End The Fed... And Replace It With What?

Whenever the subject of eliminating the Federal Reserve is raised, there is an inevitable question posed: What would replace it? This question leads to one of the most common criticisms levelled against the "End the Fed" crowd: Eliminating the central bank and giving control of monetary policy to Congress would result a situation like Zimbabwe, where the national legislature printed insane quantities of worthless money. The Zimbabwean dollar was ultimately destroyed.

This argument is only valid if we assume that the government is allowed to issue fiat money. A government which can issue as much worthless currency as it likes, on a whim, is indeed the 'nightmare scenario'.

On the other hand, if the money issued is sound money, directly exchangeable for a set value of a commodity (such as gold or silver), then the government can only issue currency equivalent to the amount of that commodity it holds. This is, in fact, the monetary system our Constitution created.

I think it's safe to say that our government will never voluntarily return to a gold standard (or some other commodity standard). There is, however, another way to achieve this goal: Allow currencies to compete with the dollar.

I'll use a hypothetical (my own) to illustrate the point:

Suppose a local hospital wants to create a way for local businesses- which are cash-strapped- to have health services coverage. The hospital (like most today) is also cash-strapped, and has difficulty paying salaries and purchasing supplies. Solution? A barter credit system, which I'll call "HospitalBux", which are redeemable for services at the local hospital.

The local grocer's sales are down and he's throwing away unsold product, and he has difficulty paying his employees because of the poor sales. The hospital needs to stock its kitchen with foodstuffs. So, the hospital offers to trade foodstuffs for HospitalBux with the grocer, who then pays his employees partially in dollars and partially in HospitalBux, since they have no health insurance (the grocer couldn't afford to offer it). The local plumber, who is self-employed and has difficulty affording insurance, agrees to an exchange of plumbing services (as needed) for HospitalBux, offsetting another expense for the hospital and giving the plumber a way to save for health services when he eventually needs them.

HospitalBux can be accumulated and never lose value (unlike dollars) since they're exchanged for services rather than money- an appendectomy, for instance, will always cost 200 HospitalBux; a person could accumulate quite alot of HospitalBux over a working lifetime, and be assured of meeting their medical needs in retirement. HospitalBux are also insured by a private insurance company, in the event the hospital goes out of business.

Other hospitals in the region set up similar HospitalBux arrangements, and these hospitals set up an exchange mechanism between themselves, allowing HospitalBux to be spent at a number of hospitals. This saves each individual hospital the expense of having to purchase and maintain equipment and hire specialists to cover every single medical need, since hospitals can now share both services supply and patient demand.

Other businesses in the area accept payment for goods and services in HospitalBux, either because they will save and use them themselves, or because other people accumulate and save them and will trade dollars for them.

As we can see, it's actually a fairly straightforward proposition to set up a new currency. One can see the benefits of such a system; one can also see how such a currency could compete with the dollar, because it never loses value (in other words, there is no inflation).

Would "HospitalBux" be a viable currency? There's no way to know, except to try it against other alternative currency models and see which functions best in the long run. As always, competition reveals which concepts work best and which fail.

There's a problem we encounter, though: legal tender laws. Once a debt is accumulated, that debt can only be satisfied with legal tender. Taxes and government fees must be paid in legal tender, as well as wages and salaries of employees. This means that no other currency could genuinely compete with the dollar, since every business and every individual must have dollars, regardless of the faults of the dollar or the superiority of other currencies.

The subject of competition brings us to part of the explanation of why the United States Constitution mandates gold and silver: More than two thousand years of currency practices had shown that pure gold and silver coins, impressed with a government seal guaranteeing weight and purity, were the most viable form of money.

Even in 1789, competing currencies were a fact of life. Whiskey, for example, was more common than the dollar as a rural currency, which inspired the Whiskey Tax. Even at the turn of the 20th century (and after the passage of the first legal tender laws), competing currencies were still in use in some manner. One need only look at a Sears and Roebuck catalogue of that era (I have several in my collection) to see this: Paper, coin, bullion, and postage stamps were all accepted by Sears as payment.

As with anything else, competition can improve the dollar. If people prefer commodity-based money over a dollar which has no intrinsic value, and the federal government were barred from taking anti-competitive actions against other currencies (legal tender laws, for example), then the federal government would be left with only two options: Take actions to make the dollar more desirable, or let the dollar fail. On the other hand, if alternative currencies are a bad idea and the current management of the dollar is the best monetary policy, then competition would bear that out, too.

Ron Paul, the greatest champion of ending the Fed, favors currency competition to make the Fed irrelevant over ending the Fed immediately.