Henry Hazlitt, noted economist, author, editor, re­viewer and columnist, is well known to readers of the New York Times, Newsweek, The Freeman, Bar­ron’s, Human Events and many others. The most recent of his numerous books is The Inflation Crisis, and How to Resolve

So asserts the title of an article in the May issue of PHP. PHP is a monthly magazine published in To­kyo, by a dominantly Japanese editorial staff. It is in English, how­ever, and aimed at a worldwide au­dience. The title initials stand for "Peace, Happiness and Prosperity." The author of the article is Konosuke Matsushita, founder of the international electric and home appliance industry, Matsushita Electric.

The hope that Mr. Matsushita ex­presses is one that has been voiced by reformers for more than a cen­tury. His arguments for it are per­suasive. He refers to the wild fluctuations in international exchange rates in the last few years. He points out that at the beginning of 1977 it took 290 yen to buy a dollar, but by the end of the year only 240. He reminds his readers that in De­cember 1971 The Group of Ten coun­tries met in Washington to set up a new international currency system, known as the "Smithsonian" agree­ment, hailed at the time as "the most important monetary agreement in history"—and that it broke down in a year or so.

After that the world entered a "floating currency" era. But this means that every day the exchange rate of every national currency fluc­tuates in terms of every other. It means that no one can foresee what any given currency will be worth in terms of any other a year from now, or even tomorrow. And so it means that every man engaged in import or export trade, or in any international business whatever, is forced to some extent to become a gambler. Deplor­ing all this, Mr. Matsushita con­cludes:

We need to integrate the wide variety of currencies we have now. In other words, I suggest we agree on the use of one currency that will be common in all the countries of the world. . . . I am fully aware of the numerous problems that would be involved, such as national pride, differences in economic level and so on. However, if we want to continue our community life on this planet, we’re going to have to integrate our currencies at the earliest possible date. . . .

I suggest the United Nations or the International Monetary Fund take up the problem, seek to overcome the dif­ficulties which lie in the way by eliciting the cooperation, effort and wisdom of every country, and therefore achieve an integration of the world’s currencies for the peace, happiness and prosperity of the world.

I find Mr. Matsushita’s article en­couraging in one respect but dis­heartening in others. It is encourag­ing as a sign that leading interna­tional businessmen are beginning to call for an end to the present intol­erable chaos in the foreign ex­change market, and are willing to set aside national prejudices to achieve a return to order. But it is disheartening as a sign that these businessmen—probably the ma­jority of them—still do not under­stand the basic causes or suspect the basic cure for the world currency chaos.

Balance of Payments

Mr. Matsushita seems to think that the basic cause of the changes in the yen dollar and other ex­change rates was changes in the "balance of payments" between in­dividual nations. He does not seem to realize that these wide fluctua­tions in the balance of payments were themselves in large part the result of different rates of inflation within the respective countries, and consequent shifts in the relation­ships between internal and external prices. His article nowhere mentions the enormous increase in the paper money issuance of individual countries. And it nowhere mentions gold.

The truth is that the world once did have a common currency, in ev­erything but name. It had such a currency roughly from the last third of the Nineteenth Century to 1914. It was known as the gold standard.

The majority of leading currencies were tied together not because they were tied to each other but because each of them was tied to gold. Each was directly convertible on demand into a specified weight of gold. The British pound was worth $4.86 be­cause it was convertible into 4.86 times the weight of gold that the dollar was. The French franc was worth approximately 19.3 cents for similar reason.

True, as an international system this had a few shortcomings. It would have been far simpler and made calculation easier if each na­tional currency had been made con­vertible into precisely the same weight of gold, or at least into a round relationship to other currencies—if, for example, the British pound had been convertible into exactly five times the weight of gold as the dollar, the dollar into exactly five times the weight of gold as the franc, and so on.

Fractional Reserve Gold Standard

A more serious shortcoming, how­ever, is that the various national currencies were not on a full gold standard but only on what is known as a fractional reserve system. That is, the gold reserve they were obliged to keep was not equal to the full amount of their outstanding paper currency, but only to a frac­tion of it. And as time went on, and individual countries experienced no excessive runs on their gold supply, they yielded to the temptation to increase their credit and currency issues more and more. Their gold reserves, in consequence, tended to become a constantly smaller and more hazardous fraction of their credit and currency issue.

The fractional reserve gold stan­dard, moreover, even while it was preserved, suffered from a chronic defect. In good times, one country after another was tempted to expand its volume of money and credit. But when one country expanded faster than its neighbors, its internal prices increased relative to theirs. It became a better place to sell to and a poorer place to buy from. Its balance of trade (or payments) became "un­favorable." Its currency went to a discount on the foreign exchange market; and if that discount passed "the gold point," the country began to lose gold. To stop the outflow, it had to raise its interest rates and contract its issuance of credit and currency. It was this that caused the recurring business cycles, the alter­nation of boom and bust, that were considered by its critics to be inher­ent in capitalism itself.

Even the fractional gold standard was abandoned in Europe in 1914. The belligerents feared to lose their precious gold reserves, and in any case they wanted to be free to expand their currency and credit.

Gold Exchange Standard

When the war was over the world went back, not to the old gold stan­dard, but to a "gold exchange" stan­dard. This was something quite dif­ferent. The gold exchange standard meant that the majority of coun­tries, instead of keeping their cur­rencies directly convertible into gold, kept them convertible only into some "key currency"—for example, the British pound or the American dollar—which was supposed to be directly convertible into gold.

As formalized at Bretton Woods in 1944, the gold exchange standard became still more attenuated. The other participating countries agreed only to keep their currencies pegged to the American dollar; the dollar alone was convertible into gold. But even then, dollars were not, as for­merly, convertible by anybody who held them, but only by foreign cen­tral banks.

The effect of this relaxation of discipline, combined with the growth of the Keynesian ideology, was increasing and almost universal inflation. The American monetary managers, under successive Admin­istrations, did not seem to have the slightest realization of the weight of responsibility they had assumed in agreeing to make the dollar the an­chor currency for the world. They continued to inflate until, when other countries finally became more importunate in their demand for ac­tual gold, President Nixon officially suspended gold payments on August 15, 1971.

A profound irony in Mr. Mat­sushita’s proposals is that he wants to turn over the problem of curing the world’s currency ills to the International Monetary Fund. But the International Monetary Fund is the problem. It was set up at Bretton Woods, chiefly under the leadership of Lord Keynes of England and Harry Dexter White of the United States, to make inflation and de­valuation easier, smoother, and re­spectable. Instead of letting each country suffer the full consequences of its own inflation, the IMF used the stronger currencies to support the weaker. The long run effect was only to weaken the stronger curren­cies. One of the Bretton Woods’ ob­jectives from the beginning was to "phase gold out of the system." One of the first steps in any real currency reform would be to dismantle the IMF.

Mr. Matsushita forgets that the meeting that drafted the Smithso­nian agreement, to which he refers, came only three months after the United States suspended gold pay­ments; that the Smithsonian agreement was thought necessary because of this suspension; and that it broke down so soon because gold convertibility was not restored. There is simply no substitute for gold convertibility.

No international organization can wave a magic wand, or draft a magic formula, that will bring a sound "world" currency. Each nation must bear full responsibility for its own currency. It can make it sound only by making it convertible into gold. And it can make and keep it conver­tible only by strictly and constantly limiting the quantity of that cur­rency.

Because of the dismal recent rec­ord of practically all countries in swindling their own citizens, the re­turn to an honest convertible cur­rency may now be difficult and re­mote. Individual nations can begin by strictly limiting any further ex­pansion of their credit and currency issue. Meanwhile they can grant the right to their own citizens to coin gold privately and even to issue gold certificates against their coins.

When governments are ready themselves to return to a gold stan­dard, it would be well if this time they kept a 100 per cent gold reserve behind their paper currency and so removed the expansionary tempta­tions of a fractional reserve system. And it would be an excellent thing, also, if their new currency unit were fixed as a definite round weight of gold, say a gram, and were called simply a gold gram—instead of a dol­lar, franc, mark, peso or what not—and if at least the leading countries could agree on the same gold weight for their unit. Then the world would really have, for all practical pur­poses, the "single" and common cur­rency that Mr. Matsushita would so much like to see.

Henry Hazlitt
Henry Hazlitt (1894-1993) was the great economic journalist of the 20th century. He is the author of Economics in One Lesson among 20 other books. See his complete bibliography. He was chief editorial writer for the New York Times, and wrote weekly for Newsweek. He serv