From Gold to Euro: On Monetary Theory and the History of Currency Systems PDF
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From Gold to Euro On Monetary Theory and the History of Currency Systems Springer-Verlag Berlin Heidelberg GmbH Heinz-Peter Spahn From Gold to Euro On Monetary Theory and the History of Currency Systems With 31 Figures and 16 Tables Springer Dr. Heinz-Peter Spahn University of Hohenheim (520 A) Lehrstuhl fUr Wirtschaftspolitik Institut fur Volkswirtschaftslehre 70593 Stuttgart Germany ISBN 978-3-642-07483-7 Library of Congress Cataloging-in-Publication Data Die Deutsche Bibliothek - CIP-Einheitsaufnahme Spahn, Heinz-Peter: From Gold to Euro: on monetary theory and the history of currency systems; with 16 tables / Heinz-Peter Spahn. ISBN 978-3-642-07483-7 ISBN 978-3-662-04358-5 (eBook) DOI 10.1007/978-3-662-04358-5 This work is subject to copyright. Ali rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illus trations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted oniy under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer-Verlag Berlin Heidelberg GmbH. Viola-tions are liable for prosecution under the German Copyright Law. © Springer-Verlag Berlin Heidelberg 2001 Originally published by Springer-Verlag Berlin Heidelberg N ew York in 2001 Softcover reprint of the hardcover lst edition 2001 The use of general descriptive names, registered names, trademarks, etc. in this publica tion does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. Hardcover-Design: Erich Kirchner, Heidelberg SPIN 10795877 42/2202-5 4 3 2 1 O - Printed on acid-free paper Preface This book deals with the evolution of monetary systems. Firstly, it argues that money forms a constitutional element in any private-ownership economy, estab lishing a nominal-standard order for the market behaviour of individual agents. The market economy is basically a payment society where money structures and values economic activities, and performs itself as a market asset. The use of re sources and the production of commodities are governed by calculations in mone tary values which subordinate production and employment to the logic of asset markets. The "veil" of money cannot be withdrawn, as a matter of fact and in theoretical analysis, without changing the economic order of society. Money originates from a credit relation between market agents, thus spot payments re place intertemporal exchange. Problems of low trust and information in mutual economic relations are projected onto the money medium in a monetary economy, thereby enhancing its efficiency and dynamics. The rate of interest is not related to time; it is the price for maintaining the agents' solvency in the current period, and it determines a positive rate of return on capital and production. Secondly, the book shows that network externalities in the use of money led to monopoly solutions in the national and hegemonic leader-follower relations in the international economy. The management of money supply has always been regu lated in order to prevent its misuse, on the part of its creating institutions, and to preserve its reputation as an impartial "a rbiter" , on the part of society. In the histo ry of banking, it proved to be impossible to found the belief in the future market acceptance of money on its "backing" by some reserve asset. Monetary policy emerged out of the profit-oriented business of private banks. Central banks learn ed to stabilize the value of money by controlling the scale of monetary transac tions via interest rate management. Soon, they were committed to follow rules, imposed as credibility-enhancing devices, but generally practised a discretionary policy aiming to stabilize financial markets. Money provides a order-theoretic framework for micro behaviour, but depends itself on macro demand policy for its own stabilization. Thirdly, the book studies how on an international level the problem of leadership arose as central banks using some reserve asset for their rule-based note issue were led to defend fixed exchange rates. A simple game-theoretic macro model analyzes the history of the key currency systems in the 20th century and explains the rise and decline of pound sterling, the dollar and the mark. It is shown that the approval of an asymmetric currency system where one country determines the world level of interest rates, and thus growth and employment in other countries, rested on a precarious equilibrium with respect to different economic policy pref erences. Key currency systems collapsed because of macroeconomic destabiliza tion or policy failures in the centre countries, accompanied by waning willingness to accept foreign leadership in monetary policy affairs. vi Preface Finally, the book argues that the creation of the euro transfonns currency policy problems into internal market adjustment challenges. Its establishment corre sponds with a world-wide tendency of replacing fixed-exchange-rate systems by flexible non-systems or currency unions. The urge to overcome a state of asym metric distribution of financial power and to democratize monetary policy deci sions was the driving force for the foundation of the European Monetary Union. At the same time, the enthronement of the European Central Bank as a supranatio nal, politically independent body and its sole obligation to maintain price stability may be regarded as a major step toward a depoliticization of central banking. But contrary to the practice of defending a price of a reserve asset, a control of infla tion entails a demand management of goods and labour market dynamics so that the central bank may not escape the field of political and economic interests. This is the tragic irony in the legacy of the Keynesian Revolution: Keynes' efforts to come off the gold standard, which he condemned as representing an outdated re straint for maintaining internal equilibrium, i.e. price stability and full employ ment, finally ended up as a concept of stabilization which relied on a stock of un employment to deter inflation. The author is deeply indebted to all those who have, consciously or unconscious ly, contributed to the completion of this study. I would like to thank the partici pants of conferences and seminars held in Berlin, Toronto, Vienna, Geneva, Lon don and Chemnitz for valuable comments on presented parts of earlier drafts of the text. Jorg Bibow, Walter Heering and Otto Steiger provided constructive ar guments to the line of the theoretical approach. Also I would like to thank Chri stoph Deutschmann, RUdiger Dragendorf, Hajo Riese and Hans-Michael Traut wein for inspiring debates over the years. During the final stage of completing the text, I have profited from many discussions with my research assistants Daniel Hartmann, Peter KUhnl, Gerhard Seidel and Udo Vullhorst; in addition, Gerhard Mauch did an excellent job of research assistance in finding and providing litera ture. And, last but not least, a big thank-you to Maggie Lycett who helped to make the English publication of the book possible. University of Hohenheim, Stuttgart December 2000 Heinz-Peter Spahn Contents Introduction ......................................................................................................... 1 PART I ON THE THEORY OF A MONETARY ECONOMy ................................... 7 1. Market Organization and Monetary Contracts ................... ..... ....... ....... 7 1.1 Standard of Value and Means of Payment: A Credit Theory of Money...... 7 1.2 The Organization of Society as a Payment Economy ................................ 12 1.3 Money as a Public Good ............................................................................ 15 2. Money, Interest and Capital...... ......... ...... ........... ..... ......... ..... ....... ... ...... 18 2.1 Neutrality of Money versus Nominal-Standard Economy......................... 18 Box 1: General Equilibrium Theory and Money ....................................... 19 2.2 Time, Interest and Money: The Myth of an Intertemporal Economy ........ 25 Box 2: Time Preference and Intertemporal Prices .................................... 28 2.3 Capital as Cash Advance: The Monetary Theory of the Rate of Interest .. 32 Box 3: The Marginal Productivity of Capital and the Rate of Interest ...... 33 2.4 Equilibrium and Employment in a Monetary Economy.. ....... ....... ... ......... 39 Box 4: Money and Unemployment ............................................................. 41 Summary of Part I ............. ............ ...... ......... .............. .......... ...... ..... ..... ....... ..... 44 PART II BANKING AND THE RISE OF MONETARY POLiCy ............................ 47 3. Banks as Creators of Money ................................................................... 47 3.1 Money as a Regulated Medium ................................................................. 47 Box 5: Banking Business and the Liquidity Problem ....... ......... ............ ..... 49 3.2 Metallic Money, Bank Deposits and Government Money ......................... 52 Box 6: Financing International Trade ...... .... ... ............. .............. ....... ... ..... 54 3.3 The "Backing" of Money in the Banking Doctrine .................................... 57 Box 7: The Property Theory of Money and Interest .................................. 60 3.4 The Monetary Logic of Mercantilism ..... ............... ..... .......... .... ......... ... ..... 63 Box 8: Free Trade and Welfare Gains ....................................................... 66 4. The Emergence of Central Banking in England ... ...... ............ ..... ......... 69 4.1 The Foundation of the Bank of England ...... ...... .... ... ....... .... ..... ... ..... ......... 69 viii Contents Box 9: Bimetallism and Gresham's Law .................................................... 73 4.2 Suspension and Resumption of the Gold Standard: The Bullion Controversy ............................................................................ 73 4.3 From Palmer's Rule to Peel's Act: The Separation of Money and Credit .. 77 4.4 The Currency-Banking Controversy on the Elasticity of Money Supply .. 83 4.5 Interest Rate Policy and the Two-Tiered Banking System .... ....... ..... ........ 88 Summary of Part II . ........ ..................................... .................... ....... ....... ..... ...... 94 PART III THE EVOLUTION OF KEY CURRENCY SYSTEMS: A GAME-THEORETIC PERSPECTIVE ...................................................... 97 5. The Hegemony of Pound Sterling in the Gold Standard ..... ......... ........ 97 5.1 The Gold Standard as an International Monetary System ......................... 97 Box 10: The Rules of the International Gold Standard, 1879-1913 .......... 99 5.2 London as the World's Banker ................................................................. 101 5.3 Macroeconomic Interdependence in a Game-Theoretic Model ............... 106 Box 11: The Economic Logic of Reaction Functions and Loss Curves ... 110 5.4 Money Demand Effects of Sterling as a Reserve Currency..................... 113 5.5 Different Policy Preferences and Shocks ................................................. 116 5.6 The End of the Game: From the Gold to the Wage Standard .................. 121 6. The Loss of Credibility and Stability in the Bretton Woods System. 126 6.1 American Monetary Policy Without a Nominal Anchor? ........................ 126 Box 12: The Bretton Woods Agreement in 1945- The Spirit of the Treaty ............................................................................ 127 Box 13: The Fixed-Rate Dollar Standard, 1950-70 ................................. 129 6.2 The Bretton Woods Model ...................................................................... 130 6.3 Triffin's Dilemma: The Liquidity Problem of the Federal Reserve . ........ 136 6.4 The Deterioration of the External Balance and World Inflation .............. 140 7. The European Paper Money Standard: A "DM Club" ..................... 144 7.1 The Determination of the Key Currency by Market Forces ..... ....... ......... 144 Box 14: The European Monetary System in 1979- The Spirit of the Treaty ............................................................................ 145 Box 15: The European Monetary System as a Greater Deutsche Mark Area 1979-92 .................................................... 148 7.2 The "Advantage" of Fighting Inflation With Tied Hands ........................ 150 7.3 Blowing up the EMS by the Bundesbank's Stabilization Policies ........... 154 Box 16: The Macroeconomic Consequences of German Currency Union ......................................................................... 156 Contents ix 7.4 The Conflict between Internal and External Equilibrium in the Key Currency Country ................................................................... 160 Summary of Part HI................................. ........ .............................................. 164 PART IV THE EURO IN THE WORLD ECONOMY ................................................ 169 8. A Monetary Union With a Denationalized Currency......................... 169 8.1 The EMU Project: A Political Refonn with Obscure Ends ..................... 169 8.2 Monetary Policy and Price Stability ........................................................ 173 9. The Multiple International Monetary Standard ................................. 179 9.1 Interest Rate Parity Condition and the Exchange Rate Random Walk .... 179 9.2 Toward a Bipolar Euro-Dollar System .................................................... 183 Summary of Part IV ....................................................................................... 187 List of Figures ..... ........ ....... ......................... .............. ........................................ 191 List of Tables ............................. ........................................................... ............ 193 References ................................................................ ................................... ...... 195 Index ................................................................................................................. 213 Introduction It is impossible to pierce the money veil in order to get to the premiums on concrete goods. If one penetrates through it one penetrates into a void. Joseph A. Schumpeter1 The political economy of international monetary systems, good or bad, can only be understood in historical perspec tive. Ronald McKinnon2 The debates on the establishment of the euro have rekindled interest in the mone tary foundations of market economies. Quite considerable effort was exerted in designing and codifying the rules of the European Central Bank. An almost con stitutional rating was given to the goal of price stability. But the intensity of the discussion on the institutional set-up of the Bank shows a deep-seated uncertainty within society over the priority of that goal and the ability of monetary policy to attain it. The controversy about the compatibility of price stability with other ma croeconomic goals as growth and employment and the famous issue of a trade-off between inflation and unemployment capture only a part of the questions related to monetary stability. The double-nature of this issue stems from the fact that, on the one hand, money - like the judicial system - is a constituent element of a market economy's commu nicative infrastructure and therefore should be controlled by a constitutional mi cropolicy aiming at an efficient order of society.3 On the other hand, the monetary system's efficiency and stability is being mainly preserved by means of demand management, i.e. by varying the financing conditions of commercial banks, which possibly interferes with the desirable development of other macroeconomic vari ables. In economic theory, this dual-faceted nature of money is mirrored in the di chotomy of acknowledging the (one-time) efficiency gain due to the existence of money and postulating the neutrality of changes of the quantity of money. Correspondingly the slogan "money matters", vividly put forward by Post Keyn esians4, can be interpreted to address two different topics: the first refers to the fact (or the puzzle - as seen from the rational-expectations school) that even an nounced changes in the path of monetary expansion usually have an impact on output and employment, possibly even in the long run. But this type of a "non neutrality" of money tends to obscure a second question: how does the existence of money affect the market order of a private-ownership economy? The traditional 1 Schumpeter 1934: 184. 2 McKinnon 1996: 7. 3 The appropriate German, but hardly translatable, term is "Ordnungspolitik". 4 Cf. Davidson 1978: 365.
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