Reforming the Monetary System

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Over the last five decades, central banks have failed to deliver both reliably sound money and smoother real growth. Instead, chronic inflation peaked in the Great Inflation of the late 1960s, while more recently a series of booms and busts led to the Great Recession of 2007. In response to this poor performance, however, many venerable ideas for monetary reform have been rediscovered.

In Renewing the Search for a Monetary Constitution, published in February by the Cato Institute, leading scholars weigh in on the debate over creating constitutional provisions that prohibit government interference with money versus those that empower it. Edited by Lawrence H. White of the Cato Institute and Victor J. Vanberg and Ekkehard A. Köhler of the Eucken Institute, this volume commemorates the 50th anniversary of economist Leland Yeager's In Search of a Monetary Constitution, a largely overlooked work that has proven to be remarkably prescient. Yeager argued in favor of a set of enforced constraints on the creation of money by government. This collection, like its earlier counterpart, takes a broad view, aiming to revitalize public discussion of constitutional monetary reform by offering a range of different views. The time is ripe to rethink monetary arrangements rather than, as White writes, "tinkering with the instruction sets for status quo institutions."

The late Nobel laureate James Buchanan believed that money is a special economic good that needs special constitutional rules. He granted that monetary arrangements can evolve spontaneously within a system of property rights, but argued that the evolved outcome wouldn't generally be efficient. Money has certain aspects of a public good, he thought, which means that a role for the state is warranted — but only a limited role. In his chapter, Buchanan endorses a constitutional mandate for government to stabilize the purchasing power of the monetary unit.

As Cato senior fellow Gerald P. O'Driscoll notes, the economist Ludwig von Mises argued that the concept of preserving sound money from a government's temptation to use inflationary finance "belongs in the same class with political constitutions and bills of rights." At the same time, the track record of the Federal Reserve's monetary policies over its hundred-year history, judged by inflation, price-level unpredictability, and real output variability, has been "unenviable" at best. Central bank histories around the world are equally or even more regrettable than the Fed's. Prompted by these poor records, O'Driscoll organizes his arguments around two questions: Can central banks be constrained to a beneficial role, or must they be abolished? And can a bad system be made better, or do we need wholesale replacement?

One new possibility for superseding central-bank money involves the gradual replacement by private alternatives that begin as parallel standards and win an increasingly larger market share. Kevin Dowd, a professor of finance and economics at Durham University and an adjunct scholar at the Cato Institute, gives a fascinating account of three such alternatives — the Liberty Dollar, E-gold, and Bitcoin — that achieved loyal clienteles, only to face legal obstacles thrown up by the U.S. federal government. The reforms necessary to unleash the potential of these new innovations are to remove all discriminatory legal restrictions that stack the deck in favor of status quo banks.

The likelihood of returning to a commodity standard is surely lower today than in the past, when, after a wartime suspension, a consensus was commonly in its favor. But low likelihood can be ascribed to any proposal other than retaining the status quo. The real question is what changes will lead to the best monetary regime. "If otherwise desirable and feasible, no reform must remain 'politically unrealistic,'" Yeager wrote in the introduction to his 1962 volume, "except as thinking makes it so." This remains as true today as it did back then.