In 1961, Milton Friedman gave his speech, “Real and Pseudo Gold Standards” to an audience at the Mont Pelerin Society (I am unable to find the attendee list, but I assume that Hayek was there as it was his final year as president). At the time, much of what Friedman said was probably not met with great disagreement from Hayek, but I find it instructive to compare Friedman’s speech to Hayek’s original views.
Friedman identifies three types of monetary standards. There is a real gold standard, where gold is used as the medium of exchange or as the base of money, but in which there is no fixed exchange rate. Then there is what Friedman calls a “pseudo gold standard” under which exchange rates are fixed by an external authority. Gold can, but often does not, circulate freely under the latter regime and monetary authorities are free to manipulate international gold flows. According to Friedman:
Though these have many surface features in common, they are at bottom fundamentally different -just as the near identity of prices charged by competitive sellers differs basically from the identity of prices charged by members of a price-ring or cartel.
The gold standard, as it historically operated in the modern, capitalist era, has operated as a “pseudo gold standard.” In this sense, it was only a nominal a gold standard whose benefits might be obscured if only some nations abandoned the gold standard or if policy supported gold hoarding by central banks, both of which occurred during and after World War I.
Friedman’s assessment dives to the heart of the debate as it occurred among free-market liberals at the time. Those who supported a return to the gold standard hoped for a real gold standard, but this is probably impossible in practice as long as government controls the money stock. Friedman rightly conjectured that any reversion to gold by national government would probably be half baked:
I believe that those of us who support it in the belief that it either is or will tend to be a real gold standard are mistakenly fostering trends the outcome of which they will be among the first to deplore.
The gold standard as it existed after 1934 was obviously of the pseudo-type, but the difference between that gold standard and the one that preceded it was much more of degree than of kind. Given the expectation that any government managed gold standard was a “pseudo gold standard,” Friedman and company called for:
A separation of gold policy from exchange-rate policy. It favors the abandonment of rigid ex-change rates between national currencies and the substitution of a system of floating exchange rates determined from day to day by private transactions without government intervention. With respect to gold, there are some differences, but most of us would currently favor the abandonment of any commitment by governments to buy and sell gold at fixed prices and of any fixed gold reserve requirements for the issue of national currency as well as the repeal of any restrictions on private dealings in gold.
I first did not understand why this was not the consensus among academics at Mont Pelerin. Hayek’s Great Depression era work provides insight into the issue.
Throughout Monetary Nationalism and International Stability, Hayek praises the gold standard for its ability to serve as a truly “international currency system.” That is, prices in one country can be directly compared to prices in any other country on the gold standard. “Differences in denomination of national currencies,” writes Hayek, “would really be no more significant than the fact that the same quantity of cloth can be stated in yards and in meters.” Hayek also observes that with the breakdown of the gold standard, “homogeneity of the circulating medium of different countries has been destroyed by the growth of separate banking systems organized on national lines.” Hayek wanted a homogeneous international unit of account, but his policy suggestion was entirely unworkable. This adds not a small amount of trouble in attempting to decipher Hayek’s argument.
To clear up the problem, we must look at Hayek’s ideal policy suggestion:
It is far less obvious why all the banking institutions in a particular area or country should be made to rely on a single national reserve. This is certainly not a system which anybody would have deliberately devised on rational grounds, and it grew up as an accidental by-product of a policy concerned with different problems. The rational choice would seem to lie between either a system of ‘free banking,’ which not only gives all banks the right of note issue and at the same time makes it necessary for them to rely on their own reserves, but also leaves them free to choose their field of operations and their correspondents without regard to national boundaries, and on the other hand, an international central banks. I need not add that both of these ideals seem utterly impracticable in the world as we know it. But I am not certain whether the compromise we have chosen, that of national central banks which have no direct power over the bulk of the national circulation but which hold as the sole ultimate reserve a comparatively small amount of gold, is not one of the most unstable arrangements imaginable.
We see again that Hayek’s actual policy suggestion was backward looking, but his ideal arrangement is far ahead of his peers. He recognized the problems with the gold standard raised over 20 years later by Friedman at Mont Pelerin, yet failed to seize upon his greatest strength. Hayek did eventually alter his policy prescriptions, but the habit of some Austrians to give backward looking policy suggestions remains to this day as a simple google search for “Austrian Gold Standard” reveals an ongoing debate among Austrians. At one extreme, some like Walter Block support a return to the 100% gold standard and the generally opposing group, which includes Larry White and George Selgin, that support a free-banking solution. The latter group certainly carry on, at least in part, Hayek’s legacy and fit well with the position of Friedman in 1961. Unfortunately, those not entirely familiar with Austrian economics are probably better acquainted with the perspectives of the former group.