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Instances as evidence

by Kurt Schuler September 10th, 2012 10:29 pm

Some months ago there was a discussion of Australia’s free banking experience at a site called “Social Democracy for the 21st Century.” I will not go into the particulars of Australia’s experience here, because I have forgotten much of what I once knew about the subject and lack time at the moment to refresh my memory. The gravamen of the criticism, however, was that the financial crisis and resulting depression Australia suffered in the early 1890s under a free banking system was more severe than the Great Depression in Australia, under a quasi-central banking system. (The government-owned Commonwealth Bank of Australia was a commercial bank and in addition exercised certain central banking functions.) This comparison supposedly discredits free banking.

Arguments like this from single instances are not persuasive. It is like saying that Zimbabwe’s hyperinflation of several years ago discredits central banking, case closed. Free banking, central banking, and other monetary systems have a variety of experience, and one must look, insofar as possible, at the totality of the evidence. The facts do not speak for themselves; we have to interpret events and determine what the facts are and which facts are salient.

We do know with certainty, though, that every one of the more than 50 documented hyperinflations of the last 250 years has occurred under central banking, or related monetary arrangements where the government treasury was the issuer of currency. Moreover, in all such cases the central bank or treasury was de jure or de facto not on a gold or silver standard, and in almost all cases was not on a foreign exchange standard either (in which the local currency was redeemable at a set rate in foreign currency). Evidence on that scale is the kind that can serve as the basis for generalizations. Single cases cannot.

22 Responses to “Instances as evidence”

  1. avatar Lord Keynes says:

    "Arguments like this from single instances are not persuasive"

    It does, however, have important relevance if anyone is going to claim that there is no instance of a "free banking" system resulting in economic disaster.

    "This comparison supposedly discredits free banking."

    To be fair, I do not argue merely from this single instance that the entire idea of free banking is discredited: it is unpersuasive for many other reasons.

    To take one example: those who claim that 1800s-early 1900s Canada was a strong instance of free banking ignore that in the 1800s, Canada had a large private bank called the "Bank of Montreal" that in some ways acted like a de facto central bank.

    For government interventions to stabilize Canada's financial system pre-1930, see Charles Goodhart and Gerhard Illing (eds.), Financial Crises, Contagion, and the Lender of Last Resort: A Reader, p. 121:

    "However, the Bank of Montreal (founded in 1817) very early became the government's bank and performed many central bank functions. Because Canadian banks kept most of their reserves on 'call' in the New York money market, they were able in this way to satisfy the public's demand for liquidity, again precluding the need for a central bank. On two occasions, 1907 and 1914, however, these reserves proved inadequate to prevent a liquidity crisis and the Government of Canada had to step in to supplement the reserves."

    Canada did not see a financial sector meltdown from 1929-1933 because of implicit government guarantees and interventions:

    Kryzanowski, Lawrence, and Gordon S. Roberts. 1993. "Canadian Banking Solvency, 1922-1940," Journal of Money, Credit, and Banking 25: 361-376.

  2. avatar John S says:

    LK (I will not disgrace JM Keynes' stature by using your ridiculous handle),

    Regardless of the merits of your arguments, few as they may be, your consistently disparaging attitude toward all viewpoints save your own is as vile and immature as that of the Rothbardians you love to attack. Some typical examples from this post (there are hundreds more):

    "There is a real paradox here: the free bankers, much like the Austrians, make a fetish of free markets."

    "What is ridiculous here are the excuses offered by free market apologists"

    "That is utter rubbish."

    "This libertarian ideology is a cult and your leader/chairman is Rothbard."

    Until you learn to express your opinions like a gentleman, I highly doubt your arguments will influence anyone's thinking. Thankfully, I am certain your manners are quite incorrigible.

    • avatar MichaelM says:

      John, disgraceful behavior is better ignored and eaten around than it is directly addressed. It will never do anything but leave a bad taste in your mouth.

      Instead, attending to the meat of his argument will lead to a much more productive discussion and might even convince him to be as involved in keeping things courteous and forthright as everybody else should be.

      Lord Keynes, in what ways was the Bank of Montreal 'like a central bank'?

      Was it able to emit legal tender paper bills? Could it prevent other banks from competing within its own market? Did it hold a greater part of the reserves of other Canadian banks?

      If 'implicit government guarantees' are a powerful tool in financial policy to be the difference between 10,000 banks failed and zero banks failed, why could they prevent a melt-down in 1929-1931 Canada but not in 2008 in the US? Surely the details matter. Could you detail these guarantees for us and explain exactly how they translated into an astoundingly stable system during the Great Contraction in Canada?

  3. avatar Lord Keynes says:

    "If 'implicit government guarantees' are a powerful tool in financial policy to be the difference between 10,000 banks failed and zero banks failed, why could they prevent a melt-down in 1929-1931 Canada but not in 2008 in the US? "

    In 2008-2009 there was no actual mass financial collapse, only a severe crisis averted by government intervention.

    Nobody claimed above that the financial sector cannot get into trouble by itself, before the government rides in and intervenes to prevent utter collapse.

    " Could you detail these guarantees for us and explain exactly how they translated into an astoundingly stable system during the Great Contraction in Canada?"

    Details are given here:

    Kryzanowski, Lawrence, and Gordon S. Roberts. 1993. "Canadian Banking Solvency, 1922-1940," Journal of Money, Credit, and Banking 25: 361-376.

    Some summary of the paper is given here in my comments at the end:

    http://socialdemocracy21stcentury.blogspot.com/2012/08/steven-horwitz-on-stimulus-spending-and.html

    E.g., in 1923 the Government of Quebec provided $15 for the merger of the Bank Nationale with the Banque
    d'Hochelaga to avoid a bank failure (Kryzanowski and Roberts 1993: 365).

    When in 1923 the Home Bank of Canada failed, "depositors in the Home Bank petitioned the Canadian Government for compensation and received payment up to 35 percent of the value of their deposits" (Kryzanowski and Roberts 1993: 365).

    There were quite public statements from finance ministers reported in the press promising government intervention to protect depositors.

    E.g., the Minister of Finance to the McKeown Commission, 1924:

    "Under no circumstances would I have allowed a bank to fail during the period in question . . . If it had appeared to me that the bank was not able to meet its public obligations, I should have taken steps to have it taken over by some other bank or banks, or failing that, would have given it necessary assistance under the Finance Act, 1914."

    The full evidence is given Kryzanowski and Roberts 1993: 365ff.

    • avatar MichaelM says:

      Unfortunately, not all of us have free access to that journal.

      Is there any evidence that these guarantees were viewed as credible? I notice the government that passed these guarantees out was not in power during the bulk of Great Contraction. Do we know that people viewed this new government as upholding the old government's promises? How do these guarantees differ from the track-record of public-private partnership bailouts that marked the New York money market throughout the 19th and into the early 20th century? Why did the presence of an explicit lender of last resort not prevent banking panic similarly in the United States during the Great Contraction?

      What about the other questions I asked, especially about the Bank of Montreal?

      • avatar John S says:

        Michael, I think LK is done here. I suggest you try asking him on his blog. However, unless you end up fully agreeing with his opinion, I predict he will either A) quickly stop uploading your posts or B) subject you to the type of vitriol I cited above.

        He doesn't want productive dialogue, he wants to shove his conclusions down any dissenter's throat. YMMV.

        • avatar Lord Keynes says:

          "Michael, I think LK is done here"

          Wrong on all counts.

          And if you think mild statements like "That is utter rubbish" are "vitriol", you're either new to the internet or incredibly naive.

          • avatar John S says:

            "you're either new to the internet or incredibly naive."

            Neither; I'm a dignified gentleman, for which you could never be mistaken.

            I'm chastising you on your manners for you own good, LK. There's a reason your alexa ranking languishes around 4-5 million after several years while someone like Aziz has skyrocketed to 200,000 in little over a year.

            Even in the Internet age, good manners still go a long way toward success.

  4. avatar Paul Marks says:

    First of all there was no such country as "Australia" in the 1890s - Australia was formed (out of New South Wales, Victoria, Queensland, South Australia, West Australia, Tasmania...) in 1901.

    As no one has made this, rather obvious, point - it seems that I must.

    As for banking collapses - and the slumps they cause....

    Of course they can happen without Central Banking - no one has denied that.

    The temptation to lend out "money" that no one has ever really saved (i.e. build a credit bubble) is always present.

    But the point is that Central Banking does not prevent this - on the contrary it makes credit money bubbles BIGGER not smaller.

    Indeed the basic point of a Central Bank (what they are set up for in the first place) is "lower interest rates" - first for government borrowing, then for general borrowing.

    How do you think these "cheap money", "lower interest rates" are achieved?

    They are achieved via building a credit bubble.

    The very thing (the "boom") that inevitable leads to the bust - whether it is in Victoria and New South Wales in the early 1890s (the time of the government backed "railway boom") or in the United States (and so on) today.

    Saying "commercial banks have a credit bubble problem - let us set up a Central Bank to deal with it" is like saying "that man has a drinking problem - let us help him by pouring a bottle of vodka down his throat".

    The terrible problems in American banking before 1913 (caused, in part, by the National Banking Acts of the Civil War period - with their ban on "discounting" the debt paper of the big New York banks, and so on) did indeed exist - but they were made WORSE (not better) by the creation of the Federal Reserve system.

    As for the Canadian experience.......

    Canada did not have a Central Bank during the crash of 1929 - fact.

    Canadian banks proved more stable (less likely to go bankrupt) than American banks - fact.

    Both of the above facts had been true long before 1929.

    • avatar Lord Keynes says:

      (1) Every nation in modern capitalist has endogenous money and money created from nothing, by means of private debts.

      The Austrians and free bankers are severely deluded in thinking money supply expansion via fractional reserve banking, promissory notes, bills of exchange or even central banking is a problem per se.

      The main problem is use of credit in blowing asset bubbles in financial asset markets or real assets, which collapse in an environment of high private debt, causing debt deflation.

      Despite what you say, a central bank and a system of effective and well designed financial regulation can and does prevent such problems.

      E.g., interest rates were also historically low all over the Western world after WWII, but because of serious and effective financial regulation in those days, no massive asset bubbles or global financial crises ever resulted.

      (2) the Austrian business cycle theory is false, so is a worthless explanation of business cycles.

      (3) Canada - as pointed out repeatedly above and below - did have a lender of last resort during the 1929 crash by means of the "Finance Act" of 1914, which gave the government the power to issue its own paper.

      You don't even need a formal central bank for the government to intervene to protect its banking system from collapse.

      • avatar John S says:

        "a central bank and a system of effective and well designed financial regulation can and does prevent such problems."

        May I ask how you have conclusively proven this with regard to all past and future financial crises? I suspect you have not.

        "You don't even need a formal central bank for the government to intervene to protect its banking system from collapse."

        So then, from a banking stability standpoint, you should have no opposition to eliminating the Federal Reserve.

        Since every healthy industry witnesses the occasional failure of some firms, the goal should not be to eliminate bank failures completely; instead, we should allow a system to emerge which can quickly recover from such events.

        Individual bank failures per se do not always lead to a complete collapse of a nation's banking system. Even the mass failures of the "wildcat" banks in the Midwest (Illinois, Michigan, Wisconsin, and Ohio)--the very worst cases of the mislabelled "free banking" era in the US--did not cause these state banking systems to collapse. In spite of ill-conceived regulations (limitations on branch banking, the requirement to back private currency issues with state bond purchases), some states, such as New York, saw the rapid evolution of stable free banking systems in the decades prior to the Civil War. Other states would most likely have followed suit if free banking had not been smothered by the National Banking Acts.

        See "Wildcat Banking," Dwyer, from p. 68. http://www.terry.uga.edu/~selgin/econ4100/ReadingsPtI.pdf

        • avatar Lord Keynes says:

          Regarding the past, its called empirical evidence: for decades when interest rates were low, the Western world had no massive asset bubbles or serious financial crises.

          Before that period, financial crises were ubiquitous.

          Once the system of effective financial regulation was transformed by neoclassicals and policymakers influenced by neoclassical theory, financial instability has once again become a problem.

          As to the future I do need to "conclusively prove" (i.e, with certainty) it: an inductive argument to the effect that it is highly probable that current problems would be fixed if we introduced an effective financial regulatory system, on the basis of the performance of that system in the past, is perfectly sufficient.

          Can you "conclusively prove" that a free banking system in the future would not result in more depressions, as in Australia in the 1890s?

          • avatar John S says:

            "Can you 'conclusively prove' that a free banking system in the future would not result in more depressions, as in Australia in the 1890s?"

            Of course not. The Australian experience is an important episode, and you have rightly cited it as an episode where a Free Banking system coincided with a crisis and depression. However, it alone does not serve as conclusive proof that Free Banking is a fundamentally flawed idea that merits no further research (or real-world implementation, though, rest assured, that will never happen in either of our lifetimes). Indeed, that is the point of Mr. Schuler's post (read the title again).

            Your problem, I believe, is that you are far too quick to jump to conclusions based on insufficient evidence. In the case of Canada in the 1920s-early 30s, we can say that the system A) had elements of a Free Banking system; B) had some aspects of a Central Banking system; and C) experienced zero bank failures during the Great Depression. But we can hardly state with certainty that B (or A) was wholly responsible for C, or that C would have held even without B.

            What is needed is a calm analysis of the facts and a discussion of what can be reasonably concluded. You, too, could be an important part of that conversation, but you seem more interested in provocation than true engagement. Show some respect for the opinions of those who disagree with you, and they will likely reciprocate.

            Re: the low interest, crisis-free period you cite--I would be interested in reading some articles supporting your view. Would you be kind enough to recommend some? However, despite your protests to the contrary, the debate on what caused this most recent crisis is far from over. I don't pretend to know if regulation or deregulation caused the subprime crisis. But neither should you. At best, you have a hypothesis that warrants further research and discussion. But to insist that you have cracked the code of financial stability is wildly overstating your case. And, at least one of your peers disagrees with you: http://www.economicthought.net/blog/?p=1372

  5. avatar Lord Keynes says:

    "notice the government that passed these guarantees out was not in power during the bulk of Great Contraction... Is there any evidence that these guarantees were viewed as credible?"

    You are wrong. From 1920-1921, Canada was ruled by the Conservative party (the "National Liberal and Conservative Party" as it was called at the time) when credible measures were taken by that government to prevent a serious bank failure. In 1921 the Conservative minister of finance Sir Henry Lumley Drayton explicitly said of the Merchants Bank "the interests of the depositors themselves required to be guaranteed" (Kryzanowski and Roberts 1993: 365). This was publicly reported in the press.

    And as early as 1914, the same Conservative party (during its tenure from 1911-1917) had also intervened to stop a financial crisis by providing reserves to the private banks, as well as implementing the "Finance Act" of 1914, which gave the government the power to issue its own paper, and hence giving it lender of last resort power (Richard S. Grossman,Unsettled Account: The Evolution of Banking in the Industrialized World, p. ).

    The same Conservative party was in power 1930-1935. This party even established the Bank of Canada - Canada's modern central bank - in July 1934.

    From 1935-1948 the Liberal party was in power, and there is no doubt they had given implicit guarantees to depositors from 1923.

    "How do these guarantees differ from the track-record of public-private partnership bailouts that marked the New York money market throughout the 19th and into the early 20th century?"

    It's fairly obvious: the government stood ready to provide liquidity to failed banks, just as it did in 1907 and 1914:

    "Because Canadian banks kept most of their reserves on 'call' in the New York money market, they were able in this way to satisfy the public's demand for liquidity, again precluding the need for a central bank. On two occasions, 1907 and 1914, however, these reserves proved inadequate to prevent a liquidity crisis and the Government of Canada had to step in to supplement the reserves."

    Charles Goodhart and Gerhard Illing (eds.), Financial Crises, Contagion, and the Lender of Last Resort: A Reader, p. 121.

    "Why did the presence of an explicit lender of last resort not prevent banking panic similarly in the United States during the Great Contraction?"

    Because there was no known commitment by the US government or Fed to prevent the financial system from collapsing, nor did they act to prevent the mass bank failures from 1931-1933, as is well known.

  6. avatar Paul Marks says:

    Lord Keynes you quote many dates - but none of these dates include 1929-1932 (the actual period of time in question).

    I am no fan of the Canadian government but quoting "1914" without mentioning that Canada was entering the FIRST WORLD WAR is a little bit unfair (or is the argument of Lord Keynes that the war was somehow a "bankers plot"?).

    As for a promise made in 1923 - words are cheap, how much MONEY was given to the banks Lord Keynes?

    I suspect it was NONE AT ALL?

    However, I agree that the creation of Central Bank in 1935 was an absurd thing to do. At least we agree there.

    The trouble with Keynesians is that you have no idea what CAUSES a "bust". The closest you come to an explination is to waffle on about "animal spirits".

    You yourself, Lord Keynes, admitted that you did not know the German lanaguage well enough to really understand Ludwig Von Mises' "Theory of Money and Credit" (1912). Although not understanding the langauge well enough to understand the book did not stop you publishing a review of the work - rather naughty to publish a review of a book you could not really understand.

    Still do not fear Lord Keynes - there are now English translations of the work (and other works on money and banking - subjects you talk a lot about, without actually knowing much about them) and you will have plenty of time to study these works - in PRISON.

    After all it is now clear that you faked your death in 1946 - so the police will be wanting to talk to you about how you made a lot of money by using confidential government information to play the stock market. Indeed how you gave financial advice to the government for the purpose of personally profiting from this advice via your stock market dealings (that is illegal you know).

    I strongly advice you to turn yourself in the police and to throw yourself on the mercy of the court - in this way you will get a reduced punishment.

    After all at your age (129 years of age) some consideration is in order.

    • avatar Lord Keynes says:

      "However, I agree that the creation of Central Bank in 1935 was an absurd thing to do."

      Then you've clearly misread/misunderstood my argument and/or post.

      I fully endorse the creation of Canada's central bank.

      "The trouble with Keynesians is that you have no idea what CAUSES a "bust". "

      Wrong. Subjective expectations in the investment decision is a sufficient condition for business cycles.

      As it happens, Keynesian theory has any amount of work on business cycles: e.g., Hyman Minsky's debt deflation theory, Steve Keen's development of that theory.

      The Austrian business cycle theory is worthless:

      http://socialdemocracy21stcentury.blogspot.com/2012/03/my-posts-on-austrian-business-cycle.html

      On Keynes' knowledge of German and the myths about his "in German I can only clearly understand what I know already!—so that new ideas are apt to be veiled from me by the difficulties of language” remark:

      http://socialdemocracy21stcentury.blogspot.com/2012/03/keynes-on-misess-theory-of-money-and.html

    • avatar Lord Keynes says:

      "As for a promise made in 1923 - words are cheap, how much MONEY was given to the banks Lord Keynes?

      I suspect it was NONE AT ALL?"

      Wrong again: in 1923 the government of Quebec provided $15 million for the merger of the Bank Nationale with the Banque d’Hochelaga to avoid a bank failure (Kryzanowski and Roberts 1993: 365).

  7. avatar MichaelM says:

    Lord Keynes, do you mind if we secluded this discussion to the linked post? I often post from my cell phone so its difficult to jump between websites too often.

    I'll write a response to that post when I have a moment.

  8. avatar Paul Marks says:

    Lord Keynes.

    You seem to have jumped from the government of Canada (itself a jump from the government of Austrialia in the 1890s - you stopped talking about that when it was pointed out that no such government, indeed no such country, existed in the 1890s) to the government of Quebec.

    However, am I to understand that you SUPPORT the 15 million Dollars in corporate welfare that the governmnent of Quebec provided?

    I, of course, totally oppose this corporate welfare - if a bank is going to go bankrupt (without corporate welfare) it should go bankrupt.

    What is your opinion of the German government in the 1930s? In the introduction to the German edition of your "General Theory....." you say that you support the totalitarian control of the economy (specifically over prices and wages) that the National Socialist government tried to enforce in Germany.

    Is this still your position Lord Keynes?

  9. avatar Paul Marks says:

    Lord Keynes by "subjective expectations" you simply retreat to your, absurd, "animal spirits" theory.

    I would have thought that (given so many years to reflect upon the matter) you would have come up with something a little better than this.

  10. avatar John S says:

    LK, you write on your blog, "Why Did Canada Have no Mass Banking Failures in the Great Depression? Many have argued that it was because of Canada’s successful bank branching system. That is most probably partly true"

    Then does this mean that the lack of branch banking in the US at onset of the Great Depression most probably partially contributed to more bank failures than would have occurred had branch banking been allowed?

    More on branching and bank failures: http://www.econ.yale.edu/seminars/echist/eh03/mitchener-033103.pdf

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