"Do We Really Need a Central Bank?"

by Steve Horwitz June 28th, 2012 12:10 pm

I don't believe I've shared this lecture here, so I will remedy that.  This is a talk I gave in December of 2009 at George Mason University in which I explore the history of banking in the US, the theoretical arguments against central banking, and then the free banking alternative. My theme was that critics of central banking need to have sound arguments from both theory and history and avoid falling into the stereotypical conspiracy theory claptrap. The talk is about an hour, and there's about 25 minutes of questions.

5 Responses to “"Do We Really Need a Central Bank?"”

  1. avatar Paul Marks says:

    There is no problem with the banking system that Central Banking (such as the Federal Reserve system) does not make WORSE.

    We can argue all day (indeed, if we lived that long, we could argue for a hundred years) over the principles of banking - but on one thing we agree.

    The Federal Reserve makes things worse - it must go, and it must go now.

    Of course the (credit bubble) economy would collapse - but it will anyway. That is already baked into the cake - there is no way to avoid economic collapse now (so time to bite the bullet and take it).

    At least the corruption that the Federal Reserve system feeds into the economy (and into civil society, and into the political process of the Republic) would end.

    The origin of Central Banking is to fund government deficits - but the American (and other Western government) fiscal situtation is now totally hopeless.

    The recent "compromise" of "infrastrcture" spending (carry on spending - and forget about getting rid of the regulations that are destroying the coal industry and preventing the keystone pipeline) and the Supreme Court judgement upholding the Obamacare tax-and-spending orgy are just iceing on the cake.

    The cake itself (the out of control Welfare State) is enough to stick in the throat of any major nation and reduce it (over time) to de facto bankruptcy. And that time has now come - "cheap money" from the Federal Reserve will not hide this for long.

    Then in the 19th century (thanks to the writings of people like Walter Bagehot - and over the objections of such people as the Governor of the Bank of England) it became accepted that a legitimate role for Central Banks was corporate welfare - sweetheart (low interest) loans (in various complex forms) to the banks.

    That is why the Federal Reserve was created in 1913 - to offer hidden subsidies to the banks and make their existing credit-expansion bubbles VASTLY BIGGER.

    The Fed has succeeded in its appointed task - indeed the "success" has been beyond the wildest dreams of its Founders.

    The United States no longer has an economy with a finacial system - and a fiancial system that has credit bubbles in it.

    The economy now IS (mostly the finanial system - the real economy (farming, mineing manufacturing....) is now a small percentage of the total "economy".

    And the financial system no longer has credit bubbles within it.

    The financial system now IS a credit bubble - real savings play only a marginal role in the modern financial system.

    And Britain (and many other nations) are much the same as the United States.

    So in terms of both the fiscal situtation (the Welfare Starte) and the monetary situation (the credit bubble financial system) the present system is hopeless.

    The only hope is to admit that - and to let it go.

    And to start building a new economy - up from the rubble.

  2. avatar Warren says:

    Good talk. One day I hope to be able to remember all the facts I need while in a conversation.

    Are you good at that sort of thing normally or have you built up your memory muscle due to teaching and lectures?

    Off topic: what this site needs is a "Start here" page. This would cover the basics of free banking, the difference between what is known as American Free Banking and actual free-banking, some handy stats covering bank failures and depositor losses in the various eras and areas, a master chart of economic/currency crisis with a capsule description of each one and where the blame really lay for the crisis and a final reckoning (to date) of all the problems caused by free-banking and those caused be central banking.

    Plus you need a master list of summarized links to videos and papers that can be read online and a list of links to books that have to be purchased to be read.

    In this way there is a single page I and others can point people to to get them started rather than having to link hunt through my bookmarks or worse the web as a whole.

    And I know you guys are academics and perhaps do not have a lot of money but maybe you can get a grant to have a video done that shows the mechanics of the banking and clearing system working. With animated bankers going to the clearing house and exchanging notes and then we that Mr. B. Ernanke has printed too much money and his cash reserves are flowing away and then his capital and then finally his personal assets. Meanwhile Mr. S. Elgin has no such problems and his bank is both liquid and solvent.

    Further, have you thought about a Free Banking online store where you could sell FB swag merchandise? Sure, it's a very niche market but it would cost hardly anything at all to set up.

    Finally, of instead of saying "fractional reserve banking" can you guys can start saying "fraction cash-reserve banking" (or gold-reserve) to make it clear that when you have securities and banker's personal assets and collateral backing the notes it's not "fractional" those notes are fully backed, it's just a matter of it's not 100% liquidity which if there is a liquidity it can be ended upon sale of some securities.

    (Note: I know you and most of the people coming here no the above I just put it in in case someone unfamiliar with the issue or someone aggressively Rothbardian wanders by.)

  3. avatar Paul Marks says:

    Well first "securites" (whether government or private) are I.O.U.s they are not "backing" for anything.

    Indeed the word "backing" is not helpful. If gold is money then gold is money, if silver is money then silver is money, if bits of paper from the Federal Reserve are money then bits of paper from the Federal Reserve are money (at least legal tender that can be demanded in taxation). "Backing" does not come into the matter.

    But more broadly bank notes are NOT the main problem. Otherwise the British Act of 1844 (resticting bank notes) would have worked. See both F.A. Hayek (although not Hayek in his old age - when he even forgot that "index money" is an absurdity) and Ludwig Von Mises on the conflict between the "Banking School" (with their waffle about credit expansion being O.K. if it was done by "responsble" people for the "needs of trade") and the "Currency School" (who were RIGHT about the problem, but WRONG about the solution).

    In reality there are many ways that banks (via their interactions) can expand credit BEYOND REAL SAVINGS without printing bank notes.

    Nor is this "fractional reserve banking" as an ordinary person would understand the word "fraction". If people "deposit" (the word "deposit" is, of course, misleading as the money is available to be LENT OUT not "deposited") one billion Dollars of real savings in the banks and the banks lend out 900 million Dollars that is a fraction of nine tenths.

    However, if people "deposit" ("invest" would be a better word) one billion actual Dollars with the banks and the banks lend out TEN billion Dollars (a "fraction" of ONE HUNDRED TENTHS) is it not misleading to call this a "fraction"?

    "Mathematically it is" - perhaps, but it is not a "fraction" as laymen normally use the word.

    Nor, I repeat, need this have anything to do with "bank notes",

    The reason there was a 19th century saying "free trade in banking is free trade in swindleing" is because bankers are often not satisfied in lending out a "fraction" (as an ordinary person would understand that word)of real savings, they wanted to lend out FAR MORE than real savings.

    This is "credit expansion" something that has been written about since the 1700s (see Richard Cantillon and others) - it is why "broad money" (bank credit) is many times bigger than the "monetary base" (cash). It is what is called a "credit bubble".

    This can occur WITHOUT a Central Bank (for example the bust of 1857 or 1907) But Central Banking makes it much WORSE.

    I am accused of repeating the same things over and over again - but if people keep making the same errors (again and again) I have to.

    Let us leave aside talk of "securities" and "personal assets" - (they are beside the point - and cover little or nothing).

    Let us also assume that civil society (civilization) recovers from the economic and social collapse that is comming (a rather bold assumption).

    Are we to go back to trying to lend out ten billion Dollars or a hundred billion Dollars when only one billion Dollars has been really saved?

    "Fractions" of ONE HUNDRED tenths or ONE THOUSAND tenths?

    If you have a credit money expansion (a "boom") you will (sooner or later) have a BUST.

    And the bigger the "boom", the bigger the BUST.

    Let a money lender (a banker) be content with being an honest money lender - lending out their own savings or the savings that others have entrusted to them.

    Let them avoid the temptation of lending out money that NEVER REALLY EXISTED.

    Credit expansion (loans that are greater than real savings) is NOT an easy road to prosperity - it is fool's gold.

    If you want to borrow money someone else must SAVE that money - really save it, i.e. choose NOT to consume income.

    And when one person lends out money (either directly or via a professional money lender - a "bank") they DO NOT HAVE THE MONEY ANY MORE (money "on deposit" is NOT "deposited" - it is LENT OUT) and they do not have the money till when and IF the money is paid back.

    Again I do not repeat myself for kicks. I repeat myself because the same errors keep get repeated again and again.

    If you want to borrow money to build a factory then someone has to SAVE (choose NOT to counsume) the money for you to build the factory - and LEND them money to you (either directly or via money lenders).

    If you want to borrow money to build TEN factories and people have only SAVED money enough for you to build ONE factory, then you CAN NOT HAVE THE OTHER NINE. Not just now - (you will have to wait till real people have actually saved the money and lend it to you, or "horror of horrors" you actually pay for further investment out of the profits of your enterprise).

    If bankers give you "money" (that no one has really saved) to build the other nine factories there is a PRICE TO PAY.

    The price of the credit expansion (the "boom") is a BUST. As the credit money bubble heads back down to the monetary base (the REAL SAVINGS).

    The bigger the credit bubble (the bigger the credit expansion) the BIGGER THE BUST.

    Central Banking makes the problem bigger (VASTLY bigger) but it does NOT create all of the problem on its own.

    The temptation among human beings to lend out "money" (either for investment or consumption) that was never really saved is an old one (very old).

    And it is NOT zero sum game.

    At the end of the boom-bust things are NOT what they would have been if the boom-bust had not happened.

    As Richard Cantillon pointed out centuries ago - at the end of the boom-bust some people (normally the wealthy and politically connected) are better off than they would have been if no boom-bust had occured, and some people (normally the poor and not politically connected) are worse off than they would have been had the boom-bust never happened.

    That is one reason why there are demands for government intervention, but another reason is the utter horror of the "bust" itself (the economic chaos the mass unemployment - even if markets are allowed to clear there will be temporary mass unemployment, and so on).

    And if you want to prevent the bust you MUST prevent the "boom".

    Want to prevent 1907? And the chaos that led to demands for the creation of the Federal Reserve (which made matters even worse) then prevent the credit expansion (the lending out of "money" that no one had really saved) before it.

    Want to prevent 1929?

    Then prevent the Benjamin Strong credit money expansion of the late 1920s.

    Do not fall into the trap of thinking that Benjamin Strong was somehow doing a good job (both Irving Fisher at the time, and ASTONISHINGLY Milton Friedman, decades later, fell into this trap).

    Want to prevent the current crises?

    Then prevent the Alan Greenspan pushed credit money expansion - that want on for many years before it.

    Do not think that "credit expansion would be O.K. if there was not a Central Bank" it would NOT be O.K. And talking of "backing" is just wrong (otherwise "broad money", bank credit, would never get bigger than the "monetary base").

    The only good thing is that it would collapse sooner (and smaller - and the smaller the "boom" the smaller the BUST). Alan Greenspan "saving the world" was actually Alan Greenspan prolongning the credit money "boom" and making the eventual crises WORSE (but there would have been a boom-bust even without him).

    Free banking will only work if people have clear eyes.

    If they understand that they can not have stuff (either consumption or investment) that no one worked for.

    You want to borrow one hundred Dollars?

    Then someone has to SAVE one hundred Dollars (not ten Dollars or one Dollar).

    People have to decide to NOT consume all of their income but to lend it out (and you can not borrow MORE than they save), and if they lend out the money (for example by entrusting it to a professional money lender, a "bank") they do NOT have the money any more.

    Not till when and IF you pay it back.

  4. avatar Paul Marks says:

    Warren it is NOT "aggressive" to say that people can not (without bad consequences) borrow more "money" than was ever really saved. Nor did M.N. Rothbard work out the cause of boom-bust events (that was worked out before he was even born).

    And to talk of "backing" when bank credit is vastly bigger than real savings, is just to miss the point.

    Bankers personal assets are not even at risk (banks are normally limited liability enterprises) and even if they WERE at risk it would make little direct difference.

    First because the shareholders of a bank are not normally the people makeing the management judgements (staff do that) but more importantly....

    The entire net worth (their REAL net worth - how much cash they could actually get their hands on) of the shareholders of the major banks is only a tiny fraction of bank credit ("broad money").

    People are NOT lending out a "fraction" (as this word is normally used) of their money - or of the money of other real savings (that has been entrusted to them).

    They have lent out VASTLY MORE "money" than this.

    That is what a "credit bubble" is.

    What you call "aggression" is actually FRUSTRATION.

    Frustration that people write about banking (and so on) and either do not know what a credit bubble is - or pretend they do not know.


    Someone who talks about the "price level" and thinks nothing is wrong with prices not (generally) FALLING at a time of economic expansion has no understanding.

    That sort of person is likely to be a Fisherite - i.e. someone thinks that "moderate" credit expansion is O.K. as long as the "price level" does not go up.

    It is not O.K. - a boom-bust will occur.

    With all the consequenes (economic and POLITICAL) of a boom-bust.

    People who do not know what a credit bubble is, or think that credit bubbles can only occur if there is a Central Bank, should really go away and do some more thinking.

    The crises is a upon us - or soon will be.

    Time to put away the hope of a fairy castle in the air - of lending greater than REAL SAVINGS.

    Time for thrift, hard work and self denial.

    A "saver" is not someone who consumes anything they want to - a "saver" is someone who GIVES UP some of their income in order that other people may build factories (and so on). A lender DOES NOT HAVE THE MONEY till when and IF they are paid back.

    This must be understood.

    Or civilisation will die.

  5. avatar Paul Marks says:

    "You are the cause of massive deflation - a price collapse".


    It is the credit bubble builders who do that.

    They create a vast credit bubble and then (when it inevitablly collapses)they complain about a "price collapse".

    If they did not create their credit bubble (their fairy castle in the air) in the first place then prices would fall gradually over time (as better ways to produce goods and services were developed). There would NOT be a general price crash.

    A price CRASH - is the result of a credit bubble maintaining (or even incresing) prices over time. And when the bust (inevitally) comes....

    Again - if you want to prevent the crash you must prevent the "boom" (the credit expansion bubble).

    Otherwise - when the bust (inevitably comes) people cry out....

    "Where did the money go".

    The money they thought that was the malinvestment prices (in dot.com shares or houses or whatever) - the money that NEVER REALLY EXISTED.

    And the demands go up for Central Banks to "expand the monetary base" to "save the financial system".

    I.E. For central banks to expand fiat money - in order to "save" the "broad money" bank credit (the credit bubble).

    I repeat.

    You can only lend out (without terrible consequences) real savings.

    Central Banking makes the problem worse - but it is NOT all of the problem on its own.

    Free Banking does NOT have to be "free trade in swindleing".

    But only if people will understand basic things.

    Such as you can not (without terrible consequences) lend out "money" that people have not really saved.

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