Sound Money is Important for Civil Liberty: Christopher Lingle at CCS

Christopher Lingle gave a talk at CCS Chintan on 19 January 2015. He is Visiting Professor of Economics at the Universidad Francisco Marroquín in Guatemala, and his research interests are specifically political economy and international economics. Prof Lingle explored the concept of sound money and why we need it, in the process highlighting how central banks, which aim to stabilise prices through monetary policy, are in fact the primary cause for their instability.

Central Banking

Prof Lingle stated that central banks play a crucial role in creating instability in markets. What is required for a well-functioning economy is sound money — i.e. stable purchasing power of money. One correlated, and very important, reason for this is that a sound money system is a means to restrain government abuse of the fiscal purse — overspending or creating additional burdens on the economy.

What is the impact of central bank policies on sound money? Central banks have certain specific activities that they are attempting to achieve — primarily, to preserve the purchasing power of money (which implicitly is a promise to give us sound money); and creating financial stability by keeping the banking system functional.

Preserving the purchasing power in domestic consumption is a control on inflation — we don’t want to see high and rising prices, just as we don’t want to see collapsing prices. Central banks also aim to preserve purchasing power in international exchange, i.e. exchange rates, creating stability between currencies. Sound money, in this sense, has to be sound on both grounds — domestic consumption and foreign trade. This in turn, will result in stable rates of economic growth and relatively low unemployment.

The second function of central banks is to create financial stability — they serve as the lender of last resort for commercial banks. The norm used to be that central banks would loan liberally against high quality collateral, at high interest rates. Over the years, central banks just lend liberally and the rest of it, central banks no longer pursue. Prof Lingle pointed out that as a result of their activities, central banks are the primary source of instability in all these areas.

Central bank independence is everything, and while central banks are much less obviously linked to government policy, the reality is that in many countries, (the USA being an example), central banks cannot raise interest rates because it would bankrupt the government. If the interest rates went up to the long term average, the capacity of the US government to spend on anything other than debt repayment would be severely diminished. In this way, then, central banks are supporting fiscal deficits.

Further, interest rates are the single most important price in the economy — it’s a price that everybody needs to know. Interest rates indicate the price of risk, and manipulating this rate is to misprice risk, which leads to a distorted production structure and malinvestments. Yet ironically, even in supposedly market economies around the world, this rate is a fixed price, not a natural or market driven price. Every industrialised country has a fixed interest rate based on central bank policy, primarily in order to support fiscal demands from the state.

Fiat Money

Prof Lingle provided an overview of the concept of fiat money, contrasting it with sound money. Fiat money is a system that has no backing to it. In the days of a gold or silver standard, money could only be issued according to the stock of gold held in reserve, and based on the exchange rate or price of gold. You could exchange money for that amount of gold, but with fiat money, what can you get in return for a piece of money is another piece of paper. This creates an infinitely elastic supply since there is no limit to the amount of money that can be issued. A gold standard limits amount of money that can be issued against a certain amount of gold.

Sound Money

Sound money is important, not just because it creates financial stability and a platform for economic growth but because it is also a way of protecting civil liberites. Mises was the one to make this observation, stating that at its heart, a government’s ability to degrade money will benefit the government at the expense of citizens. If they are able to debase our currency, in a way we are giving up things that we produce and own for less than what we should be entitled to under a sound money system.

Sound money is something everyone will accept, because they know others will accept it. It will hold value over time, and it is accepted with the anticipation that others will accept it at more or less the same value later.

Mises, and later, Hayek, talked about how currencies can be chosen and produced by demand for, and free supply of, money. As a consequence, monetary authorities will be unable to interfere with the value of money.

We live in a world of unsound money — we have government-controlled fiat money in a fractional reserve banking system. Money today has value by declaration. The solution to this is to allow it to be a product of the free market, just as any other good; end the state monopoly on money production and management and scrap legal tender laws; and end bailout guarantees (that lower the cost of poor management of risk and increase chances of failure). A free banking system would go a long way in restoring the soundness of money.

A podcast of his talk can be accessed here and his presentation is available here.