All Commentary
Saturday, January 1, 1972

In Search of a New Monetary Order

Dr. Sennholz heads the Department of Economics at Grove City College and is a noted writer and lecturer on monetary and economic principles and practices.

Ever since President Nixon suspended gold payments, on August 15, 1971, the question of realistic par values of the world’s currencies has become a vexing international political issue. Governments and central banks are searching for new rules that permit “more flexible” currency fluctuations. Something beyond dollars and gold is needed, they believe, to provide a solid base for a new monetary order. Return to the old system spawned at Bretton Woods, N. H., in 1944, is out of the question. It was a gold and dollar standard, with the U.S. dollar payable in gold at $35 an ounce while other countries pegged their moneys to the dollar, holding them within a range of 1 per cent up or down from the parity registered with the 118-country International Monetary Fund.

Now, since the suspension of gold payments, the world has been waiting for monetary authorities to find a new monetary system. The process must necessarily be slow, as a political solution is sought to economic problems that were generated by various political considerations. After all, the depreciation of the U.S. dollar, which finally led to the gold payment suspension, was a political act by the monetary authorities of several Federal administrations. The decision to “float” the dollar rather than face the humiliation of a formal devaluation was also a political act. Similarly, the other governments are motivated politically in their attempts at monetary management.

While most “experts” make the government, its powers and objectives, their point of departure for monetary deliberation, a few scholars continue to base their inquiries on the fundamental principles that flow from individual choice and action. In their judgment, the factors that affect the exchange relations between various national currencies rest on the economic principles that determine the purchasing power of each and every type of medium of exchange, whether it is a precious metal or government fiat money.

As they see it, the purchasing power of any monetary unit depends on the relation between the demand for and the quantity of money in individual cash holdings. The demand for money is purely individual, although a great many extraneous factors may influence this demand. There is, for instance, the expectation of future changes in the exchange value of money. An expected fall tends to reduce the demand for money and thus its purchasing power; an expected rise brings about the opposite. Also, the availability of goods affects the demand for money. In an expanding economy when more and better goods are offered on the market, the demand for money tends to rise; in a declining economy, where capital is consumed and the division of labor breaks down, the demand for money tends to decline.1

The Stock of Money

The supply of money is the stock of money available for exchange. During the age of the gold standard it consisted of gold bullion, gold coins and their various substitutes, such as bank notes, tokens, and demand deposits. In this age of government currency, it consists of fiat money and its substitutes, such as tokens and demand deposits. The substitutes may either be fully backed by money proper or else they are fiduciary, i.e., uncovered. Thus, an expansion or contraction of fiduciary media directly affects the total quantity of money available for exchange.

A change in the money relation through changes in either the demand for money or the stock of money affects changes in the purchasing power of money. As one factor of demand or supply cannot perfectly offset changes in the other factors, money can never be neutral. Now, if there are two or more media of exchange, such as gold or silver, or various fiat currencies, what determines the exchange ratio between the various media? Their purchasing powers! That is to say, exchange ratios correspond to the ratio of each one’s purchasing power in terms of all other goods. Market forces tend to establish the parity between the purchasing powers and thus their exchange ratios. The equilibrium exchange rate is called the purchasing power parity.

Gold and Silver as Money

For more than 2,500 years the civilized world used gold and silver as money. These metals became valuable media of exchange because they were not only desirable for non-monetary uses, but also suited so well for economic exchanges as they were durable, portable, and divisible. Silver was generally used for small transactions and gold in all larger exchanges. And throughout the ages their exchange ratios were determined by their purchasing power parities. If one ounce of gold bought a horse that also could be bought for 10 ounces of silver, the parity between gold and silver was 1:10. If for any reason the exchange rate differed from this parity, arbitrage would soon restore the exchange ratio to its purchasing power parity. If, in our example, the exchange ratio should be 11:1 and the purchasing power 10:1 it would be very profitable to exchange gold for silver and then buy commodities. But such money exchanges would soon drive the ratio back to its parity.

In all countries where gold was the standard money, the exchange ratios between gold coins of different weight and fineness were determined simply by this difference. If one coin weighed one ounce and another coin of equal fineness only one third of an ounce, the exchange ratio obviously was 1:3. Under the gold-coin standard, commonly called the orthodox or classical gold standard, gold coins were the standard money. National currencies represented a certain quantity of gold of a certain fineness. The U.S. dollar, for example, consisted of 25.8 grains of gold, nine-tenths fine, before the 1934 devaluation, and 15 5/21 grains thereafter, or in troy ounces 1/20.67 and 1/35 respectively. The U.S. $20 gold coin (Double Eagle) contained 30.09312 grams of fine gold, the $10 coin (Eagle) 15.04656 grams, and the $5 coin (Half Eagle) 7.52328 grams. The British Sovereign contained 7.322 grams, the Mexican 50 Peso coin 37.5 grams, the French 20 Francs coin, also called Napoleon, 5.8 grams, and the Swiss 20 Francs coin 5.8 grams.2 Exchange ratios between the various currency units consisting of gold thus were determined by their relative measures of gold.

International Acceptability

The world had an international currency while on the classical gold standard. It evolved without international treaties, conventions or institutions. No one had to make the gold standard work as an international system. When the leading countries had adopted gold as their standard money the world had an international currency without problems of convertibility or even parity. The fact that the coins bore different names and had different weights hardly mattered. As long as they consisted of gold, the national stamp or brand did not negate their function as an international medium of exchange.

The purchasing power of gold tended to be the same the world over. Once it was mined, it rendered exchange services throughout the world market, moving back and forth and thereby equalizing its purchasing power except for the costs of transport. It is true, the composition of this purchasing power differed from place to place. A gram of gold would buy more labor in Mexico than in the U.S. But as long as some goods were traded, gold, like any other economic good, would move to seek its highest purchasing power and thereby equalize its value throughout the world market. As all coins and bullion were traded in terms of weight of gold, there were no “exchange rates” such as those between gold and silver, or various fiat monies.

The Exchange Rate Dilemma

The departure from the gold coin standard, set the stage for the present exchange rate dilemma. At first, governments began to restrict the actual circulation of gold. They gradually established the gold bullion standard in which government or its central bank was managing the country’s bullion supply. Gold coins were withdrawn from individual cash holdings and national currency was no longer redeemable in gold coins, but only in large, expensive gold bars. This standard then gave way to the gold exchange standard in which the gold reserves were replaced by trusted foreign currency that was redeemable in gold bullion at a given rate. The world’s monetary gold was held by a few central banks, such as the Bank of England and the Federal Reserve System, that served as the reserve banks of the world.³ But after World War II, the Bank of England which was holding the gold reserves for more than 60 countries, commonly called the pound sterling area, gradually lost its eminent position. It began to hold most of its reserves in U.S. dollar claims to gold, which made the Federal Reserve System the ultimate reserve bank of the world; thus the gold-exchange standard became a de facto gold and dollar standard. Finally, during the accelerating inflation and credit expansion of the 1960′s in the U.S., the dollar gradually fell from its respected position. Several monetary crises which triggered worldwide demands for dollar redemption greatly depleted the American stock of gold, and created precarious payment situations.

Altogether, in less than four years, we experienced seven currency crises that foretold the end of the international monetary system. In November, 1967, Great Britain devalued the pound and a number of other countries immediately followed suit. In March of 1968, under the pressure of massive pound sterling liquidation, the nine-nation gold pool was abandoned and the two-tier system adopted. The third crisis occurred in France in May, 1969, when political riots, followed by rapid currency expansion, greatly weakened the franc which was later devalued. The fourth crisis erupted in September, 1969, when massive dollar conversions to West German marks forced the German central bank to “float” the mark and then revalue it upward by 9.3 per cent. The fifth crisis occurred in March and early April, 1971, when a new flight from the dollar threatened to inundate several European central banks. In a concerted effort, the U.S. Treasury and the Export Import Bank endeavored to “sop up” the dollar flood. The sixth crisis began in May, 1971, when a new flow of dollars into German marks, Swiss francs, and several other currencies caused the mark to float anew, the Swiss franc to be revalued upward by 7.07 per cent, and several other currencies to be allowed to float or be revalued. The seventh and last crisis was of such massive proportions that President Nixon was forced to announce the collapse of the old monetary order.

Why the Breakdown of International Monetary Relations?

What had caused this gradual deterioration of international monetary relations? An understanding of the causes may provide an answer to the dilemma, prevent further deterioration, and hopefully find a cure to all its somber consequences.

The popular explanation usually runs as follows: The rapid worsening of the U.S. international balance-of-payment deficit was the proverbial straw that broke the system’s back. From a small surplus of $2.7 billion in 1969, achieved mainly through various government manipulations that amounted to window dressing, the 1970 payments deficit soared to an all-time record deficit of some $10.7 billion, on official settlement basis, i.e., official settlements between governments only. Then, in May, 1971, the U.S. Commerce Department announced that the first quarter 1971 deficit had grown to a record $5.4 billion.’ And finally, private sources estimated that in 1971, up through mid-August, some $22 billion more dollars flowed out of the country than came in.

These new payment deficits were added to the accumulated unpaid deficits of the U.S. for many years. U.S. dollars and short-term claims to dollars in foreign hands amounted to $43 billion at the end of 1970. After deducting U.S. short-term claims on foreigners our net obligations exceeded $32 billion, plus the current deficits mentioned above. And while the U.S. gold stock stood at $11 billion, the lowest level since World War II, it became obvious that the U.S. could not meet its foreign obligations in gold.5

Dr. Arthur F. Burns, Chairman of the Federal Reserve Board, probably reflected the official position of the U.S. government when, on May 20, 1971, he blamed foreign governments for the precarious situation. He urged them to release their restraints on imports and American investments, and to help us with our foreign military operating expenses. Raising our interest rates, he asserted, was not the right way to improve the ailing dollar. He advocated more U.S. borrowing from the Eurodollar market through Treasury certificates and, in order to become more competitive in world markets, an “incomes policy” that would restrain the cost-push momentum of American labor.6 Less than three months later President Nixon announced a 90-day price and wage freeze, to be followed by some government control thereafter, and a 10 per cent surtax on imports to stem the flood of cheap foreign goods.

“National Balance of Payment”

Academic theories basically concurred with Dr. Burns’ explanation although some offered different solutions, such as a crawling peg, a wider bank, flexible exchange rates, or the creation of new reserve assets, such as Special Drawing Rights by the International Monetary Fund.7 But no matter what solution they proffer, their point of departure is the collectivist concept of the “national” balance of payment. Without any reference to individual actions and balances, they build ambiguous structures that ignore the causes. Balance of payments of a country is that very small segment of the combined balances of millions of individuals, the segment that is based on personal exchanges across national boundaries. As an individual may choose to increase or decrease his cash holdings, so may the millions of residents of a given country. But when they increase their holdings, that is called “favorable” in balance of payments terminology. And when they choose to reduce their cash holdings, that is called “unfavorable.” The fact is that drains of gold are not mysterious forces that must be managed by wise governments, but are the result of deliberate choices by people eager to reduce their cash holdings.

Wherever governments resort to inflation, people tend to reduce their cash holdings through purchases of goods and services. When domestic prices begin to rise while foreign prices continue to be stable or rise at lower rates, individuals like to buy more foreign goods at bargain prices. They ship some of their money abroad in exchange for cheaper foreign products or property. Thus, an outflow of foreign exchange and gold sets in. It is the inevitable result of a rate of domestic inflation that exceeds that of the rest of the world and sets into operation “Gresham’s Law.”

During the 1960′s, the decade of the “Great Society,” and again during 1970 and 1971, money and credit were created at unprecedented rates prompted by record-breaking government deficits. Private demand deposits, bank credit at commercial banks, and Federal Reserve credit, which is fueling the credit expansion, often rose at rates of 10 per cent or more a year. Therefore, in spite of countless promises and reassurances by the President and his advisers, the U.S. dollar suffered inevitable depreciation at home and abroad. And the August 15, 1971, default of payment was the result of this depreciation.

Blaming the Creditor

Refusal to make gold payments by the United States, the richest and most powerful country on earth, casts serious doubt on future monetary cooperation. The immediate prospect for worldwide monetary reform is not too bright. The U.S., as the defaulting debtor, is taking the position that it is up to the countries with huge surpluses in their international payments to adjust their currencies upward against the dollar. It is Washington’s basic premise that the U.S. was unfairly treated in international commerce and that it is time for correction. Convinced of the indispensability of the U.S. dollar as a world reserve currency, the U.S. is defiantly waiting for the others to act.

Bad debtors, when called upon to make payment, often make such charges against their creditors. It is shocking, however, that the U.S. government should prove to be such a poor debtor. Even its basic assumption, the indispensability of the dollar, no longer goes unchallenged. Sterling balances look more attractive today than dollar holdings. In fact, the holdings of deutsche marks by central banks and treasuries probably exceed $3 billion. Foreign airlines and shippers have ceased to accept U.S. currency. And Eurodollar bonds are all but unsaleable in European capital markets, while mark, guilder, and Swiss franc securities remain in demand. The foreign position generally rejects the Washington charge of unfair treatment. If the U.S. had adopted appropriate domestic policies, foreign officials argue, it would not have accrued its huge international payments deficits. Therefore, they want the U.S. to share the burden of realignment. They are seeking a devaluation of the dollar along with realignment of their currencies. And above all, no one is suggesting that the U.S. dollar continue to serve as an international reserve currency.

After all, managed currencies are the products of political manipulations by parties and pressure groups, and all are destined to be destroyed gradually by weak administrations yielding to popular pressures for government largess and economic redistribution. No such currency can serve for long as the international reserve currency to which all others can repair. The U.S. dollar is no exception.

In the chaotic conditions of late 1971, the world may still have the following options:

(1) It may continue on its present road of fiat money and inflation, government manipulation of exchange rates, trade restrictions, and exchange controls. The goal is “national autonomy” in monetary and fiscal policies, an essential objective for all forms of central economic planning. On this road we are bound to suffer not only more inflation and depreciation, but also a gradual disintegration of the world economy and its division of labor. Our ultimate destination is a worldwide depression.

(2) Or the world may choose to turn off this road of self-destruction and seek stability in sound money. The very monetary authorities that have created the chaos and are now sitting in judgment over the international monetary order must relinquish their rights and powers over the people’s money. This road leads to the various forms of gold standard, from the gold exchange to the gold bullion, and finally the gold coin standard. For gold is the only international money the quantity of which is limited by high costs of mining and the value of which is independent of political aspirations and policies. Only the gold standard can afford monetary stability and peaceful international cooperation.



1 Ludwig von Mises, The Theory of Money and Credit (Irvington-on-Hudson, N. Y.: The Foundation for Economic Education, Inc., 1971), p. 97 et seq.

2 Cf. Franz Pick, Currency Yearbook (New York: Pick Publishing Corp., 1970), pp. 1315.

3 Cf. Leland B. Yeager, International Monetary Relations (New York: Harper & Row, Publishers, 1966), p. 251 et seq.

4 Federal Reserve Bulletin, Sept., 1971, Chronicle, June 9, 1971, p. 16.

5 Ibid., p. 94.

6 The Commercial and Financial p. A75.   

7 Cf. William Feliner “On Limited Exchange Rate Flexibility,” Chapter 5 of Maintaining and Restoring Balance in International Payments, Princeton University Press, 1966; George N. Halm, “The Bank Proposal: The Limit of Permissible Exchange Rate Variations,” Princeton Special Papers in International Economics, No. 6; John H. Williamson: “The Crawling Peg,” Princeton Essays in International Finance, No. 50; Francis Cassell, International Adjustment and the Dollar, 9th District Economic Information Series, Federal Reserve Bank of Minneapolis, June, 1970; Walter S. Salant, “International Reserves and Payments Adjustment,” Banca Nazionale del Lavoro, Quarterly Review, Sept., 1969; Thomas D. Willet and Francesco Forte, “Interest Rate Policy and External Balance,” Quarterly Journal of Economics, May, 1969; Friedrich A. Lutz, “Money Rates of Interest, Real Rates of Interest, and Capital Movements,” Chapter 11 of Maintaining and Restoring Balance in International Payments, Princeton University Press, 1966; Milton Gilbert, “The GoldDollar System: Conditions of Equilibrium and the Price of Gold,” Princeton Essays in International Finance, No. 70.



Freedom is the Answer

There is nothing wrong with money that freedom will not cure. This is another way of saying that the Good Society which many reformers have sought by way of monetary reform cannot be achieved that way; if it is ever to be achieved, it will be done by freedom. So, then, the fight for sound money, to have meaning, must be related to the broader fight for freedom. It is only one of the several battles that must be fought.

FRANK CHODOROV, from “Shackles of Gold” 

  • Hans F. Sennholz (1922-2007) was Ludwig von Mises' first PhD student in the United States. He taught economics at Grove City College, 1956–1992, having been hired as department chair upon arrival. After he retired, he became president of the Foundation for Economic Education, 1992–1997.