Good Money, Part I: The New World (1999) is a series of papers written by Friedrich Hayek in the 1920s and 1930s, edited by Stephen Kresge. They apparently constitute all of Hayek’s major papers on monetary topics during that time.
Back when I was just starting to learn about economics, around 1998, I was reading the writing of Ludwig von Mises and Friedrich Hayek for the first time. From the beginning, I could tell that Mises had the better mind. He was much more careful about what he said. It seemed that he had thought out the implications and corollaries, and avoided pitfalls that most others had fallen into. His writings have an internal consistency to them, even if I think that he did have some major errors, and certainly some major omissions. But, I had the impression that Mises himself was aware of his own shortcomings. He had to press on and paper over the cracks nevertheless, but it seemed to me that he could tell that there were unresolved inconsistencies that perhaps could be remedied at a later date. I still put Mises among the best of the twentieth century. If there were others that were better, it was because they came afterwards and had the advantage of building upon what people like Mises had done.
Hayek’s writing was notably inferior. It did not take long before I abandoned them altogether, since there was little in them that Mises did not express more exactly. (It is interesting that, even then, with literally months of experience, I was able to distinguish quite clearly the errors and fallacies of supposed “experts.”) I like Hayek’s post-WWII writings on broader topics, notably The Road to Serfdom and The Fatal Conceit. But, for some reason Hayek is now remembered as some kind of monetary authority, even above Mises. So, about twenty years after my first exposure to Hayek, I thought I should return and see if there was something I missed.
Those first impressions have not changed after having read Hayek’s major papers from the 1920s and 1930s. If anything, they have been confirmed. Hayek was a bit of a mess. Actually, he was a lot of a mess; we can use the gentler terms mostly because, despite his failings, he was still, I am sure, better than most in those days, or today for that matter. I have not read Hayek’s books from that time, including Monetary Theory and the Trade Cycle (1929), Prices and Production (1931), Monetary Nationalism and International Stability (1937) or Profits, Interest and Investment (1939). But I notice that nobody else does either. Presumably, they are congruent with the papers in this book. These papers were nevertheless worthwhile reading, as they give a good impression of what people were thinking about during that time, including Hayek.
What we find here, and also in Good Money, Part II which follows Hayek through to the 1970s, is that Hayek was never a fan of the gold standard. He has very little to say about it at all; what little there is that is positive is of the “it was the best we could do in that primitive age but we are so much more sophisticated now” variety. Mostly, he disparages the gold standard; a sensible conclusion, perhaps, considering how little he seemed to understand about it. From his youth, and on until his death, Hayek was a fan of some form of commodity basket standard. (Mises, on the other hand, was more of a gold standard fan.)
We have looked at this in the past:
Humans have used other commodities besides gold (or silver or copper) in a monetary framework since the beginnings of human history, around 3000 B.C. For thousands of years, gold and silver served as high-value money, and as a unit of account, but payment was often in the form of other commodities. Cattle, salt, wheat, and cowrie shells had long periods of monetary use stretching centuries, usually alongside gold and silver. In China during the Han Dynasty, ministers’ salaries were often defined in gold, but paid in a variety of commodities, including rice and silk cloth. In Sumer (Mesopotamia), in the third millennium B.C., silver was the unit of account and standard of value (unit in which prices were denominated), but payment was often in the form of other commodities. Ancient Egypt had a centuries-long history of wheat banking. You would deposit the crop in the “wheat bank,” and then you could write checks against it to pay your taxes and bills. This system of “wheat banking” eventually stretched nationwide, and some historians have compared its development to the English banking system of the nineteenth century. Nevertheless, in Egypt too, gold was a higher form of money. In pre-Columbian Mesoamerica (Mexico), cacao beans (chocolate) were the common form of small-scale money, but gold and silver were the high-value monies. In North Carolina in the eighteenth century, seventeen commodities were officially recognized as legal tender, including tobacco. Warehouse receipts–paper money–were even issued against them, and were tradeable among third parties. But here too, the British silver shilling served as the unit of account and measure of value.
Usually, these “commodity monies” were in the form of single commodities, not a defined basket of commodities. You could argue that the use of so many commodities simultaneously served as a sort of commodity basket. In any case, it would have been a short step to establish such a basket. The idea of a “tabular standard” of commodities serving as a standard of value and unit of account dates at least as far back as the debates over gold restoration in Britain in the 1810s, and was mentioned by David Ricardo.
The long history, stretching thousands of years and throughout Europe, Asia and the New World, is that commodities were often used alongside gold and silver in a monetary role. Usually, most commerce was actually in the form of commodities, especially since, in this precoinage era, gold and silver had to be carefully weighed, while wheat or rice could be easily measured out and served as the primary small-denomination money. The end result, everywhere in the world, was that other commodities were gradually abandoned as money wherever possible, leaving gold, silver and copper. We tried using wheat, cattle, cacao beans, shells, rice, cloth or hides as money, and we don’t do it anymore. Even when commodities were used, gold and silver were typically the unit of account and standard of value.
Adam Smith, the famous early economist writing in the 1770s, actually considered “corn” (staple grains, primarily wheat but including maize, oats or barley; this itself is a sort of “basket”) to be a better long-term measure of value than silver, the basis of the British money since ancient times. Smith argued that the price of labor was, ultimately, based on the price of “corn” required to feed the laborer; and labor was the basis and source of all economic production. Smith also tended to include “butchers’ meat” (beef, pork, chicken, mutton) in his evaluation of the value of labor as expressed in food commodities; together “corn” and “butchers’ meat” created a rather extensive sort of basket. (Smith argued that the values of “corn” and “butchers’ meat” were themselves linked, since the rise or decline in their relative market values would cause land use to move from pasture to crops and vice versa). However, Smith insisted that the usefulness of “corn” as a measure of value was only apparent over decades and centuries. He was particularly impressed by the rise in the price of “corn” vs. silver in the sixteenth century, two hundred years before he was writing. In the “short term,” by which he meant day to day, week to week, month to month, year to year and even decade to decade, Smith said that silver’s value was more stable than “corn,” which had considerable annual variation, and consequently, silver was a better basis of money–it has a more stable value–for all practical uses.
“Though the real value of a corn rent [corn], it is to be observed however, varies much less from century to century than that of a money rent [silver], it varies much more from year to year. The money price of labour, as I shall endeavour to show hereafter, does not fluctuate from year to year with the money price of corn, but seems to be every where accommodated, not to the temporary or occasional, but to the average or ordinary price of that necessary of life. The average or ordinary price of corn again is regulated, as I shall likewise endeavour to show hereafter, by the value of silver … But the value of silver, though it sometimes varies greatly from century to century, seldom varies much from year to year, but frequently continues the same, or very nearly the same, for half a century or a century together. The ordinary or average money price of corn, therefore, may, during so long a period, continue the same or very nearly the same too, and along with it the money price of labour, provided, at least, the society continues, in other respects, in the same or nearly in the same condition. In the mean time the temporary and occasional price of corn may frequently be double, one year, of what it had been the year before, or fluctuate, for example, from five and twenty to fifty shillings the quarter. But when corn is at the latter price, not only the nominal, but the real value of a corn rent will be double of what it is when at the former, or will command double the quantity either of labour or of the greater part of other commodities; the money price of labour, and along with it that of most other things, continuing the same during all these fluctuations.”
The Wealth of Nations, Chapter V
I disagree with Smith in some particulars. Even if the value of labor (market price of labor) was directly linked to corn, I can imagine situations in which the real value of corn may fall, and with it the value of labor. The end result is that the entire price structure would decline, compared to this “absolute standard of value” that I imagine. Or, the price of corn could rise, and the price of labor along with it, leading to a generally higher price structure overall, compared to this “absolute standard of value.”
Ricardo, like Mises, came to a similar conclusion as Smith. Although it was hard to identify a definitive, scientific standard which could conclude the debate decisively, nevertheless they concluded that gold and silver were more stable in value than any other commodity, and more stable than a basket of commodities. They could see that commodity prices varied quite a lot against each over from year to year or month to month. The value of no single commodity was apparently very stable at all. You could argue that diversification would help remedy this. Nevertheless, it disproved the notion that a commodity basket represented a stable measure of value by definition. They could also see that major events, such as wars, Depressions, droughts etc. created broad influences on commodity prices as a whole, just as one would expect.
In general, those that have been “commodity basket” fans have not considered the question of which is more stable — gold or a commodity basket — in a sort of careful manner perhaps including an examination of history or historical prices. They usually just assume that this is the case. It is an idea that appeals to them, and so they just assume that it is true. Sometimes this has even taken the form of defining “stable value” as being an index of commodity prices. The idea that a commodity basket could vary in value compared to some absolute ideal of “stable money” is excised from the start. The possibility of it is not even allowed to exist. It is hard to believe that anyone could be so silly, but as we have seen, these sorts of arguments continue to the present day:
And so we see, in a funny case of “projection,” that most commodity-basket fans seem to think that gold fans come to their conclusions from superstition and habit, while they are sober and scientific, when in fact, it is the gold guys who have considered the subject carefully, rationally and scientifically, while the commodity basket guys mostly just assume that things are so because they would like it to be so.
Hayek mostly does not go quite this far. But, he is in this general camp.
The idea of a commodity-basket standard, instead of gold, became popular in the 1890s, especially with the writing of Irving Fischer, who received the very first PhD in economics from Yale University in 1891. (He was also a member of Skull and Bones when he was an undergraduate at Yale.) This was basically a reflection of the debates of the 1890s, in which commodity prices had been depressed by, I argue, dramatically expanding production. People in the U.S. and elsewhere argued for “free coinage of silver,” which would have amounted to a devaluation of currencies compared to gold. Fischer took this idea and systematized it somewhat. Basically, it amounted to an argument for devaluation. When commodity prices declined vs. gold, the currency would be devalued (vs. gold) to return nominal commodity prices to their long-term averages. This had two elements: one was to support nominal commodity prices in the condition of market glut (increased supply), as was happening at that time. Second, it was an argument for the devaluation of currencies in the event of a recession, which was commonly associated with a decline in commodity prices from decreased demand. Not much was said about what would happen when commodity prices recovered. Would the currency then be revalued higher, thus imposing “deflationary” pressures on the economy? When commodity prices in the U.S. soared in 1916 in response to demand from World War I, this argument was nowhere heard. Although couched in terms of “stability of value,” these commodity basket arguments of the time amounted to rationalizations for currency devaluations.
I think that will be enough for today. These things easily get pretty long. We will begin to look at Hayek in more detail next time.