The Currency "Trilemma"
June 2, 2011
(This item originally appeared in Forbes.com on June 2, 2011.)
Technically, pegging a currency to gold--via some automatic mechanism
like a currency board--is no different than pegging it to the euro or
dollar. There's nothing inherently difficult about it. Eventually, one
might conclude that gold is a better thing to peg to than the euro or
dollar. Just read the newspapers and see what Ben Bernanke or the ECB
are doing with their floating fiat currencies. Who wants to be a part
The Keynesians, at first, will typically try to insist that this is not
possible at all. They insinuate that currencies are naturally
free-floating, and that to manage them amounts to "market
manipulation," which is inevitably doomed to failure.
This is nonsense, of course, so when the Keynesians are pressed on the
matter--when they see that they aren't going to get by so easily with
these sorts of rhetorical tricks--they admit that fixing a currency is
entirely possible. However, you would have to give up "sovereign
monetary policy." This the Keynesians would never do, because it is the
core of their entire soft-money religion.
For example, here's Paul Krugman explaining the "impossible trinity."
Actually, there isn't a "trilemma" as some describe. One of the
combinations--sovereign monetary policy, fixed exchange rate and
controlled capital flows--is not inherently stable. The controlled
capital flows would allow a government to maintain this unstable
condition for longer than it would otherwise, but eventually something
During the Bretton Woods period in the 1950s and 1960s, the U.S.
attempted to have both a gold standard system ("fixed exchange rate"
with gold) and a certain amount of Keynesian "sovereign monetary
policy." This caused chronic problems, and various forms of capital
controls were attempted to help keep the fundamental inconsistency
intact. This allowed the system to persist longer than it would have
otherwise, but it still collapsed.
Thus, there are really only two options: "Sovereign monetary policy,"
and some sort of automatic system, without discretionary input, which
is most typically a "fixed exchange rate." It could be a fixed exchange
rate with another currency, or a currency basket, some sort of
statistical hodgepodge, or gold. You could even link your currency to
the phases of the moon--possible, but I wouldn't recommend it.
Thus, the hard money advocate simply gives up any "sovereign monetary
policy." Ultimately, fooling with the currency can only be destructive.
The best currency is a stable currency. The best way to attain a stable
currency, in an imperfect world, is to link it to gold. We have been
doing this a long, long time--thousands of years, actually--so we
already know the answers to these questions.
What happens when you give up "sovereign monetary policy"? Many
countries have already done this, typically with a currency board with
some major currency. There are now twelve currencies pegged to the
euro, including 26 countries. Twenty-two countries peg their currencies
to the dollar. Three peg to the British pound. Brunei pegs to the
Singapore dollar and Macau pegs to the Hong Kong dollar (which is in
turn pegged to the U.S. dollar). Another ten countries use the U.S.
dollar officially, and an additional twelve countries use it
unofficially. There are now seventeen official members of the eurozone,
using euros, an additional seven official euro users, and four
My informal count shows ninety-nine countries today that have given up
"sovereign monetary policy" and have adopted a "fixed exchange rate,"
either by using a major international currency itself or a peg to a
major international currency. I'm sure I've missed many others. During
the gold standard years of the 1950s or 1890s, this was typically the
case as well: most countries pegged to a major international currency,
which was in turn pegged to gold.
So you see, this is not exactly hypothetical. The only question is:
does it make more sense to peg to a fluctuating dollar or euro, or to
stable gold? For a major currency, the question is: Does it make more
sense to have a "fixed exchange rate" with gold, or cross our fingers
and hope that Ben Bernanke gets lucky with his "sovereign monetary
These questions have been around a long time. In a 1928 book called The Intelligent Woman's Guide to Socialism
and Capitalism, George Bernard Shaw said:
"The most important thing about money
is to maintain its stability ... You have to choose between trusting
the natural stability of gold and the honesty and intelligence of
members of the government. With due respect for these gentlemen, I
advise you, as long as the capitalist system lasts, to vote for gold."
In 1928 intelligent women were expected to understand these things.
Today, you should understand these things. Make your decision: fixed or