Probably after his stance on the Iraq war, the issue that most prominently sets Ron Paul apart from the rest of the field of the US presidential candidates is his view of currency: particularly, his belief that the government should reinstitute the gold standard to avoid the so-called ‘inflation tax’ caused by seigniorage.  Perhaps due to the importance placed on the issue of sound money by Paul and other prominent libertarians, one of the most active threads [registration required] at the UK Libertarian Party’s forum is in the same vein.

However, I’ve avoided the discussion for reason of disagreement(perhaps counter-productive, but the day’s only so long, and I don’t have as much time to argue the toss on internet fora as I once did!). The rallying cry of ‘Safety in Gold!’ is a common one amongst libertarians, but it simply doesn’t add up. As Milton Friedman was eager to point out to those that thought gold a suitable refuge (as, indeed, the world’s governments did when he wrote Capitalism and Freedom), to link the value of money to a single commodity is insanity.

The most obvious economic argument against the gold standard is that value of gold, and indeed of any commodity, is it has no inherent or eternal value. Production technologies change in different industries at different rates, and, should mining benefit from a great investment or miraculous technological progress, the price of gold would slump, leading to inflation in a country stuck to the gold standard. The same problem applies if silver, oil, electricity, or other commodities are used as benchmarks.

To solve this problem, one would have to find a commodity that increases at exactly (or close above, if the target is small positive inflation, as can be easily justified) the rate of economic growth. As Friedman argued, the Great Depression, by and large, occurred because the money supply grew more slowly than the rate of economic growth during the 1920s: due to the gold standard. Since no commodity will increase in circulation at the same rate as economic growth, a commodity-backed currency can’t work as flawlessly as its proponents claim.

The truly libertarian solution would be to scrap the legal tender, remove any obligation on individuals interacting with the government (mostly paying taxes, etc) in sterling, and let them trade in whatever currency they see fit. A similar system existed in the 19th century; in the absence of legal tender, Spanish and Mexican silver dollars emerged as the currency of choice in east Asia, whilst the local currencies - debased by their rulers to raise currency through seigniorage - were rarely used except where dollars weren’t available.

Currency competition puts an incentive on the government of a given country to protect the value of its currency, lest people cease to use it as a means of exchange. If a government does guard the value of its money better than its competitors, it can use a limited degree of seigniorage to cover some of its operations (the ‘profit’ of being more efficient in the market of issuing currency, if you will). This would be a tax that affects only those that choose to use the currency out of their own self-interest: another way the state can raise money without coercing anyone.

I think competition is the true free-market response, and the one that libertarians ought to follow, rather than foolishly backing a government monopoly tied to the value of a lump of shiny metal.

When he passed away in 2006, Milton Friedman was rightly mourned by all, but by none more so than libertarians.  To us, he was nothing short of a hero.  His Capitalism and Freedom has become a classic in defence of both economic and civil freedoms.  In Counter-Revolution in Monetary Theory, he wrote the oft-quoted principle behind monetary policy:

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.

These words, sadly, seem to have been lost on the vast majority of economics students today.

I’ve never claimed to have any high expectations of my fellow economics students.  In fact, I barely mask by outright contempt for the vast majority of them, who fill their otherwise empty heads with propaganda spouted by the leftist lecturers in the hope that it’s their passport to a job at an investment bank.  Today took the biscuit for sheer stupidity.

In a hall of over 200 second-year economics students, not a single person ventured the correct answer to the question, “In medium-run equilibrium, what is the inflation equal to?”  OK, I’m sure some people knew the answer but couldn’t be arsed to say it.  After all, I was in the class myself, but I far too interested in seeing long it would be, and how many ridiculous answers would be proffered, before we’d somebody would guess the right one (I have to get inspiration and amusement somehow!).

It was a long time.  One third-year student, with a job at a top investment bank waiting for him on graduation, thought that it was the same as equilibrium output.  Inflation and GDP are the same?  God, help us all…

Of course, Milton Friedman was right.  By the Fisher equation, inflation is the growth of the money supply above what the real economy can support.  If the money supply increases by 5%, but GDP increases by only 3%, inflation will be 2% [Very roughly.  I’m taking some liberties, but not nearly as many as the aforementioned halfwits].  This very simple relation is lost on a year of student economists.

Judging by the Daily Mail’s front page on Tuesday, it’s a relation lost on far more.  Apparently, we can cure all our woes by reducing interest rates.  By reducing the interest rate, the government increases the money supply, leading to spiralling inflation as outlined above.  That’s a good solution for the Daily Mail’s readership of home owners, who beg for government-induced inflation to pay off their huge mortgages for them, but it’s pretty shitty for the rest of us, and, in the long-run, the economy as a whole.

If one assumes that the state does have a role in controlling the currency (and there are sound economic arguments against it), the Bank of England’s first priority should be defend the value of the currency that it requires its citizens to hold as sacrosanct.  They’re bankers: their job is to keep money safe, and that means not destroying its value.

To do that requires a knowledge of monetary theory that is sadly lost on them, on the Daily Mail, and, judging by the current crop of UCL undergraduates, on the next generation of hedge-fund managers.