I just want to reinforce what Matt had to say regarding a book that was published a hundred years ago and that is that it still continues to generate controversy, argument, and it gives us a framework for thinking about developments today, and thinking about, for example, the financial crisis.
So my paper is more or less a response to an ongoing debate with the free banking school led by Larry White and George Selgin and others and the topic of my paper itself is controversial, I mean the title, excuse me, is controversial because a currency school free banker is a contradiction in terms according to the free banking school.
Currently School believed in a central bank to set a rule to limit the amount of unbacked
bank notes that were issued, whereas the free bankers don't believe there should be any
regulation at all of banking, that is, that banks should be free to set their own reserve
ratios. So how could Mises be a Currently School free banker? Well, Matt went into some
Some of this, Matt explained that Mises indeed was a big admirer of the currency school,
not only an admirer but an exponent of its main doctrine, the currency principle.
So let me just give you an overview of what my paper is about, I'm not going to be able
to go through the whole thing.
But basically I talk a little bit about the currency school theory and history in the
first chapter and then I have a number of quotes showing that indeed Mises was not only
Mises was not only an admirer, but a proponent of the currency school and that he pretty much single-handedly brought back the currency school to relevance after it had fallen into complete discredit as a result of some flaws in its own theory that were applied with Peel's Act I also want to show that Mises was in favor of free banking but not for the reasons that the free bankers give
that free banking would, in a very short while, suppress all additional issue of bank notes
and deposits, okay, when you sort of rehabilitated the currency principle, if you added bank
deposits, all additional emission of these notes and deposits would be suppressed simply
by the force of competition, and as I'll argue in a moment, that's exactly the opposite
of what White and Seljand see as the outcome
of a free banking system.
And then I wanna talk a little bit about a note
on the banknote, which for the free bankers
is the seen and known qua non of free banking.
That is, free banks have to issue banknotes.
If they don't issue banknotes,
then it's not really free banking.
Well, it's interesting that Mises has some very,
some dubious thoughts on whether or not
and this can actually exist in a free market.
So who are the currency school?
As Matt pointed out, they're a group of British bankers,
merchants, economists, they wrote during the 19th century,
they're their names.
The currency principles, easily stated,
just simply said a nation's mixed money supply,
which consisted of gold in various forms
and at the time banknotes, should behave exactly
and in their words as a purely metallic currency.
There were also bank deposits,
But that was one of the flaws of the currency school.
They did not include bank deposits in their definition of the money supply, whereas the
banking school did.
And finally, they did triumph in 1844 with the Enactment Appeals Act.
Now what were the implications of the currency principle?
One that the changes in the money supply should rigidly reflect changes in the supply of gold.
That is that your money supply should only increase or decrease if you were not a gold
in a country through the changes in the balances of payments, which would reflect changes in
relative demands for money in different countries. Secondly, all further issue of banknotes that
are not fully backed by gold would be fully suppressed. That is a marginal 100% reserve
ratio. That is, Mises wasn't in favor of, nor the current school, of getting rid of
unbacked notes that already existed, okay, because that would involve deflation. But
But in fact, going forward, there would be no more issue of what's called fiduciary media, unbacked notes to the currency school, unbacked notes and checking deposits to von Mises.
And then all banking and political influence on the supply of money would be abolished.
And finally, the quantity, value and distribution of money would then be exclusively determined by the market.
Now, this seems like an alien principle in today's world, but in fact, abstracting for a moment from the Fed's actions in the United States, let's assume that the Fed lays off and doesn't increase the money supply or decrease the money supply.
The currency principle is exactly what controls the various money supplies between the various states, between the various cities.
So, for example, we've seen a precipitous drop in the money supply of Michigan because of the relative change in demand from products built in Detroit and the suppliers of autos and so on
and a tremendous increase in the supply of money in Silicon Valley from the 1980s. This is done by the market. There was no central bank involved in this redistribution of the money supply.
As people's incomes fell in areas that were economically retrogressing, their demands for money for cash balances fell because they were going to be engaging in fewer transactions.
And conversely, as incomes increased in Silicon Valley, well, incomes increased, wealth increased, and of course, people's cash balances increased.
So the currency principle, absent the central bank, is the principle that distributes money interregionally, between cities, even among families.
So at bottom, it's not an antiquarian principle, it's a principle that we all depend on within the country or within a common currency area.
currency area. Now, the currency school and Mises certainly up until 1914 saw most developed nations on a gold standard. And so that, as Hayek pointed out, it's wrong to claim that there's a deflation in the money supply in Michigan because it has fallen as a result of a change in demand for products away from Michigan products towards, let's say, California products. Okay? Deflation and inflation occur in a closed system, not in an open system. The currency
The principle applied to an open system, in which the money was, or the base money was, was gold.
There were flaws, I'm not going to go through this, but that already did.
One was that currency school could not get it through their thick skulls, that in fact, bank deposits were interchangeable bank notes, they functioned in the same way, so they left them out of the money supply.
And they also could believe that the best way to enforce the currency principle was through a quasi-central bank.
At the time, the Bank of England was a privileged private bank, it was a quasi-central bank.
They thought that the only way to enforce the principle was to centralize power and reserves in the hands of the central bank.
And they reaped the whirlwind.
The Bank of England was free to expand deposits, because deposits were not included, they were not restrained pound for pound by the amount of gold, as were the notes, in fact they split the bank into two departments, the issue department and the banking department, the banking department just went on creating deposits, which were then used as the reserves for the private banks, which then inflated the overall money supply,
And so we then had the boom and bust cycles of 47, 57, these were all in the 19th century, 66, 90, all of which were blamed on the currency school and Peel's Act.
And so it fell into discredit by the time Mises wrote it, it had fallen into discredit.
All right, that's the background. Let me just very quickly sort of outline the thesis of my paper in just a few paragraphs.
What I argue in my paper is that Mises was a proponent of both the currency principle and free banking.
This is contrary to the claims of the free banking school in Austrian Economics today,
because they are opposed to the currency principle.
This school denies that Mises was a follower of the currency school,
or that he was an advocate of sound money as defined by the currency principle.
The free bankers base their claims on the fact that Mises was a vigorous proponent of free banking,
Banking, which I will show you in a moment, he indeed was. In contrast, most, although
not all members of the original currency school, opposed free banking and were in favor of
a powerful central bank, though constrained by the currency principle. Thus, modern free
bankers maintain that Mises, as a free banker, must have supported what they call the monetary
equilibrium principle. According to this principle, the supply of money must be continually
changed and manipulated by the banking system in order to accommodate any changes in the demand for money.
Okay, so any time there's an increase in demand for cash balances and there's a
the the implication is that their prices will fall, the free bankers believe that under a free banking system banks will automatically respond
by just offsetting that increase in demand by issuing further unbacked bank notes and checking deposits.
And for them, this would preserve monetary equilibrium, maintain the aggregate flow of spending, and prevent purchasing power of the dollar from increasing, that is, prices falling.
I just want to point out that in modern macroeconomic jargon, this so-called macro-monetary equilibrium principle is nothing more than a nominal income target that many Keynesians favor.
favor, except they set the nominal income target at zero, whereas Keynesians would want
it set at the rate of real growth, potential output and so on.
And it's not surprising that both Larry White and George Selden did support at least one
of the two quantitative easing programs, because in fact there was an increase in the demand
for money.
We did have what's a decline in velocity right before the first quantitative easing episode
and so they were both in favor of that and I think George was in favor of even the second one.
So let me go on and now prove, in a sense, my thesis in a few minutes.
Okay, here are a number of quotations taken from Mises in his 1928 book.
And I'll just read the first one.
Every advance toward explaining the business fluctuations to date is due to the currency school.
We are also indebted to this school alone, alone.
The idea is responsible for policies aimed at eliminating business fluctuations.
He was an admirer of the currency school.
Now, in his earlier work, in the book that we're celebrating here, The Theory of Money and Credit, written 100 years ago,
he was a little bit ambivalent about whether or not setting a 100% reserve ratio on future deposits and bank notes was the best thing to do.
He called it a heroic remedy with a vengeance
and said that it renounced all advantages
of stabilizing the purchasing power of money.
Sounds a bit free-banky here, right?
He wants the price level to be maintained stable, okay?
But he ends his book by quoting from,
this is the second edition, which is in English,
he quotes in the first edition, okay, in the second edition.
Right at the end he says,
it is obvious that the only way of eliminating human,
And when he talked about human influence, he always meant the influence of politicians rather than the market.
On the credit system is to suppress all further issue of fiduciary media.
That is unbacked, the issue of unbacked notes and deposits.
Notes and deposits that were not backed dollar for dollar, pound for pound by gold.
The basic conception of Peel's Act ought to be restated and more completely implemented.
That is, let's bring in deposits.
by including the issue of credit in the form of bank balances
within the legislative prohibition.
So he wanted 100% reserves.
And then here he says that all of this means
a return to the theory of the currency school
which sought to suppress all future expansion
of circulation credit and thus all further creation
of fiduciary media.
Now, the free bankers believe that banks have,
that under a free banking system,
you're not gonna get a suppression
of unbacked notes and deposits.
In fact, they're going to have to flexibly respond
to changes in demand for money, or in today's terms,
to changes in velocity.
He goes on, I mean, he goes on and he says,
the banks would be obliged at all times
to maintain metallic backing for all notes,
except for the sums of those outstanding.
So he didn't wanna go back in time
and cause a deflation and back them all,
but just the future ones, okay?
He also says, by this act alone, cyclical policy would be directed in earnest toward the elimination of crises.
This is all in 1928, okay?
This is the second, the next book on money after Theory of Money and Credit.
Okay, now, how can this be consistent with his favoring of free banking?
How are you going to suppress, without a central bank in place, all further issue of, again I use the older term, fiduciary media?
Well, Mises talked a little bit about this. So in his first attempt at this, which was
in 1928, he pointed out that, well, people will be able to distinguish between different
brands of notes, number one, and the ones that are obviously, the banks are obviously
irresponsible, imprudent, and reckless, their brands of notes will immediately be ejected,
as he puts it, from circulation. But he said there's a second more subtle mechanism, it's
It's basically the price PC flow mechanism that controls the balance of payments.
What he said was that there'll be an inter-bank clearing mechanism.
So if one bank is reckless, or not reckless, but tends to inflate more than other banks,
so to issue more on back notes and deposits, then in fact what's going to happen is that
the clients of other banks are going to get these notes as they sell things to the clients
of the expanding bank, and they're going to have an adverse clearing balance.
That is, the bank that expands too much is going to have to pay these notes off with
gold.
That was his mechanism.
But then later on, when he got to human action,
he makes some statements.
For example, he says, the establishment of free banking
was never seriously considered precisely
because it would have been too efficient
in restricting credit expansion.
That is, central banks tend to expand, not free banks.
And he says, the notion of normal credit expansion
is absurd, meaning, and this is in direct contradiction
to what the free bankers say that there would be
no additional issuance of fiduciary immediately.
There's no such thing as a normal increase
in the money supply.
An increase that just offsets a fall in velocity
or just offsets the tendency for prices to fall.
And then he goes on to say that
if the government's never interfered,
we would have a free banking system
in which there would be severe restriction
on the Emission of Fiduciary Media, okay?
And banks would look to their own solvency
and they would be very cautious.
And he brings back in Human Action,
which he wrote in 1949, the inter-bank clearing mechanism.
But in Human Action, he went a step further
and said there's an even narrower restraint,
which the free bankers completely ignore.
There's a narrower restraint on the issue
of unbanked notes and deposits.
He talks about the money substitute. It's a very definition.
Checks are not money. Especially checks from different banks
that aren't backed up by a central bank. They all are branded. They have different brands.
People trust the brands more or less. Banks know that. They have to build up a
fund of goodwill. So he says that claims for definite sums of money
against a debtor about whose solvency and willingness to pay them does not
prevail the slightest doubt. That's how he defines a money substitute.
The slightest doubt, so these are the essential qualities, there must be undoubted solvency and willingness to pay, by the debtor, meaning the bank, there has to be daily maturity, you have to be able to redeem your check at any moment in time, again, there's no lender of last resort here, so people are very, very suspicious of any delay, even from one day to the next, in paying off their, or allowing them to withdraw their money.
All the parties that the individual exchanges with must be perfectly familiar with the qualities of the claim.
That is to say, if you have a multiplicity of banks competing against one another,
different clients choose different banks for locational reasons, for reasons of size and so on,
and they're not as familiar with other, the checks of other banks, okay?
So what he's pointing out is that your clientele puts narrow limits on how much you can expand your deposits.
So here's what he talks about. He says, what makes a banknote a good money substitute is the kind of special goodwill of the issuing bank.
And again, the slightest doubt concerning that bank's ability or willingness to pay will cause the banknote to be kicked out.
The people will suddenly not accept it.
So even before they start losing a lot of gold reserves, if there's any sort of glitch in paying off depositors, then according to Mises, you have the money substitute suddenly becoming just a piece of paper, no one trusts it, actually there's an intermediate step, some people start not to trust it, and it begins to circulate at a discount,
full dollar, it's only 80 cents, but at which point you have the arbitrageurs
coming in buying them up at 80 cents and then going to the bank and causing it
more of a drain of gold because they have to pay off at face value. IT says
that every bank that issues fiduciary media is in a rather precarious position
because of its asset being its reputation. It must go bankrupt as soon as
doubts arise concerning its perfect trustworthiness and insolvency. And so
So it goes on and on, okay, basically what he keeps saying is that free banks have to
be very cautious and will be forced to be very cautious after a number of failures in
issuing fiduciary media to the point at which they will stop altogether. That is any additional
bank note or checking account that they issue will always be based on an influx of gold.
The currency principle then will have been established not just internationally but interregionally
Interlocally, between banks, money will move according to changes in demand, as the monetary approach to the balance of payments, Arthur Laffer, and so on, used to say in the 1970s and 1980s, and Mundell,
The money supply would be completely demand driven, that is determined by consumers and their demands for cash balances, and not driven, supply driven, that is determined by central banks and issuers.
Putting aside for a moment that there would be a very slow increase in the mining of gold.
And then I want to close with something that I found that I didn't, you know, I read the book a number of times, I didn't realize it was in there.
A note on banknotes, actually a note on the banknote, Mises doesn't even think that money certificates, those are fully backed banknotes, would exist in a free market because they're very costly to put into circulation, okay?
And he says, issuing money certificates, that is, unlike fiduciary media, fully backed notes, is a ruinous business if not connected with issuing fiduciary media.
In other words, if you don't, issue them with these unbacked notes, which you can create out of thin air and generate interest on.
And he points out that really the only banks that issued money certificates were the Bank of Amsterdam. They were connected to government.
One last point here. He has an interesting sort of a joke. He says, governments did not foster the use of bank notes in order to avoid inconvenience to lady shopping.
Their idea was to lower the rate of interest and to open a source of cheap credit to their treasuries.
Bank notes are not indispensable. He's talking about all bank notes now, even fully backed ones.
All the economic achievements of capitalism would have been accomplished if they had never existed.
Besides, deposit currency can do all the things bank notes do.
He talks about deposit currency. He talks about deposit currency in places like Germany and France,
where only big business used checking accounts.
Workers did not use them.
In this case, whenever a business gave a check
to another business, gold was immediately withdrawn.
So there could be no pyramiding.
So there were no bank notes,
and checks would only be used to transfer money.
There could be no pyramiding in the multiple deposit expansion
multiplier process that we talk about.
So when Mises, at the end here,
when he quotes the French economist
who was testifying before the French parliament,
on banknotes, who was also a free banker.
He means this literally, I never knew that before.
He says, this is what Czernuski said.
He said, I believe that what is called freedom of banking
would result in a total suppression
of banknotes in France.
I want to give everybody the right to issue banknotes
so that nobody should take banknotes any longer.
Now I thought he just meant, when I originally read this,
that, and even Murray Rothbard interpreted it this way,
just fiduciary banknotes, banknotes that run back.
but if you read Mises more closely it means
he wants to get rid of all banknotes
and to end, in 1952 when he wrote his epilogue
to The Theory of Money and Credit
on the, when it came to monetary reform
for the United States, which was a sort of
a halfway house back to the gold standard,
Mises said, I think all banknotes below $10,
back then $10 could buy you something in 1952,
should be suppressed.
That is, that only gold coins should circulate
for below $10.
Otherwise, Banknotes, again, wasn't his complete plan,
but I think that all goes together to show
that Mises actually was not only anti-futurary media,
he was anti-banknote.
And if you talk to George Selgin and Larry White,
for them, the banknote is the whole key
to the free banking system.
That's what it stands on.
I'll stop here. Thank you.