A "Rules-Based" Monetary System Means A Fixed-Value
November 19, 2014
(This item originally appeared at Forbes.com on November 19,
I think there is a little too much abstraction in discussion
of monetary topics today. For example, here’s former Fed
Chairman Paul Volcker, speaking last June:
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
There’s a fair amount of talk these days about “rules-based”
monetary systems, in no small part because, as
, the absence of rules has tended to
cause a lot of chaos and destruction. Today’s monetary
affairs are typically conducted in a somewhat ad-hoc,
seat-of-the-pants fashion, with floating fiat currencies
mismanaged by unelected bureaucrats. If there are “rules,”
such as the occasional mention of a Taylor Rule or other
such guideline, these tend to be fleeting public
justifications for doing whatever the central bank head felt
was appropriate that month, and are discarded whenever their
usefulness in that role wanes.
At some point, we might have a public discussion about these
topics in Congress, if Kevin Brady’s Centennial
bill passes. So, let’s do some
If we want a “rules-based system,” what should the rule be?
One such rule is what I’ve called a “fixed-value
” which is a rule that the value of the
currency will be kept stable against some definite
benchmark. A common variant of the fixed-value rule is a
gold standard system. For over a century, the United States
held the principle of a dollar whose value was equivalent to
23.2 troy grains of gold, or 1/20.67th of a troy ounce.
Later, during the Bretton Woods era of the 1950s and 1960s,
the dollar’s fixed-value parity was 1/35th of an ounce.
Other countries did much the same thing.
Unfortunately, the currency managers of that time didn’t
have much idea of how they were supposed to maintain this
fixed-value policy goal (hint: something
like a currency board
), and so it fell apart from ignorance
. The present rules-less anti-system
we have today was the accidental outcome of this failure in
But, a gold standard system is not the only kind of
fixed-value rule that has been found in history. Today, we
a number of countries
(27 at last count) which have a
fixed-value arrangement with the floating fiat euro, plus
another 28 that use the euro itself as a common currency. I
would consider a common currency to be a variant of the
fixed-value approach. In practical monetary terms, it has
much the same characteristics as a separate currency linked
to the euro with a currency board. Estonia had its own
euro-based currency board until 2011, when it transitioned
to using the euro itself. In monetary terms, the outcome was
about the same either way.
There are other kinds of fixed-value rules you could create.
Currency baskets are a common notion today, with the
International Monetary Fund still pushing its SDR idea.
Commodity baskets have been proposed since the mid-19th
century. Other single commodities, from silver to umbrellas,
have been used as fixed-value benchmarks. A group in Ithaca,
New York, even has a “community currency” based on one hour
All of these fixed-value approaches have a few things in
common: they are definite rules, and consequently, there is
no particular role for an independent money bureaucrat to
make stuff up as he goes along, except perhaps in some of
the minor details of its execution.
And so, I note that, whether in the form of a gold-basis
fixed-value rule in the past, or a euro-or-dollar-basis
fixed-value rule today, these fixed-value rules-based
systems have been very common throughout history, and work
fine for decades at a stretch, as long as you manage and
maintain them properly.
Alas, there are quite a few other “rules-based” proposals
out there. In the past, it was a popular notion to suggest
that the U.S. dollar monetary base should expand by perhaps
3% per year. Others have suggested, somewhat vaguely, that
the monetary base should not expand at all, and that any
expansion whatsoever constitutes “inflation.” More vague
suggestions have included the notions that base money supply
should expand in line with gold mining production (in
practice, about 2% per year), or should be the reciprocal of
some amount of gold already held in a vault somewhere.
Somewhat more complicated proposals have been along the
lines of “inflation targeting,” or “nominal GDP targeting,”
or a Taylor-rule-like arrangement.
You could make up many more such rules. One thing they all
have in common is: they have never been tried. Another thing
is: the value of the currency is basically an unpredictable
residual of the rule. Since these are hard-and-fast
rules-based frameworks, not just momentary guidelines for
making it up as you go along, you would have to live with
whatever you get, for better or worse. One advantage of the
seat-of-the-pants method is that you can attempt to fix
things if they get out of hand.
In practice, if anyone did try such a thing – as Paul
Volcker arguably did in late 1979 – it would probably cause
intolerable problems and would soon be abandoned. You would
soon be back to an ad-hoc approach, probably in less than
Actually, there is a recent example of using a variant of
the “3% per year increase in supply” rule: Bitcoin
The extreme volatility of that experiment simply
demonstrates that the people who said years ago that exactly
that outcome would happen, if it was applied to the U.S.
dollar as proposed, were right. Actually, there have now
been dozens of Bitcoin-like experiments, and, after taking
their owners on a roller-coaster ride, they tend to go to
zero when people tire of fooling around with them.
Thus, we find: gold-standard fixed-value systems used by
many, many countries, for very long periods of time
stretching centuries, and a long history of success;
fiat-currency fixed-value systems today which are as good
(or bad) as the fiat currencies they are linked to; and a
number of untested hypotheses that are rather badly flawed
I suggest that this simplifies things somewhat: the only
feasible “rules-based” system is a fixed-value system.
Maybe, depending on the conditions of the day, this could be
a link to a major international fiat currency, or even a
currency basket. Possibly a commodity basket. Or, it could
be a link to gold.
There really isn’t much left on the menu of “rules-based”
Since the U.S. itself is not likely to link the dollar to a
“major international fiat currency,” or a currency basket,
the list of options gets very short indeed.
Fortunately, a gold standard system, which the United States
used until 1971, actually works very well in practice. It
helped the U.S. become the wealthiest and most powerful
country of that era. The final two decades, the 1950s and
1960s, were an especially fine time to be an American. So,
our remaining choices are not particularly unattractive.
For some reason, people make this stuff so complicated. It
seems pretty simple to me.
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