he argues, ancient gold monetary units were a natural outgrowth of traders' pre-monetary habit of expressing prices in terms of oxen or cows. (4) There was, on the other hand, no such thing as a natural gold unit in which prices might be expressed. Instead, gold became the first object upon which the art of weighing was practiced, with grain serving as a weighing medium. As oxen were worth about 130 grains of gold throughout the ancient world when gold came to be employed as an exchange medium, that quantity of gold became the basis of the earliest gold units, and eventually of coins representing those units. This simple transition, Ridgeway observes, accounts both for the surprising uniformity of independently developed gold units diroughout the ancient world, and for the tendency for the name of the old barter unit to attach itself to the new metallic ones. In ancient Athens, for example, the first current gold coins bore the symbol of an ox, and values continued to be expressed in ox-units, though those units were now represented not by oxen themselves but by their metallic value equivalents. The same development is reflected in the various monetary terms having the latin word pecunia as their root.

Despite claims to the contrary dating back to Herodotus, coinage--the packaging of raw metal into units of standard size and purity--was also, so far as can be determined, a private-market development rather than an invention of Gyges, Pheidon, Theseus, or some other ancient tyrant. There is in any event no technical reason why coining, an industrial process, cannot have begun as a private undertaking, as it has occasionally been in more recent times. Kings and princes were nonetheless quick to make the coining of precious metals (and, sometimes, of base metals as well) a royal prerogative. Notwithstanding the naive belief that governments were obliged to monopolize coinage for the sake of protecting their citizens from abuses to which competitive coinage would expose diem, it was not private firms but government authorities themselves who posed the greatest danger of abusing coinage, and who would in fact be responsible for all the more notorious abuses of the power to coin, including countless episodes of debasement stretching from Roman to early modem times. Governments were able, by virtue of their coinage prerogatives and associated power to compel acceptance of their coins at par, to arbitrarily redefine national money units, and to thereby turn former products of commercial custom into playthings of public law.

That metallic units became matters of public law rather than custom might itself have spelled the end of durable precious-metal standards had debasement not ceased, in early modem times, to be an effective means for raising revenue. In England, first and foremost, the debasements of Henry VIII and Edward VI left the coinage in such a state as compelled Elizabeth I to renounce her predecessors' policies and restore England's pre-debasement (silver) standard. A century later, when merchants' resort to goldsmiths' notes again threatened to undermine the demand for coin, the government took the next logical step, in 1666, of renouncing debasement altogether, by ceasing to coin on its own account and instead devoting its mints (in unconscious imitation of a competitive coinage system) to the "free" (i.e., unlimited) coinage of metal on...