Transitioning standards of value in fixed-value monetary systems.

• Author: Lewis, Nathan
• Position: Essay

By now I think we can agree that the absence of an official, rules-based, cooperatively managed monetary system has not been a great success. In fact, international financial crises seem at least as frequent and more destructive in impeding economic stability and growth.

--Paul Volcker (2014)

Soft and Hard Money Approaches to Monetary Affairs

Historically, there have been two basic frameworks by which a government organizes its monetary affairs. One of these--the Soft Money approach--we are quite familiar with today: a process by which a committee of government bureaucrats manages a floating fiat currency of some sort, on a day-to-day and ad hoc basis. The other format--the Hard Money approach--is typified by the Rule of Law, which is some definite and unchanging framework by which the currency is managed. Consequently, there is no need or role for a day-to-day human discretionary element, except perhaps in some of the particulars of the system's execution.

Nathan Lewis is a columnist for Forbes.com and the author of Gold: the Monetary Polaris (2013).

The Soft Money Approach

Under the Soft Money approach, the goal of monetary policy is to maintain full employment, price stability, and moderate interest rates--and to satisfy an array of interest groups. These include voters and the political class; exporters, importers, and other commercial interests; bankers and the financial industry; agricultural and other commodity producers; creditors; and debtors of various sorts, particularly the federal government.

What a wondrous tool money can seemingly be, to address all of these issues and interests. And, it has no apparent cost, or, it appears, need to bother with a parliamentary process. Thus, the "Rule of Man" is paramount, and typically unfettered in practice by any defined framework whatsoever.

The Hard Money Approach

In practice, there has been only one kind of law or rule that is used in the Hard Money approach: namely, a "fixed-value system" in which the value of the currency is to be the same as some defined benchmark. Although a variety of commodities have been used as a monetary base, gold and silver have long been dominant. In the late 19th century, these bimetallic systems were simplified further into monometallic systems. The value of the currency would be fixed at, for example, 23.2 troy grains of gold, or l/20.67th of a troy ounce.

Fixed-Value Policies Are Very Common Today

Although it may seem that the Hard Money approach to organizing monetary affairs is basically nonexistent today, many countries have adopted forms of a fixed-value system. Consequently, these countries do not attempt to address all of the myriad interests of the Soft Money enthusiasts via management of the currency. There is no meaningful discretionary element.

Many governments in the world have a fixed-value policy with some major international currency. The 19 members of the eurozone have adopted a common currency over which the members and their central banks have no direct control. In effect, they have given up their domestic discretionaiy policy in favor of a form of fixed-value policy with what amounts to an external benchmark. This arrangement is not much different from dollarized countries such as Ecuador and El Salvador. In addition, there are six other states that use the euro, but are not officially part of the eurozone (Monaco, San Marino, Vatican City, Andorra, Kosovo, and Montenegro), plus four territories (Akrotiri and Dhekelia, Saint Pierre and Miquelon, French Southern and Antarctic Lands, and Saint-Barthelemy). Also, there are 27 countries that have a currency linked to the euro, often via a currency board. They include eight African countries that use the West African CFA franc, seven African countries that use the Central African CFA franc, plus Bulgaria, Denmark, and Morocco.

Altogether, a total of 55 nations and autonomous territories have variants of a nondiscretionary fixed-value policy with the euro, not counting those countries where the euro is in common but informal/unofficial usage. These governments, in effect, have adopted a Rule of Law ("use the euro" or "link to the euro") and have consequently abandoned discretionary monetary policy.

In recent years, this arrangement has infuriated many economists who are ardent believers in the advantages of discretionary monetary management. This has led them to insist that Spain, Greece--and most any other country that gets itself into economic difficulties-- would be better off leaving the eurozone and adopting some independent floating currency arrangement, which could then be independently managed to produce the kinds of economic outcomes they hope for. Typically, it is suggested that this process begin with a substantial devaluation.

One might invent other rules-based systems without any discretionary element based on measures of prices, quantity-based measures, or other indicators. (1) Sometimes it is proposed diat floating fiat monetary policy be rigidly determined by a Taylor rule, inflation targeting, nominal GDP targeting, or various measures of credit. But these ambitions are typically abandoned almost immediately in practice for a day-to-day, ad hoc approach.

Thus, it turns out that the only rules-based system of any demonstrable practicality is a fixed-value system. The only real question is: What should one fix the value to? Or, in old-fashioned terminology: What should be the standard of value?

Fixed-Value Systems Are Market Based

The term "market based" is often applied to fixed-value systems, because the amount of currency in existence (the base money supply) is determined by market participants via the automatic currencyboard-type system, rather than by the decisions of a board of bureaucrats. The base money supplies of existing currency board systems vaiy on a daily basis, expanding or contracting depending on people's interest in holding the currency. When Bulgarians (or indeed anyone) want to hold more Bulgarian levs, they go to the Bulgarian...