Money and Markets: Essays in Honor of Leland B. Yeager

8 Roger KopplBuchanan mentions Yeager’s 1954 growth paper. “I had scarcely put the articledown,” he reports, “before I commenced to search out Yeager’s possible interest ina position on our faculty.” As I indicated above, Yeager’s article drew out thehidden monetary elements in then-popular growth models. This was to be the firstin a very long list of contributions to monetary theory, including “A Rehabilitationof Purchasing-Power Parity” (1958b), International Monetary Relations: Theory, Historyand Policy (1966), “The Essential Properties of the Medium of Exchange” (1968),Experiences with Stopping Inflation (1981), and “A Laissez Faire Approach to MonetaryStability” (Greenfield and Yeager 1983). Readers interested in Yeager’s monetarytheory should consult Yeager (1997) and the introduction by its editor, GeorgeSelgin. Yeager’s achievements in monetary theory are reflected in several contributionsto this volume.Rob Greenfield (Chapter 10) uses metaphors characteristically his own, to giveus a kind of primer on Yeagerian monetary disequilibrium theory and indirectconvertibility. A primer on indirect convertibility seems especially desirable to me.I have long felt that the monetary proposal of Greenfield and Yeager, the “BFHsystem” as they unhappily dubbed it, has been underappreciated and misunderstood.(Their odd name derives from an attempt to honor some of their sources:Black, Fama, and Hall.) Their proposal is simpler and infinitely more practical thanit is sometimes made out to be. Perhaps it would be helpful to some readers if Iexplained a simplified version of BFH.Imagine we have a monetary system with one bank. Bank notes, and only banknotes, circulate as hand-to-hand currency. To keep things really simple, imaginethat there are no checkable deposits in this system. We will call the unit for banknotes the “dollar.” Notes are denominated in silver, with each dollar in notes beingworth, say, 0.8 ounces of silver. Thus, the “dollar” is a unit for counting bank notes,but a dollar should also be worth 0.8 ounces of silver. The notes, after all, aredenominated in silver. But does the silver value of a dollar have operationalmeaning? If I cannot redeem bank notes, the stated silver value may be a fiction. Inour imaginary system, bank notes can be redeemed, but in gold rather than silver.Each dollar can be redeemed for as much gold as happens to equal in value 0.8ounces of silver. This ratio values silver at $1.25 per ounce. Bank notes cannot bedirectly converted into a fixed quantity of silver. They can, however, be convertedinto a variable amount of gold, the amount depending on the price of gold in termsof silver. Such a system has “indirect convertibility.” Let us imagine that the priceof silver is $1.25 per ounce and the price of gold is $20 per ounce. If I have a $10bank note, I can go to the issuer and demand my gold. For each dollar, he must giveme as much gold as is worth 0.8 ounces of silver. He must redeem my note for $10-worth of gold. Given the assumed prices, a $10 note can be redeemed for half anounce of gold.Let’s say the price of silver somehow rises to $1.50 per ounce. Perhaps, the bankhas over-issued. With that 20 percent increase in the price of silver, we mightimagine that we also have a 20 percent increase in the price of gold, bringing it to$25 per ounce. This possibility turns out not to matter, however, for the operationof the system. Thus, we will continue to imagine gold is priced at $20 per ounce. If