Central banking and the debate over central planning passed each other like two ships in the night in the early 1900s. Central banking was becoming the standard monetary system that economists recommended. Financial conferences held by the League of Nations in Brussels in 1920 and Genoa in 1922 proposed that countries, as least independent countries, should have central banks. The idea was that politically independent central banks would take control of monetary policy from government treasuries that had become the de facto monetary policymakers during World War I and had created substantial inflation in many countries.
At the same time, Ludwig von Mises published an article in 1920 called “Economic Calculation in the Socialist Society” and a 1922 book, Socialism: An Economic and Sociological Analysis, arguing that comprehensive central planning of the economy would be disastrous because central planners lacked market prices and market institutions to inform their actions, hence they would waste resources on a vast and even fatal scale. Because most economists did not understand the depth of Mises’s challenge, economists generally did not acknowledge his argument as valid until communism collapsed from 1989 to 1991.
Not until Lawrence H. White’s 1984 book Free Banking in Britain and George Selgin’s 1988 Theory of Free Banking did economists confront these two powerful currents of thought directly with each other. And even though mainstream economics now blames the Federal Reserve and the Bank of France for the intensity of the Great Depression and acknowledges that too many central banks have created runaway inflations, mainstream economists have been slow to answer the challenge that free banking theory now poses to central banking. The only real exception has been Charles Goodhart, the world’s leading expert on central banking. Goodhart’s writings on central banking and his criticisms of free banking are well worth reading, but such an important issue needs multiple thinkers on both sides working to bring out its many facets.
Central planning failed as a comprehensive economic system; why should we expect central planning limited to particular fields of economic activity to do better? Central banking is a form of central planning. Rather than leaving the selection and production of the monetary base open to competition, it concentrates them in a monopoly sponsored by and nowadays almost always owned by government. As part of this monopolization, it typically prohibits would-be competitors from issuing notes and coins that might displace those the government has issued.
David Glasner has two posts claiming that central banking is not central planning. I do not find them convincing. Central banks are government monopolies that consciously try to steer the economy. If that is not central planning, nothing is. (And by the way, it will not do to cite the younger Hayek in support of central banking when the older Hayek in Denationalisation of Money wrote about “the obvious corollary that the abolition of the government issue of money should involve also the disappearance of central banks as we know them” [page 105].)
I think, however, that pointing out that central banking is a form of central planning is not sufficient by itself as an argument. Monetary theory and practice have for decades been built on the idea that ultimate power in monetary matters properly rests with governments. Displacing ideas and institutions that are now long established is not merely a matter of writing a few books, much less a few blog posts.
In my next post I will discuss a surprising advocate of free banking.