The monetary system needs to be reformed

IT IS encouraging to see political debate start moving from monetary policy towards monetary regimes. Tinkering with the present system is a necessary but ultimately futile way to ensure a more stable economy, because it is the system itself that is the problem.

Douglas Carswell MP is confronting these issues with a ten minute rule bill to allow competing currencies. His proposal intends to give consumers more choice over their currency, by making a basket of different currencies legal tender.

There are two ways in which legal tender laws impact economic exchanges. The first is fiscal, since they determine the currency people may use to pay their taxes. The second is legal, since you cannot be sued for non-payment of a debt if it is offered in legal tender. In the UK, banknotes from the Bank of England and coins (up to certain limits) from the Royal Mint are legal tender, and therefore businesses cannot refuse them as payment (and indeed customers cannot refuse them as change). But legal tender laws do not grant a monopoly privilege on any one currency. Just because pound sterling is legal tender does not mean that people cannot enter contracts in other currencies. Many of us already trade in euros, dollars, or Swiss francs.

Therefore, extending legal tender laws to a basket of currencies creates two problems. The first concerns how we determine the exchange rates to use when paying the tax bill. The second are the costs involved of forcing all businesses to deal in multiple currencies.

Focusing on legal tender laws seems to misunderstand the functions of money. The primary function is that it’s the medium of exchange, but the majority of transactions are made with non-cash methods such as debit cards, personal cheques or credit cards, where legal tender laws do not apply. And although businesses cannot refuse to accept pound sterling, they are always free to refuse the trade in the first place.

A secondary function of money is as a store of value, and sterling has done a lousy job of protecting the public’s purchasing power. But we tend to keep a small proportion of our wealth as money, and already have the ability to hold it in other currencies if we wish to do so.

Even if you feel that legal tender laws matter, the solution would not be to expand their scope but to abolish them. Friedrich Hayek’s proposal in The Denationalisation of Money is to remove any obstacles to currency competition or the free exercise of banks. These might include exchange controls, taxes on metals, or the ability to operate across national borders. By all means remove restrictions on parallel currencies, but don’t mandate their use.

In short, legal tender laws come low down on the list of ways in which the government intervenes in the monetary system, and are no silver bullet for free market money reform.

Anthony J. Evans is associate professor of economics at ESCP Europe Business School in London, and Fulbright scholar-in-residence at San Jose State University. His website is www.anthonyjevans.com.