December 01, 1997
Money Meltdown: Restoring Order to the Global Currency System
by Judy Shelton
Free Press/Macmillan 1994 (399 pages)
If the CIA had been reading Judy Shelton's eerily prophetic The Coming Soviet Crash (Free Press, 1989), the United States might have lost less money, and its leaders less sleep, during the twilight years of the Cold War. In that book, Shelton depicted the Soviet Union as an empire in its death throes, struggling against the self-inflicted cancer of communism. The fall of a mighty nation makes a loud crash, but the collapse of many is sure to cause a cacophony. This is what Shelton's new book, Money Meltdown, predicts for the international trading community, if it continues down the road of exchange-rate manipulation and monetary tinkering, for the sake of domestic economic quick fixes.
Though the book begins with an account of recent international monetary crises, Shelton addresses a problem which has been with us for much longer than the most recent century, that is, what to do about money, that most peculiar of goods. Shelton digs for the roots of recent monetary uncertainty, finding them in the demise of her beloved Bretton Woods system. Chapter two is a short history of modern global economics, including some nice shots at J.M. Keynes which continue throughout the book (e.g., "Keynes's abiding faith in the wisdom of superior beings such as himself . . . foster[ed] his preference for deliberate government intervention in the economic sphere" ). Chapter three contains the bulk of Shelton's prophecies, a few of which have already been fulfilled (e.g., Japan's shift from American lackey to rebelliousness instigator, manifested in a willingness to threaten pulling out of the U.S. bond market --- see N.Y. Times, June 24, 1997, B1; the growing political influence of "red hot" China's entrepreneurial class, and China's increasing international importance --- see any current news media). Chapters four through six present the core of Shelton's theory.
To be sure, Shelton is not just another of the many doomsayers, the sale of whose eschatological titles seem to keep publishing houses in business at this, the exaggerated end of the Hyperbolic Century. Her main topic is not millennial, but perennial. Her book is about money, which Murray Rothbard called the "nerve center" of the economy, and which came about virtually by accident, much like language. As Shelton points out, money is a commodity, and people have adopted a stunning variety of commodities as money: mollusk shells, beaver pelts, sugar, tobacco, salt, even stone. Eventually, much of the world settled on gold, whose characteristics (scarcity, portability, divisibility, durability) especially suited it to monetary use. The adoption of money permitted commercial freedom and a prosperity of degrees previously unknown to humanity under the barter system. As they began to accumulate wealth, people entrusted their savings to the local goldsmith, in exchange for more convenient paper claims, or notes. Soon, however, the goldsmith learned that he could create purchasing power and enhance his profits by writing out additional paper claims, even when the value of the gold in his vault was not sufficient to cover these new titles: Banking was born. Medieval princes clipped coins, thus imposing a hidden tax on their subjects: Seigniorage was born. Several hundred years later, development of the fractional-reserve system institutionalized such fraudulent practices, creating the "button-down business of banking." (173) And today our credit system is nothing more than an inverted pyramid constructed of playing cards, or maybe toothpicks. "When a monetary Ponzi scheme reaches its limits, the last person stuck with the paper currency loses." (250) Indeed, the modern fractional-reserve system, where billions of banknotes are precariously balanced like King Kong on top of the Empire State Building, is quite like the children's game, "musical chairs" --- better not be the last one to sit down.
Which leads one to wonder why the whole works won't soon come crashing down. Ludwig von Mises's regression theorem showed that the present value of money depends on the matrix of all its previous values. Shelton warns: "Fiat money . . . has value only as long as the next person accepts it in payment for goods and services." (250) But legal tender laws force Americans to accept paper dollars which are backed by the guarantee of the U.S. Treasury, which is backed by the willingness of investors to purchase U.S. debt, and by the willingness of U.S. citizens to continue paying taxes, which is backed by . . . the point of a gun (to crib from Ayn Rand).
To end the violence of the U.S. monetary system (not to mention the violent instability of the foreign exchange markets), Shelton prescribes the revival of a classical international gold standard, like the one in operation from the end of the 19th century to the First World War. Shelton notes that a distinct advantage of gold lies in the straitjacket it places on public finance. An international gold standard also promotes stable exchange rates, a steady monetary growth rate, and increased trade resulting from the reduction in transaction costs associated with the elimination of foreign exchange risk. Advocates of commodity basket indexing once considered it unwise to base such a fundamental institution as the international monetary system on a single commodity whose principle ore deposits are found in South Africa and the former Soviet Union, two international pariahs plagued by political instability. Other critics of gold have noted that an international gold standard would face chronic supply instability, as the monetary growth rate would equal the rate at which gold is mined, refined, and minted. Newer, more efficient processing methods might reduce the cost of gold production, thereby causing inflation.
Shelton cleverly responds by noting that annual new gold production makes only a small addition to the existing gold stock, and that the potentially destabilizing impact of advances in gold-mining technology "pales in comparison to the fiscal offenses that are carried out by profligate politicians" (252) in the void of gold-imposed discipline. The first goldsmiths, operating like warehousemen, exhibited such discipline. Similarly, when you entrust a garment to the neighborhood cleaner, he gives you a claim ticket, which you can later exchange to repossess your garment, cleaned. So it is with the coat check at a finer restaurant, or a storage facility, or the urban parking garage. Yet when you deposit your hard-earned wages in a demand account at the local bank, all you have is the promise that the "full faith and credit" of the United States Government will guarantee that your money is returned at request. Never mind that the banker keeps in his vault only a fraction of the bank's total deposits. He's gambling that there will never be an occasion on which more than a fraction of all depositors simultaneously demand their deposits. And should such an occasion arise, he'll just wire the regional Federal Reserve Bank for more cash. It's that simple. It's also that fraudulent, says Shelton: "Not to maintain sufficient inventory to preserve the integrity of the currency is an act of fraud." (261)
Is Shelton arguing for a bailment system, a la Rothbard? Not at all. Shelton speaks of "sufficient inventory," rather than 100% reserves. Yes, "gold bugs" seeking a carefully calculated theoretical case for 100%-reserve gold will less than purist. Surely, Shelton opposes the current state of affairs, but alternatives to fiat money usually fall into one of three broad categories: market approaches, commodity indexing, and constitutional monetarism. Market advocates (the "Austrian" school) include the bailment school (Rothbard) and the free-banking school (F.A. Hayek, Lawrence White). While it is not clear whether Shelton would embrace the bailment idea, she flatly dismisses the "competitive currencies" concept, though she chronicles the successes of free-banking systems in Foochow (China), Sweden, and Scotland. Shelton questions whether consumers really want so much choice (253). (Why not let consumers make that decision?) Indexing proponents favor pursuing price stability through diversification, tying the monetary unit to a commodity basket to achieve the cancellation effect of opposing price fluctuations of individual commodities. Shelton rejects this as too cumbersome, and probably in pursuit of an elusive goal. Constitutional monetarists favor writing a monetary growth rate into law, either by means of a growth rule (Milton Friedman), or a commodity rule (Shelton). Milton Friedman is the foremost proponent of the former, while Shelton prefers the latter, tying the monetary growth rate to that of the gold stock.
Shelton hits a home run when she sees monetary tinkering for what it is: a political game. "[T]he power to issue money is intensely political, and no government gives up that power lightly or without recourse," (199) and, "[Governments] don't want to lose their ability to use monetary policy as a convenient way to absorb a multitude of fiscal sins." (248) The financial establishment, supported by the dominant press and academic circles, continues to pretend as if monetary policy is simply an innocuous "fine-tuning" of the economy, when it is really nothing less than social engineering on the grandest scale. A policymaker's highfalutin arguments for monetary meddling provide little solace to the corner grocer who, after expanding his store to service a perceived increase in demand, regretfully learns that it is no more than a phantom prosperity cooked up by monetary inflation.
The book's major contribution to the money debate lies in its identification of monetary policy as a means to achieve fiscal ends. Through currency manipulation, government officials can finance public projects without having to resort to politically unpopular tax hikes. The Treasury simply "borrows" the money it needs by issuing debt certificates which it promises it will honor. When these notes come due, the Treasury issues new debt to raise funds to pay off the old debt. In this manner, the government can defer payment on the pork-barrel projects of the dominant generation to future generations. This is, in essence, taxation without representation. Shelton makes it clear that if a serious theoretical critique of central banking is to have any practical success, the voting public must see money as something more than a stale issue.
Surely, this book is not the first to expose the "unholy alliance" uniting central bankers, financiers, and government budgeters. But Shelton's effort to simplify complex ideas is to be celebrated, even if her effort is sometimes overzealous: "As long as everyone recognizes the cold, hard reality of an objective monetary standard, economic frustrations are less likely to turn into dangerous provocations." (250) If Shelton intends to convince the whole of humanity with one book, she is setting herself up for a major disappointment. It will be difficult to convince angry, unemployed factory workers of the need to accept the "cold, hard reality" of fixed exchange rates and comparative advantage. But Shelton correctly perceives that the question of money, which is hardly moot, can become an energizing, populist issue. Her book is a useful addition to the current free-market arsenal, a beacon in the stormy, gray sea of the "mixed" economy.
*Aaron A. Goach is a second-year student at Harvard Law School, where he serves as Treasurer to the campus chapter of the Federalist Society, and Senior Editor to the Harvard Journal of Law & Public Policy. He is currently serving a summer internship with the New York City Law Department, Office of the Corporation Counsel, Affirmative Litigation Division. He previously served as District Legislative Aide to the Pennsylvania House of Representatives. Mr. Goach is a Phi Beta Kappa graduate of Muhlenberg College, Allentown, Pennsylvania, where he studied international economics and produced a thesis, Alternative Monetary Regimes and the Austrian Perspective. He is the author of "International Factor Mobility and the Economics of Immigration," Issues in Political Economy (1996) and is an alumnus of several international libertarian student conferences, including those of the Ludwig von Mises Institute (Auburn University) and the Institute for Humane Studies (George Mason University).