Free Banking 

Given that I do not expect to see free banking in the immediate future, I would like to see one, or preferably more, central banks that now target inflation try targeting nominal GDP targeting instead. Targeting nominal GDP has some prospective advantages over inflation targeting. One is that nominal GDP targeting allows what seems to be a more appropriate behavior for prices over the business cycle, allowing “good” (productivity- rather than money supply-driven) deflation during the boom and “good” inflation during the bust.

Another is that inflation targeting as it has been both most widely proposed and as it has always been adopted has been a “bygones are bygones” version, with no later compensation for past misses of the target. During the Great Recession, many central banks undershot their targets, even allowing deflation to occur. They never corrected their mistakes. Nominal GDP targeting in the form that Scott Sumner and others have advocated it requires the central bank to undo its past mistakes. If it undershot last year’s target, it has to increase the growth rate of the monetary base, other things being equal, to meet this year’s target, which is last year’s target plus several percentage points.

For all that, I am not an enthusiast of nominal GDP targeting. It is worth experimenting with, seeing as how that the widespread use of inflation targeting did not prevent the worst financial crisis since the Great Depression. (Indeed, inflation targeting aggravated the crisis with procyclical policies, according to accounts that I find convincing such as Robert Hetzel’s book The Great Recession.) Anyone with a long memory, though, will have some skepticism towards nominal GDP targeting. In the late 1980s and the 1990s a wave of enthusiasm for inflation targeting swept through economists and policy makers. Inflation targeting was supposed to be superior to what had come before it. As with nominal GDP targeting now, its advocates had the luxury of contrasting an idealized hypothetical system with an actual system that, like all actual systems, had faults. (George Selgin’s Less Than Zero was one of the few real criticisms of inflation targeting, comparing idealized inflation targeting to an idealized theoretical benchmark, the “productivity norm,” in a consistent way.) Now that we have experience with inflation targeting, we can compare actual inflation targeting to other actual monetary arrangements, and obviously it has lost the luster it had when it was only hypothetical. In particular, advocates of inflation targeting did not anticipate that central banks would be so willing to allow such rapid, though brief, deflation.

With nominal GDP targeting it may well also happen that there will be flaws that only become apparent through experience. My reason for thinking that flaws are likely is that, like inflation targeting, nominal GDP targeting is an imposed monetary arrangement. It is not a fully competitive one that that people are at liberty to cease using at will, individually, the way they can cease buying Coca-Coca and start buying Pepsi or apple juice instead. Nominal GDP targeting when carried out by a central bank, which has monopoly powers, is a form of central economic planning subject to the same criticisms that apply to all forms of central planning. In particular, it does not allow for the occurrence of the type of discovery of knowledge that comes from being able to replace one arrangement with another through competition.

Economists' favorite number is one: one person/firm/country/good. Their second favorite number is two: one person/firm/country/good and a composite representing all the rest. Economists don't like numbers greater than two so much when making models because with three or more, complex interaction effects can occur.  That to me is the whole point, though. The world is complex, and reducing it to a single ("representative") agent or to one versus the rest of the world often produces misleading results by neglecting differences that are vitally important economically or politically. Money, for instance, requires the existence of at least three goods in principle, and many more in practice. Hence I was gratified to come across this passage:

I am speaking of the claim that it is best for the city to be entirely one to the greatest possible degree, for Socrates adopts that hypothesis [in Plato's Republic]. And yet it is evident that by advancing and becoming more of a one it will not be a city. For a city is by nature a certain kind of multiplicity; by becoming more of a one it would turn from a city into a household and from a household into a human being.

-- Aristotle, Politics, Book II, chapter 4, Bekker page 1261B about lines 16-20, translated by Joe Sachs (Newburyport, Massachusetts: Focus Publishing, 2012)

"Modern Monetary Theory versus the Austrian School." The antagonists are Robert Murphy (Mises Institute) and Warren Mosler ("modern monetary theory" school, who has a blog with the wonderful title "The Center of the Universe"--it turns out to be the U.S. Virgin Islands, where he lives).

6:15 p.m. (Eastern Daylight Time), room 103, Jerome Greene Hall, Columbia Law School, New York City.

Here is the link. The debate will be live streamed on video.

For me, the big lesson of the episode of the errors in the paper by Carmen Reinhart and Kenneth Rogoff is, Show your work. From the time they released their first working papers drawing on the data they would use in their book This Time Is Different, they have been slow to release the data. When I reviewed their book for the Cato Journal about a year and a half after it was released I complained that they still had not yet posted much of the data online.

Before the Internet there was no convenient way to make data readily accessible to anyone who might be interested in it. The best one could expect was that the authors or a journal that published their work would store it in a file and send copies on request. For at least the last decade, though, there has been no excuse for failing to make data available online if it is potentially important and if it does not violate copyright restrictions or confidentiality agreements. Reinhart and Rogoff could have posted their data and calculations immediately and their error might have been detected much sooner, allowing them to correct their results at an early stage with less embarrassment.

For future work on free banking using historical statistics and making calculations, authors should post the spreadsheets or computer code. They should also describe the original sources precisely, so that other researchers can find them, and where the sources are not already available online and are out of copyright, it would be very helpful to post digital photographs showing the data. In fact, a central repository of text and data on free banking would be enormously helpful because it would enable researchers to avoid duplicating effort collecting material. I have been informally helping to organize a similar repository concerning currency boards (easier than for free banking because the data are more centralized, but still requiring an enormous amount of work, mainly done by students in this case). It will go online later this year, at which point I will write a post about it.

I have tried to practice what I preach with my book The Bretton Woods Transcripts (e-book 2012, hardcover forthcoming in a few weeks). Although the book does not contain any statistics or calculations, it did require significant editing of the original transcripts of the Bretton Woods conference. My co-editor Andrew Rosenberg took photos of the original typescripts of the conference at the National Archive and we posted them on the publisher’s Web site. Readers who want to compare our edited book to the original typescripts can readily do so.

From time to time I see comments in the press or on the Internet comparing the euro to the gold standard. In point of fact, they have little in common.

Most obviously, of course, the euro is a fiat currency having a floating exchange rate, while under different forms of the gold standard, national currencies were redeemable in, well, gold at a set rate.

The euro is in several ways more monolithic than the historical gold standard was. Under the gold standard, many countries went off the standard and later returned. The United States, for instance, went off the gold standard near the start of the Civil War and returned to it in 1879. Britain went off it during the Napoleonic Wars. No country has so far left the euro area, so of course no country has returned to the euro area.

The euro is a single currency. A euro note in Finland is accordingly interchangeable with a euro note in France in terms of the ability to spend it readily on local goods without any transaction fees. Under the gold standard there were multiple national currencies, which while exchangeable at set rates were not fully interchangeable. A century ago you would have had a hard time spending a Canadian $50 note in Atlanta even though the Canadian and U.S. dollars were worth the same amount of gold.

In the euro area there is a single central bank practicing a single monetary policy, reflected in a single main policy interest rate. Under the gold standard there were multiple central banks as well as other monetary authorities and free banking systems. The central banks had differing policy interest rates (for some examples see the spreadsheet for “policy interest rates” available in this data set I edit).

National central banks within the euro area do not impose fees or erect other impediments that give rise to fees for exchanging euros across national borders. Under the gold standard central banks sometimes imposed explicit fees or established procedures that imposed implicit costs for transferring gold from one country to another. An example was that central banks would sometimes switch from redeeming their currencies in gold coins to gold bullion, which was harder to subdivide and slightly less desirable than coin for many purposes of international trade. Or, instead of paying out gold coins that had little wear and tear, they would pay out coins that were within the legally established range of tolerance but more worn, hence usually used in domestic rather than international trade.

Finally, the gold standard provided profit and loss signals to guide monetary policy that are absent under fiat currency. Under the gold standard, a bank that held excessive gold reserves forwent profits it could have safely made, while a bank that held not enough gold reserves risked bankruptcy. This discipline was not as strong for central banks as for free banks, especially not on the reserve accumulation side, but it existed. The European Central Bank looks at market indicators--indeed, probably a wider variety than the old gold standard central banks did--but no market signal operates directly on its balance sheet the way that loss or gain of gold reserves did.

The euro has some resemblance to the gold standard in the sense that both are international standards, constraining the exchange rates of the countries that use the euro or gold. That is about the limit of the analogy, though. Economists should cease making it because it says more about their lack of knowledge of the two systems they are trying to compare than it helps to illuminate anything.

In my previous post I mentioned that my admiration for Keynes overall is quite strong. It is based on his deeds as a practioner of economic policy as well as his words as a theorist. Among his major writings on monetary economics, Indian Currency and Finance is now very little read because it concerns controversies long past. A Tract on Monetary Reform is, along with Dennis Robertson’s little primer Money, the only book on monetary theory I know of in English that has high merit both as economics and literature. The second volume of the Treatise on Money remains worthwhile for specialists in central banking. The General Theory of Employment, Interest and Money is, as I have previously mentioned, a muddle.

Keynes was deeply involved in running Britain’s war finances during World War I and World War II. Despite great strains, Britain avoided the postwar high inflations, maxi-devaluations, and currency confiscations that the other European belligerents suffered. The wars weakened the pound sterling but did not destroy it and the property relations that rested upon it. Keynes deserves some of the credit, especially as concerns World War II, in which his pamphlet “How to Pay for the War” influenced British policy.

That brings me to my theme. In monetary theory and even in most systematic treatments of monetary policy, the influence of war receives little or no attention. There have been many specialized studies of wartime monetary conditions, but look at a treatise or a textbook on monetary economics and you will not find war and its problems woven into the story even though war has been the source of many major changes to monetary systems.

War is particularly a problem for free banking. Governments’ desire to finance war through inflation and measures of “financial repression” such as exchange controls and forced saving (or confiscation of savings) are fundamentally at odds with the spirit of voluntary cooperation underlying free banking and the market economy more broadly. An important question for research in free banking is whether and how a free banking system that has been in effect nationalized during wartime can be privatized again in peacetime. War has often had a ratchet effect on government involvement in the financial system. In the United States, for instance, the federal government issued notes (paper money) during the Civil War and has continued to do so ever since. It is not enough to say, as Leonard Read did about wage and price controls, that “I’d Push the Button” if there were one to abolish them immediately. Many countries have rapidly decontrolled wages and prices. I am unaware of any country that has switched from government control of the monetary system to free banking with similar speed and energy. Switches have happened, but they have been matters of years rather than days.

Psst. Keynes was a homosexual. Pass it on.

Late last week Niall Ferguson, professor of history at Harvard, gave a talk at an investment conference. In response to a question from the audience he criticized Keynes's focus on short-term economic policies and hypothesized that it was related to Keynes's homosexuality and childlessness. (When young, Keynes and the painter Duncan Grant were lovers. Later, to the great surprise of his friends, he married the Russian ballerina Lydia Lopokova, and by all accounts they were a devoted couple.) Ferguson's remarks brought down a storm of criticism, and he beat a hasty retreat, retracting his remarks.

The incident piles irony on top of irony in a delicious seven-layer cake of ridiculousness.

1. The quote Ferguson was asked to comment on, Keynes's famous remark that "In the long run we are all dead," from the Tract on Monetary Reform, is not an argument for focusing on the short term in economic policy, but a criticism of economic analysis that concentrates on long-run equilibrium while neglecting what may be extreme, highly disruptive turbulence that occurs in the short term.

2. Keynes is the ultimate privileged dead white male, yet because of his early homosexuality the deacons of political correctness have rallied to him, arguing that it was invidious to criticize him for it.

3. If Keynes's homosexuality is not relevant, can we now get rid of all the university programs of ethnic, gender, postcolonial, and other identity studies erected on the premise that such things are relevant?

4. As Jonah Goldberg noted, Ferguson's criticism linking Keynes's short-termism to his childlessness was not new. Joseph Schumpeter, a contemporary who had the opportunity to observe Keynes and a deeper intellect than anybody who has blogged on the subject, made the criticism in his obituary of Keynes. Others have done likewise since.

5. I assume, however, that Schumpeter and others did not know that Keynes and Lopokova were not childless by choice. We now know that she had a miscarriage.

6. Ferguson's quick cave-in to political correctness must be a record for a tenured professor who is ostensibly not a man of the Left. Larry Summers held out a lot longer. Apparently the thought of living on a professor's salary and book royalties alone, seeing the speaking fees dry up, and getting the cold shoulder in the faculty lounge were too much for him. I expect better from one whose position is so secure. Perhaps it's time for Harvard to replace "Veritas" on its seal with a chicken rampant to represent the ethos of the university more accurately.

7. To top the whole thing off, there was some truth to Ferguson's remarks; it just not as direct as he asserted. As someone who has read a lot by and about Keynes, including bringing to light previously neglected material by him on two occasions, I think Keynes's homosexuality did influence his views. Although by birth an insider in the English intellectual class, Keynes's homosexuality, along with his lack of religion, gave him an outsider's perspective on many issues. One of his common modes of argument was to attempt to skewer conventional opinion, something he drew great pleasure in doing. His essay "My Early Beliefs" discusses where that quality came from and how he came to have some grudging respect for conventional opinion as he grew older. He does not discuss his early homosexuality because at the time it was still, regrettably, "the love that dare not speak its name." Keynes's first biographer, Roy Harrod, likewise omitted mention of it. Knowing about Keynes's homosexuality makes the essay even more revealing. Keynes's sexuality matters no more for the truth or error of his ideas than Plato's sexuality matters for the truth or error of Plato's ideas. It was, however, part of the psychological makeup that made Keynes unconventional and more willing to experiment with ideas than someone of otherwise similar background. There are two control cases for my claim: Keynes's father John Neville and his brother Geoffrey. Both were highly accomplished men, important in their time, but John Maynard Keynes is an immortal, in a wholly different league from them. Keynes's willingness to experiment with ideas, and change them frequently, lays his ideas on economic policy open to what I consider a fair charge that they are too focused on the short term. The experience of his times is some excuse: Keynes faced war, recession, currency crises, depression, and war again, and was always in the thick of things as a policy maker, speculator, or influential outside hectorer.  Still, he had too much confidence in his own ability to influence British economic policy and paid too little attention to the long-term consequences of his quicksilver short-term policy maneuvers.

The larger lesson for me is the continuing malign effect of political correctness. Although Ferguson's remarks were sloppy, the connections between the qualities or behavior of a thinker and his ideas are legitimate subjects of inquiry. We want to know what made significant thinkers tick because there have been so few of them. The climate that stifles such inquiry is also the climate that stifles inquiry into matters less charged by identity politics, such as the gold standard and free banking, by insulting them rather than answering them.

And now for some cherries on the top.

Despite Keynes's not being religious, I read recently that Keynes did a greater service to the Church of England than perhaps anyone else in the 20th century when he advised that after World War II it should shift many of its assets from bonds to stocks. Stocks roughly kept pace with inflation and sometimes more, while bonds did not.

Years ago, Peter Boettke told me a story about a conference where Ludwig von Mises's wife Margit was present. One of the speakers mentioned Keynes and Mises favorably in the same sentence, calling them the two greatest economists of the century. Margit von Mises rose and spluttered, "How can you compare my husband to Keynes? Keynes was a  homosexual, and let me tell you, Ludwig von Mises was no homosexual!"

Finally, for a previous post on Keynes, see here. My admiration for Keynes overall is quite strong, although I think The General Theory was his worst-written book and has many problems. As for his sex life, if he were living it today it would today be fodder for some cult series on HBO, and I don't watch HBO.

Psst. Keynes was a fascinating economist and man. Pass it on.

(Richard M. Salsman wrote this e-mail to me in response to my previous post and gave me permission to share it with readers of the blog.)

Prompted by Glasner’s recent critique of claims about the “golden constant” (Jastram’s finding of long-term relative stability in gold’s real purchasing power), Kurt Schuler recently wished to locate a “middle ground” between our current (post-1971) monetary system of central banking and fiat money (hereafter, “CB&FM”) and a system of free banking on the gold-coin standard (hereafter, “FB&GS”).

Why a middle ground, or at least something of a transition period?

Kurt is right, I believe, in arguing that central banking and gold-based money are incompatible; in logic and history alike they don’t go together, at least not for long. “If you want the gold standard in durable form,” he writes, “you can’t have central banking,” and “if you want central banking, you should not mix it with the gold standard.” This means a “Bretton-Woods II,” while tempting (compared to our current system), would likely prove futile; before long, its golden element would be manipulated or sabotaged, as happened under B-W (1945-1971), and the financial fallout will be blamed on gold, yet again, not on a deficit-spending Treasury or a debt-monetizing Fed. As I showed in Gold & Liberty (1995), the gold standard wasn’t the cause of the Great Depression, nor of the breakdown of B-W I; see also Chapter VII, and the section titled “The Incompatibility of Central Banking and the Gold Standard.” And in a recent article, “The End of Central Banking,” I expand on the Selgin-White thesis that the purpose (“end”) of central banking is largely fiscal – and not a “fix” of supposed “market failures” (“A Fiscal Theory of Government’s Role in Money,” 1999), and their thesis that private financial institutions have far greater credibility than central banks in maintaining gold-convertibility or even fixed exchange rates (“Credible Currency: A Constitutional Perspective,” 2005). In short, the reason central banking is incompatible with the gold standard is that it exists mainly to help finance the fiscally-profligate state – a state that requires limitless fiat money.

Yet immediate adoption of a system of free banking and gold-based money is a remote possibility – as remote as immediate repeal of the fiscally-overextended welfare-warfare state – despite welcome optimism from certain gold-money advocates. How then might a “middle ground” be established, without sacrificing principles in support of liberty and the rule of law for government generally and money and banking particularly? The only plausible version I’ve ever found to be defensible – and even then, only as a transition to a pure system of FB&GS – is the supply-side case for a “gold price rule” (hereafter, a “GPR”).

Under a GPR, the Fed would only buy and sell gold at a fixed price; there’s no currency convertibility, and no actual gold coinage in circulation, nor even any minimum required gold reserves at the Fed (and none at the banks, either, although they’d be free to buy and hold gold).  A GPR could be advocated as a worthy competitor to today’s two dominant rules – the monetarist rule (money supply targeting; in extremis, QE – “quantitative easing”) and the Keynesian rule (interest-rate targeting; in extremis, the ZIRP – “zero interest-rate policy”). But a GPR also could be our middle-ground path to a purer (free-market) monetary system, when (and if) the ideological climate changed sufficiently to restrain or reduce the size, scope, and cost of government (hence, its fiscal neediness).

A GPR was first comprehensively advocated by Art Laffer in 1980 (“Reinstatement of the Dollar: A Blueprint”), and was the basis for the “Gold Reserve Act of 1980” (GRA), introduced by then-Sen. Jesse Helms. The GRA died with the Gold Commission (1982). Not many supply-siders, of course, would go so far as to advise the eventual phasing-out of central banking. At best, their version of GPR was to morph into central-bank managed currency convertibility. According to Laffer and Kadlec, “the purpose of a gold standard is not to turn every dollar bill into a warehouse receipt for an equivalent amount of gold, but to provide the central bank with an operating rule that will facilitate the maintenance of a stable price level” (“The Point of Linking the Dollar to Gold,” Wall Street Journal, October 13, 1981). To this day, most supply-siders place undue trust in central banks’ willingness to establish or preserve gold-based money. Yet free bankers, in rejecting this premise, need not also reject the positive aspects of a GPR – its superiority to Keynesian and Monetarist rules, and its role as a path to purity. For an analogous precedent in political theory-history, see the shift from absolute monarchies – to constitutional monarchies – to constitutional republics.

A major objection to the GPR would be that it merely gives a central planner (Fed) advice – purportedly, “a better rule.” But a GPR advocate can simultaneously stress opposition to central planning (central banking), and present a GPR as the means to an even better system. A GPR would help markets and banks become comfortable again with gold-based monetary stability. Also, free bankers could stipulate, as part of a GPR, that the Fed can’t own government securities and must divest those it now holds, and that it no longer regulate banks. Additionally, we must phase out the array of subsidies now made to banks: the discount window, the FDIC, and the TBTF policy. We start with GPR, but seek gradually to reduce and withdraw the moral hazard aspects of CB&FM.

We must also insist that the Fed no longer manipulate or gyrate interest rates (the Keynesian rule), but leave their determination to markets. Oddly, some supply-siders (Wayne Angell, others) believe a GPR is best attained by a central bank altering interest rates: raising them when the gold price moves above the target, and lowering them when gold declines below it. At any rate, under a GPR that has the central bank dealing only in gold, not government securities, interest rates nevertheless should be more stable, since the dollar itself would be more stable (fixed to gold). But if the Fed is to be stripped of such powers, why not just have the Treasury conduct the GPR, directly?  As long as government exists, even its legitimate fiscal needs require a Treasury, which surely can borrow, to handle uneven revenues and spending. Treasury itself could buy and sell gold at a fixed price, with dollar-denominated Treasury notes (TNs). Retire Federal Reserve Notes (FRNs) and replace them with TNs. Banks today already hold liquid T-Bills and thus can easily handle TNs. In time private banks could issue currency, in dollars, with “dollar” defined as a fixed weight of gold (say 1/1500ths an ounce of gold – today’s rate), with full convertibility under fractional reserves.

In short, a GPR could be a helpful “middle ground” that’s both achievable in our time and yet a viable path to FB&GS, should the reigning political ideology ever permit it. Advocates of FB&GS can remain “policy relevant,” in a world that still heavily favors CB&FM, without sacrificing their deeper, libertarian principles.

Comments and criticisms are most welcomed.

(Prompted by a recent post by David Glasner.)

A number of advocates of the gold standard claim they want to return to a "real," pre-World War I style gold standard rather than the interwar or Bretton Woods versions, which proved not to be durable. Unlike the pre-World War I gold standard, though, where countries representing only about half of the world's economic output had central banks--and the biggest economy, the United States, was not among them--they propose to leave central banks in place.

Critics of the gold standard point to the disastrous experience of the interwar gold standard as an argument against returning to gold. What only a few acknowledge is that the interwar gold standard worked much differently from the prewar gold standard. In particular, research into the behavior of the Federal Reserve and the Bank of France has shown that, because they were central banks with discretionary monopoly powers rather than competitive commercial banks, they made decisions to accumulate and sit on large stocks of gold that competitive banks would not have done. Dick Timberlake returns to this point regarding the Federal Reserve in his new book Constitutional Money. He points out that when Franklin Roosevelt took the United States off the gold standard in 1933, the Federal Reserve held about substantially more gold than the minimum required by law; moreover, it had the power under the law to go below the minimum if it declared that emergency circumstances required doing so. The Fed could have followed a much more expansionary policy in the years after the stock market crash of 1929. Dick reiterates the theme of an important article he wrote several years ago, that the reason it did not do so was that it was guiding its policy by a version of the "real bills doctrine."  While benign for competitive commercial banks, the real bills doctrine has what Dick terms a "dark side" if implemented by a central bank as the Fed did.

Here's what I propose as the middle ground for the advocates and critics of the gold standard: central banking and a pre-World War I-style gold standard are incompatible. If you want the gold standard in durable form, you can't have central banking. If you want central banking, you should not mix it with the gold standard.

As I have written before, it will not do to use the experience of the interwar period as an argument against the gold standard simply. It is an argument against the gold standard under central banking. The Great Depression was Great precisely because it was uncommon. During all the previous centuries of experience with gold and silver standards there was nothing to compare to it. It is sobering in that context to observe that at present, most of  Europe (Germany, a few of its neighbors, and Russia being exceptions) and Japan are still below their pre-recession peaks of output, and that in some cases they have been below their pre-recession peaks longer than they were during the Great Depression. Prolonged economic sluggishness is just as possible without a gold standard as with it.

Following up on the comments to George Selgin's post on Bitcoin, here's a suggestion. An enterprisising reader should write a paper on the early history of Bitcoin, while people's memories are still fresh. Answer the questions George suggested, and give other details of just how Bitcoin got off the ground. Whether or not Bitcoin becomes bigger than it is, you will have contributed an important piece of knowledge.