Is there a paradox of indirect convertibility?

I. Indirect Convertibility

A paradox allegedly plagues systems in which money is only indirectly, not directly, convertible (or redeemable; we use the words interchangeably). Knut Wicksell, W. William Woolsey, John Whittaker and Norbert Schnadt, Tyler Cowen and Randall Kroszner, and Hans-Michael Trautwein have described scenarios in which indirect convertibility would have catastrophic consequences [21; 23; 17; 18; 19; 3; 20].

Currency, deposits, and checks are indirectly convertible when they are not redeemed directly in the medium of account. (The latter term is Niehans's; it means the commodity or commodity bundle of which some specified quantity defines the unit of account [16, 1].) Money is redeemable, instead, in some redemption medium--some other commodity or even some security--in amounts equal in value to the quantity of medium of account defining the unit.

Recent proposals combine indirect convertibility with free banking, promising to stabilize the price level and avoid monetary disequilibrium that would disturb income and employment [13; 12; 25; 26; 27; 28; 4]. In this BFH system (so named, perhaps misleadingly, to acknowledge ideas borrowed, altered, and recombined from writings of Fischer Black, Eugene Fama, and Robert Hall), government money is forbidden. Only competing private banks issue notes, coins, and checking accounts.

Earlier proposals assumed government issue of currency. Simon Newcomb and Aneurin Williams advocated money convertible into whatever variable amount of gold, as redemption medium, had a fixed general purchasing power [15; 22]. Irving Fisher, citing their proposals, argued that the dollar could be stabilized through convertibility into an amount of gold equal in value to a bundle of goods [10, 331-2]. (Indirect convertibility is not the same as Fisher's better-known proposal for a "compensated dollar" [8, 337-47; 10, 494-502; 11, 95-7]. In place of his earlier brief suggestion for indirect convertibility, Fisher later envisaged periodic discrete adjustments in the gold content of the dollar, that is, in the official price of gold, prompted by deviations of a price index from target. The reader should be careful to distinguish indirect convertibility from the compensated dollar.)

Advantages of indirect convertibility, including lessened danger of panicky scrambles for the redemption medium, are beginning to command attention [5]. Allegedly, though, a paradox blocks achieving them.

We will describe Wicksell's version of the paradox. We believe that his scenario points to a serious problem. If the actual market price of the medium of account was somehow shocked away from its "official" price, the changes in the quantity of money and total spending necessary to reverse that deviation could impinge on output and employment. That impact would be especially severe if the price of the medium of account was "sticky". Wicksell, however, glosses over that pedestrian macroeconomic concern and instead describes extreme fluctuations in the price of the redemption medium. We believe that part of his paradox scenario is implausible.

II. Wicksell on the Paradox

Anderson's System

The paradox of indirect convertibility appears first, to our knowledge, in Knut Wicksell's reply to an attack on the quantity theory of money (one whose details need not concern us) mounted by Benjamin Anderson [21; 1, 150-51]. Anderson had postulated a dollar defined by a fixed weight of gold. None is coined, however. Government paper dollars are redeemable not in gold but in whatever (changeable) amount of silver has a market value actually equal to that of the dollar-defining amount of gold. In the other direction, the government issues a new paper dollar against that amount of silver. The dollar always remains worth the specified unit amount of gold. Anderson finds total quantities of redemption medium and money irrelevant to the dollar's value. (In other versions of indirect convertibility, some composite good is the medium of account. The reader should pay close attention, in the examples that follow, to what is the redemption medium and what is the medium of account.)

Wicksell's Critique

Besides scoring other points, Wicksell argued that Anderson's system of indirect convertibility would collapse in the face of an increase in the relative price of gold. He supposed that the dollar-defining unit quantity of gold is initially worth 30 times as much--30 weight-units of--silver. Now a change in demand for or supply of gold doubles the price of its unit amount to $2 in paper money. (The reader may be bothered already, but that is what Wicksell supposes.) Accordingly, a dollar bill becomes redeemable in and issuable against 2 times 30 = 60 units of silver. The implied great cheapening of silver spurs its industrial consumption, which draws on the government's reserves. The prices of all commodities except silver remain nearly unchanged for the time being. Even though gold supposedly defines the dollar, Wicksell's scenario has it temporarily continuing to command its new market price of $2, which is worth 120 units of silver, since the government is delivering 60 units per dollar redeemed. This situation now forces the government to raise its redemption and issue price of the dollar bill to 120 units of silver, making 1 unit of gold become worth approximately 240 units of silver on the market, and so on.

Each new cheapening of silver further spurs its use, perhaps even for cookware. On Wicksell's assumptions about the elasticity of industrial demand for silver and about the government's silver reserves relative to the money supply, the reserves would run out before the paper-money circulation, and with it the prices of gold and other things, had fallen by more than a few percent. The government would have to abandon the system and leave paper money irredeemable. Its attempt to restore the dollar to parity with appreciated gold would have failed.

The system would fare less badly in the face of an initial decline in the value of gold, say to haft a dollar. The government would accordingly reduce the amount of silver delivered in each redemption and required against newly issued money. A self-reinforcing rise in the government's price of silver would spur the melting of silver objects and delivery of silver to the government for newly issued money. The resulting great monetary expansion would raise prices in general until a unit of gold, though rising in price less sharply than other things, was eventually worth 1 full dollar again, as before the disturbance. (Indirect, like direct, convertibility works asymmetrically: there is a limit, namely zero, to how low reserves of the redemption medium can fall but no definite limit to how high they can rise. At the new equilibrium price level in the second case, although gold has been restored to its money value implied by the dollar's definition, it remains cheaper relative to goods and services in general than before the postulated fundamental shift in its supply or demand.)

If the initial supply or demand shift affected the market value of silver, the redemption medium, rather than the value of gold, the complications described would not occur. The government could allow the price used in its calculations at the redemption window to change to reflect the new fundamentals in the silver market.

Differences Between Direct and Indirect Convertibility

Wicksell's scenario points to an important distinction between direct and indirect convertibility. When gold serves as medium of account as well as redemption medium, two processes tend to fix the price of gold. First, the government can directly offset any shift tending to raise the price of gold by releasing enough gold from its reserve to correct the resulting shortage at the "official" price. Second, the withdrawal of currency from circulation simultaneously contracts the quantity of money and tends to restrain spending. That restraint indirectly corrects the shortage of gold by gradually decreasing its demand at the official price.

In Anderson's scheme, in which gold remained the medium of account but silver served as the redemption medium, the government could not directly correct a shortage of gold at its "official" price by releasing silver reserves. That release of reserves instead would lower the price of silver both on the market and at the government's redemption window. Only the second, indirect process would remain. As money was redeemed with silver, the consequent decrease in its quantity would tend to restrain spending and reduce the demand for gold (and most other things as well). Assuming that a change in the quantity of money would influence the demand for the medium of account only gradually, it becomes at least plausible that the actual market price of the medium of account could somehow be shocked above its "official" price.

Is the Price of Gold Stuck above Par?

The most important insight provided by Wicksell's scenario, in our view, is that serious problems would result if the price of the medium of account failed to return promptly to its defined price of one dollar. In his scenario, the actual market price of gold rose from $1 to $2, and then remained stuck at near its new inflated level. Given that assumption, maintaining indirect convertibility would be inconsistent with macroeconomic equilibrium. Or rather, the only possible equilibrium would be the absurd one in which all money had been redeemed. (Dowd emphasizes that point [6].) The quantity of money would be zero, as would be money expenditures. Assuming firms would not produce what they could not sell for money, then real output and employment would be zero as well.

A more plausible scenario is that the contraction of money and spending would cause the actual market price of the medium of account to decrease and return to its defined price of $1. Yet Wicksell's extreme assumption provides an important insight. If the price of the medium of account was only "sticky", a severe deflation of money and expenditures might be necessary to promptly return its actual market price to par. That could cause the prices of other goods and services to be driven below their long run equilibrium values, or if other prices were sticky as well, devastating decreases in output and employment.

Wicksell's scenario somewhat obscures this insight, for he criticized a system using gold as medium of account. A sticky price for gold seems implausible. (Speculation by gold traders, of course, might keep the price of gold from deviating away from its defined price of one dollar. The scenario, however, has gold's price stuck away from its defined price of $1.) Further, a doubling of the relative price of gold would require a 50 percent decrease in the price level, so even moderate stickiness of other prices would imply a devastating decrease in output and employment. That disaster, however, could not be attributed to indirect convertibility especially. Such a severe shock to the relative value of gold would cause similar devastation in the context of an ordinary gold standard.

The Price of the Redemption Medium

Wicksell, however, failed to discuss the consequences of a sticky price of the medium of account for output and employment. He instead emphasized the consequences for the price of silver, arguing that the government would be forced to suspend indirect convertibility before any significant deflationary pressure developed. We believe he was mistaken. His argument is at best misleading and marred by a small oversight. Worse, it suffers from major oversights regarding the avenues by which the government could maintain indirect convertibility.

In Wicksell's scenario, the price of gold doubled, so indirect convertibility obligated the government to sell silver from its redemption window for 50 percent of the current market price. (The amount of silver equal in weight to the amount of gold that defined the dollar was sold for approximately 1.67 cents (1/60) at the redemption window rather than for its original market price of approximately 3.33 cents (1/30). With the government selling silver at a bargain price, those needing it for industrial purposes would obtain it at the redemption window. Further, given the extreme price difference in Wicksell's scenario, arbitrageurs would redeem money for silver and sell it on the market. If the government was meeting redemption demands from its reserves, the release of its reserves would influence the fundamentals in the silver market, tending to drive down the market price.

Wicksell, however, described the process in a peculiar way. He argued as if the government could continue to sell silver from its redemption window for 1.67 cents until an equilibrium developed when the market price approached 1.67 cents as well. He explained that situation could not be an equilibrium after all, since given a market price of 1.67 cents, a dollar must be redeemed with 120 units of silver. That implies a price at the redemption window of approximately 0.83 cents. On Wicksell's account, indirect convertibility appears to cause a further 50 percent decrease in the price of silver during every "period" in which the price of gold remained double its official price.

That appearance, however, is misleading. Assuming the price of gold remained double its official price and ignoring speculation in the silver market, the price of silver would decrease continuously both on market and at the redemption window at a rate governed entirely by the quantity of silver reserves that had been released and the elasticities of supply and demand in the silver market. The sequential, periodic decreases in the price of silver follow solely from Wicksell's counterfactual assumption. If the government could keep the price of silver at its redemption window unchanged, an equilibrium would be obtained once the market price reached that same price. Leaving the price of silver at the redemption window fixed, however, would be inconsistent with indirect convertibility. As soon as the release of reserves caused any change in the market price of silver, the government would be required to decrease the price at its redemption window in proportion.

Speculation in the Silver Market

A small oversight mars Wicksell's presentation: he envisaged systematic successive decreases in the price of silver, but speculation would bring a prompt collapse instead. Holders of silver, expecting the government to release a substantial part of its reserves, would hasten to dump their own holdings. As soon as the price of gold had deviated above $1, and perhaps even before, the market price of silver would plunge to the level consistent with speculators' expectations about the government's ultimate release of reserves.

Yet the government would be obligated to sell silver from its redemption window at a price 50 percent below the already lowered market price. Since the quantity of money would decrease as money was redeemed with silver, the price of gold could return to one dollar before the government's silver reserve was depleted. Wicksell, however, believed that the release of the government's entire silver reserve would fail to cause a decrease in the quantity of money sufficient to cause the price of gold to return to par. We agree.

Credit Contraction

Committing another oversight, Wicksell overstressed the release of silver from reserves as the means of shrinking the quantity of money. Surely the government would use ordinary open-market operations as well. Even if release of the entire silver reserve would not suffice by itself to shrink the quantity of money adequately, sufficient sales of bonds could conceivably shrink money and spending enough to return the price of gold to par before the silver reserve ran out.

Further, suppose that the government's silver reserve was depleted. Wicksell assumed that the scheme would break down at that point, but he overlooked another important possibility. The government could purchase additional silver on the market as it was needed for further redemptions. Purchasing the silver with newly issued money would compound the government's difficulties, expanding its liabilities while further inflating prices, including the price of gold. If, however, it used some of the money received from open-market sales to purchase the needed silver, the combined transactions would shrink the quantity of money. It is likely, however, that the government would buy the needed silver on credit, since purchasing silver for "cash" would largely result in that money being redeemed instantly, exhausting the silver just purchased. If the government purchased silver on credit and used it to redeem money, the net consequence of the transactions would be identical to an ordinary open market sale: a contraction of the quantity of money and an increase in the outstanding debt liabilities of the government.

Assuming the price of gold was doubled, the government would be purchasing silver at the current market price and then selling it at its redemption window for 50 percent less, so it would be suffering severe financial losses. (If the price difference was small, the government would be providing a small subsidy for industrial users of silver, but given the large price difference in Wicksell's scenario, it would be suffering arbitrage losses matching the gains obtained by arbitrageurs.) As long as the government remained solvent, however, it could continue to maintain indirect convertibility.

The market price of silver would not be influenced directly by those redemptions that involved no release of reserves. The additional "supply" created by the government's sale of silver at its redemption window would be offset by added "demand" created by its purchases of silver on the market, leaving little net effect on the relative supply and demand conditions for silver. (The market price of silver would be slightly inflated since the government would have to purchase enough silver to meet the added demand of the subsidized industrial users; however, it would be depressed, like all prices, by the contraction of money and spending.)

We believe that the depletion of reserves is a plausible scenario, for the government would have no reason to hold more than minimal silver reserves. Silver reserves would not reduce the government's financial losses and protect its solvency. If the price of gold rose above par, the government would be compelled to sell silver it had bought at some point for less than its current market price. (50 percent less in Wicksell's scenario.) Since any significant release of reserves would tend to depress the current market price of silver to something less than what the government had paid, the government's arbitrage losses would be compounded by capital losses on its silver holdings. If the government instead purchased silver as needed for redemptions, it would suffer the arbitrage losses only. Yet if government held only minimal silver reserves, there would be no significant release of silver reserves, and hence, no extraordinary changes in the market price of silver.

Once Wicksell's more serious oversights are corrected, the consequences of Anderson's scheme look very different. The government would use open-market operations to cause whatever changes in the quantity of money it desired. Redemptions would be a mechanism that imposed financial losses on the government whenever the price of gold was deviating from its defined price of $1. To avoid those losses, the government would have an incentive to use open-market operations to cause the changes in the quantity of money and expenditures needed to reverse, or even preempt, deviations of the price of gold from par.

III. The Paradox and BFH Free Banking

The BFH System of Free Banking

Wicksell's paradox scenario involves a system no one advocated, but both he and Anderson recognized it as similar to the government-operated system advocated by Newcomb, Williams, and the early Fisher. Woolsey and Schnadt and Whittaker have claimed that the paradox of indirect convertibility also vitiates the BFH system [23, 120-5; 17; 18; 19]. (Schnadt and Whittaker were writing unaware of Woolsey's work and all were initially unaware of Wicksell's.) Cowen and Kroszner include the paradox theme (citing Woolsey) in their assorted criticisms of BFH [3, 30-34]. Trautwein also claims that a version of the paradox applies to BFH [20].

The BFH system would be significantly different from Anderson's conception, since its medium of account would be a nearly comprehensive bundle of goods and services. Further, the means of payment, including notes, coins, checking accounts, and perhaps even checkable mutual funds, would be privately issued. There would be, however, one important similarity. Notes, coins, and checks would be indirectly convertible; amounts denominated as one dollar would be redeemable into an amount of some redemption medium equal in market value to the bundle of goods that defined the dollar. While much of the BFH literature has assumed that gold (or even securities) would serve as the redemption medium, we will attempt to avoid confusion by continuing with Anderson's assumption that silver serves that purpose.

The Total Price of Bundle

The BFH dollar would be defined as a bundle of goods and services. The dollar prices of the items in the bundle, however, cannot be assumed to sum to $1 by definition alone. People actually setting prices for the items in the bundle would not necessarily pay attention to the definition of the dollar. Each would separately seek maximum profit in view of perceived and expected cost and supply and demand conditions in specific markets. Further, the banks would not be holding inventories of the various bundle-items to be released in response to excess demands. The total price of the bundle, therefore, could deviate from its defined price of $1, much as the price of gold deviated from par in Wicksell's scenario. Further, that deviation would be reversed only through appropriate changes in the quantity of money and spending--more on that below.

One significant difference remains, however. Wicksell assumed that gold doubled in relative value, so that the equilibrium price level decreased by 50 percent. Such a shock would be impossible in the BFH system. The prices of nearly all goods and services could not significantly rise relative to the prices of all goods and services. Shocks that caused the price of the bundle to deviate from par would be shocks that simultaneously caused a change in the price level. BFH, therefore, would require that money and spending change enough to rapidly reverse or preempt shifts in the price level, but it would not require that money and spending change enough to force the sort of massive change in the price level required in Wicksell's scenario.

If the price level and the price of the bundle increased, and the price of the bundle remained rigidly stuck above its defined price (much as Wicksell assumed that the price of gold was stuck near $2), then the only equilibrium consistent with indirect convertibility would be the absurd one with a zero quantity of money, no expenditures, and no output or employment. Since the medium of account would include most goods and services, however, it would almost certainly include, and might be deliberately specified to include, some goods and services with highly flexible prices. That would make the total price of the bundle flexible as well. The more plausible scenario, therefore, would be for the contraction of money and spending to cause the total price of the bundle to return to its defined price of $1.

If the increase in the price level was due to some increase in aggregate demand (such as a monetary shock), then only the more flexible prices would be increased immediately. The contraction in the quantity of money could promptly decrease those same prices with little difficulty.

If the increase to the price level was due to an increase in the price of some particular good which thereby caused an increase in the price of the bundle (and the price level) as an immediate, arithmetic consequence, more serious macroeconomic difficulties would develop. Those difficulties, however, should not be exaggerated. Even a large change in the relative supply and demand conditions for any one good would cause only a small increase in the price of the bundle (and the price level). Further, the total price of the bundle could promptly return to $1, even if that required a somewhat excessive decrease in money and expenditures and caused a slight over-adjustment of the more flexible prices. The quantity of money, expenditures, and the flexible prices would recover as the stickier prices finally decreased as well. Yet the temporary, excessive contraction of spending would cause a temporary, excessive contraction of output and employment.

Wicksell's implausible assumption that the price of the medium of account (gold in his scenario) remained almost fixed above par, therefore, points to a potential difficulty with the BFH system. Since some of the items in a nearly-comprehensive bundle of goods and services probably would have sticky prices, supply shocks that tended to cause deviations of the total price of the bundle away from par probably would cause excessive fluctuations of output and employment.

BFH and the Price of the Redemption Medium

We believe that Wicksell's (and the other paradoxers') focus on the market for the redemption medium was mistaken, especially in the context of the BFH system. If banks held large silver reserves and released them when the price of the bundle was above par, then the price of silver would be depressed. Any release of reserves, however, would be largely irrelevant to the needed contraction in money and spending. Credit contraction (or expansion if the price of the medium of account was below par) would play a dominant role in the BFH system, because any one bank could shift the financial losses suffered from redeeming money with silver to its competitors by manipulating its net clearings.

For example, suppose the price of the bundle increased by five percent, requiring banks to sell silver at their redemption windows for approximately five percent below its current market price. Any one bank could contract credit by selling bonds or obtaining net repayments of loans (or attract deposits from competitors by raising deposit interest rates) and obtain payment largely in checks drawn on, and notes and coins issued by, other banks. Those checks, notes, and coins would be routed through the clearing, tending to provide that bank with favorable clearings. It would insist that its competitors settle that net balance with silver at the same bargain price provided to anyone else redeeming money. The bank would be avoiding financial losses, since it would be "buying" silver from its competitors for the same bargain price that it had to offer at its own redemption window. Further, if the price differential was large enough to support outright arbitrage, any one bank could profit by contracting credit on a large scale, obtaining silver from its competitors at the bargain price and then selling it on the market.

Not all banks, of course, could successfully utilize that strategy. The actual consequence of their efforts, however, would be a contraction of credit and the quantity of money. That contraction would promptly return the actual market price of the bundle to its defined price of $1, allowing the banks again to sell silver from their redemption windows at its market price.

Further, each bank would have an incentive to contract credit in anticipation of an increase in the market price of the bundle, obtaining checks drawn on, and notes and coins issued by, their competitors to be routed through the clearing after the price of the bundle had deviated from par. That activity could preempt the change in the price of the bundle.

Still further, each bank would have an incentive to contract credit in an effort to reduce the capital losses on its security portfolio that would occur once banks contracted credit in their efforts to avoid financial losses from redemptions of silver. Even if all banks understood that the price of the bundle would remain at par because their credit contraction would reverse the consequences of an inflationary shock, the desire to limit capital losses would still provide the necessary incentive for each bank to undertake the needed credit contraction.

Silver Reserves?

Credit contraction or expansion would be sufficient to cause the changes in the quantity of money needed to reverse or preempt any deviation of the price of the bundle from $1. Would that process be associated with a significant change in the price of the redemption medium? The answer depends on whether banks would hold and then release (or accumulate) significant silver reserves in parallel with their adjustments in credit.

We believe the answer is no. While a government-run system might accept the capital losses entailed by that policy, competition would not allow the survival of any private bank that attempted to hold and then release excessive silver reserves. Holding silver reserves would involve the sacrifice of interest income and the risk of capital losses due to changes peculiar to the silver market. More importantly, silver reserves would provide no protection when the price of the bundle increased above par. As explained above in the context of Anderson's system, the banks would be forced to sell silver that they had purchased at some point for a price that would be even lower than its current, depressed, market price. Since holding a reserve asset subject to heavy capital losses when needed would make a commitment to maintain indirect convertibility less credible, competition would likely force banks to instead maintain adequate capital ratios and hold a "reserve" of liquid securities instead.

If private banks held only minimal silver reserves, then an increase in the price of the medium of account would have no significant consequence for the market price of the redemption medium. Banks would purchase silver on the market as needed for redemptions, and the added "demand" implied by their purchases would roughly offset the added "supply" implied by their sales from their redemption windows. The silver market fundamentals would be little changed (aside from the usual consequences of a subsidy to silver users or producers). Banks, however, would suffer financial losses as long as the price of the bundle remained above par, since they would be buying silver at the market price and then selling it in redemptions at a lower price.

We doubt, however, whether such losses would be significant in practice. Given the powerful incentives for credit contraction if the price of the bundle rose, or was expected to rise, above its defined price of $1 (and creation should it fall below par), we believe that BFH is best analyzed on the assumption that the price of the bundle would remain pegged at $1 [14; 27]. Credit conditions and the quantity of money would adjust whatever amount was needed to reverse the consequences of various macroeconomic shocks. (With supply shocks, output and employment would also adjust as necessary to keep the price of the bundle pegged.)

IV. Conclusions

Wicksell and most of the other paradoxers, obsessed with the market for the redemption medium, have drawn red herring across the trail in a nearly literal sense of that metaphor. (One of the co-authors can testify from recollection of his own earlier thinking.) The paradoxers have described fanciful scenarios in which the price of the redemption medium zooms off to zero (or infinity), largely because they assume that banks (or government as money issuer), instead of buying that medium as it is needed (or selling it), will draw on initially ample reserves of it (or will passively accumulate reserves in indefinite amounts).

Some of them insist on the supposed paradoxicality of a spread between the market price and redemption-window "price" of the redemption medium when the price of the medium of account deviates from par [18, 4-5], even though the spread and the deviation are arithmetical counterparts of each other, and although the spread serves as the trigger of corrective processes. They overlook, it seems to us, the largely reductio ad absurdum function of scenarios in which the price of the medium of account does deviate from par.

Most seriously, perhaps, red-herring scenarios of perverse movements in the price of the redemption medium draw attention away from the genuinely serious problems. Probably the greatest disadvantage of indirect convertibility is that when the price of the medium of account has been shocked above par, the automatically triggered corrective pressures of deflation of credit, money, and spending impinge on the entire economy while impinging on the price of the medium of account in particular only as a kind of by-product. Under direct convertibility, by contrast, with the same commodity serving as both medium of account and redemption medium, redemptions of money not only restrain spending throughout the economy but specifically counteract any upward deviations of the price of the standard commodity by releasing that commodity from reserves into commercial channels.

This contrast between the two kinds of convertibility is one main reason for preferring a multicommodity to a single-commodity medium of account under a system of indirect convertibility. If corrective deflationary pressures are to operate broadly, let them have a broad target so that they do not fritter themselves away in unfortunate side effects. Furthermore, targeting on a broad basket means a closer approach to price-level stability than targeting on one single commodity as the medium of account [13, 313-4].

An adverse supply shock could cause difficulties even if the broadest possible bundle of goods and services was used to define the dollar. Any scheme of money of stable purchasing power, however, must be evaluated in that context. While circumstances in which an adverse supply shock could cause deflationary devastation throughout the economy under the BFH system are unrealistic (in our judgment), they are indeed conceivable; and pondering them can be instructive. Pondering them can provide insights into an ideal composition of the BFH bundle, into provisions for redefining the bundle from time to time or when certain contingencies occur, into the relative merits of checkable equity mutual funds and of dollar-denominated notes and deposits as media of exchange, and into other details of the BFH system. (Coats has made a good start on thinking about such "technical difficulties", as has Dowd [2, 23-5; 7].)

No set of monetary institutions, whether historical or imaginary, has advantages only and no disadvantages. Tradeoffs must be faced and overall comparisons made. The BFH system is instructive as one pole in the comparative-institutional discussion. Featuring a unit of account defined to have stable purchasing power over a broad aggregate of goods and services and with the denomination of media of exchange in that unit kept operational by indirect convertibility, the BFH system of privatized money offers an escape from the long record of governmental abuse. No paradox of indirect convertibility forecloses this line of reform.

References

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