Tuesday, October 29, 2013

Turning Point: Hayek as Monetary Visionary

In 1949, Hayek reflected on the success of socialist ideology and the waning of classical liberalism:
In particular, socialist thought owes its appeal to the young largely to its visionary character; the very courage to indulge in Utopian thought is in this respect a source of strength to the socialists which traditional liberalism sadly lacks. He closes the article by arguing:
We must make the building of a free society once more an intellectual adventure, a deed of courage. What we lack is a liberal Utopia, a program which seems neither a mere defense of things as they are nor a diluted kind of socialism, but a truly liberal radicalism which does not spare the susceptibilities of the mighty (including the trade unions), which is not too severely practical, and which does not confine itself to what appears today as politically possible.
During the Great Depression Hayek had struggled to convince his colleagues of the merits of certain classical liberal tenants that he valued. He failed to sway their opinion concerning the gold standard. This was also true concerning the Austrian Business Cycle Theory. He only partly succeeded in disillusioning them of their socialist utopian dreams with his participation in the Socialist Calculation Debate. Where had Hayek gone wrong? Hayek’s remarks in “Intellectuals and Socialism” about utopianism appear to be confession. He had not been idealistic enough.

Written before “Intellectuals and Socialism” in 1943, Hayek’s “A Commodity Reserve Currency” represents a shift in his research program where he begins to stress future avenues to prosperity and political organization, rather than a propose solutions that might be interpreted as “a mere defense of things as they are.” It is a truly symbolic of this change in that he moves from criticizing price level stabilization to proposing not only how it might successfully operate, but how the rules of its operations my mitigate the extreme fluctuations of the business cycle. His proposal is not the same as his peers. He suggests that, rather than having the price level be stabilized by changes in the money stock that offset changes in velocity, the use of a commodity reserves can stabilize the general price of commodities directly by setting a fixed exchange rate for commodities which will increase demand for them when prices fall below the fixed rate and alleviate demand when prices rise above the fixed rate:
With this [commodity] system in operation an increase in the demand for liquid assets would lead to the accumulation of stocks of raw commodities of the most general usefulness. As the hoarded money was again returned to circulation, and demand for commodities increased these stock would be released to satisfy the new demand.
He explains how this will dampen the business cycle:
The revival of activity will not lead to an extra stimulus to the production of raw commodities which would continue on an even keel. There is reason to regard the temporary stimulus of excessive expansion of production to raw commodities, which used to be given by the sharp rise of their prices in boom periods, as one of the most serious causes of general instability. This would be entirely avoided under the proposed scheme – at least so long as the monetary authority had any stocks from which to sell.
 Instead of pointing to the problem associated with past policies and suggesting a return to the golden days – which is easily interpreted as a return to the status quo – Hayek projects a vision of a future that improves upon the past.

This represents an about face from the direction of much of his previous work. His critique of price level stabilization and promotion of the gold standard during the 1930s had apparently gained Hayek few followers. The western world had suffered tragedy twice within two decades – first with the Great War, then the Great Depression – and the zeitgeist of the era did not look to the past for future success. Intellectuals craved idealism, not recitation of former creeds. They wanted swift change and saw the state as the vehicle for that change. Hayek learned that if the liberal values that he promoted were to survive, he needed to propose policies that were a radical departure for the past. The new vision must present previously unrealized solutions that constrain, rather than empower, the state. This new program is well exemplified in a couple passages of his 1943 article where he stresses the importance of rules:
There would, in particular, be no need for the monetary authorities or the government in any way directly to handle the many commodities of which the commodity unit is composed. Both the bringing-together of the required assortment of warrants and the actual storing of the commodities could be safely left to private initiative. Specialist brokers would soon take care of the collecting and tendering of warrants as soon as their aggregate market price fell ever so little below the standard figure and of withdrawing and redistributing the warrants to their various markets if their aggregate prices rose above that figure. In this respect the business of the monetary authority would be as mechanical as the buying and selling of gold under the gold standard.
Even apart from monetary consideration, the great need is for a system under which these controls are taken from the separate bodies which can but act in what is essentially an arbitrary and unpredictable manner and to make the controls instead subject to a mechanical and predictable rule.

We can certainly see the roots of Hayek’s later work on spontaneous order as Hayek suggested rules that might procure stability that allows economic agents to make plans and coordinate them with others.


  1. I haven't been following your posts very closely, but your blog is certainly now on my radar. Keep up the good work.

    I believe Hayek took inspiration from Benjamin Graham's proposal, correct? It seems Graham's idea attracted a fair amount of attention at one time, but has been largely forgotten.


    If you have time, I hope you can answer a few questions. First: How do you imagine hypothetical gold-based free banking systems (e.g. Canada, Scotland) would have evolved had they not switched over to central banking? Say a bank offered to redeem currency either in gold or the market equivalent amount of silver. Wouldn't this lead to a broadening of the commodity base if depositors accepted this arrangement and other banks agreed to use silver (market to market) for note clearing?

    Conversely, do you agree with Kevin Dowd that financial assets would assume more importance in clearing arrangements (and gold less importance)?

  2. You are certainly correct that Hayek drew the idea from Graham. I may post about that in the near future.

    A primary component of the freebanking system were the CHAs (clearing house associations) In Canada, and in the US before the establishment of the Fed (Benjamin Anderson comments on this in his chapter on the panic of 1907 in Economics and the Public Welfare which is worth visiting. They have it at mises.org for free) clearinghouse associations provided liquidity to banks that faced undue hardship as a result of a liquidity crunch. This is a rudimentary source of stability in a free-banking system. Furthermore, as Larry White shows in his "The Theory of Monetary Institutions," a freebanking system will support reserve levels according to the market rate so that a sizable volume a fiduciary currency would be supported from a base. Concerning broadness of reserves, the existence of ETFs in the modern era attest to the sorts of effects freebanking would ultimately have. David Glasner's Freebanking and Monetary Reform has much to say about this, but I'll sum (with my own biases reflected) by saying that if fiat currency restrictions were not binding, we might see a world where ETFs were used as actual moneys rather than quasi-moneys. I have strong reason to believe that this would broaden the commodity base, as you suggest. Banks might use silver, wheat, oil, or any standard that best supported their operations.

    On first glance of Dowd's argument I agree, but I need to revisit his work to give a definitive answer.

    I'm glad that you are enjoying my review of Hayek. There will certainly be more to come,of Hayek and of a variety of thinkers and theories.

  3. Very interesting point about ETFs. I was thinking along the same lines about commodity futures. I will definitely have to get Glasner's book, since I haven't seen this type of discussion anywhere else. Thanks for the pointer.