Is There a Paradox of Indirect Convertibility?

Abstract

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 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 betterknown 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