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C. Paper Standards
Under a paper money standard, it is essential to anchor
the system to a nominal fiat reserve -- what economists call
"outside" money, provided by a central bank, another govern-
mental agency or even a nongovernmental agency. In our
paper money system, the monetary base of the Federal Reserve
System serves as outside money. First, we examine current
monetary arrangements and then, by contrast, arrangements
that would prevail under a radical restructuring of the
monetary system.
1. Current Monetary Arrangements
Our current monetary arrangements rely on the discretion
of the Board of Governors of the Federal Reserve System. To
insulate the Board from short-run political pressures, safe-
guards are provided by the staggered 14-year terms of the
governors, the decentralization and somewhat autonomous
regional Reserve Banks, and the independence from Congressional
appropriations. Congress has no direct supervisory
authority over either the Board or the Reserve Banks, although
the chairman and other members of the Board testify frequently
before various Congressional committees. Twice a year, as
required by the Full Employment and Balanced Growth Act of
1978, the Board submits a written report to Congress on the
state of the economy and the course of monetary policy and
consults with the Congress on its report.
It is the responsibility of the Federal Reserve Banks to
provide without limit the amount of paper currency that the
public demands. A limit on the quantity of paper money that
the Federal Reserve could issue existed before 1968 when it
was required by law to keep a 25 percent gold backing for
each dollar it issued. Instead of controlling the amount of
currency in circulation — it now constitutes about one-fourth
of the money supply aggregate Ml, defined as the sura of
currency, travelers checks, and all transaction deposits --
the Federal Reserve attempts to control the money supply.
Although reserve requirements on transaction deposits
provide an essential institutional setting, the most important
discretionary tool the Federal Reserve possesses for monetary
control is its portfolio of government securities. It is
through increasing and decreasing its holdings of government
securities that the Federal Reserve is able to effect changes
in the reserve positions of banks and other depository
institutions. When the Federal Reserve buys government
securities, it pays for them by adding to the reserves of
depository institutions. Federal Reserve sales of government
securities reduce reserves. Institutions expand their lending
activities, and hence increase transaction deposits, when
their reserves increase. The opposite effects occur when
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A. Gold
1. Pure variants X X • X / ? X
2. Classical X X X b • 9 X
variants
B. Commodity • X • X • • ?
C. Paper
1. Current • • X • X X 9
2. Competing ? • • / ? ? 9
monies variant
a
Check means standard satisfies condition, X means it does not;
question mark indicates effects are uncertain
including the present one, is that they exact minimum costs in the
form of resources used to produce the money supply, and they are
sufficiently flexible to accommodate economic growth. Moreover,
if accompanied by flexible exchange rates, they can insulate the
economy from external shocks.
1. Current Monetary Arrangements
For some observers, the discretionary character of the paper
standard is an advantage. Monetary authorities have a choice of
policy goals and are free to determine how to use their powers to
attain them. As problems change, their goals may change.
Other observers view the historical record of our fractional
reserve managed paper money system as one of considerable instability
both in the short run and the long run and have advocated a number
of proposals designed to reduce:
instability associated with fractional reserve banking
(100% reserve proposal);
instability associated with discretionary policy
(monetary growth rules);and
inefficiencies associated with the costlessness of
producing paper money balances (paying interest on bank
demand deposits).
2. Proposals for Competing Monies
Finally, we evaluate the case for competing monies. Its
principal appeal lies in its reliance on the impersonal forces of
the market rather than the monopoly power of government. However,
unless brand names can be attached to competing private monies,
that is, unless the public can be guaranteed that private money
issuers will not overissue for private gain, it seems likely that
government regulation will be necessary.11
With respect to the proposal for a parallel currency, the
extent to which it would contribute to price stability depends on
the reason shifts would occur between dollars and gold. If a
shift occurred because of overissue of dollars, Federal Reserve
actions to reduce the money supply would be desirable. However,
if a shift reflected a change in the public's taste for gold and
dollars unrelated to price behavior, or to a shock in the gold
market, then such actions would be undesirable. The question then
arises, how would the Federal Reserve know the source of a shift?
U.S. experience under the greenback standard is not comparable
to the proposal for a parallel currency. In the greenback era, the
price of gold was fixed by Great Britain. What varied was the
dollar price of gold, reflecting a changing value of the dollar.
The country had a dual currency system because dollars were used for
domestic purposes, gold for international transactions (with the
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Notes to Chapter 3
The great English economist Alfred Marshall also proposed a
combination of silver and gold that he designated symmetalism.
He argued that a bimetallic standard would inevitably degenerate
into a single standard of either gold or silver, one metal tending
to drive the other out of circulation. Symmetalism was a plan
to make a composite bar of fixed proportions of gold of given
weight with a weight of silver, say, twenty times greater, the
government undertaking to buy or sell on demand the composite
bar for a fixed amount of currency. Neither metal separately
would be convertible into currency at a fixed rate nor would
currency be convertible at a fixed rate into either metal.
See Memorials of Alfred Marshall, ed. A.C. Pigou, Macmillan:
London, 1925, pp.204-06.
This assumes that it is costless to shift from nonmonetary to
monetary use of gold. The cost was either borne by the Mint or
paid by the public when gold coins circulated in the past.
See, for example, D.N. McCloskey and J.R. Zecher, "How the Gold
Standard Worked, 1880-1913," in J.A. Frenkel and H.G. Johnson,
eds., The Monetary Approach to the Balance of Payments, Toronto:
University of Toronto Press, 1976.
As happened when sterling was devalued in 1949 and 1967.
A survey of the pre-1950 literature on commodity standards may
be found in Milton Friedman, "Commodity-Reserve Currency," in
his Essays in Positive Economics, Chicago: University of Chicago
Press, 1953, pp. 204-50. See also Robert Hall, "The Government
and the Monetary Unit," unpublished paper #159 of the National
Bureau of Economic Research Inflation Project.
See his Choice in Currency, A Way to Stop Inflation, The Institute
of Economic Affairs, Occasional Paper 48, London, February 1976;
Denationalisation of Money, An Analysis of the Theory and Practice_
of Concurrent Currencies, The Institute of Economic Affairs,
Hobart Paper Special, No. 70, London, October 1976.
See Joe Cobb, U.S. Choice in Currency Commission, "Rahn Proposal
for Capital Gains Treatment of Gold Coins," (February 10, 1982).
There is some historical precedent for competing monies. Such a
system was quite successful in late eighteenth and early nineteenth
century Scotland and in the antebellum United States (except for
wildcat banks). See Lawrence White, "Free Banking in Scotland
Prior to 1844," Unpublished Ph.D. dissertation (November 1981),
and Hugh Rockoff, "The Free Banking Era: A Re-examination,"
Journal of Money, Credit and Banking 6 (May 1974): 141-68.
This discussion does not incorporate gold producers' expectations
about movements of the gold prices, nor does it incorporate
asset-holders' expectations. For a discussion of the traditional
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