AEP and “The Chicago Plan Revisited

Towards the end of last year, Ambrose Evans-Pritchard discovered the IMF working paper “The Chicago Plan Revisited” (PDF), which “revives the scheme first put forward by professors Henry Simons and Irving Fisher in 1936 during the ferment of creative thinking in the late Depression”. He was perplexed:

Arguably, it would smother freedom and enthrone a Leviathan state. It might be even more irksome in the long run than rule by bankers. Personally, I am a long way from reaching an conclusion in this extraordinary debate. Let it run, and let us all fight until we flush out the arguments. One thing is sure. The City of London will have great trouble earning its keep if any variant of the Chicago Plan ever gains wide support.

In the spirit of the second paragraph, I intend in this essay to outline a more accurate history of the antecedents of this plan advocated by the Chicago monetarists.  I show the Austrian heritage that predates this, and show how and why the Austrian proposal of Jesus Huerta de Soto is actually freedom-enhancing. On the way, we will also suggest where Ambrose Evans-Prichard may wish to revise his views on the origin of money.

The Austrian School settings of what has become known as the Chicago Plan

I draw to your attention this letter between Prof Jesus Huerta de Soto and the two IMF authors, sent on the 9th of October:

Dear Michael and Jaromir, After reading the e-mail between my disciple working in the Stability Department of the Bank of Spain Dr. Antonio Pancorbo and Michael Kumhof (August 29 and 31, 2012) I would like to stress the point that the 100 per cent proposal was launched for the first time by Ludwig von Mises in the 1912 first edition of his “Theory of Money and Credit”, as recognized by the Chicago School economists of the 1930’s (see specially Albert G. Hart, “The Chicago Plan of Banking Reform”, Review of Economics Studies 2, 1935, footnote p. 104). Of course, in 1912 the Gold Standard was still in force, but this should not be interpreted as if there should be a necessary link between the 100 per cent proposal and the reintroduction of the Gold Standard. Although Austrian economists generally support both reforms, they would be happy, as a second best, with the 100 per cent proposal for the reasons originally given by Mises in 1912 (specially the need to avoid artificial credit expansions not backed by previous real genuine savings). In my opinion your most interesting paper would be improved in its part dedicated to the history of the 100% proposal with the recognition to the Mises original contribution. Furthermore, if you should have considered in your model the huge malinvestments induced through each cycle by credit expansions financed by the current fractional reserve banking system (which are analyzed in detail by the Austrian Business Cycle Theory), the introduction of the 100 per cent reserves reform would produce output gains significantly higher than the 10 per cent you mention in your paper. Finally you probably will be interested to know the growing political and popular debate on the 100 per cent reform that is taking place in Europe. To show this see enclosed the “Hayek Memorial Lecture” I delivered at the London School of Economics in which I mention the piece of legislation proposed by two Tory MP’s at the British Parliament aimed at the establishment of 100 per cent banking for demand deposits, as well as the English version of the movie produced by my department of economics at King Juan Carlos University that was showed at the Spanish TV defending the 100 per cent proposal and which got 7 per cent of total audience (!__english ). Sincerely yours, Jesús Huerta de Soto Catedrático de Economía Política Universidad Rey Juan Carlos P.S.: From the methodological point of view I think we should be a little bit more humble regarding both the evaluation of the historical “evidence” (that Michael Kumhof believes shows “unequivocally” a pure fiat money system is far superior to a gold standard) and the “evidence” obtained from your model (that should not be considered more than a “potentially illustrative abstraction”).

A full video and the speech of my 2010 Hayek Lecture at the LSE where Prof Huerta de Soto spoke are available here. Prof Jesus Huerta de Soto’s 1998 book, translated to English in 2006 as Money, Bank Credit and Economic Cycles, can be downloaded here (PDF). Chapter 9 discusses all the 20th Century proposals for reform on these lines and the Nobel winners who have supported proposals in this tradition. Huerta de Soto then discuses his proposal and the implications for a free society. Ambrose Evans-Prichard may learn much from these links to serious scholarship. In short, Huerta de Soto swaps immaterial demand deposits for physical cash. He does not use bonds. The physical cash is a one-off printing of notes by the state in direct exchange for ownership of these bank liabilities (the demand deposits), which it can promptly destroy, thus leaving the banks and their customers owning what they think they own: their own money. And the banks, being liberated from having these current liabilities, now have the asset side of their balance sheet intact with no demand deposit liability. The increase in bank net worth should be able to pay off the national debt, which of course is simply a byproduct of this reform. The real aim is to fix money to gold and abolish the central bank, which would then remove monetary socialism from our system. With stable and honest money, redeemable in a commodity once more, and with governments nowhere near it, freedom and liberties would be massively boosted. However, it is best to read the actual proposal rather than my quick and dirty summary. Evans-Pritchard’s Telegraph colleague, Daniel Hannan, MEP, asked me to put forward this proposal in no more than 1200 words and offer a reward for anyone who could refute it. I did, the link is here and no one has refuted it. If you read through the comments thread, you will see various attacks and rebuttals and points of clarification. Fantastical as this all may sound, in the cold light of day it does stack up and it may well be the only solution left to the authorities should the system collapse again. After all, not much good can come from nationalising an already state-dominated money and banking system.

The origins of money

Ambrose Evans-Pritchard has a different view as to the origins of money from myself. He disagrees with the account of Adam Smith and he claims that Aristotle says, in Ethics, that money was fiat and derived its value from the state. I will see if his assertions can withstand scrutiny by going to the texts themselves, and I will take this in chronological order.


The claim:

Anthropological studies show that social fiat currencies began with the dawn of time. The Spartans banned gold coins, replacing them with iron disks of little intrinsic value. The early Romans used bronze tablets. Their worth was entirely determined by law – a doctrine made explicit by Aristotle in his Ethics – like the dollar, the euro, or sterling today.

In all of the works of Aristotle, at best we may find 20-30 pages of economics. I find nothing on the origins of money in Ethics. I am happy to be proved wrong, but I do find the relevant points in his Politics which I reprint in full from “The Complete Works of Aristotle , Vol 2″ – John Barnes (Princeton / Bollingen Series LXX1.2, 1257 a1, Book 1, 9, line 18 to line 10 of 1257b1, pages 1994-1995)

In the first community, indeed, which is the family, this art is obviously of no use, but it begins to be useful when the society increases. For the members of the family originally had all things in common; later, when the family divided into parts, the parts shared in many things, and different parts in different things, which they had to give in exchange for what they wanted, a kind of barter which is still practiced among barbarous nations who exchange with one another the necessaries of life and nothing more; giving and receiving wine, for example, in exchange for coin, and the like. This sort of barter is not part of the wealth-getting art and is not contrary to nature, but is needed for the satisfaction of men’s natural wants.


The other or more complex form of exchange grew, as might have been inferred, out of the simpler. When the inhabitants of one country became more dependent on those of another, and they imported what they needed, and exported what they had too much of, money necessarily came into use. For the various necessaries of life are not easily carried about, and hence men agreed to employ in their dealings with each other something which was intrinsically useful and easily applicable to the purposes of life, for example, iron, silver, and the like. Of this the value was at first measured simply by size and weight, but in process of time they put a stamp upon it, to save the trouble of weighing and to mark the value. When the use of coin had once been discovered, out of the barter of necessary articles arose the other art of wealth getting, namely, retail trade; which was at first probably a simple matter, but became more complicated as soon as men learned by experience whence and by what exchanges the greatest profit might be made. Originating in the use of coin, the art of getting wealth is generally thought to be chiefly concerned with it, and to be the art which produces riches and wealth; having to consider how they may be accumulated. Indeed, riches is assumed by many to be only a quantity of coin, because the arts of getting wealth and retail trade are concerned with coin.

The natural and spontaneous discovery by man of money, as the final means for complex exchange, that over and above barter, was seemingly explored by Aristotle in Politics and not in Ethics. Also there is no mention of fiat money. There is also the traditional story of the origin of money as a solution to the double coincidence of wants. Another commodity, the most marketable, called money, was used to facilitate indirect exchange. All of this from Aristotle would seem to be diametrically opposed to Evans-Pritchard’s understanding of the great polymath. Aristotle can be cited as one of the first economists to talk about the spontaneous origins of money, but he has erroneously been presented as an intellectual ancestor to Georg Friedrich Knapp, author of ‘The State Theory of Money’. The phrase “they put a stamp upon it” has been taken to imply that money has value because the state has endorsed it. Some people put their 21st century hats on, and assume the state introduced the quality stamp, but these were private mints stamping money; there is no evidence of state-owned mints at this time. More importantly, the stamp simply gave comfort to users of money that the coins had the requisite metallic content. This prevented deception, supporting the subjective value that money-holders attached to money, but it did not create the subjective value. This is a point lost by many Chartalist thinkers. Ambrose Evans-Pritchard would have us believe that private money is an aberration:

The conjuring trick [of the Chicago Plan] is to replace our system of private bank-created money — roughly 97pc of the money supply — with state-created money. We return to the historical norm, before Charles II placed control of the money supply in private hands with the English Free Coinage Act of 1666.

Money was a means to overcome barter. Some two and a half thousand years ago, Aristotle noted how this was a spontaneous, market-driven process. It is true that the notes and coins produced by today’s states form a small percentage of the overall supply of money. Money has always been largely a creature of the private sector, though there is also a long history of government meddling and debasement.  Here’s what Adam Smith has to say on the matter:

From the time of Charlemagne among the French, and from that of William the Conqueror among the English, the proportion between the pound, the shilling, and the penny, seems to have been uniformly the same as at present, though the value of each has been very different; for in every country of the world, I believe, the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been originally contained in their coins. The Roman as, in the latter ages of the republic, was reduced to the twenty-fourth part of its original value, and, instead of weighing a pound, came to weigh only half an ounce. The English pound and penny contain at present about a third only; the Scots pound and penny about a thirty-sixth; and the French pound and penny about a sixty-sixth part of their original value. By means of those operations, the princes and sovereign states which per-formed them were enabled, in appearance, to pay their debts and fulfill their engagements with a smaller quantity of silver than would otherwise have been requisite. It was indeed in appearance only; for their creditors were really defrauded of a part of what was due to them. All other debtors in the state were allowed the same privilege, and might pay with the same nominal sum of the new and debased coin whatever they had borrowed in the old. Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor, and have sometimes produced a greater and more universal revolution in the fortunes of private persons, than could have been occasioned by a very great public calamity.

All value is determined subjectively. The politicians in the Weimar Republic could not convince their citizens to accept the value of the money that they were issuing in bucket loads. Like King Canute, they can stand in front of the sea and command it to go back, but the millions of subjective valuations will never respond to a state decree of value. Adam Smith Let us now consider Ambrose Evans-Pritchard’s reference to Adam Smith and his views on the origin of money.

It is a myth – innocently propagated by the great Adam Smith – that money developed as a commodity-based or gold-linked means of exchange. Gold was always highly valued, but that is another story. Metal-lovers often conflate the two issues.

When accusing a scholar of such standing as Adam Smith to be labouring under a myth, you really have to be sure of what you are alleging. Again, we will go to the original source and see if AEP’s claim stacks up to closer scrutiny.

3rd Edition 1784 Pages 33-42 CHAPTER IV OF THE ORIGIN AND USE OF MONEY The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. But they have nothing to offer in exchange, except the different productions of their respective trades, and the butcher is already provided with all the bread and beer which he has immediate occasion for. No exchange can, in this case, be made between them. He cannot be their merchant, nor they his customers; and they are all of them thus mutually less serviceable to one another. In order to avoid the inconveniency of such situations, every prudent man in every period of society, after the first establishment of the division of labour, must naturally have endeavoured to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as he imagined few people would be likely to refuse in exchange for the produce of their industry. Many different commodities, it is probable, were successively both thought of and employed for this purpose. In the rude ages of society, cattle are said to have been the common instrument of commerce; and, though they must have been a most inconvenient one, yet, in old times, we find things were frequently valued according to the number of cattle which had been given in exchange for them. The armour of Diomede, says Homer, cost only nine oxen; but that of Glaucus cost a hundred oxen. Salt is said to be the common instrument of commerce and exchanges in Abyssinia; a species of shells in some parts of the coast of India; dried cod at Newfoundland; tobacco in Virginia; sugar in some of our West India colonies; hides or dressed leather in some other countries; and there is at this day a village in Scotland, where it is not uncommon, I am told, for a workman to carry nails instead of money to the baker’s shop or the ale-house. In all countries, however, men seem at last to have been determined by irresistible reasons to give the preference, for this employment, to metals above every other commodity. Metals can not only be kept with as little loss as any other commodity, scarce any thing being less perishable than they are, but they can like- wise, without any loss, be divided into any number of parts, as by fusion those parts can easily be re-united again; a quality which no other equally durable commodities possess, and which, more than any other quality, renders them fit to be the instruments of commerce and circulation. The man who wanted to buy salt, for example, and had nothing but cattle to give in exchange for it, must have been obliged to buy salt to the value of a whole ox, or a whole sheep, at a time. He could seldom buy less than this, because what he was to give for it could seldom be divided without loss; and if he had a mind to buy more, he must, for the same reasons, have been obliged to buy double or triple the quantity, the value, to wit, of two or three oxen, or of two or three sheep. If, on the contrary, instead of sheep or oxen, he had metals to give in exchange for it, he could easily proportion the quantity of the metal to the precise quantity of the commodity which he had immediate occasion for. Different metals have been made use of by different nations for this purpose. Iron was the common instrument of commerce among the ancient Spartans, copper among the ancient Romans, and gold and silver among all rich and commercial nations.

In summary , the division of labour causes and excess of goods needed for direct exchange, which allows a whole host of other commodities to be used to facilitate indirect exchange until various metals get settled on. In discussing the use of metals and the control of the abuse of weights he comments as follows:

To prevent such abuses, to facilitate exchanges, and thereby to encourage all sorts of industry and commerce, it has been found necessary, in all countries that have made any considerable advances towards improvement, to affix a public stamp upon certain quantities of such particular metals, as were in those countries commonly made use of to purchase goods. Hence the origin of coined money, and of those public offices called mints; institutions exactly of the same nature with those of the aulnagers and stamp-masters of woollen and linen cloth. All of them are equally meant to ascertain, by means of a public stamp, the quantity and uniform goodness of those different commodities when brought to market. The first public stamps of this kind that were affixed to the current metals, seem in many cases to have been intended to ascertain, what it was both most difficult and most important to ascertain, the goodness or fineness of the metal, and to have resembled the sterling mark which is at present affixed to plate and bars of silver, or the Spanish mark which is sometimes affixed to ingots of gold, and which, being struck only upon one side of the piece, and not covering the whole surface, ascertains the fineness, but not the weight of the metal.

So money arises from the people, via various commodities, with metals being selected invariably as first choice. The public minting process starts privately and then various despots, tyrants, governments get behind the stamping of coins.  Gold is a part of this process, but is one of many commodities. The key point is that money started its life as a commodity. Further on in this section, Smith gives many examples in history of how various commodities were used and references various texts to prove it.  Pliny is quoted from the Timaeus, Abraham and Ephron are used as examples, along with Henry III, Henry VIII and Robert the Bruce. I doubt Smith is labouring under a myth. I find his reasoning and examples compelling. Chartalists who hold, like Evans-Prichard, that money is the creature of the state often cite various examples of credit being granted in ancient empires long forgotton, but upon closer inspection you will see that some good was being exchanged and that the creation of a running tab of credit to facilitate these exchanges only prolonged the act of completing a transaction for commodity money. A relatively modern example is tally sticks. A notched stick was split, with one half given to the person who advanced money, and the other to the person who had received it.  Matching the unique split between the two parts made sure you could not put more notches (claims to real money) on it as further transactions were embarked upon. Note that in all of this, money was the final settlement and the initial act to kick off the transaction and the credit. All these credit instruments mentioned by the Chartalist School and State Theory of Money School miss out this critical point. Credit was always eventually settled in money. Before fiat money proper, money was always a commodity of some kind or commodity-backed. This is an indisputable fact. With a correct understanding of money’s origin, we can understand why it has value. Understanding this will enable us to conclude that if the state tries to detach money from the valuations of it by its citizens, it will cease to be an effective money. In a short period of time it will not be money. Ludwig von Mises shows us why in his 1912 book “The Theory of Money and Credit.”


XVII. INDIRECT EXCHANGE 4. The Determination of the Purchasing Power of Money As soon as an economic good is demanded not only by those who want to use it for consumption or production, but also by people who want to keep it as a medium of exchange and to give it away at need in a later act of exchange, the demand for it increases. A new employment for this good has emerged and creates an additional demand for it. As with every other economic good, such an additional demand brings about a rise in its value in exchange, i.e., in the quantity of other goods which are offered for its acquisition. The amount of other goods which can be obtained in giving away a medium of exchange, its “price” as expressed in terms of various goods and services, is in part determined by the demand of those who want to acquire it as a medium of exchange. If people stop using the good in question as a medium of exchange, this additional specific demand disappears and the “price” drops concomitantly. Thus the demand for a medium of exchange is the composite of two partial demands: the demand displayed by the intention to use it in consumption and production and that displayed by the intention to use it as a medium of exchange. With regard to modern metallic money one speaks of the industrial demand and of the monetary demand. The value in exchange (purchasing power) of a medium of exchange is the resultant of the cumulative effect of both partial demands. Now the extent of that part of the demand for a medium of exchange which is displayed on account of its service as a medium of exchange depends on its value in exchange. This fact raises difficulties which many economists considered insoluble so that they abstained from following farther along this line of reasoning. It is illogical, they said, to explain the purchasing power of money by reference to the demand for money, and the demand for money by reference to its purchasing power. The difficulty is, however, merely apparent. The purchasing power which we explain by referring to the extent of specific demand is not the same purchasing power the height of which determines this specific demand. The problem is to conceive the determination of the purchasing power of the immediate future, of the impending moment. For the solution of this problem we refer to the purchasing power of the immediate past, of the moment just passed. These are two distinct magnitudes. It is erroneous to object to our theorem, which may be called the regression theorem, that it moves in a vicious circle. But, say the critics, this is tantamount to merely pushing back the problem. For now one must still explain the determination of yesterday’s purchasing power. If one explains this in the same way by referring to the purchasing power of the day before yesterday and so on, one slips into a regressus in infinitum. This reasoning, they assert, is certainly not a complete and logically satisfactory solution of the problem involved. What these critics fail to see is that the regression does not go back endlessly. It reaches a point at which the explanation is completed and no further question remains unanswered. If we trace the purchasing power of money back step by step, we finally arrive at the point at which the service of the good concerned as a medium of exchange begins. At this point yesterday’s exchange value is exclusively determined by the nonmonetary –industrial–demand which is displayed only by those who want to use this good for other employments than that of a medium of exchange. But, the critics continue, this means explaining that part of money’s purchasing power which is due to its service as a medium of exchange by its employment for industrial purposes. The very problem, the explanation of the specific monetary component of its exchange value, remains unsolved. Here too the critics are mistaken. That component of money’s value which is an outcome of the services it renders as a medium of exchange is entirely explained by reference to these specific monetary services and the demand they create. Two facts are not to be denied and are not denied by anybody. First, that the demand for a medium of exchange is determined by considerations of its exchange value which is an outcome both of the monetary and the industrial services it renders. Second, that the exchange value of a good which has not yet been demanded for service as a medium of exchange is determined solely by a demand on the part of people eager to use it for industrial purposes, i.e., either for consumption or for production. Now, the regression theorem aims at interpreting the first emergence of a monetary demand for a good which previously had been demanded exclusively for industrial purposes as influenced by the exchange value that was ascribed to it at this moment on account of its nonmonetary services only. This certainly does not involve explaining the specific monetary exchange value of a medium of exchange on the ground of its industrial exchange value. Finally it was objected to the regression theorem that its approach is historical, not theoretical. This objection is no less mistaken. To explain an event historically means to show how it was produced by forces and factors operating at a definite date and a definite place. These individual forces and factors are the ultimate elements of the interpretation. They are ultimate data and as such not open to any further analysis and reduction. To explain a phenomenon theoretically means to trace back its appearance to the operation of general rules which are already comprised in the theoretical system. The regression theorem complies with this requirement. It traces the specific exchange value of a medium of exchange back to its function as such a medium and to the theorems concerning the process of valuing and pricing as developed by the general catallactic theory. It deduces a more special case from the rules of a more universal theory. It shows how the special phenomenon necessarily emerges out of the operation of the rules generally valid for all phenomena. It does not say: This happened at that time and at that place. It says: This always happens when the conditions appear; whenever a good which has not been demanded previously for the employment as a medium of exchange begins to be demanded for this employment, the same effects must appear again; no good can be employed for the function of a medium of exchange which at the very beginning of its use for this purpose did not have exchange value on account of other employments. And all these statements implied in the regression theorem are enounced apodictically as implied in the apriorism of praxeology. It must happen this way. Nobody can ever succeed in construction a hypothetical case in which things were to occur in a different way.

Mises gives us the theory to explain the subjective value origins of money. It applies to all points in the history of money. Grasp this theory and you are liberated from the state view of money once and for all.

Will Commodity Money be the End of the City of London?

Evans-Pritchard seems to think the Chicago Plan would change the role of the City of London. Here, at last, he’s right. Banks would need to lend real savings, rather than simply extending credit. This is a good thing. Why? When you save, you refrain from consumption and put away money for future purchases.  One day you will buy goods and services made by entrepreneurs who have been lent your savings.  Thus, the right amount of money will be set aside to produce the right amount of goods and services in the future. The caveat is that entrepreneurs need to stay focused on producing what future consumers want. Thankfully, in the absence of quick and easy credit only competent entrepreneurs can survive. With a sound banking system as suggested by Prof Huerta de Soto, and real savings and investment, we can see a return to the entrepreneurial glory days of our nation. But as long as the government retains the power to create money, our prosperity will be at risk.

Ron Paul’s Monetary Policy Anthology

I received an email the other day from Paul-Martin Foss, Legislative Assistant at the Office of Congressman Ron Paul:

Dear Friends of Dr. Paul, If you are receiving this email, it is because you are a friend of Dr. Paul, a witness at one of our monetary policy hearings, a contributor to what has become Dr. Paul’s Monetary Policy Anthology, or likely some combination of the three. To honor and preserve Dr. Paul’s legacy as Chairman of the Subcommittee on Domestic Monetary Policy, we have compiled an anthology containing all of Dr. Paul’s activities as chairman. It contains all of his hearings within the DMP subcommittee, transcripts of our Tea Talk Lecture Series, transcripts of his exchanges with Fed Chairman Bernanke, etc. As a single document, the anthology as formatted runs to over 5000 pages, so we are splitting it into multiple sections and hosting it on Dr. Paul’s Congressional website. Today is the only day that those files will be available online, because today is the last day of the 112th Congress and our website will likely be taken down by close of business today.

Mr Foss subsequently uploaded the files to Dropbox for posterity. We have also archived them in our Downloads section. Here are the direct links: