A Laissez-Faire Approach to Monetary Stability

Author(s): Robert L. Greenfield and Leland B. Yeager

Source: Journal of Money, Credit and Banking , Aug., 1983, Vol. 15, No. 3 (Aug., 1983),
pp. 302-315
Published by: Ohio State University Press

Stable URL: https://www.jstor.org/stable/1992481

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 -

ROBERT L. GREENFIELD
LELAND B. YEAGER*

A Laissez-Faire Approach to Monetary

Stability

THIS PAPER DEVELOPS some diverse hints for a new mone-

tary system offered separately by Fischer Black, Eugene Fama, and Robert E. Hall.
(For reasons that will become evident, though, we should perhaps say "payments
system" instead of monetary system.) None of the economists mentioned has
actually proposed the particular system set forth here nor examined all its proper-
ties, and we call it the "BFH system" not to implicate them but only to give credit
for some component ideas and to have a convenient label.l Regardless of who if
anyone may actually advocate the system, contemplating it is instructive. It illumi-
nates, by contrast, some characteristics of our existing and recent systems.

*The authors thank the Institute for Humane Studies for the opportunity to work together on this and
related topics and James M. Buchanan, James P. Cover, and Kaj Areskoug for written comments on
earlier drafts, Robert E. Hall, Joseph T. Salerno, and William Breit for discussion, and Lawrence H.
White for large and valuable amounts of both. Buchanan suggested the story of the fungus that we shall
use and contributed to explaining how what he called "indirect convertibility" might be said to charac-
terize the BFH system.
lWe do not claim to be offering an accurate summary or synthesis of particular persons' proposals.
Instead, we are picking and choosing among ideas and modifying and extending them. (Incidentally, we
would welcome suggestions for a name more descriptive than "BFH system.")
While Black and Fama do consider using commodities as numeraire (and Fama even considers using
space-ship permits), they mainly discuss how an unregulated financial system would operate. While Hall
also champions deregulation, he stresses his idea of a unit of account defined by a bundle of com-
modities. He would define the unit in terms of a small number of commodities whose amounts would be
adjusted from time to time to stabilize a general price index. (He thus extends Irving Fisher's idea of a
"compensated dollar" of adjustable gold content.) We, however, consider a unit defined once and for all
in terms of so many commodities that its stability in terms of the unchanging bundle would come close to
stability of its general purchasing power.

ROBERT L. GREENFIELD is associate professor of economics andfinance, Fairleigh Dickin-

son University, Madison. LELAND B. YEAGER is professor of economics, University of
Virginia.

Journal of Money, Credit, and Banking, Vol. 15, No 3 (August 1983)

Copyright t) 1983 by the Ohio State University Press

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 ROBERT L. GREENFIELD AND LELAND B. YEAGER : 303

Briefly, the idea is to define the unit of account physically, in terms of many
commodities, and not in terms of any medium of exchange whose value depends on
regulation of its quantity or on its redeemability. (We use the terms "unit of
account," "value unit," and "pricing unit" as synonyms, preferring one or an-
other according to the particular emphasis intended.) Apart from defining the unit
and enforcing contracts, the government would practice laissez faire toward the
medium of exchange and the banking and financial system.
Remarks by readers of our drafts have alerted us to the danger of being misin-
terpreted, no matter how clearly we say what we mean. This danger is understand-
able. People absorb ideas, and even sense impressions, by classifying them in
relation to their earlier experiences [8]. People then sometimes react more to the
pigeonholes they use than to the ideas themselves. We must insist, therefore, that
the system we describe does not fit into familiar pigeonholes. We must warn our
readers against preconceptions and urge them to await what we actually say.
The BFH system is not a variant of the often-proposed composite-commodity or
commodity-reserve money. It is not a variant of the tabular standard (widespread
indexing). Questions about whether the BFH system involves convertible or incon-
vertible money-questions presupposing some familiar answer are inapplicable to
it. The definition of the BFH unit of account does not require "implementation"
through convertibility of any familiar sort, any more than does maintenance of the
defined length of the meter.
Although the BFH system would indeed lack money as we now know it, it would
not entail the textbook inconveniences of barter. The advantages of having a defi-
nite unit of account and convenient methods of payment would be retained and
enhanced.
Also false is the notion that the BFH system is impractical for somehow running
counter to the natural evolution of monetary and financial institutions. Our existing
system is far from the pure product of any such evolution. Dismantling it would
require legislation, whose specific provisions would be bound to nudge subsequent
developments one way or another. That is why it is not self-contradictory to assess
alternative payments systems even from a laissez-faire position.

1. SYSTEMS COMPARED AND QUESTIONS ILLUMINATED

We gain better understanding of a given payments system by comparing it with

alternatives. Walter Eucken [2, pp. 159-72] and Heinrich Rittershausen [9, pp.
57-69] have emphasized crucial differences between systems that unite and those
that separate the unit of account and the medium of exchange. Separation, though
familiar in the Middle Ages, is unfamiliar nowadays, a fact that makes the separated
system we shall describe particularly instructive. In one type of monetary system,
properly so called, the unit of account is the unit of the medium of exchange, whose
value depends on the demand for it as such and on restriction of its quantity. This is
our present system of fiat money. Under a second type of system, money is denomi-
nated in a unit kept equal in value to a definite quantity of some commodity by

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304 : MONEY, CREDIT, AND BANKING

interconvertibility at a fixed ratio. The monetary commodity has a "natural" scar-

city value; unlike fiat money, it cannot be simply printed or written into existence.
This is the logic of the gold standard. The same logic applies, and more powerfully,
to the often proposed composite-commodity or commodity-reserve standard, which
would make the money unit interconvertible not with a single commodity but with a
physically specified bundle of commodities.
A third type of payments system is the one examined here. It resembles the
composite-commodity standard in its definition of the unit of account but differs
from that standard in lacking any government-issued or government-specified medi-
um of exchange and in lacking any claims obligatorily redeemable in bundles of the
specific commodities defining the unit. One fundamental difference between this
third (BFH) system and either ordinary system relates to the supply and demand that
determine the value of the unit of account. Under both fiat money and an ordinary
commodity standard, the unit's value is determined by supply of and demand for
money or a monetary commodity, with the demand being wholly (for fiat money) or
largely (for commodity money) of a monetary character. Under the BFH system, in
contrast, the demand for the many commodities defining the unit is almost entirely
nonmonetary. Under fiat money or an ordinary commodity standard, an imbalance
between actual and desired money holdings can develop and (barring adroit re-
medial money-supply management) can call for adjustment of the real value of the
unit of account. Pressures for this adjustment may work only sluggishly and there-
fore painfully because of stickiness in many individual prices and wages. Under the
BFH system, in contrast, because of the almost wholly nonmonetary character of
the demands for and supplies of the commodities defining the unit and because of
the unit's separation from the medium of exchange, no monetary pressures can
come to exert themselves, either sluggishly and painfully or otherwise, on the value
of the unit. The BFH system offers much less scope than an ordinary monetary
system for destructive monetary disequilibrium.
Comparison of the BFH system with others should help forestall misapplication
of propositions true under one system to another system under which they do not
apply. It should aid in pondering several interrelated questions. What are the pos-
sibilities and consequences of separating the unit of account and medium of ex-
change? What are the similarities and the differences between a unit of value and
other units of weights and measures? What is necessary for an operationally mean-
ingful definition of the pricing unit and for a determinate price level? By what
processes does the value of the money unit change? Under what circumstances, if
any, is the real-bills or needs-of-trade doctrine valid and is James Tobin's notion
valid of a natural economic limit to the nominal size of the money and banking
system? Under what circumstances and in what senses is it true that the supply of
money tends to create its own demand and that the demand for money tends to
create its own supply? What is the role of base money when the bulk of the
circulating medium consists of demand obligations backed by fractional reserves of
it? What market processes tend to forestall or correct an imbalance between mon-
ey's supply and demand, and what circumstances impair these processes, permitting

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 ROBERT L. GREENFIELD AND LELAND B. YEAGER : 305

painful macroeconomic consequences? Most broadly, what are the merits and de-
fects of different systems?

2. THE BLACK-FAMA-HALL SYSTEM

The BFH system would get rid of any distinct money existing in a definite
quantity. The government would be forbidden to issue obligations fixed in value in
the unit of account and especially suitable as media of exchange. It would not give
legal-tender status to any particular means of payment but would simply enforce
contracts in which the parties themselves had specified what would constitute ful-
fillment. No longer would there be any such thing as money whose purchasing
power depended on limitation of its quantity. No longer, then, could there be too
much of it, causing price inflation, or too little, causing depression, or a sequence of
imbalances, causing stagflation. A wrong quantity of money could no longer cause
problems because money would not exist.
But without money, how would prices be quoted, contracts expressed, and finan-
cial records kept? The answer is that there would be a defined unit of value, just as
there are defined units of length, weight, volume, time, temperature, and energy.
Business practice, left to itself, might eventually converge on a specific definition
of the unit. The government could hasten and probably improve the choice, howev-
er, by noncoercively offering a definition, just as it does with weights and mea-
sures. The unit would be defined by a suitable bundle of commodities. Just as the
meter is defined physically as 1,650,763.73 wavelengths of the orange-red radiation
of krypton 86, so the value unit would be defined physically as the total market
value of, say, 50 kg of ammonium nitrate + 40 kg of copper + 35 kg of aluminum
+ 80 square meters of plywood of a specified grade (the four commodities men-
tioned by Robert Hall) + definite amounts of still other commodities. The prices of
the individual commodities would not be fixed and would remain free to vary in
relation to one another. Only the bundle as a whole would, by definition, have the
fixed price of 1 unit. (For a unit of convenient size, however, the bundle might be
designated as worth 1 thousand units.) The bundle would be composed of precisely
gradable, competitively traded, and industrially important commodities, and in
amounts corresponding to their relative importance. Many would be materials used
in the production of a wide range of goods so that adopting the bundle as the value
unit would come close to stabilizing the general level of prices expressed in that
unit.
The commodities defining the unit would have the characteristics envisaged in
the composite-commodity or commodity-reserve proposal, with one exception.
They would not have to be storable, that is, capable of being held as monetary
reserves, since the BFH scheme does not require any direct convertibility of obliga-
tions into the particular commodities defining the value unit. This difference this
lack of dependence on any particular base money-deserves emphasis. The more
familiar proposal calls for an ordinary commodity standard in the sense that stan-

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306 : MONEY, CREDIT, AND BANKING

dard commodity bundles would be exchangeable for newly issued money and
money would be redeemable in bundles at a fixed ratio. That proposed system
differs from the gold standard chiefly in that a bundle of commodities takes the
place of a single one. It, like the gold standard, is vulnerable to abandonment or to
devaluation of the money unit. When the gold standard is abandoned or the gold
content of the money unit is cut, the old unit keeps its functions, and people regard
gold as a commodity whose price has risen. Part of the beauty of the BFH system, in
contrast, is that the value unit remains stable in terms of the designated commodity
bundle because its value never did depend on direct convertibility into that bundle or
any specific commodity. Instead, its value is fixed by definition. It is free of any
link to issues of money that might become inflated.
The BFH system bears a superficial resemblance to the proposed tabular standard
of value, that is, widespread indexing, in that both involve specifying a standard
bundle of goods and services. The latter system, however, presupposes the con-
tinued existence of an ordinary medium of exchange whose unit also serves as the
ordinary unit of account. The total price of the standard bundle quoted in that
ordinary unit-or, rather, changes in that price level is what the price index
measures. Use of the index to calculate current ordinary-money equivalents of
certain debts and payments erects a unit of constant purchasing power, correspond-
ing to the price index employed and its commodity bundle, into a unit of account
rivaling the ordinary money unit. This rival unit presumably serves mainly in
contracts spanning substantial periods of time (it is a "standard of deferred pay-
ments," as the older textbooks used to say). The BFH system, in sharp contrast,
abolishes any ordinary money in terms of which a price index might be calculated
and so avoids any rivalry between distinct units of account.2
Robert Hall suggested an analogy between the yard and the proposed value unit
(in his taped panel discussion; what follows here embroiders on what he actually
said). Both are units of measurement-one of length, the other of value. Both are
defined in physical terms. Neither unit has any quantitative existence. It is nonsense
to ask how many yards or how many value units there are in existence. Another
element of the analogy is that no one seeks to maintain the size of the yard or of the
value unit by maintaining any direct convertibility, as between cloth and yardsticks
or between money and specific commodities. (Issuers of demand obligations, like
other debtors, would be concerned about maintaining the value of their own obliga-
tions, but that is not the same as their bearing responsibility for the real value of the
unit of account itself.)
Of course, an analogy is just that and not an identity. There are differences
between units of length and value, just as between units of length and weight. The
key similarity is that both are defined units whose definitions do not change or stop
being applicable because of changes in some quantity or because of other physical
or economic events.

2Further discussion of the tabular standard and of why it is parasitical on the continued existence of
ordinary money and unindexed prices appears in Yeager [15].

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 ROBERT L. GREENFIELD AND LELAND B YEAGER : 307

With no money quantitatively existing, people make payments by transferring

other property. To buy a bicycle priced at 100 value units or pay a debt of 100 units,
one transfers property having that total value. Although the BFH system is barter in
that sense, it is not crude barter. People need not haggle over the particular goods to
be accepted in each transaction. The profit motive will surely lead competing
private firms to offer convenient methods of payment.
Under laissez faire, financial intermediaries blending the characteristics of pre-
sent-day banks and mutual funds would presumably develop. People would make
payments by writing checks (or doing the equivalent electronically) to transfer the
appropriate amounts value-unit-worths-of shares of ownership in these funds.
(Convenience would dictate writing checks in numbers of value units, not in num-
bers of shares of heterogeneous funds.) The funds would invest in primary securities
(business and personal loans and stocks and bonds) and perhaps in real estate and
commodities. They would seek to attract customers (owners of their shares) by
compiling records of high earnings, safety, and efficiency in administering the
payments (checking) system. The funds would presumably charge for their check-
ing services, so that investors would not be subsidizing customers using them
mainly as checking accounts. Payment and investment institutions like these would
arise unless entrepreneurs devised even more convenient ones that we have not been
able to imagine. Different funds would specialize in different fields and services.
A customer's holding in his fund would not have to be fixed in size in value units.
Apart from his adding to it or drawing it down, his holding would rise or fall in
value as his fund received earnings and made capital gains or as it suffered losses on
its asset portfolio. (In effect, holdings would bear interest or dividends at fluctuating
rates, possibly sometimes negative.) Despite these fluctuations in value, the cus-
tomer could watch his holding closely enough to avoid writing too big a volume of
checks. He would probably be using the fund partly as an investment vehicle,
anyway, and would not want to keep his holding down to the minimum required for
transactions. Furthermore, funds might well arrange to honor overdraft checks by
making automatic loans to their drawers.
Funds would have to make settlements with one another, as banks do nowadays,
for the differences between the value-amounts of checks written on each one and of
checks on others deposited with it. How would the funds do this? Remember there
is no base money neither government-issued fiat money nor monetary stocks of
particular commodities. Again, competition would favor efficient practices. Funds
would presumably agree, under the auspices of their clearinghouses, on what port-
folio assets-perhaps specified securities would be acceptable in settlements.
The question of settlements leads into the question of what would happen if many
owners of a particular fund wanted to get out of it. The departing owners would
presumably write checks against their old fund and deposit them in their new funds.
The shrinking fund would have to transfer assets to the growing ones. Loss of
owners and of the value of assets and shareholdings would punish poor manage-
ment. The discipline of competition would favor good performance.
What would serve as hand-to-hand currency? Fund shares of fluctuating value-

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308 : MONEY, CREDIT, AND BANKING

some of themould take the physical form of coins and circulating paper. It would
probably prove convenient, however, for currency to be denominated in the unit of
account. (The distinction between evaluation and denomination deserves attention.
All property can have its current value, changeable or not, measured in units of
account. An asset so denominated, however like a $10 bill of today has its value
specified as so many units.)
Nowadays, by way of a minor administrative detail or public-relations device,
most money-market mutual funds fix the value of their shares at $1 each and take
account of earnings (or losses) by adjusting the number of shares in each owner's
holding. If, similarly, BFH funds kept their shares worth 1 unit of account each,
then some bearer shares could circulate as coins and notes. Only a small fraction of
all shares would presumably take that form, however, unless some convenient way
were devised for adjusting not merely the number of book-entry shares but also the
number of shares circulating as currency to reflect the earnings or losses of indi-
vidual funds. Alternatively, instead of being ownership shares, the circulating cur-
rency (and also some deposits) could be debt instruments issued by funds and other
organizations and denominated in units of account.

3. ADVANTAGES

Considering its possible advantages will serve further to contrast

with our existing system and to provide a focus for certain questions. Firstly, the
system would provide a stable unit for pricing, invoicing, accounting, economic
calculation, borrowing and lending, and writing contracts reaching into the future.
The government, secondly, would come under financial discipline. It would have to
borrow on the same basis as any other borrower and could no longer acquire
resources by issuing money and otherwise imposing inflationary "taxation without
representation." Competition under laissez faire, thirdly, would spur innovation in
finance and the payments system and would exert discipline on banks and invest-
ment funds. Institutions would evolve, yes, but would no longer exhibit the socially
unproductive instability hitherto associated with continual attempts to wriggle
around changing government regulations.
A fourth set of advantages follows from the fact that the medium of exchange
(i.e., readily transferable property) would not be redeemable in any particular base
money, whether commodity money or government fiat money. No multiple expan-
sions and contractions of ordinary money could occur in response to changes in the
amount of any base money held as fractional reserves. No runs on financial institu-
tions could occur of the self-aggravating type that used to be familiar (especially
before government insurance of bank deposits, which, by the way, would be inap-
propriate under the BFH system). No scramble for base money of limited total
quantity could make suspicion of particular institutions spread to others. Suspicion
would be more nearly concentrated on poorly managed funds, holdings in which
would depreciate in value, particularly as settlement of checks drawn by customers
shifting to other funds stripped the shrinking funds of their most readily acceptable

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 ROBERT L. GREENFIELD AND LELAND B. YEAGER : 309

assets. Runs would be less catastrophic under the BFH system than under an
ordinary banking system for reasons resembling the reasons for the differences
between runs on national currencies under a system of pegged exchange rates and
the more nearly self-restraining runs under floating exchange rates.
A related advantage is avoidance of multiple expansions and contractions of
money supplies through the balance of payments. No longer could a payments
deficit drain away base money and impose multiple deflation of a country's ordinary
money supply. A country under the BFH system would have no fixed exchange rate
(unless, quite exceptionally, and sacrificing key features of the system, it chose to
define its unit of account as an amount of some foreign currency). Foreign curren-
cies would be free to fluctuate in value against both the country's physically defined
unit of account and its various media of exchange. A deficit on current account
would necessarily mean either that foreigners were acquiring financial claims on the
country or that its residents were disposing of financial claims on foreigners. No
balance-of-payments surplus, to mention the opposite disorder, could impose im-
ported inflation.

4. AVOIDING MACROECONOMIC DIFFICULTIES

Our existing monetary system is subject not only to inflation but also to stagfla-
tion, deflation, and depression because the unit of account and the medium of
exchange are tied together and because the actual quantity of money can fail to
correspond to the total of money holdings desired at the existing price level (or
entrenched price trend). Market-clearing forces do not work very well to maintain
or restore equilibrium between money's supply and demand because money does
not have a single price of its own that can adjust on a market of its own. Instead, the
medium of exchange has a fixed price in the unit of account (each dollar of the
money supply has a price of exactly $1). With no specific price and market to
impinge upon, imbalance between money's supply and demand must operate upon
the dollar's purchasing power, that is, on the whole general price level. This process
requires adjustments on the markets and in the prices of millions of individual goods
and services, leaving scope for quantities traded and produced to be affected. Prices
and wages respond far from promptly enough to absorb the full impact of im-
balances; they are sticky some more so than others for reasons that make excel-
lent sense from the standpoints of individual price-setters and wage-negotiators.
Under these realistic circumstances, failure to keep the quantity of money correctly
and steadily managed can have momentous consequences.3
Inadequate effective demand for goods and services is sometimes blamed on
oversaving. That as such, we insist (without repeating in detail what we have
written elsewhere), is not what threatens general deflation of economic activity. The
trouble comes, rather, from attempts to save by acquiring money, a good for which

3To avoid repetition, we refer to four papers by Yeager.

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310 : MONEY, CREDIT, AND BANKING

excess demand can develop and persist because it has no price of its own that could
adjust on a market of its own to equilibrate supply and demand. Since money
routinely facilitates exchanges of goods for one another, impairment of its circula-
tion obstructs those exchanges and in turn obstructs the production of goods to be
exchanged. In these respects money has no close counterpart in the BFH system.
In avoiding these monetary difficulties, the BFH system offers yet a fifth set of
advantages. The unit of account no longer has its value dependent on the quantity of
the medium of exchange. The unit's general purchasing power, being practically
fixed by definition, is never called upon to undergo adjustment through a process
exposed to the hitches characteristic of our existing system. The very concepts of
quantity of money and of possibly divergent actual and demanded quantities be-
come inapplicable. What serves as the medium of exchange is indefinite, plastic,
and subject to the desires of market participants. As in a barter world, no clear line
separates media of exchange from other assets. Most owners of funds would be
holding shares both as checking accounts and as investments. They could reclassify
portions of their holdings as serving one purpose or the other as suited their chang-
ing circumstances and desires (if they ever bothered to make such a classification in
the first place). Media of exchange would no longer have a fixed price in the unit of
account (anyway, not all of them would). No longer could the pressures of im-
balance between money's supply and demand be tending to change the purchasing
power of the unit but only sluggishly, with adverse side effects on quantities of
goods and services traded and produced.
These macroeconomic advantages are worth a closer look. Actual quantities of
media of exchange (liquid assets, readily transferable property) would adjust to the
demand for them. In our existing world, by contrast, the nominal quantity of a
country's medium of exchange is primarily determined on the supply side in the
way described by the money-multiplier analysis of the money-and-banking text-
books (the analysis involving the quantity of base money and reserve and curren-
cy/deposit ratios). The real (purchasing-power) quantity of the medium of exchange
does tend to be determined on the demand side, but through the roundabout and
possibly sluggish and painful process of adjustment of the whole general price level.
(For familiar reasons, this proposition about supply-side determination of the nomi-
nal quantity of money and demand-side determination of the real quantity applies
strictly only to a closed economy, a country with a floating exchange rate, or a key-
currency country in the special position that the United States enjoyed even under
the Bretton Woods system. Under a fixed exchange rate regime, demands for
money holdings can affect even the actual nominal quantity in a non-key-currency
country through the balance of payments.)
In the BFH world, the (near-) fixity of the purchasing power of the unit of
account obliterates any distinction between determination of real and determination
of nominal quantities of assets usable as means of payment. No base money exists
to constrain or support their quantities from the supply side. The fuzziness of the
dividing line between these and other assets, furthermore, obviates the distinction
that does hold in our actual world between the predominantly supply-side determin-

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 ROBERT L. GREENFIELD AND LELAND B. YEAGER : 3l1

ation of nominal amounts of money and the supply-and-demand determination of

nominal as well as real amounts of nearmoneys and nonmoneys.

5. RESPONSES OF QUANTITIES OF MEDIA OF EXCHANGE

With money of our present kind, the nominal quantity is determined on the
supply side, with the nominal demand for it falling passively into line (subject to the
standard exception for an open economy under fixed exchange rates). The unit's
real size tends to adjust appropriately, but through a roundabout and possibly
painful process.
With BFH fund shares serving as the media of exchange, their actual quantity,
measured in units of account, is determined by interaction of demand with supply.
Interest rates, broadly interpreted, play a role in the equilibration. By divorcing the
unit of account and medium of exchange, the BFH system avoids supply-side
determination of the latter's quantity. Just as even the nominal money supply is
demand-determined in an open economy with a fixed exchange rate whose price
level is dictated to it by the world market, so the volume of media of exchange is
demand-determined in a BFH economy whose unit of account has a purchasing
power dictated by its multicommodity definition.
Space permits only few examples of the process at work.4 Suppose people's
tastes shift away from holding fund shares and in favor of holding "bonds." (Here
we stretch the term to cover all primary securities stocks, bonds, promissory
notes, mortgage obligations, and the like issued by the users of the resources so
obtained and even to cover any real estate and other physical assets in which funds
might invest.) Accordingly, the rate of return paid on fund shares rises, while the
bond rate falls, the latter being an average rate of retum on "bonds" in our
stretched sense of the word. That is to say, the spread of the bond rate over the share
rate the price of intermediation services falls, as is to be expected in conse-
quence of the postulated decline in demand for those services. The unit-of-account
volume of fund shares supplied goes down, matching the decline in demand for
them.
For an example of an automatically accommodated increase in demand for media
of exchange, suppose that some development expands the real size of the economy
at full employment. Under an ordinary monetary system, an accommodating expan-
sion of the nominal money supply is limited by the monetary base (as determined by
policy or by the workings of a commodity standard) and by the determinants of the
money multiplier. Under the BFH system, no such limitation or contingency im-
pedes the expansion of fund shares. On the liability or equity side of their balance
sheets, funds find their owners willing to hold more shares. On their asset side,
funds find business firms willing to borrow more and issue more securities to

4Space constraints have forced deletion of our fuller discussion, as well as of our mathematical and
graphical analysis. Copies of this material are available upon request from Greenfield.

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312 : MONEY, CREDIT, AND BANKINC

finance taking advantage of the increased labor supply (if that, e.g.,
element making for real growth) and of expanded markets for output
Finally, let us suppose, or try to suppose, something analogous to ex
an ordinary money supply at the initiative of issuers. Under our existi
central bank expands the stock of base money, the banking system re
refuses payment in the newly created money, and spending and resp
expanded money supply raises prices until it all is demanded as cash b
all.
Under the BFH system, by way of an analogy that will prove incomplete, the
funds step into the financial markets to grant loans and buy securities, paying with
their own newly created shares. The more imprudently expanding funds face ad-
verse clearing balances and the necessity of surrendering assets acceptable in inter-
fund settlements. This happens not only because of their relatively great expansion
of shares against which checks are now being written but also because doubts about
their soundness lead owners to shift their holdings into more prudent funds. Both
the asset portfolios of and shareholdings in the relatively imprudent funds decline
not only in amount but also in price in terms of the unit of account, especially as
those funds must part with their least dubious assets in interfund settlements. The
settlement assets gained by the relatively prudent funds are not a close counterpart
of base money under our existing system and cannot support a multiple expansion of
assets and shares by those funds.
The crucial part of the story, however, is still to be told. As funds in general seek
increased earnings by expanding at their own initiative, the firms and individuals
borrowing from them or selling securities to them move to spend the shares thereby
acquired. Shares accordingly depreciate against commodities, the unit of account,
and funds' portfolio earnings. Just as would be th-e case were tastes simply to shift
away from shareholdings and in favor of current consumption, share rates of return
and then bond interest rates rise, discouraging the funds' supply of shares to the
public and issuers' supply of primary securities to the funds. The funds' efforts to
expand meet restraint after all.
Under both our existing system and the BFH system, the real volume of media of
exchange is determined by demand (interacting with supply); and under the BFH
system, fixity of the unit of account means that the volume measured in it, the
nominal volume, is demand-determined also. This condition shields the BFH sys-
tem from the macroeconomic disorder that does accompany an excess demand for
or supply of money in our existing system. The BFH system has no clearly distinct
medium of exchange that routinely flows to lubricate transactions in goods and
services in such a way that expansion or restriction of its flow would do great
damage. The medium of exchanger a major part of it, shareholdings in funds-
has a flexible price in terms of the stable-by-definition unit of account. (Recall the
distinction between an asset's being denominated in a unit and its having a value
expressible in that unit. ) The total quantity of the medium of exchange-if that total
is meaningful at all, in view of the vague and shiftable distinction between the
exchange medium and investment assets tends to adjust, as we have seen, to

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 ROBERT L. GREENFIELD AND LELAND B. YEAGER : 313

accommodate the demand for it. (Thus, the "natural economic limit" attributed by
James Tobin [1 1], erroneously, to the nominal size of a money and banking system
of our current type would operate under the BFH system.)

6. OPERATIONALITY AND DETERMINACY

Some readers may still be wondering whether the physical definition of the unit
of account has operational meaning and whether the level of prices expressed in that
unit is determinate. Determinacy, as Schumpeter [10] said of a monetary system,
presupposes the specification from outside the market process of some "critical
figure," some nominal magnitude .(as by control of the number of money units in
existence or, altematively, by operational specification of the money price of some
commodity or composite of commodities).
In the BFH system, that "critical figure" can only be theS commodity-bundle
definition of the unit of account. That definition leaves the individual prices of the
items in the bundle free to respond to supply and demand changes. Could market
conditions, then, establish prices that, when multiplied by the specified quantities,
add up to more (or less) than 1 unit of account, contradicting the unit's definition?
Our reassuring answer does not rest on a circular argument. We do suppose but
on empirical grounds, namely, the tremendous convenience of a generally em-
ployed unit of account that people take the government-suggested unit seriously in
expressing prices, debts, and accounts. That unit has no plausible rivals. In an
ordinary monetary system, the unit in which the medium of exchange is denomi-
nated remains available as an alternative to any proposed commodity-bundle unit.
The BFH system, however, happily lacks any homogeneous medium of exchange
denominated in units of itself.
Suppose that the BFH bundle were defined as 1 apple + 1 banana + 1 cherry.
Prices are to be paid and debts settled in bundles-worths of convenient payment
property. Now apples are struck by a fungus. What market forces arise to accom-
plish the appropriate changes in relative prices while still enforcing the unit's
definition?
We know that apples should rise in price relative to miscellaneous goods and
services and to bananas and cherries also. By hypothesis, bundles are now more
difficult to obtain. And if it is more difficult to come by a BFH bundle, then it is
more difficult to come by anything worth a BFH bundle. People therefore offer
bundles-or bundles-worths of payment property less eagerly than before in try-
ing to buy miscellaneous commodities, whose prices therefore fall relative to the
bundle itself.
Now, the banana and the cherry, besides being components of the bundle, are
themselves desired commodities. They therefore number among the goods for
which people bid less eagerly in view of the hypothesized increased difficulty of
obtaining bundles and so bundles-worths of payment property. The resulting fall in
the prices of bananas and cherries counterbalances the increased unit-of-account
price of apples.

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314 : MONEY, CREDIT, AND BANKING

This view of the market process that maintains the commodity-bundle definition
of the unit of account emphasizes the advantages of defining the BFH bundle in a
more comprehensive way. In our simple example of a three-fruit bundle, the general
price level comes under substantial downward pressure when apples are attacked by
the fungus. Such pressure, confronting sluggishly adjusting disequilibrium prices,
can impede exchange and so impede production and employment. This impedi-
ment, however, is a consequence of utilizing such a narrowly defined bundle.
If the bundle were more widely defined, the undisturbed supply conditions of the
other items composing it would mitigate the deflationary impact of the worsened
apple-supply conditions. Bundles and bundles-worths of property would become
only marginally more difficult to come by, and as a result, the general price level
would come under only slight deflationary pressure. Thus, the wider the definition
of the bundle, the greater the degree to which appropriate changes in relative price
are effected by change in the unit-of-account price of any particular bundle compo-
nent struck by altered supply or demand conditions. A widely defined bundle thus
concentrates the impact of such changes, avoiding widespread and possibly painful
repercussions.

The absence of convertibility of a familiar type lacks the ominous consequences

that it might have in a monetary system with a homogeneous medium of exchange.
Under the often-proposed composite-commodity standard, for example, in which
the paper dollar is set equal in value to a certain bundle of commodities, tension
arises between regarding the paper dollar and regarding the commodity bundle as
the unit of account. In such a system, two-way convertibility must be maintained to
prevent a divergence of the two units. The BFH system, however, lacking as it does
any paper dollar that might rival the commodity bundle as the unit of account, never
permits such tension to arise. Absence of a rival unit makes the BFH system's lack
of convertibility of the usual sort irrelevant to the system's operationality and
determinacy. Worries about lack of convertibility reflect an understandable but
inappropriate carry-over of concepts suited to existing monetary systems instead.
The BFH system of sophisticated barter does seem to avoid the disadvantages
both of crude barter and of money as we have known it. We postpone considering a
transition to the BFH system. It is a type of reform whose success does not hinge on
its early adoption. (In contrast, one might plausibly argue that delay in adopting the
program of today's monetarists threatens to entrench a situation in which rapid
institutional change and the blurring of the very concept of money will have made
that program no longer workable.) Regardless of whether the BFH system ever is
adopted, the proposal offers a fresh slant on some crucial aspects of actual monetary
systems.

LITERATURE CITED

1. Black, Fischer. "Banking and Interest Rates in a World without Money." Journal of
Bank Research (Autumn 1970), 8-20.

2. Eucken, Walter. The Foundations of Economics. Translated by T. W. Hutchison. Lon-

don: Hodge, 1950.

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 ROBERT L. GREENFIELD AND LELAND B. YEAGER : 315

3. Fama, Eugene F. "Banking in the Theory of Finance." Journal of Monetary Econom-

ics, 6 (1980), 39-57.

4. Fisher, Irving. Stabilizing the Dollar. New York: Macmillan, 1920.

5. Hall, Robert E. "The Government and the Monetary Unit." Unpublished manuscript,
1981.

6. . "Monetary Strategies for Ending Inflation." Contribution to a panel discussion

chaired by Michael R. Darby and also including Eugene F. Fama, Milton Friedman, and
Roy W. Jastram at the meetings of the Western Economic Association, San Francisco,
July 5, 1981, recorded on cassette tapes 18A and 18B by Audio-Stats, Marina del Rey,
California.

7. . "Explorations in the Gold Standard and Related Policies for Stabilizing the
Dollar." In Inflation: Causes and Eects, edited by Robert E. Hall, pp. 111-22.
Chicago: University of Chicago Press for National Bureau of Economic Research, 1982.

8. Hayek, Friedrich A. The Sensory Order. London: Routledge & Kegan Paul, 1952.

9. Rittershausen, Heinrich. Bankpolitik. Frankfurt: Knapp, 1956.

10. Schumpeter, Joseph A. Das Wesen des Geldes. Edited from manuscript (mostly drafted
by around 1930) and with an introduction by Fritz Karl Mann. Gottingen: Vandenhoeck
& Ruprecht, 1970.

11. Tobin, James. "Commercial Banks as Creators of 'Money. ' " In Banking and Monetary
Studies, edited by Deane Carson, pp. 408-19. Homewood, Ill.: Irwin, 1963.

12. Yeager, Leland B. "Essential Properties of the Medium of Exchange." Kyklos, 21

(1968), 45-69. Reprinted in Monetary Theory: Selected Readings, edited by Robert W.
Clower, pp. 37-60. Baltimore: Penguin, 1969.

13. . "What Are Banks?" Atlantic Economic Journal, 6 (December 1978), 1-14.

14. . "Sticky Prices or Equilibrium Always?" Presented at the meetings of the

Western Economic Association, San Francisco, July 7, 1981.

15. . "Stable Money and Free-Market Currencies." Paper for a Cato Institute Con-
ference of January 21-22, 1983. Cato Journal, 6 (Spring 1983).

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