The medieval practice of managed currency

The lessons of monetary experience. Essays in honour of Irving Fisher, presented to him on the occasion of his seventieth birthday, London, G. Allen & Unwin 1937, pp. 259-268

1. Let us suppose that a country, or the most important commercial countries of the world, adopted the following monetary system:

a)    The unit of money of account is called a «dollar». The dollar is not coined, nor will it ever be coined; nor will paper notes ever be issued in dollars. The dollar is merely an instrument for accounting of pricing. All accounts are drawn and settled in dollars; all debts, and likewise the budgets of nations, states, companies, and private persons, as well as taxes, salaries, and wages, are fixed in dollars. In stock and merchandise exchanges, in markets and shops, all goods, securities, lands, houses are quoted in dollars. Nobody, however, has ever seen or will ever see the dollar in its material shape.

b)    The mint will coin gold pounds, platinum guineas, and silver florins, all of them weighing 120 grains each. On the face of the coins, only the words «one pound», «one guinea», and «one florin», their multiples and submultiples, will appear. No legal connection ought to be established or otherwise maintained between pounds, guineas, and florins.

c)    The printing press of the central bank will issue notes payable in so many gold pounds, platinum guineas, and silver florins. It will be the duty of the central bank to issue notes against gold, platinum, and silver and to pay precious metals of the required species against notes. Within the limits of safety the central bank can issue notes to the state against the promise to pay so much gold, platinum, or silver.

As dollars are an imaginary money of account, pound, guinea, and florin coins and notes will be the money of effective payment. The wages of a railway man will be fixed at so many dollars a day and paid in so many pounds or florins.

2. All that is needed to make the system work is an initial proclamation, to be followed in due course of time by successive proclamations, fixing the connection between the money of account (dollar) and the species of effective moneys of payment, let us say, gold pounds. Let us fix the initial connection at five dollars to the gold pound. Thenceforward the system will work in part automatically and in part by proclamation.

3. The problem can be better approached from three points of view: (1) permanence of all three or more precious metals in circulation; (2) stability of the price level; (3) stability of the foreign exchanges.

4. The first aim to be achieved is permanence of all coins – gold, platinum, and silver – and of notes representing them and in circulation at the same time. The assumption is that it is desirable to have several metals circulating simultaneously. It is useless to justify this assumption here, because I need not rehearse all the bimetallist arguments, and, if the contrary view is preferred, the problem will become all the more simple. I merely make the assumption to prove that the system will work even in the most complicated case.

The stumbling block of bimetallism has always been the pretence of the government to fix a legal connection between gold and silver. As soon as the legal rate of exchange between gold and silver coins was no longer identical with the commercial rate, the system foundered on the rock of Gresham’s law. Silver or gold coins which were undervalued as against bars disappeared. The remedy was found long ago by that greatest wit of the eighteenth century, Ferdinando Galiani, in his Della Moneta, one of the few books on money worth reading even now. Writing in 1750, at the age of twenty-one, he pertinently asked: «Why should the state fix the price of coins? The prices of wheat, wine and oil are much more important than the price of coins; and no statute but only the common opinion of the people regulates them». Bowing, however, to the prejudices of mankind, he proposed that the government should fix the legal rate of exchange between what I have called imaginary money of account and effective money of payment; but the legal rate would have to be optional. People should be free to contract out of the legal rate. It is interesting to remember that in 1706 John Law, the celebrated financier, in a memoir published only in 1757 by Forbonnais, made the same criticism against fixing legal rates between the two sorts of money; but he did not, like Galiani, propose that the legal rate should be optional. Galiani’s clause fell to the ground and was forgotten.

It is truly a live clause, if read in conjunction with the existence of these two sorts of moneys. If a proclamation said that one gold pound is worth five dollars, we may indeed leave it to the market to fix the rates between platinum guineas and silver florins on the one hand and dollars on the other. As all monetary units weight 120 grains, if the commercial rate of exchange between platinum, gold, and silver bars is 0.80 grains platinum = 1 grain gold = 80 grains silver; and if 5 dollars = 1 gold pound, then 1 platinum guinea = 6.25 dollars; and 1 silver florin = 0.0625 dollars or 6,1/4 dollar cents. If the commercial rate exchange to 1 grain platinum = 1 grain gold = 100 grains silver, and if 1 gold pound = 5 dollars, then 1 platinum guinea becomes = 5 dollars and 1 silver florin = 0.05 dollars or 5 dollar-cents. Debtors, customers, and employers who are in debt so many dollars will pay indifferently, in gold, platinum, or silver coins or notes, according to the ruling market rate. There is nothing in the system which could expel any of the coins from circulation. Stability of bi-or trimetallism is reached through the device of pricing all coins of different metals in the same imaginary money of account while fixing legally only one of the three prices, viz., gold, or, if fixing all three, through Galiani’s device of making it optional for people to contract out of the legal rate.

5. The result, we must admit, appeals only to that section of opinion which is favorable to bi-or trimetallism. Monometallists or bimetallists alike are bound, however, to appreciate the second aim which the system claims to achieve, viz., stability of the general price level.

Of course the system cannot pretend to achieve its end without a certain dose of management. But, in so far as the achievement is thought of a something definite, desirable, and possible, the device is as good as, or perhaps better than, any other. The usual device, when prices are rising or falling and the monetary authority thinks it desirable to prevent such an occurrence, or wishes to retrace its steps, is to revalue or devalue.

Devaluation is now, as it has always been, more frequent than revaluation. But devaluation requires that the gold or silver or platinum weight of pounds, florins, or guineas, hitherto fixed at 120 grains, be reduced, let us say to 100 grains. This is a clumsy affair, as for the time being coins must be outlawed from circulation, put into the coffers of the central bank, recoined and reissued. In the meantime the place of coins is taken wholly by inconvertible notes – and «in the meantime» often means decades or longer. Now, suppose that prices had fallen 16.66 per cent. All that is required, under the system, is a proclamation increasing the rate of exchange between the money of account (dollar) and the money of payment (gold pound) from 5 dollars = 1 pound to 6 dollars = 1 pound. As said above, the rates of silver florins and platinum guineas will adjust themselves on the market. Without a change in the amount of effective coins and notes in circulation, or in the weight and fineness of coins, the circulation of the money of account is increased 20 per cent by fiat. People and banks find their pocket money and their till notes increased by 20 per cent in dollar valuation. Prices which, with gold pounds at 5 dollars, had sunk from 100 to a level of 83.33, will tend to rise again to 100 with gold pounds at 6 dollars.

The central bank will have its balance in equilibrium as it was before the fall of prices. For instance, 1 billion gold pound notes will be secured by 0.5 billion gold pound coins and 0.5 billion gold pound state promissory bills. Only the account units will have increased, on both sides, from 5 to 6 billion dollars.

Other banks which keep their accounts in dollars will, against a deposit liability of, say, 1,000,000 dollars, have assets amounting to 500,000 dollars of advances and discounts and 500,000 dollars of securities. If, in consequence of a fall in prices, the rate of exchange between dollars and gold pounds changes from 5 to 6, liabilities will be payable in 166,666 gold pounds instead of 200,000. But assets will likewise be reduced, because 500,000 dollars of advances and discount will be legally reimbursable with only 83,333 gold pounds. As to the prices of securities, if fixed-interest bearing, there is no reason why their dollar price should change. The only difference will be that, the divisor being 6 instead of 5, their price in gold pounds will be 83,333, just sufficient to balance liabilities. Under the usual system securities bearing variable dividends would have a tendency to sink and put the bank in jeopardy. Under the two-money system the automatic increase of the dollars in circulation will tend to keep the value of these securities at 500,000 dollars; which, with the divisor 6, is sufficient to balance the bank’s liabilities. The inverse process would take place if, after a rise of the price level from 100 to 125, a proclamation had changed the rate between the dollar and the gold pound from 5 to 4. Liabilities and assets of 1,000,000 dollars would then correspond to 250,000 gold pounds.

Salaried people whose salary is fixed at 3,000 dollars a year will receive 600 gold pounds if the rate of exchange between dollar and pound is 5 and the price level is 100; or 500 gold pounds if the price level sinks to 83.333 and the rate of exchange rises, by proclamation, to 6; or 750 gold pounds if the price level rises to 125 and the rate of exchange is made to fall to 4.

6. Stability of foreign exchanges, which is the third aim of an ideal monetary system, is likewise achieved by the two-money device. We must remember that money of account is valid only for internal purposes; it can be called a dollar in the United States, a peso, franc, lira, mark, or pound sterling in the other respective countries. The effective money, in coins or bars, will be the only money accepted for settling international accounts. As there will never be need for changing the weight and fineness of gold, platinum, and silver coins, foreign exchange will be stable by definition. Fluctuations of exchanges will be wholly an internal affair. At first men will be bewildered; but by-and-by they will grow accustomed to seeing daily fluctuations in the dollar prices of silver florins and platinum guineas and to frequent official changes by proclamation in the dollar rate of gold pounds. As already said, almost two hundred years ago by Galiani, coins will gradually come to be seen as subject to price fluctuations like wheat or oil or securities. If the system can be managed successfully, men will find it obvious that a given salary or wage or rent fixed in dollars has a variable buying power in gold or silver, as is the case with wheat and oil, but a stable buying power in an assortment of goods, viz., a constant general purchasing power. Men will slowly free themselves from a superstition which in Europe has bred much ill will between nations: the superstition of the foreign origin of the fall in the value of internal money. The great majority of people in Germany, France, Italy, and elsewhere are convinced that their marks, francs, and lire fell in past years owing to manipulations of their enemies. The press is full of tales of assaults by New York or London or Amsterdam against national moneys, and even books are written on such silly topics. The new system will bring even to the uneducated mind of the man in the street the truth that the value of the national monetary unit is an internal problem; and that increases or decreases of the gold, platinum, and silver value of the dollar unit are the consequences of the acts of the government of each nation. If fluctuation in the gold price of the dollar unit are accompanied by the stability of purchasing power of coins or notes received or paid, the people will come to praise the good administration of their national monetary authorities; if the contrary happens, the people will connect their bad experiences with the folly or wickedness of their countrymen in charge of monetary affairs. Even if the system had only this one effect, its achievements should be deemed very important.

7. Let me confess at once that the above plan is not of my invention. Indeed, it is not a fruit of imagination at all. Men, for a thousand years before the French Revolution, did not know of any other monetary system. Books and pamphlets and statutes of the ninth to the eighteenth century are unintelligible if one does not bear in mind the distinction between money of account or imaginary money and effective or coined money. Usually the money of account was called libra, livre, lira. Men kept accounts, drew instruments of debts, sold and bought goods and securities and property rights in imaginary money, which they never saw. Coins had strange names, they poured into each country from all parts of the world, wore gold and silver and half silver dresses, were minted at home or by foreign princes.

That made no difference to people who continued to talk and negotiate and keep accounts in libras. The idea got ingrained in the minds of the people that the libra, the monetary unit of account, was something invariable, however changing was the price or quotation of the effective moneys.[1] There was something very ludicrous in this conception because princes often made use of the device of increasing the libra price of coins – which was the old name of devaluation – when they desired to repay smaller sums than those received. If a prince had received 5,000,000 libras when 1 gold sequin was equal to 5 libras, by the simple device of increasing by proclamation the price of the gold sequin to 10 libras, the prince was enabled to halve his debt; repaying 500,000 gold sequins instead of the 1,000,000 received, and pretending to have repaid the identical sum of 5,000,000 libras received.

Under the naïve misapprehension of the people and the dishonest behavior of the princes lay, however, a lofty ideal. It is the same ideal as that which today prompts so many theorists to construct system designed to give us a stable money. Perhaps involuntarily and without a plan, before the French Revolution, people hit upon the idea that gold and silver coins were merely goods which ought to be priced like any other goods in the market.

8. The imaginary or account money, the libra or livre or lira of old, was not a true money. It was something even more abstract than a paper note, which is an image, or mirror, reflecting money, it was a mere «ratio». The price of a good is, indeed, not a material thing.

When we now say that the price of a hat is 5 dollars we do not mean that the price means so much gold; we say only that the ratio between two goods, one hat and one dollar is the number 5. This number 5 is not merchandise itself; it is an abstract ratio. However, we must reason to arrive at this conclusion. Most men, being unable to reason, are apt to fall into the trap of thinking that a price is something material.

Medieval man knew better. The device of imaginary or account money came gradually to be adopted all over Europe between the ninth and the eighteenth century as a convenient way of stating that the price of merchandise is a ratio between a given quantity of that article of merchandise and a given quantity of another. When people said that one hat was worth 5 libras, they did not say that something material called 5 libras must be given in exchange. What they meant was simply that 5 was a useful number to make clear the relationship existing between the two goods, one hat and one sequin. The hat was not the sequin or vice versa; but both were bound together by the abstraction of 5 libras.

There is a difference between the present and the old terminology. When we now say 1 hat = 5 dollars, we are likely to think that there is something identical between two material thing, between the hat and the gold contained in a 5 dollar coin. We think and speak in terms of a mysterious «substance» which gives an identical «value» to the goods. When in olden times people said that one hat and one sequin were both equal to 5 libras, they were easily brought to the conclusion that these words meant only an affirmation of an equality «ratio» between the two goods exchanged, inasmuch as they knew that there was no substance whatever in the words «5 libras». By creating an intermediate step between goods and coined money, men invented something which could be utilized for the better management of the monetary system.

9. True, princes misused the tool, and men were made so angry by these misuses that they threw it overboard at the end of the eighteenth century. When the people proclaimed that there was only one monetary unit, a coin of so much gold – weight and fineness – they were persuaded to think that they had made a great step in the direction of simplicity and good faith. After so many other bitter experiences, however, the World War proved finally that devices were not wanting for devaluing the monetary unit, though the pretence was maintained that it was still the same unit as before. The gold units did not prove to be a sufficient bulwark against manipulations of money.

Against these manipulations no system whatever is invulnerable. Gold money and managed currency alike are subject to misuse. The following queries are therefore pertinent: Can the old two-money system offer nothing useful to contemporary practice? Must the idea of a money which cannot be coined, which cannot even be issued in the form of representative paper, a money which is a mere «ratio», be discarded without examination? Does not its millenarian life suggest that there is something in it worth discussing? The present paper is not a plea to adopt the imaginary money again. It only aims at setting forth its case. It is not the defence of a project, but the philosophy of an old practice, which perhaps may be considered again.