Most people with a reasonable grasp of economics understand the basic issues associated with price fixing. Fix the price of bananas and there will be either a glut of bananas (if you fix too high) or a shortage of bananas (if you fix too low). Alternatively with a less fungible product you might get a shift in quality instead of quantity. So for instance if the price of cars is fixed too low then you might get a decline in quality rather than a shortage, although probably in practice you would get a bit of both (or maybe a lot of both). Free Market types generally agree that you shouldn’t fix prices but rather you should allow the market price to signal to consumers and producers the relative scarcity of a given good for a given quality. Behaviour can then adjust accordingly.

Too often it is claimed that economic growth is inflationary. The following chart should shatter that myth (but probably won’t). During the 1800s when the British economy expanded massively the price level actually halved.

Some recent discussion here on the ALS blog has centred around the issue of private currency, fractional reserve banking (FRB) and the historical role of gold within monetary systems. Whilst some of the associated questions will no doubt get rehashed again and again I would like to focus this article on what I think is the key obstacle to freedom when it comes to the question of private currency.

Currency comes in a multitude of forms. Some alternate categorisations that we might apply to currencies are:-

- Privately issued or Government issued.
- Fiat or Promisory
- Tangible or Electronic
- Paper or metallic

Perhaps the most familiar form of currency is the national fiat currencies that we encounter daily such as the plastic Australian notes we find in our wallets or the green paper notes that we call US dollars. Both of these are examples of currencies issued by governments where the value is determined by government monetary policy and market demand rather than via any contractual promise. As such they are known as fiat currencies.

Not all government issued currencies are necessarily fiat currencies. In earlier times many governments routinely issued currencies that entailed an explicit promise and they were in essence a contract between the holder of the currency and the issuer (in this case the government). The following picture shows an early US dollar that was promisory in nature and carries words that outline an explicit commitment to redeem the currency for some specific article. In this example the note carries the words: “This Certifies that there is on deposit at the Treasury of The United States of America One Dollar in Silver Payable to the Bearer on Demand”. So long as the term “One Dollar in Silver” means a specific weight of Silver (as in US law it once did) then such a note is not a fiat currency but a promisory note.

So a government issued currency need not be a fiat currency, even though pretty much every government issued currency today is. Private institutions can in theory also issue such promisory notes. The next images shows an historical example of a promise issue by “The City Bank of Sydney”.

This note promises to pay the bearer 20 Pounds on demand. At the time “20 Pounds” legally meant a particular quantity of gold coin.

However such paper promises will only function as a medium of exchange if they are transferable. If the promise is explicitly made out to a particular person, rather than to the bearer (holder) in general, then the item can not serve as a medium of exchange. A promise that is to a particular named party does not have any redemtion value to a third party and so it won’t circulate. The following images shows a modern example of a paper promise that won’t circulate because it is specific to a named party only.

The images shows a gold certificate issued by the Perth Mint which promised to pay a given amount of gold on demand. These Perth Mint certificates come in two forms, allocated metal or unallocated metal. However the certificate is to a named party and as such the certificate is not transferable and can not circulate or act as a medium of exchange.

In 1910 the Australian Federal Government passed several monetary reforms and one of these was know as “The Bank Notes Act of 1910″. Whilst the act does not prohibit private currency in Australia it does impose a 10% tax on redemption for all private currencies. Such a tax is prohibitive in nature and it effectively brought to an end the existance of privately issued currencies in Australia.

The most simple freedom orientated monetary reform that we could have in Australia would be to abolish “The Bank Notes Act of 1910″. It would not bring to an end the dominance of the fiat Australian dollar, nor reform the basis of monetary policy, but it would pave the way for private alternatives. It would not open a flood gate but it would leave the door slightly ajar. It is hard to see any more ambitious reform towards privatising money having any effect without this first basic step. In the monetary arena even such a basic level of freedom is rare in the world today but it does exist. The best precedent for such freedom comes from Scotland where today private banks still issue private promisory notes, payable to the bearer on demand and circulating as a functional alternate currency. Given the political will Australia could very easily make this quite minor technical adjustment and become one more niche of freedom in the world and present at least a modest reminder of the way a less centrally controlled world once worked.

Gold coins (ie coins made mostly of gold metal) that are legal tender in Australia are certainly available. The image to the left shows a recent issue of legal tender gold coin from the Royal Australian Mint. However the legal tender value assigned to such coins ensures that they will never circulate (as opposed to being hoarded in collections).

The coin shown has a legal tender value of A$200. The Royal Australian Mint retails this coin for A$650. And with 0.5 troy ounces of gold in the coin it has a market value of around A$403 at todays gold price. The relative orientation of these three numbers is most significant.

Setting the legal tender value.  

In order for the mint to avoid making a loss the retail price of the coin must be more than the gold value in the coin (ie the material cost of production). And in order for the mint to avoid being inundated with arbitrage driven demand then the legal tender value must be equal or less than the retail price. However with both these conditions met it is possible for the legal tender value to be more or less than the gold value in the coin and it is the orientation of these two values with respect to eachother that will determine if the coin circulates.

Non circulating coins:  Retail Price > Gold Value > Legal Tender

Circulating coins:  Retail Price > Legal Tender > Gold Value

So if the coin illustrated above was struck exactly as it is at the moment with the slight modification that the legal tender value was A$500 then the coin would stand a chance of circulating. And if the legal tender value was set closer to $650 then the coin would definitely circulate, although it would still be more tightly held relative to other forms of the currency (in keeping with Greshams law).

Monetary reform.

As a monetary reform I would propose that the mint be required to always have on issue a coin series with a legal tender value of A$1000 and a retail price of A$1000 (plus handling costs as per the normal coins issue to banks) and a gold content value of at least A$800. As the gold price changes over time they would be free to adjust the design and weight of the coin to stay within these parameters so long as each new series was distinguishable from the last. In practive this would mean most designs include A$900 worth of gold so that any shift up or down in the gold price did not mean that the issue had to be immediately replaced redesigned.

The effect of having such high value coins in circulation would be evident over time as inflation pushes up the price of gold. If the gold price went up such that the gold content of circulating coins was worth more than the legal tender value then these coins would ultimately disappear from circulation (and eventually be melted down, collected or sold abroad for their gold content) and the monterary base (M0) would in essence notionally contract. Of course Reserve Bank Policy and the notes issue would of course be the final determinent of inflation. Under such a reform the community would once again get a practical feel for how gold operates as a monetary entity. And it can hardly be argued that such a reform would cause any harm.

Over the fold is a price chart that I made a few years ago. In it I have charted the US dollar price of gold (shown in red) and of oil (shown in blue) with both prices normalised so that in both instances the price is 100 unit in the base year (1955). They are shown on a log scale so that relative volatility during different eras is more easily compared.

Observations, notes and comments:-

i) The gold standard years in the 1950s and 1960s are clearly shown by the flat gold price.
ii) During the gold standard years oil prices were extremely stable.
iii) The gold standard years were characterised by stable consumer prices (much like the last decade has been).
iv) The gold standard years were characterised by stable commodity and currency prices (unlike the last decade).
v) When the gold standard was terminated in 1971 it is clear that the rise in the gold price led the rise in the oil price.
vi) In terms of gold the price of oil closed at the same level that it started. They remain roughly on par with eachother.

Okay we are up and running.