A monetary constitution to add on to the legal constitution?

Economic governance

A reader of ‘My View’ has inquired from me whether there is something called ‘economic governance’ relating to economic matters of society similar to the concept of political or corporate governance which people usually talk about.

His query was clear: In political and corporate worlds, good, truthful and noble behaviour by those who have the power over political decisions or corporate life respectively is something which society expects of them. Are people who have powers over important economic policy making that affects all members of society too required to demonstrate a similar good, truthful and noble behaviour? If so, in which field of economic decision making should it prominently be demonstrated?

One of my economist friends in the meantime sent me an article published recently in the Journal of Economic Behaviour and Organization in its issue No 80 in 2011 relating to an important aspect of economic governance.

The article authored by USA’s St. Lawrence University Professor Steven Horwitz under the title ‘Do we need a distinct monetary constitution?’ in honour of Nobel Laureate James M. Buchanan had opened up a long-standing debate whether governments should have monopoly over producing money in a society or whether it should be done competitively by the private sector or if the governments should have powers over producing money how should the society introduce ‘checks, balances and safety measures’ to prevent the governments from abusing their power.

The content of this article and the debate that is behind this issue for a long time are very much important to today’s societies.

Private people producing money

Can someone imagine a situation where money is produced by private people in a society? It will be somewhat inconceivable to many who have lived long enough in a society where governments have produced money and used that money for practically every type of transactions they have conducted. The long familiarity with such government produced money will make them consider even a proposition to allow private people to produce money to be outrageous.

But the historical experience relating to the issue is not that.

Kautilyan prescription

The fourth century BCE Indian economist and statesman, Kautilya, in his economic and political text ‘The Arthashastra,’ mentions about private people producing, issuing and circulating coins and the King’s role to assure their genuineness. For this purpose, a special official designated Coin Examiner should be appointed.

For every coin issued by private people, the government collects a fee of 8% of the face value and no coin can be circulated or accepted for transactions, unless it is certified by the Coin Examiner. The use of non-certified coins for payment of dues to the King was punishable by death.

Private people had produced money in ancient Lanka

The ancient kings of Lanka who too followed Kautilya’s economic philosophy and principles had allowed private people to produce coins. Archaeologist Osmund Bopearachchi and Numismatist Rajah M. Wickremasinhe, in a groundbreaking publication titled ‘Ruhuna: An Ancient Civilisation Revisited’ that has presented their findings in the archaeological survey conducted in Ridiyagama and other places in the Southern Province in Sri Lanka mentions of the discovery of a large quantity of coins produced by private people.

The legends in these coins in Brahmi script read such qualifications like ‘Of Pussa, the son of household Dutaka; Of Gutta; Of Guttamagga; Of Majima; Of Lady Sama; Of Lady Uttama, the householder; Of the Municipal Officer Nakati’ to mention but a few of such representations of private citizens who have issued coins. All these coins had belonged to the 4th and 5th centuries of the Common Era.

Obviously, these coins would have been issued, as in the case of Kautilyan economies, under the king’s supervision.

Adam Smith on Kings’ abuse of power to issue coins

In recent history, governments got the monopoly power over producing money because it gave them a free passport to print money excessively and finance numerous extravagant expenditure programmes. This was desisted and disapproved pretty much by economists throughout the history.

Even as early as 1776, Adam Smith, thought it fit to make the following comment in The Wealth of Nations regarding the abuse of this power by kings: “For in every country in the world, I believe the avarice and injustice of princes and sovereign states abusing the confidence of their subjects, have by degrees diminished the real quality of metal, which had been originally contained in their coins”.

Adam Smith has further commented that such devious operations of kings and sovereign states have enabled them to repay their public debt with a smaller quantity of money and get people to work for the state with a smaller salary, though in appearance the coins were same. He says that it has always favoured the debtors and been ruinous to the creditors and making those who receive payments in debased coins miserable. This is the old version of the perils of inflation tax which modern economists talk about.

So, in economic governance, governments and those who are charged with making economic policies affecting people should desist from embracing ‘avarice and injustice’ and abusing their powers, according to this old principle.

Hayek’s attack on governments’ abuse of money issuing power

In modern times, the debate over governments’ abusing the power which the society has given them to produce quality, value assured and fine money, has taken three different points on a pole.

At one end, there is the school of economists, chiefly led by Nobel Laureate Friedrich A Hayek, which says that money should be allowed to be produced competitively by private people. At the other end, there is the school which advocates for the government monopoly of money production and this school mainly consists of government policy makers in charge of money production.

In between, there is the school, led chiefly by another Nobel Laureate James M Buchanan, which believes that money production should be ‘subject to such constitutional safeguards as the safeguards provided for in a constitution for citizens’ rights’. For them, the need of the day is a distinct monetary constitution, the title of the article by Steven Horvitz mentioned above.

Friedrich A. Hayek who wrote two books in 1976 for the London-based Institute of Economic Affairs, one under the title ‘Choice in Currency’ and the other ‘Denationalisation of Money’ in 1976 and in his Nobel Prize Oration in 1974, made a scathing attack on governments’ abuse of the noble duty entrusted to them to produce and supply quality, value-assured and fine money in their respective countries and suggested that the task of supplying money by governments should be “de-nationalised”.

Hayek: Honest versus dishonest money

Hayek’s arguments go as follows. Kings and governments have been given monopoly powers by their respective societies to produce money with a proviso added to that duty. The proviso is that they should not maintain the real value of the moneys they have produced at all times so that people who accept those moneys will not encounter losses in their economic transactions, whether they are consumers, worker or producers.

But the kings and governments have abused this power and produced money in excess and used such excessively produced money to finance various extravagant expenditure programmes which Hayek has criticised severely in his Nobel Prize Oration.

The result has been a forced decline in the real value of these moneys which people today call ‘increases in cost of living’ or in the words of economists, ‘setting inflation’ in an economy. Hayek calls the value assured fine money ‘honest money’ and therefore, the debased money should be called ‘dishonest money’ produced by kings and governments.

The practical way to prevent the kings and governments from producing dishonest money is to allow private people too to produce money competitively with the government and it would force governments to maintain honesty in the money they produce.

This is indeed similar to the system which Kautilya had prescribed and which had been in practice in ancient Lanka.

Hayek: Repeal legal tender of governments’ produced money

So, in Hayek’s words, economic governance is producing ‘honest money’ by kings and governments. In the book ‘Choice of Currency,’ he has further said that it is time to remove the legal tender that is given to money produced by governments because they have failed to keep on producing honest moneys. When it is done, people could carry out business in whatever the money of their choice, dollars, marks, gold or EU’s proposition at that time, Europas.

In countries like Cambodia, Vietnam and Laos, where governments have continued to produce ‘dishonest moneys’, what Hayek has prescribed has actually happened: people use US Dollar notes freely for day to day transactions.

Buchanan: both monetary anarchy and politicisation are ruinous

Nobel Laureate James M. Buchanan has not been an extremist as Hayek though he too has found that governments have failed in their noble duty of producing value assured money.

In an article he wrote to Cato Journal in 2010 under the title ‘The Constitutionalization of Money,’ he has represented his old views on the subject in a summary form. He has found two polar views relating to money production issue: one advocating complete removal of governments’ monopoly powers and the other advocating giving all the powers to the politicians.

Buchanan has termed the first one as monetary anarchy and the second one complete politicisation of producing money. He has argued both are ruinous since they cannot work effectively.

In an anarchical state where private people produce money at their will, there will be two issues: producers of money will not be able to assure the stability of value and markets will face the problem of fixing the appropriate exchange rates among those moneys due to lack the relevant information regarding the economic and financial strength of the issuer.

In a similar vein, Buchanan criticised a completely politicised monetary system where politicians with the active connivance of their central banks would produce excessive money and cause inflation.

In my view, Buchanan’s arguments are obvious.

Even though the production of money by private people could be supervised and regulated by governments to assure stability in value and fineness, the government regulatory mechanism may not be effective enough to realise the cherished goal.

The inadequacy of the efficacy of the regulatory machinery, seepage of unwarranted political interference and proliferation of corruption are some of the issues involved. Similarly, in a completely politicised monetary system as was the case in Zimbabwe in the recent past, people will be at the mercy of the politicians.

Politicians will extract economic power from people by inflating the economy and thereby driving people to irredeemable misery. At the end, even when the politicians are removed, say by a popular revolution as was the case in North Africa in recent times, the old glory which people had enjoyed could not be recovered.

Hence, according to Buchanan, the solution should be found in the middle ground where the governments will have the monopoly power, but their powers are effectively restricted by a higher law like the constitution, an arrangement like enacting a monetary constitution.

Horwitz endorses Buchanan

Steven Horwitz in his article in honour of Buchanan has not minced his words when he has attacked the current politicisation of money supply. He has said that “leaving the quantity of money to the incentive structure of the modern American political institutions is a recipe for disaster as the political actors are almost always willing to take the short run illusion of economic well-being that inflation creates and pass the costs onto the future, whether those cost bearers are the citizenry or the political actors, including their future selves”.

Hence, it is dangerous to leave the money supply producing task to politicians or central banks that function at the will of those politicians. It would be worse if people inside central banks, though they are called intellectuals, believe in this ideology and suggest these prescriptions to politicians so that they could always get out of accountability and blame the intellectuals when the systems paralyses beyond redemption due to inflation.

A separate monetary constitution

The suggestion by Buchanan and Horwitz who endorses Buchanan is that have a separate monetary constitution which has to be observed by the central bank intellectuals and politicians alike. Buchanan, while rejecting monetary anarchy, has brought in an interesting analogy to his claim.

The 17th century political philosopher Thomas Hobbes who wrote the treatise The Leviathan or the state monster has philosophised that the need for physical security had led people to have a government with immense powers but that government in time could become a monster. Hence, a social contract was arrived at between the king and the people.

In the Indian systems, this was like the governing of a country by a king by observing tenfold rules of justice practised by a monarchy. If the king failed to observe and preserve these rules, the people had a right to remove him from power. So, both in Hobbes’ philosophy and Indian practice, the social contract was the principles of good governance.

Buchanan suggests that this social contract should be extended to the production of money because like the preservation of the physical security, it is important to preserve the security of money, namely, the stability of its value over time. The monetary constitution guarantees this.

Good economic governance: produce honest money

In effect, what Buchanan and Horwitz have talked about is nothing but ‘economic governance’. Central banks have been created by societies to produce money, assure its quality and ensure its stable value. This goal should be followed by central banks honestly, truthfully and nobly. If they do so, they observe good economic governance. If they do not, they not only fail but also make the life of the citizens miserable.

Those citizens are very often unheard, voiceless and defenceless victims unlike the politicians who enjoy all the powers. So, Buchanan has recommended that central banks should be made independent and the laws that have created them should be upgraded to the status of the constitutions of their countries.

A monetary constitution meaningless without an effective institutional system

But will just the elevation of a central bank law to the status of the constitution be successful? Yes, if there are powerful institutions that could see that the constitutions are not violated by the rulers of a country. These institutions comprise an independent judiciary, people-based organisations, independent media and the presence of intellectuals who could speak their mind truthfully and honestly.

Possibly, the US may be a country which has been equipped with such an effective institutional structure. But many developing countries, as has been shown by the experience of North Africa and the Middle East in the recent past, lack such an institutional structure and therefore surely fail both Buchanan and Horwitz.

(Wijewardena can be reached at [email protected].)