George Selgin

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George Selgin is a Professor of Economics at the University of Georgia's Terry College of Business. He is a senior fellow at the Cato Institute. His research covers a broad range of topics within the field of monetary economics, including monetary history, macroeconomic theory, and the history of monetary thought. He is the author of The Theory of Free Banking (Rowman & Littlefield, 1988), Bank Deregulation and Monetary Order (Routledge, 1996), Less Than Zero: The Case for a Falling Price Level in a Growing Economy (The Institute of Economic Affairs, 1997), and, most recently, Good Money: Birmingham Button Makers, the Royal Mint, and the Beginnings of Modern Coinage (University of Michigan Press, 2008). He has written as well for numerous scholarly journals, including the British Numismatic Journal, The Economic Journal, the Economic History Review, the Journal of Economic Literature, and the Journal of Money, Credit, and Banking, and for popular outlets such as The Christian Science Monitor, The Financial Times, The Wall Street Journal, and other popular outlets. Professor Selgin is also, a co-editor of Econ Journal Watch, an electronic journal devoted to exposing “inappropriate assumptions, weak chains of argument, phony claims of relevance, and omissions of pertinent truths” in the writings of professional economists. He holds a B.A. in economics and zoology from Drew University, and a Ph.D. in economics from New York University.

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Free Banking and the Dollar

by George Selgin December 12th, 2014 5:51 pm

I've been getting some flak lately from hard-core free market types for occasionally saying some nice things about NGDP targeting, and especially for suggesting, in the course of a recent Cato forum contribution, that we might improve upon the present U.S. arrangement by replacing the FOMC with a tamper-proof Bitcoin-type protocol that automatically adjusts the output of base dollars so as to maintain a steady NGDP (or, better, Domestic Final Demand) growth rate. Call the dollar thus reformed the "Bitdollar."

My Bitdollar proposal, my hard-core critics maintain, places me firmly in the ranks of apologists for state "manipulation" of the money supply. Consequently I am, by their reckoning, a turncoat in the fight for monetary freedom, and (since I still have the brass gall to post on a site called "freebanking.org") a hypocrite to boot.

What have I to say in response to such charges? Considering their sources, I'm tempted to settle for a Bronx cheer. But as some others may wonder if there isn't some merit in their accusations, I think I'd better indulge my critics by entering a plea of "Not Guilty."

My defense? It is simply this: that while I'm all for monetary freedom and competition, I'm also for reforming the U.S. dollar, which for me means freeing it from control by discretionary central bankers. Like it or not, the dollar is presently the standard money, not just of several hundred million U.S. inhabitants, but of many millions of inhabitants of other countries. What's more, these millions, unlike holders of U.S. securities, hold fiat dollars under some degree of duress, because a combination of network externalities and legal restrictions makes it almost impossible for them--my hard-core critics included--to survive without equipping themselves with dollar-denominated exchange media, or because they live in places where the dollar seems rock-solid compared to anything local authorities have to offer.

Consider, then, some other purportedly free-market strategies for monetary reform, and the alternative fates to which each would consign the world's hapless dollar holders. There is, first, the inevitable catastrophe strategy, according to which, in the wake of a long-forestalled but nonetheless inevitable hyperinflation, a state of monetary freedom (gold version, usually) emerges Phoenix-like from the dollar's ashes. Then there's the level playing field strategy, which supposes that mere elimination of legal tender laws and other government-erected impediments to free choice in currency would provoke a spontaneous switch from dollars to other currencies, leaving to the Fed the choice of either shedding assets to preserve the dollar's value, or letting it become worthless. Next there's the back to gold strategy, in which the Fed (or some replacement agency) is compelled to turn present "IOU nothings" back into redeemable claims to gold. Finally, there's the frozen Fed strategy, which equates any change in the stock of base dollars with monetary interventionism, and therefore treats a frozen base as the closest fiat-money equivalent to monetary laissez-faire.

Unless you happen to live in a bomb-proof shelter equipped with a lifetime supply of canned goods, the catastrophe strategy will, I trust, strike you as undesirable both because you might be among the people wiped-out by the anticipated hyperinflation, and also because that hyperinflation could be a long-time coming. A long delay is also likely to be in store for those banking on the level-playing field strategy, which downplays, I think severely, the likelihood that the dollar will stay in the saddle so long as catastrophe doesn't strike. As for a return to gold payments, I've explained elsewhere why I doubt such a return could be sustained, assuming it might be achieved at all.

That leaves the frozen Fed strategy. For this alternative I admit to having considerable sympathy: I can hardly do otherwise, having proposed the idea myself in my first book (see chapter 11). Besides, unlike the other plans this one could preserve the dollar network whilst safeguarding dollar holders from the Fed's machinations. But in what sense is this strategy any less of a cop-out than my now favorite plan for replacing the present Federal Reserve dollar with an NGDP- (or Domestic Final Demand) stabilizing Bitdollar? If a tamper-proof Bitdollar is a form of monetary central planning, then so is a frozen Fed dollar. The difference between the schemes is, not that one involves a planned base money stock and the other doesn't, but that one involves a fixed base money stock and the other doesn't.

But, you may ask, isn't a fixed stock of base money more consistent with laissez-faire than a stock that grows at some constant rate while also adjusting, albeit automatically, in response to changes in the real demand for base money? No, it isn't. Consider the classical gold standard, or any commodity-money regime for that matter. Such a regime involves, not a constant monetary base, but one that tends to expand along with growth in the real demand for base dollars. Thus the long-run price-level stability that was one of the gold standard's most noteworthy achievements. Whatever else it might be doing, a discretionary Fed that insisted upon keeping the monetary base constant would not be emulating a gold standard. Instead, it would be pursuing a policy that might well lead to disturbances as serious, if not considerably more serious, than those that could be justly attributed to the historical gold standard or (for that matter) than those that might arise today under a discretion-based regime that yielded low and steady inflation. In any event the belief that a central bank is "doing nothing" when it chooses to maintain a constant monetary base (or constant stock of any monetary aggregate) is my personal choice for top honors (and, take my word for it, the competition is stiff) in the "crudest free market monetary fallacy" contest.

Free banking would, to be sure, go a long way toward reducing the risk of money shortages, and consequent downturns, in a frozen-base regime, both because it would allow changes in the relative demand for currency to be accommodated through greater emissions of private banknotes (or their digital counterparts) without need for more base money, and because changes in the free-banking base-money multiplier would tend (for reasons also given in The Theory of Free Banking) to automatically compensate for changes in the velocity of money. But these tendencies would still not suffice to avoid some risk of unwanted deflation--which is to say, deflation that's not just a reflection of productivity gains.* In particular, they would not allow for monetary expansion to accommodate growth in the supply of factors of production, and of labor especially. An automatic and tamper-proof regime providing for a constant spending growth rate would come closer to avoiding both monetary excess and monetary shortages. And that's why I favor such a regime, now that Bitcoin has suggested a means for implementing it.

It would be unnecessary for me to say, where it not for certain contrary animadversions, that, far from being a monetary freedom apostate, I remain as committed to free banking, and to monetary freedom in the more general sense, as ever. I still pine for truly unregulated banking, minus all the regulatory red-tape but also minus government safety nets and the prospect of Fed (or Treasury) bailouts. I still oppose all artificial restraints upon free trade in currency. I still would rather have private mints coining and private firms issuing our small change, for goodness sake! But I also want to see the dollar made safe and sound, and the sooner the better; and I can think of no better way of making it so than by replacing the present discretion-based version with one that provides for an automatically-determined supply of dollars--an automatic mechanism not unlike the one that characterized the gold standard, though one both more conducive to short-run stability and less dependent upon untrustworthy promises.

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*I can hear certain self-styled Austrian economists grumbling to themselves, "but there's nothing wrong with any sort of deflation!" Here is another good candidate for the previously-mentioned contest. Like it or not, in today's world, many prices, and wage rates especially, are notoriously "sticky" downwards, which means that a plunge in general spending is bound to result in otherwise avoidable unemployment. True, Murray Rothbard says otherwise in the theoretical part of America's Great Depression. But then he spends the rest of the book explaining how Hoover changed everything with his silly high-wages doctrine. Whether or not price stickiness originated with Hoover, it certainly didn't end with him!


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We Are All Free Banking Theorists Now*

by George Selgin December 7th, 2014 12:33 am

(*And we always have been.)

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Yesterday, while giving Cato's interns an impromptu talk about my work, I found myself saying something that seems worth putting in writing. This was that the difference between me and Larry White and Kevin Dowd, among others, and most other monetary economists, isn't that we theorize about free banking, and they don't. It's that we're mindful of our free-banking theories, whereas they're mostly heedless of their own.

Consider: an economist says that central banks prevent or limit the severity of financial crises, or that without mandatory deposit insurance even sound banks are likely to face runs, or that banks can never be expected to hold enough capital unless we force them to, or that commercially-supplied banknotes will tend to be discounted. All such claims--which is to say any claims about the need for or consequences of government intervention in banking--depend, if not on an explicit understanding of the nature and workings of a laissez-faire banking system, then on some implicit understanding. And this understanding in turn implies a theory of some sort, for reference to experience alone won't suffice for drawing the sort of sweeping conclusions I'm talking about. It follows that all economists who have anything to say about the effects of government intervention in the banking system are either self-proclaimed free banking theorists or are free banking theorists who don't admit (and perhaps don't realize) it.

The rub is that tacit or subconscious theories of free banking--the sort people rely upon when they are "doing" free banking theory without being conscious of it--are likely to be bad theories because, being unstated, they can't be challenged, and, being unchallenged, they don't tend to be systematically corrected. A self-conscious free banking theorist confronted with some claim of banking-market failure might point to his own theory suggesting that no such failure exists, and might also point to contrary evidence. But he can't generally infer, and therefore can't directly contradict, the theory behind the claim.

If even economists who've never heard of free banking, or who dismiss both it and the people who take it seriously, nevertheless subscribe to some free banking theories of their own, where do their theories come from? As I can't read other economists' minds, I can't pretend to know the answer. However, I can, and I will, hazard a guess or two.

Consider, if you will, your typical fresh PhD, having monetary or (more commonly) macroeconomics as a specialty, as might have been disgorged by any save a handful of the doctoral programs in the U.S. sometime during, say, the last 30 years. In all likelihood that graduate never took a class on economic history, let alone one on monetary history or (least likely of all) the history of economic thought. Nor is he or she likely to have become familiar with even present day monetary institutions through any other coursework, most of which is devoted to mastering either statistical methods or highly abstract models. As for the monetary sequence itself, it is likely to have involved toying with Overlapping Generations models, which don't even get the definition of money right, or Woodford-style neo-Wicksellian economics, which (unlike the Swedish real McCoy) strives to avoid using the "m" word altogether. Some better students, to be sure, will make up for the lack of institutional meat in their bland graduate-school porridge by grabbing the occasional vitamin from the library. But even when I went to school (NYU, class of '86), that sort of thing was relatively rare. Today, to judge from the many grad students I talk to, a student who dare's to do it, besides risking failure by having less time left to study for prelims, is sure to be regarded as a weirdo.

After graduation, perhaps? So far as most economists employed in research universities are concerned, Fuggedaboudit. Publish or perish means, for the vast majority, polishing up the three-articles that comprise their dissertation, and then milking the same highly-specialized human capital that sufficed for producing those "chapters" for all it's worth, which, with luck, will be additional articles enough to get one over the tenure threshold. With the tenure clock ticking inexorably, and journals taking their sweet time to return reports, who can afford to be intellectually curious? After tenure? Not likely, since most tenured faculty, having developed a shtick which, with the help of some elegant variations, may serve as well in getting them promoted again as it did in getting them tenured, still won't get around to learning stuff that they now regard, with perfect justice, as perfectly irrelevant to mastering their profession. Better to angle for department head, or (for those with higher aspirations) to take up golf.

The upshot of all this is that most of what our monetary economist knows or believes about monetary institutions he or she learned as an undergraduate. And what was that? To infer from the contents of most principles and money and banking textbooks, very little, and much of it misleading. Of monetary history, in particular, such books (1) say very little, if anything at all; (2) refer (if written for the U.S. market or by U.S.-trained economists) only to U.S. experience; and (3) get that wrong. Reading such books, you are quite likely to learn (for examples) that banking started out as a big swindle, that before the Civil War U.S. banks were hardly regulated at all and that, for that reason, American's were saddled with all sorts of banknotes, most of which were worth far less than their face values; that the Federal Government nationalized the currency supply, forcing state banks out of the business, during the Civil War because it was suddenly inspired to establish a uniform currency; that post-Civil War panics were inevitable given that we still lacked a central bank; that during the Great Depression people staged runs willy-nilly on good and bad banks alike until, in early 1933, they lost confidence in every last one of 'em, thus proving beyond doubt the necessity of nationwide deposit insurance; and that the Fed is an independent central bank, having become so in 1951. My conjecture, in short, is that tacit theories of free banking are most likely cobbled together, unconsciously and therefore haphazardly, from such substandard undergraduate building material.

So much for academic economists, or at least for the vast majority of them under the age of 60. If you want an academic economist who really knows his monetary institutions, a good rule of thumb is, the older the better. Try Dick Timberlake (92), or Leland Yeager (90), or Alan Meltzer (86), or Axel Leijonhufvud (81), or Charles Goodhart (78), or David Laidler (76). But beware that, even among Laidler's cohort, there are plenty who don't seem to be know a bank from a hole in the ground, or a redeemable banknote from (say) a durable good.

True, economists who work for the Fed, or at least for research departments of the various reserve banks, are another matter. Their jobs tend to encourage them to be familiar with at least some real-world monetary institutions; and I know quite a few, not all of them yet 60, who know their monetary history pretty well, including a fair bit about free banking. Having actually heard of it and thought about it, their theories of free banking, if still implicit, are at least reasonably well informed. They also tend to be rather more interested in, and favorably disposed to, what we avowed free-banking theorists have been saying, than their academic counterparts.

Would that this were also true of the Fed's higher ups, including its highest-ups of all. Alas, officially at least, their understanding of free banking is not much better than that of our lowly tenure-grubbing assistant professor. Consider even Ben Bernanke, a Fed chair regarded as an expert monetary history. To judge from his GWU lectures, at least, his general take on U.S. monetary experience doesn't seem all that different from the conventional textbook wisdom I mentioned a few paragraphs ago. The Fed's other "educational" productions, aimed at general readers (as opposed to its research intended for other experts) are for the most part even worse.

Some persons hearing me claim that many economists, including those who want nothing to do with free banking theory, are free banking theorists themselves, albeit ones who don't know it (and whose theory is likely to be the poorer for it) will, I imagine, think to themselves, "What in the blazes is Selgin thinking? Of course free banking's critics have a theory, and not just a tacit one. They've got a theory and they know it. They've got...Diamond and Dybvig! What's more, it's a real theory, a rigorous theory, with equations and optimization and all, not like the loosey-goosey stuff free-bankers churn out. What more can Selgin possibly want?"

A lot more, actually. Because, notwithstanding all its bells and whistles and tweakability (the quality of lending itself to publishable variations), the Diamond-Dybvig model isn't a formal representation of free banking at all. It's a formal representation of the same cartoon version of free banking that, if I guess correctly, informs most tacit free banking theories. More precisely, it's a formal model that takes as its starting point the assumption than an unregulated banking system is one that might at any moment fall victim to random yet system-wide runs.

I'm not saying that the D-D model is anything less than ingenious. In fact, it isn't easy at all to come up with a model that obeys the rule of not having agents do anything that doesn't increase their expected utility, and yet have it imply occasional if not frequent disasters. In this case, it took some doing. Diamond and Dybvig had to assume away, among other things, (1) the difference between a bunch of idiosyncratic banks and a single representative bank; (2) bank equity, which would otherwise drive a wedge between adverse shocks and bank insolvency; (3) any distinction between banks' reserves and an economy's consumption goods (which makes consumption equivalent to disintermediation); (4)...well, read Kevin Dowd's excellent survey if you want the whole rather long list. The gist of it all, anyway, is that in Diamond and Dybvig we have, not a formal model explaining the workings of some actual banking system, laissez-faire or otherwise, but a formal and in that sense only "rigorous" re-telling of a hackneyed textbook banking myth.

Does any of this prove that the self-aware free banking theorizing of myself, Kevin Dowd, Larry White, and others is any good? Of course it doesn't. Our theories might be perfectly lousy, and I suppose some of them are so. But at least we've arrived at these theories deliberately, after consulting evidence from actual free (or at least relatively free) banking systems, and with due attention to criticisms that our attempts have elicited. Of course it's possible nonetheless that some of the tacit theories informing the case for intervention are, for all their slap-dashed-ness, closer to the mark. But what are the odds? Better, I'm sure, than those of a chimp typing War and Peace. But not nearly enough to bet on.

But the point of my remarks isn't to pass judgement on the views of critics of free banking. It is merely to encourage more of them to join in a more explicit debate concerning what a free banking system would look like, and how well it might perform.


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A 1920-21 Recovery Myth

by George Selgin December 4th, 2014 3:00 pm

The Forgotten Depression, Jim Grant's excellent book about the 1920-21 downturn and the recovery that followed, has generated a burst of critical commentary from persons anxious to reject the principal conclusion Grant draws from that episode. That conclusion, in brief, is that the U.S. was able to recover relatively quickly from at least one deep slump (and the '21 slump was deep, to judge not only from price statistics but also from available if sketchy unemployment statistics) despite authorities' refusal to resort to either fiscal or monetary stimulus. On the contrary, Grant observes, both fiscal and monetary policy were, according to today's Keynesian-influenced understanding, more contractionary than expansionary.

I've no desire to plunge into the general controversy concerning what other lessons one might safely draw from the 1920-21 episode, except to point out (as many of Grant's critics fail to do) that Grant himself resists drawing many other conclusions. He never claims, first of all, that Harding-administration-type policies might have been a dandy solution in 2008. Nor does he insist that post-2008-style expansionary fiscal and monetary policies would have made for a less satisfactory recovery had they been employed in '21. "We can't know what might have been," Grant writes (p. 2) "if Wilson and Harding had intervened as presidents in of the late 20th and early 21st centuries are wont to do." Grant merely settles for observing that "When, as 31st president, Hoover did intervene--notably, in an attempt to prevent a drop in wages--the results were unsatisfactory" (ibid.) The results of FDR's more aggressive interference with price and wage cuts, through the NRA and AAA, were, I would add, still more so.

If there's a foolish generalization lurking about here, or anywhere else in Grant's book (say, for instance, a "citation of the 1921 economic recovery as somehow refuting everything we’ve learned about macroeconomics since then," or an assertion to the effect that "If only we had let wages and prices crash in 2009, we would be in la la land right now,") I hope someone (Paul? Barkley?) will be so kind as to point it out to me. I also hope Barkley will explain to me why, in purporting to refute Grant's thesis, he compares what happened in 1920-21, not with what transpired in 1929-33 (which is the one episode concerning which Grant himself draws comparisons) but with what happened in various post-WWII recessions to which Grant himself never even refers.

My concern here, in any event, isn't with the general lessons that either should or shouldn't be drawn from the post-21 recovery, but with a particular myth concerning that recovery, namely, the myth that, contrary to what Grant and others have suggested, the Fed did in fact help out, and help out in a big way, by loosening of monetary policy.

Barkley Rosser has been particularly anxious to make hay with this claim, especially in the post (linked above) written in response to the recent Cato Book Forum over which I presided, featuring Grant's book. (For his part Krugman settles for a mere link to Barkley's post--this in a post implicitly accusing Grant, whose book Krugman almost certainly didn't bother to read, of laziness!) "In 1921," Barkley writes, "the Fed reversed course and lowered the discount rate back down to 4%. The economy then went into its rapid rebound. I note that in his remarks at Cato, at least Larry White did note this point as a caveat on all the proceedings. Bordo et al also note that both Irving Fisher and also Friedman and Schwartz pinpointed the role of the Fed in all this and declared it to have behaved very irresponsibly in the entire episode. But for Grant and Samuelson, the Fed barely even existed then."

The claim about Fed easing having ended the 21 slump has been repeated by many others, including The Economist, which in its review of Grant's book observes that "The Fed brought on the 1920-21 depression with high interest rates. Those rates drew in gold anew, which, along with deflation and political pressure, eventually caused the Fed to relent and lower rates. The slump and recovery were thus not the spontaneous product of the free market but of deliberate policy, much as in later recessions." Another proponent of this view is Daniel Kuehn, who has written two articles and several blog posts countering Austrian claims about the implications of the 1920-21 episode. In a comment responding to a laudatory David Glasner post concerning his work on the subject, for example, Kuehn claims that Fed "loosening...definitely played a prominent role in the recovery" from the 1921 slump.

What, then, are the facts of the matter? One fact, or set of them, to which Barkley and Co. refer, is that the Fed banks did indeed lower their discount rates, from 7%, where they'd stood since June of 1920, to 6.5% in May 1921, and then all the way to 4.5% in November 1921. (The further reduction to 4% to which Barkley refers did not occur until June 1922.) But, as Scott Sumner has been tirelessly observing for some years now, even under an interest-rate targeting regime, a low policy rate doesn't necessarily mean easy money. Instead, low rates can reflect slack demand for funds, and indeed tend to do just that in any slump. A Wicksellian would say that what matters isn't where rates stand absolutely, but where they are relative to their "natural" counterparts.

But treating the discount rate as an indicator of the stance of monetary policy with reference to the 1920-21 episode is even worse than treating it so in reference to more recent experience. In recent times, you see, the relevant policy rate has been, not the Fed's discount rate--the rate at which it extends discount-window loans--but the federal funds rate, to which, in the good old day's before the recent recession, it assigned a target value, to be achieved using open-market operations, by means of which the supply of federal funds (that is, overnight loans of bank reserves) would be either increased or reduced sufficiently to bring the funds rate to its target level. A decision to "lower interest rates" by the Fed thus tended to imply a decision to expand the monetary base by adding to the Fed's security holdings. Thus, although low rates didn't necessarily mean "easy" money, a decision to target lower rates did at least tend to mean more money.

Back in the 20s, on the other hand, a lowering of the Fed's policy rate--here, not the federal funds rate but the discount rate--might not even imply an increase in Fed lending or security purchases. In reducing its discount rate from 6.5% to 4.5%, for example, the Fed merely allowed banks possessing the requisite commercial paper to discount that paper with it at the newly reduced rates. Whether they would do so, however, depended on whether the rates in question were low, not merely compared to previous rates, but relative to market rates generally or, again, to "natural" rates. If not, the volume of discounting might not budge, and the lower rates would not imply any actual monetary expansion, except perhaps relative to the contraction that might have ensued had rates remained high.

So, did the Fed, by lowering its discount rate, actually give the U.S. economy a dose of monetary stimulus? It did not, as can be readily seen by referring to the chart below, reproduced from Nathan Lewis's New World Economics blog:

Fed1920sassets

As you can see from the chart, although there was some increase in "bills discounted" in response to the Fed's lowering of its discount rate, the increase was slight compared to the massive decline in total Fed non-gold assets since 1920. What's more, it was more-or-less perfectly--and by implication quite intentionally--offset or "sterilized" by means of Fed sales of government securities. The Fed's contribution to recovery, in short, consisted, not of any actual monetary stimulus, but of a mere cessation of what had been a precipitous decline in its interest-earning asset holdings.

This isn't to say that monetary expansion played no part in the post-1921 recovery. In fact, it played a significant part. But the expansion that took place was due solely to gold inflows, which were themselves encouraged by relatively high interest rates as well as by falling prices--that is, by the normal working of the price mechanism rather than by activist Fed policy. (In the 30s as well, by the way, such recovery as took place was entirely the result not of Fed easing--or of fiscal stimulus--but of the dollar's devaluation and subsequent gold inflows from Europe.) That gold flows (as opposed to Fed easing) contributed to the post-1921 recovery is itself a fact that Jim Grant readily acknowledges; his book's 17th chapter is called "Gold Pours into America."

In fine, far from having overlooked the real cause of the recovery, as his critics claim, Grant seems to have gotten it just right, whereas they all seem to have been led astray by an interest-rate red-herring.
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Postscript:
While preparing this post I was unaware of Bob Murphy's reply to Krugman's remarks, which is very much worth reading.


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Money, Economic Growth, and the Fed

by George Selgin December 3rd, 2014 1:49 pm

That's the title of my contribution to Cato's online forum on "Reviving Economic Growth." The forum anticipates a conference on "The Future of U.S. Economic Growth" being held at Cato all day tomorrow.

My forum piece is an edited version of a somewhat longer paper I plan to publish separately.


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Dizzy Miss Izzy

by George Selgin November 24th, 2014 9:21 pm

Dizzy
I'm so dizzy my head is spinning
Like a whirlpool it never ends
And its you, girl, making it spin
You're making me dizzy*

Tell me I'm not with it, if you must, but the fact is that until a couple of days ago I'd never heard of Izabella Kaminska, who bills herself as a "finance blogger" and believer in something called the "collaborative economy," in which sharing things takes the place of buying and selling them, the result being, she claims, a reduced carbon footprint.

Although I rather doubt that we're likely to witness an end to our "propensity to truck and barter" anytime soon, I don't doubt that such an event would in fact reduce carbon emissions: there would, for one thing, be a lot less less breathing going on. But what concerns me isn't Ms. Kaminska's general economic philosophy, to call it that. It's her vertiginous spin on free banking, which she saw fit to air this past week, first on FT Alphaville, and then on a blog of her own called, appropriately enough, Dizzynomics.

All this might have gone happily unremarked had the Econ Blogosphere's Grand Pooh Bah not seen fit to deem the last of these disorienting missives worthy of his readers' attention. And so it happens that, Despicable Free Banking Nobody though I am, I find myself submitting, for The Rt. Hon. GPB's consideration, my own humble post, the gist of which is that Ms. Kaminska hasn't the foggiest idea what she's talking about.

Because I addressed some errors in Ms. Kaminska's FT post in comments to that post itself, I'll embellish a bit here rather than repeat myself.

In discussing the founding of the Bank of England, Kaminska refers to the risk that "a private syndicate" took in "lending money to" the "UK" government. Let pass the anachronism. What matters is that the arrangement in question involved, not a loan directly made by the parties in question, but one made from the proceeds of a public stock offering, the lure for which consisted of monopoly powers the new Bank was expected to command. The stock sold in 12 days, and though the investors (again, not the scheme's principals) could hardly avoid taking some risk, their gamble had every appearance of being a darn safe one. According to Sir John Clapham (History of the Bank of England i, p. 20), among the various projects being floated in those times, "the Bank with its Parliamentary backing, its high sounding name, and its guaranteed income from the taxes was a very attractive proposition. The speed of the subscription need not surprise those more familiar than any pamphleteer of 1695 could be with how and why men invest."

I comment in the FT post itself on Kaminska's suggestion that the Bank of England was particularly effective at enhancing England's prosperity, so let me add here some brief excerpts from the source I referred to in that comment: Rondo Cameron's chapters on "England" and "Scotland" from his edited volume, Banking in the Early Stages of Industrialization (Oxford University Press, 1967). "The English banking system from 1750 to 1844, " Cameron observes, "was far from ideal in its contributions to either stability or growth of the economy as a whole." Topping Cameron's list of that system's infirmities is the Bank of England itself, whose "contributions to industrial finance were negligible, if not negative." Regarding Scotland Cameron says, in contrast, first, that despite having been "a poor country by any standard" in 1750, it "stood with England in the forefront of the world's industrial nations" a century later, and, second, that "the superiority of its banking system stands out as one of the major determining factors" of this relatively rapid growth.

Ms. Kaminska's estimate of the contribution of the Bank of England's monopoly privileges toward British economic stability is just as unfounded as her opinion regarding its contribution toward British prosperity. "Before the Bank knew it," she writes, "its notes had become the most liquid and trusted in the land." Actually, because the Bank didn't even bother to have branches beyond London before 1826, its notes were until that time seldom seen beyond the metropolis. (Nor, prior to the French wars, did the Bank issue notes for less than the princely sum of 10 quid.) If the Old Lady's notes were nonetheless judged safer than those of country banks, that was because those banks were severely under-capitalized and under-diversified. And why was that? Because they were not only denied Joint-Stock status, but subject to a rule limiting their ownership to six partners or fewer. In short the country banks--the only sort, remember, allowed to operate wherever the Bank of England chose not to--were by law prevented from achieving any reasonable degree of financial diversification and strength. Here we see how, like most apologists for central banks, Ms. Kaminska fails to appreciate how the advantages commanded by such banks have as their precise counterpart limitations imposed upon all others. Little wonder so many English country banks fell victim to the Panic of 1825! Contrast, again, the situation in Scotland at the time, with three chartered banks and twenty-nine provincial ones, all commanding nationwide branch networks, and not one bank failure since a private bank failed in 1816--and even that one paying 9s on the pound! "Certainly Scotland," Sir John observes, "appeared to have secrets of sound banking that England might inquire into."

Ms. Kaminska is sanguine enough to allow that the Bank of England's powers tempted it to engage in "imprudent money-printing." But she spoils this lapse from her otherwise unalloyed confidence in the benevolence of state-sponsored monopolies by adding, gratuitously, that the bank was "not helped by the fact that [it] still had to compete with a whole bunch of private banks who were just as keen to issue money to an equally imprudent degree." But, as I've noted, "compete" with "private" (meaning, presumably, country) banks is just what the Bank did not do, at least not until after 1826. Instead, by the terms of its charter it subjected them to inhibiting constraints, and then, having led them on by means of its own generous discounts, led them fend for themselves. (For evidence, see the relevant section of my article, "Bank Lending 'Manias' in Theory and History.")

Kaminska can at least take credit for originality in reporting that, during the 1840s, "a terrible inflation" took hold in England, and that it was to combat that outbreak that Peel's 1844 Act was passed. Alas, the claim owes its originality to the fact that there's not an ounce of truth to it. The same may be said for her claim that the Scottish system was stable only because Scottish bankers "were so good at forging oligopolistic cartels that happily restricted competition." As I noted in my FT comments, there's no evidence that limited entry was a source of any significant monopoly power in Scottish banking. (On the contrary: the system was notoriously efficient.) Nor is there any evidence that Scottish banks policed one another other than by engaging in regular note exchanges, as they would have been no less compelled to do had entry into the industry been open. But let us assume, for the sake of argument, that Ms. Kaminska is correct in holding that oligopoly was the cause of the Scottish system's superior stability. Then why, one wonders, does she not grant that a similar oligopoly might also have made England better off than it managed to be with its patently unstable blend of monopoly and hamstrung polypoly?

In 1833, thanks to a the efforts of the great Thomas Joplin, the terrible Six Partner Rule was partially circumvented by way of the discovery that its language encompassed note-issuing banks only, and not mere banks of deposit. The Bank of England thus faced for the first time competition from other joint-stock banks. Such are the facts. And what does Ms. Kaminska's make of this development? First, that it came, not in 1833--that is, well ahead of Peel's Act--but "in the latter half of the 19th century"; and, second, that it occurred, not because a clever banker discovered a loophole in the law aimed at severely restraining the Bank of England's rivals, but supposedly because restrictions imposed by Peel's Act on the Bank of England itself created "conditions" favoring the rise of "a new type of unregulated" bank. "Some history" indeed.

Ms. Kaminska concludes her remarks on English versus Scottish banking with a long excerpt from the Bank of England's web pages, telling of how it "established the concept of lender of last resort" in the wake of the crises of 1866 and 1890. Had the "concept" thrust down its throat, by Walter Bagehot, is closer to the truth. What that great man had to say concerning the respective merits of the English ("one reserve") and Scottish ("natural") systems is, or ought to be, too well known to warrant repeating.

In her Dizzynomics follow up Ms. Kaminska adds little to the substance of her FT argument against free banking, such as it is, preferring instead to heap anathemas upon free bankers, who according to her reckoning are thick on the ground (were it only so!), and whom she regards as "reason and logic deniers" incapable of grasping the fact "that whenever we've had free-banking systems they've resulted in chaos or alternatively co-beneficial collusion to the point were the system is not free by the standard definition of free."

No one, so far as I know, has ever claimed that the systems generally held out as examples of "free" banking--Scotland, of course, and Canada before 1914, among others--were perfectly so. Not me. Nor Kevin Dowd. Nor Larry White. Nor any other free banker I know. Of course those systems weren't perfectly free. No banking system ever was. Nor has Hong Kong ever witnessed free trade in all its unsullied glory. So what? The question is always whether the examples come close enough to serve as evidence of the likely consequences of the fully-realized alternative. Was Scottish banking, to return to that case, "close enough" to shed light on the consequences of truly free banking? The debate on that question was joined some years back, with Larry White weighing in in the affirmative against the counterarguments of Murry Rothbard, Larry Sechrest, and Tyler Cowen and Randy Kroszner, among others. Ms. Kaminska, having found the opposition's case neatly summarized in a blog post, simply overlooks White's rejoinders. She overlooks as well the not-insignificant body of theoretical work using induction aided by deduction rather than deduction alone to draw inferences about the likely consequences of unalloyed freedom in banking.

Kaminska herself needs no theory, on the other hand, to reach the conclusion that genuinely free banking, unlike the Scottish mongrel, must lead to "chaos." How can she know? As she offers neither evidence nor argument, one must hazard a guess. Mine is that she is referring to the U.S. banking system between the demise of the second Bank of the United States, in 1836, and the outbreak of the Civil War, and that she imagines, as many people do, that because a half-dozen states passed so-called "free banking" laws during that interval, it qualifies as one of perfect freedom from any sort of bank regulation. Excuse me for having had to suppress a yawn just now--it is a long post, after all, and fatigue is setting in, quite possibly for us both. Suffice to say, then, that old banking myths die hard, and that this especially hoary one about U.S. "free banking" seems harder to kill than Rasputin himself. That it is mostly hokum is nonetheless easily established: just have a look at any post-1975 work by an economic historian on the subject, including the locus classicus, Hugh Rockoff's The Free Banking Era: A Re-Examination (Arno, 1975). (A later survey piece is here.)

A misreading of the same U.S. experience seems also to inform several of the obiter dicta that follow Kaminska's opening thrust, including her claim that free bankers fail to "appreciate that it was standardizing certain subjective [?] values like weights, distances, time [sic] itself that has allowed society to cooperate, grow and thrive." (Because antebellum state banking laws generally prohibited branching, state banknotes tended to be subjected to discounts when encountered any distance from their source; in contrast, in the Scottish and Canadian systems, where banks were free to establish branch networks, banknote discounts were unknown.) Ditto her belief that free bankers "advocate a Wild West model where no one can trust anyone and everyone has to do due diligence themselves." (Though it's true that the antebellum [old] west was inundated by all sorts of phony bank paper, that result came about, not because banking was unregulated there, but because territorial authorities, by having outlawed it, made their citizens perfect targets for phony notes purporting to come from legitimate banks down east. Where banking was more, though not perfectly, free, as in 19th century Canada or Scotland, in contrast, it sufficed to trust one bank, and to accept only those notes regarded as current at that bank, to avoid trouble.)

I hope I've said enough to suggest why I find it remarkable than anyone should take Ms. Kaminska's ramblings on free banking (or, I now feel justified in saying, on any subject whatsoever) seriously. Perhaps no one does. Still I wish Tyler hadn't given those ramblings more currency by advertising them, without the benefit of critical comment, on Marginal Revolution: here, surely, is a case where sharing adds to rather than subtracts from the world's burden of hot air.
____________________
*Tommy Roe, "Dizzy."


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Good and Bad News from the UK

by George Selgin November 21st, 2014 7:47 pm

The good news is Wycomb member Steve Baker's excellent speech in Parliament on "Money Creation and Society," the transcript of which I copy below in full.

The bad news is this silly response in FT Alphaville, to which your correspondent has appended a comment.

* * *

Money Creation and Society

Steve Baker (Wycombe) (Con): I beg to move,

That this House has considered money creation and society.

The methods of money production in society today are profoundly corrupting in ways that would matter to everyone if they were clearly understood. The essence of this debate is: who should be allowed to create money, how and at whose risk? It is no wonder that it has attracted support from across the political spectrum, although, looking around the Chamber, I think that the Rochester and Strood by-election has perhaps taken its toll. None the less, I am grateful to right hon. and hon. Friends from all political parties, including the hon. Members for Clacton (Douglas Carswell) and for Brighton, Pavilion (Caroline Lucas) and the right hon. Member for Oldham West and Royton (Mr Meacher), for their support in securing this debate.

One of the most memorable quotes about money and banking is usually attributed to Henry Ford:

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did I believe there would be a revolution before tomorrow morning.”

Let us hope we do not have a revolution, as I feel sure we are all conservatives on that issue.

How is it done? The process is so simple that the mind is repelled. It is this:

“Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”

I have been told many times that this is ridiculous, even by one employee who had previously worked for the Federal Deposit Insurance Corporation of the United States. The explanation is taken from the Bank of England article, “Money creation in the modern economy”, and it seems to me it is rather hard to dismiss.

Today, while the state maintains a monopoly on the creation of notes and coins in central bank reserves, that monopoly has been diluted to give us a hybrid system because private banks can create claims on money, and those claims are precisely equivalent to notes and coins in their economic function. It is a criminal offence to counterfeit bank notes or coins, but a banking licence is formal permission from the Government to create equivalent money at interest.

There is a wide range of perspectives on whether that is legitimate. The Spanish economist, Jesús Huerta de Soto explains in his book “Money, Bank Credit and Economic Cycles” that it is positively a fraud—a fraud that causes the business cycle. Positive Money, a British campaign group, is campaigning for the complete nationalisation of money production. On the other hand, free banking scholars, George Selgin, Kevin Dowd and others would argue that although the state might define money in terms of a commodity such as gold, banking should be conducted under the ordinary commercial law without legal privileges of any kind. They would allow the issue of claims on money proper, backed by other assets—provided that the issuer bore

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all of the risk. Some want the complete denationalisation of money. Cryptocurrencies are now performing the task of showing us that that is possible.

The argument that banks should not be allowed to create money has an honourable history. The Bank Charter Act 1844 was enacted because banks’ issue of notes in excess of gold was causing economic chaos, particularly through reckless lending and imprudent speculation. I am once again reminded that the only thing we learn from history is that we learn nothing from history.

Thomas Docherty (Dunfermline and West Fife) (Lab): I welcome today’s debate. The hon. Gentleman makes a valid point about learning from history. Does he agree with me that we should look seriously at putting this subject on the curriculum so that young people gain a better understanding of the history of this issue?

Steve Baker: That is absolutely right. It would be wonderful if the history curriculum covered the Bank Charter Act 1844. I would be full of joy about that, but we would of course need to cover economics, too, in order for people to really understand the issue. Since the hon. Gentleman raises the subject, there were ideas at the time of that Act that would be considered idiocy today, while some ideas rejected then are now part of the economic mainstream. Sir Robert Peel spent some considerable time emphasising that the definition of a pound was a specific quantity and quality of gold. The notion that anyone could reject that was considered ridiculous. How times change.

One problem with the Bank Charter Act 1844 was that it failed to recognise that bank deposits were functioning as equivalent to notes, so it did not succeed in its aim. There was a massive controversy at the time between the so-called currency school and the banking school. It appeared that the currency school had won; in fact, in practice, the banks went on to create deposits drawn by cheque and the ideas of the banking school went forward. The idea that one school or the other won should be rejected; the truth is that we have ended up with something of a mess.

We are in a debt crisis of historic proportions because for far too long profit-maximising banks have been lending money into existence as debt with too few effective restraints on their conduct and all the risks of doing so forced on the taxpayer by the power of the state. A blend of legal privilege, private interest and political necessity has created, over the centuries, a system that today lawfully promotes the excesses for which capitalism is so frequently condemned. It is undermining faith in the market economy on which we rely not merely for our prosperity, but for our lives.

Thankfully, the institution of money is a human, social institution and it can be changed. It has been changed and I believe it should be changed further. The timing of today’s debate is serendipitous, with the Prime Minister explaining that the warning lights are flashing on the dashboard of the world economy, and it looks like quantitative easing is going to be stepped up in Europe and Japan, just as it is being ramped out in America—and, of course, it has stopped in the UK. If anything, we are not at the end of a great experiment

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in monetary policy; we are at some mid point of it. The experiment will not be over until all the quantitative easing has been unwound, if it ever is.

We cannot really understand the effect of money production on society without remembering that our society is founded on the division of labour. We have to share the burden of providing for one another, and we must therefore have money as a means of exchange and final payment of debts, and also as a store of value and unit of account. It is through the price system that money allows us to reckon profit and loss, guiding entrepreneurs and investors to allocate resources in the way that best meets the needs of society. That is why every party in the House now accepts the market economy. The question is whether our society is vulnerable to false signals through that price system, and I believe that it is. That is why any flaws in our monetary arrangements feed into the price system and permeate the whole of society. In their own ways, Keynes and Mises—two economists who never particularly agreed with one another—were both able to say that currency debasement was the best way in which to overturn the existing basis of society.

Even before quantitative easing began, we lived in an era of chronic monetary inflation, unprecedented in the industrial age. Between 1991 and 2009, the money supply increased fourfold. It tripled between 1997 and 2010, from £700 billion to £2.2 trillion, and that accelerated into the crisis. It is simply not possible to increase the money supply at such a rate without profound consequences, and they are the consequences that are with us today, but it goes back further. The House of Commons Library and the Office for National Statistics produced a paper tracing consumer price inflation back to 1750. It shows that there was a flat line until about the 20th century, when there was some inflation over the wars, but from 1971 onwards, the value of money collapsed. What had happened? The Bretton Woods agreement had come to an end. The last link to gold had been severed, and that removed one of the most effective restraints on credit expansion. Perhaps in another debate we might consider why.

Mr Angus Brendan MacNeil (Na h-Eileanan an Iar) (SNP): Does the hon. Gentleman agree that the end of the gold standard and the increased supply of money enabled business, enterprise and the economy to grow? Once we were no longer tied to the supply of gold, other avenues could be used for the growth of the economy.

Steve Baker: The hon. Gentleman has made an important point, which has pre-empted some of the questions that I intended to raise later in my speech. There is no doubt that the period of our lives has been a time of enormous economic, social and political transformation, but so was the 19th century, and during that century there was a secular decline in prices overall.

The truth is that any reasonable amount of money is adequate if prices are allowed to adjust. We are all aware of the phenomenon whereby the prices of computers, cars, and more or less anything else whose production is not determined by the state become gently lower as productivity increases. That is a rise in real living standards. We want prices to become lower in real terms compared to wages, which is why we argue about living standards.

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Sir William Cash (Stone) (Con): My hon. Friend is making an incredibly important speech. I only wish that more people were here to listen to it. I wonder whether he has read Nicholas Wapshott’s book about Hayek and Keynes, which deals very carefully with the question that he has raised. Does he agree that the unpleasantness of the Weimar republic and the inflationary increase at that time led to the troubles with Germany later on, but that we are now in a new cycle which also needs to be addressed along the lines that he has just been describing?

Steve Baker: I am grateful to my hon. Friend. What he has said emphasises that the subject that is at issue today goes to the heart of the survival of a free civilisation. That is something that Hayek wrote about, and I think it is absolutely true.

If I were allowed props in the Chamber, Mr Speaker, I might wave this 100 trillion Zimbabwe dollar note. You can hold bad politics in your hand: that is the truth of the matter. People try to explain that hyperinflation has never happened just through technocratic error, and that it happens in the context of, for example, extremely high debt levels and the inability of politicians to constrain them. In what circumstances do we find ourselves today, when we are still borrowing broadly triple what Labour was borrowing?

Ann McKechin (Glasgow North) (Lab): I am interested to hear what the hon. Gentleman is saying. He will be aware that the balance between wages and capital has shifted significantly in favour of capital over the past 30 years. Does he agree that the way in which we tax and provide reliefs to capital is key to controlling that balance? Does he also agree that we need to do more to increase wage levels, which have historically been going down in relation to capital over a long period of time?

Steve Baker: I think I hear the echoes of a particularly fashionable economist there. If the hon. Lady is saying that she would like rising real wage levels, of course I agree with her. Who wouldn’t? I want rising real wage levels, but something about which I get incredibly frustrated is the use of that word “capital”. I have heard economists talk about capital when what they really mean is money, and typically what they mean by money is new bank credit, because 97% of the money supply is bank credit. That is not capital; capital is the means of production. There is a lengthy conversation to be had on this subject, but if the hon. Lady will forgive me, I do not want to go into that today. I fear that we have started to label as capital money that has been loaned into existence without any real backing. That might explain why our capital stock has been undermined as we have de-industrialised, and why real wages have dropped. In the end, real wages can rise only if productivity increases, and that means an increase in the real stock of capital.

To return to where I wanted to go: where did all the money that was created as debt go? The sectoral lending figures show that while some of it went into commercial property, and some into personal loans, credit cards and so on, the rise of lending into real productive businesses excluding the financial sector was relatively moderate. Overwhelmingly, the new debt went into mortgages and the financial sector. Exchange and the distribution of wealth are part of the same social process. If I buy an apple, the distribution of apples and money will change. Money is used to buy houses, and we

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should not be at all surprised that an increased supply of money into house-buying will boost the price of those homes.

Mr Ronnie Campbell (Blyth Valley) (Lab): This is a great debate, but let us talk about ordinary people and their labour, because that involves money as well. To those people, talking about how capitalism works is like talking about something at the end of the universe. They simply need money to survive, and anything else might as well be at the end of the universe.

Steve Baker: The hon. Gentleman is quite right, and I welcome the spirit in which he asks that question. The vast majority of us, on both sides of the House, live on our labour. We work in order to obtain money so that we can obtain the things we need to survive.

The hon. Gentleman pre-empts another remark that I was going to make, which is that there is a categorical difference between earning money through the sweat of one’s brow and making money by lending it to someone in exchange for a claim on the deeds to their house. Those two concepts are fundamentally, categorically different, and this goes to the heart of how capitalism works. I appreciate that very little of this would find its way on to an election leaflet, but it matters a great deal nevertheless. Perhaps I shall need to ask my opponent if he has followed this debate.

My point is that if a great fountain of new money gushes up into the financial sector, we should not be surprised to find that the banking system is far wealthier than anyone else. We should not be surprised if financing and housing in London and the south-east are far wealthier than anywhere else. Indeed, I remember that when quantitative easing began, house prices started rising in Chiswick and Islington. Money is not neutral. It redistributes real income from later to earlier owners—that is, from the poor to the rich, on the whole. That distribution effect is key to understanding the effect of new money on society. It is the primary cause of almost all conflicts revolving around the production of money and around the relations between creditors and debtors.

Sir William Cash: My hon. Friend might be aware that, before the last general election, my right hon. Friend the Member for Wokingham (Mr Redwood) and I and one or two others attacked the Labour party for the lack of growth and expressed our concern about the level of debt. If we add in all the debts from Network Rail, nuclear decommissioning, unfunded pension liabilities and so on, the actual debt is reaching extremely high levels. According to the Government’s own statements, it could now be between £3.5 trillion and £4 trillion. Does my hon. Friend agree that that is extremely dangerous?

Steve Baker: It is extremely dangerous and it has been repeated around the world. An extremely good book by economist and writer Philip Coggan, of The Economist, sets out just how dangerous it is. In “Paper Promises: Money, Debt and the New World Order”; a journalist from The Economist seriously suggests that this huge pile of debt created as money will lead to a wholly new monetary system.


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Hayekian Musings of a Gold-Standard Pessimist

by George Selgin November 17th, 2014 10:44 am

I reckon myself a fan of the classical (pre-WWI) gold standard, considering it to have been the best monetary arrangement ever, and a far better one than the various supposedly scientific alternatives seen since. I also bristle at misinformed criticisms of that standard, including the very popular claim that it, rather than the machinations of central bankers bent on severing the normal connection between gold flows and money supply adjustments, was responsible for the Great Depression.

I'm convinced, furthermore, that there is a strong positive relation between the smugness with which an economists dismisses the gold standard (and all having anything nice to say about such) and the likelihood that that economist knows nothing at all about the subject. Evidence of this happened to come across my desk just yesterday, when I found myself obliged to real a stack of papers about Bitcoin. Although they were all perfectly lousy, the one that earned pride of place for dishing-out the single most idiotic bit of disinformation did so by declaring, in the course of a brief (and entirely erroneous) review of the gold standard's shortcomings, that the former connection between the U.S. dollar and gold rested upon gold reserves held at Fort Knox! (The writer, by the way, is a chaired professor at a leading U.S. business school, who holds a Harvard Ph.D. in "business economics.")

But while I'm for barring no holds when it comes to defending the old gold standard against unthinking critics, and even some thinking ones, I've never been one to rest my hopes for monetary reform upon the prospect of its revival. I have a number of reasons for not doing so, including my fear that such a revival, if it could be accomplished at all, could prove extremely disruptive, as well as my belief that to be worth having a revived gold standard would have to be no less international in scope as the original, making gold a poor basis for any unilateral reform. But my main reason consists of my belief that the legal foundations of the historical gold standard may themselves prove impossible to recover. The paper I wrote for this year's Cato Monetary Conference on "Law, Legislation, and the Gold Standard," spells out this last source of my doubts in some detail.

If anyone, having read the paper, thinks he or she can restore my hopes for gold, I am all ears.

Postscript: For some reason SSRN is being stubborn about letting people download my paper using the link supplied. If you find that that's so in your case, just google the paper title and my name, and the appropriate SSRN page with top the results list. You should be able to download the paper without trouble by clicking on that result.


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Mammom Dearest

by George Selgin November 12th, 2014 12:45 pm

(This past weekend I took part in a Liberty Fund conference having as its main topic David Graeber's Debt: the First 5000 Years (Melville House, 2011), but also addressing parts of Felix Martin's Money: The Unauthorized Biography (Knopf, 2014). Although Martin is an economist and Graeber an anthropologist, the two works have much in common, including their authors' general contempt for what Martin refers to as "Adam Smith and his school," meaning just about every economist who has ever had anything nice to say about either money or free markets.

It so happens that a review I'd written of Martin's work appeared, in somewhat abbreviated form and minus the title I'd given it, in Barron's (together with Larry White's review of Jim Grant's The Forgotten Depression and a review of a book about football that almost certainly got the the most attention) a week prior to the Liberty Fund event. Here, by kind permission of Barron's Gene Epstein, is the original version. By way of further comment I will say only that, as bad as I think Martin's book is, Graeber's is even worse--so much so that I am seriously contemplating having an intern here at Cato compile a list of scholars--and economists especially--who have praised it, so that I might make a mental note to never again take any of their recommendations or criticisms seriously.)

*****

The aftermath of the worst financial crisis since the Great Depression is a good time for taking a hard look at money, that most basic of all financial institutions atop which all the rest teeter. As his book’s subtitle suggests, Felix Martin, having taken such a look, reports, not with a flattering portrait, but with a warts-and-all unmasking.

Mr. Martin’s good prose and eye for money’s naughtier antics help to equip him for his task. Nor is he short of tales to tell, about money’s little prank of masquerading as stone wheels in the western Pacific, its domestication by Greek kings, its adolescent kidnapping by crafty private bankers, its disastrous fling with John Law, and, finally, its post-2001 binge. Mr. Martin relates them all, and many others, with élan.

But in his eagerness to reveal truths to which others have been blind, Mr. Martin ends up exposing, not so much money’s mysteries as his own incomprehension of it. He goes astray, first of all, in assuming that, because credit rather than barter came before money, money consists, not of any physical stuff, but solely of a more-or-less elaborate system of IOUs. But while simple societies may track and settle debts in many different ways, among relative strangers and throughout most of history monetary promises have been promises to pay some particular stuff, whether tobacco, metal discs, or engraved paper strips.

The distinction between monetary promises and the stuff promised is, admittedly, often muddied, as it was when Great Britain’s pound sterling ceased to refer to any actual coin (gold guineas having been worth a bit more than £1), and when modern central banks turned their paper promises to pay gold into what one former New York Fed President dubbed “IOU nothings.” But the fact that a Federal Reserve note is no longer a promise to pay anything doesn’t make the dollar an “arbitrary increment on an abstract value scale” or “a unit of abstract, universally applicable economic value.” When a diner sells me bacon and eggs for $4.99, that doesn’t mean that bacon and eggs are worth $4.99, “universally” or otherwise. It means that to the diner they are worth less, and to me, more.

Mr. Martin’s understanding of what economists have had to say about money is still more inadequate. With the phrase “Adam Smith and his school,” he lumps together every thinker from John Locke and Bernard Mandeville to Friedrich Hayek, throwing some later mathematical economists in for good measure, and excepting only John Law, Walter Bagehot, and John Maynard Keynes. He then attributes to this homogenized mass “a vision of society in which economic value had become the measure of all things” together with a blindness to the “debt and financial instability” to which this crass vision leads. Horse feathers. The monetary theories of John Locke (Martin’s unlikely heavy) didn’t particularly impress Smith, though Locke’s mercantilism did—unfavorably; and far from sharing Mandeville’s identification of narrow self-interest (“private vices”) with public virtue, Smith condemned it as “pernicious.” No one aware of the English currency controversies that raged for decades after the Panic of 1825 could possibly hold English economists oblivious to financial turmoil. Finally (to cut a long list short), in saying that the Bank of England should serve as a lender of last resort, Bagehot was taking issue, not with his fellow economists, but with the Bank’s short-sighted Directors.

If Mr. Martin’s knowledge of the history of economics is less than reassuring, his choice of economic good guys, Bagehot apart, is downright scary. He has soft spots for the ancient Spartans, who (according to him) wisely chose to dispense with money and all the “impersonal and inhumane relations its use entailed,” and for Lenin and his crew, who tried unsuccessfully to do the same. Another of Martin’s heroes is John Law, the Scottish “projector” whose “System,” implemented in France in 1720, was, according to Martin, “ingenious, innovative, and centuries ahead of its time.” Just shy of three centuries, one is tempted to elaborate. (Law’s “system” collapsed, catastrophically, in 1721.)

That a jaundiced view of both money and most expert thinking about it shouldn’t lead to any novel proposal for its reform isn’t surprising. Stopping shy of suggesting another stab at Sparta’s convivial solution, Mr. Martin instead endorses the old-hat idea of making commercial banks keep reserves (of “abstract units,” presumably) equal to their readily transferable liabilities. To be free of the bathwater of financial crises we must, in other words, give old-fashioned banking the old heave-ho.

A proper respect for the crucial role bank loans play in promoting economic growth—in industrialized countries still, but especially in developing ones—combined with a glance beyond the limited experience of a few countries ought to suffice to make anyone think twice about such a Procrustean (if lately de rigueur) remedy: Canada, for instance, which has a very highly developed banking system (and one that has, since 1987, been utterly-free of Glass-Steagall-like regulations separating commercial from investment banking) experienced neither bank failures nor insolvent-bank bailouts during the recent crisis; indeed it has had an almost uninterrupted record of financial stability since the mid-19th century. Scotland long boasted a similar record, with no central bank to look to for bailouts, and very little bank regulation of any kind, until English currency laws were thoughtlessly imposed upon it in 1845.

It happens that Adam Smith supplied an especially eloquent account of the workings and advantages of Scotland’s once brilliant fractional-reserve banking system as he witnessed it in its formative years. That account can be found in Book II, chapter 2 of The Wealth of Nations. Alas, so far as Mr. Martin is concerned, Smith’s real thoughts about money might as well be among the very deepest of its secrets.


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Keynes to FDR: Forget Quantitative Easing

by George Selgin November 4th, 2014 10:08 am

From Keynes' "Open Letter to President Roosevelt," published December 16, 1933:

"Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor."

This near the very bottom of the Great Depression. Perhaps Keynes was wrong then. But is there not a strong case to be made, nevertheless, that the recent rounds of QE were, what with all that heaping-up of excess reserves, just so much unhelpful belt-loosening?

What say ye, my Market Monetarist friends?


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When the Best Plan is No Plan at All

by George Selgin July 21st, 2014 4:53 pm

I was recently asked to submit a "solution proposal" concerning a panel, on "The New Global Financial Architecture," in which I'm to take part at this September's Global Economic Symposium in Kuala Lumpur.  The proposal is supposed to summarize my own scheme for reforming the global financial system, showing, in 700-1000 words, that my plan is "feasible," "innovative," and (naturally) of "positive social impact."

A you might well expect, the request posed something of a challenge to this unreconstructed Hayekian.  Here, for whatever it may be worth, is what he came up with.

Truth be told, I'm not quite sure that my proposal is consistent with the organizers' assumption, as given in their "challenge" to the panel, that "Different regulators - including the monetary authorities - must cooperate in order to achieve better but not necessarily more regulation." I hope, in any event, that it will help fuel a spirited discussion.


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