Discussion

FRIEDMAN VERSUS HAYEK ON PRIVATEOUTSIDE MONIES: COMMENT

I. Harry David*

In a recent article in Economic Affairs, Luther (2013) successfully challenges the conjecturethat in the absence of legal restrictions money users will necessarily switch from an unstablecurrency to a superior alternative. He errs however, first, in attributing this to Friedrich A.Hayek, and, second, in maintaining that Hayek’s proposal for monetary reform relies on moneyusers being hypersensitive to changes in purchasing power. In fact, Hayek acknowledges thatmany individuals will continue to use the more liquid money in the short run. For this reason,Hayek does not base his argument on the conjecture that users will switch monies for thepurpose of making cash payments at the retail level. Rather, Hayek (1978, p. 227) maintainsthat users will switch currencies for the purpose of conducting business-to-business transactions.

In what follows, I briefly review Luther’s argument and then provide textual evidenceopposing his view. Whereas Luther relies primarily on Hayek’s Denationalisation of Money,I consider Hayek’s ‘Choice in Currency: A Way to Stop Inflation’ as well. Finally, aftercorrecting Luther’s reading of Hayek, I offer suggestions as to what evidence, both in theabstract and in the case of Somalia, would be sufficient to rebut Hayek.

According to Luther (2013, pp. 132–3), Hayek argues that ‘network effects and switchingcosts [are] always and everywhere small such that removing legal restrictions [on exiting thenetwork] in any context would suffice to bring about a better alternative’. Luther recalls MiltonFriedman’s argument (1984) that, to the contrary, network effects and switching costs are largeenough to prevent switching, provided only that the benefit of switching in terms of greaterstability is not extremely high. Luther shows that Hayek would be proven wrong – andFriedman right – if we were to find a case with an extremely high benefit of switching andwithout any legal restrictions, but fail to observe users switching. After considering the recentexperience of Somalia – which Luther claims fits the bill – he concludes that Hayek is ‘almostcertainly wrong’ (2013, p. 133).

One may accept that users are not hypersensitive to changes in relative purchasing power,while at the same time claim that the absence of legal restrictions may induce enough users toswitch that nations will be constrained to adopt responsible monetary policies. Hayek appearsto have claimed just this.

Hayek acknowledges that, even in cases with a high benefit from switching, a low fixed costof switching, and no legal restrictions, households would not collectively or instantaneouslyswitch. He admits that ‘it may be that in the short run liquidity may sometimes be moreimportant than stability, or that the acceptability of a more stable money may for some reason

*Institute for Humane Studies. Email: harrydavid1@gmail.com. The author wishes to thank William J. Luther and JaymeS. Lemke for helpful comments. The usual disclaimer applies.

© 2013 The Author. Economic Affairs © 2013 Institute of Economic Affairs. Published by John Wiley & Sons Ltd

be confined to rather limited circles’ (Hayek 1999, p. 163). He posits a case in which the cost ofswitching is low: notwithstanding that ‘ordinary men’ may know ‘neither how to handle norhow to obtain strange kinds of money’ (Hayek 1978, p. 226), these faults would be made up forby electronic calculators, which would convert prices within seconds and would soon be usedeverywhere. But even with a low cost of switching, ‘unless the national government all toobadly mismanaged the currency it issued, it would probably continue to be used in everydayretail transactions’ (1978, p. 227).

If the demand for the more stable currency does not come from its use in retail transactions,then where, in Hayek’s proposal, does it come from? Hayek claims that although ‘at first[,]convenience in daily purchases might be thought decisive. . . it would prove that suitability as aunit of account would rule the roost’. It is money’s service as a unit of account that ‘makesstability of value the most desirable of all’ (1999, p. 171) its attributes. Since the preference fora stable money would be for the purpose of having a suitable unit of account, ‘it would mainlybe the tendency of all business and capital transactions rapidly to switch to a more reliablestandard (and to base calculations and accounting on it) which would keep national monetarypolicy on the right path’ (1978, p. 227). Thus, Hayek’s proposal for the denationalisation ofmoney does not rest on the claim that money users in general respond to small changes incurrencies’ relative stability, but rather on the claim that businesses in particular respondin this way.

In revising our understanding of Hayek in this way, we are not thereby rejecting the case ofSomalia as evidence against Hayek’s conjecture. For it to count as evidence, though, one wouldat least have to show, first, that even businesses did not switch from the Somali shilling to amore stable currency as a standard of deferred payments and unit of account, or second, thateven in the long run, individuals did not switch to a more stable currency for retail transactions.However, this second claim may not be enough. An equilibrium might exist whereby businessesfind it worthwhile to switch but retail users do not.

The question of whether the case of Somalia would rebut Hayek’s argument even if weaccept the reading that I offer here is beyond the scope of this comment. I hope only to haveshown that, contrary to Luther’s claim, Hayek’s proposal does not rest on a failure toappreciate the empirical significance of network effects for a medium of exchange at the retaillevel.

References

Friedman, M. (1984) ‘Currency Competition: A Skeptical View’, in P. Salin (ed.), Currency Competitionand Monetary Union, The Hague: Martinus Nijhoff.

Hayek, F. A. (1978) ‘Choice in Currency: A Way to Stop Inflation’, in F. A. Hayek, New Studies inPhilosophy, Politics, Economics, and the History of Ideas, London: Routledge & Kegan Paul.

Hayek, F. A. (1999) ‘Denationalisation of Money: An Analysis of the Theory and Practice of ConcurrentCurrencies’. In Good Money, Part II, vol. 6 of S. Kresge (ed.), The Collected Works of F.A. Hayek.Chicago: The University of Chicago Press. Originally published in 1976 in London by the Institute ofEconomic Affairs.

Luther, W. J. (2013) ‘Friedman Versus Hayek on Private Outside Monies: New Evidence for the Debate’,Economic Affairs, 33(1), 127–35.

264 i. h. david

© 2013 The Author. Economic Affairs © 2013 Institute of Economic Affairs. Published by John Wiley & Sons Ltd