Unit 9 Lecture Notes

As discussed in The Bitcoin Standard, the major European economies of the world moved away from the gold standard (imperfect as it was) toward a system of 'Monetary Nationalism', a term coined by Friedrich Hayek in a volume of lectures entitled Monetary Nationalism and International Stability. For all the popularity of Hayek's work (at least relative to other Austrian economists), it always astonishes me how few people have ever read this series of lectures, or have any inkling of its content.

Hayek defines the title of the series of lectures:

On the detrimental effect of the centralization of banking, Hayek explains:

Hayek makes it clear that the gold standard as it existed in the late nineteenth century did not conform to his International Monetary System ideal, as it was not based only on gold but also on bank deposits as base money. This undermined the uniformity of the monetary asset and allowed governments some margin to inflate the money supply. But for all its faults, the gold standard was far superior to what followed after 1914.

The centralization of gold reserves with one national bank, and the granting of that bank with monopoly privileges in the issuance of currency, and taking it with counteracting financial crises was always going to be a recipe for inflationary disaster, and Hayek explained why very presciently:

It led Hayek to conclude with a startling observation:

This last excerpt is one of the most eye-opening sentences I have read, and it has fundamentally altered the way I view money and central banking. The ability of banks to expand the money supply through the creation of bank deposits rests entirely on the presence of a larger institution capable of converting the banks' deposits into banknotes or gold. Without the growth of central banking, individual banks were restricted in their ability to expand credit, as the increase in their supply would immediately devalue them compared to gold and note bills. The only way a bank can maintain the value of its expanded deposits on par with the fractional cash reserve backing them is if it had a central bank provide it with liquid cash reserves to meet the demands of depositors, but that would result in the devaluation of the media of circulation, or the exit of gold from the central bank's nation to other nations as it is used to settle global payments.

While the global monetary system before 1914 was superior to what came after it, it nonetheless was not a globally homogeneous international system and allowed for a certain degree of inflationary credit expansion as central banks existed to backstop banks when their reserves ran out. But as national currencies were redeemable in gold, credit expansion by banks would inflate the supply of the monetary media of exchange beyond the gold backing them, thus devaluing the currency compared to other international currencies. As the problems of this monetary expansion were magnified in the late nineteenth and early twentieth century, the solutions proposed by banks and governments were to seek more centralisation and nationalisation of banking systems, not less. Although this only exacerbated the problem, it nonetheless gave them more margin for inflation. Rather than nip the inflationism of the banking system in the bud, the early twentieth century central bankers indulged inflationism by erecting barriers to limit the conversion between various national currencies; this allowed each nation a larger margin with which to engage in inflationary credit expansion. The vicious cycle of increased centralization leading to more inflationism only intensified in the century since. As Hayek explains:

What came to be known as the developing world, in my view, consists of countries that had not yet adopted modern industrial technologies by 1914, when a relatively sound global monetary system was replaced by an inflationary one. These societies' development was continuously compromised by the dysfunctional global monetary system that enabled governments to expropriate the wealth produced by their people in order to finance increasingly stupid and destructive policies.

By 1914, the only nations that had achieved a considerable degree of industrialization and accumulation of capital resources were those of Western Europe, as well as the United States, Canada, and Australia. Modern industrialization was making its way into eastern Europe, the north and south of Africa, and many parts of Asia and South America around 1914. The more a country engaged in trade, the more technologically advanced it became, and the closer to the technological frontier it was. The first World War stunted this progress, and the global monetary system that emerged after (and consequently the Great Depression) undermined it even further.

The development of the global monetary system in the post-World War I period is discussed in detail in The Bitcoin Standard, and this piece will only recap a few relevant highlights. After all major economies engaged in large scale inflation to finance the war, their currencies were devalued against gold and were no longer redeemable at the pre-war rate. The healthy step would have been to acknowledge reality, admit to inflationism, and reinstitute a new exchange rate; but that would have been politically unpopular, and the political and monetary authorities instead tried to maintain the previous pre-war rate. But markets cannot be made to lie in order to suit the needs of politicians, and the overvaluation of the pound resulted in the drain of gold from Britain to both France and the US where it was more fairly valued. It's important to understand the arbitrage opportunity available here, as it would become far more common in the fiat-based future of developing countries. Since all currencies were fixed in terms of gold, it necessarily followed that the ex change rates between these currencies were fixed too. So if a country drastically increased its currency's supply while trying to maintain the same pre-inflation gold exchange rate, it would essentially be offering its gold reserves for sale at a steep discount to arbitrageurs and foreigners from countries that hadn't increased the supply of their own currency as drastically.

As Rothbard described it in America's Great Depression:

As these imbalances began to appear around the world, politicians would of course refuse to return to the gold standard and instead sought to solve them in ways that amplified their power and enabled their insatiable addition to inflationary expansion. The major economies of the world met in Genoa in 1922 and agreed to use the British pound and the US dollar as global reserve currencies. This magic step would now allow Britain to export its inflation to the rest of the world, by having central banks hold its shitcoin as if it were gold, thereby reducing its depreciation in terms of gold. The Treaty of Genoa was the beginning of the use of political money as an international reserve, and the first in an endless series of international summits between central banks and governments catastrophically centrally-planning the global money markets.

From then on, it became the prime imperative self-interest of the US and the UK to get as many central banks in the world to hold as much of their currencies as possible. This was money printing and inflationism on a global scale never seen before. As other countries began to settle their trade in dollars and pounds, they needed larger quantities of these reserves, and that prevented these currencies from depreciating to the extent that their inflationary expansion would have otherwise dictated. World politics has since been to a large degree motivated by major governments' desire to get their inflationary currencies adopted as international reserves in order to allow them more inflation.

The inflationary policies of the US and the UK in the 1920's would eventually lead to the 1929 crash and subsequent Great Depression, as described in meticulously researched detail by the great Murray Rothbard in one of his most important books, America's Great Depression. The combination of a global depression and monetary nationalism led to global catastrophe on an unprecedented scale, presciently described by Friedrich Hayek in Monetary Nationalism and International Stability, published in 1937.

Centrally-planned easy money is not only responsible for financial crises and depressions as illustrated with Austrian Business Cycle Theory; it is also the root cause of tensions over international trade and
finance. As the abandonment of the gold standard allowed central banks to diminish the value of every country's currency, international trade and finance became the release valve through which national inflationary economic distortions would correct themselves. A devaluing currency would incentivize citizens to unload their country's currency for foreign currencies, or foreign goods, which would reduce its demand and; further decrease its value, undermining the government's ability to rob their people through inflation. Rather than try to reverse that trend through reducing inflation, of course, the statist economists of the time sought to fix it by limiting the free movement of capital and goods. More and more trade barriers came up during the Great Depression, and international hostilities around trade continued to increase.

The imposition of trade barriers in turn resulted in further deterioration of the economic situation of the countries imposing them, even as their own citizens suffered from them. The governments imposing them, and their paid actors who play economists in university and TV, would of course never admit that it was the inflation, increasing centralization, and trade barriers that are the causes of the progressively worsening depression. Instead, the blame was placed on other countries and on local ethnic minorities. Years of growing hostility to and scapegoating of foreigners and minorities came to a head in 1939, as the world's totalitarian socialist regimes began to turn on each other and on their minorities. It was this threat to global peace that Hayek had identified in his Monetary Nationalism and International Stability lectures, but his warnings fell on deaf ears. As the monetary standard was no longer a homogeneous money freely moving around the world to where its owners found the best use for it, it became a tool for increasingly omnipotent governments worldwide to finance their warmongering regimes.

Government control of money allowed central planning of the economy in a way that was probably last seen in the western world during the final days of the Roman Empire. To fight the growing unemployment and inflation caused by their inflationist monetary policies, governments imposed price controls, minimum wage laws, work-sharing laws, and various others brands of destructive statist economic insanity. As the economy shrank further and people's lives suffered, they became more and more dependent on the government that could conjure money from thin air, which reinforced governments' power.

The history of the second World War is far too sordid to recount in this space, but suffice it to say that government-approved history and economics textbooks are completely silent on its monetary origins, and the role of monetary nationalism in fostering it. Far from inventing a new alchemy that allowed governments to build a bright future (as its promoters had promised), government control of money destroyed the world's economies by the late-1930's, crippled global free trade, created omnipotent totalitarian governments with many reasons to be hostile to one another, and increasingly turned previously prosperous populations into serfs dependent on government and canon fodder for its wars.

There was one more subtle yet important impact of government control of money and the economy: it allowed government control of the education system, and essentially transformed universities from places for learning and training into propaganda indoctrination centres. A titan like Mises could no longer find a job at a university system whose only imperatives were the dissemination of government propaganda and central planning. It is this class of statist that has shaped the understanding of economics and politics for generations of developing country leaders and economists. This intellectual and historical context is essential to understanding the economic catastrophes of the developing world in the postwar period.

The number and influence of third world leaders who were educated in British and American universities from the 1930's onward is staggering. I have seen no systematic study or data on the topic, but any familiarity with the economic history of developing countries, particularly those that have made "development" a priority will reveal the extent of this influence, which is so persuasive as to not even be worthy of discussion. This piece gives a flavor of some important names in the third world who were heavily influenced with the leftist curriculum of the universities of the time. More generally, any perusal of any economic development textbook, or familiarity with the rhetoric of any development agency or ministry in a developing country will clearly convey the distinct stench of Marxist and Keynesian notions of central planning. The entire framing of the question of economic development is driven ultimately by a highly socialist view of how an economy functions. The alert reader will not miss the fascination with macroeconomic aggregates and the way in which the government and the development sector are viewed as the omniscient, omnipotent forces of justice working to achieve the holy goals of development.